My prior posting briefly describes two typical tenant in common structures ("TIC"), and then addresses some of the issues effecting a workout where the borrower is a TIC.  (In a workout, "TIC" rhymes with ______.)

Here are two other major topics that come into play:

  • Documents: How do the loan documents,  the TIC documents and possible new documents address the following topics –
    • do the documents properly address the 15-part test articulated in Revenue Procedure 2002-22 (thus allowing the TIC investment to be classified as an investment in real estate, and not as an investment in a partnership)?
    • does the TIC structure comply with federal and state securities laws?  (Does the documentation and records of the TIC sponsor support the view that the TIC interests are a security?  The Sunwest senior living law suit shows that the SEC will actively pursue TIC sponsors in the proper case.)
    • do the notice provisions require actual delivery of written notices, or is delivery deemed given when sent? (This topic is huge: actual, physical deliver of notices to a large of TICs can be difficult.)
    • how do the documents address removal of the manager of the TIC or of the master lessee?  (See my prior posting for a depiction of the two typical TIC structures.)
    • how difficult will it be to engage a new manager? (Beware of the scope of the indemnifications required by this new manager.)
    • are the TICs willing to "roll up" the TIC structure into a single entity (such as a limited liability company)?
  • Tax Picture: What is the tax situation of each TIC?
    • Typically, each TIC has a low basis due to the 1031 Exchange (Consequently, a forced sale of the collateral, a deed in lieu of foreclosure or forgiveness of debt may create "phantom" income to the TIC investor, which results in a taxable gain for federal income tax purposes.)
    • This tax issue could be the motivating factor for a TIC in a workout or restructure

These fundamental topics will control a workout or restructure of any commercial real estate loan where the borrower is a TIC.*

If you have questions or comments on these topics, please post them below.

* While I have given presentations on this topic, special thanks to these Winstead lawyers, who gave me additional information prepared by them: Eli ColumbusErick Weiting HsuJeff MatthewsEd Peterson & Brian Short.

 

The second day of seminars, at the annual meeting of the American College of Mortgage Attorneys, had two key take-aways for me.  The first nugget focuses on the Dodd-Frank financial law.

The second nugget (below) is much more practical.  Inspired by comments made by Jim Allen during a panel presentation (he’s with the Miller Canfield law firm), I take his list, enhance it (slightly), throw in some links to TT4L (for more details), and give you a short list of key topics for use in working out a distressed commercial loan.  And I also attach our "dealno deal" decision tree for your use.

Remember, this is a short list – it is NOT an all-inclusive "end all for all."  But, it will get you going quickly.

  1. Using Rent for X, Y or Z: for example, no funds from property will be used to pay B’s legal fees, except for work related to the property (such as new leases, etc.).  Diversion of rent is a hot topic.
  2. Trap Rent: put cash management or a lock box into place – control the cash
  3. Property Operations: in time, replace the property manager with a third party
  4. Title and Taxes:
    review the existing title policy
    –  check to see if it covers mechanics’ liens
    – will the title policy run to the benefit of a note buyer?
    – order an up-date (checking for new liens, etc.)
    – what taxes remain unpaid? is there money to pay them? (pay taxes BEFORE you foreclose)
  5. Send default letter
    – give notice about default interest?
    – what is the default?
  6. Send negotiation letter – Issues include:
    – will Borrower waive all claims v Lender?
    – only waive specified claims v. Lender?
    – drop this requirement? (Choices: if no letter, then no workout discussions; but beware that if this letter is heavily negotiated, then the entire process could be a failure – or at least very, very slow and painful)
  7. Agree to a forbearance if there is a "real" risk of a decent Lender liability case; time can “solve” many lender liability claims
  8. Focus on sources of “new” funds available to borrower; or through a mezz lender; or via a tax refund
    – know the tax position of the sponsor
  9. Get a receiver appointed; and with the appropriate judicial order, the receiver could obtain a loan for funds needed for new tenant improvements and leasing commissions
  10. Look for non-recourse liability events (in the absence of a full guaranty agreement)
  11. Appoint a new leasing agent, with contractual terms giving the Lender permission to talk with tenants or prospects

For the "bigger" picture, attached is our "dealno deal" decision tree.

One final thought: as I took Jim’s list and elaborated on it, I realized that TT4L has become a powerful knowledge base.  Next time that you have a question, do what I did as I prepared this: take your key phrase, and use the "keyword" search function. 

If you have other resources, links or materials, please post a comment below.

Recently the IRS corrected a mistake inadvertently created by it in September 2009, when it made changes to the REMIC rules governing changes to CMBS loans.  One result of the 2009 change was that partial releases, expressly contemplated in the CMBS loan document, must pass the “principally secured by real estate” test for qualified mortgages at the time of the partial release (see Section 860G(a)(3)(A) of the Internal Revenue Code and Section 1.860G-2(a)(8) of the Income Tax Regulations).

Failing this test could result in the CMBS pool losing its status as a REMIC, which would have horrible consequences to the tax-free status of the CMBS trust.

Thus, the loan servicer was placed in a no-win situation: the borrower had a right to a partial lien release under the loan documents; yet doing so would violate REMIC rules and the servicer’s agreement (in the servicing agreement) to comply with REMIC rules.  (Loss of tax-free status for the trust = heads roll at the loan servicer).

The borrower, of course, was not interested in the loan servicer’s problem; it simply wanted the benefit of the bargain (see CMBS gripes of borrowers).  (Sounds like a personal problem of the loan servicer.)

The IRS’ new Revenue Procedure 2010-30 gives guidance on this problem and details how the IRS will provide relief for loan modifications of CMBS loans that are “grandfathered qualified mortgages” and “qualified pay-down transactions.”

The Revenue Procedure provides that a partial lien release will be a "grandfathered modification" if:

  • it occurs by operation of the terms of the debt instrument, and
  • the terms providing for the lien release are contained in a contract that was executed no later than December 6, 2010.

The Revenue Procedure defines a "qualified pay-down transaction" as a transaction in which a lien is released on an interest in real property and which includes a payment by the borrower resulting in a reduction in the adjusted issue price of the loan by a qualified amount.

So, if the CMBS loan expressly permits a partial release of a portion of the property upon the payment of a partial release price (all as expressly specified in the loan documents), then the CMBS loan servicer may go forward with the partial release.

This is good news.

Nice to have good news.

It is interesting that the IRS does not address this request: dropping the requirement for a  retesting of collateral released when a loan is in default.  This request was made by industry organizations in order to give CMBS special servicers additional flexibility as they deal with defaulted CMBS loans.

If you have a war story on this topic, or simply want to comment, please post it below.

This is a series of blog entries in which we provide some quick answers to lenders’ frequently asked questions (FAQ).

Borrower’s failure to pay property tax liens often is a good indicator that the loan, and the collateral, are in trouble; and that soon, Borrower will fail to pay the scheduled installments on the loan.

So, a lender or a loan servicer should add these topics to the task list: (i) monitor state tax due dates, and then (ii) dealing with property taxes (if they are not paid).

This topic is very state-specific in that each state seems to have its own rules on this topic.  Even with that important qualification, these general statements will get you started on this important topic –

FAQ #38 – Should Lender pay off state property taxes before foreclosure?

  • If the loan documents permit the Lender to pay these taxes (and this should be permitted under the loan documents – but read the loan documents to confirm this), then Lender should pay unpaid property taxes prior to foreclosure in order to include such advances in the loan, and thereby increase the amount of any deficiency.

FAQ #39 – What happens to State tax liens after a foreclosure; do they "survive" a foreclosure or does the foreclosure extinguish the state tax liens (wipe them out)?

  • Ad valorem taxes encumber the property with unique powers.  So, in Texas they are "super liens" and have priority over prior mortgage liens.  This means that they are not extinguished by the foreclosure (meaning that they do not "go away").  Thus the importance for you to consider #38 above.

To read the entire Tough Times "FAQ" series, please click here.

Two things should be kept in mind. First, none of these questions can be answered in a vacuum. Questions should be considered with a thorough review of the file and an interview with appropriate loan officers. And secondly, many of the questions are worth revisiting from time to time because subsequent events will impact the answers.

If you have thoughts, suggestions or questions on this topic, please post a comment below.
 

As I’ve commented previously, Congress has been contemplating imposing a stiff tax increase on the "carried interest" or a developer’s "promote" in real estate deals; and a long, long list of commercial real estate industry organizations have been fighting to stop the tax increase.

This tax would be a real hardship on commercial real estate, and consequently would result in even more tough times for lenders.  (And of course, Congress is looking for ways to raise money in order to combat the deficit.)

Here’s some good news in troubled times for commercial real estate: the tax increase on carried interest is dead (for the immediate future).

Recall that the House passed its version of the tax increase (H.R. 4123; The American Jobs and Closing Tax Loopholes Act ) in late May.  Here is the summary of the House bill by the Mortgage Bankers Association:

"Under the House-passed bill, 50 percent of any carried interest that does not reflect a return on investment capital would be taxed at the significantly higher income tax rate (up to 35 percent), instead of as long-term capital gains, which are taxed at 15 percent. In 2013, the portion of carried interest taxed at the higher rate would climb to 75 percent. The Joint Economic Committee has found that this provision would raise taxes by $18.7 billion over the next 10 years."

Distressed borrowers and lenders alike now can sigh a (small) sigh of relief . . .  because on last Thursday (June 24), the Senate failed for a third time (it was try, try and try again) to persuade 60 Senators to support the bill.  Here is the summary and announcement from the National Multi Housing Council:

". . . Senator Max Baucus (D-MT) twice modified the carried interest proposal to try to make it more palatable to real estate partnerships. 

The latest iteration would have taxed 75% of a carried interest at ordinary income rates and 25% at capital gains rates as of 2011. A carried interest attributable to assets held for at least five years would have been taxed at a 50-50 split. The language was also modified to exempt family partnerships who allocate carried interests on a pro-rata basis from the tax law change. Those partnerships would have continued to be taxed at capital gains levels. 

While the most immediate threat appears to have passed, NAA/NMHC remain vigilant as the Senate could take up the extenders bill again in the fall, and carried interest remains a possible "pay for" for other forthcoming legislation."

I know that this is this is the "tough times" blog, where things are always suppose to be dark and . . . hopeless – or at least coated in a thick layer of winter gray.  But, this is good news . . . .

It is nice to have some good news.

And kudos to Steve Church of JLL for bringing this "news" to my attention.

If you have any comments or other perspectives on this, please post a comment.

While the nature of the collateral securing a loan may change, while the local market may change, while the number and nature of the lenders in the credit stack may change, while "X" (you fill in the  "X") may change, ONE thing never changes . . . . 

. . . income taxes.

And I suspect that the impact of debt restructures (and foreclosures) on income taxes will become more and more important in the future.  But let’s not overlook the importance of this topic today.

In prior postings, we’ve touched on the importance of income tax issues, including cancellation of debt income and other "bad" consequences [2nd of two postings].

Below is a list furnished by a partner of mine, Julie Sassenrath.  Julie has in-depth knowledge of the tax code, case law and IRS rulings, and has a very, very practical bent.  She uses variations of this list as a starting point to assess the tax consequences of a specific workout or foreclosure.

Collecting this information often is a key element in any debt restructuring plan, whether you are the key principal behind the borrower, or the asset manager pursuing the recovery of the Lender’s investment.

Here is Julie’s quick list:

  • Amount of debt (principal and accrued but unpaid interest)
  • Has accrued but unpaid interest been deducted?
  • Recourse v. non-recourse nature of the debt
  • Guarantors or other persons liable for debt (and relationship to partners), and nature of liability
  • Basis of the property (collateral)
  • Basis of partnership interests of the partners
  • How has the debt been allocated among the partners for tax/basis purposes?
  • Identity of the partners (and their partners if a partnership) and ownership interests
  • Financial status of each partner (solvent, insolvent, bankrupt, etc.)
  • Tax attributes of each partner (NOLs, passive losses, capital losses, etc.) and overall tax picture of each partner
  • Other real estate interests held by each partner
  • Other assets held by the partnership
  • Fair market value of the property (collateral)

If and when you focus on income taxes in a plan, be sure to contact an experienced adviser.

Frankly, I am NOT familiar with this topic.  When faced with this topic, I quickly reach out to Julie or another tax lawyer at my law firm for help.

If you have information or questions to add to this list, please post a comment below.

 

Here’s a very, very interesting announcement from the CREF-C.  It covers an important issue in every distressed debt situation: the tax picture of the borrower.

From the CREF-C:

  • "The Senate Committee on Finance has proposed a substitute amendment to the House-passed H.R. 4213, The American Jobs and Closing Tax Loopholes Act, which would soften (but not eliminate) the tax provision related to "carried interest" for real estate partnerships.  The issue remains a high priority for many real estate trade associations, particularly commercial borrower groups.  For its part, the CRE Finance Council has supported coalition efforts, including a letter along with other trade groups urging Members of Congress to vote against the tax increases for carried interest."
  • The other trade groups?
    • American Hotel & Lodging Association
    • American Resort Development Association
    • American Seniors Housing Association
    • Building Owners and Managers Association International
    • CRE Finance Council
    • Council for Affordable and Rural Housing
    • International Council of Shopping Centers
    • NAIOP, The Commercial Real Estate Development Assn.
    • National Apartment Association
    • National Association of Home Builders
    • National Association of Real Estate Investment Managers
    • National Multi Housing Council
    • The Real Estate Roundtable

If you have links to other commentary on this legislation, or want to post your own comments, please do so below.

 

 Our friends at Cantrell McCulloch [link to website] bring to our attention a topic that could literally be a “drag” on your collateral: the valuation given to the collateral by the applicable taxing authorities (public and private).

Taxing authorities could be state, county, city, hospital, school, road and other governmental authorities; and also “private” (not governmental) bodies in instances, for example, where fees are “spread” among multiple lots or parcels pursuant to private agreements (such as deed restrictions).

When you stop and think about it, you’ve probably seen line items in operating budgets for taxes and assessments, but have you stopped to consider whether the borrower has actively protested or tried to lower the valuation that provides the basis for the cost? And, have you (as lender or servicer) investigated and considered your ability to lower valuation PRIOR to taking title to the collateral?

I know, you’re thinking: “surely the borrower has investigated the tax valuation of the property.”

Maybe. Maybe not.

Often, borrowers have much, much larger fires to fight; and devoting a reduced staff to reducing property valuation so as to save money in the FUTURE is, well, not important when the borrower is fighting simply to keep afloat today – and keep the property.

So, my suggestion simply is to add this topic to your workout check list, and include the following as tasks directed at this ticking sound:

  • What taxes or assessments cover or encumber the collaterals? Governmental (per a current search of applicable governmental taxing offices)? Private (per a current title report)?
  • What valuation has been given to the collateral? (Is it high?)
  • How is valuation determined?
  • What are the key dates (Due dates? Appeal dates? Etc.)
  • Has the ownerborrower contested the valuation? Are written agreements covering valuation in place?
  • Is it possible to file a “late” appeal? Are there special conditions for filing a late appeal?
  • What input or role does the lenderservicer have in the valuation determination or appeal process? (Under applicable law or regulations? Under the loan documents?)

Todd Franks (with The Cantrell Company) tells me that they have recovered over $100,000 in overpaid property taxes for one loan servicer, after a borrower failed to timely protest their 2008 property tax valuation (in a situation involving Texas real property collateral). His experience is that if the current owner is unsophisticated andor unfamiliar with the property valuation process, then when the owner is struggling to keep the property and to avoid a loan default or a foreclosure, many owners simply give up on contesting property valuations handed out by taxing authorities. (The result: it is a problem discovered by you AFTER you take title.)

Clearly, this topic qualifies as another one of my “ticking sounds” –  topics inherent in real property collateral that can jump up and bite you during and after a loan falls into distress. (For other “ticking” topics, search this blog using the search term “ticking” in the search box on the lower right side of the page.)

Put this topic on your check list.

And follow up with Todd Frank (at tfranks@cantrellcompany.com) if you’d like to talk with him.

Finally, as always, if you have any questions, comments or practical advice on this topic, please post a comment.

This is a special series of blog entries in which we provide some quick answers to lenders’ frequently asked questions (FAQ). Two things should be kept in mind.  First, none of these questions can be answered in a vacuum.  Questions should be considered with a thorough review of the file and an interview with appropriate loan officers.  And secondly, many of the questions are worth revisiting from time to time because subsequent events will impact the answers.

FAQ #7 – Should I pay the property taxes prior to foreclosure?
Taxes and Escrows: Escrows may be in your possession and available for tax payments.  Taxes should typically be paid prior to foreclosure in order to add them to the loan deficiency amount–unless it is your plan to sell at the close, subject to taxes to a third party.

FAQ #8 – What other legal issues or hurdles should I consider in proceeding with foreclosure
Each state’s law governs when and how a lender proceeds with foreclosure.  The following questions should be considered:

  • Is there an anti-deficiency statute or single cause of action rule?
  • What are the mechanics lien filing periods?
  • What are the content and timing requirements for sending notice of default and acceleration?
  • How does my course of dealing affect the existence of the default?

To read the entire Tough Times FAQ series, please click here.
 

Sick and beyond tired of the inflexibility of CMBS servicers in making needed modifications to CMBS loans that we all know are in the ditch?  Help might be here:

On September 15, 2009, the IRS and the Department of the Treasury issued three pieces of guidance relating to commercial mortgage loans held by a securitization vehicle (a CMBS loan).

  • The final rules (see PDF entitled "TD 9463") regarding "Modifications of Commercial Mortgage Loans Held by a Real Estate Mortgage Investment Conduit (REMIC)" include changes in collateral, guarantees, credit enhancement of an obligation and changes to the recourse nature of an obligation.  These rules expand the list of exceptions that will not be considered "significant modifications" of a CMBS loan obligation held by a REMIC.
  • The IRS also issued Revenue Procedure 2009-45 (PDF), which is a final ruling that describes the conditions under which modifications to certain mortgage loans will not cause the IRS to challenge the tax status of REMICs.  Specifically, note the factor that allows a servicer to take action more than one year prior to maturity.  Furthermore, a servicer is able to rely on information provided by the borrower unless it has knowledge to the contrary.  More importantly, while past performance of the loan is a factor in assessing risk, a "significant risk of default" (based upon a "reasonable" belief standard) can be found by the holder or servicer even if the loan is currently performing (This is great news for principals who are keeping the loan payments current from sources other than rent).
  • In addition, the IRS and Treasury issued Notice 2009-79 (PDF) and are requesting comments on what additional guidance, if any, is needed regarding modifications of commercial mortgage loans held by investment trusts.

Additional information can be found on the CMSA’s Web site (link to REMIC Reform).

Hopefully, these guidelines will allow CMBS loan servicers and borrowers greater flexibility to assess risk and allow for appropriate modifications to CMBS loans.  It is desperately needed.

We know that the public is in no mood to support a "rescue" plan for commercial real estate.  Maybe,  just maybe, "tweaking" the tax code like this will be the approach that will be taken by the government—sort of a "back door" rescue plan for commercial real estate.  However, I believe that it’ll take much, much more than tweaks like this one to help commercial real estate to QUICKLY recover.

Kudos to the broad cross section of the commercial real estate industry that worked on this initiative (Mortgage Bankers Association, Commercial Mortgage Securities Association, ICSC, Real Estate Roundtable, and others).

If you have any questions or other information, please post a comment.