title insurance for real estate mezzanine financing: ucc policy requirements...

Title Insurance For Real Estate Mezzanine

Financing: UCC Policy Requirements

and Coverage

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THURSDAY, FEBRUARY 14, 2019

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

Grant Puleo, Partner, Duane Morris, San Diego

Gary Zimmerman, Senior VP UCC Division, Fidelity National Financial, Chicago

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Presenter

Grant Puleo, Esq.

Partner

Duane Morris LLP

1-619-744-2234 │ [email protected]

Title Insurance for Real Estate Mezzanine Financing: UCC Policy Requirements and Coverage

Presented by:Grant Puleo, Esq.

Partner, Duane Morris LLPand

Gary M. ZimmermanSVP/Chief Underwriting Counsel

Fidelity National Title GroupUCC Division

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History and Origin of UCC Title Insurance

• Introduction of real estate mezzanine financing 20 years ago.

• Desire for Mezzanine Lenders to securitize their mezzanine loans.

• A new opportunity for title insurance companies to expand their portfolio of title insurance offerings.

• Many of the large title insurance companies have offered Uniform Commercial Code (UCC) Title Insurance Policies for the past 18 years.

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Quick Overview of Article 9 of the Uniform Commercial Code:

• Article 9 is called Secured Transactions

• A statute enacted by each state, (also Guam, Puerto Rico and the US Virgin Islands) to allow a lender to achieve a first lien and security interest in defined personal property collateral –a secured transaction.

• Provisions are also contained in Article 9 which allows the secured lender to foreclose on its security interest if a default occurs under the associated loan.

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A Quote From a Very “Wise” Man

• The process of achieving a first priority security interest in Article 9 collateral is complex, detailed and exacting.

• The key to achieving a properly perfected security interest in personal property under Article 9:

• “If there is any mistake in the process of perfecting your security interest, the whole thing falls apart. You have to do everything right”.

• Source: Steven O. Weise, Secured Transactions: what Lawyers Need to Know About UCC Article 9, 2017.

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Article 9: Covers Many Types of Personal Property

• Some typical types of Collateral:

• Accounts

• Chattel paper

• Promissory Notes

• Inventory

• Instruments

• Investment Property

• Certificated and Uncertificated Securities

• Equipment

• Fixtures

• Deposit/Securities Accounts

• Letter of Credit Rights

• General Intangibles

• Even As Extracted Collateral and Timber to be cut!

• See 9-102 of the UCC

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What is Real Estate Mezzanine Finance?

• Focus is on equity collateral-a general intangible or a certificated or uncertificated security that is taken as collateral in a mezzanine finance transaction.

• Moody’s describes it as “lending to a borrowing entity or group of entities that directly or indirectly own a real property owning entity, which debt is secured by a perfected first security interest in the mezzanine borrower’s pledges ownership interest in the property owner”.

• Generally a grant of security interest or pledge by the debtor of its interest in the property owning entity (the “Issuer”) which is most commonly a limited liability company or limited partnership. The property owning entity is commonly referred to as the Issuer.

• The Issuer is typically a newly formed bankruptcy remote /SPE/Delaware LLC.

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What is Real Estate Mezzanine Finance in the context of a Secured Transaction?

• A pledge of equity in a limited liability company (“LLC”) or limited partnership (“LP”) in a mezzanine financing context is a secured transaction.

• For Article 9 purposes an interest in an LLC or an LP is a General Intangible.

• For Article 8 purposes an interest in an LLC or an LP is either Investment Property or a Certificated or Uncertificated Security.

• Keep that in mind when we talk later about how to properly perfect a security interest.

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Basic Mezzanine Loan Structure

Principals

MezzBorrower, LLC

MortgageBorrower, LLC(Project Owner)

Commercial Real Estate Project

100%

100%

Non-Recourse Guaranty

$

Mezz NotePledge

Mezz Lender

$

MORTGAGELOAN

MEZZ LOAN

Mortgage NoteMortgage

Mortgage Lender

Intercreditor Agreement

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CMBS and CRE CDO: Moody’s Approach to Rating Commercial Real Estate Mezzanine Loans

• Pledge of 100 % of the equity interest of the Issuer.

• Opt in to Article 8- To be explained shortly.

• Perfection by Certificating the Equity Interest.

• Belts and Suspenders: File a financing statement.

• Control the ability of the Issuer to “opt –out” (again to be explained shortly).

• Obtain a UCC Insurance Policy.

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How To Properly Create A Security Interest Under Article 9- Attachment

• Attachment (9-203 of the Uniform Commercial Code).

• (9-203 (a) A security interest attaches to collateral when it becomes enforceable against the Debtor with respect to the collateral.

• Need 3 things: (9-203 (a) and (b))

• 1. Debtor either has ownership rights or “rights in the collateral” sufficient to transfer the collateral to the lender/secured party.

• 2. The lender has given value- i.e. loaned money or committed to loan money or if value goes to a third party guarantor.

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How To Properly Create A Security Interest Under Article 9-Attachment

• 3. The debtor has “authenticated“ (signed) a security agreement or evidenced its intent to grant a security interest in the collateral.

• Should be formal Security Agreement-but see In re Colortran, Inc. 218 BR 507 (BAP9th Cir. 1997) - Substance over form.

• NO SECURITY INTEREST CAN BE PERFECTED BY THE LENDER UNTIL THE LENDER’S LIEN HAS FIRST ATTACHED TO THE COLLATERAL.

• Once attached the security interest will attach to all Proceeds (9-315(a)(2) - Example: Proceeds of Inventory.

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How to Properly Perfect a Security Interest Under Article 9-Perfection

• Perfection (9-308 to 9-316 of the Uniform Commercial

Code).

• Attachment only perfects the secured lender as against the borrower/debtor but not any third parties.

• Need to perfect to protect against competing claims of these parties: i) Purchasers, ii) Other Secured Creditors and iii) most importantly, the Trustee in bankruptcy. (9-315(a), 9-317(a) and 11 UCS 544(a).

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How to Properly Perfect a SecurityInterest Under Article 9-Perfection

• Perfection, under the UCC is much more complex than under real property laws.

• Article 9 recognizes and allows multiple ways to perfect with the method of perfection impacting the lender’s lien priority.

• The proper method of perfection depends on the type of collateral being pledged.

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How to Properly Perfect a SecurityInterest Under Article 9

• Four different ways to perfect under Article 9:

• 1. File a financing statement.

– Can perfect for all types of collateral (9-310) (including General Intangibles and Investment Property) but excluding Money, Deposit Accounts, Letter of Credit Rights.

– Most common and exclusive way to perfect for Accounts, Inventory, Equipment, General Intangibles.

– (9-501-9-526).

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• Form and Content of a Financing Statement:

1. Debtor’s exact legal name (9-503).

– Registered organizations 9-102(a) (70).

– Corporations.

– Limited Liability Companies.

– Limited Partnerships.

– Individuals (2013 revisions).

2. Name of Secured Party (9-502(a)(2), 9-506, Comment 2); less exacting.

3. A description of the collateral (9-108)

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• A description of the collateral continued:• Standard: Collateral must be reasonably identified in the

pledge/security agreement.

• No all asset grants in the security agreement.

• Best Practice: Use the 9-102 defined definitions.

• Code allows to describe by type or category.

• UCCPlus Policy uses the UCC definitions.

• Exception: Commercial Tort Claims.

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How to Properly Perfect a Security Interest Under Article 9-Filing

• Where to File?

• Individual (9-307 (b) (1)): State of principal residence.

• Partnership (9-307 (b) (3)): State of Chief Executive Office.

• Registered Organization: LLC, LP, Corporation: State of Registered Organization.

• Non-US Entity (9-307 (c)): Country of Chief Executive Office if country has filing system similar to UCC ieCanada.

• If not, DC Recorder of Deeds.

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Perfection Problems

• Searching and Filing is Complex and Detailed:

• Florida’s “insertion point” search logic.

• Search Logic-varies from state to state.

• Continual Issues with search office errors and omissions-Example Delaware.

• Indexing Inconsistencies.

• Financing Statement requirements versus inaccuracies/typos/human error.

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How to Properly Perfect aSecurity Interest Under Article 9-

Possession


• 2. Possession of the Collateral (9-313).

– (Instruments, Certificated Securities, Negotiable Documents of Title, Money, Tangible Chattel Paper).

– Possession through an Agent is acceptable.

– Key Concept: Possession Beats Filing regardless of the timing.

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How to Properly Perfect aSecurity Interest Under Article 9-Control


• 3. Control over the collateral.– Deposit Accounts (9-104).

– Electronic Chattel Paper (9-105).

– Investment Property (9-106) (8-106):

– Securities, Securities Accounts, Securities Entitlements.

– Letter of Credit Rights (9-107).

• Very complex. The method of control varies for each type of collateral.

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How to Properly Perfect aSecurity Interest Under Article 9-Automatic

Four different ways to perfect under Article 9:

• 4. Automatically– Concept is that a security interest is perfected automatically without

the need for the above three methods of perfection and that perfection still stands up to the trustee in bankruptcy.

– Could be its own two hour presentation! Not for this presentation.

– Highlights:• Purchase Money Security Interests (9-309).

• Supporting Obligations (9-308(d)).

• Sales of Payment Intangibles (9-309).

• Healthcare Assignments (9-309-5) .

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Perfection With Respect to an Equity Pledge: Opting-In, Opting-Out

• Moody’s requires an Opt-In to Article 8.

• To accomplish the above, the Issuer must “Opt-In” to Article 8.

• Once opted-in, an interest in an LLC or LP is either a Certificated or Uncertificated Security.

• For a Mezzanine Loan, the Mezzanine Lender must become a Secured Creditor by Control of a security under Article 8 and Investment Property Under Article 9.

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• How does one Opt-In to Article 8?

• In the organic document that controls the entity whose equity interest is being pledged.

• Only in the Limited Liability Company Agreement, Limited Partnership Agreement.

• Not the Pledge Agreement or any other document!

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Perfection With Respect to an Equity Pledge: Opting In, Opting Out

Sample Opt-In Language:Each limited liability company interest in the Company shall constitute and shall remain a "security" within the meaning of (i) Section 8-102(a)(15) of the Uniform Commercial Code as in effect from time to time in the State of Delaware and (ii) the Uniform Commercial Code of any other applicable jurisdiction that now or hereafter substantially includes the 1994 revisions to Article 8 thereof as adopted by the American Law Institute and the National Conference of Commissioners on Uniform State Laws and approved by the American Bar Association on February 14, 1995. Notwithstanding any provision of this Agreement to the contrary, to the extent that any provision of this Agreement is inconsistent with any non-waivable provision of Article 8 of the Uniform Commercial Code as in effect in the State of Delaware (6 Del C. § 8-101, et seq.) (the "UCC"), such provision of Article 8 of the UCC shall be controlling.

https://www.lawinsider.com/clause/article-8-opt-in for more samples.

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• Once Opted-In, the Mezzanine Lender most commonly perfects in one of two ways:

• 1. Certificated by means of Perfection by possession coupled with endorsement control (i.e. a “Stock Power” signed in blank).

• Or

• 2. Uncertificated by means of perfection by Control Agreement.

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Perfection With Respect to an Equity Pledge:Opting-In, Opting-Out

• The Ultimate Goal of the Mezzanine Lender:

Be a Protected Purchaser Under Article 8.

• Definition of a Protected Purchaser:

• 1. Gives value.

• 2. Does not have notice of any adverse claims to the security.

• 3. Obtains control of the security.

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Post Mezzanine Loan ClosingPerfection Problems

• Downside to Perfection By Filing: After Mezzanine Loan closes, Issuer “opts-in” and tenders a certificate and power to a second lender who becomes a Protected Purchaser.

• Downside to Perfection By Possession of Certificate and Power under Article 8: lost certificates.

• Discussion of Lost Certificate(s).

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Priority Under Article 9

• Priority (9-317 to 9-342 of the Uniform Commercial

Code).

• Who are the competitors?– 1. Unsecured Creditors.

– 2. Purchasers ie Buyers in the ordinary course of business.

– 3. Competing Secured Creditors.

– 4. The Trustee in Bankruptcy.

– Article: See Secured Financing and Priorities Among Creditors 88 Yale LJ 1143 (1979).

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Basic Insuring Provisions of aUCC Title Insurance Policy

• A Lender’s Policy of Title Insurance:• 1. The functional equivalent to a real estate lenders title insurance

lender’s policy.

• 2. UCC Policies Insures the Lender for proper Attachment, Perfection

and Priority of the security interest for the collateral pledged by

the Debtor.

• 3. Insures against Fraud and Forgery

• 4. Provides for Defense Cost and Indemnification

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Major Benefits in Obtaining a UCC Title Insurance Policy

• Getting It Right; What could go wrong?• 1. Not getting the Debtors exact legal name correct.

• 2. Not conducting a proper UCC search.

• 3. Not utilizing proper search logic.

• 4. Not filling out the financing statement correctly.

• 5. Not filing the financing statement at the right time.

• 6. Hoping the search results from the search company are correct.

• 7. Hoping that another secured party didn’t file in the gap period.

• 8. Hoping that all the loan/security documents are drafted correctly.

• 9. Hoping that the loan/security documents are properly executed

• 10. Hoping that if anything goes wrong, that the loss suffered by the lender won’t be too great.

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• Getting It Right; What could go wrong?

• In re Motors Liquidation Co. • Official Committee of Unsecured Creditors v JP Morgan Chase Bank, N. A. Appeal No. 13-2187 (2nd Cir.

Jan. 21, 2013 (Second Circuit Decision).

• Description of what happened.

• Numerous reviews by both Lender’s and Borrowers counsel.

• A huge loss taken by the Lender.

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• Who is Standing Behind You if Things Go Wrong?• 1. Will the search company make you whole if their searches are

inaccurate?

• 2. Will the search company make you whole if the financing statement is misfiled?

• 3. Even assuming that you can get any sort of meaningful opinion from counsel, will they stand behind their opinion? (Remember opinion practice largely went away with respect to real estate loan transactions because the lender is obtaining a… real estate tile insurance policy… and has been doing so for many, many years.

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Major Benefits in Obtaining a UCC Insurance Policy

• Underwriting Personnel

• 1. Underwriting staffs are very familiar with the Uniform Commercial Code

• 2. Your loan transaction and related documents are given a thorough review-a ‘Second set of eyes”.

• 3. Underwriting staff fully familiar with searching and filing under the UCC.

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• Title Company Strength

• 1. Experienced

• 2. Stable

• 3. Well Capitalized

• 4. Regulated

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UCCPlus Insurance Due Diligence Requirements

• Generic Overview (each loan has its own requirements):

• For any Debtor who is Registered Entity: current certified good standing and articles of formation.

• Copies of all versions of llc/lp, operating/partnership agreements.

• Current UCC searches .

• Transaction Documents: Security/Pledge Agreement, Loan Agreement, Note, Financing Statement, Certificates and Powers.

• All Resolutions.

• Transaction specific documents/due diligence.

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UCC Title Insurance Policy Exclusions

• Matters created, suffered, assumed by the Insured lender

• Matters known and not disclosed to the Company

• A general Creditor’s Rights exclusion

• No coverage for a Purchase Money Security Interest

• Most exclusions deal with Article 9 statutory priority exclusions-best example would be the buyer in the ordinary course code provisions

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UCC Title Insurance Endorsements:Mezzanine Endorsement

• What Does It Accomplish?

• The UCC Mezzanine Endorsement waives certain exceptions in the UCC Title Insurance Policy for:

• 1. Any liens or security interests of any prior owners of the Issuer (the property owning entity);

• 2. Any prior holders of the equity interest in the Issuer;

• 3. The existence of any anti-assignment statutes which would affect the enforceability of the related pledge of equity as security for the Mezzanine Loan.

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UCC Title Insurance Mezzanine Endorsement

• Compare With a Real Estate Mezzanine Endorsement:

• The typical real estate mezzanine endorsement (which attaches to the real estate owners policy) does the following:

• 1. Makes the Mezz Lender an assignee of any payment under the Owners Policy not to exceed the Mezz Debt;

• 2. Provides non-imputation coverage to the Mezz Lender;

• 3. Includes ‘Fairway” coverage;

• 4. Retains the right of the title company to interplead;

• 5. Reserves the Title Company’s rights of subrogation and indemnity after the Mezz Lender has recovered its indebtedness.

• One has nothing to do with the Other!

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Your Presenters

• Gary M. Zimmerman, Senior Vice President and Chief Underwriting Counsel [email protected] 312-223-2441

• www.uccplus.com

• Grant Puleo, Esq.

• Partner, Duane Morris [email protected] 619-744-2234

• www.duanemorris.com

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