title insurance risks in distressed real estate...

Title Insurance Risks in Distressed Real Estate Transactions Evaluating and Dealing With Liens and Other Encumbrances During Title Due Diligence

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WEDNESDSAY, APRIL 4, 2012

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

David Weissmann, Partner, Weissmann Zucker Euster Morochnik, Atlanta

Mark D. Euster, Partner, Weissmann Zucker Euster Morochnik, Atlanta

Karl R. Phares, Underwriting Counsel, First American Title Insurance Company National Commercial Services, Kansas City, Mo.

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Title Insurance Risks in Distressed Real Estate Transactions Evaluating and Dealing With Liens and Other Encumbrances During Title Due Diligence

David A. Weissmann Weissmann Zucker Euster Morochnik P.C. Atlanta, Georgia 30305 404.364.4620 direct [email protected]

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Flushing the System – Where We Are Today

7

THE GREAT FLUSH Impediments to liquidating bad assets are

alleviating somewhat as: The Fed continues to put extreme pressure on banks

to increase capital reserves and bank losses are lessening somewhat, allowing more bad loan losses to be recognized

Banks are still reluctant to reveal the extent of their losses, which are exaggerated due to declines in property values

Long term capital is more readily available from insurance companies and even CMBS loans but short term capital remains scarce

8

As long as “deleveraging” continues, banks are reluctant to loan against real estate to facilitate purchases of REO (real estate owned) property Capital for REO purchases is coming from private

sources and vulture funds Property values have declined dramatically, as much

as 75% or more in some cases

9

Methods of Disposition of Bad Assets Note Sales – the sale of the note and

accompanying loan and security documents “The” surprise of this downturn – Note sales have been

more prevalent than in other downturns Short Sales – the borrower sells the secured

property for a price less than the outstanding balance of the loan and the lender releases the loan documents

REO Sales – the sale of the foreclosed asset or receiver’s sale

10

Note Sales The loan generally is delinquent or soon to be

delinquent Electronic auctions have become commonplace,

but more recently word of mouth and sales teams have been utilized

The borrower is a possible purchaser, for a discount, but some banks have been reluctant to “reward” the borrower even though borrower is most likely “purchaser” to preserve equity

11

Note Sales Technically, the sale is not complicated, but can

happen quickly Sale is “as is” with limited representations as to

ownership of the loan documents, outstanding balance and status of default

Short review period; may allow conversations with borrower

Documents will be sold “free and clear” of all liens, participations and encumbrances but generally no other warranties or representations

12

Note Sales Mechanics of the transfer

Endorsement of the note, or allonge Transfer and assignment of loan documents Recordable assignment of security instruments Assignment or amendment of UCC’s Estoppel from borrower: outstanding balance/default

May be impossible to obtain

13

Note Sales – Quick Cash Motivations for the lender are quick transposition

of loan obligation into cash Federal reserve requirements have not necessarily

changed, but they are being more scrutinized and enforced, requiring quick infusion of cash into bank’s liquidity coffer

The ratio of loan to deposits or cash reserves indicate one element of financial stability

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Note Sales – Quick Cash Some State loan-to-deposit ratios are*:

California 101% Connecticut 104% Florida 94% Georgia 95% Hawaii 78% New York 70% North Dakota 172%

*Source: Federal Reserve Publication 2009

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Note Sales – Quick Cash Please note that if bank has a high loan-to-deposit

ratio, and property values decline, then even if the loan-to-value ratio of loans generally was conservative (i.e. 80%), many loans could still be “underwater” thereby threatening the financial stability of the bank

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Note Sales - Words of Caution Pay attention to default letters and notices to

determine status of loan Third tier financing may not be of public record –

must to be careful regarding liens on the loan documents

Title searches may not reveal litigation that can impact the loan or the collateral

Pooled collateral prevents borrower from bidding on its own loan separately

17

Short Sales Property is sold for less than the debt

Necessitates an agreement with the lender to release the collateral

May involve a delinquency or “wish” note Lenders are reluctant to accept a short sale if the

borrower will retain tangible benefit of the property, as purchaser or tenant

18

Short Sales Affidavit is required whereby purchaser affirms

that: The borrower is not related through blood or business There are no hidden agreements or special

understandings There are no oral agreements whereby borrower

retains possession or beneficial ownership, or proceeds of sale

19

Short Sales Penalty for false affidavit is that the affiant and

purchaser may be liable for the deficiency because the lender relied on the purchaser’s promises and affirmations when releasing the collateral to the detriment of the lender

20

REO Sales The traditional means of flushing the system –

foreclosure followed by sale of the “real estate owned”

Value used by lender at foreclosure is generally higher than a purchaser will pay

While banking regulations do not require a quick sale, liquidity and reserve requirements generally necessitate quicker sales

21

REO Sales The sales are “as is” – some lenders even want

indemnities from the purchaser for property liabilities (hazardous materials and others)

The less a lender knows about liabilities, the better Lender’s may therefore avoid complete inspections of

the property so as to be a “mere holder” of secured property rather than a true property owner

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REO Sales Typically short fuses – 30 day inspection followed

by 15 day closing Leverage is very much with the purchaser and re-

trading is common The calendar quarter may drive the sales; as bank

books are cleaned up, the bank becomes more attractive to the Fed and to potential suitors

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CREDITORS RIGHTS AND MORTGAGE MODIFICATIONS: TITLE INSURANCE INDUSTRY RESPONSE TO AN ECONOMIC COLLAPSE

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Bankruptcy Avoidance Powers Risk Loss of Title Primarily concerned:

fraudulent conveyances under Section 548 preferences under Section 547

Equitable subordination is also a risk

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Fraudulent Conveyances A transfer made within two years before

bankruptcy if (i) the transfer was made “with actual intent to hinder, delay, or defraud” a then existing or subsequent creditor, or (ii) the debtor was insolvent or had insufficient capital at the time of the transfer, and received less than the reasonable equivalent value of the transferred property

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Section 548(c): transferee “for value” and “in good faith”: Retains lien up to value notwithstanding

fraudulent conveyance concerns Good faith means having sufficient

knowledge to place transferee on inquiry notice of the debtor’s possible insolvency, or abstaining from unconscionable behavior to the detriment of other creditors

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Fraudulent transfer risks to the lender: Foreclosures Deeds in lieu of foreclosure especially if

value of property is more than lender would receive in Chapter 7 liquidation

Mortgages granted as additional security

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Preferences: Transfers of interest in property, to or for the

benefit of a creditor, for or on account of a pre-existing debt, made when the debtor was insolvent, and made within 90 days of the filing of the petition generally, or within 1 year of the filing of the petition by insiders, whereby the creditor obtains property valued in excess of what would have been received in a Chapter 7 bankruptcy

29

Preferences: Uncertainty whether a foreclosure made

within the statutory period could constitute a preference, especially if the secured claim is substantially less than the value of the foreclosed property, because the creditor receives dramatically more than it would receive in a Chapter 7 liquidation

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Preferences: Issue on time of recordation: Does

preference period relate back to date of deed, or date of recording?

Statute now grants 30 days grace period to record to retain relation back to date of deed and transaction

31

Exclusions to title coverage provide protection to insurers No coverage for damages which “would

not have been sustained if the [insured] had paid value for” mortgage/property (covers a failure of consideration) (Exclusion 3(e) ALTA 2006)

Language refers to grounds for fraudulent conveyance

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Exclusions to title coverage have always provided protection to insurers Exclusion for matters “attaching or

created subsequent to the Date of the Policy” (Exclusion 3(d) ALTA 2006 – the “post-policy exclusion”) Bankruptcy is always a matter created

subsequent to the date of the policy

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Specific bankruptcy creditors’ rights exclusions: 1990 ALTA Policy: excludes liability for

claims arising under the operation of federal bankruptcy, state insolvency, or similar creditor’s rights laws Deletion was often done by endorsement at

little or no charge with little review In later years, there was more attention to

detailed financial information

34

ALTA offered specific creditor’s rights coverage in 2006, insuring the invalidity, unenforceability, lack of priority or avoidance of” the insured lien: Resulting from fraudulent transfer

occurring prior to the transaction creating the lien; or

Resulting from failure to timely record lien (preference issue)

35

Creditors’ rights exclusion also modified, excluding coverage if transaction creating lien: is a fraudulent conveyance or transfer is a preferential transfer (other than if due to a

failure to timely record) Even if not specifically excluded, other

exclusions arguably still apply

36

ALTA Endorsement 21-06 (Creditors’ Rights) insures against loss: Sustained by reason of avoidance due to

an occurrence on or before the effective date of the policy of a fraudulent transfer or preference unless fraudulent nature was “known” to the

insured or insured is not a purchase in “good” faith

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ALTA Endorsement 21-06 is decertified in February 2010 Business risk shifts back to business

players Title companies reviewed upcoming

defaults and determined risk was too great

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Mortgage modifications on the rise as banks have leeway to kick the can Extensions of maturity Increase in interest rate Payment modifications Additional collateral Cross default/cross collateralize Partial releases

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Modifications can prime junior liens Is modification materials or substantially

prejudicial so as to jeopardize the junior lien holder Increase in interest or payment put stress on

the property Changes in maturity date may not be

prejudicial but case law is mixed Cross collateralization/cross default increase

risk to junior lien holder

40

Original mortgage language or intercreditor agreement can protect Future advance clauses provide some

protection, depending on local law Language that note secured includes

amendments and renewals helps Cut-off letter from junior lender may be

required nonetheless

41

Intercreditor and subordination agreements Generally contain broad provisions which

prohibit modifications Can be limited to “major” modifications such

as interest, payment terms, principal amount

42

Restatement of Property (Mortgages): 7.3(b) – Senior mortgage if modified is

effective against junior lien holder unless modification is materially prejudicial and is not within the scope of reservation of right to modify

43

Restatement of Property (Mortgages): Assumption that extensions are also for

the benefit of junior lien holders Assumption that courts will view increase

in interest rate or principal detrimental to junior lien holders

44

Restatement of Property (Mortgages): Should respect language in senior

mortgage allowing for modifications unless “cutoff notice” is provided

45

Title insurance does not always cover modification unless insured obtains endorsement Policy jacket exclusions may apply:

Exclusion for risk voluntarily assumed by insured

Exclusion for liability created, suffered or assumed by insured

Exclusion for post-policy actions

46

Types of endorsements – Date down Brings forward the effective date and

revises description of mortgage to include modification

Any creditors’ rights protection in the policy would be brought forward as well

47

Types of endorsements – ALTA Form 11-06 Insures priority of mortgage as modified

but does not bring forward the effective date

Contains specific exclusions for creditors’ rights (fraudulent transfer and preference)

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Word of caution: To endorse or not to endorse Title companies may deny coverage even on

simple modifications such as extensions Getting title companies to agree that they

will continue coverage under the original policy without the endorsement is a problem

Title Insurance Risks in Distressed Real Estate

Transactions

Mark Euster Weissmann Zucker Euster Morochnik (404) 364-4621 [email protected]

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Due Diligence Review When Buying Notes

Legal counsel must determine the

purchaser’s goal in acquiring the loan.

Certain aspects of due diligence may differ if the investor is looking to acquire the loan for its potential return or the real estate securing the note.

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The executed loan documents must be reviewed for content, enforceability, recording, proper execution and acknowledgement.

Supporting documents must be reviewed to ascertain borrower’s and guarantor’s authority to enter into the loan transaction.

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The title policy must be updated and endorsed to reflect the assignment and bring the effective date forward

The loan’s chain of ownership must be ascertained.

UCC searches must be obtained on the borrower and guarantors. 52

Consideration should be given in obtaining a UCC Search on the holder of the loan.

Purchasers of loans who are looking to obtain the real estate collateral securing the loan should consider obtaining additional due diligence items such as zoning and utility letters, current surveys, etc.

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New Owner’s Title Policy vs Existing Loan Policy Coverage under a Loan Policy will

generally continue after a Lender takes back title to the property by deed in lieu of foreclosure or a foreclosure.

Certain actions by the Lender can jeopardize continued coverage.

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In order for the underwriter to continue coverage, title to the property should be taken by the insured entity under the loan policy.

If the Lender wants to take title in an reo affiliate, the loan should be transferred to the affiliate and the loan policy endorsed to reflect the new insured.

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Alternatively, the insured Lender could take back title in its name and then convey title by a warranty deed to i) the insured’s parent who must wholly owned by the insured; or ii) to a wholly-owned affiliate of the insured Lender.

56

The are numerous advantages to the Lender obtaining an Owners Policy instead of relying on the existing loan policy.

An Owners Title Policy protects the Lender if there were any defects in the foreclosure.

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Owner’s Title Policies also insure title between the effective date of the Loan Policy and the date of the foreclosure or the filing date of the deed in lieu.

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Title Insurance Risks in Distressed Real Estate Transactions

April 4, 2012

The following presentation is for informational purposes only and is not and may not be construed as legal advice. First American is not a law firm and does not offer legal services of any kind. No third-party entity may rely upon anything contained herein when making legal and/or other determination regarding title practices. You should consult with an attorney prior to embarking upon any specific course of action.

©2012 First American Financial Corporation and/or its affiliates. All rights reserved. ▼ NYSE: FAF

Karl R. Phares Underwriting Counsel 816.421.3479 [email protected]

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Title Insurance Risks in Distressed Real Estate Transactions

Modifications Foreclosure Sales Deeds in Lieu of Foreclosure Bankruptcy Considerations


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Opportunity to salvage/prolong existing loan agreements for current lenders.

Tools for successor/assignee lenders to reel in pre-existing loan agreements.

Common modification endorsement requests: – ALTA 11 Date Down Modification. – ALTA 10 Assignment and 10.1 Assignment w/ Date Down. – Record Search.

Modifications


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Procedure by which lender can gain title to the collateral upon borrower’s default under the mortgage loan.

Typically results in liens subsequent and subordinate to lender’s mortgage being wiped out (subsequent mortgages, judgment liens, etc.).

Some liens have super priority and may not be extinguished or may only be extinguished by following specific procedures (mechanics’ liens, fed liens, taxes, etc.).

Foreclosure


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Methods of Foreclosure: – The process(es) for completing a valid foreclosure

sale depends on the remedies available in the state in which the subject property is located.

– Judicial Foreclosure (KS example). – Non-judicial Foreclosure (MO example).

Foreclosure


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Kansas Foreclosure Commitment Requirement: We have been informed that the title to be insured by our policy will come through foreclosure proceedings of the

Mortgage shown at Item __. We require that an appropriate proceeding be commenced in the District Court of ____ County, and concluded in strict compliance with law and the orders of said court, including but not limited to the following:

A. The filing of a petition praying for foreclosure of the mortgage against the parties named in paragraph 3 of Schedule A hereof.

B. The entry of a journal entry of judgment declaring the lien of the mortgage paramount to the interest of all defendants, and adjudging it foreclosed.

C. Sheriff’s sale, pursuant to proper order and notice. D. Expiration of the redemption rights of all parties having a right to redeem, and delivery of a proper

Sheriff’s Deed to the lawful holder of the Sheriff’s Certificate of Purchase on the date of expiration of said rights.

E. Obtain possession of the premises from the mortgagor and any persons claiming through him. We reserve the right to make additional requirements in connection with the following matters:

1. The form of the foreclosure proceedings; 2. The identity of the proposed insured and the sale price, when the same become known; and 3. Federal tax liens or bankruptcy proceedings intervening subsequent to the date of the commitment

and prior to the acquisition of title by the proposed insured.

Foreclosure


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Missouri Non-Judicial Foreclosure Commitment Requirement: We have been informed that the title to be insured by our policy will come through foreclosure proceedings of the

Deed of Trust to be foreclosed. In this respect, and in strict compliance with Section 443.325, RSMo., we require the following:

• A. An affidavit, which is to be recorded, executed by the foreclosing Trustee, and supplying the necessary date of mailing notices, persons to whom mailed and the addresses to which the notices were mailed (alternatively, if the foreclosing Trustee deems it more convenient, the necessary statement of facts may be recited in the Trustee’s Deed, in which case, the receipts for registered or certified mail must be attached to the deed and incorporated therein by reference);

• B. Compliance with all the recorded requests for notice of sale under the Deed of Trust to be foreclosed; • C. Proper notice of sale be given to any subsequent lienholder (including judgment liens, mechanic’s liens

and leases); and • D. Proper notice to the Internal Revenue Service as to any federal tax liens set forth herein. • E. Proof that no owner has died within six months next preceding the date of the foreclosure sale; • F. The property described in the Deed of Trust is located within the limits of ____ County, and publication of

notice of foreclosure in strict compliance with 443.320 RSMo; • G. Proof that no owner is entitled to the protection of the Servicemembers Civil Relief Act;…cont’d.

Foreclosure


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H. Proof that no owner has given notice of intention to redeem; I. We reserve the right to make further requirements in regard to federal tax liens or bankruptcy proceedings

which might intervene after the commitment and prior to the sale; J. Issuance of the Policy is conditioned upon the purchaser’s obtaining possession of the property

peacefully; K. We reserve the right to make such further requirements when the identity of the purchaser and the sale

price are known as the title company may deem necessary. In the event that there is a substantial discrepancy between the amount of the debt and the amount bid at the sale, a waiver of the right to sue for a deficiency may be requested as a condition to insuring the title of the purchaser at such sale.

L. Your attention is directed to the fact that Bankruptcy Code Section 362 operates as an automatic stay of any proceedings to foreclose, so that an examination of the Bankruptcy Court records will have to be made through and including the date of foreclosure in order to determine whether or not a petition in bankruptcy has been filed by or against an owner.

M. If the Deed of Trust is a Second Mortgage Loan as defined by Section 408.231 RSMo, as amended, furnish proof of strict compliance with the provisions of Sections 408.554 and 408.555 RSMo, as amended pertaining to notice of default and right to cure default.

N. In the event the proposed insured is the foreclosing mortgagee or any other party who does not constitute a bona fide purchaser for the present fair equivalent value, the Owner’s Policy will contain the following exception: “Right of any party interested to sue or petition to have the foreclosure sale set aside or modified or contest the foreclosure sale or the deed pursuant thereto through which title to the land insured is derived.”

Foreclosure


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Title Insurance for Foreclosure Sales: – Related title products. – Related title requirements. – Exceptions to coverage in owner’s policies

following foreclosure.

Foreclosure


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• Arrangement between Borrower and Lender whereby lender can obtain title to the collateral without going through the foreclosure process.

• Possibly, quicker, less expensive. • Depends on number of parties/lienholders

involved and Borrower/Lender relationship.

Deeds in Lieu of Foreclosure


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• The mortgage instrument is typically not released, so that in the event borrower or other interested party challenges the DIL transaction and it is set aside, Lender may still be able to exercise foreclosure rights.

• Also, if there are subordinate liens, once Lender takes title, it can foreclose those liens prior to selling the property. This may be advantageous if there is ongoing litigation involving the property (such as mechanics’ liens enforcement).



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Key Documentation: – Deed. – Settlement Agreement. – Estoppel Affidavit. – Appraisal.



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Elements of Insurability: – Absolute Conveyance. No fraudulent conveyance/preferential transfer. No equitable mortgage.

– Established Value of the Land. No borrower equity. Policy liability amount determination.

– Application of Creditors’ Rights Exclusion.

Deeds In Lieu of Foreclosure


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Additional Considerations: – Non-merger language. – Subsequent conveyances. – Policy coverage considerations. Off-record matters. Standard exceptions.

Deeds In Lieu of Foreclosure


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• Bankruptcy Sales: • Federal Code and Rules which allow

borrower/debtor time to liquidate or reorganize without pressure of enforcement actions.

• Usually pertaining to one asset that is one aspect of a larger bankruptcy case.

Bankruptcy Considerations


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• § 363 Sales: • Allows debtor to institute bidding to sell property of the

bankrupt estate. Lender can credit bid the debt, and if the highest bidder, can obtain title to the subject property.

• Most 363 sales are done free and clear of all liens and require a court order stating that the sale is free and clear of all liens and that any lien attach to the proceeds from the sale. From a title company perspective, “all liens” may not necessarily be all of the liens…



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• § 363 Sale Requirement: – We are informed that the sale to the proposed insured will be a sale free and clear of

liens under section 363(f) of the Bankruptcy Code in connection with a proceeding now pending in the United States Bankruptcy Court for the ____ District of ____, styled In the Matter of ____, Debtor, and being Case No. ____ therein.

– Said sale must be completed in strict conformity with the applicable sections of the Bankruptcy Code, the Rules of Bankruptcy, and the orders of said Court.

– An Order Authorizing a Sale Free and Clear of Liens must be entered prior to the recording of the Deed.

– After the Court has entered its order confirming said sale and the time to appeal therefrom expired, evidence of compliance with all the foregoing must be presented to the Company for examination and approval.

– We reserve the right to make any additional requirements on the above matter as we deem necessary.



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Insert common modification endorsements referenced herein.

Insert sample deed in lieu estoppel affidavit referenced herein.

Insert sample approved § 363 Order referenced herein.

Forms and Examples
