Appointment of a Receiver
• After the mortgagor has defaulted, the mortgagee may ask
court to appoint a receiver for mortgaged property
– If appointed, the receiver takes possession and control of the
property, pursuant to court’s receivership order
• Receivership is an equitable “ancillary” remedy that
mortgagee can seek in an action for (1) foreclosure of the
mortgage, (2) for a judgment on the debt, or (3) for specific
performance of an assignment of rents
Appointment of a Receiver: Con
• Con: receivership is costly, particularly by comparison to
direct collection of rent by notification to tenants
– Attorneys’ fees for court process (pleadings, hearing)
– Receiver has to post fidelity bond
– Receiver gets a fee (typically higher than a regular property
management fee)
– If the property is no longer generating enough cash flow to pay
operating and carrying costs, mortgagee will have to “fund” the
additional cost of the receivership
Appointment of a Receiver: Pro
• Gets the mortgagor out of possession of the land (and out of
control of rents), but without making the lender a “mortgagee
in possession”
– This is of particular value in states with long foreclosure timelines
• Receiver, as an agent for court, can manage property and
enter into new leases pending foreclosure
– Mortgagee, as mortgagee in possession, couldn’t effectively enter
into leases w/out the consent of mortgagor
• Note: in Missouri, receivership is very uncommon in cases
of financial defaults on mortgage of completed project
– Nonjudicial foreclosure happens very fast (45-60 days)
– The risk of “losing” the small amount of rent that would accrue in
such a short period of time may not justify the expenses of a
receivership
• By contrast, receivership is more likely in the case of a
“failed” development (e.g., where mortgagor goes into
default before construction is completed)
– Receiver could supervise completion of construction and eventual
sale of the property or foreclosure of the mortgage
Receivership: Discretionary, or Mandatory?
• Traditionally, appointment was in
discretion of court
• Today, “receivership” clauses in
commercial mortgages provide
mortgagor’s consent to appointment of a
receiver after default (e.g., Fannie
multifamily mortgage)
• Should such a clause bind the court?
• Dart case (p. 414) reflects the traditional judicial approach
– Receivership is an equitable remedy, not a contract right (parties cannot
contract to control a court’s equitable discretion)
– Court won’t appoint a receiver if mortgagee’s legal remedy is adequate
– In Dart, mortgagee was “oversecured” (value of land >>> mortgage debt), and
there was no evidence of waste or threat to value of the land
• Restatement § 4.3(b): mortgagee entitled to receiver after default, if
mortgage explicitly so provides, w/out regard to adequacy of security
[p. 418, note 2]
– Uniform Assignment of Rents Act is similar [p. 405]
– Some states (NY, MN, IL, IN) have statutes making appointment mandatory
upon mortgagor default, where mortgage contains consent to appointment
Appointment of Receiver. Beneficiary, separately or in any
action to foreclose this Deed of Trust, shall be entitled (without
notice and without regard to the adequacy of any security for the
Note, the absence of waste or deterioration of the Property or
other arguments based in equity) to the appointment of a
receiver of the Rents of the Property who shall have, in addition
to all the rights and powers customarily given to and exercised by
such receiver, all the rights and powers granted to Beneficiary by
the covenants contained herein. Once appointed, at
Beneficiary’s option, such receiver may remain in place until all
amounts secured hereby are paid in full.
Foreclosure: Real vs. Personal Property
• Under Article 9, secured party can sell personal property
collateral in a private sale, as long as sale is
“commercially reasonable” in all respects [§ 9-610(b)]
• Under real estate law, foreclosure sale is ALWAYS a
public auction sale on courthouse steps
– This is true whether the foreclosure is a judicial foreclosure or
(as in Missouri) a nonjudicial foreclosure
Private Sales
• UCC rationale for allowing private
sales: “they frequently will result in
higher realization [i.e., higher sale
price] on collateral for the benefit of all
concerned.” [§ 9-610, comment 2]
• Why doesn’t real estate law permit
foreclosure in private sales?
Can the Receiver Sell the Property?
• Traditionally, “equity” or “general” receivers (appointed
to take over all assets of the debtor) had the power to
sell receivership property (subject to court approval)
– By contrast, “custodial” or “special” receivers (appointed for
specific property) were viewed as having only the power to
preserve the property, not to sell it
– Under this view, receiver could not sell property free and
clear of liens (i.e., with same impact as a foreclosure sale)
Shubh Hotels Boca LLC
• Bank made $28.8MM mortgage loan to Shubh to renovate
Doubletree Guest Suites in Boca Raton
• Bank obtained receiver, but in receivership, hotel was still losing
$28,000 per month
• May 2010: upon motion by Bank, court authorized receiver to
sell the property in a private sale
• June 2010: receiver signed contract to sell property to new
buyer for $9 million, court approved sale terms
• Shubh (mortgagor) objected
• Should the court be able to empower the receiver to sell the
property free and clear of the borrower’s redemption right, or
should sale be permissible only in a foreclosure sale (that would
trigger borrower’s redemption right)?
Waste
• Tort law restrains the owner of a present estate in land from
changing its physical characteristics in a way that reduces the
value of another person’s interest in that land
– Landlord-tenant
– Life tenant-remainder
– Mortgagor-mortgagee
• E.g., Uphoff sets his house on fire (arson), reducing its value
from $350,000 to $50,000
– If Uphoff’s home was subject to a mortgage held by Bank, Uphoff’s
act = legal waste
• Problem: Bank may not have an enforceable claim
against Uphoff under contract law
– Example: Some mortgage debts are “nonrecourse,” either
by contract or due to state anti-deficiency legislation
– Example: Uphoff may have acquired the land from the
original mortgagor, but without assuming personal liability
on the mortgage debt (Spencer’s Kenosha Bowl, p. 404)
• In these situations, bringing a “waste” action in tort would
be the only way Bank could recover from Uphoff for the
economic harm occasioned by his wasteful conduct
• Bank’s mortgage on Uphoff’s home
secures Uphoff’s obligation to
repay the loan secured by the
mortgage
• So why would Bank sue Uphoff in
tort, for waste?
• If Uphoff hasn’t paid back the loan,
why not just sue him in contract,
for a judgment for the unpaid
balance of the mortgage loan?
Why Sue
for
Waste?
Waste (Review)
• Mortgagee has cause of action in tort, for waste, for
conduct that changes the land in its physical
characteristics in a fashion that reduces its value
• Waste liability doesn’t matter if defendant has contractual
liability on the debt
– Waste liability matters where (1) mortgage is nonrecourse, or
(2) defendant has no personal liability on debt (e.g., 3d party)
Problem 2: Waste or Not?
• Mortgagor does not replace roof of
mortgaged premises
• Mortgagor fails to pay real estate taxes
($150,000) when they become due
• Mortgagor enters into a 10-year “belowmarket rent” lease with a new tenant
• Mortgagor increases casualty insurance
deductible from $10,000 to $1MM
Property Maintenance/Repair
• Mortgagee can avoid any ambiguity as to whether failure
to maintain/repair constitutes actionable waste by
imposing an express affirmative covenant upon the
mortgagor to maintain and repair mortgaged premises
– E.g., Fannie Uniform DOT ¶ 7 (“Borrower shall maintain the
Property in order to prevent the Property from deteriorating or
decreasing in value due to its condition.... Borrower shall
promptly repair the Property if damaged to avoid further
deterioration or damage.”) [p. 1445]
Roof Replacement?
• Traditional rule: “ordinary wear and tear” ≠ waste
• Common law drew a distinction between “active waste”
(actionable) and “passive waste” (not actionable) [p. 431,
Spencer’s decision]
• Modern rule: “Waste occurs when ... [the mortgagor]
fails to maintain and repair the real estate in a
reasonable manner” [Restatement § 4.6(a)(2)]
Problem 2: Waste or Not?
• Mortgagor does not replace roof of
mortgaged premises
• Mortgagor fails to pay real estate taxes
($150,000) when they become due
• Mortgagor enters into a 10-year “belowmarket rent” lease with a new tenant
• Mortgagor increases casualty insurance
deductible from $10,000 to $1MM
Nonpayment of Real Estate Taxes
• Older decisions: nonpayment of taxes was not waste (b/c land
is unchanged in its physical character)
– E.g., State v. Kaye (Mo.Ct.App. 1900) (“The nonpayment of taxes was
not damage or waste to the lands.”)
• Nearly all recent case law (e.g., Spencer’s) and Restatement §
4.6(a)(3) holds that nonpayment of taxes = legal waste
– Rationale: failure to pay taxes harms mortgagee’s security, b/c
local government’s lien for unpaid taxes has priority over
mortgagee’s lien!
• Answer depends on what theory the state follows
• Title theory states = Ætna could recover $150,000
– Mortgagee is “title” holder, and is thus entitled to damages for
full reduction in value of land
– Ætna has to apply damages to reduce unpaid debt!
• Lien theory states = Ætna can recover no damages
– Under lien theory, mortgagee can recover damages equal to
the amount by which its security is impaired
– Here, no security impairment (even after tax lien arises, land is
still worth $6,850,000, more than the $6,000,000 balance)
• Mortgagor fails to pay real
estate taxes ($150,000)
• Unpaid mortgage balance
owed to Ætna = $6,000,000
• FMV of mortgaged land =
$7,000,000
• How much can Ætna recover
from Mortgagor in an action for
waste based on nonpayment of
taxes?
Problem 3
Problem 2: Waste or Not?
• Mortgagor does not replace roof of
mortgaged premises
• Mortgagor fails to pay real estate taxes
($150,000) when they become due
• Mortgagor enters into a 10-year “belowmarket rent” lease with a new tenant
• Mortgagor increases casualty insurance
deductible from $10,000 to $1MM
Insurance Deductible
• Change in deductible threatens Lender’s security, but it is not
“waste” (no physical change to land and no immediate impact on
the land’s value)
• Mortgagee must address this threat by covenant (contract)
– E.g., Fannie DOT ¶ 5 [p. 1443]: “insurance shall be maintained in
the amounts (including deductible levels) and for the periods that
Lender requires”
– Failure = default; Mortgagee can accelerate
Nonrecourse Loans
• On nonrecourse commercial mortgage loan, the Lender
often requires a “guaranty” agreement from one or
more principals of the Borrower
– Typically, a guarantor takes on personal liability for repaying
the guaranteed debt, or some portion of it
• How is the guaranty agreement in Problem 4 different
from a “typical” guaranty?
• In economic terms, a below-market lease
reduces the land’s value to Landlord
(land’s value is a function of net rentals
the land generates)
“Sweetheart”
Lease?
– The longer the term of the lease, the
greater the financial impact
• It is not “waste,” however (as there’s no
physical damage or change to land)
• Lenders address this risk by contract (e.g.,
Assignment of Rents: entering into belowmarket lease w/out Lender’s prior consent
= default)
“Nonrecourse Carveout” or “Bad Boy” Guaranty
• Under the Guaranty in Problem 4, the guarantor takes on
personal liability, not for the debt itself, for certain “bad
acts” or “bad conduct,” including:
– Waste [¶ 1(f)]
– Nonpayment of taxes or charges that would result in mechanics’
lien [¶ 1(j)]
– Misappropriation of rents [¶ 1(c)], insurance proceeds [¶ 1(b)],
condemnation awards [¶ 1(b)], or tenant security deposits [¶ 1(e)]
– Uninsured portion of casualty loss [¶ 1(i)]
– Loss due to criminal forfeiture of mortgaged property [¶ 1(g)]
• Uphoff owns a home, subject to a
mortgage held by Bank
– Uphoff carries fire insurance on the home
with State Farm
– Bank is not carrying a separate policy on
the home; Uphoff’s policy says nothing
about Bank’s interest as mortgagee
Insurance
Problem
• Uphoff’s house is struck by lightning
and it burns to the ground
• Does Bank have any claim to the
insurance proceeds payable under
Uphoff’s fire insurance policy?
• Common law: casualty insurance contract is between insurer
and insured party; mortgagee has no claim against insurance
proceeds payable under mortgagor’s policy, unless either:
– (1) the policy expressly insures the mortgagee as well, or
– (2) the mortgage by its terms expressly obligated mortgagor to insure the
property for the mortgagee’s benefit
• In situation (1), Bank would have claim as insured party
• In situation (2), courts treat mortgagee as having an “equitable
lien” on insurance monies [p. 453]
– As a result, mortgage documents impose this obligation expressly
[Fannie/Freddie DOT, p. 1442-1443, ¶ 5]
– Restatement § 4.7(a)(1) confirms this result
Casualty Insurance: Realty
• Mortgagor and mortgagee each have insurable interests in
the mortgaged property
– Either (or both) are capable of insuring those interests
– Problem: if both parties carry duplicative insurance vs. casualty,
it’s a waste of resources
• Thus, mortgage forms customarily require the mortgagor to
insure both parties’ interests
– E.g., Fannie/Freddie DOT [p. 1245, ¶ 5]
Casualty Insurance: Personalty
• Compare Article 9: Insurance monies for damage to personal
property collateral constitute “proceeds” of collateral [UCC § 9102(a)(64)(E)]
– Security interest in original collateral automatically extends to
“proceeds” [UCC § 9-315(a)(2)]
• Thus, under Article 9, a secured party has lien on insurance
proceeds from damage to collateral, without regard to:
– Whether the policy expressly insured the secured party’s interest, or
– Whether the security agreement obligated the debtor to insure the
collateral for the secured party’s benefit
Insurance Clause in Mortgages [Fannie ¶ 5, p. 1442]
• Policy must include “standard mortgage” clause
– Insurer can’t deny coverage vs. mortgagee, even if it could’ve denied
coverage vs. the mortgagor (e.g., arson by mortgagor)
• Policy must name mortgagee as an additional insured (proceeds
jointly paid to both parties)
• Policy must provide that insurer can’t cancel the policy without
prior notice to mortgagee
• Mortgagee can “force-place” coverage (and add that cost of that
coverage to the unpaid debt) if mortgagor’s insurance lapses
Why Should Bailey Get Proceeds to Rebuild?
• Bailey expected to have 30 years to repay the loan, unless
he defaulted
• He wasn’t responsible for the fire
• If home is rebuilt, Bank will be more than fully secured, so its
security isn’t really threatened
• Contract should be enforced in accordance with reasonable
unexpressed expectations, so court should allow Bailey to
rebuild (if mortgage contract doesn’t prohibit that result)
Problem 1: Control of Insurance Proceeds
• 1994: Bailey bought home for $100K
– Bailey borrowed $90K from Bank, 30-year mortgage, 10% interest
• 2014: Fire occurs; Insurer pays $50K (cost to repair)
– Balance due on mortgage loan at time of fire = $63K
• Bank wants to apply insurance $$ to reduce debt to $13K
• Bailey wants to use proceeds to rebuild the house
• If mortgage is silent, who gets to control the proceeds?
Why Let Bank Apply Proceeds to Debt?
• Monitoring reconstruction of mortgaged property involves risk to
mortgagee
– Bailey might divert funds, or might fail to pay contractors who might obtain
mechanics’ liens
• Bank may not like Bailey’s rebuilding plans
• Bailey’s financial condition may have changed
• At this point, the interest rate on Bailey’s loan may no longer be
favorable to Bank (it may now be “below-market” if rates have
increased)!
• Traditional default rule: if mortgagee has a valid lien against the
insurance proceeds, mortgagee can apply them against the debt
– Mortgagee with valid lien on insurance proceeds does NOT have to
make them available for rebuilding, unless mortgage so requires
– Under this approach, if Bailey wants to rebuild, he can do so, but he’d
have to go out and get a new mortgage loan (and pay off the $13K
outstanding balance on the old mortgage)
• Fannie Uniform DOT ¶ 5 [p. 1444: “Unless Lender and Borrower
otherwise agree in writing, any insurance proceeds ... shall be
applied to restoration or repair of the Property, if the restoration or
repair is economically feasible and Lender’s security is not
threatened.” [This “flips” the traditional default rule.]
“Credit Bidding”
• At foreclosure sales, third parties bidding at the sale
typically have to bid/pay in cash
• By contrast, the foreclosing lienholder can “credit bid”
(i.e., bid against the outstanding debt)
• E.g., Bank is foreclosing mortgage vs. Debtor’s home
– At time of foreclosure, mortgage balance = $200K
– Bank can “credit bid” until the bid amount surpasses $200K
Traditional
(majority) rule
Mortgagee can apply proceeds to debt, unless
mortgage provides otherwise
Starkman rule
[Restatement §
4.7]
Mortgagee must make proceeds available
for restoration (to extent its security is not
impaired), unless mortgage provides
otherwise
Schoolcraft (only in
California)
Mortgagee must make proceeds available for
restoration (to extent its security is not
impaired), EVEN IF mortgage provides
otherwise
• Uphoff defaulted on mortgage to Bank
(balance = $200K)
• At foreclosure sale, Bank buys home
for a $200K “credit bid”
• Unknown to Bank, the home had
burned down the night before!
• State Farm pays Uphoff $200K under
his insurance policy (assume this was
the insured loss)
• Does Bank have claim to the money?
Problem 2
Effect of “Full Credit Bid”
• When mortgagee buys at foreclosure sale by making a “full
credit bid,” the mortgage debt is satisfied in full
– At time of fire, the Bank’s insured interest was as a mortgagee
– However, Bank suffered no loss as mortgagee, because the debt
was repaid in full by virtue of the credit bid!
– Thus, Bank has no claim against insurance funds, and Uphoff gets
the insurance money!
• Is this a sensible result?
Insurance Certificates
• ACORD 28 (Evidence of Commercial Property
Insurance) form distributed in last Tuesday’s class
– This form is commonly provided as “proof” of insurance
• Note: if the form is wrong (i.e., if it says the policy
covers replacement cost, but the actual policy does
not), the policy controls
– Thus, a lender cannot rely on review of the certificate as a
“short cut”; must review the policy itself
Insurance Proceeds for Post-Foreclosure Loss
• Note 7, page 468: If fire had occurred AFTER
mortgagee purchased home at foreclosure by credit bid,
mortgagee would have claim against insurance
proceeds
– Note: this is true where (1) policy insured mortgagee as an
additional insured or (2) where mortgagor was obligated to
provide insurance for benefit of mortgagee
Escrows for Insurance/Taxes
• Mortgage often requires mortgagor to make “escrow” payment
each month = 1/12 of expected annual cost of taxes, insurance,
PMI [Fannie DOT, ¶ 3, pp. 1440]
– Mortgagee uses escrow funds to pay these costs as they come
due during the year
– Escrow is mandatory for residential mortgages (Fannie/Freddie
requirement)
– By contrast, escrow is negotiable (and is often waived) on
commercial mortgages
Escrow Deposits: Interest
• Some state laws require a lender to pay interest on escrow
deposit balances (note: no such requirement in Missouri!)
– Note: OCC regulations [12 CFR § 560.2] pre-empt any state laws that
would require federally chartered S&Ls to pay interest on escrow
deposits
• Fannie DOT [§ 3, p. 1441]: “Unless an agreement is made in
writing or Applicable Law requires interest to be paid on the
Funds, Lender shall not be required to pay Borrower any interest
or earnings on the Funds.”
Waiver of Escrow: Drafting
• If commercial borrower wanted a waiver of escrow
requirement for insurance/taxes, what kinds of “protections”
would you want to draft into the loan documents?
– Nonpayment = breach/default
– Borrower will provide Lender proof of payment in advance (in time
for Lender to act if proof is not provided)
– Insurance policy to provide notice to Lender prior to cancellation