Acquisition of Distressed Real Estate Mezzanine Debt — Gravel2Gavel Construction & Real Estate Law Blog — November 21, 2022

We not long ago provided an define of merchandise to diligence when obtaining a home loan bank loan in distress—and separately also talked over issues to diligence when paying for a mezzanine bank loan in distress. This write-up (the 3rd in this series) outlines Uniform Industrial Code (UCC) foreclosures in normal conditions and describes key considerations for mezzanine creditors (and the purchasers of distressed mezzanine financial loans) considering or preparing a UCC foreclosure.

In our prior posts, we’ve emphasised how diligence is vital. In this installment, we will discover how and why preparing is also very important!

As we’ve defined in previously posts, a mezzanine bank loan is secured by a pledge of interests in a assets operator, and enforcement of a mezzanine loan falls less than the UCC. In this regard, note that while every Condition has a UCC, and certain States have enacted the “model UCC” (which means reference ought to be produced to each and every State’s UCC when crafting a UCC foreclosures), this article will describe specified overarching “principles” and greatest techniques that are typically relevant throughout States.

Also, be aware that whilst the UCC does allow for judicial foreclosures (not compared with foreclosures on a real estate mortgage), in this article we will concentration on the “self-help” solutions that are out there to creditors below the UCC and that are additional expeditious (i.e., more rapidly and cheaper) to complete. These remedies—which are issue to UCC necessities that health supplement (and normally override) provisions in the mezzanine bank loan stability documents—are:

• A public sale
• A non-public sale
• Rigid foreclosure

The elementary and guiding theory that should really advise the arranging and execution of any UCC foreclosure is the requirement beneath the UCC that “[e]pretty factor of a disposition of collateral, which includes the technique, way, time, spot, and other phrases, will have to be commercially realistic.” In this regard, note that what is commercially reasonable is reality-specific and dependent on marketplace disorders. Also be aware that any right after-the-truth analysis by a court docket will target on the approach and technique utilized by the foreclosing financial institution. For that reason, encounter and market place consciousness are critical, and thorough setting up is significant!

Allow us commence with a shorter description of the “public sale.” A general public sale is a person where by there is a meaningful possibility for competitive bidding and calls for some sort of advertisement (a notice of sale) to the basic public—such as in market publications exactly where UCC foreclosures are typically marketed. Take note that the UCC has many rules regarding the form and content of the observe of sale that will have to be given—and that whilst the UCC provides for a 10-working day observe time period as a harmless harbor, for a longer time intervals of 30 times or far more are prevalent. In this regard, be aware that private events may perhaps agree by contract (in a pledge and stability settlement) to strategies or requirements for community sale. If ever litigated, that settlement commonly will be enforced by a courtroom delivered its phrases are not manifestly unreasonable or inconsistent with specific provisions of the UCC.

The secured loan company may well bid on the collateral in a community sale (not like non-public product sales). This is a vital advantage for mezzanine lenders with a loan-to-own approach.

In building a commercially fair sale process—and maintaining in head the overarching basic principle that “[e]extremely component of a disposition of collateral, which includes the technique, fashion, time, location, and other phrases, ought to be commercially reasonable”—a mezzanine lender should really contemplate:

• Retaining advisors, together with a broker and/or auctioneer. Notice that these specialists may be resources of info for individuals wanting to obtain mezzanine credit card debt or home by means of a financial loan to own approach
• Outreach to possible purchasers through several channels (for instance, brokers will ordinarily access out to focus on lists of clientele/contacts they imagine may well be active in the marketplace)
• Information and facts and time out there for diligence, like the institution of a facts home
• Allowing future bidders to have entry to the assets in advance of the auction, if attainable
• Public recognize requirements and
• Bidding procedures.

With regards to the public notice demands, the statutory requirements contained in sections 9-613 and 9-614 of the UCC need that the secured financial institution (in the discover):

• Involve data about the debtor and the secured party, a description of the collateral, and the time and area of the auction and
• Give for:
  • accessibility to knowledge web-site (usually upon execution of confidentiality agreements) and
  • deposit and closing timing troubles and official terms of sale.

Remember, in structuring any sale, that there could be “Qualified Transferee” and other requirements imposed by any Intercreditor Arrangement (see prior posts on ICAs right here and below)—the settlement that normally exists among a mortgage loan provider and a mezzanine loan provider. These might contain requirements pertaining to who can be a foreclosing lender—and will possible also involve prerequisites about steps that should be taken and deliveries that have to be pleased (this kind of as the prerequisite to produce supplemental ensures)—all of which will have to be deemed in preparing a community discover (and structuring any sale).

At the time the scheduling levels are done and the discover is placed, it’s time for the sale. Relating to the sale, observe that:

• An auction may well be digital
• The secured party does not essentially have to have to settle for the optimum bid (e.g., it may perhaps be improved to settle for a reduce value that is all-hard cash than a larger price that is section cash, element notes)
• It is not essential to clearly show that the auction value was the finest value offered in the marketplace and
• An auction can generally be adjourned devoid of a sale.

Also take note, regarding credit bidding, that a mezzanine loan provider has the proper to credit rating bid up to the full sum of its debt (and can bid additional quantities in funds) if desired. The credit rating bid amount of money can include things like all desire, charges and charges furnished for in the mezzanine bank loan documents. Also be aware that the mezzanine loan provider need to think about bidding much less than the comprehensive volume of its personal debt to preserve its rights to pursue guarantors and other collateral.

We be aware that, as a simple issue, by the time of the auction, the mezzanine loan company is most likely to have a excellent feeling of any industry curiosity in the collateral so that it can construction its credit rating bid accordingly.

Besides a general public sale, a secured lender may structure the sale as a “private sale,” a sale in which there has not been an advertisement that gave the general public a meaningful option to participate. In a private sale, the secured get together can not be the consumer of the collateral (apart from for specific collateral types with publicly quoted industry rates). As with a community sale, a personal sale should be performed in a commercially realistic manner. Otherwise, the creditor risks exposing by itself to legal responsibility. Here, as well, there is no need to show that the private sale yielded the finest price tag readily available.

In addition, a secured lender might think about “strict foreclosures.” In a rigid foreclosure, the secured bash may well make a proposal to the mezzanine borrower to take the collateral in comprehensive or partial pleasure of the mezzanine financial loan. The proposal need to be consented to by the mezzanine borrower immediately after the default has occurred. Rigorous foreclosures agreements are not subject to the “commercial reasonableness” conventional, but will have to be manufactured in “good religion.” This is a difference with out a distinction and suggests retaining appraisers or other pros is warranted.

A mezzanine lender whose enforcement initiatives are not commercially reasonable or normally violate the UCC’s terms may expose alone to liability under the UCC. For case in point, and though we take note that the next provisions can be altered by agreement, a debtor or obligor might be ready to seek out injunctive relief from a sale which is not commercially realistic (underneath UCC 9-625(a)). In the same way, a debtor or yet another junior secured creditor may request a claim for damages versus the loan company (below UCC 9-625(b)-(c)) or may look for recovery of damages for decline of surplus (beneath UCC 9-625(d)).

To keep away from these types of outcomes, often retain in intellect the necessity for professional reasonableness and prepare thoroughly. Scheduling is vital!

For the reason that setting up is important, an knowledge of potential bankruptcy tactics and concerns is required—and will be the topic of the next write-up in our series on the acquisition of distressed serious estate debt.

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