November 4, 2010
Distressed Real Estate
Roundtable Materials
Contents
Panelist Profiles
K&L Gates Distressed Real Estate Alerts
K&L Gates Distressed Real Estate Practice
K&L Gates includes lawyers practicing out of 36 offices located in North America, Europe, Asia and the Middle East, and represents
numerous GLOBAL 500, FORTUNE 100, and FTSE 100 corporations, in addition to growth and middle market companies,
entrepreneurs, capital market participants and public sector entities. For more information, visit www.klgates.com.
K&L Gates comprises multiple affiliated entities: a limited liability partnership with the full name K&L Gates LLP qualified in Delaware
and maintaining offices throughout the United States, in Berlin and Frankfurt, Germany, in Beijing (K&L Gates LLP Beijing
Representative Office), in Dubai, U.A.E., in Shanghai (K&L Gates LLP Shanghai Representative Office), in Tokyo, and in Singapore; a
limited liability partnership (also named K&L Gates LLP) incorporated in England and maintaining offices in London and Paris; a Taiwan
general partnership (K&L Gates) maintaining an office in Taipei; a Hong Kong general partnership (K&L Gates, Solicitors) maintaining
an office in Hong Kong; a Polish limited partnership (K&L Gates Jamka sp. k.) maintaining an office in Warsaw; and a Delaware limited
liability company (K&L Gates Holdings, LLC) maintaining an office in Moscow. K&L Gates maintains appropriate registrations in the
jurisdictions in which its offices are located. A list of the partners or members in each entity is available for inspection at any K&L Gates
office.
©1996-2010 K&L Gates LLP. All Rights Reserved.
Panelist Profiles
Moderators
David Jones
Distressed Real Estate Task Force Chair, K&L Gates LLP
Mr. Jones focuses his practice on real estate joint ventures, public/private partnerships, real estate
financing, real estate debt restructuring and work outs, real estate development, and real estate taxation. He
represents real estate investors, developers and lenders in the structuring and negotiation of real estate
equity and debt financing and debt restructuring; owners and developers in the acquisition, development,
disposition, and financing of multi-family housing; and real estate developers in negotiating for development
incentives from local governments, and in structuring of tax-increment financing and similar transactions.
Andrew Petersen
Head of Distressed Real Estate Task Force Europe, K&L Gates LLP
Mr. Petersen advises financial institutions and private equity funds on debt and equity lending,
restructurings, workouts and enforcement of debt and equity positions. He works closely with business
support, restructuring and litigation teams in relation to positions involving capital market issues, providing
strategic advice to loan servicers and sellers of loans and mortgage-backed securities and investors owning
or acquiring troubled or distressed assets. He has spent a period of time in the U.S. and has unique
crossover experience acting for investors purchasing, selling and managing CMBS, B notes and mezzanine
loans, both in the U.S. and in Europe.
Panelists
Steven Altman
Director, Torchlight Loan Services (formerly ING Clarion)
Mr. Altman joined Torchlight Investors in 2003 and is a Director overseeing special servicing and distressed
debt workout. He has 23 years of professional experience. Prior to Torchlight, Mr. Altman worked at
Commerzbank Securities, Fitch Ratings, Metropolitan Life Insurance Company and Arthur Andersen LLP.
He is a Certified Public Accountant in Michigan and holds an MBA and a BBA from the University of
Michigan.
Jeff Fastov
Founding Principal, Oasis Real Estate Partners
Mr. Fastov specializes in all aspects of commercial real estate credit. He is the former head of Goldman
Sachs’ commercial real estate lending business with responsibilities for new business development, client
coverage, transaction negotiation and execution, underwriting, credit, and securitization.
He previously co-headed the development of Goldman Sachs Commercial Mortgage Capital and joint
ventures with Central Park Capital and AMRESCO. Mr. Fastov was a member of both the GS Real Estate
Credit Committee and the GS Real Estate Partners Investment Committee. He has led banking teams
responsible for acquisition diligence, asset and liability valuation, and developing funding structures for
clients investing in banks, finance companies, and segregated loan portfolios. Mr. Fastov has also led
transaction teams that bid on sub-performing and non-performing loan pools sold by the RTC, banks,
insurance companies, and finance companies. Mr. Fastov joined Goldman Sachs in 1992 as a Vice
President and became a Managing Director in 1999. Previously, he worked at Moody's Investors Service,
where he established the CMBS group and developed Moody's ratings criteria. Mr. Fastov serves on the
Board of Governors of the Commercial Mortgage Securities Association. He is a graduate of the
University of Rochester (BA Economics) and has an MBA from Columbia University.
Jeffrey Lavine
Managing Director, SNB StabFund Investment Management, UBS Investment Bank
Mr. Lavine is a Managing Director and Senior Portfolio Manager at UBS AG and Co-Head of a Commercial
Real Estate Group, where he co-manages a domestic portfolio of whole loans, subordinate debt, REO
properties and securities. Prior to his role with the UBS AG, Mr. Lavine was the Head of Transaction
Management and Loan Structuring for the Real Estate Finance Group at UBS Investment Bank.
Prior to joining UBS, Mr. Lavine was a Senior Managing Director at Bear Stearns & Co., Inc. In that role he
created and headed the U.S. Loan Closing and Structuring Group. Mr. Lavine had been a key member in
the creation and implementation of large loan, small loan and other conduit programs for both securitized
and balance sheet lending in all major property and transaction types. Mr. Lavine was also involved in the
establishment of Bear Stearns’ London and Tokyo real estate lending units. He holds a BA from Tufts
University, magna cum laude, an MBA from Columbia Business School and a JD from Boston University
School of Law, where he was Administrative Editor of the International Law Journal.
Andrew S. Levine
General Counsel, SL Green
Mr. Green has served as Chief Legal Officer since April 2007 and as General Counsel, Executive Vice
President and Secretary since November 2000. Prior to joining the Company, Mr. Levine was a partner in
the REIT and Real Estate Transactions and Business groups at the law firm of Pryor, Cashman, Sherman &
Flynn, LLP. Prior to joining Pryor, Cashman, Sherman & Flynn, LLP, he was a partner at the law firm of
Dreyer & Traub. Mr. Levine received a B.A. degree from the University of Vermont and a J.D. degree from
Rutgers School of Law, where Mr. Levine was an Editor of the Law Review.
Spencer Levy
Senior Managing Director, CBRE
Mr. Levy is responsible for overseeing and coordinating the activities of more than 300 investment sales and
debt/equity finance professionals in the Eastern Region of the United States. In addition to his duties in
Capital Markets, he is co-head of the Recovery and Restructuring Services (RRS) business line, which
assists both large financial institutions and government entities with real estate services required for both
REO and whole loan assets. Prior to joining CBRE, Mr. Levy was a Principal at Stifel Nicolaus (formerly
Legg Mason Capital Markets), one of the most active and diverse real estate investment banking practices
in the US. As Principal, he was responsible for leading overall execution several major merger and
acquisition assignments. Mr. Levy played a significant role in the initial public offering of six REITs, as well
as dozens of other public and private capital-raising transactions. Previous to this position, he served as
Assistant General Counsel of the Witkoff Group, formerly one of the largest property owners in the New York
City area.
Mr. Levy is a frequent lecturer at real estate industry events and is often quoted in prominent real estate
publications. Most recently, he was interviewed on Fox Business News and has been quoted in The New
York Observer, The New York Times, Puget Sound Business Journal (Seattle), Crain’s New York Business,
National Real Estate Investor, The Washington Post and Real Estate Forum.
Perry Mandarino
U.S. Head of Business Recovery Services, PriceWaterhouseCoopers
Mr. Mandarino, a Certified Public Accountant, provides assistance to clients in the areas of strategic
planning, complex debt restructurings, preparation of turnaround and business plans, cash flow analyses,
preference investigations, fraud and fraudulent conveyance investigations, collateral evaluation and claims
resolution. He assists numerous clients in the negotiation, development and implementation of Plans of
Reorganization.
Mr. Mandarino served as the Chief Restructuring Officer of Hoop Holdings, Inc. d/b/a/ The Disney Stores.
He also served as the Examiner in the Polaroid, Inc. and Summit Global Logistics chapter 11 cases. Mr.
Mandarino has represented several lending institutions, including D.E. Shaw, BNP Paribas, Wachovia Bank
and Lampe, Conway & Co. He has extensive experience in the Bankruptcy Courts in the Districts of
Delaware, New Jersey and New York, where he has testified and been qualified as an expert in matters
related to financial viability, valuation, general reorganization matters and financing. He has assisted clients
in raising over $700 million in debt and equity financings, and has represented over 300 clients during his
career. Mr. Mandarino received a Bachelor of Science from Seton Hall University.
Matthew Webster
Managing Director, Global Head of Real Estate Financing, HSBC Bank Plc Chairman, Commercial
Real Estate Finance Council Europe
Mr. Webster is responsible for coordinating Commercial Real Estate Financing activities on a $100 billion
loan book. He joined HSBC in 2005 from Hypo Real Estate Bank International to develop a principal
Commercial Mortgage Backed Securities loan origination and securitisation platform. Mr. Webster also has
been responsible for initiating and developing the distribution capacity for real estate mezzanine risk for all
European Real Estate products. He has held various positions at Goldman Sachs International, Morgan
Stanley International, Fitch Ratings Limited and Capital Reinsurance Corp.
Mr. Webster has over 18 years experience working with commercial real estate in various capacities as
lender, debt investor, insurer, rating agency analyst and capital market participant in the U.S. and Europe.
He has worked with numerous other asset classes, including Corporate Acquisitions, Mezzanine Loan
facilities and various Corporate Receivables, amongst others, totaling in excess of $400 billion of
investments. Mr. Webster holds a Bachelor of Science Degree in Economics and a Bachelor of Science
Degree in Business Management from North Carolina State University. He obtained his Chartered Financial
Analyst certificate in 1996 from the CFA Institute. He also represents HSBC on the Board of Governors for
the Commercial Real Estate Finance Council – Europe and is the 2011 CREFC-Europe Chair.
Trevor Williams
Chief Economist, Lloyds Banking Group
Mr. Williams joined Lloyds Bank from the UK civil service, where he worked as an economist after being
offered a position whilst studying for a PhD. He has also worked as a lecturer. Mr. Williams is a member of
the Economic Research, Corporate Markets divisions of Lloyds Banking Group. The Corporate Markets
economics team supports the bank’s trading and sales activities. Mr. Williams is a member of the Institute
for Economic Affairs Shadow Monetary Policy Committee, setup two months after the actual MPC in 1997.
He is also on the executive committee of the Financial Statistics User Group (FSUG). Mr. Williams regularly
appears on radio and TV to represent the economic views of Lloyds TSB Corporate Markets, and to be
interviewed on current economic issues. He has a BA honours degree and a masters in economics.
Real Estate Alert
April 15, 2010
Authors:
William J. Brian, Jr.
bill.brian@klgates.com
+1.919.466.1261
Nathaniel C. Parker
nathaniel.parker@klgates.com
+1.919.466.1118
K&L Gates includes lawyers practicing out
of 36 offices located in North America,
Europe, Asia and the Middle East, and
represents numerous GLOBAL 500,
FORTUNE 100, and FTSE 100
corporations, in addition to growth and
middle market companies, entrepreneurs,
capital market participants and public
sector entities. For more information,
visit www.klgates.com.
Going … Going … Gone!
Why Time is of the Essence in Preserving the
Value of Development Entitlements in
Distressed Real Estate Assets
In one more twist of the current recession, many banks and other institutional lenders
have found themselves playing an unfamiliar role. Rather than financing
development projects, they own them. Unfortunately, taking over a distressed real
estate asset raises a whole host of potential challenges and risks.
In particular, lenders acquiring projects still under development must understand the
role the zoning and entitlement process plays in creating and maintaining the value
of the asset. Land use regulations vary among states and localities, but the key to
due diligence in any jurisdiction is understanding what approvals have been
obtained, what they cover, and when they expire.
In general terms, development entitlements derive from federal, state, regional, and
local authorities. Most businesses dealing with real estate in any way are familiar
with wetlands delineations approved by the U.S. Army Corps of Engineers,
stormwater management permits issued by a state’s environmental agency, or a
municipal building permit, but these entitlements are only the tip of the proverbial
iceberg. Not only do development entitlements range up and down the jurisdictional
hierarchy, but they also span the subjects of land use, environmental regulation,
infrastructure, and contractual agreements.
Determining what entitlements apply to a given project is wholly dependent on
where the project is located, because each state, county, and city offers its own menu
of land use, environmental, and infrastructural requirements – using inconsistent
nomenclature and riddled with local peculiarities. A case study illustrates this
complexity:
A lender recently acquired an incomplete mixed use community. The infrastructure
had been started, but no structures had been sold or leased. Therefore, the value of
the asset was based on the ability to build and sell developed parcels. This ability,
and therefore the asset’s value, was entirely based on a series of entitlements. First,
the land use approvals that the project had received from the county included zoning
to a greater density that required a special use permit, subdivision approval to create
the saleable lots, and site plans for the common area amenities. Second, the project
had received environmental approvals from the state’s environmental agency and the
U.S. Army Corps of Engineers including a permit for development in an area of
environmental concern, a state stormwater management permit, an approved erosion
and sedimentation control plan, and an approved wetlands delineation. Third, the
project was required as a condition of its special use permit to provide a portion of its
water capacity for public use.
Real Estate Alert
Understanding what entitlements were present was
only the beginning. Ensuring that these valuable
entitlements were maintained required action. To
move forward with the project (or to sell the project
to someone who can move forward with it), the
lender needed to transfer most of the approvals from
the defaulting borrower to itself. Next, it needed to
determine what the zoning, subdivision, and site
plans allowed to be built. Re-orienting the plans to a
changed market was limited by the prior land use
approvals or required re-applying for new approvals.
Not moving forward with the project was also
problematic because the site plan approval would
expire if specific progress was not made on the
project. Moreover, the special use permit
conditioned beginning the project on a number of
specific commitments, for which the lender would
have to bear the cost. The environmental
entitlements also required oversight. Permits
required renewal, or in some cases, that
infrastructure be constructed before the permit
expired. In the case of this project, a new state law
had extended the expiration date of several of the
permits – a point which local authorities were
unenthusiastic to learn.
The moral of this case study is that a lender may
acquire a real property asset to reduce losses, but in
order to preserve the value of the asset, the lender
must know the nature and timing of all approvals
and entitlements that benefit and encumber the
project. That process is complex, varies from
jurisdiction to jurisdiction, and the clock does not
stop for anyone, even foreclosing lenders. That is
why engaging knowledgeable professionals to guide
lenders through this process is vital. K&L Gates
has attorneys experienced in all phases of the
entitlement process across the country who can help
you understand and preserve the value of real estate
assets.
Anchorage Austin Beijing Berlin Boston Charlotte Chicago Dallas Dubai Fort Worth Frankfurt Harrisburg Hong Kong London
Los Angeles Miami Moscow Newark New York Orange County Palo Alto Paris Pittsburgh Portland Raleigh Research Triangle Park
San Diego San Francisco Seattle Shanghai Singapore Spokane/Coeur d’Alene Taipei Tokyo Warsaw
Washington, D.C.
K&L Gates includes lawyers practicing out of 36 offices located in North America, Europe, Asia and the Middle East, and represents numerous
GLOBAL 500, FORTUNE 100, and FTSE 100 corporations, in addition to growth and middle market companies, entrepreneurs, capital market
participants and public sector entities. For more information, visit www.klgates.com.
K&L Gates is comprised of multiple affiliated entities: a limited liability partnership with the full name K&L Gates LLP qualified in Delaware and
maintaining offices throughout the United States, in Berlin and Frankfurt, Germany, in Beijing (K&L Gates LLP Beijing Representative Office), in
Dubai, U.A.E., in Shanghai (K&L Gates LLP Shanghai Representative Office), in Tokyo, and in Singapore; a limited liability partnership (also named
K&L Gates LLP) incorporated in England and maintaining offices in London and Paris; a Taiwan general partnership (K&L Gates) maintaining an
office in Taipei; a Hong Kong general partnership (K&L Gates, Solicitors) maintaining an office in Hong Kong; a Polish limited partnership (K&L
Gates Jamka sp. k.) maintaining an office in Warsaw; and a Delaware limited liability company (K&L Gates Holdings, LLC) maintaining an office in
Moscow. K&L Gates maintains appropriate registrations in the jurisdictions in which its offices are located. A list of the partners or members in each
entity is available for inspection at any K&L Gates office.
This publication is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon
in regard to any particular facts or circumstances without first consulting a lawyer.
©2010 K&L Gates LLP. All Rights Reserved.
April 15, 2010
2
Distressed Real Estate Alert
February 2010
Authors:
Terrence E. Budny
terrence.budny@klgates.com
+1.312.807.4293
Brian P. Evans
brian.evans@klgates.com
+1.704.331.7479
K&L Gates includes lawyers practicing
out of 35 offices located in North
America, Europe, Asia and the Middle
East, and represents numerous GLOBAL
500, FORTUNE 100, and FTSE 100
corporations, in addition to growth and
middle market companies,
entrepreneurs, capital market
participants and public sector entities.
For more information, visit
www.klgates.com.
Title Insurance Industry Reacts to Recession:
Creditors’ Rights Endorsements Decertified
by ALTA and Generally Unavailable
The title insurance industry has for all practical purposes eliminated an important
layer of coverage provided by both owner’s and lender's title insurance policies.
This coverage, embodied in what is called the “creditors' rights endorsement,”
protected real estate owners and lenders from risks that would customarily arise
when either the party from whom the insured owner purchased the property, or the
mortgagor who granted the insured lender a mortgage, files for bankruptcy. Real
estate purchasers and lenders will have to evaluate these bankruptcy risks themselves
rather than relying on the title insurer to do it for them. Below is a discussion of
what this means to the real estate industry.
The current (2006) American Land Title Association (“ALTA”) form of loan policy
of title insurance, which is in general use by title insurers throughout the United
States, excludes from coverage the following (collectively, “Creditors’ Rights”):
Any claim, by reason of the operation of federal bankruptcy, state
insolvency, or similar creditors’ rights laws, that the transaction
creating the lien of the insured mortgage, is:
i) a fraudulent conveyance or fraudulent transfer, or
ii) a preferential transfer for any reason not stated in Covered Risk
13(b) of this Policy.
(Covered Risk 13 (b) covers loss arising out of Creditors’ Rights by reason of a
failure to timely record the instrument creating the estate or lien, or a defect in that
instrument resulting in failure to impart record notice.)
There is a similar exclusion in the ALTA form of owner’s policy of title insurance.
California has its own forms that are prescribed by the California Land Title
Association and which tend to mirror the ALTA forms.
The purpose of this exclusion is to isolate the title insurer from liability under the
title policy in the event that the acquisition of the subject property (as to an owner’s
policy) or the encumbering of the subject property by a mortgage, deed of trust or
equivalent (as to a loan policy) by the insured is challenged by a creditor of the
transferor or by a trustee in bankruptcy on the basis of the fraudulent conveyance
provisions of Section 548 of the United States Bankruptcy Code (the “Code”) or
substantively equivalent state laws, or on the basis of the preferential transfer
provisions of Section 547 of the Code.
Distressed Real Estate Alert
In addition to transfers made with an intent to
defraud a creditor, fraudulent transfers under the
Code include transfers for less than “reasonably
equivalent value” and in which the party transferring
the property is insolvent, illiquid, or
undercapitalized. If a creditor successfully asserts
that a transaction is a fraudulent transfer under the
Code, that transfer can be voided and the property
that was fraudulently transferred, or its value, can be
recovered from the transferee for the benefit of the
bankrupt’s estate. Transferees are afforded
protection if the property interest was acquired for
value and in good faith, but the transferee would
have to establish those facts in bankruptcy court.
Therefore, if a purchaser acquires fee simple to a
shopping center for a price that is drastically under
market, and is aware that the seller will be insolvent
after the transfer, then other creditors of the
shopping center seller could force the seller into
bankruptcy, attack the sale as a fraudulent transfer,
and seek to recover from the purchaser the
difference between the price paid and the market
value of the center.
A preference under Section 547 of the Code includes
a transfer of an interest in property to secure an
antecedent debt made while the debtor was insolvent
and within 90 days before the date of the filing of
the bankruptcy petition. Lenders in the current
environment are scrambling to get better secured.
Let’s say a lender made a $5,000,000 loan to an
office building owner secured by a deed of trust on
the building. Suspecting that the value of the
property has declined, the lender obtains an
appraisal, which shows that the property is now
worth only $1,500,000. This breaches a loan
covenant, and the lender notifies the borrower of that
fact. The borrower responds that she owns a beach
house worth $3,000,000 that is unencumbered. She
offers to give a mortgage on that house to secure the
$5,000,000 loan, and the lender accepts. Within 90
days she declares bankruptcy. The lender’s
mortgage on the beach house can likely be set aside
as a preference.
Purchasers and lenders have been able to obtain
coverage over Creditors’ Rights (except in New
York, Texas and New Mexico), either by obtaining
title insurance in the form of the 1970 (revised 1984)
ALTA policies (which do not exclude Creditors’
Rights from coverage), deleting the Creditors’
Rights exclusion by endorsement, or obtaining a
“creditor’s rights endorsement” (which ALTA
adopted as ALTA Endorsements 21 and 21-06, and
which CLTA adopted as CLTA 131 and 131-06)
that results in insurance protection from the
assertion of these Creditors’ Rights. In order to
obtain such coverage, title insurers have had to
separately underwrite the risk that Creditors’ Rights
would be asserted and have customarily required the
submission by the parties to the transaction of a
“creditors’ rights affidavit” and financial
information regarding both the subject property and
the transferor under the deed or mortgage to be
insured. In many states, an additional premium has
been charged for this coverage. Given the
considerable benefits conferred by Creditors’ Rights
coverage, its issuance has become fairly standard
for commercial real estate transactions, and the
creditors’ rights endorsement has long been a staple
on the menu of endorsements required by lenders.
If the shopping center owner in the first example
above had an owner’s policy with Creditors’ Rights
coverage, it could have made a claim on its owner’s
policy for the loss suffered. If the lender taking the
beach house as additional collateral had a loan
policy with Creditors’ Rights coverage, she could
likewise make a claim for loss arising out of the
avoidance of the lien of the mortgage, subject to the
other terms of the policy.
The recent turmoil in the commercial real estate
markets has led to the challenge, particularly in the
context of a bankruptcy, of sales and mortgages as
either fraudulent conveyances or preferential
transfers. Where the subject transaction has
involved the issuance of a title insurance policy with
Creditors’ Rights coverage, the insured has tendered
the defense of these claims to the title insurer. This
in turn has led to considerable exposure to the title
insurance industry, both for the costs of litigation
and ultimately for the full amount of insurance
under the applicable title insurance policies.
The magnitude of this exposure has led to the recent
announcement by ALTA that it has voted to
withdraw or decertify the ALTA Endorsements 21
and 21-06 as official ALTA forms effective March
8, 2010. ALTA has confirmed that title insurers
may decide on their own whether to issue coverage
over Creditors’ Rights and what form of
February 2010
2
Distressed Real Estate Alert
endorsement to use, but as of March 8 there will be
no current ALTA approved form.
reasonable expectation is that all title insurers will
follow suit.
Recently, the states of New Jersey, Pennsylvania,
Delaware and Oregon (which are states that require
the approval of endorsement forms issued by title
insurers writing policies in their respective
jurisdictions) have taken the same step.
Pennsylvania’s action took effect February 1, 2010;
the effective date in the other states awaits final
administrative action. Effective February 4, CLTA
decertified CLTA 131 and 131-06. The result is that
creditors’ rights endorsements are no longer
available in these states.
Where does this leave purchasers and lenders who
have become accustomed to Creditors’ Rights
coverage? The burden of underwriting the risk of a
fraudulent transfer or preference has been shifted
from the title insurers to their insureds. Lenders
purchasing owner’s policies for property purchased
out of a foreclosure or by deed in lieu must be
careful to calculate any bid or relief of indebtedness
to approximate the fair market value of the property.
Lenders will need to pay even closer attention to the
value of their collateral and the financial strength of
their borrowers. Borrowers must negotiate any
requirement for creditors’ rights coverage out of
their loan commitments. Purchasers will likewise
need to be alert to sales for less than value and
sellers in financial distress. Doing so is particularly
difficult in the current environment of declining
values and general financial instability.
As might be expected, the Fidelity National Title
group of underwriters, which includes Chicago Title,
Fidelity National Title, Ticor Title, Lawyers Title,
Commonwealth Land Title, Security Union Title and
Alamo Title, announced on February 4, 2010 that
effective as of that date, Creditors’ Rights coverage
will no longer be offered. In addition, First
American Title Insurance Company announced on
February 8, 2010 that it too will no longer provide
Creditors’ Rights coverage. First American cites
“the economic impact of our current market cycle,
actions of rating bureaus, recent Bankruptcy Court
decisions and a lack of availability of excess
reinsurance for these risks.” While some title
insurers may be willing to continue to issue
coverage over Creditors’ Rights, the more
There is likely little comfort in knowing that
purchasers and lenders nationwide will now be
treated the same as their counterparts in New York,
Texas and New Mexico. In any event, just as these
counterparts, they will have to rely on their own
analyses of the fraudulent conveyance and
preference risks inherent in their transactions, price
them accordingly and act at their own, and not the
title insurers’, risk.
Anchorage Austin Beijing Berlin Boston Charlotte Chicago Dallas Dubai Fort Worth Frankfurt Harrisburg Hong Kong London
Los Angeles Miami Moscow Newark New York Orange County Palo Alto Paris Pittsburgh Portland Raleigh Research Triangle Park
San Diego San Francisco Seattle Shanghai Singapore Spokane/Coeur d’Alene Taipei Tokyo Washington, D.C.
K&L Gates includes lawyers practicing out of 35 offices located in North America, Europe, Asia and the Middle East, and represents numerous
GLOBAL 500, FORTUNE 100, and FTSE 100 corporations, in addition to growth and middle market companies, entrepreneurs, capital market
participants and public sector entities. For more information, visit www.klgates.com.
K&L Gates is comprised of multiple affiliated entities: a limited liability partnership with the full name K&L Gates LLP qualified in Delaware and
maintaining offices throughout the United States, in Berlin and Frankfurt, Germany, in Beijing (K&L Gates LLP Beijing Representative Office), in
Dubai, U.A.E., in Shanghai (K&L Gates LLP Shanghai Representative Office), in Tokyo, and in Singapore; a limited liability partnership (also named
K&L Gates LLP) incorporated in England and maintaining offices in London and Paris; a Taiwan general partnership (K&L Gates) maintaining an
office in Taipei; a Hong Kong general partnership (K&L Gates, Solicitors) maintaining an office in Hong Kong; and a Delaware limited liability
company (K&L Gates Holdings, LLC) maintaining an office in Moscow. K&L Gates maintains appropriate registrations in the jurisdictions in which its
offices are located. A list of the partners or members in each entity is available for inspection at any K&L Gates office.
This publication is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon
in regard to any particular facts or circumstances without first consulting a lawyer.
©2010 K&L Gates LLP. All Rights Reserved.
February 2010
3
Distressed Real Estate Alert
November 10, 2009
Authors:
David E. Rabin
david.rabin@klgates.com
+1.212.536.4002
David H. Jones
david.jones@klgates.com
+1.704.331.7481
K&L Gates is a global law firm with
lawyers in 33 offices located in North
America, Europe, Asia and the Middle
East, and represents numerous GLOBAL
500, FORTUNE 100, and FTSE 100
corporations, in addition to growth and
middle market companies,
entrepreneurs, capital market
participants and public sector entities.
For more information, visit
www.klgates.com.
New Policy Statement on Commercial Real
Estate Loan Workouts – Providing Welcomed
Flexibility
When as a child we received a long-awaited toy that required assembly, so often we
would rush to throw it together without even glancing at the thick instruction manual
left sitting in the box, believing we could rely on past experience and instinct to get it
right – that is, until we got towards the end and discovered that a critical piece could
not be inserted without unwinding many of the prior steps. In a few cases, the error
was irreversible, and the toy was ruined. The hard lesson learned was to take the
time to follow the instruction manual in order to enjoy the gift both immediately and
into the future.
On October 30, 2009, the agencies of the Federal Financial Institutions Examination
Council1 issued a Policy Statement on Prudent Commercial Real Estate Loan
Workouts (the “Policy Statement”). Although the Policy Statement does not provide
a “step-by-step manual” on how to structure workouts of commercial real estate
loans, it does provide a broad overview of what factors the financial regulators will
consider in determining whether a loan workout is conducted prudently, and it
includes numerous practical examples of both successful and unfavorable strategies.
Knowing how the financial regulators are likely to view a restructured loan provides
(a) real estate borrowers with a realistic expectation of whether their loan workout
proposals might be acceptable to their lenders and (b) real estate lenders with a road
map to a restructuring that will avoid adverse regulatory treatment. Although the
Policy Statement does in some instances require that lenders recognize losses for all
or part of loans that are not reasonably assured of repayment, notably it also
expressly states that an undercollateralized mortgage loan will not be adversely
classified solely because the value of the real estate has declined to less than the loan
balance—as long as the borrower has the ability to repay the restructured debt on
reasonable terms. As a result, lenders now have new breathing room and may be
permitted to retain billions of dollars of undersecured commercial real estate loans
without having to write down these assets. The investors who have been waiting on
the sidelines thinking that this recession might present a new opportunity to pluck
out investments for pennies on the dollar and reap the type of bonanzas they saw
during the RTC days will have to keep waiting.
1
The Policy Statement was issued on behalf of the Board of Governors of the Federal Reserve System, the
Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of
the Currency, the Office of Thrift Supervision, and the Federal Financial Institutions Examination Council State
Liaison Committee.
Distressed Real Estate Alert
The Council’s statement may be found at:
http://www.fdic.gov/news/news/financial/2009/fil09
061a1.pdf. The purpose of the Policy Statement is to
instruct the examiners working for the various
financial regulators on how loan workouts should be
classified on the balance sheets of the institutions.
The Policy Statement provides numerous examples
of how the drafters of the Policy Statement believe
those loans should be classified.
The Policy Statement applies to federally regulated
financial institutions such as banks and savings and
loans institutions and to loans held for investment by
those institutions. It does not expressly provide
guidance to servicers and special servicers of loans
in pools supporting commercial mortgage backed
securities. In those instances, the servicer’s and the
special servicer’s actions are governed first and
foremost by the terms and conditions of applicable
pooling and servicing agreements and by the tax
limitations generally applicable to Real Estate
Mortgage Investment Conduits (“REMICs”) (recent
modifications to some of these limitations that bear
on commercial mortgage loan workouts were
discussed in our Distressed Real Estate and Tax
Alert, “New REMIC Rules May Provide More
Room to Modify Commercial Real Estate Loans,”
which can be viewed at:
http://www.klgates.com/newsstand/Detail.aspx?publ
ication=5953. However, given that nothing as clear
and detailed as the Policy Statement has been issued
in the past in any forum, that the guidance provided
by the Policy Statement with respect to evaluating
loan structures is of general applicability and is not
specific to regulated banking institutions, and that
pooling and servicing agreements typically do not
provide the level of guidance to special servicers as
that found in the Policy Statement2, we believe that
the principles of the Policy Statement will be
adopted broadly and will find their way in some
fashion into securitized structures.
Categorization of Loans
How loans are categorized directly affects how
banks and savings and loans report income,
recognize losses and must maintain reserves. These
regulated lenders will be less inclined to approve
loan workouts that require them to recognize losses
or increase their reserves or those that result in such
lenders not being able to recognize interest income.
The Policy Statement focuses on three aspects of the
loan categorization system in connection with
commercial real estate loan workouts. The basic
classification system sorts loans based on the
likelihood of full repayment. The highest
classification is referred to as “Pass.” A loan is
classified as “Pass” if it is performing, and the bank
does not perceive any specific potential weakness
that might jeopardize its repayment. The next
classification is “Special Mention.” Loans that are
classified as “Special Mention” are performing
loans that have a recognized potential weakness that
deserve close attention by the lender and that, if left
uncorrected, could result in a risk of prepayment.
The next level down is a “Substandard” loan, which
means that the loan is not adequately collateralized,
or the paying capacity of the borrower is considered
inadequate. A substandard loan has some welldefined weakness that jeopardizes the repayment of
the debt in full.
Below substandard loans are “Doubtful” loans.
These are substandard loans where the identified
weakness makes repayment in full highly
questionable and improbable. Finally, the lowest
category is a “Loss” classification. Loans classified
as “Loss” are considered uncollectible.
When the Policy Statement refers to a loan having a
“weakness,” it means anything that increases the
risk that the loan will not be repaid in full on time.
A weakness could be a drop in the value of
collateral, an adverse change in the financial
condition of the borrower or the guarantor, market
conditions that depress rents or sales activities, the
bankruptcy of a large anchor tenant, a rise in rent
payment delinquencies, the lack of refinancing
options or combinations of any of these factors or
others.
2
A typical pooling and servicing agreement will not offer the servicer or
special servicer as much guidance as the Policy Statement, but will
contain restrictions on the servicer’s or special servicer’s ability to
conduct certain workout activities, which may be circumscribed by,
among other things, REMIC limitations, requirements for rating agency
confirmations, and consent or purchase rights of holders of junior
classes of certificates or subordinate or mezzanine debt interests.
However, in all cases, servicers and special servicers are generally
required to conduct their activities in accordance with a “Servicing
Standard.” That usually is defined by reference in some manner to a
paradigm such as “the customary and usual standards of practice of
prudent institutional commercial mortgage lenders servicing their own
loans.” The Policy Statement likely will provide a handy benchmark for
what those “customary and usual standards” entail.
November 10, 2009
2
Distressed Real Estate Alert
The second type of categorization conducted by
bank management and regulators is whether the loan
should be considered on “Accrual” or “Non-accrual”
status. When a loan is on “Accrual” status, the
interest accruing on that loan may be booked as
income for the financial institution. If a loan is on
“Non-accrual” status, the interest accruing on that
loan is not recognized as part of the income of the
financial institution.
The final type of categorization addressed in the
Policy Statement deals with so-called “Troubled
Debt Restructures” or “TDRs.” A loan workout is
considered to be a TDR if the borrower is
experiencing financial difficulties and the terms of
the workout provide a “concession” to the borrower.
If a loan is classified as a TDR, then that loan must
be assessed individually in accordance with
appropriate accounting standards and will be
deemed to be an impaired asset on the books of the
lender, which will require the value of the loan to be
reduced on the lender’s books to then market value.
The Policy Statement is realistic in acknowledging
that many restructurings will result in loans having
an adverse classification (that is, anything below a
“Pass”) and provides that entering into a workout
will not be criticized by the regulators so long as
management of the financial institution enters into
the workout:
o
procurement and review of current
valuations of the collateral, which may or
may not require a new formal appraisal;
o
determination and analysis of an
appropriate loan structure; and
o
preparation of appropriate legal
documentation for any changes to the loan
terms.
•
After a thorough analysis of a borrower’s and
guarantor’s entire debt service capacities, not
just as to the particular loan in question
(referred to as its “global” debt); and
•
With the ability to monitor performance under
the terms of the workout plan.
The most interesting aspect of the Policy Statement
is a series of six different examples, each of which
presents multiple alternative scenarios involving
hypothetical loan restructures. These hypothetical
restructures are then critiqued using the categories
described above (e.g., pass, special mention, etc.,
accrual or non-accrual and whether the restructure is
a TDR). While space does not permit an analysis of
these examples, there are two principles worth
pointing out:
Extensions Will Be Easier
•
Pursuant to a “prudent workout policy” that
establishes appropriate loan terms and
amortization schedules and allows the institution
to modify a particular loan workout if the first
attempt does not result in sustained
performance;
•
Pursuant to a “prudent workout plan” for each
loan that takes into account current financial
information of the borrower and any guarantor
and that supports the ultimate collection of
principal and interest; the key components of a
prudent workout plan would include:
o
review and analysis of an updated and
comprehensive financial information
regarding the borrower, the guarantor and
the real estate collateral;
The first principle relates to the loan’s maturity
date. In reviewing the Policy Statement, one sees
that the regulators’ primary focus is on the “ultimate
repayment” of principal and interest, not necessarily
on the “on time” repayment of principal and
interest. Many loans held by banks and savings and
loans are considered troubled not because of an
existing payment default but because the maturity
dates of these loans have come and gone without
any refinancing available in the market (while the
borrowers have continued to make their monthly
payments of principal and interest timely, although
the value of the real estate securing these loans
might have fallen below the balloon payment
amounts). A reasonable extension of such a loan’s
maturity date which does not alter the monthly
payment amount should be a restructuring that,
absent some other glaring weakness in the loan or
the financial status of the borrower or guarantor,
poses little or no regulatory concerns to the lenders.
November 10, 2009
3
Distressed Real Estate Alert
The Policy Statement also contemplates more
complicated scenarios with different outcomes.
Be Prepared to Create a Good Loan
and a Bad Loan
The Policy Statement makes it clear that a lender can
benefit by severing a single distressed loan into a
“good” loan and a “bad” loan: one of which will
receive a pass grade, stay on an accrual basis and not
be considered a TDR, and the other of which will
receive a grade of some level below pass, be treated
as non-accrual and be considered a TDR. The bank
will come out ahead in terms of regulatory results
when compared to a workout that keeps the
distressed loan on the bank’s books as a single loan.
If the loan remains evidenced by a single note
secured by a single set of security documents, then
the entire loan may be classified in one of the lower
classifications, considered non-accrual or considered
to be a TDR. A “good note/bad note” structure has
the benefit of preserving at least a portion of the loan
on the bank’s books as a performing asset without
any financial impairment.
It is not realistic for borrowers or lenders to believe
that they will be able to create a restructured loan in
all scenarios that will avoid adverse regulatory
outcomes. There are many severely impaired
commercial mortgage loans being carried today, and
many inevitably will result in foreclosures and
losses. However, many distressed loans held under
the cloud of uncertainty that has hung over the
commercial real estate finance sector for more than
the last year now can be restructured in a way that
will avoid or minimize losses to the lenders while
allowing borrowers to retain control of their
properties on reasonable terms. Lenders will be
better motivated now to clean up their balance
sheets by implementing a “prudent workout policy”
within the parameters set forth in the Policy
Statement. Likewise, from the borrowers’
perspective, knowing the areas of concern for the
financial regulators and working to minimize
outcomes that would cause the lenders to come
under scrutiny will make it easier for lending
institutions to accept workout proposals. Borrowers
need to understand the regulatory constraints that
lenders are operating under and be prepared to
deliver updated financial information and collateral
values, to permit ongoing monitoring, and
fundamentally to set their expectations of what
might be achieved in a loan workout realistically.
The Policy Statement will likely have the effect of
reducing the number of loans, particularly those
with “hidden” value, that find their way onto the
secondary market, and it may curtail the flood of
distressed loans that investors have been hoping to
see. The Policy Statement may not be the perfect
instruction manual, but it’s a good beginning to
getting restructured deals assembled properly.
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©2009 K&L Gates LLP. All Rights Reserved.
November 10, 2009
4
Finance and Distressed Real Estate Alert
12 October 2009
Authors:
Buying and Selling Real Estate Debt
Andrew Petersen
andrew.petersen.com
+44.(0)20.7360.8291
James Spencer
james.spencer@klgates.com
+44.(0)20.7360.8176
K&L Gates is a global law firm with
lawyers in 33 offices located in North
America, Europe, Asia and the Middle
East, and represents numerous
GLOBAL 500, FORTUNE 100, and
FTSE 100 corporations, in addition to
growth and middle market companies,
entrepreneurs, capital market
participants and public sector entities.
For more information, visit
www.klgates.com.
Introduction
As liquidity in the European banking sector begins to improve, buyers aiming to
capitalize on declining or declined real estate values prevalent in the market are
increasingly seeking out opportunities to buy real estate-backed loans at
realistically priced discounts to par. Such buyers are also now beginning to target
loans made to distressed owners of sound properties (core assets at opportunistic
pricing are today's holy grail), although this is not a pre-requisite to finding
realistically priced assets. This sentiment is beginning to put pressure on sellers,
particularly in the UK where there is a perception that it is at the bottom of the
cycle in terms of perceived value, to consider the assets they hold.
Real estate debt (more so at this stage of the cycle) is not without risk. Prior to
buying such debt, a buyer must determine, through financial due diligence, whether
or not: (i) the underlying borrower(s) and/or guarantor(s) of the debt have the
financial capability to honour their respective debt obligations under the finance
documents; and (ii) whether the value of the underlying real estate (and all other
collateral) exceeds the amount paid by the buyer for the debt together with
incidental costs. The answer to these questions will dictate the buyer's decision on
whether or not to buy. A buyer will also need to analyze the underlying collateral
for title issues, perhaps inspect the real estate and consider environmental issues
(via desktop or otherwise) and other related matters, check the ranking of the
security and whether such security has been validly created and properly perfected.
While a buyer seeking to buy a single loan or a portfolio may think of itself as
simply a buyer in the traditional, financial sense of the word, it is essentially a
mortgage lender, real estate buyer, financial analyst, real estate operator and due
diligence expert all wrapped into one. Accordingly, a successful buyer of real
estate debt must possess expertise in all of the foregoing areas or be prepared to
engage third parties who are experienced in such transactions.
Moreover, it is important to remember the goals of the parties as a backdrop to the
financing transaction. The ultimate goal of the seller is either to reduce its
exposure to the real estate sector or to sell the real estate debt at a profit. The buyer
of a real estate loan will generally utilise variations of a “loan to own” or a “buyfix-sell” model by seeking to make a profit by (i) receiving principal repayments
on the total loan balance from the borrower in an amount exceeding the price paid
for the loan, or (ii) enforce and sell or operate the underlying real estate in manner
that renders income to the buyer that exceeds the price paid for the loan. At the
outset, given current market conditions, both seller and buyer will need to
determine if the loan to be purchased is to be treated as a distressed asset given the
status of the deal or merely an asset trading at a heavy discount. This approach
will have some impact on how the buyer, and the seller will approach the
transaction and the terms of the sale documentation (for example the level and
scope of asset level representations, more on which below). In the current market,
it is possible for distressed assets (e.g. those subject to payment defaults) to be
trading at prices notably higher than non-distressed assets, where for example the
price is being driven down to low levels as a result of loan to value ratios rather
than any actual payment defaults.
Finance and Distressed Real Estate Alert
The keys to limiting the buyer's liability during
the purchase process and enhancing the
likelihood of an eventual profit to the buyer are
thorough due diligence and careful
documentation of the transaction. A buyer of real
estate debt should analyze the transaction as
though it were buying the underlying real estate
or as if it were underwriting and originating the
debt in the first place. Considerations and issues
differ depending on the type of loan and the type
of collateral securing the loan. Regardless of the
type of debt purchase transaction anticipated,
competent counsel with an in-depth knowledge of
real estate loan purchase and sale transactions can
be the difference between a successful transaction
and an unsuccessful one. Moreover, in a
European context, its likely that the loan,
security, obligors and the real estate will be
subject to differing governing laws and therefore,
buyers will need to seek advice from professional
advisers in all applicable jurisdictions in order to
be fully appraised of local issues, especially in
the context of a work out or enforcement
scenario.
The Loan Sale Agreement
The loan sale agreement will contain all the terms
on which the loan is sold by the seller and bought
by the buyer, typically setting out the purchase
price, the treatment of accrued but unpaid
interest, and any other specifically negotiated
deal points.
The contract should provide for the seller’s
agreement to unconditionally sell the loan and
transfer all its rights under the finance
documents, namely the loan agreement and all
security documents. Such a transfer obviously
includes with it all of the seller’s rights to enforce
the terms of the loan documents and exercise all
remedies against the borrower, including without
limitation the right to enforce the real estate
security and assert claims against guarantors.
The contract should contain provisions requiring
the seller to provide copies of all loan documents,
report on titles, legal opinions, asset management
agreements and all other material documents
included in the loan file, such as copies of
insurance, the latest real estate valuation,
financial statements of the borrower and rent roll.
It is common for the agreement to provide the
buyer with an appropriate due diligence period
during which the buyer can adequately conduct
all due diligence, the outcome of which will
determine whether or not the buyer is bound to
proceed with the purchase.
The loan sale agreement will usually contain a
number of representations and warranties. The
type and level of representations given will often
be the subject of heavy negotiation, depending
on whether or not they are 'seller representations'
or 'asset level representations', the latter being
the area of most discussion. Seller
representations typically include representations
by the seller that (i) it is validly existing under
the laws of its jurisdiction of incorporation, (ii) it
has due capacity, power and authority to enter
into the loan sale agreement, and (iii) its
obligations under the loan sale agreement are
legal, valid and binding. A seller's starting
position will typically be that it will not give any
asset level representations, however, in the
current market, and especially if the buyer is
viewing the transaction as a distressed asset, it is
becoming increasingly common (but still
dependant on the bargaining power of the
respective parties) for buyers to benefit from
asset level representations from the seller. As an
absolute minimum, the buyer will want the seller
to represent and warrant that (i) it is the legal and
beneficial owner of the loan, free and clear of all
encumbrances, (ii) the loan has not been
previously assigned, transferred or subparticipated, and (iii) the loan is not currently in
default. If the buyer considers the asset to be a
distressed asset then it may require the seller
give more detailed representations, such as those
published by the Loan Market Association in its
distressed debt documentation. It will, of course,
ultimately be a matter of negotiation on the exact
nature and content of the representations given.
Moreover, representations and warranties can be
taken out of the equation entirely with the use of
title insurance as a method of ensuring the
liquidity of the asset.
Any buyer should, through its counsel or
otherwise, make every effort to obtain as much
information as possible on the loans and the
documents governing the underlying loan before
executing the contract. Further any seller should
ensure that all loan files and information
obtained in the underwriting and origination
process (basically all material documents in its
possession, in particular original land charges
and other such security which will be needed in
any subsequent enforcement situation) are
collated and readily accessible to the buyer either
through a virtual data room (which we are able to
provide) or physically handed over to the buyer
and its counsel. Thus, it is important to locate
and put in order all documentation that will be
required for the sale in a timely manner. The
12 October 2009
2
Finance and Distressed Real Estate Alert
more information the parties to a potential sale
can gather at the outset of the process and prior to
entering into the contract, the better able they will
be to evaluate any resulting implications and
incorporate them into any purchase price, as well
as mitigating the risk of reaching an impasse (due
to the necessity of a price adjustment midcontract) after incurring due diligence expenses.
Due Diligence Process
Generally
The due diligence process is perhaps the most
crucial undertaking in connection with buying or
selling real estate debt. It is during this stage that
the buyer can determine whether the price to be
paid under the contract justifies the risks
associated with the purchase. The only way the
buyer can do this is by thoroughly analyzing each
aspect of the purchase, including review of the
loan documents (such review to consider,
amongst other things, whether the security has
been validly created and properly perfected), the
real estate collateral for the loan, the financial
condition and solvency of the borrower and any
guarantors, the financial condition and solvency
of the seller, and the legal opinions (each of
which is dealt with in detail below). Often when
we are advising on these transactions, we provide
a detailed asset purchase check list for our clients
setting out each stage of the due diligence process
that needs to be completed to ensure that nothing
is overlooked. If during this process an
unacceptable risk is discovered (assuming the
buyer's lawyers have appropriately drafted the
contract), the contract may be terminated without
continued liability prior to the expiration of any
“free look” due diligence period. Haphazard due
diligence, however, may place the buyer in a less
desirable position with severely undervalued
assets if, for instance, an unresolved title defect,
development restrictions, or pre-existing
environmental conditions exist on the real estate
securing the loans.
Review of Loan Documents
(i) Loan Agreement
The loan agreement governing the underlying
loan, along with the related security, serves as a
general guide of the lender’s remedies in the
event of a borrower’s default. The terms of these
documents determine the various rights and
remedies of the buyer, as lender of the loan, and
those of the underlying borrower. Other matters
to be considered include the financial covenants
such as the loan-to-value and debt service, other
general covenants and income and expense
projections relating to the cash flow of the real
estate. In the event of any existing borrower
defaults, the buyer will want to consider whether
the default is material, whether the lender (or
loan seller) has formally called a default, and the
likelihood that the borrower can cure such
default. A buyer should ensure that the transfer
provisions set out in the loan agreement (and any
related intercreditor agreement) are complied
with, namely ensuring that the restrictions on
transfer are not breached and that the loan is in
fact transferred pursuant to an appropriately
drafted and correct form transfer certificate. This
will require input from the buyer's legal counsel,
as an incorrectly drafted transfer certificate raises
numerous issues potentially nullifying the sale.
Furthermore, there is a particular issue in
Germany that the transfer provision and draft
form transfer certificate in some loan agreements
drafted under English law may fail to deal with
the effect that if there is a novation of rights and
claims, the accessory security (bank accounts,
pledges and the like) cease to exist. The
obligations of the Lenders under such transfer
certificate however can be novated. The form of
the transfer certificate set out in the underlying
loan, which should substantially be followed,
may need to be amended to deal with this, as at
the time of origination, many lenders did not
focus on this issue.
A further issue resulting from the current market
conditions surround the increasing number of
borrowers (or other companies within the
sponsor group) looking to buy-back their own
debt from lenders under pressure to trade out of a
position. There are a number of reasons why a
borrower group company may want to buy its
own debt, most notably: (i) buying its own debt
at a discount is effectively the same as repaying
the debt at a discount; (ii) it may be able to sell
the loan at a later date for a profit; and (iii) it
gives the borrower (or its sponsor) a seat at the
creditor's table, which may enable them to
influence the creditors. In the context of real
estate debt transactions, the buy-back of debt
would usually occur at the subordinated or B
loan level (i.e. the first loss position). Whilst the
underlying loan agreement may not prohibit
borrower group companies from owning the
debt, a number of intercreditor agreements in the
market (especially those put in place in the later
stages of the European commercial mortgagebacked securitisation (“CMBS”) boom) restrict
subordinated lenders transferring the B loan to
borrower group companies. In deals where a
borrower group company has bought debt
subject to these restrictions, the restriction must
12 October 2009
3
Finance and Distressed Real Estate Alert
first be waived. The waiver is usually subject to
the subordinated lender rights being 'turned off' in
their entirety (more on such rights below) and in
some cases, there may also be a change to the
waterfall of payments, removing the ability for
the borrower group company to receive the
interest coupon on the B loan, with such funds
being redirected in prepayment of the senior loan
(most typically held in the CMBS). During its
analysis therefore, the buyer should also
determine the existence of any intercreditor
agreement and determine how they impact on the
buyer's ability (or appetite) to purchase the loan.
If the buyer is buying a B loan or other
subordinated interest in a whole loan, it will need
to consider and negotiate, amongst other things,
what cure rights, control rights, purchase rights
and other subordinated lender rights it requires,
as notwithstanding any prohibitions in the
intercreditor agreement, consent to a transfer of
the B loan to a borrower/sponsor affiliate is
typically only granted on the basis that the typical
B lender rights should be ‘turned off’ and should
not be exercisable whilst the borrower or sponsor
affiliate remains a B Lender. Accordingly,
immediately following any such transfer, the new
borrower affiliate buyer may not be able to
exercise, have exercised on its behalf (other than
by a servicer or a special servicer in accordance
with the terms of the servicing agreement) or
have accruing to it any cure, enforcement,
consultation, approval, appointment and/or
control rights (together the ‘Rights’) otherwise
available to it under the terms of the underlying
loan agreement, the intercreditor agreement
and/or the servicing agreement.
Such transfers should provide that the Rights may
be reinstated (a) for so long as the B lender, (i)
does not control or manage (in each case directly
or indirectly) the management or voting rights in
the underlying borrower or an affiliate of the
underlying borrower, (ii) is not controlled or
managed (in each case directly or indirectly) by
an underlying borrower or an affiliate of the
underlying borrower, (iii) is not party to any
arrangements with any other entity pursuant to
which the underlying borrower or any of its
affiliates would have any indirect control of
whatsoever nature in relation to any of the Rights,
and (iv) is not an underlying borrower or an
affiliate of the underlying borrower, in each case
being confirmed to the reasonable satisfaction of
the facility agent; or (b) with respect to the whole
or any part of the transferred B loans, following a
subsequent transfer or assignment of such
participation by the B lender. The transfer should
further provide that each of the servicer and the
special servicer will be required to notify the B
lender (or any of its designees) with respect to
material actions (as determined by the servicer
and/or special servicer acting reasonably) to be
taken with respect to the whole loan provided
that (a) neither the servicer or, as the case may
be, the special servicer will be required to
disclose any information to the B lender that, in
the discretion of the servicer or the special
servicer (acting reasonably), will compromise
the position of the other lenders in the deal or
reveal any strategy of the other lenders that could
compromise the position of the other lenders
with respect to the whole loan, (b) no such
notification will be required where immediate
action is required to be taken in accordance with
the servicing standard; and, (c) for the avoidance
of doubt, no such rights shall oblige the servicer
and/or special servicer to take into account any
advice, direction or representation made by the B
lender in connection with such notification.
Moreover, the B lender should agree that, prior
to any subsequent assignment or transfer of
whole or any part of any transferred B loan being
effective (along with the ability to exercise all or
any corresponding Rights) (i) the B lender either
confirms or procures confirmation to a security
agent that the subsequent assignee/B lender is a
qualifying lender, and (ii) the conditions set out
in both the underlying loan agreement and the
intercreditor agreement must be otherwise
complied with.
(ii) Security
The jurisdiction of the underlying real estate will
dictate the appropriate form of security required
and so appropriately appointed legal counsel will
be needed to advise any buyer on the related
security documents. Assuming the real estate is
located in England Wales, the real estate should
be secured by way of legal mortgage with the
appropriate registrations made at the Land
Registry (if registered land). The mortgage is the
legal mechanism by which the buyer can obtain
title to underlying real estate. This document
plays a crucial role because it allows the buyer,
directly or through any security trustee to take
legal ownership of the real estate, appoint a
receiver of the real estate or otherwise exercise
its power of sale over the real estate. The
mortgage should specifically entitle the lender
(or its security trustee) to enforce the security
following an event of default under the loan
agreement. The buyer will want to ensure that
the security it has is first ranking, and so it is
important to ensure that the security was not only
validly created, but also properly perfected
12 October 2009
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Finance and Distressed Real Estate Alert
(through whatever registration, notice and other
requirements are required in the relevant
jurisdiction). The priority of the mortgage (and
all other security) is of paramount importance,
since a first ranking charge will entitle the buyer
to enforce its security and apply all proceeds
realised from any sale towards the discharge of
the entirety of its debt, generally free and clear of
any inferior security
forced to enforce its security over the real estate.
By determining the amount of equity the
borrower has in the real estate (by comparing the
latest valuation of the real estate against the
outstanding loan balance), the buyer can
determine the likelihood of default and
subsequent enforcement risk, with the more
equity held decreasing the possibility of a
borrower’s default, and vice versa.
(iii) Real Estate Collateral
(v) Legal Opinions
With respect to any real estate collateral, the debt
purchase should be treated as a traditional real
estate purchase. The buyer should perform an
onsite inspection of the mortgaged real estate and
determine whether an updated survey is required.
To limit the buyer’s liability, an environmental
site assessment of the real estate should be
obtained, and the buyer should ensure that the
current use of the real estate is in compliance
with user, planning and other governmental
restrictions on the real estate. Additionally, it is
essential that the buyer obtain a new valuation of
the real estate, so that it may get an accurate
understanding of the current value of the land.
The valuation will show the approximate market
value of the real estate, but not necessarily what
the buyer could expect to receive on an enforced
sale. The buyer should also obtain any other
third party reports during this stage. Finally, the
buyer should analyze any income stream from the
real estate, and ensure that the purchase price
justifies the risk relating to such income stream in
the event the buyer ultimately owns the real
estate following enforcement of the mortgage.
Analyzing the foregoing issues will mitigate any
chance of the buyer being exposed to unknown,
and potentially costly liabilities relating to the
real estate.
All underlying legal opinions provided in
connection with the debt being purchased should
be reviewed by buyer's counsel. Such legal
opinions should be checked for the following to
ensure that:
(iv) Financial Analysis of Borrower and Seller
The financial solvency of the underlying
borrower and any guarantors of the loan is
important to the buyer for several reasons.
Determining the solvency of the borrower allows
the buyer to assess the likelihood that the
borrower and/or guarantor can remedy any
current or future default under the loan or other
loan documents. The buyer should analyze the
borrower’s financial statements to determine if it
is in compliance with any financial performance
covenants and/or reporting requirements pursuant
to the loan agreement (e.g., net worth
requirements, debt-to-income ratios, etc.).
Implicit in this analysis is a determination of the
likelihood of whether the buyer will ultimately be
•
They are addressed to the underlying finance
and secured parties and any permitted
successors and assigns, or at the very least,
the security trustee for the benefit of the
finance and secured parties from time to
time;
•
They are not subject to any unusual
assumptions and qualifications;
•
They provide a legal valid and binding
opinion on the finance documents and
provides a valid security interest opinion on
the security created by the security
documents;
•
That, if the security perfection opinion is
qualified by reference to other acts or
documents to be carried out or delivered,
that these other acts or documents are made
a condition precedent to the acquisition of
the loan;
•
They opine on all applicable documents; and
•
There are no other major issues identified in
the opinion.
Further, local counsel should review all relevant
foreign law opinions for the same issues as set
out above.
Conclusion
Real estate debt purchases have once again
become the opportunity of choice for clients to
profit from the uncertainties in the cyclical real
estate market. Real estate and real estate debt
may still be an effective protective hedge against
inflation. For those buyers and sellers that are
willing to utilise and accept a mixture of “valueadd” asset management through to implementing
12 October 2009
5
Finance and Distressed Real Estate Alert
successful “buy-fix-sell” and/or “loan to own”
strategies, understanding the process as a whole
and appreciating the risks associated with owning
the underlying real estate through the debt is the
key to success. Moreover, those buyers who see
the current distressed real estate market as an
opportunity to expand their 'core' investment
portfolio with good quality assets which are
trading at good discounts to poor, will be well
placed to profit from their investment. On the
other hand, those that can't distinguish between
good assets at a cheap price and bad assets at a
cheap price will be less successful. Likewise
those buyers that think creatively and attempt to
work with sellers to share upside and approach
these purchases in an intelligent manner will
benefit. Buyers cannot take the view that they
can buy core assets at opportunistic pricing and
hope to be overrun with an array of assets, as this
time around, many sellers who lost out during the
last downturn cannot afford to do so again.
Those buyers that realise this will benefit.
debt purchase are having to explore more
innovative ways of unlocking the transaction. At
the buyer level, such solutions including deferred
consideration, vendor guarantees, assumption/
novation of the debt, vendor loans, mezzanine
debt, subordinated debt , tranched debt, capital
injections, or total return swaps may be explored.
At the real estate level, dropping the property
into limited partnerships, or introducing geared
leases (split or otherwise) and use of sub-trust
are all options. Similarly at the seller level,
traditional profit share schemes, debt for equity
swaps or new share issuances can all be
explored.
Our lawyers at K&L Gates have extensive
experience in the types of transactions and have
geographically diverse, interdisciplinary teams
focused specifically on Distressed Real Estate
and a Real Estate Finance. We would be happy
to provide assistance on the types of transactions
discussed in this alert.
Finally, current conditions in the debt markets
mean that, increasingly, parties to a proposed
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numerous GLOBAL 500, FORTUNE 100, and FTSE 100 corporations, in addition to growth and middle market companies, entrepreneurs,
capital market participants and public sector entities. For more information, visit www.klgates.com.
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maintaining offices throughout the U.S., in Berlin and Frankfurt, Germany, in Beijing (K&L Gates LLP Beijing Representative Office), in Dubai,
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This publication is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied
upon in regard to any particular facts or circumstances without first consulting a lawyer.
©2009 K&L Gates LLP. All Rights Reserved.
12 October 2009
6
K&L Gates Distressed Real Estate Practice
K&L Gates LLP is a global law firm with 36 offices across the United States, Europe, Asia and the Middle
East. Our interdisciplinary global Distressed Real Estate team represents institutional real estate lenders
holding troubled real estate loans and mortgage-backed securities and investors who own or desire to
acquire distressed real estate and real estate loans. Drawing upon a large number of experienced
bankruptcy and transactional real estate and finance lawyers, we help clients maximize their recoveries and
preserve their legal and equitable rights in the most efficient and cost-effective way. With over 75 bankruptcy
and insolvency lawyers and over 180 transactional real estate lawyers globally, we bring an experienced,
business-oriented approach to analyzing the special issues arising from troubled real estate loans and
collateral, and proposing specific solutions to best address the needs of our clients. Our practice offers deep
market experience, knowledge and presence, affording our clients a local connection for interests they may
have across a wide geography.
The Distressed Real Estate team is led by a cross-section of experienced practitioners across several
offices and disciplines throughout the firm:
William J. Bernfeld
Los Angeles
william.bernfeld@klgates.com
(310) 552-5014
James E. Morgan
Chicago
james.morgan@klgates.com
(312) 781-7234
Koren Blair
New York
koren.blair@klgates.com
(212) 536-4879
Richard S. Novak
Boston
rick.novak@klgates.com
(617) 261-3241
J. Michael Booe
Charlotte
mike.booe@klgates.com
(704) 331-7556
Dianne G. Penchina
New York
dianne.penchina@klgates.com
(212) 536-4878
Philip M. Cedar
New York
phil.cedar@klgates.com
(212) 536-4820
Andrew V. Petersen*
London
andrew.petersen@klgates.com
+44.(0)20.7360.8291
Bill Finkelstein
Dallas
bill.finkelstein@klgates.com
(214) 939-5757
David E. Rabin
New York
david.rabin@klgates.com
(212) 536-4002
Sue J. Hodges
San Diego
sue.hodges@klgates.com
(858) 509-7433
Eugene F. Segrest
Dallas
gene.segrest@klgates.com
(214) 939-4991
* Co-Leaders
David H. Jones*
Charlotte
david.jones@klgates.com
(704) 331-7481
Shannon J. Skinner
Seattle
shannon.skinner@klgates.com
(206) 370-7657
Phillip J. Kardis II
Washington, D.C.
phillip.kardis@klgates.com
(202) 778-9401
Edward Smith
London
edward.smith@klgates.com
+44.(0)20.7360.8189
Richard S. Miller
New York
richard.miller@klgates.com
(212) 536-3922
Richard J. Smith
London
richard.smith@klgates.com
+44.(0)20.7360.8200
* Co-Leaders