1. | Intercreditor Agreements (a) | One issue of particular importance to mezzanine lenders is their ability to conduct a UCC foreclosure on the mezzanine collateral when the senior loan is in default. New York courts have been presented with this issue on several occasions. The case law demonstrates the importance of careful drafting and attention to the language of intercreditor agreements. See Karmely v. Wertheimer, 737 F.3d 197, 198-99 (2d Cir. 2013) (concluding that documents relevant to mezzanine loan, including intercreditor agreement, were ambiguous as to whether mezzanine borrower’s failure to pay a promissory note at maturity triggered mezzanine lender’s right to foreclose on mezzanine collateral). |
| 2. | Mezzanine lenders need to exercise any special rights under the intercreditor agreement prior to any event that terminates the intercreditor agreement, such as a senior loan foreclosure sale. (a) | Some intercreditor agreements seek to restrict a mezzanine lender’s ability to foreclose on the equity collateral by requiring certain defaults to be cured prior to foreclosure by the mezzanine lender. | (b) | If the mortgage lender has accelerated its loan, a requirement that the mezzanine lender cure defaults may result in the mezzanine lender needing to pay the mortgage loan in full before it may foreclose. | (c) | Priority disputes among lenders: U.S. Bank Nat’l Assoc. v. Lightstone Holdings LLC, 103 A.D.3d 458 (1st Dep’t 2013): (i) | Here, the parties – senior lenders and mezzanine lenders – disputed who had priority to payments personally guaranteed by defendant-guarantor. The dispute arose out of the bankruptcy of the debtors to a series of loans totaling $7.4 billion dollars, each of which was personally guaranteed by guarantor. | (ii) | Following the debtors’ bankruptcy, the collateral securing the senior loans (more than 600 hotel properties) was sold and the senior lenders were paid $3.9 of the $4.1 billion owed. The mezzanine lenders, however, received none of the money they were owed, and subsequently filed suit to enforce the guaranty agreements. In relevant part, the mezzanine loan guarantee agreements provided mezzanine lenders with the right to collect a capped amount ($100 million) in the event of bankruptcy. In an effort to prevent the mezzanine lenders from recovering under the guaranty agreements while the balance of the senior loan remained unpaid, the senior lenders filed suit. | (iii) | The First Department reversed, in part, the trial court’s decision in the mezzanine lenders’ favor. The court concluded that the intercreditor agreement – the sole document governing the relationship between the lenders – was ambiguous as to the lenders’ respective rights to collect on the guarantee claims. | (iv) | The court reasoned that the provisions of the various agreements “that [were] not fully consistent with each other,” were open to more than one reasonable interpretation. Id. at 458-60. In other words, the Senior Lenders’ and Mezzanine Lenders’ competing interpretations were “equally plausible.” Id. at 459-60. |
| (d) | Bank of Am., N.A. v. PSW NYC LLC, 2010 N.Y. Misc. LEXIS 5200 (N.Y. County Sept. 16, 2010). (i) | The dispute related to the foreclosure of Stuyvesant Town and Peter Cooper Village, the largest rent-regulated residential housing development in New York. The property was financed through a $3 billion dollar senior loan, secured by the property, and an additional $1.4 billion in mezzanine loans. The mezzanine loans were divided into 11 tiers. The junior loans were secured by a pledge granting each junior lender an equity interest in the corresponding borrower. The relationship between the senior and junior lenders was governed by an intercreditor agreement. Id. at *2-5. | (ii) | In 2010, the senior borrowers defaulted under the loan and, shortly thereafter, the senior lender issued a notice of default, which was also delivered to the junior lenders. The servicer to the loan notified the senior and junior borrowers that the senior loan was being accelerated, making all amounts immediately due. The junior lenders were notified of their right to cure the default pursuant to the intercreditor agreement. None took that opportunity. Id. at *8-9. | (iii) | In February of 2010, the senior lenders filed suit in the Southern District of New York, seeking to foreclose on the property. A judgment of foreclosure was entered several months later. Id. at *9-10. | (iv) | Prior to foreclosure, the senior lenders were notified that the interests in certain mezzanine loans had been transferred to PSW and that PSW intended to conduct a UCC foreclosure on the equity collateral without paying off the senior mortgage. Id. at *10-11. | (v) | The mortgage lender sued PSW to prevent PSW’s proposed UCC foreclosure while the senior loan default remained uncured – arguing that the mezzanine lenders could not foreclose until they first paid off the $3.1 billion mortgage. Id. at *9. | (vi) | The trial court, agreeing with the senior lenders, reasoned that the intercreditor agreement unambiguously obligated PSW to cure all senior loan defaults if PSW acquires the equity collateral. Id. at *9-10. | (vii) | In relevant part, the intercreditor agreement provided that: Where a transferee “acquires the equity collateral pledged to a Junior Lender . . . [t]ransferee shall acquire the [equity collateral] subject to (i) the Senior Loan and the terms, conditions and provisions of the Senior Loan Documents[.]” | (viii) | As a condition to transferee’s acquisition of the equity collateral, transferee was required to (1) affirm that it was bound by senior loan documents and (2) cure “all defaults under (1) the Senior Loan and (2) the applicable Senior Junior Loans, in each case which remain uncured or unwaived as of the date of such acquisition[.]” Id. at *16 (emphasis in original). | (ix) | Although the intercreditor agreement permitted “defaults that can only be cured by the Junior Lender following its acquisition of the Equity Collateral” to “be cured by the Junior Lender prior to the expiration of the applicable Extended Non-Monetary Cure Period,” the court reasoned that the default under the senior loan is not one that can “only be cured” following PSW’s acquisition. Accordingly, PSW was required to cure the senior loan default “as of the date of [its] acquisition.” Id. at *16-17. |
| (e) | The PSW decision was followed in CSMSC 2007-C2 Broadway Portfolio II, LLC v. OREP/Oxford HY Venture Funding 4, L.P., No. 652809/2011, Order (Sup. Ct. N.Y. County Dec. 12, 2011) (ECF. No. 12) (granting preliminary injunction to senior lender preventing mezzanine lender from conducting UCC foreclosure on the equity collateral where the senior loan was in default and had not been cured). (i) | The court, relying on Bank of America, N.A. v. PSW NYC LLC, 918 N.Y.S.2d 396 (N.Y. Sup. Ct. 2010), concluded that the senior lender demonstrated a strong likelihood of success where the mezzanine lender had not complied with the two following provisions of the intercreditor agreement: “(i) the Mezzanine Lender . . . shall have agreed in writing . . . thereafter to perform . . . all conditions and provisions of the Senior Loan Documents on Borrower’s part to be performed and (ii) all defaults under the Senior Loan Documents which remain uncured as of the date of . . . acquisition [of the mezzanine collateral] have been cured . . .” Id. at 5-6 (emphasis added). Id. | (ii) | The court was not swayed by the potential effect of a preliminary injunction on the mezzanine lender – namely, that it would be left “bankrupt or nearly so” – concluding that the balance of equities did not weigh in its favor given the strong likelihood of success. Id. at 7. |
| | | | (f) | However, PSW sued when CW Capital entered into an agreement 6 years later to sell Stuyvesant Town to Blackstone for $5.6 billion. Ultimately, PSW and CW Capital, the mortgage loan servicer, entered into a settlement and a CW Capital affiliate repurchased the mezzanine loan from PSW for $45 million. PSW NYC LLC v. Bank of Am., N.A., No. 650390/2016 (Sup. Ct. N.Y. County Oct. 31, 2016) (granting defendants’ motion to dismiss complaint for claims arising from the sale of rights under mezzanine loan). (i) | With the CW Capital affiliate now owning the mezzanine loans, CW Capital conducted a strict foreclosure on the mezzanine collateral, “without paying off the [senior loan],” which CW Capital argued PSW was prevented from doing by the intercreditor agreement. | (ii) | In dismissing PSW’s claims, the court reasoned that, although PSW could still sue defendants for a breach of the sale agreement, there was no support for PSW’s contention that defendants agreed to abide by the terms of the intercreditor agreement. Although defendants warranted that the sale of the mezzanine loans to CW Capital would not violate any “judgment, order, injunction, decree or award of any court” (e.g., the 2010 injunction), the injunction was no longer in existence for defendants to violate when they conducted the strict foreclosure. Accordingly, “even if defendants’ subsequent assumption of control over the mezzanine collateral would have violated the injunction had it not been dissolved . . . such assumption could not have violated [the 2010] preliminary injunction” and no violation of the agreement would be found. Id. at 11. | (iii) | As a result of the court’s determination that none of the relevant warrants had been breached, PSW’s claims were dismissed. |
| (g) | U.S. Bank Nat’l Assoc. v. RFC CDO 2006-1, Ltd., No. 11-cv-664, 2011 WL 9530795 (D. Ariz. Dec. 6, 2011) (granting injunction preventing mezzanine lender from conducting UCC foreclosure, reasoning that intercreditor agreement applying New York law required mezzanine lender to cure senior loan default before foreclosure). (i) | As part of the development of a resort, Borrower obtained a $145 million dollar loan (the “Senior Loan”) secured by “a deed of trust lien and security interests in the assets of the Borrower.” Id. at *1. To obtain additional funding, the sole member of Borrower (the “Mezzanine Borrower”) obtained a $20 million dollar mezzanine loan, secured by a pledge of Mezzanine Borrower’s 100% ownership interest in Borrower. The senior and mezzanine lenders’ relationship was governed by an intercreditor agreement. The intercreditor agreement was governed by New York law. | (ii) | Ultimately, both the Borrower and Mezzanine Borrower defaulted. Following the defaults, senior lender noticed its intent to initiate foreclosure proceedings. The Mezzanine lender, similarly, noticed its intent to conduct a UCC sale on the mezzanine collateral. Id. | (iii) | Senior lender filed suit seeking to enjoin the proposed UCC sale. | (iv) | The court, similar to the 2010 PSW court, concluded that senior lender was entitled to a preliminary injunction enjoining the proposed UCC sale where the senior loan remained uncured. The court began by looking to the language of the intercreditor agreement – which contained provisions almost identical to those in PSW. Among the requirements relevant to the court’s decision, the intercreditor agreement provided that any transferee that acquired the mezzanine collateral “shall have caused two things to happen—one being that ‘as of the date of the acquisition’ the Qualified Transferee shall have cured all defaults under the Senior Loan. The Qualified Transferee must have cured the defaults as of the date of the acquisition.” Id. at *3 (emphasis in original). |
| (h) | However, the Stuyvesant Town decision was rejected in U.S. Bank National Association v. LH Hospitality LLC, No. 653351/ 2012 (Sup. Ct. N.Y. County Oct. 16, 2012) (concluding that mezzanine lender subject to identical language in the PSW intercreditor agreement at issue in Stuyvesant Town could conduct UCC foreclosure prior to curing default on senior loan). (i) | U.S. Bank sought to enjoin LH Hospitality from conducting a UCC sale of the equity collateral – a 100% ownership interest in the borrower of the senior loan – securing a $35 million dollar mezzanine loan. | (ii) | The agreement at issue, identical to the PSW inter-creditor, required a transferee to (1) reaffirm that they are bound by the obligations applicable to the transferor and (2) cure all defaults. | (iii) | The court, however, declined to follow the logic of the 2010 decision in PSW and agreed with defendant that the relevant provisions of the intercreditor agreement were not conditions precedent to the transferee taking possession of the mezzanine collateral. Defendant contended, and the court agreed, that the relevant provisions were aimed at preventing the acceleration of the loan. The court agreed that under plaintiff’s interpretation “[t]here would be no point” in requiring a transferee to cure the senior loan if the loan was already accelerated. |
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| 3. | All assets of a UCC foreclose sale must be “Commercially Reasonable” (a) | AC I LEDGEWOOD MEZZ LLC vs. DMR CRE OPPORTUNITY FUND I LP, No. 153809/2014, Order (Sup. Ct. N.Y. County Feb. 3, 2015) (ECF No. 100) (rejecting claim that UCC foreclosure sale was commercially unreasonable). (i) | This dispute arose out of the mezzanine loan between plaintiff-borrower and BCM, under which plaintiff pledged BCM a security interest in all of plaintiff’s membership interests in Ledgewood. Following plaintiff’s default, BCM noticed a public sale of the mezzanine collateral. Ultimately, the sale was commenced with the mezzanine collateral being sold to defendant – an affiliate of BCM. Id. at *1. | (ii) | Plaintiff sought to vacate the sale of its membership interests and halt the sale of Ledgewood’s sole asset, arguing that BCM acted in a commercially unreasonable manner that permitted its affiliate to obtain its membership interests in Ledgewood and the sole asset of Ledgewood for far below market value. Id. | | | | (iii) | The court rejected plaintiff’s claims finding them barred by collateral estoppel; plaintiff had previously unsuccessfully attempted to enjoin the foreclosure. Id. at 14. In the prior decision the court held that the UCC foreclosure sale was conducted and noticed in accordance with UCC law, and therefore permitted the foreclosure sale to go forward. |
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| 4. | Sutton 58 Owner, LLC v. Sutton 58 Associates LLC, Index No. 650832/16, Transcript (Sup. Ct. N.Y. County Feb. 23, 2016) (ECF No. 33) (denying plaintiffs’ request for a preliminary injunction, finding that there was no showing that the proposed UCC foreclosure was commercially unreasonable where plaintiffs were unable to explain how delaying the proposed disposition would have any effect). (a) | Plaintiffs, led by Joe Beninati, sought a preliminary injunction to prevent a UCC foreclosure on the equity collateral – a 100% ownership interest in the owner – pledged as security on a mezzanine loan in connection with a development site at EGM and Sutton Place. Plaintiffs claimed that the proposed foreclosure was not being conducted in a commercially reasonable manner and that the UCC foreclosure would clog the owner’s equity right of redemption. | (b) | The court denied plaintiffs’ motion, explaining that plaintiffs failed to demonstrate a likelihood of success, irreparable harm, or even a balance of equities in their favor. There was no indication that the sale was not properly noticed or otherwise conducted in accordance with NY UCC. The court drew particular attention to the plaintiffs’ inability to answer when asked “what makes you think anything is going to be different from what your client has been after [i.e., financing] for the last year [assuming the preliminary injunction is granted]?” Id. at 37. |
| 5. | Clogging Equity of Redemption (a) | One concern arising in the dual loan context, where a single lender issues both a mortgage loan and a mezzanine loan to a borrower in connection with a transaction, is whether a borrower’s pledge to grant the lender a 100% ownership interest in the borrower as security for the loan “clogs” the borrower’s right of redemption under the mortgage loan. New York law is clear that a borrower cannot waive its right of redemption under the mortgage loan. The concern, where equity is pledged in relation to a mortgage raised primarily by law professors and not judges, is whether foreclosure on the pledge would “clog” or prevent the borrower from exercising that right. Commentators have suggested one potential way to mitigate risk to address concerns regarding the clogging of the equity of redemption is to require the delivery of an affidavit from the mortgagor providing that it is his or her understanding that the transaction will not clog the equity of the redemption. See John C. Murray, Clogging Revisited, 33 Real Prop. & Tr. J. 279 (1998-1999). | (b) | The purpose of granting an equity interest to the lender is to allow the lender to have the ability to either (i) foreclose on the mortgage or (ii) foreclose on the pledge of equity. This dual loan structure provides the lender added protection in the event they are unable to foreclose on the mortgage by granting them another avenue to recover money due (namely, through a UCC foreclosure on the equity pledge). | (c) | Despite frequent challenges to UCC foreclosures, there is relatively little case law addressing whether such a foreclosure clogs the borrower’s right of redemption. Clogging claims in the dual loan context are likely to encounter some judicial resistance as these loan structures usually involve sophisticated parties on both sides of the table and the UCC foreclosure process requires a commercially reasonable sales process. See John C. Murray, Clogging Revisited, 33 Real Prop. & Tr. J. 279 (1998-1999) (noting the paucity of case law regarding clogging claims in mezzanine finance transactions and that “courts ought not to take an overly restrictive view of the clogging doctrine as applied to mezzanine financing transactions”). Moreover, New York cases that have addressed the equity of redemption more generally have typically involved situations where borrower was effectively denied the right to repay the debt and repay the property. See Mooney v. Byrne, 163 N.Y. 86 (1900) (finding that plaintiff’s equity of redemption where the property was worth substantially more than the debt and did not have an avenue to repay the debt); Basile v. Erhal Holding Corp., 538 N.Y.S.2d 831 (2d Dep’t 1989) (where mortgagor gave mortgagee a mortgage that would not be recorded unless the mortgagor defaulted, the court granted mortgagor a right of redemption). | (d) | In Larson v. Hinds, 394 P.2d 129 (Colo. 1964), the Colorado Supreme Court concluded that a transaction under which a deed was placed in escrow and was to be “immediately deliver[ed]” in the event of a default “deprived the defendants of any redemption rights which the public policy of this state guarantees and amounted to a forefeiture which the policy of this state abhors. The evidence in this case compels the conclusion that under the circumstances here present the arrangement was a security transaction as a matter of law and the court erred in holding the same to be an absolute sale.” Id. at 132-33. | (e) | See Sutton 58 Owner, LLC v. Sutton 58 Associates LLC, Transcript at 20 (rejecting plaintiffs’ claim that the structure of the transaction – under which the lender issued a mortgage loan and a separate mezzanine loan secured by an equity pledge – was designed to allow lender to effectively defeat its equity right of redemption, reasoning that “[t]hese are highly sophisticated . . . real estate professionals, who are well counseled”). | (f) | In YL Sheffield LLC v. Wells Fargo Bank, 2009 WL 6408598 (N.Y. Sup. Ct. July 29, 2009), the borrower failed to pay maturity a mortgage loan and a mezzanine loan. The governing documents provided that upon default ownership of the mezzanine entity would transfer to the lender. Following the transfer to the lender, the lender commenced a UCC foreclosure sale. The court found that “[d]efendants’ legitimate exercise . . . of their remedies upon default – in this case, [UCC] foreclosure – cannot constitute irreparable harm to Plaintiffs. . . . In this case, there is no dispute that the Current First Mezzanine Loan is valid, in default, and subject to foreclosure. That foreclosure then cannot, as a matter of law, cause irreparable harm to Plaintiffs.” |
| 6. | Deed in the Box (a) | New York law is clear that at the outset of a loan, the lender may not require that the borrower place the deed to the property in escrow in the event of a default. The giving of a deed as security merely creates a mortgage, and the lender must nonetheless go through the mortgage foreclosure process. See N.Y. Real Prop. Law § 320. However, practitioners have generally believed that, if the deed in escrow is given after an Event of Default and in consideration for a forbearance agreement or a loan modification, the “deed in the box” arrangement for a future default was permissible. See Verity v. Metropolis Land Co., 248 AD 748 (N.Y. App. Div. 1936); Ringling Joint Venture II v. Huntington Nat. Bank, 595 So. 2d 180 (Fla. Dist. Ct. App. 1992) (deed delivered from escrow to defendant after default in commercial transaction was enforceable and did not clog borrower’s right of redemption). A recent First Department case has created significant uncertainty in this area. | (b) | Patmos Fifth Real Estate Inc. v. Mazl Bldg., LLC, 140 A.D.3d 527 (1st Dep’t 2016) (concluding that deed given to defendant to secure agreement for an additional loan and extension of time following default on a consolidated mortgage created a mortgage requiring defendant to commence foreclosure proceedings prior to filing the deed). (i) | In Patmos, the plaintiffs defaulted on a consolidated mortgage relating to property plaintiffs purchased and financed through defendants. The defendants, however, agreed to give plaintiffs additional time and credit. This agreement was secured by plaintiffs executing a deed to the property to be held in escrow and not to be released unless and until plaintiffs defaulted. Id. at 527. | (ii) | Plaintiffs defaulted under the agreement. Defendants subsequently “filed and recorded the deed and became the record owner of the property.” Id. at 527. | (iii) | Plaintiffs – who had paid taxes and renovated the property – contended that defendants improperly filed the deed without first commencing foreclosure proceedings in accordance with New York law. Id. The court agreed, explaining that “the courts are steadfast in holding that a conveyance, whatever its form, if in fact given to secure a debt, is neither an absolute nor a conditional sale, but a mortgage, and that the grantor and grantee have merely the rights and are subject only to the obligations of mortgagor and mortgagee. Significantly, the statute does not require a conclusive showing that the transfer was intended as security; it is sufficient that the conveyance appears to be intended only as a security in the nature of a mortgage.” Id. at 528 (internal citations and quotation omitted). |
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