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Special Servicers and Defaulted CMBS Loans Restructuring or Foreclosing Distressed Assets While Navigating Regulatory and Contractual Challenges
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THURSDAY, FEBRUARY 21, 2013
Presenting a live 90-minute webinar with interactive Q&A
Patrick E. Mears, Partner, Barnes & Thornburg, Grand Rapids, Mich.
Joseph E. Lubinski, Senior Associate, Ballard Spahr, Denver
Lori Lustberg Smith, Partner, Andrews Kurth, Dallas
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Duties and Responsibilities of the Special Servicer under Pooling and Servicing Agreements
Joseph Lubinski 1225 17th Street, Suite 2300 Denver, Colorado 80202 303.299.7359 [email protected]
6
Manage Loan Documentation
Review of the Loan File
Is the file “complete”?
Are there originals?
Does it appear there might be subsequent modifications or amendments that didn’t make it to the file?
Based on the file only, who is the current holder?
7
Manage Loan Documentation
Review of the Loan File (cont’d)
What Existing Information Is (Probably) Not in the File?
Current balance information/payoff statement
Borrower financial information
Project historical information
Rent rolls, quarterly statements, annual statements
Current borrower contact information
8
Manage Loan Documentation
Supplementing the Loan File
What updated information should be requested/ordered from third parties?
Appraisal
Phase I Report
Lien Search
Title Commitment
Survey
9
Manage Loan Documentation
Assessing and Evaluating the File
How meaningful are the gaps in documentation?
What are the “lender” obligations under the loan documents?
Approval rights
Response timelines
10
Manage Loan Documentation
Assessing and Evaluating the File (cont’d)
What is the nature of the default (payment, maturity, non-monetary)?
What are the consequences of default (lockbox, leases, default interest rate, etc.)?
What borrower obligations may have been missed over time?
What are the lender’s remedies and options
11
Manage Loan Documentation
Assessing and Evaluating Servicer Options
Regardless of what the loan permits, are there local limitations on remedies?
What approvals must be obtained before the special servicer can take action?
12
Negotiate Restructuring of Mortgage Loan and
Security Documents
After Evaluation of the Documents, Evaluate the “Deal”
How is the property operating?
What are the borrower’s financials?
What are the market conditions?
13
Negotiate Restructuring of Mortgage Loan and Security Documents
Typical Modification Requirements
Realistic operating forecast
Existing NOI
Current leases
Future leases
14
Negotiate Restructuring of Mortgage Loan and Security Documents
Typical Modification Requirements (cont’d)
Equity Investment / Principal Paydown
Borrower
Guarantor
New Equity
Liquidation of Reserves/Escrows
Additional Collateral
15
Negotiate Restructuring of Mortgage Loan and Security Documents
How Much is Owed?
Outstanding principal
Accrued interest
Default interest
Late charges
Consultant costs
Attorney’s Fees
Advances
Other fees (servicing, modification, etc.)
16
Negotiate Restructuring of Mortgage Loan and Security Documents
What are the Usual Structures/Options
Rate modification (temporary or permanent)
Extend, pretend (and hope)
Split the debt (A/B notes)
17
Negotiate Restructuring of Mortgage Loan and Security Documents
No Deal?!?
On to remedies...
© 2012 Barnes & Thornburg LLP. All Rights Reserved. This page, and all information on it, is the property of Barnes & Thornburg LLP which may not be reproduced, disseminated or disclosed without the express written consent of the
author or presenter. The information on this page is intended for informational purposes only and shall not be construed as legal advice or a legal opinion of Barnes & Thornburg LLP.
SPECIAL SERVICERS AND DEFAULTED
OR DELINQUIENT CMB LOANS:
Commencing Mortgage Foreclosure Proceedings, Seeking the Appointment of a
Receiver and Pursuing Claims Against Guarantors
Prepared by:
Patrick E. Mears
Lisa D. Updike
Barnes & Thornburg LLP
616-742-3936
© 2012 Barnes & Thornburg LLP. All Rights Reserved. This page, and all information on it, is the property of Barnes & Thornburg LLP which may
not be reproduced, disseminated or disclosed without the express written consent of the author or presenter. The information on this page is
intended for informational purposes only and shall not be construed as legal advice or a legal opinion of Barnes & Thornburg LLP. 19
I. Commencing Mortgage Foreclosure
Proceedings
• Review and Analysis of Mortgage Loan
Documents
– Identify critical documents
– Scope of review
• Proper execution
• Compliance with applicable law
• Verification of existence of a default
• Verification of proper assignments of loan
documents
© 2012 Barnes & Thornburg LLP. All Rights Reserved. This page, and all information on it, is the property of Barnes & Thornburg LLP which may
not be reproduced, disseminated or disclosed without the express written consent of the author or presenter. The information on this page is
intended for informational purposes only and shall not be construed as legal advice or a legal opinion of Barnes & Thornburg LLP. 20
I. Commencing Mortgage Foreclosure
Proceedings (cont’d)
– Analyze title search results and UCC search
results
• Determine perfection and priority of liens
• Determine proper defendants in judicial
foreclosure action
© 2012 Barnes & Thornburg LLP. All Rights Reserved. This page, and all information on it, is the property of Barnes & Thornburg LLP which may
not be reproduced, disseminated or disclosed without the express written consent of the author or presenter. The information on this page is
intended for informational purposes only and shall not be construed as legal advice or a legal opinion of Barnes & Thornburg LLP. 21
I. Commencing Mortgage Foreclosure
Proceedings (cont’d)
• Selecting the Method of Foreclosure: Judicial or
Nonjudicial
– Judicial foreclosures
• Summons and complaint filed in proper jurisdiction
• Applicability of one-action rule
• Joinder of parties and claims
• Entry of foreclosure judgment
• Establishment of upset price
• Determination of redemption period
• Conduct and confirmation of sale
© 2012 Barnes & Thornburg LLP. All Rights Reserved. This page, and all information on it, is the property of Barnes & Thornburg LLP which may
not be reproduced, disseminated or disclosed without the express written consent of the author or presenter. The information on this page is
intended for informational purposes only and shall not be construed as legal advice or a legal opinion of Barnes & Thornburg LLP. 22
I. Commencing Mortgage Foreclosure
Proceedings (cont’d)
– Nonjudicial foreclosure
• Publication and posting of notice of foreclosure
• Sale notice requirements
• Conduct of foreclosure sale
• Determination of redemption rights
© 2012 Barnes & Thornburg LLP. All Rights Reserved. This page, and all information on it, is the property of Barnes & Thornburg LLP which may
not be reproduced, disseminated or disclosed without the express written consent of the author or presenter. The information on this page is
intended for informational purposes only and shall not be construed as legal advice or a legal opinion of Barnes & Thornburg LLP. 23
I. Commencing Mortgage Foreclosure
Proceedings (cont’d)
– Which foreclosure method should I choose?
• Length of time to complete procedure
• Need to determine priority of liens
• Title insurance issues
© 2012 Barnes & Thornburg LLP. All Rights Reserved. This page, and all information on it, is the property of Barnes & Thornburg LLP which may
not be reproduced, disseminated or disclosed without the express written consent of the author or presenter. The information on this page is
intended for informational purposes only and shall not be construed as legal advice or a legal opinion of Barnes & Thornburg LLP. 24
II. Requesting the Appointment of a Receiver
• Nonuniformity of Receivership Law
• Federal or State Receiver
– State receiverships: action commenced in state
court where subject property is located
– Federal receivership: alternative requirements of
diversity of citizenship and federal question
jurisdiction
© 2012 Barnes & Thornburg LLP. All Rights Reserved. This page, and all information on it, is the property of Barnes & Thornburg LLP which may
not be reproduced, disseminated or disclosed without the express written consent of the author or presenter. The information on this page is
intended for informational purposes only and shall not be construed as legal advice or a legal opinion of Barnes & Thornburg LLP. 25
II. Requesting the Appointment of a Receiver
(cont’d)
• Considerations Suggesting Need for Receiver
– Failure of restructuring efforts
– Mortgagor is a fraudster
– Need for quick seizure of mortgaged realty and
rents
– Threatened or actual waste
– Purchaser wanting quick purchase of property
© 2012 Barnes & Thornburg LLP. All Rights Reserved. This page, and all information on it, is the property of Barnes & Thornburg LLP which may
not be reproduced, disseminated or disclosed without the express written consent of the author or presenter. The information on this page is
intended for informational purposes only and shall not be construed as legal advice or a legal opinion of Barnes & Thornburg LLP. 26
II. Requesting the Appointment of a Receiver
(cont’d)
• Enforcement of Rent Assignments
– Many states permit mortgagee to obtain
assignment of rents and leases and to enforce
same
– Many mortgagees prefer having a receiver
appointed to collect rents
– Bankruptcy risk of doing nothing: rents as “cash
collateral”
© 2012 Barnes & Thornburg LLP. All Rights Reserved. This page, and all information on it, is the property of Barnes & Thornburg LLP which may
not be reproduced, disseminated or disclosed without the express written consent of the author or presenter. The information on this page is
intended for informational purposes only and shall not be construed as legal advice or a legal opinion of Barnes & Thornburg LLP. 27
II. Requesting the Appointment of a Receiver
(cont’d)
• Court Procedures for Appointment of a Receiver
– File summons and complaint in jurisdiction where
property is located
– File motion for the appointment of a receiver
– Propose Order Appointing Receiver: CRITICAL
DOCUMENT
– Administration of receivership estate
– Sales of receivership property free and clear of
liens and interests
– Termination of receivership proceeding
© 2012 Barnes & Thornburg LLP. All Rights Reserved. This page, and all information on it, is the property of Barnes & Thornburg LLP which may
not be reproduced, disseminated or disclosed without the express written consent of the author or presenter. The information on this page is
intended for informational purposes only and shall not be construed as legal advice or a legal opinion of Barnes & Thornburg LLP. 28
III. Obtaining and Enforcing Deficiency Judgment
Against Mortgagor and Guarantors
• Entry of Money Judgment Against Mortgagor and
Guarantors in Judicial Foreclosure Action
• Entry of Money Judgment Against Mortgagor and
Guarantors in Separate Action
• Bad-Boy Guaranties are Common in CMBS
Transactions
© 2012 Barnes & Thornburg LLP. All Rights Reserved. This page, and all information on it, is the property of Barnes & Thornburg LLP which may
not be reproduced, disseminated or disclosed without the express written consent of the author or presenter. The information on this page is
intended for informational purposes only and shall not be construed as legal advice or a legal opinion of Barnes & Thornburg LLP. 29
III. Obtaining and Enforcing Deficiency Judgment
Against Mortgagor and Guarantors (cont’d)
• Case Law Generally Enforces Terms of Bad-Boy
Guaranties
– Trend of case law
– Cherryland decision: a well-known exception to
enforcement
• Common Defenses to Enforcement of Guaranties
Asserted by Defendants
• Entry of Final Judgments and Commencement of
Collection Actions
Straight talk about
your business
February 21, 2013
andrewskurth.com
SPECIAL SERVICERS AND
DEFAULTED CMBS LOANS -
REMIC ISSUES
Lori Lustberg Smith 214.659.4647
PURPOSE OF REMIC
Real Estate Mortgage Investment Conduit.
Fixed pools of mortgages in which investors hold various classes of interests.
Pass-through entity.
Not subject to being taxed at trust level.
CMBS transactions structured and priced based on assumption that will not be subject to tax.
Violation of REMIC rules subjects Trust to imposition of taxes.
2/19/2013 Andrews Kurth 31
GENERAL REMIC CHARACTERISTICS
To preserve tax-exemption, REMICs must continually hold “qualified mortgages” or “permitted investments”.
Generally “qualified mortgage” means mortgages secured by real property collateral that:
(1) have a LTV ratio not greater than 125%, and
(2) are transferred to the REMIC within 3 month period starting with Trust’s startup date or on the first day the REMIC issues securities.
“Permitted Investments” means:
(1) Temporary “cash flow investments” – passive investments from which REMIC earns interest,
(2) “Qualified Reserve Assets” which is cash the Trust holds on hand to pay expenses, or
(3) “Foreclosure Property”.
2/19/2013 Andrews Kurth 32
REQUESTS FOR MODIFICATION
No “significant modifications” permitted.
“Significant” modifications to loans are held to be “deemed exchanges” under IRS rules, thereby violating the second prong of the “qualified mortgage” test and incurring tax penalties.
Exception for Defaulted Mortgage Loans.
Borrower default or “reasonably foreseeable default”
• If servicer reasonably believes there is a sign of risk of default of loan upon maturity or at earlier date, modification can be made (expanded 2009)
Exception for Assumptions.
Exception for Substituting Collateral.
• If obligation continues to be “principally secured” by an interest in real property (added 2009). “Principally secured” means:
(1) FMV at least 80% of adjusted issue price (appraisal, sales price or other commercial valuation) OR
(2) FMV before > FMV after (appraisals or other commercial valuation)
Exception for changing recourse nature (as long as continues to be “principally secured” by interest in real property) (added 2009).
2/19/2013 Andrews Kurth 33
REO & REMIC CONCERNS
“Foreclosure Property” REO
Timing for REMIC Holding REO/Extension
Construction on REO
Disposition of REO
2/19/2013 Andrews Kurth 34
TIME LIMIT FOR HOLDING REO PROPERTIES
How long can REO remain “foreclosure property”?
• Grace Period – End of 3rd tax year following the tax year of foreclosure.
• Discretionary one-time extension (for up to 3 years) might be allowed thereafter.
• No other extensions permitted.
2/19/2013 Andrews Kurth 35
EXTENSION OF TIME LIMIT FOR HOLDING REO PROPERTIES
Process for Extension
• When?
‒ Prior to October 31 of the year in which the Grace Period expires
• What to provide?
‒ Regs require:
Name, address, taxpayer ID of REMIC
Date foreclosure property was acquired
Statement as to whether previous extensions requested
Statement as to when the Grace Period should be extended
Description of the efforts to dispose of the property
‒ Also often request:
Tax returns
Statement as to nature and operations of the property
2/19/2013 Andrews Kurth 36
EXTENSION OF TIME LIMIT FOR HOLDING REO PROPERTIES
Must establish that an extension of the Grace Period is necessary for the orderly liquidation of the REMIC’s interest in the foreclosure property.
Good faith efforts to dispose.
Market conditions precluded disposing of the property.
Accompanied by penalties of perjury statement signed by authorized representative of REMIC.
2/19/2013 Andrews Kurth 37
PERMITTED ACTIVITY FOR REO
A REMIC must be passive (i.e. may not “actively engage” in a trade or business).
Upon foreclosure, Trust is forced to operate the property.
Careful balance.
2/19/2013 Andrews Kurth 38
PROHIBITED ACTIVITY FOR REO
Active Income.
Construction (unless underway at the time of default and constructed by an independent contractor).
‒ 10% complete before default becomes imminent.
‒ Construction more than 90 days after property became REO is performed by an independent contractor.
Typically Special Servicer may not make significant operating decisions that address matters other than consistent with normal course of business or completing construction.
Retain third party management company.
2/19/2013 Andrews Kurth 39
CONSTRUCTION ON REO
Construction includes:
• Renovations
• Remodeling to reconfigure layout
2/19/2013 Andrews Kurth 40
CONSTRUCTION ON REO
Construction does not include:
• Repair/maintenance of a building/improvement to offset normal wear and tear or obsolescence.
• Restoration because of casualty.
• Preparation for a new tenant provided:
‒ Useful life of building/improvement not extended, and
‒ No significant increase in value.
• Deferred maintenance.
2/19/2013 Andrews Kurth 41
DISPOSITION OF REO
General Standard for Disposition
• Special Servicer uses its reasonable efforts consistent with servicing standard to solicit cash bids.
• Reasonably likely to realize fair price within customary and normal time frame.
• Special Servicer determines “fair price”.
‒ occupancy
‒ physical condition
‒ state/local economy and market
‒ obligation to dispose
2/19/2013 Andrews Kurth 42
MULTIPLE SALES OF REO
Sale of REO in Multiple Transactions.
• No specific REMIC requirement that sales be separate.
• Could result in REMIC being engaged in trade or business of development or selling REO.
• Must analyze facts and circumstances.
2/19/2013 Andrews Kurth 43
GENERAL OBSERVATIONS
Observations:
• Regs create a framework for allowing liquidation of REO in a manner that makes sense while preserving the passive nature of the REMIC.
• These goals are often at odds and result in uncertainty.
‒ Regs often provide limited guidance
‒ Results are fact and circumstance specific
‒ Common sense and credit don’t control
REMIC Opinions
• Required
• Helpful/Cover Yourself
2/19/2013 Andrews Kurth 44
CONCLUSION
REMIC rules always permeate.
Address on front end.
PSA and regulations.
When in doubt, ask.
2/19/2013 Andrews Kurth 45
Copyright © 2012 by Andrews Kurth LLP. Andrews Kurth, the Andrews Kurth logo and Straight Talk Is Good Business are registered service marks of Andrews Kurth LLP. All Rights Reserved. This presentation has been prepared for informational purposes only
and does not constitute legal advice. This information is not intended to create (and receipt of it does not constitute) an attorney-client relationship. Readers should not act on this information without seeking professional counsel. Prior results do not
guarantee a similar outcome and depend on the facts of each matter.
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