Structuring and Enforcing Real Estate Mezzanine Intercreditor and B Note

Presenting a live 90-minute webinar with interactive Q&A
Structuring and Enforcing Real Estate
Mezzanine Intercreditor and B Note
Agreements: Latest Developments
Lessons for Lenders from Past Workouts and Real Estate Bankruptcies on Enforceability and Remedies
1pm Eastern
12pm Central | 11am Mountain
10am Pacific
Today’s faculty features:
Mark S. Fawer, Partner, Arent Fox, New York
Jerry L. Hall, Counsel, Pillsbury Winthrop Shaw Pittman, Washington, D.C.
Robert (Robin) Childress Jones, Jr., Retired Partner, Pillsbury Winthrop Shaw Pittman,
Washington, D.C.
The audio portion of the conference may be accessed via the telephone or by using your computer's
speakers. Please refer to the instructions emailed to registrants for additional information. If you
have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.
Outline of Presentation
 Description and Analysis of the Architecture of Real Estate Mezzanine
 Background of Mezzanine Financing and Mezzanine B-Note Structures
 Interrelationship of the Parties in a Mezzanine or B-Note Structure
 Intercreditor Agreement Structure and Key ICA Issues
 Sponsor Recourse Liability
 Overview of Bankruptcy Issues and Case Study of Georgian Voluntary
Bankruptcy/365 Sale
 Lessons from CMBS 1.0 for CMBS 2.0
 Advanced Topics
 Subordination of Sponsor Recourse Claims and Cure Payments
 Release of Sponsor Claims Against Foreclosed Entities
 Non-Foreclosure Takeover of Pledged Equity [Colony v Gramercy]
 Warehouse financing
Page | 2
What is Mezzanine Financing?
 Financing that is between equity
and the mortgage lender in terms
of risk, return and security.
 Not a second mortgage loan (i.e.,
not secured by the same assets as
mortgage lender)
Mortgage Lender
Page | 3
What is Mezzanine Financing?
 Many forms ranging from loan to
preferred equity.
 Contractual subordination: second
lender agrees to subordinate its
payment or security [primary
mechanism for corporate sub debt].
 Structural subordination: second
lender subordinate via borrower
structure [typical real estate/CMBS
Mortgage Lender
Page | 4
Traditional Real Estate Second Mortgage Financing
1st Mortgage Lender is secured by lien on borrower’s assets.
1st Mortgage Lender’s loan-to-value restriction limits size of 1st mortgage
2nd Mortgage Lender could interfere with 1st Mortgage foreclosure, so 1st
Mortgage Lender prohibits 2nd Mortgage.
$ Loan
Property Owner, LLC
Mortgage Lender
Page | 5
Typical Real Estate Mezz Loan
Mezz and Mortgage Lender have parallel loan documents.
Key Difference: separate borrower and separate collateral.
$ Loan
Mezz Lender
Mezz Borrower, LLC
Pledge of LLC
$ Loan
Property Owner, LLC
Mortgage Lender
Page | 6
Bankruptcy Remoteness
 Each of the property owner and its parent are “special purpose
entities” designed (and contractually required) to be “bankruptcy
 The property owner is thus insulated against bankruptcy of its
parent/mezz borrower.
 Each entity in the chain has as its only business the ownership of the
property (in the case of the mortgage borrower) or of the equity in the
property owner (in the case of the mezz borrower).
 These SPEs are not authorized to incur other debt, have other
activities, etc.
Page | 7
Mezz Lender is Structurally Subordinate
 Mezz Lender is not a creditor of the property owner.
 Mezz Lender has no lien against the underlying property.
 If the property owner files for bankruptcy, the Mezz Lender has no
“seat at the table.”
 If Mezz Lender forecloses, it owns the property owner, subject to the
Mortgage and any other obligations of the property owner .
Page | 8
If the Mortgage Lender forecloses…
Mezz Borrower, LLC
The “structure” of the borrower chain
subordinates the Mezz Lender to the
Mortgage Lender – i.e, “structural
$ Loan
Mezz Lender
Property Owner, LLC
Pledge of LLC
Mortgage Lender
Real Estate
Page | 9
If the Mezz Lender forecloses…
Mezz Lender
Mezz Borrower, LLC
Mtge Loan
Property Owner, LLC
Mortgage Lender
Real Estate
Page | 10
Sample Spreads
Lenders add a risk premium
Loan Rate
 Mortgage
 LIBOR + 100 bps
 1st Mezz
 LIBOR + 250 bps
 2nd Mezz
 LIBOR + 620 bps
 3rd Mezz
 LIBOR + 925 bps
Page | 11
Key Loan Documents
Mortgage Loan
Mezz Loan
 Senior Loan Agreement
 Mezz Loan Agreement
 Senior Promissory Note
 Mezz Promissory Note
 Mortgage, ALR & Security Agreement
 Pledge Agreement
 Assignment of Management Agreement
 Subordination of Management Fee
 Senior Recourse Guaranty
 Mezz Recourse Guaranty
Page | 12
Other Key Documents – Interest Rate Cap and Title
 Interest Rate Cap Agreement
 Protects a borrower with a variable rate
loan against the rate exceeding the cap
 Assignment of Interest Rate Cap
 Assigns payments to the lender
 Title Insurance
 Conventional property title insurance for
mortgage loan
 ”Eagle 9” UCC insurance for mezz loan
Page | 13
Other Key Documents – Lockbox
 Clearing Account Agreement
 Receives directly all property cash
(principally rents) and sends to
Deposit Bank
 Cash Management Agreement
 Receives cash from Clearing Account
and disburses per cash “waterfall”
agreement of lenders and borrowers
Page | 14
Participation Agreements and
B-Notes/Co-Lender Agreements
 What is a “B-Note”? Either a junior participation in a mortgage loan
secured by the property or a junior note from the property owner,
secured by the same mortgage which secures the more senior notes.
 The term “B-Note” is also used to refer generally to multiple junior
notes – there may be a C-Note, D-Note, etc. – each junior to the prior.
 Relationship between holders of A-Note and B-Note: governed by
a Participation Agreement or Co-Lender Agreement.
 Administration of Whole Loan: typically by a servicer acting
pursuant to a servicing agreement or pooling agreement
 Control of Servicer/Whole Loan: junior-most B-Note with 25% of
loan value (after actual/appraisal value losses) has right to approve
major servicer actions
Page | 15
Major Distinctions Between Senior/Mezz
Relationship and A-Note/B-Note Relationship
 Mezz Lender has direct access to its Mezz  B-Note holder must act through a
Borrower under its own mezz loan
servicer administering the whole
documents; within ICA limitations, does not
mortgage loan; if not “controlling
need consent or approval of anyone else
holder”, may have no approval of
to take action.
servicer actions.
 Upon default, Mezz Lender may take over
equity with credit bid at UCC auction, but
takes title to equity subject any
indebtedness/liens of property owner.
 Servicer can foreclose mortgage if all
noteholders then have undivided
interest in REO (now-owned real
 Mezz Lender may be “primed” by
intervening liens/senior borrower debt.
 B-Note holder has benefit and priority
of mortgage securing the whole loan
in which B-Note participates.
 Mezz Lender has refinancing risk when
 As part of whole loan in which B-Note
mortgage loan matures – can be wiped out
participates, B-Note holder must be
if mortgage cannot be refinanced.
refinanced at mortgage loan maturity.
Page | 16
Major Terms of B-Note/Co-Lender Agreement
 Controlling B-Note holder may replace special servicer (with or
without cause) and has major decision consent rights until a “Control
Appraisal Event.”
 “Control Appraisal Event”
 Generally occurs following a bankruptcy of property owner, 60 days after mortgage
default, commencement of a mortgage foreclosure or other major credit event.
Appraisal then ordered by servicer.
Appraisal calculation starts with 90% of appraised value, subtracts unpaid taxes,
servicer advances, etc., and adds back reserves, etc.
Net appraised value then measured against outstanding loan stack with any
shortfall allocated successively to most junior B-Notes.
Reduction in value of B-Note to less than 25% of face results in a shift in control to
next more senior holder (if there is no more senior B-Note, then to A-Note holder).
In some deals, B-Note holder has right to avoid losing control by pledging cash
collateral in an amount necessary to compensate for drop in value.
Page | 17
Intercreditor Agreement
 Addresses rights between the senior and mezzanine lenders in event
of loan default, foreclosure, borrower bankruptcy, etc.
 Protects senior lender by imposing conditions on Mezz Lender’s rights
to foreclosure on its equity collateral, limitations on Mezz Lender’s
rights to modify mezz loan documents and priority to payment rights
from senior collateral and with respect to property owner (senior
borrower) in a property owner bankruptcy.
 Protects Mezz Lender by acknowledging Mezz Lender’s separate
collateral rights, limiting Senior Lender’s rights to modify senior loan
documents, requiring Senior Lender to accept Mezz Lender as owner
of property owner on mezz UCC foreclosure, and providing Mezz
Lender rights to protect itself against mortgage loan defaults or
foreclosure by curing the default or purchasing the senior loan at par.
Page | 18
Important ICA Issues
 Who may be a successor Mezz Lender (transfer rights)
 Separate collateral
 Payment subordinaton
 Cure rights
 Senior loan purchase rights and triggers
 Loan modification limitations
 Duties/obligations on a Mezz foreclosure
 Qualified Transferee
 Default cures
 Replacement guarantos
 When do ICA Restrictions End?
Page | 19
ICA Issues (cont’d)
 Will have to deal with the Stuyvesant case in connection with any
mezz foreclosure (may be forced to pay off the more senior debt to
“cure” the senior defaults as a pre-condition to mezz foreclosure).
 If junior mezz tries to foreclose a junior mezz loan, senior (mezz and
mortgagor) can use Stuyvesant against foreclosing junior to force
senior (mezz and mortgagor) pay-off in full.
 Maturity Date Default: no cure rights available, only purchase option.
 After maturity, there is no ordered hierarchy to allow the most-junior to
foreclose first as cure right standstill does not exist at maturity – freefor-all race to foreclosure.
Page | 20
ICA Issues (cont’d)
 Conversion of mezz from Lender to Equity Holder and Termination of
ICA Obligations
 A typical ICA provides that it is binding on a mezz lender only in its
capacity as a lender and terminates as to such lender “upon
transfer of title to the Junior Lenders of their respective Separate
Collateral . . . ; provided, however, that any rights or remedies of
any party hereto arising out of any breach of any provision hereof
occurring prior to the date of termination shall survive such
termination.” Accordingly, post-foreclosure breaches should not be
actionable under the ICA.
Page | 21
Sponsor Recourse Guaranty
 Given by ultimate party controlling the equity (preferably a “warm
 Typically has two “wings”:
 “losses” indemnity for “bad boy” acts such as fraud, appropriating rents or
insurance proceeds, intentional misrepresentation, waste, etc.
full recourse (entire loan) for intentional acts that inhibit recourse to the
collateral – voluntary bankruptcy, collusive involuntary bankruptcy, nonpermitted transfers, non-permitted liens, etc.
 Separate guaranties provided to Senior Lender and each Mezz
Lender and thus subordination issues for claims against common
recourse guarantor.
Page | 22
Sponsor Recourse Guaranty (cont’d)
 Caps and limits on recourse amounts sometimes negotiated by strong
 Net worth and liquidity covenants advisable.
 Where ICA requires that a replacement guarantor must be
“reasonably satisfactory” to senior lender, net worth and liquidity
covenants provide an objective standard.
 With individual guarantors, can have issues with respect to death
(heirs will try to minimize contingent liability and unlikelihood of
triggering to fix reserved liability at low amount to allow distribution of
estate) and that a developer’s net worth may be primarily equity in
other projects (behind financing of other projects and other recourse
Page | 23
MSA Form Loophole
 In the event that such Transfer results in the removal of any
guarantor, indemnitor, pledgor, or other obligor under the Senior
Loan Documents (each, a “Third Party Obligor”), such transferee or
an Affiliate thereof reasonably satisfactory to the Senior Lender shall:
(A) execute and deliver to Senior Lender a guaranty, indemnity,
pledge agreement or other agreement which provides for the
obligations of such obligor (each, a “Third Party Agreement”), in each
case, in a form substantially similar to the Third Party Agreement that
it is replacing, pursuant to which the Third Party Obligor shall
undertake the obligations set forth therein.
Page | 24
Two Major Cases Exploiting Replacement Guarantor
 Stuyvesant [Bank of Am., N.A. v. PSW NYC LLC, 29 Misc. 3rd
1216(A), 918 N.Y.S.2d 396 (Table), 2010 WL 4243437 (Sup. Ct. N.Y.
Cnty. 2010)] – must Mezz cure (or commit to cure) to foreclose its
equity pledge?
 Jameson [In re JER/Jameson Mezz Borrower II, LLC, 461 B.R. 293
(2011)] – can a Mezz lender take non-judicial control of a borrower
and file for bankruptcy (primarily to use the automatic stay to avoid
foreclosure) without triggering the ICA requirement to provide a
replacement guarantor?
Page | 25
Distinguishing Stuyvesant Case to
Avoid Enjoining of Foreclosure
In the 9/10/10 Stuyvesant case, a NY trial judge issued a preliminary
injunction blocking a UCC foreclosure sale of Manhattan’s Stuyvesant TownPeter Cooper Village property. The judge held that the intercreditor
agreement (which he considered “unambiguous”) obligated the mezz lender
to cure all senior defaults as a precondition to its UCC foreclosure. Since the
senior loan was accelerated, such cure would amount to a mandatory pay-off
of the senior loan.
This decision stood the normal understanding of the subject provision on its
head – it was intended to provide a shield for allow the foreclosing mezz to
keep the senior in place, not a sword to force the mezz to pay off the senior
loan as a condition to exercise its remedies against its separate collateral;
moreover, the cure obligation was a post-foreclosure obligation (“within ten
(10) days after the transfer”), not a pre-requisite. The mezz appealed the
decision but was then bought out by the senior loan for what they paid for the
mezz, so the appeal was voluntarily discontinued and the decision stands.
Page | 26
Distinguishing Stuyvesant (cont’d)
Stuyvesant involved a pre-maturity payment default, where the mezz declined
to cure within its ICA cure periods. At maturity, there are no cure rights, only
a right to purchase the senior debt at par. While Stuyvesant did not deal with
a situation where cure rights were inapplicable (i.e., at maturity), the status of
acceleration (loan fully due) is analogous to the debt being fully due at
While the mezz community thinks Stuyvesant was wrongly decided on an
overly literal reading of Section 6(b) of the ICA, it is relatively well-written and
carefully documented and reasoned, and could be persuasive to other state
court judges in New York or to a federal district judge applying NY law [but
see U.S. Bank Nat’l Ass’n v. LH Hospitality LLC]. Thus a strategy aimed at
getting some other judge to reach a conclusion that is at odds with Stuyvesant
involves risk and if the mezz wants to acquire its collateral, then the collateral
acquisition would better occur prior to the senior indebtedness being
accelerated or coming due at maturity (unless the mezz is prepared to
refinance the senior debt).
Page | 27
Distinguishing Stuyvesant (cont’d)
Stuyvesant Cure Provisions
6(d) To the extent that any Qualified Transferee acquires the Equity Collateral pledged to a Junior
Lender pursuant to the Junior Loan Documents in accordance with the provisions and conditions of
this Agreement (including, but not limited to Section 12 hereof), such Qualified Transferee shall
acquire the same subject to (i) the Senior Loan and the terms, conditions and provisions of the
Senior Loan Documents and (ii) the applicable Senior Junior Loans and the terms, conditions and
provisions of the applicable Senior Junior Loan Documents, in each case for the balance of the term
thereof, which shall not be accelerated by Senior Lender or the related Senior Junior Lender solely
due to such acquisition and shall remain in full force and effect; provided, however, that [as a
condition thereto,] (A) such Qualified Transferee shall cause, within ten (10) days after the
transfer, (1) Borrower and (2) the applicable Senior Junior Borrowers, in each case to reaffirm in
writing, subject to such exculpatory provisions as shall be set forth in the Senior Loan Documents
and the related Senior Junior Loan Documents, as applicable, all of the terms, conditions and
provisions of the Senior Loan Documents and the related Senior Junior Loan Documents, as
applicable, on Borrower's or the applicable Senior Junior Borrower's, as applicable, part to be
performed and (B) all defaults under (1) the Senior Loan and (2) the applicable Senior Junior
Loans, in each case which remain uncured or unwaived as of the date of such acquisition
have been cured by such Qualified Transferee or in the case of defaults that can only be
cured by the Junior Lender, following its acquisition of the Equity Collateral, the same shall
be cured by the Junior Lender prior to the expiration of the applicable Extended NonMonetary Cure Period.
Page | 28
Independent Directors
In an effort to make the borrower entities “bankruptcy remote”, the LLC
operating agreements of each borrower entity in the stack have one or two
independent directors, who are usually employees of a company which
supplies professional independent directors.
The LLC Agreements provide that the vote of the member and the
independent directors is required for any bankruptcy filing, but a typical
provision provides that “upon the exercise of its rights under the Mezzanine
Pledge Agreement, to the fullest extent permitted by law, the Mezz Lender (or
its designee) shall have, among its other powers, the right to appoint and
remove Independent Managers.”
As the IMs are obligated to act in the best interests of the LLC (rather than the
lender), we have convinced IMs to approve a bankruptcy in other
transactions, so having IMs is not an impenetrable barrier to a bankruptcy.
In General Growth certain independent directors were replaced, and such
replacements were not judicially set aside.
Page | 29
 Procedure for Filing Chapter 11
 solvency is not a prerequisite (solvent debtors are bankruptcy eligible)
 voluntary petition requires corporate authority, including independent director(s)
(lender may replace IDs when enforcing remedies) – IDs often support filings
involuntary petition requires at least three unsecured/undersecured creditors –
shouldn’t exist for an SPE mezz borrower
 Venue
 petition can be filed where the debtor is organized
 petition can be filed where substantial assets are located
 other venues are possible based upon the location of the pledged equity interests
 Bankruptcy Objective – Confirm a Consensual Restructuring Plan that
Eliminates Underwater Debt and the Equity
Page | 30
Bankruptcy (cont’d)
 Benefits of Chapter 11 – Generally
 automatic stay (injunction) stops all foreclosures
 time to negotiate – 120 day exclusivity for debtor to file a plan (usally able to be
extended) – debtor controls process
capital structure can be modified pursuant to a reorganization plan
assets can be sold pursuant to “363 sales” free and clear of liens and claims
transfer taxes can be avoided for transactions consummated under a plan
 Challenges of Chapter 11 – Generally
 debt will likely have to be serviced during the proceeding (distributions issue –
permitted in General Growth)
lender may seek relief from the automatic stay or dismissal (which should be denied
in the early stages of the case if debt is being serviced and a plan is filed relatively
“cramdown” (confirming a plan over the objection of the lender) is virtually
impossible because mezz borrowers should not have any non-lender debt – lender
controls plan vote and can veto
Page | 31
Bankruptcy (cont’d)
 Management of Recourse Guaranty Liability – Another Challenge
 bankruptcy filing triggers guaranty liability
 consensually manage by obtaining lender forbearance and support for
non-consensually manage by limited funding of affiliate guarantor of qualified
transferee and possible bankruptcy of the recourse guarantor entity
 Role of Valuation
 important to establishing lender’s adequate protection to justify distributions
 important to a lender’s lift-stay motion based upon lack of collateral equity
 important to establish the value of lender’s secured claim under the plan and
whether the lender is over-secured or under-secured, and ultimately, who controls
the bankruptcy
real estate and equity valuations will be required (two experts)
both lender and debtor are entitled to present expert valuation evidence where
value is disputed
Page | 32
Bankruptcy (cont’d)
 Contents of Plan
 an over-secured lender is entitled to be paid in full with interest
 unsecured trade creditors (which should exist only at the property level) will be paid
in full, but only because that debtor is solvent
“cramdown” will be virtually impossible (especially at mezz level) – any re-setting of
loan terms must be consensual because the lender is impaired
the alternative is to “unimpair” lenders and pay them in full before they exercise
rights against their collateral
the mezzanine lender who is partially secured and partially unsecured becomes the
new owner of property owner – all or a portion of the mezzanine lender’s undersecured claim is converted to equity in the reorganized property owner
the mezzanine lenders who are entirely unsecured should receive nothing
assets can be sold pursuant to free and clear 363 sales (relevant probably at only
the property owner level)
Page | 33
The Georgian Case
 Structure: senior loan with A and B Notes and single mezzanine loan.
 B note was partially underwater and mezz loan fully underwater; all
loans in payment default and special servicer and receiver in place.
 Mortgage loan was through IDOT structure (MD structure where
property owner is guarantor and property leased to affiliated borrower;
recording tax due only upon enforcement of guaranty).
 Sponsor had recourse liability for IDOT as well as customary sponsor
non-recourse guaranty.
 Goal of client was to take control of property and restore to profitability.
 Client purchased B note (to be controlling holder of mortgage loan) at
significant discount and mezz loan (to block equity rescue) for nominal
Page | 34
The Georgian Case (cont’d)
 Bankruptcy strategy was to take a double-barrelled approach:
 voluntary bankruptcy with 363 auction and senior loan credit bid controlled
by client as B Note controlling holder, and
backstopped (if 363 third-party bids did not exceed credit bid) by
reorganization plan where mortgage loan maturity extended, B note partially
converted into an extended cashflow-only note, balance of B note converted
into equity of property owner and mezz loan wiped out.
 363 auction was acceptable to special servicer as transparent, courtsupervised valuation process.
 Sponsor persuaded to cooperate by release of IDOT and recourse
liability on bankruptcy plan approval and payment for cooperation
pursuant to two-tier forbearance and plan cooperation agreements.
 Lenders controlled Plan documents and filings; sponsor and
borrowers obligated to go along so long as no new or additional
sponsor-recourse liability.
Page | 35
Lessons from CMBS 1.0 for CMBS 2.0
 Obstacles to Foreclosure of “Separate Collateral”
 Provision of a Replacement Guaranty
 “Continuing Agreement” Clauses
 Recourse Liability for SPE Covenants
 Senior Loan Modifications
 Protective Advances and Cure Payments
 Senior Loan Purchase Option
Page | 36
Clearing Obstacles to Foreclosure
of “Separate Collateral”
 Following the Stuyvesant1 case, mezz lenders should beware any
requirement to cure senior loan defaults as a condition to foreclosing on
 “Qualified Transferee” definition: a trap for the unwary.
 an overly restrictive definition could chill 3rd parties from bidding at UCC
auction or the assignment of a winning “credit bid” to 3rd party.
see also U.S. Bank Nat’l Ass’n v. RFC CDO 2006-1, Ltd., CV 11-664, 2011 U.S. Dist.
LEXIS 156734 (D. Ariz. Dec. 6, 2011) (relevant provision more clearly intends
compliance with requirements to be conditions precedent to mezzanine lender
foreclosure). But see Stipulation attached to So-Ordered Transcript of October 16, 2012
Proceedings, Docket No. 33, U.S. Bank Nat’l Ass’n v. LH Hospitality LLC, Index No.
653351/2012 (Sup. Ct. N.Y. Cnty. Oct. 17, 2012) (analysis of a provision in an
intercreditor agreement substantially similar to that contained in the Stuyvesant case
results in a decision contrary to the Stuyvesant holding).
Page | 37
Replacement Guaranty
previously, only replace to the extent existing guaranty released
Replacement Guarantor:
a mezz lender should be expected to have this apply only to acts
occurring after UCC foreclosure sale that are within its control
Who is eligible?
Any Qualified Transferee?
Financial Test?
does existing guarantor have an equitable defense to recourse claims by
senior lender after transfer of equity if existing recourse guaranty is not
Page | 38
“Continuing Agreement” Clauses
 Does the Intercreditor Agreement (together with its protections for the
Mezz Lender) survive:
 a Senior Loan foreclosure sale (or deed-in-lieu thereof) and the ensuing transfer of
title to the underlying property? No.
a Mezzanine Loan foreclosure sale and the ensuing transfer of the pledged equity?
the payment in full of the Senior Loan and/or the Mezzanine Loan? No.
 Ramifications: Mezz Lender should exercise any special rights under
the Intercreditor Agreement (e.g., extended cure rights; foreclosure of
“separate collateral”; or exercise offer option to purchase Senior Loan
at par) prior to any event which terminates the Intercreditor
Page | 39
Recourse Liability for SPE Covenants
SPE covenants should be carefully reviewed and thought through, particularly
where breach can cause the entire loan to become recourse even if lender is
not damaged by the specific breach or the breach is cured. See:
full recourse liability for breach of covenant to remain solvent: Wells Fargo Bank,
N.A. v. Mitchell's Park, LLC, 2012 WL 4899888 (United States District Court, N.D.
Georgia 2012); Wells Fargo Bank, N.A. v. Cherryland Mill Ltd. P’ship, 812 N.W.2d
799 (Mich. Ct. App. 2011), remanded, 820 N.W.2d 901 (Mich. 2012); and 51382
Gratiot Avenue Holdings, LLC v.Chesterfield Development Co., 835 F.Supp.2d 384,
393–94 (E.D.Mich. 2011), but also see the Nonrecourse Mortgage Loan Act, Mich.
Comp. Laws § 445.1591 – 445.1595 (2012), which retroactively prohibits the
imposition of full recourse liability for borrower’s insolvency under a carve-out guaranty.
full recourse liability for breach of covenant against subordinate debt financing even
though default had been cured: CSFB 2001–CP–4 Princeton Park Corporate
Center, LLC v. SB Rental I, LLC, 410 N.J.Super. 114, 980 A.2d 1
full recourse for amendment of articles of incorporation: LaSalle Bank N.A. v.Mobile
Hotel Properties, LLC, 367 F.Supp.2d 1022 (E.D.La.2004)
Page | 40
Senior Loan Modifications
 Many older intercreditor agreements permitted senior lenders to
modify material terms of senior loan documents (other than an
increase in loan amount) during a “workout” of the senior loan.
 Newer intercreditor agreements sometime either eliminate that
exception or expand the list of material terms that may not be
modified even during a “workout.”
Page | 41
Protective Advances and Cure Payments
 Mezz lenders generally seek the right to add “protective advances” to
principal amount of mezz loan permitted by intercreditor agreement.
 Mezz lenders generally seek to classify cure payments made by
sponsor with non-property funds as “separate collateral” that do not
have to be turned over to the senior lender.
 Sponsor may well have an incentive to cure mezz loan to stay in the
game even if senior is also in default – mezz UCC foreclosure may
usually be accomplished much more quickly than senior mortgage
Page | 42
Senior Loan Purchase Option
 Mezz Lenders seek to keep at par, without default interest,
prepayment premiums, etc.
 When may this option be exercised?
Earlier of Senior Borrower’s bankruptcy;
Acceleration of Senior Loan;
Commencement of an enforcement action; or
Senior Loan becoming a Specially Serviced Loan.
 Mezz Lenders also must have this option available prior to Senior
Lender accepting a deed in lieu of foreclosure – time period may be
much tighter
 In very large deals, mezz purchase right may be useless as a
practical matter if other refinancing is not available
Page | 43
Exercise of Extension Options
 Include right of Mezzanine Lender to exercise extension option if
Senior Borrower has failed to do so
Page | 44
Cash Management
 Outside of Intercreditor Agreement, provide for payment of Mezzanine
Lender’s debt service after payment of approved Operating Expenses
and approved Extraordinary Expenses, but prior to residue flowing to
Senior Borrower
Page | 45
Advanced Topics
 Release of Sponsor Claims Against Foreclosed Entities
 Non-Foreclosure Takeover of Pledged Equity
[Colony v Gramercy in Jameson]
 Subordination of Mezz Recourse Claims Against Sponsor
 Warehouse Financing of Mezz Loans
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Subordination of Sponsor Recourse Claims and
Cure Payments
 “Separate collateral” vs traditional senior payment subordination
 Sponsor cure payments and recourse guaranty claims do not derive
from the property, however sponsor guarantor is common obligor for
both senior and mezz
 Differentiate voluntary payments (cures) vs recourse claims?
 Where recourse is for improper transfer or voluntary bankruptcy, mezz
may have no other recourse if property removed from ownership
 Some ICAs allow mezz enforcement but require turnover to senior
and/or cessation of mezz claim if senior is also claiming
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Taking Non-Foreclosure Control of Pledged Equity
 Typical pledge agreements provide for pre-foreclosure lender rights
such as giving pledger only a non default-proxy to vote equity or
transfer of voting rights to lender on mere occurrence of a default:
“If an Event of Default shall occur and be continuing, Lender may exercise, in
addition to all other rights and remedies granted in this Agreement: (a) all rights and
remedies of a secured party under the UCC and such additional rights and remedies to
which a secured party is entitled under the laws in effect in any jurisdiction where any
rights and remedies hereunder may be asserted, including, without limitation, the right,
to the maximum extent permitted by law, to exercise all voting, consensual and other
powers of ownership pertaining to the Collateral as if Lender were the sole and
absolute owner thereof”
“Subject to the terms of the Loan Documents, and unless an Event of Default shall
have occurred and be continuing, Pledgor shall be permitted to receive all LLC
membership interest distributions actually paid in the normal course of business of the
Pledged Interest Entities, and to exercise all voting and regular LLC membership
interests with respect to the Pledged Securities”
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Taking Non-Foreclosure Control of Pledged Equity
[Jameson] (cont’d)
 From the borrower’s point of view, these provisions accomplish a
“back-door” foreclosure giving lender control of the ownership chain to
the property without the notices and safeguards of the foreclosure
 From senior lender’s point of view, these provisions enable the mezz
lender to take control of the ownership chain to the property without
complying with the ICA foreclosure requirements, including providing a
replacement recourse guarantor.
 In Jameson, junior mezz lender Gramercy used this mechanism to
take control of the senior mezz borrower, replace the LLC manager
with its nominee and file a bankruptcy to try to stop Colony’s senior
mezz foreclosure.
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Release of Sponsor Claims vs Foreclosed Entities
 Once Mezz Lender forecloses or takes a deed-in-lieu, Mezz Lender
becomes the holder of the property owner equity.
 However, as equity, foreclosing Mezz Lender is behind all property
owner creditors, including any claims of prior-owner affiliates.
 Prior-owner affiliate claims could include subrogation for recourse
guaranty claims, management fees, environmental indemnity
payments, construction completion guaranties, etc.
 Deed-in-lieu resolutions typically include recourse guaranty releases
for cooperating sponsor – condition of release of sponsor affiliate
claims [worth anticipating going in as well].
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Warehouse Financing of Mezz Loans
 Structure and documentation
 Repo characterization vs secured loan
 Practical and liquidity issues – mark to market requirements and
purchaser discretion
 Loan pledgee status under the Intercreditor Agreement
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Thank You
Mark S. Fawer
Arent Fox
[email protected]
Jerry L. Hall
Pillsbury Winthrop Shaw Pittman
[email protected]
Robert (Robin) Childress Jones, Jr.
Pillsbury Winthrop Shaw Pittman
[email protected]
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