Real Estate Law Blog

Mezzanine Lender Held to Strict Terms of Intercreditor

In a recent decision, the US District Court in Arizona ruled on a dispute between a senior (real-estate-secured) lender and the mezzanine (ownership-interest-secured) lender on a resort property in Arizona, granting the senior lender's request for a preliminary injunction to prevent the mezzanine lender from conducting a UCC sale of its collateral. The ruling in U.S. Bank National Association, Trustee v. RFC CDO 2006-1 Ltd. has drawn a lot of attention among lenders and their lawyers because of its implications in the many such disputes now or anticipated to be engaged.

The ruling turned on the interpretation of provisions in the intercreditor agreement that the two lenders signed when the project financing originally was put into place. Based on a widely used form of intercreditor, the agreement was the mechanism by which the two lenders structured their respective rights and obligations with respect to each other. With the project in trouble and the loans in default, the mezzanine lender sought to realize on its collateral by conducting a UCC sale and thus acquiring the ownership interest in the entity that owns the project (that is, the senior lender's borrower). The senior lender objected, claiming that the mezzanine lender could not enforce its rights to its collateral without first curing outstanding defaults under the senior loan. In analyzing the agreement, the Court agreed with the senior lender, finding that the intercreditor agreement's clear language prohibited the mezzanine lender from conducting a UCC sale without, among other things, first curing all outstanding borrower defaults under the senior loan.

The Court looked carefully at the agreement's language, including verb tenses in the relevant sentences, to find the requirement that the cure of senior loan defaults must have been cured as of the time that the mezzanine collateral (i.e., ownership interests in the senior lender's borrowing entity) is transferred. The Court enjoined the mezzanine lender from conducting the sale unless and until all requirements of the intercreditor are satisfied.

This ruling is a reminder of something that contract parties (and their lawyers) should already know: language matters. One can assume that a lot of lenders' attorneys will be reviewing their intercreditor forms and rethinking the provisions analyzed by the Court in this case.

For a copy of this ruling, or to discuss its implications for your past or present loan transactions, please feel free to contact me.

Laura McClellan
www.tklaw.com

 

Limits on Lender Insurance Requirements

When making real-estate-secured loans, lenders routinely require borrowers to maintain specified types and amounts of insurance on the property that serves as the lender's collateral. Loan document insurance provisions also typically require the borrower to provide to the lender evidence that the required insurance is in place. As a reminder, Texas law prohibits lenders from requiring a borrower to provide evidence of renewal/replacement policies any sooner than 15 days before the expiration of an existing policy (Sec. 549.054 of the Texas Insurance Code).

If you have questions about insurance requirements or other loan document provisions, feel free to contact me.

Laura McClellan
www.tklaw.com

 

Railroad Commission of Texas Approves Hydraulic Fracturing Chemical Disclosure Rules

In December 2011 the Railroad Commission of Texas (“RRC”) approved rules that will require operators to disclose the composition of hydraulic fracturing fluids and the total volume of water used in a hydraulic fracturing treatment. Wells permitted by the RRC on or after February 1, 2012, will be subject to the disclosure requirements.

Some of my colleagues have prepared an informative alert regarding the new rules. You can read the alert by clicking here. For more information, feel free to call me or any of the following T&K lawyers: Jim Morriss, Chris Smith, or Ashley Phillips.

Laura McClellan
www.tklaw.com

 

Guest Post: Two Legal Implications of Appraisal Management Bonds

Danielle Rodabaugh is the editor of the Surety Bonds Insider, an online publication that takes a critical look at developments within the surety industry. As a part of the publication's educational outreach program, Danielle has recently taken an interest in writing about appraisal management bonds since they are new to both the surety and real estate industries. I thought the information Danielle offers below would be of interest to readers of this Real Estate Law Blog.

It's no secret that the housing market and its professionals have been under scrutiny as a result of business practices that took place throughout the past decade. The housing bubble burst, mortgage professionals committed fraud, and let's not forget the AppraiserLoft fiasco that stiffed so many real estate professionals. Ever since, state agencies have been looking for ways to regulate the market and protect consumer investments. As such, 10 states have set surety bond requirements for appraisal management companies. Although surety bond requirements have been used to regulate a number of industries for hundreds of years, professionals and consumers alike often remain uneducated about the legal protection provided by bonds. There are two fundamental ways that surety bonds provide legally enforceable protection to those who have a stake in the housing market.

1) Each appraisal management bond issued is a legally binding contact.

When an AMC purchases an appraisal management bond, it binds itself to two other entities in a legally enforceable contract.

1. The principal is the company that buys the appraisal management bond. As a principal, an AMC promises to fulfill whatever stipulations are found within the bond's legal language.
2. The obligee is the government agency that requires the AMC to purchase a bond. When an obligee requires a surety bond, it's doing so for two reasons: to regulate companies that work in a specific industry and to protect consumer interests.
3. The surety is the agency that issues the appraisal management bond. By executing the bond, the surety becomes legally obligated to pay for any claims made against a bond.

Each surety bond that's executed functions as a line of credit that guarantees a principal will adhere to industry regulations. As such, surety bonds aim to keep AMCs from participating in unethical business practices. For this reason appraisal management bond regulations are on the rise in today’s real estate industry.

2) Appraisal management bonds provide real estate appraisers and their clients with legal recourse.

The exact protection provided by an appraisal management bond depends on the legal language found within the bond. Most bonds allow claims to be made by any party harmed as a result of an AMCs inability to meet the bond's terms. However, bonds in some states specifically dictate that consumer claims are given priority in recovering losses (i.e. claims made by homeowners rather than real estate appraisers). The main goal of appraisal management bonds ensures AMCs are held financially accountable for their business practices. If a bonded AMC fails to meet the bond's expectations, harmed parties can make a claim on the bond to recover their losses. Appraisal management bonds essentially give harmed parties a means of legal recourse should all other recovery methods be exhausted. However, since appraisal management bonds are so new, their effectiveness remains to be seen. States that currently enforce AMC bonding requirements include Arkansas, Arizona, Georgia, Kentucky, Missouri, Nebraska, New Mexico, Oregon, Tennessee and Washington. A few of the laws don't require appraisal management companies to post a surety bond until some point in 2012. If you're a real estate appraiser or homeowner in one of these states and you believe an AMC failed to follow industry protocol, contact the company's surety bond provider to explore the claims process.

Loan Modifications - A Few Considerations

During real estate downturns, commercial mortgage loans may be difficult to refinance, and some borrowers might suffer from insufficient cash flow to service their mortgage debt. In some cases, lenders might prefer to modify delinquent or nonperforming loans rather than foreclose. If, by granting concessions – temporary or permanent – the lender can end up with a borrower that can continue servicing the debt, the lender then can avoid taking on the headaches of owning property that cannot be quickly disposed of. Whatever the reason, though, modification of a mortgage loan requires careful thought and attention to prudent processes.

While by no means comprehensive, following is a list of some factors that should be considered when modifying a commercial mortgage loan:

• Seek the consent of any junior lienholders where appropriate, in order to preserve priority of the lien. Even if the recorded mortgage expressly reserves the lender’s right to modify in the future, the prudent lender will carefully evaluate the potential claims of any junior lienholders of the collateral. Any modification that could impair a subordinate lienholder’s ability to collect on its lien could result in a loss of priority unless the junior lienholder consents. This is particularly relevant if the proposed modification will increase the interest rate or the amount of the debt, or will shorten the time for repayment. If, on the other hand, the modification extends the time for repayment or reduces the monetary obligations (e.g., interest rate or principal amount), then the junior lienholders could be seen to benefit. Nevertheless, the prudent lender will carefully review title to the real property that secures the loan, and seek consent from any junior lienors if and where appropriate.
• Protect the lender’s title insurance coverage. Lender title policies expressly exclude coverage for any post-issuance modifications to the insured deed of trust. Most jurisdictions, however, provide for the issuance of an endorsement to the lender’s policy to assure the lender that its title insurance coverage will not be impaired by the execution and delivery of the modification. Under appropriate circumstances, Texas title companies can issue the T-38 endorsement, which insures that “the company will not claim that the policy coverage has terminated or that policy coverage has been reduced solely by reason of the execution of” the modification agreement described in the endorsement. As a condition to issuing this endorsement, though, the title company will want to review the proposed agreement to confirm that it falls within the parameters of the types of modifications that can be insured by means of this endorsement.
• Obtain the consent of any guarantors of the loan. In general, a guarantor will be released from liability under its guaranty if the principal obligation is modified without the guarantor’s consent, often regardless of whether the guarantor waived notice of modification in his or her guaranty. Best practice is to have the guarantor(s) sign the modification, acknowledging and consenting to the modifications of the loan and reaffirming the obligations under the guaranty for the loan as modified.
• Record the executed modification promptly in the real property records of the county where the real estate is located. This will put the public (and thus future lien claimants) on notice of the loan’s modified terms. Again, the goal is to preserve the priority of the modified mortgage lien over subsequent liens.
• Consider bankruptcy implications. If the lender requires additional collateral for the loan as part of the modification, for example, the receipt of that additional collateral might be deemed a preferential transfer under the bankruptcy code. The modification agreement should include a borrower representation and warranty that no bankruptcy proceedings are pending or contemplated, and the lender should evaluate the borrower’s financial condition to satisfy itself as to the risk of a bankruptcy filing soon after the modification is filed.

Questions? Feel free to call.

Laura McClellan
www.tklaw.com

 

Foreclosure, Deficiencies, and the "Property Owner Rule"

When a deed of trust lien is foreclosed after default of the secured indebtedness, a deficiency will result if the sale price at foreclosure is less than the outstanding secured debt. In many states, including Texas, the secured lender then can seek to recover that deficiency by a lawsuit against the responsible parties (e.g., the borrower or a guarantor of the debt). Under Section 51.003 of the Texas Property Code, any person against whom recovery of such a deficiency is sought can ask the court to determine the property's fair market value ("FMV") as of the foreclosure date. On a hearing of that motion, the parties must introduce "competent evidence" of the property's value. If, after reviewing the evidence, the court determines that the property's FMV was more than the sale price at foreclosure, then the deficiency amount will be adjusted to reflect that fact.

In hearing such FMV cases in the past, the Texas Supreme Court has established the "Property Owner Rule," which says that a property owner is qualified to testify as to his own property's value even if he is not an expert in real estate property values and would not be competent to testify as to the value of other property. (See Porras v. Craig, 675 S.W.2d 503, 504 (Tex. 1984)). Recent Texas court opinions have extended the benefits of the Property Owner Rule to real-estate-owning entities, as well as individuals. In Reid Road Mun. Dist. No. 2 v. Speedy Stop Food Stores, Ltd., 337 S.W.3d 846 (Tex. 2011), the Texas Supreme Court held that an organization should be treated the same as an individual for purposes of the Property Owner Rule. Of course, an entity cannot testify directly -- only a natural person can appear in a courtroom to testify -- and the Supreme Court made it clear that not just any employee can testify on behalf of an organization under the Property Owner Rule. The Speedy Stop case limits admissible testimony to those witnesses whose roles and duties within the organization give them personal familiarity with the property at issue and its FMV. In fact, the Supreme Court ruled in Speedy Stop that the proffered testimony was not admissible because the witness didn't meet the requirements noted above. In the summer of 2011, though, the Dallas Court of Appeals, in a case dealing with these issues (Corniello v. State Bank & Trust Dallas, 334 S.W.3d 601 (Tex.App. - Dallas 2011), ruled that the sole member of a property-owning limited liability company was competent to testify on the LLC's behalf as to the FMV of its real estate, which had been foreclosed upon by its lender, leaving a deficiency that the lender sought to recover.

If you have questions about foreclosure, deficiency liability, or the Property Owner Rule, please feel free to contact me or T&K trial partner Steve Schoettmer for more information.

Laura McClellan
www.tklaw.com

 

 

Upcoming Webinar: Arbitration

International arbitration theoretically offers a safe, quick, and affordable alternative to protracted litigation in farflung venues. But it often fails to deliver on its promise, providing litigation by another name with all the costs and none of the benefits. At noon Central time on Thursday, October 6, 2011, Thompson & Knight will present a webinar discussing the issues surrounding arbitration and offering practical tips and suggestions on how to make arbitration work as it was supposed to, from drafting the arbitration clause to conducting the hearings.

To register for this free webinar, click here. For more information, contact any of the following T&K partners: Paul Cohen, Bill Katz, or Andrew Melsheimer.

Laura McClellan
www.tklaw.com

 

New TX Legislation Puts Teeth Into Assignments of Rents

On June 17, 2011, Texas SB 889 became effective to create first-of-its-kind Texas legislation regarding assignments of rents in connection with financing real property. In essence, the bill legislatively validates a significant lender remedy under defaulted real property loans by allowing lenders to collect rents without first foreclosing on the property. Some of my T&K colleagues have put together a memo that briefly summarizes the impact of SB 889. You can read the memo by clicking this link. For more information, feel free to call me or any of the following: Andrew Ingrum (T&K Dallas), Alfie Meyerson (T&K Houston), or Susan Coleman (T&K Fort Worth). Click on any of the foregoing names for contact information.

Laura McClellan
www.tklaw.com

TX AG Issues General Foreclosure Suspension & Demand Letter

The Texas AG has issued a letter to approximately 30 lenders and servicers, alleging that the institutions had some of the same foreclosure issues as Ally Financial (e.g., false claims of personal knowledge of facts and the filing of false affidavits) and demanding that the institutions cease foreclosures and certain other enforcement activities until certain demands are met with respect to their foreclosure processes. A copy of the letter is available on the AG's website; click here to see the press release and a link to a sample of the letter.

Some of my colleagues here at Thompson & Knight have prepared a client alert regarding the AG's letter. To read the alert, click here. For more information, contact Jeff Boyd, John Orton, or me.

Laura McClellan
www.tklaw.com

July 29 Free Webinar | Legislative & Regulatory Update: The Latest in Financial & Tax Reform

On July 29, 2010, from noon to 1 pm CST, some of my partners are offering a free webinar on recent legislative and regulatory developments with respect to tax and financial reform. Click here for more information about the webinar, including how to sign up to participate.