Sometimes a buyer is upset because he received less than he paid for.  On the other hand, sometimes the buyer is upset because he received way more than he paid for.  In a recent Texas Supreme Court decision, the buyer of contracts out of bankruptcy realized too late that it had purchased tens of millions in liability under an undisclosed indemnity agreement which had been dormant for years.

Indemnity Cat

To understand what happened, it’s helpful to have a general understanding of two things.  First, what is an executory contract.  Second, how does a sale process work in bankruptcy.

An executory contract is any contract under which both sides still owe an obligation under the contract at the time of the bankruptcy filing of one of the parties.

In defining an executory contract, the US Supreme Court has stated:

“Congress intended the term to mean a contract on which performance is due to some extent on both sides.

The Fifth Circuit has said:

“an agreement is executory if at the time of the bankruptcy filing, the failure of either party to complete performance would constitute a material breach of the contract, thereby excusing the performance of the other party.”

The characterization of an executory contract is important because the bankruptcy code has special provisions on how they must be treated.  One of the features of an executory contract is that it can be treated as an asset which can be “sold” to a third party; even over the objection of the contract counter-party.

Importantly, to sell an executory contract, the purchaser must take the contract subject to all of its terms.  The process is referred to as the assumption/rejection process.  (because the executory contract can also be rejected, which is a way to jettison liability on a bad contract).

As an asset of the bankruptcy case, an executory contract can be sold (technically assigned) either on its own or as part of a larger purchase.   This can done in a couple of ways, but one of the safer ways to do it is in a chapter 11 plan.  That was the case in Noble Energy v. ConocoPhillips in the Texas Supreme Court.

Noble purchased a slew of oil and gas properties and rights from a bankrupt debtor.  Prior to bankruptcy, the Debtor had entered into a number of transactions with ConocoPhillips.  One of the transactions included an environmental indemnity agreement which broadly and forever required ConocoPhillips and the Debtor to indemnify each other for environmental claims made against oil and gas properties they traded.

Unfortunately for Noble, those indemnity agreements were never disclosed in any way in the bankruptcy case – not even in the applicable purchase agreement.  Fortunately for ConocoPhillips, when Noble purchased the assets from the Debtor:

The Plan provides that any executory contracts not specifically referenced were to be assumed and assigned to Noble unless rejected at closing.  Noble agreed to the Plan and the APA has language that basically said “the assets and contracts we are purchasing includes, but is not limited to x y & z.”

Here was the error for Noble (in my humble opinion).  Noble had no actual knowledge of the existing indemnity agreement.  However, it agreed to assume – with all the burdens – ALL executory contracts unless specifically rejected.  Noble did not know about the indemnity agreements, so it did not “specifically reject” the unknown contracts.

Now, fast forward 10 years and ConocoPhillips sues Noble for $63 million based on the dormant environmental indemnity provision.

In the case, the Texas Supreme Court holds (importantly for the bankruptcy folks), that the cross indemnity provision was legally an executory contract which could be “sold” in bankruptcy.  The Texas Supreme Court holds (importantly for the transactional folks) that the unlimited scope of the purchase caused the unknown and undisclosed indemnity agreement to be part of the asset purchase agreement and bankruptcy plan thereby binding Noble to the terms.  Interestingly the environmental claim arose prior to the bankruptcy case, but the claim for indemnity was not made until after the purchase by Noble was completed.

While there is some interesting points on bankruptcy law in the opinion, the larger lesson from this case is that the common desire in drafting APAs to capture as much as possible may backfire if the purchaser unknowingly captures an indemnity that is sleeping.

Noble Energy, Inc. v. ConocoPhillips Company, cause no. 15-0502, Supreme Court of Texas.  June 23, 2017.

One of the many tools of the FDIC in resolving failed banks is the Extender Statute which, by its terms, replaces existing statutes of limitation under state law by a period of years.  In simple terms, the Extender Statute creates a longer statute of limitations for bringing a lawsuit on behalf of the now defunct bank.  The technical nature, and the amount in contest has led some defendants in FDIC lawsuits to argue that the Extender Statute of 12 U.S.C § 1821(d)(14) applies only to statutes of limitation, and not to statutes of repose.  This argument has recently been declined in the 5th Circuit and, in doing so the 5th Circuit has allowed lawsuits against RBS Securities, Deutsche Bank Securities and Goldman Sachs with damages of almost a billion dollars to proceed despite state law.

time for that later

In short, Guaranty Bank failed after investing about $840 million into residential mortgage backed securities offered by the defendants RBS Securities, Inc., Deutsche Bank Securities, Inc. and Goldman Sachs & Co.  After Guaranty Bank failed the FDIC was appointed receiver and sued all of the defendants on a number of securities claims, including claims under Texas securities laws.  In response, the defendants asserted that the claims were barred by statute of repose in Texas.

 I. The Extender Statute

Following the Savings and Loan scandal and failure of the 1980’s, the U.S. Congress passed the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”). FIRREA did a lot of things beyond the scope of this post.  However, one of the things FIRREA did was create the Extender Statute.

 “The FDIC Extender Statute works by hooking any claims that are live at the time of the FDIC’s appointment as receiver and pulling them forward to a new, federal, minimum limitations period…”

At a minimum, the Extender Statute gives the FDIC 3 years from the date it is appointed receiver over a failed bank to decide whether to sue anyone for bad acts related to the failed bank.

In the case cited above, Guaranty Bank in Texas had failed, the FDIC had taken over and within three years of appointment as receiver, the FDIC sued RBS Securities, Deutsche Bank Securities and Goldman Sachs & Co. on claims related to alleged bad mortgage backed securities investments.

The issues in the appeal is that under Texas Securities Law (Tex. Rev. Civ. State. Art. 581-33(H)(2)(b)) the claims brought by the FDIC were barred by a statute of repose which ran shortly after the appointment of the FDIC as receiver.

II. Statutes of Limitations v. Repose

While the FDIC Extender Statute refers to a “statute of limitation”, the Texas Securities Law is a statute of repose.  Ordinarily the distinction is important, but not in this case.

To paraphrase the 5th Circuit: A statute of limitations creates a deadline for suing in a civil case based on the accrual of claim – which is typically when the damage is discovered or should have been discovered.  On the other hand, a statute of repose creates a deadline for suing in a civil case based on the last bad act – without regard to damage.

In the case, everyone agrees that the Texas Securities Law is a statute of repose and everyone agrees that the FDIC Extender Statute only references statutes of limitation.

III. The Holding

In 36 pages of dense and technical reasoning, the 5th Circuit holds that the Federal Extender Statute applies to extend statutes of limitation and the statute of repose under state law, such as the Texas Securities Law.

The statutory construction analysis is worthy of an attorney’s only blog post.  I will do you the favor of omitting the analysis here.  However, it is sufficient to say the opinion is comprehensive in its analysis.

IV. Why it Matters

Why does it matter?  RBS Securities, Deutsche Bank Securities and Goldman Sachs were all sued by the FDIC based on a failed bank’s investments into their residential mortgage backed securities trusts outside of state law prohibited time period.

When quantifying risk, the monetary exposure is just as important as the burn time of the limitations period.  Concerning this securities issue, the FDIC as managed to extend the otherwise applicable five year statute of repose to a eight year state of limitation in a case with damages near $1 billion.

If you are a lender and your counter-party is an FDIC insured bank, the statute of limitations on risk might be significantly longer than anticipated if the counter-party bank fails.

FDIC v. RBS Securities, Inc., case no. 14-51055 (cons w/ 51066), In the United States Court of Appeals for the Fifth Circuit.

Claim subordination is the opposite of alchemy.  In most bankruptcy cases, creditors might look for ways to improve their treatment.  Claim subordination in the bankruptcy code provides a mechanism to force a creditor to receive worse treatment (relative to other non-subordinated claims which is, admittedly, not that great of treatment).

alchemy_lab

In bankruptcy, there are a few ways for a claim to be subordinated.  A claim could be subordinated because you did something bad.  A claim could be functionally subordinated by having debt determined to be equity.  Or, among others, a claim could arise as a result of a transaction involving the sale of stock of the bankrupt debtor or its affiliate.  It is the last one that has come up recently in a Fifth Circuit opinion in a way I thought was interesting because it deals with guaranties.

 I. The Underlying Case

The underlying bankruptcy case involves the debtor American Housing Foundation (“AHF”) which, prior to entering bankruptcy, operated to promote and develop low income housing and obtain Low Income Housing Tax Credits (known as “LIHTC”).  Each actual housing project was operated out of a specific single purpose entity (“SPE”) which was controlled by AHF.

In the course of its operations, AHF would form limited partnerships with AHF as general partner.  AHF would then solicit and obtain investors to put money into the LPs in exchange for limited partnership interests.  That money invested into the LP was then supposed to be put into a specific SPE (which actually held the asset) as unsecured debt to cover pre-financing costs.

Other than the opportunity to receive a distribution from the LP, inventors would also be able to claim a LIHTC.  But to sweeten the deal even more, AHF provided a guaranty of the money invested into the LP to each investor.  Some the guaranty agreements even provided for interest.

To make a long story short, AHF acquired property too quickly and exhausted capital needed for operations of existing projects.  This apparently caused AHF to use some new cash to fund operations, pay dividends and fraudulently divert some of the cash to the principal of AHF.   This proved untenable and AHF was put into an involuntary bankruptcy case.  As is usually the case, after the bankruptcy filing everyone got sued.

 II. Guaranty Subordination

Templeton was an investor in several of the LIHTC LPs.  As was typical, Templeton received LP interest in exchange for his investment and also received a guaranty from AHF.

While the notion of a guaranty of an investment might not seem too far off mark, the careful lender will recall that a guaranty is a contract for the repayment of debt. In contrast, an equity investment is not debt.  The Fifth Circuit touches on this issue in its opinion.  However, what is ultimately the legal reason for subordinating the guaranty obligation is section 510(b) of the Bankruptcy Code.

I would commend to you the actual text of 510(b), but the Fifth Circuit summarizes the section as such:

“Accordingly, this provision makes clear that claims arising from equity investments in a debtor’s affiliate should be treated the same as equity investments in the debtor itself–i.e., both are subordinated to the claims of general creditors.”

So, because Templeton’s “guaranty” from AHF arose from the sale of the LP interest, any recovery on account of the guaranty was automatically subordinated to the other creditors of AHF for the purposes of distribution.  In this case, Templeton is projected to receive nothing if subordinated as opposed to ~40% as a general unsecured creditor.

III. Things to Consider

Regardless of whether a guaranty of an equity investment is enforceable as such (notwithstanding the lack of actual debt), the guaranty will be subject to mandatory subordination if the guarantor files bankruptcy and the equity company is an affiliate of the guarantor.

This particular type of subordination puts the claim below general unsecured creditors, which puts any chance of recovery in the “very unlikely” category.

By the same token, if you are a lender and your collateral is a lien in such guaranty, then you face the same prospect of subordination as the borrower.

Finally, the opinion discusses other issues of some note, which did not make it into this post because of length.  The opinion discusses preference ordinary course defense, and valuation for the purposes of fraudulent transfers.

Templeton v O’Cheskey (In the Matter of: American Housing Foundation), case no. 14-10563, in the United States Court of Appeals for the Fifth Circuit.  Opinion revised June 8, 2015.

Opinion is here.

I have been told that in a traffic jam ambulance drivers are taught to move to the first opening available in traffic and figure out where to go after that.  Sometimes legal strategy takes that same philosophy.  In a recent 2nd Circuit Case, PriceWaterhouseCoopers, LLP (“PwC”) asserted in pari delicto to avoid immediate liability in a MF Global, Inc. (“MF Global”) related lawsuit.  What happens next, I assume has already been figured out by their very capable lawyers.

PP 68 PONTIAC AMBULANCE

It is helpful to know what the legal doctrine of in pari delicto means, if you do not already know.  The doctrine is “an affirmative defense which mandates that the courts will not intercede to resolve a dispute between two wrongdoers.”  In essence, if two wrongdoers come to court, the court will not resolve who is at fault.  More simply, if a party asserts they are not liable on a theory of in pari delicto, they are necessarily claiming to be a wrongdoer.

Following the collapse of MF Global a lot of people got sued.  Among the people who were sued were the D&Os of MF Global and PwC on behalf of MF Global.  PwC is alleged to have conducted audits of MF Global during the time in which MF Global is alleged to have “raided” (not my word) the commodities customers’ accounts in an attempt to keep MF Global afloat.   Stated in a broad stroke, the plaintiffs assert that PwC should have caught the alleged violations of the various securities laws, but did not.  The damages were asserted to be in the billions of dollars.

Here is where another legal concept comes into play – a derivative lawsuit:

In simple terms, a derivative lawsuit is where a third party brings a lawsuit on behalf of the primary party against a second party.

In this case, the aggrieved commodities customers filed a derivative lawsuit on behalf of MF Global against PwC claiming that PwC has violated securities laws when it raided the accounts.  Among PwC’s responses (of which, I presume there were many), PwC asserted the  affirmative defense of in pari delicto because the true party was MF Global (because it was a derivative lawsuit), and thus they were both wrongdoers.

Personally, I think it takes a lot of confidence on the part of PwC’s attorneys to assert the affirmative defense of in pari delicto in this, or any case.  In doing so, the client is being advised to assert that is a wrongdoer.

The case itself has been up and down the system.  However, it’s the recent ruling on May 22, 2015 which affirmed that PwC would not be liable to the commodities customers because PwC had prevailed on its affirmative defense of in pari delicto.  (The 2nd Cir. affirmed that there could be no professional negligence claim because PwC never worked for the plaintiffs).

What to take away from this decision and fact pattern for a lender?

  • Consider the true sources of recovery. If you are banking on a third party liability policy, then it might not be there.
  • Sometimes accountants might not act properly, and if they do, the lender might not be able to recover from them.

As a legal matter, this dispute is likely not over any time soon.  By essentially asserting wrongdoing, PwC has prevented liability from the derivative claimants, but has not addressed the potential for liability from other claimants.  Nevertheless, the tactic worked and now PwC is on to the next fight, having avoided liability at the first. In effect, PwC has gone for the first opening in heavy traffic and will figure out where to go after that.

Bearing Fund, LP., et al. v. PriceWaterhouseCoopers, LLP (In re MF Global Holdings Ltd. Investment Litigation), case no. 14-1249-cv, In the United States Court of Appeals for the Second Circuit, opinion issued May 22, 2015.

The Order is here.

I always assume that people who like NASCAR are really watching for the wrecks.  The cars loop around the track for hours, but only the wrecks make the highlight reels.  In a recent Texas Supreme Court case, the high court considered whether a supermarket was liable for destruction of evidence when it retained only the video recorded around the time of a slip and fall after its looped camera system deleted the rest.

shake and bake

The case is Brookshire Brothers Ltd. v. Aldridge at the Texas Supreme Court (for those of you outside of Texas, Brookshire Brothers is a supermarket).

In the Brookshire case, a slip and fall claim made it to the SCOTX because Brookshire had allowed a security camera (on a loop) to record over all but a few minutes before and after of the actual fall.  At the heart of Brookshire’s reasoning for recording over the video was the risk manager’s mistaken belief that the time prior to the fall was “not relevant”.

Even folks not familiar with the law have a general concept that destroying evidence is a bad thing.  The question in practical terms in a real lawsuit is – what is “evidence”.  At the heart of that question is relevance to the dispute.  That concept fills volumes of scholarly papers.  I won’t go into it here.

It is enough to know in the Brookshire case that the deleted portion of the looped tape was relevant, destroyed and the subject of the appeal. The Brookshire opinion is helpful for a few reasons, but primarily because it attempts to give a bright line to follow for dealing with a potential spoliation issue (which is the fancy name for “destroying evidence”).

For the lawyers reading, the SCOTX sets forth the test to determine after the fact whether evidence has been spoiled.

  • The trial judge gets to decide whether spoliation has occurred.
  • If so, did the party have a duty to reasonably preserve the evidence and did the party negligent breach that duty by failing to do so.

If the Judge determines that evidence has been destroyed, then the Judge gets to decide the remedy (which might include a spoliation instruction to the jury).

Important for the lenders on the front end – According to the SCOTX:

  • The duty to preserve arises when a party reasonably knows there is a substantial chance that a claim will be filed, and
  • That evidence in its possession or control will be material and relevant to the case.
  • Substantial chance of litigation means: when litigation is more than an abstract possibility or fear.

For the lenders, the take home rule is that if you spoil evidence either intentionally or negligently, after being aware of the claim you might be liable.

(A side concern is when does the duty actually arise?  In a future post I may go over litigation hold letters if anyone is interested)

Once you have spoiled evidence, the remedies are wide-ranging and unpleasant.  In Texas, if the spoliation was intentional then the jury may be instructed that all the spoiled evidence will reflect negatively on the spoiler.  Meaning, even if the destroyed evidence actually showed you doing the right thing, the court may instruct the jury that you were doing the wrong thing.

The Brookshire’s case is more than important to lenders.  Forget for a moment that this is a slip and fall grocery store case.  Rather, assume this is a lender liability suit and consider the volume of data that is aggregated and deleted daily in your databases.  For lenders, that alleged bad act rarely occurs in the branch office, but rather in the broader lending relationship.  The email statements, verbal statements, internal memos, meeting notes, calendar entries, etc. may be evidence at the next lender liability lawsuit.  At what rate are those being deleted and by whom?  Importantly, what does your retention policy look like?

Some clients have systems that automatically delete data as the data stream goes forward.  (Not to say that a doc retention policy can’t do that, but when a duty to preserve arises it generally will trump the retention policy.)  The lesson here is that regardless of whether your data is being deleted on a loop or not, you still want to be able to preserve all the information about the crash and not just the crash itself.

Believe it or not, when you (the good guy) accidently produce in discovery an internal memo which is subject to attorney-client privilege to the bad guys (the guys suing you), the bad guys might not give back all the copies.  And, if you are really unlucky, the bad guys will distribute it to other bad guys also suing you for similar reasons.  You might even litigate the issue to the Fifth Circuit court of appeals and win, but the cat will be out of the bag.

In the Fifth Circuit case Exxon Mobil v. Hill, No. 13-30830 the Court held that an internal memo discussing the radioactivity of material (and its harm) was subject to attorney-client privilege. The Court held that the nature of its creation precluded the need to provide the memo in discovery (even though people got very sick from the radiation).  However, the cautionary tale is that even though the plaintiff returned a copy, he did not return all copies of the memo that was accidently shared.  What ensured was years of litigation.

At the center of the case is a memo drafted by Exxon’s in-house counsel concerning whether to provide radioactivity test results (related to drilling pipe) to a potential contractual counter party who was offering to clean the drilling pipe as a contractor.  In the memo, the in-house counsel opines that Exxon should only provide the information specifically requested by the contractor and that Exxon would not provide the additional information which showed a significantly higher level or radioactivity.

Not surprisingly, litigation ensued over the course of many years after numerous workers became sick from the radioactivity on the drilling pipe.  In the course of one of the many lawsuits “Exxon accidently produced..” the memo.  Exxon’s counsel realized the mistake and invoked the claw back provision (which should require the other side to give back the document).  The opposing counsel did, in fact, return the copy he received.  But, the attorney also “kept a copy of the [] memo and distributed it to other plaintiffs’ attorneys, who in turn attempted to use it in the other cases.”

What following was another parallel set of litigation in which Exxon sought to assert the privilege over the memo in numerous state and federal courts with mixed results.

The 5th circuit, in considering whether to permit the assertion of privilege over the document, held that the memo was privileged.  While the court construed Louisiana state law, the Louisiana version of the rule of evidence is fairly similar to the Texas rule governing privilege.

The 5th circuit stated “The []memo reflects the advice by in-house counsel concerning the disclosure of certain data during negotiations.  Context here is key: The document was prepared during contract negotiations in which both side were assisted by legal counsel.  The negotiations, according to the record, involved a number of legal issues, including indemnity for downstream tort claims, storage and handling of nuclear residue, licensure, trade secrets and other issues.”

Thus, the memo was subject to attorney-client privilege.  But, the general counsel reading this post are not now reaffirming their belief in the technical protections of the attorney-client privilege. Rather, the underlying lesson here is: don’t accidentally send documents that are subject to the attorney client privilege out the door.  Easier said than done (and paid for).  Here, Exxon won the battle and lost the war.

In some litigation arenas, the trend is to produce everything and then figure out what was subject to privilege (for cost reasons).  For lenders who might be exposed to other similar litigation, the relief you have in not paying for a more thorough vetting of documents might be replaced by the anxiety of litigating about it more years.

Over the last few weeks, I’ve commented on the new version of the OCC’s Commercial Real Estate Lending Handbook (I give it a gentlemen’s C); and I listed a few legal topics that deserve some guidance from the OCC. “Guidance” could even merely be a list of important topics (ending with a warning that the list is NOT an all-inclusive list). I expect legal issues to be identified and put on the “check the box” list by the OCC  – with the banks expect to check the box. The "Blank" List   Unfortunately, instead of leading the class by at least listing legal issues associated with risks in commercial real estate lending, the OCC implicitly affirms those banks that under value and under utilize legal counsel.  (Let’s resist the temptation to comment on “why” this takes place.) Fortunately, some banks are very good at identifying and monitoring legal issues. Several of them do this by a simple two step process:

  1. List key legal provisions in loan documents
  2. Instruct legal counsel to report, in writing AND PRIOR to closing, if these provisions are altered

Here is a sample list (it is NOT an exhaustive or all-inclusive list):  legal counsel must report (in writing) any changes, from the bank’s standard form, in loan document provisions that cover the following –

  • grace period, late charges and default interest
  • prepayment, lockout and yield maintenance
  • transfer restrictions (due on sale) provisions
  • subordinate financing (due on encumbrance provisions)
  • material deviations in, or deletions of, the remedies provisions (unless required under the governing law of the state in which the collateral is located)
  • recourse provisions
  • environmental provisions
  • taxes and insurance premiums escrows
  • any reserves or other escrows
  • granting clauses or form description of collateral contained in such granting clauses (unless required under the governing law of the state in which the collateral is located)
  • casualty or condemnation provisions
  • addition of a provision allowing a release of collateral (unless expressly provided for in the credit approval)
  • lender approval process relating to amendments, renewals or termination of major leases (or new leases)
  • cooperation provisions, including use of any future technology required by lender (such as on-line reporting and delivery of required materials and information)
  • WARNING: __________ [this list is not “all-inclusive” and you should revise it as needed]

My suggestion is that every bank (or other lender) take this approach.  Surely at some point, the OCC will view this simple approach as a key to safe and sound banking practices. Please share you comments below.                

Last month, the Office of the Comptroller of the Currency published the Commercial Real Estate Lending handbook (August 2013).  The 128 page handbook gives guidance to bank examiners and bankers on risks inherent in commercial real estate (“CRE”) lending.  It replaces a 95 page version published in 1995 (and revised in 1998). For this new school year and since commerical real estae lending is increasing in the “recovering” economy, I expected the OCC’s CRE lending handbook to grade-out with an “A+.” Instead, it is a solid, gentleman’s “C.” Make that a fraternity “C.”

Your Company is in this picture, too!
And probably make that a “C” for your company, too.   Like the OCC’s handbook, in many companies there is a disconnect or chasm between the business platform and legal issues undergirding the platform.  The “C” grade is NOT limited to the OCC and the banking sector. The OCC’s Commercial Real Estate Lending handbook takes an inconsistent approach in the role or importance of basic legal issues as a subset of risk management.  The approach swings from:

  • “legal light”: a few topics list legal issues and mention lawyers, but the topics are limited in number –
    • in the context of environmental risks,  handbook lists specific legal issues (p. 71)
    • the term “counsel” appears 5 times:
      • in the review of (ground) lease documents  (p. 53)
      • in assessing environmental risks (p. 70)
      • in the review of loan docs and other agreements “to determine if the improvement” comply with applicable laws and restriction (p. 104)
      • in the review of takeout agreements (p.107)
      • in the review of completion insurance bonds (p. 108)
  • “I know it when I see it – but you have to guess what I see”: some topics include the use of the phrases “legally bound” and “legally enforceable,” but with no guidance on “how” an examiner or banker is to verify or arrive at these legal conclusion (assuming the examiner or banker is not an experienced commercial real estate lawyer) –
    • what do these phrases mean or require?  They are not defined in the Glossary (Appendix C). Are legal opinions required? Does this require hiring a lawyer? If “yes,” this sidesteps the reality that most Companies are seeking ways to spend LESS money on lawyers.
    • similarly, the handbook contains references to “appropriate” loan documentation and “loan documentation policies.”  Again, what do these phrases mean or require?  Broad generalizations give no guidance on loan document provisions, and are not helpful in addressing or mitigating risk.
  • neglect: most topics simply do not include any reference to anything legal –
    • maybe for purposes of the OCC handbook, legal issues simply are outside the scope of the OCC handbook.  If this is the OCC’s approach, then legal issues should be disclaimed, with no mention of legal issues.
    • one of my problems with this “neglect” approach is that it denies reality.  Legal issues are part of the DNA of safe and sound lending, and risk management.  Banks and the OCC acknowledtge this by spending millions of dollars on legal services.  Indeed, guidance might even help to control legal fees.

My expectation was that the handbook would give lists of “no” change provisions, or a list of legal topics that need to be addressed (with the ability of a bank to explain any deviation from the provisions or list). Clearly, either I misunderstand the uses of the handbook, or the OCC missed an opportunity to give more meaningful guidance. Perhaps the gentleman’s “C” is too gentle. In future posts, I’ll describe a few of my favorite “no-no change” provision, and give an overview on current legal topics covered at several recent seminars. Please post your comments and perspectives below.

In some parts of the country, a recovering local economy means the special asset (or problem loan) groups are reducing staff, as loan production groups come back to life.  Leaving the special asset group under-staffed could be a mistake if the staff is not able to properly complete basic foreclosure tasks.  One basic task is inspecting the property prior to taking title to the property (whether through foreclosure or a deed in lieu of foreclosure [FAQ series for information on deeds in lieu]).  Here’s a decision tree that might help you in deciding if an inspection “really” is needed, and a recent example that should energize you to look before you leap (into ownership of the collateral).   Decision tree: verify that your mortgage loan documents give you the right to enter the property, then

  • Current Inspection Report: ask yourself this question: “when was the last time that someone looked at every part of the property?” If the answer is “more than a few months” then a current inspection should be a priority
  • Court Ordered Entry: if the borrower does not allow you to inspect the property, then investigate (with your lawyer) the available court orders that could give you access to the property (in order to inspect it)
  • Extraordinary Situations:  of course, there are situations where inspecting the property just is not possible, with the result that –
    • Foreclosure is the only option (for example, the lien itself is about to lapse or expire) (I’m having a tough time thinking of other justifications to not inspect)
    • Receivership is the better option (for example, you already know of problems and your presence on the property [during an inspection] could cause you problems)

Still not convinced that an inspection should be a top-shelf priority item? Once Upon a Time . . . The phone rings and you’re called to meet with City officials at the police precinct office near your “new” apartment project (shortly after you foreclosed on what seemed like just another project). At the meeting, you’re introduced to the Chief of Police and representatives from the Mayor’s office, the zoning department, the City health department and a lawyer from the local District Attorney’s office.   They vaporize you with a list of alarming health and safety issues at the apartments. The bottom-line message was simple: you have 30 days to show some “progress” on the issues or the City would take enforcement actions. Their list included the following:

  • an active farm growing illegal plants
  • sewage flowing into one of the units
  • on unit has a 50 foot hole in it, with dirt piled up to the window
  • organized dog fighting

As always, it is the basic stuff that jumps up to bite you.  (And gets the immediate attention of your insurance group.) Please share your comments below.  

Lenders are refreshing their mortgage loan documents with provisions based on the “lessons learned” during the recent (continuing?) economic experience.  One change is to add a service of process provision. The change is based on this basic lesson learned: when the tough times hit, borrowers and guarantors sometimes are hard to find. A few simply disappear behind gated communities, on yachts, or regularly move from one remote estates to another – maybe intending to make it difficult for the lender to give them required legal notices of litigation or foreclosure (referred to as “service of process“).

Hide and Seek – in style
Or maybe this simply is a desire to get away from the stress of it all – leave the train wreck (1913 State Fair Trains Collide) for the lawyers.  Or perhaps just a final surrender to the wanderlust whisper. In response, many lenders now bake into their loan documents a provision where the borrower (and the guarantor) agree that legal notices (or service of process) will be given to a designated person (or company), who will accept those notices. So far, I haven’t had a borrower object to the provision. If you’re tired of spending money and wasting time in an adult version of hide and seek (or simply not wanting someone to do what you can’t do), then consider adding a service of process provision in your standard forms of documents for:

For other “lessons learned,” click this link (or use another search term). If you have comments, or your own suggestions, please comment below – then board your yacht or follow your wanderlust.