Presenting a live 90‐minute webinar with interactive Q&A

Short Sales and Bankruptcy Sales p yof Commercial PropertiesStrategies for Investors and Owners to Minimize Business and Legal Risks

T d ’ f l f

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

TUESDAY, JANUARY 18, 2011

Today’s faculty features:

Ren R. Hayhurst, Partner, Bryan Cave, Irvine, Calif.

Hal Mark Mersel, Partner, Bryan Cave, Irvine, Calif.

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Collateral Properties: ShortCollateral Properties: Short Sales and Foreclosure Sales

Ren Hayhurst (Irvine,CA)949-223-7125; rrhayhurst@bryancave.com

Mark Mersel (Irvine CA)Mark Mersel (Irvine,CA)949-223-7160; mark.mersel@bryancave.com

Overview of Note and REO Sales • Note Sales

– Acquire Debt, Not the Underlying AssetSeller is the Lender Not the Borrower/Debtor– Seller is the Lender, Not the Borrower/Debtor

– Subject to Defects in Documentation, Title, etc.– Must Complete Foreclosure Process Before Assuming Control

of the Propertyof the Property– Know Your Enforcement Options

• REO SalesT k Titl t th A t– Take Title to the Asset

• Can occur before or after foreclosure; • Deal Directly with Owner (but must be approved by lender if prior

to foreclosure)to foreclosure)

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Note Sale Issues • Advantages of Note Sales

– Avoids time and expense of foreclosure for the lender• Transfers bankruptcy and litigation risk to the note buyer• Risk sharing is difficult to negotiate

– Avoids risk of being stuck with REO for lengthy period– Preferred Disposition Method for the FDIC

• FDIC sales can come with protections, such as:– Loss share agreements, and – Use of the FDIC “super powers”

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REO Sale Issues

• Advantages Over Note Sales– Title can be Cleaned Up for Purchaser (if sale follows foreclosure)

Bankruptcy Risk Eliminated– Bankruptcy Risk Eliminated– Can Be Structured in a Manner More Familiar to Purchasers

• Requires No Special Expertise or Experience as Required for Note Sales

• Obstacles• Obstacles– Lenders Favor Short Sales prior to Foreclosure Because of

Increasing Reluctance to Take REO on the Books• Lose the ability to clean up titleLose the ability to clean up title• Difficult to structure in “broken” construction loans or deals with

subordinate debt

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Basic Due Diligence Issues

• Due Diligence Challenges– Note Sales Require Due Diligence on:

• The Loan,• Bankruptcy risk,• Potential lender liability and/or defects in loan documentation or

d i i t tiadministration, • Condition of Title, and • Condition of the Property.

REO S l R i St d d P t P h d S l– REO Sales Requires Standard Property Purchase and Sale Due Diligence:

• Condition of Title, and C diti f th P t• Condition of the Property.

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Use of Special Purpose Entities

• Often Used in REO Sales Following a Foreclosure• Reasons for Forming SPE in Foreclosure

– Isolate Troubled Asset from the Rest of the Loan Portfolio/Pool

• Who Controls the SPEAgent or Lead Bank– Agent or Lead Bank

– Special Servicer• Sole member vs. Multiple Members

• Problems – Transfer of all Tranche/Syndication Interests into SPE– Partial Note Foreclosure IssuesPartial Note Foreclosure Issues

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Common REO Issues- Regulatory Considerations for Banks• Holding Period

– Only Applies to Regulated Institutions– 5-Year Maximum – Regulatory Drive to Sellg y

• Appraisals– Valuation for Foreclosure/Bidding Strategy– Hold vs. Sale Considerations

• Property Inspection– Use, Repair and Maintenance Issues

• Environmental Audit– Foreclosure Review– Use, Repair and Maintenance Issues– Alternative Remedies – Personal Liability

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Holding and Operating REO Properties• Survey and title• Land use• Successor liability • Unfinished construction• Construction defect liability risks for unfinished projects• When REO is unit of larger project

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REO Properties -- Land Use Considerations• Entitlements

– Unstarted/Stalled Project – Beware of:• Moratoriums, • Changes in Developments Plans, • Expiring Development Agreements, and• Replacement Bonds

• Rent Control– Typically Survive ForeclosureTypically Survive Foreclosure

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REO Properties -- Successor Liability• Leases

– Review Liability Under SNDA:• Past Defaults, • Defaults During Ownership, and• Assignor and Assignee Liability.

• HOA/CC&R Defaults and Assessments– Typically Do Not Survive Foreclosure, But Do Survive Sales

• Profit Participation/Marketing Fees• Profit Participation/Marketing Fees– Controlled by Agreements and Subordinations

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Project Development Challenges

• Stepping Into Former Project– Construction Bonds need to be replacedp– Broken Condos and/or Subdivisions

• Gaining Control of the Declarant’s Rights– Expired Entitlements and Development

Agreement– Fee Credit issues - Reimbursements?Fee Credit issues Reimbursements?

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Bankruptcy Salesp y

• Section 363(f) of the Bankruptcy Code provides that assets may be sold free and clear of the liens claims encumbrances andbe sold free and clear of the liens, claims, encumbrances and interests of third-parties, if one of five conditions is met:– Non-bankruptcy law permits a sale of the assets free and clear of

the interestthe interest

– The interest holder consents

– The interest is a lien, and the price for the assets is greater than the aggregate value of all liens on such propertyaggregate value of all liens on such property

– The interest is in bona fide dispute

– The holder of the interest could be compelled to accept a money satisfaction in a legal or equitable proceedingsatisfaction in a legal or equitable proceeding

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Advantages of Section 363 Bankruptcy S lSales• Can provide viable alternative to foreclosure or receiver’s sale

• Can provide time and cost savings under certain scenarios, particularly if borrower has already commenced chapter 11 bankruptcy case

• Sales are free and clear of liens, encumbrances or interests

• Generally limits successor liability

• Bulk sales laws are inapplicable

• Purchaser may pick and choose specific assets to acquire, including contracts, leases, licenses and tangible assets

• Rejection of undesirable leases/contracts

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Disadvantages of Section 363 B k t S lBankruptcy Sales• Purchaser cannot expect to derive any significant protection by

f d bt ’ t ti ti dmeans of a debtor’s representations, warranties and indemnification

• Uncertainty whether the sale can be free of certain types of y ypclaims, such as product liability and environmental claims

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Section 363 ProceduresSection 363 Procedures

• Debtor usually enters into a Purchase and Sale Agreement (“PSA”) ith th “ t lki h ” A bidd ill h t(“PSA”) with the “stalking horse.” Any over bidder will have to purchase under the same terms and conditions as the PSA.

• The Court first considers and approves a motion to establish ppbidding procedures and then schedules the auction.

• Potential bidders are usually afforded due diligence time.

• Usually, order requires bidders to pre-qualify and perhaps make a refundable deposit.

• Usually, minimum overbids are established.y,

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Section 363 ProceduresSection 363 Procedures

• Frequently, the procedures order provides for a “break up” fee to compensate the “stalking horse” if it is o erbid and does not acq ire thecompensate the “stalking horse” if it is overbid and does not acquire the property.

• The “break up fee” can be an amount certain to reimburse the “stalking horse” for its attorney’s fees and out of pocket expenseshorse for its attorney s fees and out of pocket expenses.

• Sometimes, the “break up fee” includes a percentage of the sales price, usually 1-3%.

• Section 363(m) of the Bankruptcy Code provides that a purchaser who acquires assets in good faith cannot have a transaction unwound on appeal even if the appellant obtains a reversal of the order authorizing the 363 salethe 363 sale

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Types of Bankruptcy Salesyp p y

• Sale prior to Bankruptcy Plan

• Sale Pursuant to Chapter 11 Plan– Sale occurs as part of confirmed chapter 11 plan

– Sale subject to auction process, but this may be before or after plan confirmation

– Chapter 11 plan process requires drafting and prosecution of plan d di l t t t hi h t dh t t t tand disclosure statement, which must adhere to statutory

requirements

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Comparison of Section 363 and Chapter 11 Plan SalesChapter 11 Plan SalesSection 363 Sales Chapter 11 Plan Sales• Subject to transfer taxes even if

plan subsequently confirmed

• More streamlined, less

• No transfer tax if sale pursuant to plan

• Requires separate hearings to ,expensive process

• No right under Bankruptcy Code for secured lender to propose a

q p gapprove disclosure statement and confirmation of plan

• Termination of exclusivity will p psection 363 sale

ypermit lender to prosecute lender plan, including a plan providing for sale

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Comparison of Section 363 and Chapter 11 Plan SalesChapter 11 Plan SalesSection 363 Sales• Not required under Bankruptcy

Chapter 11 Plan Sales

• Plan must pay administrative and• Not required under Bankruptcy Code to pay other creditors, though as practical matter bankruptcy court will be reluctant to approve sale that benefits only the secured lender

• Plan must pay administrative and priority claims in full and typically will provide some distribution to unsecured creditors

benefits only the secured lender

• Related executory contracts can be assumed and assigned to purchaser or rejected

• Executory contracts and unexpired leases treated same as in section 363 sales

j

• Leases can be assumed or assigned or rejected. Monetary defaults need to be cured if executory contract or lease is to beexecutory contract or lease is to be assumed and assigned

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Relationship to Lift Stay and Dismissal MotionsMotionsTermination of stay will simply result in foreclosure going forward

• Borrower will retain ability to litigate and otherwise attempt to delay and frustrate foreclosure process

• Even if foreclosure is uncontested in certain jurisdictions• Even if foreclosure is uncontested, in certain jurisdictions foreclosure process can take materially longer than bankruptcy sales process

• Foreclosure and subsequent sale subject to transfer tax

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Flexibilityy

• Bankruptcy sale can be structured to offer maximum flexibility– Sale can be cash sale

– Sale can provide for assumption of secured debt on reinstated or restructured basis

• Absent consent of secure lender, reinstatement must comply with cure requirements of Bankruptcy Code

• Any restructuring of secured debt must be either consensual or as part y g pof “cram down”

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Credit Biddingg

• Section 363(k) permits credit bidding of full amount of allowed l i if t i ld t t ti 363 lclaim if property is sold pursuant to section 363, unless

bankruptcy court otherwise orders

• Bankruptcy court can preclude credit bidding under section 363 p y p gif court concludes that credit bidding would chill bidding or cause otherwise exists (e.g., lien is avoidable)

• Credit bid not limited to value of collateral but rather full amountCredit bid not limited to value of collateral but rather full amount of claim

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Receiver Sales

• Lender obtains appointment of a receiver in state court i hi tireceivership action.

• The powers of the receiver are set forth by statute and by the order appointing the receiver.pp g

• C.C.P. Section 568.5 recognizes that receivers have the authority to seek an order selling real or personal property.

• Receivership orders can provide the receiver with the power and authority to market the property, engage brokers, etc.

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Receiver Sales – Part II

• Borrower has opportunity to object to a proposed receiver sale. Uncertainty is created for the buyer if a receiver sale isUncertainty is created for the buyer if a receiver sale is approved by the court over the borrower’s objection because the borrower could file an appeal.

• Title companies are reluctant to insure title after a contested• Title companies are reluctant to insure title after a contested receiver sale.

• The receiver would need lender approval to seek a sale with a discounted payoffdiscounted payoff.

• An “option agreement” can be used to enter into an agreement to sell the property on the condition that the foreclosure sale is completedcompleted.

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