RISKIER PLAYS
If senior mortgages reside on the safer side of the debt risk
spectrum, then most attorneys agree construction loans fall on
the opposite end. By their very nature construction loans have a
number of moving parts that can come crashing down on a debt
buyer.
“Construction loans are the most perilous because there are
many more circumstances where the lender has to make decisions
on funding,” says Greenberg & Taurig’s Ivanhoe. “There are
always conditions precedent to when the lender is supposed to
fund, and the borrower has to comply.”
Problems, says Campbell, inevitably arise during recessionary
times. Lease commitments could dwindle or an anchor tenant
could file for bankruptcy. Cost overruns are another possibility
that could create conflict between the borrower and the lender,
who may halt loan advances. That in turn may ignite conflicts with
contractors looking to be paid and they may walk off the job or
file a lien. In that instance, the contractors may
fight with the lender over the priority of their
The buyer’s
liens against the mortgage loan.
“A lot of things can happen in either the
legal due
interaction between the lender and the borrower
diligence should
or in the economics,” Campbell says. “So the
prospect for lender liability claims is much higher
be similar to the
in a construction loan scenario than in the case of
a term loan.” Lender liability claims, which are
investigation
essentially filed for breach of contract, are often
more of a nuisance than an actual threat to the
and analysis that
lender, says the attorney.
it would have
“When lenders go to enforce,” he says,
“borrowers tend to bring claims to slow down the
undertaken if it
process or wear down the lender to force them into
negotiating workouts or discounted payments.”
were purchasing
Industry insiders say that Donald Trump did just
that when Deutsche Bank stopped financing
the property.”
the construction of the $640-million Trump
International Hotel and Tower in Chicago.
Jeffrey A. Lenobel The real estate mogul filed suit last November
Schulte Roth & Zabel LLP only to be countersued by the lenders, who
demanded Trump pay the $40-million personal
guarantee he made to complete the 92-story
development, according to the New York Law Journal, a sister
publication of Real Estate Forum. In early March, both parties
agreed to temporarily suspend litigation, giving Trump time to
complete the development.
Lenobel advises debt investors to also keep in mind the possibility
of general lender liability when buying a mortgage loan. He says
that in the residential context, courts have found buyers of real
estate loans to be liable for the selling lenders’ transgressions of
state and federal licensing statutes. Some courts have held that a
purchaser of a loan would be liable for a violation of state lending
laws by an original lender.
“These decisions have been mostly limited in the residential
context, but it is certainly something to be aware of in the
commercial arena,” he says. If the original lender committed
liability, the buyer will also incur successor liability issues.
Typically, the agreement would allow the subordinate loan to be
sold only to a qualified transferee and would preclude sales to
other entities unless there was rating agency approval of those
parties, says Lenobel.
The next major concern would be the mezzanine buyer’s ability
to foreclose, which may be curtailed by a standstill clause in the
inter-creditor contract. There are many enforcement matters in
these types of agreements of which a mezzanine lender needs
to be aware. For example, if both the buyer in this instance and
the mortgage lender has a common guarantor, Lenobel says the
agreement would likely restrict the mezzanine lender’s ability to
pursue the guarantor until the mortgage lender does.
Dealing with the amendments to the mortgage loan document
is also imperative. Look out for those that would increase the risk
of default by the borrower and jeopardize the mezzanine loan
collateral. The inter-creditor contract usually restricts the mortgage
lender from doing things like increasing the amount of the mortgage
loan or the interest rates. “The mezzanine
lender has to be sure that the mortgage lender
can’t change the mortgage loan documents
without its consent,” says Lenobel.
The attorney stresses the importance
of determining cure and purchase rights.
Mezzanine lenders, he says, do not have cure
rights—the opportunity to remedy default
under the loan—by statute. If the mortgage
holder gives the mezzanine buyer the right to
cure, then he or she can address the default
and keep the mortgage loan intact. Or, with
purchase rights, the mezzanine lender can
acquire the loan rather than cure a default.
Either way, it’s vital for the subordinate debt
buyer to have some options because, “If the
mortgage loan forecloses, the mezzanine
lender loses everything,” says Lenobel.
With that possibility in mind, some
subordinate lenders are leveraging their
positions to salvage some profits. Take Realty
Finance Corp., for example. When the principal
lender on Riverton Houses in Harlem started
foreclosure proceedings in February, the
Hartford, CT-based investor’s mezzanine position was threatened.
Stellar Management and Rockpoint Group, the owners of the
1,250-unit apartment complex are pressing the senior mortgage
lenders to restructure the $225-million note. But in order for a
workout to commence, Realty Finance—as stipulated in its inter-creditor agreement—must first give its approval.
Since the investor’s $25-million mezzanine note is all but
worthless at this point, Realty Finance is reportedly asking for
a payment of $5 million to allow the restructuring to proceed.
While the bondholders could certainly foreclose on the asset,
thanks to New York City laws they would incur a $7.5-million tax
penalty for transferring the property’s title.
To protect its position in a multi-prong capital stack, a mezzanine
lender could also buy out the mortgage or subordinate lenders.
But gaining control of the lending syndicate by shelling out more
money may not make much economic sense. Often, aligning with
other like-minded note holders can achieve the same end result
of having greater power.
“Tranche warfare often has to do with litigating over who has
control over the loan or whether the servicer or administrative
agent for the loan can take certain action without the consent of
one or the other lenders,” relates Stroock’s Campbell.
ALL THINGS CONSIDERED
The wave of bank failures in recent months has made the Federal
Deposit Insurance Corp. one of the largest sellers of debt. Back
in February, the agency completed the sale of nearly $1.5 billion
of distressed residential and commercial construction loans from
BUYER BE AWARE continued on page 54
