Structuring and Enforcing Real Estate Mezzanine Intercreditor and B - - PowerPoint PPT Presentation

Structuring and Enforcing Real Estate Mezzanine Intercreditor and B Note Agreements: Latest Developments

Lessons for Lenders from Past Workouts and Real Estate Bankruptcies on Enforceability and Remedies

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1pm East ern | 12pm Cent ral | 11am Mount ain | 10am Pacific

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THURS DAY, APRIL 24, 2014

Presenting a live 90-minute webinar with interactive Q&A

Mark S . Fawer, Partner, Arent Fox, New Y

• rk

Jerry L. Hall, Counsel, Pillsbury Winthrop Shaw Pittman, Washington, D.C. Robert (Robin) Childress Jones, Jr., Retired Partner, Pillsbury Winthrop Shaw Pittman, Washington, D.C.

Outline of Presentation

• Description and Analysis of the Architecture of Real Estate Mezzanine

Lending 

Background of Mezzanine Financing and Mezzanine B-Note Structures



Interrelationship of the Parties in a Mezzanine or B-Note Structure



Intercreditor Agreement Structure and Key ICA Issues



Sponsor Recourse Liability

• Overview of Bankruptcy Issues and Case Study of Georgian Voluntary

Bankruptcy/365 Sale

• Lessons from CMBS 1.0 for CMBS 2.0
• Advanced Topics



Subordination of Sponsor Recourse Claims and Cure Payments



Release of Sponsor Claims Against Foreclosed Entities



Non-Foreclosure Takeover of Pledged Equity [Colony v Gramercy]



Warehouse financing

Page | 2

What is Mezzanine Financing?

• Financing that is between equity

and the mortgage lender in terms

• f risk, return and security.
• Not a second mortgage loan (i.e.,

not secured by the same assets as mortgage lender)

Equity Mortgage Lender Mezzanine Financing

Page | 3

What is Mezzanine Financing?

• Many forms ranging from loan to

preferred equity.

• Contractual subordination: second

lender agrees to subordinate its payment or security [primary mechanism for corporate sub debt].

• Structural subordination: second

lender subordinate via borrower structure [typical real estate/CMBS structure].

Equity Mortgage Lender Mezzanine Financing

Page | 4

Traditional Real Estate Second Mortgage Financing

• 1st Mortgage Lender is secured by lien on borrower’s assets.
• 1st Mortgage Lender’s loan-to-value restriction limits size of 1st mortgage

loan.

• 2nd Mortgage Lender could interfere with 1st Mortgage foreclosure, so 1st

Mortgage Lender prohibits 2nd Mortgage.

Equity

Property Owner, LLC

$ Loan Mortgage

Mortgage Lender

Page | 5

Typical Real Estate Mezz Loan

• Mezz and Mortgage Lender have parallel loan documents.
• Key Difference: separate borrower and separate collateral.

$ Loan Mortgage Mortgage Lender Mezz Lender $ Loan

Pledge of LLC Interests

Mezz Borrower, LLC Property Owner, LLC

Equity

Page | 6

Bankruptcy Remoteness

• Each of the property owner and its parent are “special purpose

entities” designed (and contractually required) to be “bankruptcy remote.”

• The property owner is thus insulated against bankruptcy of its

parent/mezz borrower.

• Each entity in the chain has as its only business the ownership of the

property (in the case of the mortgage borrower) or of the equity in the property owner (in the case of the mezz borrower).

• These SPEs are not authorized to incur other debt, have other

activities, etc.

Page | 7

Mezz Lender is Structurally Subordinate

• Mezz Lender is not a creditor of the property owner.
• Mezz Lender has no lien against the underlying property.
• If the property owner files for bankruptcy, the Mezz Lender has no

“seat at the table.”

• If Mezz Lender forecloses, it owns the property owner, subject to the

Mortgage and any other obligations of the property owner .

Page | 8

If the Mortgage Lender forecloses…

Property Owner, LLC Mortgage Lender Mezz Lender $ Loan

Real Estate

x

The “structure” of the borrower chain subordinates the Mezz Lender to the Mortgage Lender – i.e, “structural subordination.”

Pledge of LLC Interests

Equity

Mezz Borrower, LLC

Page | 9

If the Mezz Lender forecloses…

Mtge Loan Mortgage Mortgage Lender Mezz Lender

Real Estate

x

Equity

Mezz Borrower, LLC Property Owner, LLC

Page | 10

Sample Spreads

Lender Loan Rate

• Mortgage
• LIBOR + 100 bps
• 1st Mezz
• LIBOR + 250 bps
• 2nd Mezz
• LIBOR + 620 bps
• 3rd Mezz
• LIBOR + 925 bps

Lenders add a risk prem ium

Page | 11

Key Loan Documents

Mortgage Loan Mezz Loan

• Senior Loan Agreement
• Mezz Loan Agreement
• Senior Promissory Note
• Mezz Promissory Note
• Mortgage, ALR & Security Agreement
• Pledge Agreement
• Assignment of Management Agreement
• Subordination of Management Fee
• Senior Recourse Guaranty
• Mezz Recourse Guaranty

Page | 12

Other Key Documents – Interest Rate Cap and Title Insurance

Document Purpose

• Interest Rate Cap Agreement
• Protects a borrower with a variable rate

loan against the rate exceeding the cap

• Assignment of Interest Rate Cap

Agreement

• Assigns payments to the lender
• Title Insurance
• Conventional property title insurance for

mortgage loan

• ”Eagle 9” UCC insurance for mezz loan

Page | 13

Other Key Documents – Lockbox

Document Purpose

• Clearing Account Agreement
• Receives directly all property cash

(principally rents) and sends to Deposit Bank

• Cash Management Agreement
• Receives cash from Clearing Account

and disburses per cash “waterfall” agreement of lenders and borrowers

Page | 14

Participation Agreements and B-Notes/Co-Lender Agreements

• What is a “B-Note”? Either a junior participation in a mortgage loan

secured by the property or a junior note from the property owner, secured by the same mortgage which secures the more senior notes.

• The term “B-Note” is also used to refer generally to multiple junior

notes – there may be a C-Note, D-Note, etc. – each junior to the prior.

• Relationship between holders of A-Note and B-Note: governed by

a Participation Agreement or Co-Lender Agreement.

• Administration of Whole Loan: typically by a servicer acting

pursuant to a servicing agreement or pooling agreement

• Control of Servicer/Whole Loan: junior-most B-Note with 25% of

loan value (after actual/appraisal value losses) has right to approve major servicer actions

Page | 15

Major Distinctions Between Senior/Mezz Relationship and A-Note/B-Note Relationship

MEZZ B-NOTE

• Mezz Lender has direct access to its Mezz

Borrower under its own mezz loan documents; within ICA limitations, does not need consent or approval of anyone else to take action.

• B-Note holder must act through a

servicer administering the whole mortgage loan; if not “controlling holder”, may have no approval of servicer actions.

• Upon default, Mezz Lender may take over

equity with credit bid at UCC auction, but takes title to equity subject any indebtedness/liens of property owner.

• Servicer can foreclose mortgage if all

noteholders then have undivided interest in REO (now-owned real estate).

• Mezz Lender may be “primed” by

intervening liens/senior borrower debt.

• B-Note holder has benefit and priority
• f mortgage securing the whole loan

in which B-Note participates.

• Mezz Lender has refinancing risk when

mortgage loan matures – can be wiped out if mortgage cannot be refinanced.

• As part of whole loan in which B-Note

participates, B-Note holder must be refinanced at mortgage loan maturity.

Page | 16

Major Terms of B-Note/Co-Lender Agreement

• Controlling B-Note holder may replace special servicer (with or

without cause) and has major decision consent rights until a “Control Appraisal Event.”

• “Control Appraisal Event”



Generally occurs following a bankruptcy of property owner, 60 days after mortgage default, commencement of a mortgage foreclosure or other major credit event.



Appraisal then ordered by servicer.



Appraisal calculation starts with 90% of appraised value, subtracts unpaid taxes, servicer advances, etc., and adds back reserves, etc.



Net appraised value then measured against outstanding loan stack with any shortfall allocated successively to most junior B-Notes.



Reduction in value of B-Note to less than 25% of face results in a shift in control to next more senior holder (if there is no more senior B-Note, then to A-Note holder).



In some deals, B-Note holder has right to avoid losing control by pledging cash collateral in an amount necessary to compensate for drop in value.

Page | 17

Intercreditor Agreement

• Addresses rights between the senior and mezzanine lenders in event
• f loan default, foreclosure, borrower bankruptcy, etc.
• Protects senior lender by imposing conditions on Mezz Lender’s rights

to foreclosure on its equity collateral, limitations on Mezz Lender’s rights to modify mezz loan documents and priority to payment rights from senior collateral and with respect to property owner (senior borrower) in a property owner bankruptcy.

• Protects Mezz Lender by acknowledging Mezz Lender’s separate

collateral rights, limiting Senior Lender’s rights to modify senior loan documents, requiring Senior Lender to accept Mezz Lender as owner

• f property owner on mezz UCC foreclosure, and providing Mezz

Lender rights to protect itself against mortgage loan defaults or foreclosure by curing the default or purchasing the senior loan at par.

Page | 18

Important ICA Issues

• Who may be a successor Mezz Lender (transfer rights)
• Separate collateral
• Payment subordinaton
• Cure rights
• Senior loan purchase rights and triggers
• Loan modification limitations
• Duties/obligations on a Mezz foreclosure



Qualified Transferee



Default cures



Replacement guarantos

• When do ICA Restrictions End?

Page | 19

ICA Issues (cont’d)

• Will have to deal with the Stuyvesant case in connection with any

mezz foreclosure (may be forced to pay off the more senior debt to “cure” the senior defaults as a pre-condition to mezz foreclosure).

• If junior mezz tries to foreclose a junior mezz loan, senior (mezz and

mortgagor) can use Stuyvesant against foreclosing junior to force senior (mezz and mortgagor) pay-off in full.

• Maturity Date Default: no cure rights available, only purchase option.
• After maturity, there is no ordered hierarchy to allow the most-junior to

foreclose first as cure right standstill does not exist at maturity – free- for-all race to foreclosure.

Page | 20

ICA Issues (cont’d)

• Conversion of mezz from Lender to Equity Holder and Termination of

ICA Obligations

 A typical ICA provides that it is binding on a mezz lender only in its

capacity as a lender and terminates as to such lender “upon transfer of title to the Junior Lenders of their respective Separate Collateral . . . ; provided, however, that any rights or remedies of any party hereto arising out of any breach of any provision hereof

• ccurring prior to the date of termination shall survive such

termination.” Accordingly, post-foreclosure breaches should not be actionable under the ICA.

Page | 21

Sponsor Recourse Guaranty

• Given by ultimate party controlling the equity (preferably a “warm

body”).

• Typically has two “wings”:



“losses” indemnity for “bad boy” acts such as fraud, appropriating rents or insurance proceeds, intentional misrepresentation, waste, etc.



full recourse (entire loan) for intentional acts that inhibit recourse to the collateral – voluntary bankruptcy, collusive involuntary bankruptcy, non- permitted transfers, non-permitted liens, etc.

• Separate guaranties provided to Senior Lender and each Mezz

Lender and thus subordination issues for claims against common recourse guarantor.

Page | 22

Sponsor Recourse Guaranty (cont’d)

• Caps and limits on recourse amounts sometimes negotiated by strong

sponsors.

• Net worth and liquidity covenants advisable.
• Where ICA requires that a replacement guarantor must be

“reasonably satisfactory” to senior lender, net worth and liquidity covenants provide an objective standard.

• With individual guarantors, can have issues with respect to death

(heirs will try to minimize contingent liability and unlikelihood of triggering to fix reserved liability at low amount to allow distribution of estate) and that a developer’s net worth may be primarily equity in

• ther projects (behind financing of other projects and other recourse

guaranties).

Page | 23

MSA Form Loophole

• In the event that such Transfer results in the removal of any

guarantor, indemnitor, pledgor, or other obligor under the Senior Loan Documents (each, a “Third Party Obligor”), such transferee or an Affiliate thereof reasonably satisfactory to the Senior Lender shall: (A) execute and deliver to Senior Lender a guaranty, indemnity, pledge agreement or other agreement which provides for the

• bligations of such obligor (each, a “Third Party Agreement”), in each

case, in a form substantially similar to the Third Party Agreement that it is replacing, pursuant to which the Third Party Obligor shall undertake the obligations set forth therein.

Page | 24

Two Major Cases Exploiting Replacement Guarantor Loopholes

• Stuyvesant [Bank of Am., N.A. v. PSW NYC LLC, 29 Misc. 3rd

1216(A), 918 N.Y.S.2d 396 (Table), 2010 WL 4243437 (Sup. Ct. N.Y.

• Cnty. 2010)] – must Mezz cure (or commit to cure) to foreclose its

equity pledge?

• Jameson [In re JER/Jameson Mezz Borrower II, LLC, 461 B.R. 293

(2011)] – can a Mezz lender take non-judicial control of a borrower and file for bankruptcy (primarily to use the automatic stay to avoid foreclosure) without triggering the ICA requirement to provide a replacement guarantor?

Page | 25

Distinguishing Stuyvesant Case to Avoid Enjoining of Foreclosure

• In the 9/10/10 Stuyvesant case, a NY trial judge issued a preliminary

injunction blocking a UCC foreclosure sale of Manhattan’s Stuyvesant Town- Peter Cooper Village property. The judge held that the intercreditor agreement (which he considered “unambiguous”) obligated the mezz lender to cure all senior defaults as a precondition to its UCC foreclosure. Since the senior loan was accelerated, such cure would amount to a mandatory pay-off

• f the senior loan.
• This decision stood the normal understanding of the subject provision on its

head – it was intended to provide a shield for allow the foreclosing mezz to keep the senior in place, not a sword to force the mezz to pay off the senior loan as a condition to exercise its remedies against its separate collateral; moreover, the cure obligation was a post-foreclosure obligation (“within ten (10) days after the transfer”), not a pre-requisite. The mezz appealed the decision but was then bought out by the senior loan for what they paid for the mezz, so the appeal was voluntarily discontinued and the decision stands.

Page | 26

Distinguishing Stuyvesant (cont’d)

• Stuyvesant involved a pre-maturity payment default, where the mezz declined

to cure within its ICA cure periods. At maturity, there are no cure rights, only a right to purchase the senior debt at par. While Stuyvesant did not deal with a situation where cure rights were inapplicable (i.e., at maturity), the status of acceleration (loan fully due) is analogous to the debt being fully due at maturity.

• While the mezz community thinks Stuyvesant was wrongly decided on an
• verly literal reading of Section 6(b) of the ICA, it is relatively well-written and

carefully documented and reasoned, and could be persuasive to other state court judges in New York or to a federal district judge applying NY law [but see U.S. Bank Nat’l Ass’n v. LH Hospitality LLC]. Thus a strategy aimed at getting some other judge to reach a conclusion that is at odds with Stuyvesant involves risk and if the mezz wants to acquire its collateral, then the collateral acquisition would better occur prior to the senior indebtedness being accelerated or coming due at maturity (unless the mezz is prepared to refinance the senior debt).

Page | 27

Distinguishing Stuyvesant (cont’d)

• 6(d) To the extent that any Qualified Transferee acquires the Equity Collateral pledged to a Junior

Lender pursuant to the Junior Loan Documents in accordance with the provisions and conditions of this Agreement (including, but not limited to Section 12 hereof), such Qualified Transferee shall acquire the same subject to (i) the Senior Loan and the terms, conditions and provisions of the Senior Loan Documents and (ii) the applicable Senior Junior Loans and the terms, conditions and provisions of the applicable Senior Junior Loan Documents, in each case for the balance of the term thereof, which shall not be accelerated by Senior Lender or the related Senior Junior Lender solely due to such acquisition and shall remain in full force and effect; provided, however, that [as a condition thereto,] (A) such Qualified Transferee shall cause, within ten (10) days after the transfer, (1) Borrower and (2) the applicable Senior Junior Borrowers, in each case to reaffirm in writing, subject to such exculpatory provisions as shall be set forth in the Senior Loan Documents and the related Senior Junior Loan Documents, as applicable, all of the terms, conditions and provisions of the Senior Loan Documents and the related Senior Junior Loan Documents, as applicable, on Borrower's or the applicable Senior Junior Borrower's, as applicable, part to be performed and (B) all defaults under (1) the Senior Loan and (2) the applicable Senior Junior Loans, in each case which remain uncured or unwaived as of the date of such acquisition have been cured by such Qualified Transferee or in the case of defaults that can only be cured by the Junior Lender, following its acquisition of the Equity Collateral, the same shall be cured by the Junior Lender prior to the expiration of the applicable Extended Non- Monetary Cure Period.

Stuyvesant Cure Provisions

Page | 28

Independent Directors

• In an effort to make the borrower entities “bankruptcy remote”, the LLC
• perating agreements of each borrower entity in the stack have one or two

independent directors, who are usually employees of a company which supplies professional independent directors.

• The LLC Agreements provide that the vote of the member and the

independent directors is required for any bankruptcy filing, but a typical provision provides that “upon the exercise of its rights under the Mezzanine Pledge Agreement, to the fullest extent permitted by law, the Mezz Lender (or its designee) shall have, among its other powers, the right to appoint and remove Independent Managers.”

• As the IMs are obligated to act in the best interests of the LLC (rather than the

lender), we have convinced IMs to approve a bankruptcy in other transactions, so having IMs is not an impenetrable barrier to a bankruptcy.

• In General Growth certain independent directors were replaced, and such

replacements were not judicially set aside.

Page | 29

Bankruptcy

• Procedure for Filing Chapter 11



solvency is not a prerequisite (solvent debtors are bankruptcy eligible)



voluntary petition requires corporate authority, including independent director(s) (lender may replace IDs when enforcing remedies) – IDs often support filings



involuntary petition requires at least three unsecured/undersecured creditors – shouldn’t exist for an SPE mezz borrower

• Venue



petition can be filed where the debtor is organized



petition can be filed where substantial assets are located



• ther venues are possible based upon the location of the pledged equity interests
• Bankruptcy Objective – Confirm a Consensual Restructuring Plan that

Eliminates Underwater Debt and the Equity

Page | 30

Bankruptcy (cont’d)

• Benefits of Chapter 11 – Generally



automatic stay (injunction) stops all foreclosures



time to negotiate – 120 day exclusivity for debtor to file a plan (usally able to be extended) – debtor controls process



capital structure can be modified pursuant to a reorganization plan



assets can be sold pursuant to “363 sales” free and clear of liens and claims



transfer taxes can be avoided for transactions consummated under a plan

• Challenges of Chapter 11 – Generally



debt will likely have to be serviced during the proceeding (distributions issue – permitted in General Growth)



lender may seek relief from the automatic stay or dismissal (which should be denied in the early stages of the case if debt is being serviced and a plan is filed relatively promptly)



“cramdown” (confirming a plan over the objection of the lender) is virtually impossible because mezz borrowers should not have any non-lender debt – lender controls plan vote and can veto

Page | 31

• Management of Recourse Guaranty Liability – Another Challenge



bankruptcy filing triggers guaranty liability



consensually manage by obtaining lender forbearance and support for restructuring



non-consensually manage by limited funding of affiliate guarantor of qualified transferee and possible bankruptcy of the recourse guarantor entity

• Role of Valuation



important to establishing lender’s adequate protection to justify distributions



important to a lender’s lift-stay motion based upon lack of collateral equity



important to establish the value of lender’s secured claim under the plan and whether the lender is over-secured or under-secured, and ultimately, who controls the bankruptcy



real estate and equity valuations will be required (two experts)



both lender and debtor are entitled to present expert valuation evidence where value is disputed

Bankruptcy (cont’d)

Page | 32

• Contents of Plan



an over-secured lender is entitled to be paid in full with interest



unsecured trade creditors (which should exist only at the property level) will be paid in full, but only because that debtor is solvent



“cramdown” will be virtually impossible (especially at mezz level) – any re-setting of loan terms must be consensual because the lender is impaired



the alternative is to “unimpair” lenders and pay them in full before they exercise rights against their collateral



the mezzanine lender who is partially secured and partially unsecured becomes the new owner of property owner – all or a portion of the mezzanine lender’s under- secured claim is converted to equity in the reorganized property owner



the mezzanine lenders who are entirely unsecured should receive nothing



assets can be sold pursuant to free and clear 363 sales (relevant probably at only the property owner level)

Bankruptcy (cont’d)

Page | 33

• Structure: senior loan with A and B Notes and single mezzanine loan.
• B note was partially underwater and mezz loan fully underwater; all

loans in payment default and special servicer and receiver in place.

• Mortgage loan was through IDOT structure (MD structure where

property owner is guarantor and property leased to affiliated borrower; recording tax due only upon enforcement of guaranty).

• Sponsor had recourse liability for IDOT as well as customary sponsor

non-recourse guaranty.

• Goal of client was to take control of property and restore to profitability.
• Client purchased B note (to be controlling holder of mortgage loan) at

significant discount and mezz loan (to block equity rescue) for nominal amount.

The Georgian Case

Page | 34

• Bankruptcy strategy was to take a double-barrelled approach:
• voluntary bankruptcy with 363 auction and senior loan credit bid controlled

by client as B Note controlling holder, and

• backstopped (if 363 third-party bids did not exceed credit bid) by

reorganization plan where mortgage loan maturity extended, B note partially converted into an extended cashflow-only note, balance of B note converted into equity of property owner and mezz loan wiped out.

• 363 auction was acceptable to special servicer as transparent, court-

supervised valuation process.

• Sponsor persuaded to cooperate by release of IDOT and recourse

liability on bankruptcy plan approval and payment for cooperation pursuant to two-tier forbearance and plan cooperation agreements.

• Lenders controlled Plan documents and filings; sponsor and

borrowers obligated to go along so long as no new or additional sponsor-recourse liability.

The Georgian Case (cont’d)

Page | 35

Lessons from CMBS 1.0 for CMBS 2.0

• Obstacles to Foreclosure of “Separate Collateral”
• Provision of a Replacement Guaranty
• “Continuing Agreement” Clauses
• Recourse Liability for SPE Covenants
• Senior Loan Modifications
• Protective Advances and Cure Payments
• Senior Loan Purchase Option

Page | 36

Clearing Obstacles to Foreclosure

• f “Separate Collateral”
• Following the Stuyvesant1 case, mezz lenders should beware any

requirement to cure senior loan defaults as a condition to foreclosing on equity.

• “Qualified Transferee” definition: a trap for the unwary.
• an overly restrictive definition could chill 3rd parties from bidding at UCC

auction or the assignment of a winning “credit bid” to 3rd party.

1 see also U.S. Bank Nat’l Ass’n v. RFC CDO 2006-1, Ltd., CV 11-664, 2011 U.S. Dist.

LEXIS 156734 (D. Ariz. Dec. 6, 2011) (relevant provision more clearly intends compliance with requirements to be conditions precedent to mezzanine lender foreclosure). But see Stipulation attached to So-Ordered Transcript of October 16, 2012 Proceedings, Docket No. 33, U.S. Bank Nat’l Ass’n v. LH Hospitality LLC, Index No. 653351/2012 (Sup. Ct. N.Y. Cnty. Oct. 17, 2012) (analysis of a provision in an intercreditor agreement substantially similar to that contained in the Stuyvesant case results in a decision contrary to the Stuyvesant holding).

Page | 37

Replacement Guaranty

• previously, only replace to the extent existing guaranty released
• a mezz lender should be expected to have this apply only to acts
• ccurring after UCC foreclosure sale that are within its control
• Replacement Guarantor:
• Who is eligible?

 Any Qualified Transferee?  Financial Test?

• does existing guarantor have an equitable defense to recourse claims by

senior lender after transfer of equity if existing recourse guaranty is not released?

Page | 38

“Continuing Agreement” Clauses

• Does the Intercreditor Agreement (together with its protections for the

Mezz Lender) survive:

• a Senior Loan foreclosure sale (or deed-in-lieu thereof) and the ensuing transfer of

title to the underlying property? No.

• a Mezzanine Loan foreclosure sale and the ensuing transfer of the pledged equity?

No.

• the payment in full of the Senior Loan and/or the Mezzanine Loan? No.
• Ramifications: Mezz Lender should exercise any special rights under

the Intercreditor Agreement (e.g., extended cure rights; foreclosure of “separate collateral”; or exercise offer option to purchase Senior Loan at par) prior to any event which terminates the Intercreditor Agreement.

Page | 39

Recourse Liability for SPE Covenants

• SPE covenants should be carefully reviewed and thought through, particularly

where breach can cause the entire loan to become recourse even if lender is not damaged by the specific breach or the breach is cured. See:



full recourse liability for breach of covenant to remain solvent: Wells Fargo Bank, N.A. v. Mitchell's Park, LLC, 2012 WL 4899888 (United States District Court, N.D. Georgia 2012); Wells Fargo Bank, N.A. v. Cherryland Mill Ltd. P’ship, 812 N.W.2d 799 (Mich. Ct. App. 2011), remanded, 820 N.W.2d 901 (Mich. 2012); and 51382 Gratiot Avenue Holdings, LLC v.Chesterfield Development Co., 835 F.Supp.2d 384, 393–94 (E.D.Mich. 2011), but also see the Nonrecourse Mortgage Loan Act, Mich.

• Comp. Laws § 445.1591 – 445.1595 (2012), which retroactively prohibits the

imposition

• f full recourse

liability for borrower’s insolvency under a carve-out guaranty.



full recourse liability for breach of covenant against subordinate debt financing even though default had been cured: CSFB 2001–CP–4 Princeton Park Corporate Center, LLC v. SB Rental I, LLC, 410 N.J.Super. 114, 980 A.2d 1 (N.J.Super.Ct.App.Div.2009)



full recourse for amendment of articles of incorporation: LaSalle Bank N.A. v.Mobile Hotel Properties, LLC, 367 F.Supp.2d 1022 (E.D.La.2004)

Page | 40

Senior Loan Modifications

• Many older intercreditor agreements permitted senior lenders to

modify material terms of senior loan documents (other than an increase in loan amount) during a “workout” of the senior loan.

• Newer intercreditor agreements sometime either eliminate that

exception or expand the list of material terms that may not be modified even during a “workout.”

Page | 41

Protective Advances and Cure Payments

• Mezz lenders generally seek the right to add “protective advances” to

principal amount of mezz loan permitted by intercreditor agreement.

• Mezz lenders generally seek to classify cure payments made by

sponsor with non-property funds as “separate collateral” that do not have to be turned over to the senior lender.

• Sponsor may well have an incentive to cure mezz loan to stay in the

game even if senior is also in default – mezz UCC foreclosure may usually be accomplished much more quickly than senior mortgage foreclosure

Page | 42

Senior Loan Purchase Option

• Mezz Lenders seek to keep at par, without default interest,

prepayment premiums, etc.

• When may this option be exercised?



Earlier of Senior Borrower’s bankruptcy;



Acceleration of Senior Loan;



Commencement of an enforcement action; or



Senior Loan becoming a Specially Serviced Loan.

• Mezz Lenders also must have this option available prior to Senior

Lender accepting a deed in lieu of foreclosure – time period may be much tighter

• In very large deals, mezz purchase right may be useless as a

practical matter if other refinancing is not available

Page | 43

Exercise of Extension Options

• Include right of Mezzanine Lender to exercise extension option if

Senior Borrower has failed to do so

Page | 44

Cash Management

• Outside of Intercreditor Agreement, provide for payment of Mezzanine

Lender’s debt service after payment of approved Operating Expenses and approved Extraordinary Expenses, but prior to residue flowing to Senior Borrower

Page | 45

Advanced Topics

• Release of Sponsor Claims Against Foreclosed Entities
• Non-Foreclosure Takeover of Pledged Equity

[Colony v Gramercy in Jameson]

• Subordination of Mezz Recourse Claims Against Sponsor
• Warehouse Financing of Mezz Loans

Page | 46

Subordination of Sponsor Recourse Claims and Cure Payments

• “Separate collateral” vs traditional senior payment subordination
• Sponsor cure payments and recourse guaranty claims do not derive

from the property, however sponsor guarantor is common obligor for both senior and mezz

• Differentiate voluntary payments (cures) vs recourse claims?
• Where recourse is for improper transfer or voluntary bankruptcy, mezz

may have no other recourse if property removed from ownership chain

• Some ICAs allow mezz enforcement but require turnover to senior

and/or cessation of mezz claim if senior is also claiming

Page | 47

Taking Non-Foreclosure Control of Pledged Equity [Jameson]

• Typical pledge agreements provide for pre-foreclosure lender rights

such as giving pledger only a non default-proxy to vote equity or transfer of voting rights to lender on mere occurrence of a default:

“If an Event of Default shall occur and be continuing, Lender may exercise, in addition to all other rights and remedies granted in this Agreement: (a) all rights and remedies of a secured party under the UCC and such additional rights and remedies to which a secured party is entitled under the laws in effect in any jurisdiction where any rights and remedies hereunder may be asserted, including, without limitation, the right, to the maximum extent permitted by law, to exercise all voting, consensual and other powers of ownership pertaining to the Collateral as if Lender were the sole and absolute owner thereof” “Subject to the terms of the Loan Documents, and unless an Event of Default shall have occurred and be continuing, Pledgor shall be permitted to receive all LLC membership interest distributions actually paid in the normal course of business of the Pledged Interest Entities, and to exercise all voting and regular LLC membership interests with respect to the Pledged Securities”

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Taking Non-Foreclosure Control of Pledged Equity [Jameson] (cont’d)

• From the borrower’s point of view, these provisions accomplish a

“back-door” foreclosure giving lender control of the ownership chain to the property without the notices and safeguards of the foreclosure process.

• From senior lender’s point of view, these provisions enable the mezz

lender to take control of the ownership chain to the property without complying with the ICA foreclosure requirements, including providing a replacement recourse guarantor.

• In Jameson, junior mezz lender Gramercy used this mechanism to

take control of the senior mezz borrower, replace the LLC manager with its nominee and file a bankruptcy to try to stop Colony’s senior mezz foreclosure.

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Release of Sponsor Claims vs Foreclosed Entities

• Once Mezz Lender forecloses or takes a deed-in-lieu, Mezz Lender

becomes the holder of the property owner equity.

• However, as equity, foreclosing Mezz Lender is behind all property
• wner creditors, including any claims of prior-owner affiliates.
• Prior-owner affiliate claims could include subrogation for recourse

guaranty claims, management fees, environmental indemnity payments, construction completion guaranties, etc.

• Deed-in-lieu resolutions typically include recourse guaranty releases

for cooperating sponsor – condition of release of sponsor affiliate claims [worth anticipating going in as well].

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Warehouse Financing of Mezz Loans

• Structure and documentation
• Repo characterization vs secured loan
• Practical and liquidity issues – mark to market requirements and

purchaser discretion

• Loan pledgee status under the Intercreditor Agreement

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Thank You

Mark S. Fawer Arent Fox mark.fawer@arentfox.com Jerry L. Hall Pillsbury Winthrop Shaw Pittman jerry.hall@pillsburylaw.com Robert (Robin) Childress Jones, Jr. Pillsbury Winthrop Shaw Pittman robin.jones@pillsburylaw.com

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