Mortgage Loans: Buying and Selling
One fallout from the real estate crash is the development of market for the sale of existing mortgage loans. Banks and other lenders are motivated to sell troubled paper in order to avoid the time and expense of renegotiating or foreclosing loans. In particular, the sale of non-performing loans enables lenders to remove them from their books. This eliminates the need to tie up capital to satisfy risk-based capital requirements and maintains the lender's reputation in the marketplace. Many investors, on the other hand, see opportunities in buying both performing and non-performing mortgages at substantial discounts. Investors intend to seek control of properties through foreclosure, restructure the loans on favorable terms, or securitize the loans for sale to the public. However, both parties in a sale of mortgages should be aware of the many legal and economic pitfalls in such purchases.
Lender Liability
One important concern for a lender is the
potential liability arising from the disclosure
of confidential information about the
borrower. The "due diligence" obligation of
the buyer often requires an inspection of the
loan documentation. Generally speaking,
the lender will not be liable for showing such
documentation. However, it is often the case
that the loan documents contain restrictions
regarding the disclosure of confidential
information (e.g., financial statements of
borrowers or guarantors). In order to avoid
liability, the lender should review the loan
documents first to determine if any such
restrictions exist. The lender also should
require the prospective buyers to execute
confidentiality statements and screen the
buyers for interests adverse to the borrower.
Sale Limitations
In some loans, the lender is barred from selling
the loan to a third party or the borrower has a
right to arrange for the purchase of the loan.
A sale inconsistent with such provisions opens the lender to potential liability. In particular,
the lender should consider a possible
contention by the borrower that there had
been ongoing negotiations or a commitment
to structure the loan when the sale to the
third party was made. In such instances,
the borrower may claim that the sale is in
breach of an agreement to restructure, with
resulting damage to the borrower. One way
for a lender to avoid such a claim is to initially
offer to sell the loan to the borrower (i.e.,
permit prepayment) on the same terms and
conditions as would be offered to a third party.
Future Funding
Obligations
Yet another consideration for the lender to
consider is whether any obligations continue
to bind the lender following sale of the loan.
For example, a lender may continue to be
bound by any future funding requirements
set forth in the loan. In that event, the lender
should be satisfied that the buyer can do the
funding (and the lender may want to secure
that obligation by a guarantee, indemnity
or other form of security). Alternatively, the
lender may consider retaining the obligation
for future funding and adjust the loan
purchase price accordingly.
Due Diligence by
Investor
Perhaps the most important concern from the
investor's perspective is the availability of full
information relating to the loan, including the
loan documents, borrower profile information
and the condition of the real property. The
investor should insist on access to all loan
documents in addition to the note and
mortgage, i.e., pledge agreements, guarantees,
letters of credit, indemnification agreements,
assignments of stock or partnership interests
and lockbox agreements. A variety of ancillary
documentation also should be inspected,
e.g., title policies and surveys, environmental
reports, permits and licenses and information
about any threatened or pending lawsuits.
Loan Purchase
Agreement
The critical document in the transaction is
the loan purchase agreement that sets forth
all the terms and conditions of the purchase.
The clause covering the presentations and
warranties to be given by the lender is likely
to be heavily negotiated. At a minimum,
the lender should represent its authority to
enter into the agreement, that the loan has
not already been sold and is not in default
and that no litigation is pending relating
to the loan or the property. Additional
representations might cover the priority of the
mortgage or deed of trust, the absence of any
defenses by the borrower and the accuracy of
information given to the purchaser.
Real Estate Focus is provided by Somerset’s Real Estate Team for our clients and other interested persons upon request. Since technical information is presented in generalized fashion, no final conclusion on these topics should be made without further review. For additional information on the issues discussed, please contact Michael Fritton, CPA. Whether you are a building owner, building manager, real estate developer, real estate professional or an investor, we hope to provide you with timely information so you may be proactive in making your business decisions.
This article was written by and published herein with the permission from professionals of BDO Seidman, LLP. Anthony La Malfa is a manager in the Real Estate and Hospitality practice in BDO’s New York office. Somerset is a member of the BDO Seidman Alliance, a nationwide association of independently owned accounting and consulting firms.
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P.C.
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Indianapolis, Indiana 46240
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