Fast foreclosures for mezzanine loans – watch out for borrowers

Mezzanine loans are often the riskiest part of real estate capital. These lenders will suffer the first loss if the value of the collateral decreases. In the event of non-payment of the loan, they also have the fastest enforcement tool in foreclosure tool remission: the ability to conduct a Uniform Commercial Code foreclosure sale, a process that can take some time. 30 to 60 days.

Indeed, the guarantee of a mezzanine loan is not a mortgage on real estate. Instead, the mezzanine borrower owns the company that actually owns the real estate. This company has already mortgaged the property to a mortgage lender. The guarantee of the mezzanine loan consists of the participation of the mezzanine borrower in the company that owns the property and has obtained the mortgage loan. These property interests are considered personal property, like a truckload of furniture. Seizures on personal property move quickly. They are not governed by the rules that slow down mortgage foreclosures.

In today’s miserable real estate markets, mezzanine lenders have started to show their muscles. If a mezzanine borrower misses a payment and the mezzanine lender wants to foreclose, the lender doesn’t need to give a series of multiple notices, file a complaint, wait for the borrower to respond, and then go through a series. of hearings and lawsuits – the complex process that can make a mortgage foreclosure take two years, at least in New York City. Instead, the mezzanine lender can notify the borrower that the lender intends to sell the collateral to the highest bidder at a UCC foreclosure auction.

Everything about this sale is required by law to be “commercially reasonable”. Thus, a mezzanine lender will need to advertise the sale in a commercially reasonable manner. Potential bidders will need to have commercially reasonable access to documents and information on the underlying property, and possibly tours of the property. The entire mezzanine lender’s sales process should be commercially reasonable.

A few mezzanine lenders have tried to organize UCC foreclosure sales during today’s pandemic. These efforts have sometimes triggered litigation in which the mezzanine borrower disputes the particular terms of the sale. Mezzanine borrowers have also argued that it is in and of itself unreasonable to try to host a mezzanine foreclosure sale during the pandemic because it is so difficult to hold an auction with bidders.

In a New York City case decided in May, the court temporarily blocked a mezzanine lender’s foreclosure sale, but then heard other arguments. In a brief ruling, the court cleared the sale. The borrower argued that the sale could not proceed due to the governor’s order blocking mortgage foreclosures. The court ruled that a UCC sale was not a mortgage foreclosure, but did not address the reasonableness of the sale, nor the borrower’s argument that in the current pandemic, it is impossible to have a commercially reasonable sale. Although the borrower argued that he would suffer an economic loss as a result of the lender’s sale proceedings, the court dismissed this concern as “speculative” and allowed the sale to proceed. (D2 Mark LLC v OREI VI Investments, LLC, Index No. 652259/2020, Supreme Court of the State of New York, County of New York.)

Another mezzanine borrower did better at the end of June. There, the lender had given the borrower 36 days notice of the sale, which would take place at a law firm or through a virtual / online auction. The successful bidder had to make a deposit of 10% of the purchase price and pay the balance within 24 hours. Until the lender changed their mind, the borrower was prohibited from bidding.

The mezzanine borrower argued that these and other procedural elements were commercially unreasonable. The borrower again argued that the governor’s order against mortgage foreclosures prevented the sale. Finally, the borrower argued that the sale violated the “good faith and fair use commitment” because the value of the collateral far exceeded the loan amount, and it was in bad faith on the part of the borrower. lender to foreclose due to a missed payment during a pandemic.

The court ordered the sale to be postponed for 30 days, to allow for more publicity and more clarity on the sale process. In theory, this also gives the mezzanine borrower some time to find new financing, although it usually takes longer than that, even under ideal circumstances. But the court cleared the sale, despite the pandemic and the governor’s order banning mortgage foreclosures. (1248 Mezz II LLC Associates vs. 12E48 Mezz II LLC, Index No. 651812/2020, Supreme Court of the State of New York, County of New York.)

Even though the second mezzanine borrower did better, he still faces a rapid loss of his investment due to the speed of mezzanine loan foreclosures.

Mezzanine borrowers have traditionally lived with this risk as part of the cost of securing an additional layer of higher risk financing. Ultimately, if a borrower wishes to mitigate risk, the borrower’s principals may need to bring in additional capital so that the borrower can discount the mezzanine loan and keep the lender at bay, at least for the month. In progress. Do managers want to throw money after the bad every month in the future?

The real estate carnage caused by the current pandemic could cause future mezzanine borrowers to try to negotiate a smoother, smoother – and most importantly, slower – mezzanine loan foreclosure process if a property runs into trouble. Whether mezzanine lenders will accept this is another discussion.

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