special servicers and defaulted cmbs...

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


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


Supplementing the Loan File

What updated information should be requested/ordered from third parties?

Appraisal

Phase I Report

Lien Search

Title Commitment

Survey

9


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


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


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


Typical Modification Requirements (cont’d)

Equity Investment / Principal Paydown

Borrower

Guarantor

New Equity

Liquidation of Reserves/Escrows

Additional Collateral

15


How Much is Owed?

Outstanding principal

Accrued interest

Default interest

Late charges

Consultant costs

Attorney’s Fees

Advances

Other fees (servicing, modification, etc.)

16


What are the Usual Structures/Options

Rate modification (temporary or permanent)

Extend, pretend (and hope)

Split the debt (A/B notes)

17


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

[email protected]

© 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





Proceedings (cont’d)

– Analyze title search results and UCC search

results

• Determine perfection and priority of liens

• Determine proper defendants in judicial

foreclosure action






• 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






– Nonjudicial foreclosure

• Publication and posting of notice of foreclosure

• Sale notice requirements

• Conduct of foreclosure sale

• Determination of redemption rights






– Which foreclosure method should I choose?

• Length of time to complete procedure

• Need to determine priority of liens

• Title insurance issues




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





(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





(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”





(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




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




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

[email protected]

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”.


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).


REO & REMIC CONCERNS

“Foreclosure Property” REO

Timing for REMIC Holding REO/Extension

Construction on REO

Disposition of REO


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.


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


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.


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.


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.


CONSTRUCTION ON REO

Construction includes:

• Renovations

• Remodeling to reconfigure layout


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.


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


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.


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


CONCLUSION

REMIC rules always permeate.

Address on front end.

PSA and regulations.

When in doubt, ask.


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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