Title Insurance Risks in Distressed Real Estate Transactions - - PowerPoint PPT Presentation

presents

Title Insurance Risks in Distressed Real Estate Transactions

presents

Evaluating and Dealing With Liens and Other Encumbrances During Title Due Diligence

A Live 90-Minute Teleconference/Webinar with Interactive Q&A

Today's panel features: David Weissmann, Partner, Weissmann Zucker Euster, Atlanta Patricia “Trish” Brown, Assistant Vice President, Regional Underwriting Counsel, First American Title Insurance Company Kansas City Mo

A Live 90-Minute Teleconference/Webinar with Interactive Q&A

First American Title Insurance Company, Kansas City, Mo. Ren R. Hayhurst, Partner, Bryan Cave, Irvine, Calif.

Wednesday, June 16, 2010 The conference begins at: The conference begins at: 1 pm Eastern 12 pm Central 11 am Mountain 10 am Pacific 10 am Pacific

You can access the audio portion of the conference on the telephone or by using your computer's speakers. Please refer to the dial in/ log in instructions emailed to registrations.

For CLE purposes, please let us know how many people are listening at your location by y

• closing the notification box
• and typing in the chat box your
• and typing in the chat box your

company name and the number of attendees attendees.

• Then click the blue icon beside the box

to send to send.

For live event only. For live event only.

• If the sound quality is not satisfactory
• If the sound quality is not satisfactory

and you are listening via your computer speakers please dial 1-866-869-6667 speakers, please dial 1 866 869 6667 and enter your PIN when prompted. Otherwise, please send us a chat or e- , p mail sound@straffordpub.com immediately so we can address the problem.

• If you dialed in and have any difficulties

during the call, press *0 for assistance.

CREDI TORS RI GHTS AND MORTGAGE MODI FI CATI ONS: TI TLE I NSURANCE I NDUSTRY MODI FI CATI ONS: TI TLE I NSURANCE I NDUSTRY RESPONSE TO AN ECONOMI C COLLAPSE

4

Bankruptcy Avoidance Pow ers Risk Bankruptcy Avoidance Pow ers Risk Loss of Title Loss of Title

• Primarily concerned:

– fraudulent conveyances under Section 548

y

– preferences under Section 547

• Equitable subordination is also a risk

Equitable subordination is also a risk

5

Fraudulent Conveyances Fraudulent Conveyances

• A

transfer made within two years before A transfer made within two years before bankruptcy if (i) the transfer was made “with actu al intent to hinder, delay,

• r

defraud” a th i ti b t dit (ii) th then existing or subsequent creditor, or (ii) the debtor was insolvent

• r

had insufficient capital at the time

• f

the transfer, and p , received less than the reasonable equivalent value

• f the transferred property

6

Section 5 4 8 ( c) : transferee “for Section 5 4 8 ( c) : transferee “for value” and “in good faith value” and “in good faith”:

”:

• Retains lien up to value notwithstanding

fraudulent conveyance concerns G d f i h h i ffi i

• Good faith means having sufficient

knowledge to place transferee on inquiry notice of the debtor’s possible insolvency or notice of the debtor s possible insolvency, or abstaining from unconscionable behavior to the detriment of other creditors

7

Fraudulent transfer risks to the len Fraudulent transfer risks to the len der: der:

• Foreclosures
• Deeds in lieu of foreclosure especially if

Deeds in lieu of foreclosure especially if value of property is more than lender would receive in Chapter 7 liquidation would receive in Chapter 7 liquidation

• Mortgages granted as additional security

8

Preferences: Preferences:

• Transfers of interest in property, to or for the

benefit of a creditor, for or on account of a pre-existing debt made when the debtor was pre existing debt, made when the debtor was insolvent, and made within 90 days of the filing of the petition generally, or within 1 year of the filing f th titi b i id h b th dit

• f the petition by insiders, whereby the creditor
• btains property valued in excess of what would

have been received in a Chapter 7 bankruptcy p p y

9

Preferences: Preferences:

• Uncertainty whether a foreclosure made

within the statutory period could constitute a preference especially if the secured claim is preference, especially if the secured claim is substantially less than the value of the foreclosed property, because the creditor foreclosed property, because the creditor receives dramatically more than it would receive in a Chapter 7 liquidation

10

Preferences: Preferences:

• Issue on time of recordation. Does

preference period relate back to date of deed, or date of recording?

• Statute now grants 30 days grace period

Statute now grants 30 days grace period to record to retain relation back to date

• f deed and transaction
• f deed and transaction

11

Exclusions to title coverage Exclusions to title coverage g provide protection to insurers provide protection to insurers

• No coverage for damages which “would
• No coverage for damages which would

not have been sustained if the [insured] had paid value for” mortgage/property had paid value for mortgage/property (covers a failure of consideration) (Exclusion 3(e) ALTA 2006) (Exclusion 3(e) ALTA 2006)

12

Exclusions to title coverage Exclusions to title coverage g provide protection to insurers provide protection to insurers

• Exclusion for matters “attaching or

created subsequent to the Date of the Policy” (Exclusion 3(d) ALTA 2006 – the “post-policy exclusion”)

– Bankruptcy is always a matter created

subsequent to the date of the policy

13

Specific Specific bankruptcy bankruptcy creditors’ creditors’ p p y p y rights rights exclusions exclusions: :

f

• 1990 ALTA Policy: excludes liability for

claims arising under the operation of federal bankruptcy, state insolvency, or federal bankruptcy, state insolvency, or similar creditor’s rights laws

– Deletion was often done by endorsement at

little or no charge with little review little or no charge with little review

– In later years, there was more attention to

detailed financial information

14

ALTA ALTA offered

• ffered specific

specific creditor’s creditor’s rights rights c c i 2 0 0 6 2 0 0 6 i i i i th th

• verage
• verage

in in 2 0 0 6 2 0 0 6 , insuring insuring the the “invalidity, “invalidity, unenforceability, unenforceability, lack lack

• f
• f

priority priority

• r
• r

avoidance avoidance

• f”
• f”

the the insured insured priority priority

• r
• r

avoidance avoidance

• f
• f

the the insured insured lien lien: :

• Resulting

from fraudulent transfer Resulting from fraudulent transfer

• ccurring prior to the transaction creating

the lien; or ;

• Resulting from failure to timely record lien

(preference issue) (p )

15

Creditors’ rights exclusion also Creditors’ rights exclusion also m odified excluding coverage if transaction m odified excluding coverage if transaction m odified, excluding coverage if transaction m odified, excluding coverage if transaction creating lien: creating lien:

• is a fraudulent conveyance or transfer
• is a preferential transfer (other than if due

to a failure to timely record)

• Even if not specifically excluded, other

exclusions arguably still apply

16

ALTA Endorsem ent 2 1 ALTA Endorsem ent 2 1 -

• 0 6 ( Creditors’ Rights)

0 6 ( Creditors’ Rights) insures against loss: insures against loss: insures against loss: insures against loss:

• Sustained by reason of avoidance due to

b f h ff i an occurrence on or before the effective date of the policy of a fraudulent transfer f

• r preference

– unless fraudulent nature was “known” to the

i d i d i h i “ d” insured or insured is not a purchase in “good” faith

17

ALTA Endorsem ent 2 1 ALTA Endorsem ent 2 1 -

• 0 6 is decertified

0 6 is decertified i F b 2 0 1 0 i F b 2 0 1 0 in February 2 0 1 0 in February 2 0 1 0

• Business risk shifts back to business

l players

• Title companies reviewed upcoming

defaults and determined risk was too great

18

Mortgage m odifications on the rise Mortgage m odifications on the rise

• Extensions of maturity

I i i t t t

• Increase in interest rate
• Payment modifications
• Additional collateral
• Cross default/cross collateralize

Cross default/cross collateralize

• Partial releases

19

Modifications can prim e junior liens Modifications can prim e junior liens

• Is modification materials or substantially

prejudicial so as to jeopardize the junior prejudicial so as to jeopardize the junior lien holder

– Increase in interest or payment put stress on

p y p the property

– Changes in maturity date may not be

prejudicial but case law is mixed prejudicial but case law is mixed

– Cross collateralization/cross default increase

risk to junior lien holder

20

Original m ortgage language or Original m ortgage language or i di i di intercreditor agreem ent can protect intercreditor agreem ent can protect

• Future advance clauses provide some

protection, depending on local law g

• Language that note secured includes

amendments and renewals helps amendments and renewals helps

• Cut-off letter from junior lender may be

required nonetheless required nonetheless

21

I ntercreditor and subordination I ntercreditor and subordination agreem ents agreem ents

• Generally contain broad provisions which

prohibit modifications

– Can be limited to “major” modifications such

as interest, payment terms, principal amount

22

Restatem ent of Property Restatem ent of Property ( Mortgages) : ( Mortgages) :

• 7.3(b) – Senior mortgage if modified is

effective against junior lien holder unless g j modification is materially prejudicial and is not within the scope of reservation of right to modify

23

Restatem ent of Property Restatem ent of Property ( Mortgages) : ( Mortgages) :

• Assumption that extensions are also for

the benefit of junior lien holders j

• Assumption that courts will view increase

in interest rate or principal detrimental to in interest rate or principal detrimental to junior lien holders

24

Restatem ent of Property Restatem ent of Property ( Mortgages) : ( Mortgages) :

• Should respect language in senior

mortgage allowing for modifications unless g g g “cutoff notice” is provided

25

Title insurance does not alw ays Title insurance does not alw ays difi i l i d difi i l i d cover m odification unless insured cover m odification unless insured

• btains endorsem ent
• btains endorsem ent
• Policy jacket exclusions may apply:

– Exclusion for risk voluntarily assumed by

Exclusion for risk voluntarily assumed by insured

– Exclusion for liability created, suffered or

y , assumed by insured

– Exclusion for post-policy actions

p p y

26

Types of endorsem ents Types of endorsem ents – – Date dow n Date dow n

• Brings forward the effective date and

revises description of mortgage to include g g modification

• Any creditors’ rights protection in the

Any creditors rights protection in the policy would be brought forward as well

27

Types of endorsem ents Types of endorsem ents – – ALTA Form 1 1 ALTA Form 1 1 -

• 0 6

0 6

• Insures priority of mortgage as modified

but does not bring forward the effective g date

• Contains specific exclusions for creditors’

Contains specific exclusions for creditors rights (fraudulent transfer and preference)

28

W ord of caution: To endorse or not W ord of caution: To endorse or not to endorse to endorse

• Title companies may deny coverage even on

simple modifications such as extensions

• Getting title companies to agree that they

will continue coverage under the original policy without the endorsement is a problem

29

Handling Distressed Real Estate

Foreclosure, Deed-In-Lieu and Bankruptcy

Foreclosure

Procedure by which lender can gain title Procedure by which lender can gain title to the collateral upon borrower default on the mortgage loan the mortgage loan.

31

Typically results in liens subsequent and subordinate to lender’s mortgage and subordinate to lender s mortgage being wiped out.

• deeds of trust and mortgages entered

into after the lender’s mortgage

• judgment liens
• mechanics’ liens (to some extent, in some

states)

32

Some liens have superpriority and may not be extinguished or may only be extinguished be extinguished or may only be extinguished by following specific procedures.

• mechanics’ liens (in some states these liens

will prime the lien of the mortgage if such f f mortgage was for construction or if work commenced prior to granting the mortgage) Li i f f h U i d S

• Liens in favor of the United States government

(28 U.S.C. 2410)

33

• Subdivision assessments
• Condominium assessments

Condominium assessments

• Real Estate taxes and special assessments
• Vendor’s and Vendee’s Liens

Vendor s and Vendee s Liens

• UCC’s
• Sewer assessments
• Sewer assessments
• IRS liens (if proper notice of foreclosure is

given, then IRS has 120 days to redeem; if g , y ; proper notice not given, then lien remains and purchaser at foreclosure will be subject to the lien) to the lien)

34

Title Insurance

• Insures the state of title post foreclosure.
• It is important to request a title

commitment specifically for foreclosure at the commencement of the foreclosure proceeding.

• Title insurance company will set forth

specific requirements that must be met in

• rder to insure.

35

Deeds-in-Lieu of Foreclosure

• Arrangement between borrower and lender

whereby lender can obtain title to the collateral ith t i th h th f l without going through the foreclosure process. Th t i t t i t i ll t

• The mortgage instrument is typically not

released so in the event borrower challenges the deed in lieu transaction and it is set aside the deed-in-lieu transaction and it is set aside, the lender may still be able to foreclose.

36

• Also, if there are subordinate liens, once

lender takes title, it can foreclose those liens prior to selling the property. This may be advantageous if there is ongoing litigation involving the property (such as litigation involving the property (such as mechanics’ liens enforcement).

37

• Due to the nature of the deed-in-lieu

transaction, the documentation used for the transaction should be very detailed. Lender should not pursue or be willing to accept a deed in lieu conveyance unless accept a deed-in-lieu conveyance unless the documentation meets the requirements.

38

Quick Guide to Title Company Quick Guide to Title Company Requirements to Insure a Deed in Lieu Transaction a Deed-in-Lieu Transaction

39

Deed

• reference that it is a deed-in-lieu of

foreclosure transaction

• include non-coercion language

40

Deed-in-Lieu/Settlement Agreement

• include amount of outstanding debt
• include covenant not to sue or release
• f personal liability under the note
• include non-coercion language

g g

• include non-merger language for deed
• f trust/mortgage
• f trust/mortgage

41

• include statement that borrower is

delivering possession of the property at delivering possession of the property at

• r before closing
• borrower cannot retain any interest in

borrower cannot retain any interest in the property, including a lease, right of repurchase, options, etc. p , p ,

42

Affidavit of Borrower

• Used in the event the settlement

agreement does not adequately dd ll f th i t address all of the requirements

43

Value of Property

• objective information that the value of

the property is less than or equal to th t f d bt b i l d the amount of debt being released

• important to establish that borrower

has no equity in the property

44

Copies of any other documentation between lender and borrower with respect to the lender and borrower with respect to the deed-in-lieu transaction

45

For sample documentation and other helpful information: helpful information:

http://title.firstam.com/resources/reference- information/john-c.-jack-murray-law- library/foreclosures,-deeds-in-lieu,-and- workouts/documenting-a-consensual-transfer-of- distressed-real-estate.html

46

Deeds in Escrow

• Deed held in escrow (usually by a title

company) whereby borrower conveys title t l d b t th d d i t d d to lender, but the deed is not recorded unless and until the occurrence of a subsequent default on the loan pursuant to subsequent default on the loan pursuant to the workout or settlement agreement. These deeds in escrow are considered

• These deeds in escrow are considered

executory contracts rejectable in bankruptcy bankruptcy.

47

Bankruptcy

• Federal Code and Rules which allow

borrower/debtor time to liquidate or i ith t f reorganize without pressure of enforcement actions.

48

Automatic Stay § 362

• Upon filing of bankruptcy, all collection

activities of creditors are temporarily h lt d halted.

49

Relief from the Automatic Stay

• Creditor can request relief from the automatic

stay under certain circumstances. If relief is t d dit d ith it granted, creditor can proceed with its enforcement action (foreclosure).

50

Sale under § 363

• Allows debtor to institute bidding to sell

property of the bankrupt estate. Lender can dit bid th d bt d if th hi h t bidd credit bid the debt and if the highest bidder, can obtain title to the property.

51

Most 363 sales are done free and clear of all liens and require a court order stating that liens and require a court order stating that the sale is free and clear of all liens and that any lien attach to the proceeds from the sale. y p From a title company perspective, “all liens” may not necessarily be all of the liens.

52

Judgment Liens

• Judgment liens that attach prior to the debtor

filing bankruptcy are not dischargeable in b k t Th l li bilit f th

• bankruptcy. The personal liability of the

debtor is discharged but the lien is not extinguished It is important that any order

• extinguished. It is important that any order

relating to judgment liens also releases the lien lien.

53

Preferential Transfers § 547

(and applicable state statutes) (and applicable state statutes)

• A transfer of an interest of the debtor in
• A transfer of an interest of the debtor in

property may be avoided if the transfer was made within 90 days prior to debtor was made within 90 days prior to debtor filing for bankruptcy (one year if creditor is an insider) and if certain criteria exists:

54

• made for the benefit of the creditor for an

antecedent debt; and

• debtor was insolvent or becomes

insolvent as a result of the transfer; and

• creditor received more than it would have

in a Chapter 7 liquidation

55

Fraudulent Transfers § 548

(and applicable state statutes) (and applicable state statutes)

• A transfer of an interest of the debtor in
• A transfer of an interest of the debtor in

property may be avoided if the transfer was made within one year prior to debtor was made within one year prior to debtor filing for bankruptcy and if certain criteria exists:

56

• debtor had actual intent to hinder, delay or

defraud creditors; or

• transfer was made for less than reasonably

equivalent value; and

• debtor was insolvent or becomes

insolvent as a result of the transfer; or

• debtor intended or believed it was

incurring debts beyond its ability to repay; or repay; or

• debtor maintained an unreasonably low

level of capital level of capital

57

Handling Distressed Real Estate

Foreclosure, Deed-In-Lieu and Bankruptcy

REO Properties: Legal p g Strategies for Lenders and Purchasers Purchasers

Ren Hayhurst (Irvine,CA) 949-223-7125; rrhayhurst@bryancave.com

Overview of Note and REO Sales

• Note Sales

– Acquire Debt, Not the Underlying Asset Seller is the Lender Not the Borrower/Debtor – Seller is the Lender, Not the Borrower/Debtor – Subject to Defects in Documentation, Title, etc. – Must Complete Foreclosure Process Before Assuming Control

• f the Property
• f the Property

– Know Your Enforcement Options

• REO Sales

T k Titl t th A t D l Di tl ith O – Take Title to the Asset; Deal Directly with Owner – Must Wait for Remedies to be Completed – Uncertainty Pending Foreclosure

60

Due Diligence Issues

• Due Diligence Challenges

– Note Sales Require Due Diligence on:

• The Loan,
• Condition of Title, and
• Condition of the Property.

– REO Sales Requires Standard Property Purchase Due Diligence:

• Condition of Title, and
• Condition of the Property.

61

Due Diligence – Note Sales

• Loan Issues

– Must Understand Risk of:

• Borrower Bankruptcy,
• Lender Liability Claims,
• Defects in Loan Enforcement
• Title Issues

– Must Understand Effect of Foreclosure On Title

• Eliminate Junior Liens

Eliminate Junior Liens

• Effect on Development Rights?
• Property Due Diligence

62

Due Diligence – REO Sales

• Focus On Property

– Title Report

• Which rights eliminated by foreclosure and which rights survive the

sale

– Market Research

• Effect of Foreclosure on Market
• Tenant Issues – Co-Tenancy Clauses, Rent Reductions, Etc.

– Environmental Report – Effect of Judicial Foreclosure vs Non-Judicial Foreclosure on Redemption Rights

63

Alternative Transaction Options

• Alternatives to Foreclosure

– Deed in Lieu of Foreclosure

• Title Subject to Competing Liens and Other Defects
• Potential Creditors’ Rights Issues
• Consensual Foreclosure

– Permits a Lender to “Clean Up” Title, And Can Speed Up the Process

• Consensual Bankruptcy
• Consensual Bankruptcy

– Risk Of Trustee Or Judicial Interference

64

Holding and Operating REO Properties

• Survey and title
• Land use
• Successor liability
• Construction defect liability risks for unfinished projects
• When REO is unit of larger project

65

Survey and Title Considerations

• Use of Prior Survey

– Update or Re-Certify Survey – Alternatives – Title Company Products (Plotted Easement Map, Etc.)

• Title Policy

– Binder if Foreclosing Owner – New Title Policy for Purchaser

Potential Problems

• Potential Problems

– Easement, Setback and Parking Issues – Mechanics’ Liens, CC&R Assessments

66

Survey and Title Considerations II: Emerging Title Issues

• Creditor's Rights Issues

– Consideration for Upstream and Downstream Guarantors – Solvency Representations/Source of Equity

• Broken Priority

– Financial Statements From Borrower/Guarantors Financial Statements From Borrower/Guarantors – Signed Indemnity Agreement from Borrower/Guarantor – Construction loan agreement

Cost Break Down and Loan Budget

• Cost Break Down and Loan Budget

– Cash Deposit/Letter of Credit

67

Land Use Considerations

• Entitlements

– Unstarted Project – Beware of:

• Moratoriums,
• Changes in Developments Plans,
• Expiring Development Agreements, and
• Replacement Bonds
• Rent Control

– Typically Survive Foreclosure Typically Survive Foreclosure

68

Successor Liability

• Assignment of Title Policy

– Should be done in any sale of a loan – Even applies to asset sales for failed banks

• HOA/CC&R Defaults and Assessments

– Typically Do Not Survive Foreclosure Typically Do Not Survive Foreclosure

• Profit Participation/Marketing Fees

– Controlled by Agreements and Subordinations

69