Nonrecourse loans are popular among commercial real estate owners because the Lender agrees only to seek recourse against the real estate and other collateral securing the loan in a default or loss situation. Unless the loss is caused by a “bad boy act”, the borrower and/or principal will not be held personally liable. Bad boy acts, also known as nonrecourse carveouts, are actions or inactions by the borrower or principal that are fraudulent and/or that cause detriment to the property (e.g. environmental contamination, failure to insure the property, waste, transfer of the property, etc.). In nonrecourse loans, borrowers and principals agree to be personally liable for the lender’s loss arising from nonrecourse carveout events.
A new law went into effect on March 27, 2013 which impacts one type of nonrecourse carveout. New Ohio Revised Code sections 1319.07 through 1319.09 make invalid and unenforceable any “postclosing solvency covenant” as a nonrecourse carveout. New Section 1319.07(D) of the Ohio Revised Code defines a “postclosing solvency covenant” as:
“any provision of the loan documents for a nonrecourse loan…that relates solely to the solvency of the borrower, including without limitation, a provision requiring that the borrower maintain adequate capital or have the ability to pay the borrower’s debts, with respect to any period of time after the date the loan is initially funded.”
This new law is a response to the result in a 2011 Michigan appellate court case, Wells Fargo Bank, NA v. Cherryland Mall Limited Partnership, which made a nonrecourse guarantor personally liable for a $2.1 million loan deficiency because the borrower’s insolvency violated a postclosing solvency covenant. The Ohio legislature, like some other jurisdictions, including Michigan, didn’t agree with the Cherryland result and therefore legislated accordingly. Many in the industry believe making a borrower or guarantor liable for a postclosing insolvency in a nonrecourse loan – based solely on economics or market circumstances – is the exception that swallows the whole (nonrecourse) rule. The Ohio General Assembly’s position is that the lender should take the risk of insolvency and postclosing solvency covenants are not only unfair but also a deceptive business practice that should be against public policy.
There are a couple important side notes regarding this new law. A voluntary bankruptcy filing or other voluntary insolvency proceeding is still a permitted nonrecourse carveout. In addition, this new law only affects nonrecourse commercial loans secured by Ohio real estate and it does not change the lender’s ability to realize on the collateral given to secure the loan. A solvency type covenant is still permitted in traditional recourse loans.
While this new law does provide some “big brother” legislative protection to commercial real estate borrowers, it still remains important for borrowers and their attorneys to review the nonrecourse carveouts as these are the events for which one may unintentionally find themselves personally liable on the loan or for the lender’s losses. This new law only makes one type of carveout unenforceable; many carveouts still remain valid and enforceable. Lastly, and equally as important, is for lenders and their attorneys to review the lender’s standard nonrecourse carveouts in light of this new law to make their documents are in compliance.
2012 is likely to be similar to 2010 and 2011 in many segments of the real estate industry. However, the residential rental market is frequently mentioned as a bright spot. There is more demand than supply to meet the needs of the market place. Apartment communities and apartment buildings will surely meet most of the need with an already existing ready to go inventory.
The over building and easy credit of the pre-recession period put many homeowners into properties which are presently under water. The lenders are faced with the decision to either:
1. Foreclose and sell;
2. Amend and extend the loan; or
3. Allow the homeowners to short sell.
None of which are good options for anyone. Employment opportunities make increasing family incomes difficult to achieve; so even employed homeowners which are not in default can not keep up as their homes lost market value as a result of foreclosures and over supply. The best thing for the home owner is to remain in their home, keep it up and seek to stabilize the neighborhood.
We can wait for the government to legislate a solution, or we can consider what is best for our lending institutions, communities and neighbors. Richard Florida in his book The Great Reset identifies the problem, cause and some solutions such as:
1. Reduce interest rates to reset the home financing to a level in which the homeowner can afford to remain in the home. Surely, this would cost less than foreclosing and selling a home at a loss.
2. Agree with the homeowner to take a deed in lieu of foreclosure, transfer ownership of the home to either the lender or a rental company; rent the home to the former homeowner at a market rental rate; and give the homeowner or renter the option to buy the home back (with appropriate credits for previously paid equity etc.).
Keep the home occupied by the people who will take care of it the best and give them an opportunity to once again become a home owner. Everyone wins when the property values in a neighborhood stabilize.
Lenders and developers can create opportunity where everyone benefits and the capital cost is low.
A Receiver's Authority to Sell Property Free and Clear of Liens and Encumbrances Gaining Momentum in Ohio
As the filing of Chapter 11 cases continues to be rare, state court alternatives for liquidation of assets continue to grow in popularity. State court alternatives typically provide a more expeditious and less expensive forum for secured lenders to direct the liquidation of their collateral—for example, state court receivership sales avoid the United States Trustee fees and unsecured creditors’ committees that add layers of expense to bankruptcy asset sales. In the past, secured creditors frequently sought the bankruptcy court as a forum for debtors to sell their assets, in large part because Section 363 of the Bankruptcy Code offered a powerful incentive: the sale of assets free and clear of liens and encumbrances. The sale of assets free and clear is critical for the efficient liquidation of collateral, because it attracts buyers who know with certainty that they are buying unencumbered assets. Until fairly recently, secured creditors in Ohio cases have been concerned whether state courts can provide similar assurances, because there is no statutory law in Ohio expressly authorizing the sale of assets free and clear.
Nevertheless, the current trend is that a receiver can sell assets free and clear of liens and encumbrances. In recent cases, the Ohio state courts have been upholding a receiver’s right to sell assets free and clear. At least one case, decided in 2010, even authorized such a sale in the face of the objection of a junior lienholder. We are aware of only one cited case in which the receiver was not authorized to sell the assets free and clear, but the receiver in that case never sent the holder of a judicial lien notice of the sale. Accordingly, Ohio courts are not providing an impediment to sales of assets free and clear outside the realm of the bankruptcy courts.
Equally important, however, is whether a title company will issue a title policy, even with the comfort of a sale order signed by an Ohio state court judge. There are title companies in Ohio that are still not convinced that title can be washed clean outside of bankruptcy unless there is a foreclosure. Certain title companies will wait to write an owner’s policy until the time for appealing the sale order has lapsed. Other title companies want assurance that all the lienholders agree to the sale. Obtaining the agreement from the title companies is critical to a successful free and clear sale, because no buyer will agree to buy assets free and clear in a receivership if the buyer cannot obtain an owner’s policy insuring title.
Accordingly, while the trend in Ohio strongly supports receivership sales free and clear of liens, the willingness of title companies in Ohio to write an owner’s title policy for the buyer is less clear. A buyer considering buying assets from an Ohio receivership should make sure to line up a title company willing to write an owner’s title policy before the buyer seeks to buy the assets.
Purchasing foreclosed real estate has never been easy or risk-free. In Ohio, all purchases are “AS-IS” and purchasers generally do not have an opportunity to inspect the property. A 10% cash deposit is due upon bidding and payment in full is due within thirty days with the threat of contempt of court if the purchase price is not paid. And the risks to purchasers are increasing.
Recently several banks have elected to stop residential foreclosures due to questions about their internal procedures. The attorneys general of all 50 states are now conducting a joint investigation into possible false or unverified information contained in affidavits and improper notarization of affidavits. Remedies for homeowners whose homes have been wrongfully foreclosed are determined by state law, but may include an unwinding of the foreclosure and returning legal title to the borrower. But what happens when that home has been purchased by a third party at foreclosure sale? Or flipped to another owner?
Remember Enron and off-balance-sheet accounting scandals? The efforts to clean up these accounting practices are still in the works and are about to hit the world of commercial real estate—arguably at the worst possible time. The Financial Accounting Standards Board (FASB) (which is endowed with the power to decide U.S. generally accepted accounting principles) and its international counterpart, the International Accounting Standards Board (IASB) are hoping to enact a new lease accounting standard by 2013. The Securities and Exchange Commission in a 2005 report to Congress estimated that the current lease accounting standards which went into effect in 1976 allow tenants to keep about $1.25 trillion in future liabilities off-balance-sheet.
Currently, a lease may be shown on a tenant’s balance sheet as either a capital lease which is treated on the balance sheet much like a finance transaction or as an operating lease which is mostly off-balance sheet. The FASB and IASB believe that investors are not getting a full picture of a tenant’s obligations when the lease is treated as an operating lease because the lease payments are recognized as an expense when they are incurred or paid rather than all of the rental payments for the term appearing as a liability on the balance sheet.
With the current housing crisis, more individuals are voluntarily choosing to cease payments on their mortgages. This scheme, known as “strategic default,” is most common where the mortgage balance exceeds the home value. The phenomenon has fueled a rigorous debate, with some arguing it is immoral to default on a mortgage which is still affordable, and others taking the position that for some homeowners the “benefits” of willingly defaulting outweigh the consequences.
A cost-benefit analysis as to whether a homeowner should strategically default is not as simple as it seems. Initially, a borrower’s credit score can plummet as much as 160 points. Although a foreclosure will stay on a credit score for seven years, its impact will lessen with time. Another risk depends on whether a homeowner resides in a non-recourse or recourse state. Non-recourse states forbid lenders to pursue borrowers for the money owed which exceeds the value of the home. Recourse states allow lenders to sue borrowers; yet, the overwhelming amount of foreclosures has lenders scrambling to stay afloat without the problem of pursuing defaulting homeowners. Finally, many defaulting homeowners wonder if they will be able to buy a home again. With a poor credit score, it can be difficult to buy a house. But financial institutions across the nation specialize in “mortgage repair” which targets homeowners who have recently defaulted on a mortgage.
Even with the uptick in the current crisis, it is surprising how few homeowners choose to default strategically. Luigi Zingales, author of “The Menace of Strategic Default” in a recent issue of the City Journal, argues this is due to moral implications: “the idea that people would walk away from their homes when they can still afford to pay the mortgage is unfounded. What does prevent people from strategic default, it seems, is their sense of what’s right.” Zingales feels social norms have a direct impact on whether an individual chooses to default or not; i.e. knowing someone who has done it makes you more likely to do it.
On June 10, in response to the wave of mortgage defaults (strategic or otherwise), a Federal Housing Administration (FHA) reform bill passed the U.S. House of Representatives with a 406 to 4 vote. The FHA Reform Act (H.R. 5072), among other goals, seeks to withdrawal FHA approval from lenders with abnormally high default rates. The bill has organizational support from those such as Robert E. Story, Jr., Chairman of the Mortgage Bankers Association, who hopes the bill “will allow FHA to address lender enforcement without discouraging responsible lenders from participating.”
Although homeowners may individually benefit from strategically defaulting, it raises an additional obstacle to the recovery of the broader housing market. When a neighbor defaults, home values in the vicinity plummet and mortgage prices increase as lenders cover default costs. Yet, what is to prevent an individual owner making a rational financial decision that it is better to breach than continue paying on a mortgage balance that substantially outweighs home value? Perhaps the idea of opportunistic, or willful, breach has trickled down to the American consumer.
In what has become an ongoing series here on the UB REAL Blog, we wanted to issue another update on the now year old Cuyahoga County Land Reutilization Corporation, better known as the land bank. Over the past six months, the Cuyahoga County Land Bank has obtained more properties and received millions in funding from the federal government.
A South Euclid lot donated to the Cuyahoga County Land Bank is soon to become one of the program’s community gardens. As of January 13, 2010, the property is the first of its kind to complete both the acquisition and disposition processes. The 50x108 lot, located at 3915 Warrendale Road, was given a market value of $22,800.
The typical co-tenancy clause provides that if occupancy at a shopping center falls below a certain level and/or certain other key tenants close, the tenant gets rent relief and at some point the right to terminate its lease. In the current retail environment, all sophisticated tenants demand some sort of co-tenancy protection. Landlords have generally accepted the fact that they must agree to some sort of co-tenancy if they are to get the tenants they desire.
However, mortgage lenders need to carefully consider the co-tenancy provisions also because they affect the value of their collateral, and of course if they are foreclosing it is likely that there is a co-tenancy failure. Obviously, a lender prefers no co-tenancy clauses in the leases. However, the challenge is that without them, there is no project in the first instance. But, the lender should carefully review all co-tenancy clauses so at least it knows the risk involved before taking any action.
Thank you to our friend Drew Stacey of First Place Bank for reminding us of the extension of the The First-Time Homebuyer Credit for the benefit of Military families for an additional year through May 1, 2011. According to the IRS:
"In general, you can claim this credit if:
You bought your main home in the United States after 2008 and before May 1, 2010 (before July 1, 2010, if you entered into a written binding contract before May 1, 2010), and
You (and your spouse if married) did not own any other main home during the 3-year period ending on the date of purchase.
No credit is allowed for a home bought after April 30, 2010 (after June 30, 2010, if you entered into a written binding contract before May 1, 2010). However, if you (or your spouse) are on qualified official extended duty outside the United States for at least 90 days after 2008 and before May 1, 2010, you have an extra year to buy a home and claim the credit. In other words, you must buy the home before May 1, 2011 (before July 1, 2011, if you entered into a written binding contract before May 1, 2011)."
According to FEMA the National Flood Insurance Program is no longer in effect. See the post from the FEMA website below and on this link:
"The NFIP will not be reauthorized by Congress by midnight of May 31, 2010. Therefore, the Program will experience a hiatus – a period without authority to:
- issue new policies for which application and premium payment dates are on or after June 1, 2010, or
- issue increased coverage on existing policies for which endorsement and premium payment dates are on or after June 1, 2010, or
- issue renewal policies for which the renewal premium is received by the company on or after June 1, 2010, and after the end of the 30-day renewal grace period, until Congress reauthorizes the Program.
While awaiting Congressional reauthorization, FEMA is issuing the guidance contained in the attached bulletin (PDF 92KB, TXT 21KB). Within this bulletin, is a set of Frequently Asked Questions concerning NFIP authorization to help you in communicating with your insurance agents and policyholders.
The hiatus period is expected to end soon. We will inform you when the NFIP is again authorized to sell new policies, issue increase coverage on existing policies, or issue renewal policies."
If you currently own real property in or around an insurable flood zone you should contact your insurance carrier to determine what sort of coverage you now have, especially in light of the fact that hurricane season is about to commence !
Parts 1 and 2 of this series on “The Commercial Real Estate Loan Market” examined differing views on the fallout of current and anticipated loan failures in the commercial real estate (“CRE”) industry. While all agree that losses will be significant, just how significant remains to be seen. Unfortunately, we don’t have a crystal ball to let us know which scenario or combination of factors will play out, and, like any forecast, we have to accept that there will be yet unknown events and circumstances which change the outcome. In the meantime, however, it is important for any participant in the CRE industry to understand the economic factors which shape the business decisions and perspectives of the players who hold and/or deal in CRE. These forces will impact all aspects of the CRE market, including, but not limited to, the market for and terms of CRE sales, the availability of financing and underwriting requirements, workout options (or lack thereof) for troubled CRE loans, and local and regional development. Understanding of the macroeconomic and microeconomic environment and acting strategically using that knowledge is an important key to success – or, perhaps, given the current economic climate, survival – in not only the CRE industry but any industry. Regardless, there are now and going to be abundant opportunities !
In contrast to the recent position taken by the Congressional Oversight Panel in their February 10, 2010 report mentioned in Part 1 of this series, there are economists, businesspeople and policymakers who have a less bleak forecast for the commercial real estate (“CRE”) loan market. One such example of this “non-crisis” position was presented in a research report by UBS Financial Services, Inc. entitled “Commercial Real Estate: Exorcising the Shoe” (the “UBS Report”). Some of the main points in UBS’ Report include the following:
(1) CRE Loan Market Smaller. The CRE loan market is one-third the size of the residential market arguably lessening the reach of any fallout from mass CRE loan failures;
(2) CRE Supply in Check. Unlike the residential real estate market, the CRE market was not overbuilt and therefore does not suffer from the excess supply issues in the residential sector. As a result, CRE valuations should not plunge as dramatically as residential home values have in many areas of the country;
(3) Better Underwriting. While CRE loans certainly weren’t immune from the more liberal underwriting standards experienced during the recent “bubble” or boom years in real estate, the underwriting on commercial mortgage loans were more thorough than residential loans and generally had lower loan-to-value ratios than typical residential loans;
(4) CRE Losses can be Absorbed. Most of the larger banks now have higher capital reserves to handle CRE losses;
(5) Some CRE Losses have already been Recognized. Some argue that the market has already taken into consideration both actual and potential defaults in the approximately $700 billion worth of CRE loans (about 20% of all CRE loans) that are in the form of commercial mortgage backed securities (“CMBS”);
(6) CRE is an Income Generating Asset. Unlike most residential real estate, commercial real estate generates (or has the potential to generate) income making workout options more viable.
The UBS Report considers the distinctions between CRE and residential real estate to be important factors in why we won’t see a repeat of the severe credit crunch created by the residential loan market in 2008 and 2009. Let’s hope they’re right!
The commercial real estate (“CRE”) loan market is floundering and is expected to increasingly experience high levels of losses over the next several years. The question on interested minds is whether the fall-out from CRE loan failures will mimic the devastation caused by the crisis in the residential mortgage loan market. Recently, the Congressional Oversight Panel, established pursuant to the Emergency Economic Stabilization Act of 2008, issued a bleak, if not frightening, report on the implications these anticipated losses in the CRE market and repercussions to the greater economy. The report, entitled “Commercial Real Estate Losses and the Risk to Financial Stability” (the “Report”), cautions that we could soon face a wave of CRE loan failures as approximately $1.4 trillion in CRE loans become due sometime between 2010 and 2014 causing our already weakened economy to suffer prolonged negative effects. The Panel believes the impact of a fallout from the CRE loan industry will be far-reaching, affecting not only those in the commercial real estate industry, but also small business owners, communities and the general public.
Notwithstanding the grim picture painted by the Report, there are some economists who argue that while the forecast from the fallout from the CRE loan market will be cloudy, it won’t be “the perfect storm” envisioned by the Report. Retail Traffic Magazine, for example, a leading authority on retail real estate trends, finds that “according to many real estate economists,…[the] fear [that fallout from the commercial real estate loan market will do as much damage as that done from the residential real estate loan market fallout] is largely misplaced. Commercial real estate debt will likely stall the recovery in the credit markets, they note, but because of a combination of factors, including the limited impact of commercial real estate loans on the overall economy, it won't bring about the same wave of distress as the housing downturn did." Watch for upcoming posts which provide a snapshot of each of these positions.
On February 3, 2010, the Board of the American Land Title Association (“ALTA”) voted to decertify the existing ALTA Endorsement Form 21-06 (Creditor’s Rights). Almost immediately, two of the largest title insurance underwriters, Fidelity National Title Group (including its subsidiaries Chicago Title, Fidelity National Title, Ticor Title, Lawyers Title, Commonwealth Land Title, Security Union Title & Alamo Title) and First American Title Insurance Company changed their underwriting policies to no longer issue the Form 21-06 or to provide any other coverage for claims arising from bankruptcy or insolvency within the insured transaction. Stewart Title Guaranty is reviewing its underwriting policy in light of the decertification by ALTA. At this time, Old Republic National Title Insurance Company will continue to issue the endorsement, however, it will now charge a financial review fee related to its due diligence prior to issuing the endorsement which is separate from the endorsement’s premium. As was the case prior to the decertification of the endorsement by the ALTA, due to the risk involved for the underwriter, the issuance of the endorsement is not guarantied and should not be expected in all cases.
The Creditor’s Rights endorsement is often requested by lenders to provide coverage for claims arising from the insolvency or bankruptcy of a party in the transaction. It arose when the 1992 form of ALTA policy created a new exclusion from coverage for insolvency or bankruptcy in the chain of title. The 1970 form was silent on the issue. The 2006 policy, in use today, scaled the exclusion back so that it only applied to the current transaction and did not provide exclusions for bankruptcy or insolvency in the chain of title. The current loan policy excludes coverage for “[a]ny 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 (a) a fraudulent conveyance or fraudulent transfer, or (b) a preferential transfer for any reason not stated in Covered Risk 13(b) of this policy.”
Without the ability to obtain the Creditor’s Rights endorsements, lenders need to perform more of their own due diligence prior to loan closing. Transactions which deserve extra scrutiny are those (i) where less than 100% of the loan proceeds are used to purchase or refinance the property or construct the improvements; (ii) between related parties; (iii) where the consideration does not appear to be market or includes something other than cash consideration; and (iv) where the seller appears to be insolvent or a bankruptcy matter is currently pending. In cases where a lender would have previously requested the Creditor’s Rights endorsement, lenders should consider requiring, as a condition of loan closing, its borrower and borrower’s seller to execute an affidavit addressing the nature of the transaction, their solvency and the flow of funds.
Ohio is one of the few remaining states that still enforce cognovit provisions in promissory notes and other loan documents. A cognovit provision allows a creditor to take judgment immediately against a borrower upon the borrower’s default without having to endure the time, expense, and risk of a lawsuit. Cognovit provisions are only enforceable in commercial transactions.
Recent Ohio case authority has addressed the problems that occur when a lender seeks to take a cognovit judgment for principal amounts owed under loan documents and attorney’s fees, when the attorney fees are not yet liquidated, i.e., established in a definite amount. In one recent case, the lender sought a cognovit judgment in the amount of the note plus "reasonable attorney fees." As is commonplace, the judgment debtor, who had guaranteed corporate obligations, challenged the cognovit judgment.
In that case, the cognovit judgment was not a final, appealable order because it did not fix a figure for attorney fees. The judgment debtor would probably have been better off not forcing the issue by filing motions and appeals. Instead, they should have either sat still or challenged the lender to execute on the judgment, since Ohio law provides that a lender cannot execute on a judgment that is not a final order.
The take away point is that it is better practice for the lender to split the fixed portion of the obligation (i.e. the promissory note or guaranty obligation) and the attorney fees into two separate orders, if the lender does not wish to assign a definite amount of attorney fees when the lender takes judgment. The judgment on the promissory note or guaranty should also state that there is no just reason for delay, per Ohio Civil Rule 54(B). The lender can then present the judgment entry for the attorney fee portion once the amount of the fees is fixed. Whether you are a borrower or a lender watch your cognovits and continue to police your loans !
The Cleveland Plain Dealer has reported that Fannie Mae, a player in the national secondary mortgage market and unwitting owner of numerous abandoned properties in the Greater Cleveland area, has reached a deal with the newly formed Cuyahoga County Land Reutilization Corporation to sell properties to it for $1 each.
Compared with our last report here, the deal represents a significant step forward for the Landbank which until now had acquired approximately 20 properties with 60 more under evaluation. The first set of transfers from Fannie Mae will consist of 25 properties, 24 of which have homes on them that will likely need to be demolished. Fannie Mae has agreed to pay up to $3500 of demolition costs on each property.
Going forward, Fannie will essentially provide the Landbank with a purchase option on any foreclosed properties valued at under $25,000. The Landbank will have 30 days to evaluate the properties for acquisition prior to them being listed on the wider market.
In other Landbank developments, the Board of Directors will consider authorizing a line of credit with KeyBank at its December 18, 2009 meeting. The credit line would go up to $7.5 million and would be a significant portion of the $15 million in financing the Landbank is looking to generate in 2010.
Both the Fannie Mae deal and the Landbank’s new financing options demonstrate that the bank has substantive long-term plans to redevelop established Cleveland neighborhoods. The Landbank has already been cited by experts as a national model for addressing lingering problems from the foreclosure crisis. In the near future, once the influx of abandoned properties have gone through the demolition and cleanup process, there should be a substantial opportunity for investors and nonprofit organizations to take the lead in transforming once-residential space into new neighborhood uses.
On October 30, a coalition of federal regulators issued the Policy Statement on Prudent Commercial Real Estate Loan Workouts. The Statement is designed to give greater flexibility to lenders in renegotiating or restructuring loans secured by commercial real estate, and should aid the flow of financing to credit-worthy borrowers.
The first purpose of the Statement is to shield institutions from criticism for restructuring loans if an adequate review of the borrower’s financial condition has been performed. A review of the borrower’s condition is adequate if the management has:
(1) Put in place a workout policy establishing loan terms and amortization schedules and that allows for modification of terms in the event there is a default in repayment;
(2) An individual credit plan that analyzes current information on the borrower and guarantors and supports ultimate repayment, including (i) updated financial information; (ii) current valuations of the collateral; (iii) analysis and determination of loan structure; and (iv) appropriate legal documentation;
(3) A global analysis of the borrower’s debt service;
(4) The ability to monitor ongoing performance;
(5) An internal loan grading system that accurately reflects risk; and
(6) An Allowance for Loan & Lease Losses (ALLL) methodology that recognizes credit losses.
Second, the Statement provides that restructured loans will not be subject to an adverse credit classification solely due to a deterioration in the underlying collateral value, or because the borrower is associated with a particular industry that has been experiencing financial difficulty of late.
As an example of these more favorable classification guidelines, the Statement offers a scenario where a lender refinances a $13.6 million balloon payment at maturation over the next 17 years. The borrower was paying timely up until the maturation date, but has experienced a decrease in cash flow and, per a recent appraisal, the LTV ratio is 104%. Under the Statement, the loan is properly classified as “pass” because the borrower has demonstrated the ability to make continuing payments even with the decline in collateral value and decreased cash flow.
This ability to avoid adverse credit classifications will prompt institutions to be more willing to engage in loan workouts where there is a realistic probability of repayment. Borrowers that have a sensible repayment plan going forward may also be more willing to approach lenders about restructuring as they will not be tied to other failures within their industry.
On November 6, 2009, President Obama signed the Worker, Homeownership and Business Assistance Act of 2009. The new law extends the first-time homebuyer temporary federal tax credit for qualifying home purchases to April 30, 2010 and expands the eligibility requirements for purchasers.
Under the new law an eligible taxpayer must buy, or enter into a binding contract to buy, a principal residence on or before April 30, 2010 and close on the home by June 30, 2010. The new law also authorizes the credit for long-time homeowners buying a replacement principal residence and raises the income limitations for qualified homeowners claiming the credit.
Homebuyers who purchased a home in 2008, 2009 or 2010 may be able to take advantage of the first-time homebuyer credit. The credit:
- Applies only to homes used as a taxpayer's principal residence.
- Reduces a taxpayer's tax bill or increases his or her refund, dollar for dollar.
- Is fully refundable, meaning the credit will be paid out to eligible taxpayers, even if they owe no tax or the credit is more than the tax owed.
Under the new law, the maximum credit amount remains at $8,000 for a first-time homebuyer (single person or married filing jointly or $4,000 for married persons filing separate returns). A “first-time buyer” is a purchaser who has not owned a primary residence during the three years up to the date of purchase.
The new law also provides a “long-time resident” tax credit of up to $6,500 to others who do not qualify as “first-time homebuyers” (single person or married filing jointly or $3,250 for married persons filing separate returns). To qualify as a “long-time resident,” a buyer must have owned and used the same home as a principal or primary residence for at least five consecutive years of the eight-year period ending on the date of purchase of a new home as a primary residence.
For all qualifying purchases in 2010, taxpayers have the option of claiming the credit on either their 2009 or 2010 tax returns. To claim the credit, a taxpayer must file Form 5405 with the Internal Revenue Service, which you file with your original or amended individual federal income tax return.
Income Limits Increased under New Law
The new law raises the income limits for people who purchase homes after November 6, 2009. The full credit will be available to taxpayers with modified adjusted gross incomes (MAGI) up to $125,000, or $225,000 for joint filers. Those with MAGI between $125,000 and $145,000, or $225,000 and $245,000 for joint filers, are eligible for a reduced credit. Those with higher incomes do not qualify.
For homes purchased prior to Nov. 7, 2009, existing MAGI limits remain in place. The full credit is available to taxpayers with MAGI up to $75,000, or $150,000 for joint filers. Those with MAGI between $75,000 and $95,000, or $150,000 and $170,000 for joint filers, are eligible for a reduced credit. Those with higher incomes do not qualify.
New Requirements under the New Law
The new law contains new restrictions on purchases after Nov. 6, 2009:
- Dependents are not eligible to claim the credit.
- The purchase price of the home cannot be more than $800,000.
- A purchaser must be at least 18 years of age on the date of purchase.
For Members of the Military
Members of the Armed Forces and certain federal employees serving outside the U.S. have an extra year to buy a principal residence in the U.S. and still qualify for the credit. An eligible taxpayer must buy or enter into a binding contract to buy a home by April 30, 2011, and close on the purchase no later June 30, 2011.
So by now you’ve been to at least three conferences which tell you the economy has hit the bottom, it’s a U curve, 2010 will still be slow with savings and not consumption being the key characteristic, 2011 is a comeback year, but real estate will never get back to the boom boom days of only a few years ago. So what does it all really mean to the real estate professional?
- Increased Competition. Whether it be for legal services, brokerage services, or commercial space, there is less demand and thus greater competition. But price is only one component of the decision factor. Service and quality still will be key decision factors. For example, while new centers have issues, retailers will still be looking to get into the established market leading centers and will pay the higher rent to get there. And having or obtaining a good relationship with a customer by providing over the top service is a great hedge against competition.
- Marketing is Still Important. We all need to pay attention to expenses, but marketing is not one of the expenses to be cut. In the face of increased competition, it is more important than ever to get the quality message across. However, the marketing budget should be examined to make sure that the budget is allocated wisely. Place an emphasis on direct, active marketing most likely to get face to face with prospective customers.
- Be Careful Extending Credit. There will still be higher than normal business failures, even by well established companies.
- Do Not Sign Long Term Deals at Today’s Rates. Consider short term deals even where you normally want long term ones. Although no one can say with certainty, there is a good chance that rates will increase in 2012, so signing a long term deal now could tie you up at lower than market rates. Also, a credit tenant may have really good leverage now. Resist the temptation to sign a deal at any price. The balance of power may shift in a couple of years and that credit tenant may not have such great credit in a few years. As a tenant, consider the goodwill you will get, which can translate into tangible benefits, by merely being reasonable and not taking undue advantage of the economic climate.
- Consider Other Sources of Income. Can the attorney branch out to other areas? Can the landlord come up with alternative uses for its vacant properties or monetize unused space ? Can the broker branch out to other consulting services?
Ohio’s Budget Bill, signed by Governor Ted Strickland on July 17, contained provisions authorizing Ohio’s first state-run New Markets Tax Credit, as well as substantially revising the state’s Historic Preservation Tax Credit. Here is a breakdown of each:
New Markets Tax Credit
Modeled after the federal New Markets Tax Credit, the state program allows up to a nearly $1 million cumulative, nonrefundable tax credit for an entity that holds an investment in a “qualified community development entity” over the next seven years. Like the federal Credit, the Program is intended to aid development in low-income areas where new projects are typically more difficult to finance.
Only insurance companies and financial institutions are eligible to receive the credit, and they may do so by holding a “qualified equity investment.” A “qualified equity investment” is an investment in a “qualified community development entity” (i.e. an entity with an allocation agreement under the Federal Credit that does business in Ohio) that: (1) is acquired solely for cash after July 17, 2009; (2) has at least 85% of its purchase price used to invest in low-income communities; and (3) is designated by the issuer as a qualified equity investment.
To receive the credit, the community development entity must invest in a “qualified active low income community business” (“QALICB”). The intention behind this provision is to ensure the credit is used for new projects that actively promote job creation in the state. The QALICB definition excludes from such businesses those that derive 15% of annual revenue from real estate, such as developers. The language may permit a developer to be a QALICB, however, if it is the end user of the property through a sale-leaseback transaction. The program permits investment in a special purpose entity (“SPE”), principally owned by the property user, if the SPE was formed solely to rent or sell the property back to the principal user. Therefore, a developer could form an SPE and lease the property to itself as the owner of a separate end user entity, so long as the user is not itself a real estate developer.
An eligible entity may receive the credit if it holds such an investment on the first day of January in 2010 through 2016. The Program credit is equal to the “applicable percentage” of the purchase price. In years 2010 and 2011, however, the applicable percentage is zero. In 2012, the credit is seven percent, and in 2013 through 2016 the credit is eight percent. At the end of seven years, the entity may receive a 39% credit on a statutorily capped maximum investment price of $2,564,000, for a total credit of up to $999,960. The total amount of credits allocated by the state under the Program each year may not exceed $10 million.
Ohio joins a number of states that offer a New Markets Tax Credit in conjunction with the federal Credit. The Program should be a useful tool, along with the Historic Preservation and Low Income Housing Tax Credits, for encouraging investment in underserviced areas.
Some time ago in this space I wrote about the prospects for revitalization from the creation of the Cuyahoga County Land Reutilization Corporation, better known as the County Landbank. Since then the Landbank has gotten up and running, or walking perhaps, but has made little progress toward its goal of returning significant amounts of abandoned and vacant property to productive use.
As stated on its website, the Landbank acquired its first two properties, not the estimated six “test cases” that had been reported, on September 3, 2009. Both properties are vacant land abutting the Big Creek Trail in Brooklyn and are slated to be added to the Trail. The Landbank should become more active in acquiring abandoned properties toward year’s end as it expects to receive its first installment of bond and loan money in November.
The Landbank is also considering a new method for acquiring properties that would proactively assist homeowners prior to the initiation of foreclosure proceedings. A proposed “better bank” would buy mortgages from lenders at a discounted rate and then pass the savings along to the homeowner in the form of a reduced mortgage payment. This new mortgage would then be sold to a lender to recoup the Landbank’s initial expense. The proposal seems like a winning situation for everyone except the original lender who would take a significant hit against its expected return on the mortgage. However, the discounted rate offered by the Landbank on properties that are seriously deteriorating and at risk for foreclosure may be its best outcome as well.
While some have questioned the legality of this “better bank” under the enacting provisions of Senate Bill 353, the idea is in fitting with the Landbank’s general purpose to “[f]acilitat[e] the reclamation, rehabilitation, and reutilization of vacant, abandoned, tax-foreclosed, or other real property within the county for whose benefit the corporation is being organized.” Further, S.B. 353 specifically stated that the Landbank’s purposes were not limited to those enumerated items.
Even if the “better bank” was outside the original scope intended for the Landbank, it shouldn’t be difficult in the current political and economic climate to drum up support for a minor change in the law that would allow the Landbank to work to keep people in their homes. It may prove a useful tool in helping the Landbank reach its lofty goals and aiding lenders and homeowners alike in navigating through the economic downswing.
Recently, the news about the $300 billion China Investment Corp. (“CIC”) invested an additional $500 million in Blackstone’s Fund-of-Funds unit and earmarked about $800 million for investing in a Morgan Stanley Global Property Fund has stirred up another round of excited discussions about China’s money pouring into the U.S. Lately, the Wall Street Journal reported that CIC is in talk with U.S. private-equity funds, including BlackRock Inc., Ivesco Ltd. and Lone Star Funds, about potential investments opportunities in the distressed commercial real estate assets in the U.S. According to the Wall Street Journal, last year, CIC deployed just $4.8 billion in global financial markets and this year it invested that much in a single month. CIC’s chairman has indicated that Mr. Jiwei Lou, if CIC's future returns are good enough, it might ask the government to let it invest more of China's $2.132 trillion foreign-exchange reserves.
CIC’s investment decisions are among the most watched indictors for Chinese private investors when they choose foreign investments. Will Chinese private investors follow CIC this time to look into the real estate market in the U.S.?
In contrast with the U.S. real estate market, China’s overall real estate market, both residential and commercial is very “hot.” Some even have concerns that a serious asset bubble is developing in real estate. According to Shanghai real estate and foreign investment lawyer, Zengli Li, a partner at Yaoliang Law’s Shanghai office, the hot China real estate market is mainly attributed to the “flood money” that Chinese investors have directed to the real estate market. According to Zengli, Chinese investors now do not have many choices when it comes to investment opportunity. Originally, Chinese investors invested heavily in manufacturing sector but because foreign consumers tighten their belts under the current economic situations, manufacture does not sustain good investment opportunity anymore. The lack of other investment opportunities domestically has pushed and concentrated the private investors to the real estate market. In July, for instance, a land parcel along Beijing's Guangqu Road was auctioned off for more than 4 billion yuan ($585 million US dollars) after fierce bidding among major developers from the mainland and Hong Kong. In Shanghai, developers of the luxury Tomson Rivers apartments, known for their price of more than 100,000 yuan per sq m ($14,000 US dollars), sold 10 units in the first 25 days of June. Some investors are starting to look outside of China. Many high end residential real estate markets around the globe are seeing discreet Chinese buyers.
However, Chinese investors are not accustomed to foreign markets. It has been decades that people are used to foreign investment flowing into China. Now Chinese investors start to reverse the general trend of investment. They have heard U.S. distressed real estate market and understand there could be opportunities for buy in low.
The channel directing the flow in of Chinese money is still not there. If you can figure out a smooth channel to attract the abundant Chinese cash, you probably need not worry about cash flow for a long time. After all, $2.132 trillion can make quite an impact!
Following an era of relaxed standards for issuing loans, lenders must be aware of a bankruptcy court’s ability to subordinate liens for equitable reasons. On May 13, 2009, in In re Yellowstone Mountain Club, the Bankruptcy Court for the District of Montana issued an order subordinating the secured lender’s $232 million claim below the (i) debtor-in-possession financing; (ii) administrative fees; and (iii) the unsecured claims. Section 510(c) of the Bankruptcy Code authorizes a bankruptcy court to subordinate a claim for equitable purposes, but it provides little insight into the reasons that would justify this harsh remedy. For non-insider claimants like the senior lender in In re Yellowstone, subordinating a claim is a drastic measure that bankruptcy courts will rarely utilize. But the lender’s conduct, in issuing a $375 million syndicated loan with little financial due diligence and far in excess of the borrower’s ability to repay, “shocked the conscience of the Court.”
The lender issued a $375 million loan to the Yellowstone Club, a high end development company controlled by Timothy Blixseth through Blixseth Group, Inc., the majority shareholder. The lender marketed its product as the equivalent of a home-equity loan, and Blixseth treated it that way, taking large distributions from Yellowstone that he never repaid. Although Yellowstone was unable to repay its debt, the lender benefited because it had obtained a $7.5 million fee for closing the loan and had unloaded portions of the loan to the other syndicates. The bankruptcy court, finding the practices tantamount to predatory lending, determined that equity dictated subordinating the loan.
Lenders should be mindful of a court’s power to subordinate claims, even if it is rarely used. Although the bankruptcy court withdrew this opinion because the parties had reached a settlement on the issue, this case is still instructive for creditors. It illustrates that bankruptcy courts can use their own discretion to determine whether a lender has indulged in unsavory lending practices, a troubling thought to secured creditors everywhere. Nonetheless, equitable subordination for non-insiders is rare (it almost never happens), and lenders that employ responsible lending practices are unlikely to ever encounter this problem.
When representing a tenant, I always want an SNDA so that if the landlord defaults on its mortgage my client is assured that it can remain in the space as long as there are no tenant defaults.
When representing a landlord, it is becoming increasingly more difficult to get lenders to make any change to their form subordination non-disturbance agreements ("SNDA"). Lenders are insisting that tenants give up termination rights, offset rights, right to casualty proceeds and other valuable rights contained in the lease that the landlord was willing to give and which may even be customary provisions in a retail lease in today’s market.
Recently, I encountered the situation where the lease contained a standard termination clause if a co-tenancy failure could not be cured within a set period of time. The landlord's lender would not agree that the tenant still had that right after a foreclosure.
So, is a tenant better off without an SNDA? If you weigh the probabilities, a tenant may be better of without one. If a lender forecloses, chances are the center is not performing well. If the lender forecloses and terminates the lease because there is no SNDA, how hurt is the tenant? Maybe the tenant would prefer termination. In the co-tenancy situation, the tenant gets the very remedy it was trying to preserve. Without an SNDA the lender either has to terminate the Lease or accept every provision in it. In this situation, the Tenant may be better off without the SNDA.
Granted if the tenant is performing well and does not wish to leave, there is some risk. But even in this situation, the only time a lender will terminate the lease is if the landlord wishes to redevelop the center. A redevelopment, which will cost substantial sums, is highly unlikely in a healthy center. It is more likely that the lender will be doing everything it can to keep a well performing tenant. Just something to consider – a tenant may very well be better off without an SNDA.
"Back In My Day Perpetual Meant Forever. Today, Five Years": New 9th Circuit Law Interpreting Perpetual Letters of Credit
A perpetual letter of credit (LOC) does not last as long as you might think. In physics “perpetual motion” is movement that goes on forever. Commercial law is less ambitious. Under U.C.C. § 5-106(d), a “perpetual” LOC expires after five years. To further complicate the issue, a recent case from the 9th Circuit held that a LOC that continues indefinitely is not “perpetual.”
According to Golden West Refining Co. v. SunTrust Bank, 538 F.3d 1233 (9th Cir. 2008), a letter of credit is only "perpetual" if that word is used explicitly. Under U.C.C. § 5-106(d), "[a] letter of credit that states that it is perpetual expires five years after its stated date of issuance, or if none is stated, after the date on which it is issued." In Golden West the bank argued that its LOC was "perpetual" and had expired 5 years after it had been issued. Its LOC terminated after 1 year, but "automatically renewed" if the lender did not elect to terminate it. The 9th Circuit rejected the bank's argument. It found that "a letter of credit is only perpetual if it expresses in words that it is perpetual." Because the LOC in question terminated after a year and did not explicitly state that it was perpetual, it was not "perpetual" under U.C.C. § 5-106(d) and did not terminate after 5 years.
Golden West has not been cited by any court outside the 9th Circuit yet. Although not binding on states outside the 9th Circuit, its holding is instructive for anyone drafting a LOC, at least until there is further law interpreting perpetual LOCs. Accordingly, if you want a LOC to last indefinitely, state that it “renews automatically.” But if you want it to be “perpetual” and expire after 5 years, use the word “perpetual.”
The Home Affordable Modification Program (HAMP) was announced on February 18, 2009. The first set of details were published by the Treasury Department on March 4, 2009. Those details were revised and republished on April 21, 2009 and updated on June 8, 2009.
The mission of the HAMP is to save risky home mortgages from foreclosure. The means is to reduce the homeowner’s monthly mortgage payments to a manageable amount. The HAMP features a sharing of the reduction by the lender and the Treasury Department. The HAMP also offers incentives to the lender, the loan servicer and the borrower.
The monthly mortgage payment reduction may be accomplished in one or a combination of ways: lowering the mortgage loan interest rate or extending the term of the mortgage loan or freezing some of the principal of the mortgage loan. The HAMP is supposed to be available to homeowners who are at risk of defaulting on their home mortgage. It is not supposed to matter whether the problem is caused by a serious family hardship, a sudden drop in income or a decline in market value of the home to a level below that of the principal balance of the mortgage loan.
The HAMP relies on mortgage servicers to promote a loan modification. Each servicer must first qualify and sign a contract with Fannie Mae. To date more than thirty servicers have qualified. However, some media have complained that the level of understanding among the servicers varies widely. In turn, that uncertainty has slowed the process in some cases.
The homeowner must satisfy the requirements for the Program. A Hardship Affidavit form must be completed by the homeowner and backed up by appropriate proof (showing income and other financial information). Then, with the assistance of the lender and the Treasury, the homeowner can arrange to have the monthly mortgage payment reduced to no more than 31% of the homeowner’s monthly income. This 31% level is supposed to be low enough to allow homeowners to make their monthly payments and avoid foreclosure. Once a homeowner has qualified, there is a 3-month trial period to make sure that the homeowner can satisfy the new, lower payment obligation.
Late in June, the Treasury Department announced a nationwide campaign to promote the HAMP and to let homeowners know that the HAMP might be able to save their home from foreclosure. The campaign is supposed to utilize housing counselors, community organizations and public officials to publicize the Program. A nationwide bus tour has been organized to bring the word to the hardest-hit cities suffering a high number of foreclosures.
A July 28 meeting was held at the U.S. Treasury in Washington to discuss ways to speed up the process. Twenty-five loan servicers attended the meeting and reportedly promised to ramp up the rate of modifications substantially. The Treasury Department announced that the new goal is to reach 500,000 home loan modifications by November 1, 2009.
On August 4, the Treasury Department issued its first report on modifications under the HAMP. The report confirms the perceived difficulties in the ramp-up, but does suggest that many servicers are beginning to understand the complicated process and are accelerating their responses to home loan modification requests. In addition to continuing these monthly reports, the Treasury Department announced that Freddie Mac will implement an audit procedure to test applications that have been declined.
So you finally got a buyer for your house after having it on the market for nine months. As frosting on the cake the buyer says she can close within a week.
Great! Right? Well, if your buyer made her mortgage loan application on or after July 30, 2009, it may take a little longer.
On July 30, Federal Reserve System rules (http://edocket.access.gpo.gov/2009/E9-11567.htm) went into effect implementing the Mortgage Disclosure Improvement Act of 2008 (MDIA). The rules - -applicable to purchase, construction and refinance situations - - impose various waiting periods between the time a transaction specific disclosure is made by the lender and the time when the residential loan transaction can close. The rules apply to all institutions engaged in closed-end, dwelling-secured lending for consumer purposes that is subject to RESPA.
The rule was going to go into effect in October 2009, but the date was moved up by the Fed two months in mid-May. Home equity lines of credit are excepted from the rule and are instead subject to separate rules for “open-end” credits. Different rules also apply for timeshare interests.Continue Reading...
Where there’s trouble, there’s trouble. As a growing number of homeowners have defaulted or neared default on their mortgages, numerous schemes have cropped up taking advantage of their willingness to do whatever it takes to save their homes.
The Court in State v. Cicerchi, 2009 Ohio 2249 (Ohio Ct. App. 2009) took the time to explain one of the more common plots:
One all-too common scam occurs when an individual or company identifies an at risk homeowner and misleads the homeowner into a "temporary" transfer of the deed to a third party with good credit. The third party then purchases the property and "leases" it back to the homeowner. The scammer convinces the homeowners that they can "refinance" their home using the third party's good credit. The homeowners are led to believe that they will pay "rent" on the home and once their credit is rehabilitated, they will get the title to their house back. The homeowners then lose title to their homes, while the perpetrator profits by remortgaging the property or pocketing fees paid by the homeowner. Rarely do the homeowners ever regain title or receive any benefit from the sale, and often lose any equity that may have been in their home.
In Cicerchi, the defendant perpetrated a similar fraud and was convicted of misdemeanor theft, securing writings by deception, and telecommunications fraud. On appeal, the Court overturned the securing writings by deception conviction due to insufficient evidence.
Earlier this year, the U.S. Department of the Treasury announced a partnership with several state and federal agencies to combat these mortgage-rescue frauds. The focus of the partnership is to identify offending companies and disseminate information to potential victims. The Federal Trade Commission and Office of the Comptroller of the Currency have each published a helpful bulletin on the variety of scams that can occur.
The obvious victims are homeowners in a situation where they require assistance to perform under their loan or otherwise come to an amenable resolution with a lender. But fraudulent foreclose rescue companies are also an impediment to banks because they commonly tell borrowers not to contact their lender or not to enter workout discussions. Banks are left in the dark until it’s likely too late. Further, the “fees” borrowers pay to participate in the scam could otherwise be paid to the lender for amounts due on the loan. Mortgage lenders would be well advised to contact distressed borrowers as soon as possible to notify them of potential scams and initiate workout negotiations.
A helpful reminder to lenders – if you’re going to foreclose, read the note and mortgage and do what they say. In a recent Ohio Court of Appeals case, the bank failed to follow these instructions and was rewarded by having its foreclosure complaint dismissed.
The borrower missed a payment on her mortgage and the bank sent a default notice via certified mail. When the past due amount was left unpaid, the bank foreclosed. Seems like a run-of-the-mill foreclosure case, right? Not quite, because the subject Note contained the following language: “Any notice that must be given to me under this Note will be given by delivering it or by mailing it by first class mail to me at the Property Address.” The borrower denied that she received the notice and, in fact, the certified mail envelope was returned to the bank as “unclaimed.”
Based on the express language of the Note (the Mortgage contained similar language), the Court rejected the bank’s arguments that it satisfied the notice requirements. The Note gave two options – delivery or mailing first class. There was no evidence the notice was actually delivered, and any presumption of delivery never arose because there was evidence, i.e. the returned envelope, that the notice was not delivered. The bank never mailed the notice by first class mail. The fundamental step of choosing the best mail service method could have saved the complaint.
This example continues a trend toward more rigorous review of lenders’ methods in foreclosure cases. From requiring proof of note ownership, to mandating alternative dispute resolution and dismissing cases under a res judicata analysis, courts have become a more borrower-friendly environment as the foreclosure crisis has progressed. As judges cast an increasingly skeptical eye upon each foreclosure action that appears on the docket, it is critical that lenders pay attention to the smallest, seemingly insignificant details of the process.
The rights of owners and tenants in post-foreclosure property have been dramatically altered by new legislation signed by President Obama. On May 20, 2009, President Obama signed the “Helping Families Save Their Home Act,” which contained provisions to aid renters whose landlords go through foreclosure. Title VII of the Helping Families Act (the “Act”) is entitled “Protecting Tenants at Foreclosure” and generally requires the immediate successor-in-interest on foreclosed property to recognize the lease rights of existing tenants on the property.
The Act applies to any property where there has been a foreclosure on a “federally-related mortgage loan or on any dwelling or residential real property” after May 20. “Federally-related mortgage loan” is defined in RESPA as being limited to mortgages on property “designed principally for the occupancy of from one to four families.” Therefore, the Act’s requirements apply only to residential, and not commercial, property.
If there are “bona-fide-tenants” on the property that signed leases prior to the foreclosure, the Act appears to require landlords to recognize the remaining term of the lease, although there is some ambiguity in the text of the Act regarding whether a landlord may choose instead to require existing tenants to vacate on ninety-days notice. “Bona-fide tenant” is a defined term essentially meaning that the tenant’s lease was the product of an arms-length transaction.
There are two situations under the Act where it is clear a post-foreclosure owner may require a tenant to vacate upon ninety-days notice. First, if the new owner sells a tenant’s unit to a purchaser who will occupy it as a primary residence, the owner may require the tenant to vacate after expiration of the notice. Second, a tenant who does not have a lease or whose lease is terminable at will must also receive a ninety-day notice before being required to vacate. The Act does not displace any federal or state requirements for terminating subsidized tenancies, or any state laws that offer greater protections to tenants. If not renewed, the Act will expire on December 31, 2012.
It is especially important for lenders to be aware of this new law, as many are becoming owners of real property through foreclosure proceedings. Anyone acquiring property post-foreclosure must carefully examine existing tenancies to ensure it recognizes leases or gives appropriate notice as required by the Act. Hopefully, better guidance will be offered in the near future concerning when a landlord may terminate an existing tenancy after giving proper notice.
In U.S. Bank National Association v. Gullotta, 120 Ohio St 3d 399, the Ohio Supreme Court decided that multiple actions under the same note and mortgage are subject to the two-dismissal rule and res judicata preclusion. The decision could have far-reaching implications for lenders seeking to workout loans with troubled borrowers.
The history of the case is important to understanding its impact. In June 2003, Giuseppe Gullotta entered into a note and mortgage with MILA, Inc., which assigned the note to U.S. Bank. In April 2004, U.S. Bank filed a foreclosure complaint for the total principal due on the note, plus interest from November 1, 2003. It voluntarily dismissed this complaint in June 2004. In September 2004, U.S. Bank filed a second identical complaint, except with interest running from December 1, 2003, which it also voluntarily dismissed in March 2005. In October 2005, U.S. Bank filed a third foreclosure complaint on Gullotta’s note and mortgage. After Gullotta filed a motion to dismiss, U.S. Bank amended its complaint to seek interest only from April 1, 2005 (the first missed payment date after its second dismissal).
Ohio Civil Procedure Rules state that “a notice of dismissal operates as an adjudication on the merits of any claim that the plaintiff has once dismissed in any court.” A second dismissal is with prejudice and res judicata preclusion takes effect. Under a res judicata analysis, any claim “arising out of the transaction or occurrence that was the subject matter of the previous action” is barred.
The Court held that each missed payment under the same note and mortgage does not give rise to a new claim, and therefore U.S. Bank’s two earlier dismissals precluded a third action. It premised this holding on four critical facts: 1) the underlying note and mortgage never changed, 2) the bank accelerated the payment upon initial default and demanded the same principal payment in every complaint, 3) Gullotta never made another payment after his initial default, and 4) U.S. Bank never reinstated the loan.
How low will they go?
Bending to market pressures, Cuyahoga County Auditor Frank Russo recently announced that the County’s 2009 valuation update will likely result in significant decreases in the County’s assessed value of residential homes – with an 8% average reduction across the County.
The media reports note that the State intends to compare Mr. Russo’s proposed values to the actual sales figures from each community and will ultimately approve new fair market values likely between 92% to 94% of the fair market value. The State’s suggestion of a 6% to 8% discount off of the appraised fair market value is really aimed at those properties that have not been recently sold. This “discount” should not be applicable to those non-residential properties where there was a recent arm’s length sale of the property.
School districts (when the sale exceeds the current assessed value) and property owners (when the sale is below the assessed value) actively seek adjustment of the market value of the non-residential properties to an amount equal to the purchase price. The Ohio Supreme Court has held that the purchase price paid in an arm’s length sale is the best indication of the fair market value of real property.
The Auditor’s decision to seek an 8% average reduction in value comes at the close of the property tax complaint filing season which ended March 31. In Cuyahoga County alone, a reported 17,000 decrease complaints were filed at the Cuyahoga County Board of Revision with respect to the 2008 tax year. Compared to the record 10,000 decrease filings last year with respect to the 2007 tax year, the 2008 “off-year” filings (the last year of the 2006-2008 triennium) are extremely notable.
Two foreclosure related bills of great interest to both borrowers and lenders were introduced in the Ohio House of Representatives in February but are moving slowly, if at all, through the legislative process. One of the bills is too bold to have a serious shot at getting signed by Governor Strickland, but the other is modest enough that it may pass.
House Bill 3, the more sweeping of the two, has languished in the Housing and Urban Revitalization Committee. At a very basic level, the bill would:
1. Impose a six-month foreclosure moratorium, during which a court could not hear or issue judgment on a foreclosure complaint. The moratorium loses a bit of its teeth, however, as a mortgagee an petition the court to proceed with the action if a borrower is more than thirty days late on a payment during the moratorium.
2. Establish new filing requirements for residential foreclosure complaints, including certain notices to be given to borrowers by loan servicers, a statement of mortgage information (including the identity of the note holder), an appraisal, and a $1,500 filing fee.
Monday marked the fourth straight day in Ohio of sunny skies and temperatures in the 80s. That’s quite remarkable given that we are just five weeks into spring and the summer solstice is almost two months off. The unusually hot weather was almost nice enough to make one think of being on a Florida spring break vacation - - if the current state of the economy had not already killed that dream.
But is it really always sunny and warm in Florida? Is Ohio that much drearier? Do the two states share similarities other than just the most recent weather conditions?
- The unemployment rate in Florida in 2008 was higher than the US average.
- Per capita personal income increased in Florida by a lesser percentage in 2008 compared to increases in the four prior years.
- Home median sale prices were down across Florida by a substantially larger percentage than in 2007.
1-month change 1-year change 2-year change
Cleveland -2.2% -5.2% -13.3%
Miami -3.6% -29.4% -43.1%
Tampa -4.4% -23.3% -34.8%
The foregoing statistics, like the recent weather, cast a warmer glow on conditions in Ohio than one might first imagine. And it is true that Florida has been hit comparatively harder in some segments than the Ohio economy.
But all statistics are relative. Just ask an Ohio resident if he would not mind having a house in Florida despite the recent home price freefall. Averages and snapshot comparisons do not always tell the whole truth. After all, the average height of a two-on-two basketball team consisting of Cavs center Zydrunas Ilgauskas and me would be 6'5".
But all statistics are relative. Just ask an Ohio resident if he would not mind having a house in Florida despite the recent home price freefall. Averages and snapshot comparisons do not always tell the whole truth. After all, the average height of a two-on-two basketball team consisting of Cavs center Zydrunas Ilgauskas and me would be 6'5".
How can you safely deposit the funds of a condominium association, development entity, municipality or any entity which needs to know that there is little or no risk of loss to the deposited funds ? The Federal Deposit Insurance Corporation (FDIC) temporarily increased deposit insurance for individuals to $250,000. The increased deposit insurance is scheduled to expire on December 31, 2009. Carving up the deposit into separate entities is cumbersome and can be difficult to manage and maintain.
Along comes the Certificate of Deposit Account Registry Service (CDARS). CDARS is owned and opperated by Promontory Interfinancial Network, LLC. Participating banks enter into a CDARS agreement in which the lead bank serves as the account custodian. CDARS then distributes the funds around to its participating banks to be invested in certificates of deposit in amounts less than the FDIC limitations ($100,000 for deposits maturing after December 31, 2009 and $250,000 for deposits maturing prior to December 31, 2009). CDARS will permit the application of FDIC deposit insurance on single deposits up to $50 million. The benefit to the depositor is working with one bank, one interest rate, one maturity date and one statement.
In these uncertain times for banks, all individuals, businesses, not for profits and municipalities should review their accounts and determine if there is a need to take advantage of the protections offered by CDARS.
"Every night before I rest my head; See those dollar bills go swirling ’round my bed."
So sang Patti Smith in the composition Free Money on her critically acclaimed 1975 debut album, Horses.
That’s a tune that cash-desperate real estate developers and project owners may have found themselves humming during the current credit crisis. But it may be more than just wishful thinking - - or wishful singing - - at least for certain projects in Cleveland.
In 2008, the City of Cleveland instituted its Vacant Property Initiative Fund which makes available up to $1,250,000 for acquisition, demolition, remediation, construction and some soft costs for non-residential projects. Big-box, mall projects and most tax-exempt uses are excluded from the program.
The money takes the form of a 6% one-year loan, but up to 40% of the loan amount is forgivable depending upon project size. A bonus 5% of loan forgiveness is available if certain green sustainability standards are met. Take out financing must be in place at the time the loan is made.
Certain vacancy or underutilization standards must be met to be eligible. Approval of the Mayor’s office and Cleveland City Council along with a recommendation of the City’s CDC is also required.
Like any program there are a host of requirements imposed on the borrower: prevailing wages, MBE/FBE and local hiring compliance, job creation and retention benchmarks and a shared first priority mortgage lien among them.
Despite the attached strings, the chance to get as much as $562,500 of free money for acquisition, construction and remediation should have project developers singing along with Patti Smith.
As I mentioned in an earlier post, Ohio Governor Ted Strickland recently signed legislation creating a new “land bank” in Cuyahoga County. Like a dose of cold medicine, Senate Bill 353 is not a cure for the foreclosure crisis, but it should help solve one of its primary symptoms – abandoned and vacant housing.
More than any other area in the state, Greater Cleveland has struggled with vacant properties due to its dramatic population decline over the past fifty years. In 1950, Cleveland’s population stood at 914,808, making it the seventh largest city in the U.S. Today, the population is estimated at 438,000. In other words, the city was built for twice as many people, leaving Clevelanders with easy commutes and plentiful abandoned properties.
Mortgage lenders scored a victory at the Ohio Supreme Court in the recently decided Wilborn v. Bank One Corporation, 2009 Ohio 306 (2009). In Wilborn, eleven borrowers brought suit against their lenders. Ten of the eleven cases (the eleventh did not involve a reinstatement provision and was decided differently) went like this: Lender brought foreclosure action against borrower. Borrower sought to reinstate the loan by paying the full amount due prior to judgment. Under the mortgage, borrower was required to pay lender’s foreclosure related attorney fees to receive reinstatement.
The borrowers objected to paying the attorney fees based on Ohio statutory and case law that precludes the collection of fees in actions enforcing a debt obligation, including foreclosure proceedings. They further argued that the attorney fee provisions of their mortgages were void because the contracts were not the product of free, bilateral negotiation. The oral arguments articulated the public policy concerns on each side.
In rejecting their claims and allowing the lenders to collect the foreclosure-related fees, the Court made a couple significant points. First, the contractual right to loan reinstatement is not the enforcement of a debt obligation but, rather, is a private contractual right. Second, even though the individual mortgages were not negotiated between borrower and lender, the Fannie Mae and Freddie Mac forms used were the products of extensive negotiation. The Court went into great detail on the creation of these forms and the inclusion of all parties’ interests in the drafting process. This precluded the borrowers’ claim that the mortgages were “adhesion” contracts.
The case attracted the attention of both the banking industry and consumer advocates, with coalitions of both groups filing amicus briefs in the case. Although the decision immediately benefits lenders, in the long run it likely aids borrowers. If a lender could not collect these fees, it would be fearful of filing a foreclosure action only to see the borrower reinstate and thereby lose the hundreds or thousands of dollars it spent in foreclosure. Lenders would, then, be very reluctant to insert reinstatement provisions in mortgage forms and borrowers would lose a valuable foreclosure alternative. Moreover, federally-backed loans are required to contain a reinstatement provision, so a contrary decision here would have made Ohio law inconsistent with federal policy and put borrowers who do not qualify for the federal loans at a distinct disadvantage.
With this decision in mind, lenders should take a moment to review current mortgage forms to make sure they require reimbursement of all attorney fees as a condition to reinstatement. The Fannie Mae form, for example, requires payment of “all expenses incurred in enforcing this Security Instrument, including, but not limited to, reasonable attorneys’ fees.”
In March 2007, Governor Strickland created the “Ohio Foreclosure Prevention Task Force” to address the ever-increasing number of foreclosures plaguing the state. The group’s final report, issued in September 2007, identified 27 recommendations for state action. Since the rise in foreclosures likely won’t be going away anytime soon, perhaps it’s appropriate to take stock of Ohio’s progress on the recommendations issued over 16 months ago.
Here are a few of the Task Force’s ideas where notable progress has been made recently:
1. Facilitate land banking of properties.
2. Encourage mediation and alternative dispute resolution.
3. Expedite the post-judgment process of property transfer.
The Ohio legislature deserves a fair amount of credit for getting substantial legislation passed quickly on these issues. Most recently, Governor Strickland signed Senate Bill 353 that authorizes Cuyahoga County to create a “county land reutilization corporation” to manage, develop, and maintain vacant property. Much more can be said about the pros and cons of this land-bank effort (and will be in a later post), but suffice to say it is a positive step toward addressing the mass amounts of abandoned properties in the Cleveland area that have resulted from the rise in foreclosures. At a recent presentation to the Cuyahoga County Law Directors Association, County Treasurer Jim Rokakis was very upbeat about being to tackle the “land” aspect of the foreclosure problem.
The goals of encouraging mediation and expediting post-judgment transfer were realized earlier through Substitute House Bill 138, signed by Gov. Strickland in September 2008. The bill made sweeping changes to Ohio’s foreclosure process, all aimed at expediting the process and locating parties who purchase properties at sheriff’s sales. It also explicitly authorizes courts to require the mortgagor and mortgagee to engage in mediation at any stage of the foreclosure.
These actions may not be enough to stem the tide of the current crisis, but addressing foreclosure-related issues through legislation now could certainly help minimize similar problems that arise in the future. Now, about those other 24 recommendations…
On January 27, 2009, the front page of the Columbus Dispatch read, “44,000 Jobs Gone.”Other articles report of companies shuttering their facilities or filing bankruptcy. As one affected employee interviewed for the Dispatch article succinctly stated, “It’s scary.” And it’s no less scary for landowners and lenders dealing with properties that have been abandoned. Landowners whose tenants have abandoned their facilities are trying to recover past rent due and expenses related to cleaning up the equipment, products and chemicals remaining at the facility. Banks are foreclosing on property or are working within the bankruptcy court to recover their money.
Landowners and first mortgage lenders in these situations should also be aware that they may be subject to environmental clean-up obligations under the Cessation of Regulated Operations (“CRO”) program. CRO was created to protect the public against exposure or pollution from hazardous chemicals left at abandoned facilities. CRO requires the owner or operator of the facility to secure the facility from trespass or vandalism and to comply with 30-day and 90-day deadlines in removing regulated substances and reporting on the progress. If the owner or operator of the facility fails to perform its CRO obligations, then the landowner or first mortgage holder may be responsible to perform certain CRO activities.
A side effect of the foreclosure crisis has been a growing concern among lending institutions over the possibility of “lender liability.” Lender liability encompasses any number of actions that may be asserted by a borrower against a lender based on either the lending process or final loan documents. Borrowers have been seeking new and inventive ways of avoiding foreclosure, often by bringing these claims against banks as counterclaims in a foreclosure action.
One of the most fruitful areas for lender liability claims to arise is in pre-agreement negotiations. It is easy for a borrower to embellish conversations to claim that an agreement arose, or even that its terms were more favorable than written. A few simple steps can minimize (although not eliminate) the chance a borrower may be successful on such a claim:
1. Require a written acknowledgement that any pre-execution communications between borrower and lender are not binding. This is particularly important in the loan work-out setting, where a lender does not want to grant concessions under the original loan documents until a final agreement has been reached.
2. One of the recurring themes in lender liability cases is the borrower’s perception that ongoing negotiations have resulted in an agreement. Placing a termination date in all pre-execution documents can avoid this problem.
3. Early in the loan application process, send a letter to the prospective borrower laying out all the required steps to be taken, by both parties, before a loan will be made.
Remember, especially in these times, you must “hope for the best and plan for the worst.” As a lender, you are hoping to benefit from a transaction financially, and are eager to get a deal done. But should litigation arise, you want a pile of evidence that all plainly supports your version of the deal. This shouldn’t be a hard sell, as extensive documentation also benefits the borrower by setting out the path to approval and eliminating any misconceptions.
If we want a healthier community we need to start with a healthy core city. I am a social worker, turned tax attorney, turned real estate deal maker. I tell you this because those phases of my life have all brought me to this point in my career. You know the theory about the donut. If there is a hole in the middle surrounded by wealthy suburbs, eventually the suburbs will crumble. Besides, urban areas are rich in character, more ethnically diverse and in general are more interesting places to hang out. Given the choice many people would prefer to live work and play in an urban landscape.
Tax credits, whether they be historic, low income or new market fuel urban development deals. Without these tax incentives restoring old buildings in the urban core makes little economic sense. The costs to rehabilitate are more then the fair market value of the buildings upon completion considering the low rents and sales price per square foot. Especially in these economic times when every bank is looking for a reason not to lend money, tax credits are even more important. Yes, tax credit deals take more time, are more complicated and result in higher professional fees. However you can raise almost 50% of the project cost in tax credit equity/ subordinate debt through tax credit programs.
Just recently I read an article in the Sandusky Register Online about the Ohio Preservation Tax Credit and the resultant loss of a deal in the Sandusky area because the program makes it difficult for it to be used with the New Market Tax Credits program. While the article oversimplified the problem, the problem still exists and I and other professionals are having a hard time convincing the Ohio Department of Development and the Ohio Department of Taxation that it needs to be fixed. Basically the program requires the credit to be allocated in proportion to a member’s ownership interest. In other words it does not allow the credit to be “specially allocated” to a member. This is important because urban development deals usually involve federal historic tax credits, state historic tax credit and either low income housing tax credits or new market tax credits. Different tax investors have different appetites depending on their presence in Ohio and their tax liabilities. If the credits could be specially allocated then investors would pay more for them rather then trying to find one investor for all credits.
If you are building new or renovating an existing building, you may have considered trying to obtain LEED certification for your project but decided after analyzing the cost that it was not within your budget. Well now, thanks to the Ohio Bipartisan Job Stimulus Plan (HB 554), LEED-certified projects may be eligible to receive funding. A little-known agency in Ohio has been tasked with reviewing and approving grants and loans under the Advanced Energy portion of HB 554. With $150 million in funding available over the next three years, this little-known agency, the Ohio Air Quality Development Authority (OAQDA), could become your next funding source.
The $150 million has been divided into two parts: $66 million for clean coal technology projects and $84 million for non-coal related projects (to be distributed in three $28 million annual appropriations). The projects eligible for non-coal related funding include various projects such as fuel cells, increased efficiency in electricity generation, advanced solid waste or construction and demolition debris conversion technologies, and renewable energy resources (wind, solar, etc.). Another category includes, “Any technologies, products, activities or management practices or strategies that reduce or support the reduction of energy consumption or support the production of clean renewable energy.”
At a recent presentation given by Kimberly Gibson, Assistant to the Energy Advisor at OAQDA, Ms. Gibson noted that “green” building projects may be eligible to receive a grant or loan under this last category. Constructing or renovating your building to be green would reduce the building’s energy consumption, the requirement of this last category. Inclusion within one of the categories is not the only requirement. When determining whether to approve a grant or loan, OAQDA also evaluates whether the project will result in new jobs, will assist Ohio manufacturing, and whether the project is adequately funded.
You know how you can smell the familiar scents of the changing seasons in the air ? Well those of us who have the honor to have survived a career in the real estate industry have recognized the smell in the air for some time. Right now that smell is pretty offensive; but we know from experience that it is going to turn sweet before you know it ! Recently, I was speaking with Mark Sinkhorn of Lawyer's Title Insurance Company National Services Division in Columbus, Ohio who reminded me that back in 1980 when the economy was experiencing record inflation and the only transactions we were doing were land contracts; and more recently in 1987 and 1994 there was a similar collapse in the lending market. In all instances, the economy and real estate industry rebounded .
Today, other than for some condominium developments in larger markets, the commercial real estate market is not over-built and once credit frees up again commercial development should lead the way as businesses expand their operations. In the mean time, manufacturing and distribution operators might wish to consider sale-leaseback transactions as an alternative to creating cash and moving assets from on balance sheets to off balance sheets. Sale-leaseback transactions properly structured are a "win-win" for both the developer (buyer/landlord) and the company (seller/tenant). Residential sellers might consider loan assumptions, seller purchase money mortgages and land contracts once again as tools to move their properties. There is a lot of room for creativity in commercial and residential property transactions, but care should be taken in the structuring of the same.