Calling the 21st century: Competition, consolidation, and convergence
Lenders like property portfolios. By lending against a group of properties rather than just one property, a lender diversifies the collateral and mitigates the risk that some local aberrational event or market shift might impair the value of a particular property. Therefore, if a borrower can deliver to a lender a mortgage on a portfolio of properties, the borrower will often obtain more loan proceeds, more flexibility, or other more favorable terms than it could have obtained by financing each property separately. The borrower may also save some transaction costs by closing a single loan for the entire portfolio.
If one entity owns the entire portfolio, the owner can grant a single mortgage on all the properties and the lender can record that mortgage in many recording offices. The entire pool secures the entire loan and no special issues arise of the type discussed here.
Most real estate investors prefer, though, to form a separate entity typically a limited liability company, sometimes a partnership-to own each property separately. They do this for many good reasons, all beyond the scope of this discussion. The use of separate entities means that no single borrowing entity owns the entire portfolio. Each property owner must deliver its own separate mortgage to secure the entire loan. Although a multiple-borrower structure makes perfect business sense, it may create some risks for lenders under bankruptcy law and under the law that generally governs the rights of debtors and creditors. This manuscript explains those risks, assesses their magnitude, and discusses some techniques to respond to them. This is intended as a general discussion of these issues in the abstract. For any particular transaction, competent professional advice must be obtained, as the actual details of any particular transaction, and the laws of a particular state, may dramatically change the analysis. The reader is cautioned not to rely solely on this manuscript for any particular transaction.
For convenience, this manuscript will use the following terms. Each "Property Owner" owns a single "Property" and delivers a "Property-Specific Mortgage" to the "Lender." The aggregate financing is the "Portfolio Loan."
The credit and collateral structure of a Portfolio Loan can be summarized as follows. The Portfolio Loan is a single loan, cross-collateralized and crossdefaulted. Each Property Owner is fully liable for the entire Portfolio Loan, but usually only on a nonrecourse basis, i.e., its liability is limited to the possible loss of its Property. Depending on the borrower's agenda, each Property Owner will often have a different general partner and different limited partners. The same ultimate parent(s) would own and control the Property Owners or, at least, their general partner(s). (For "general partner," one can substitute "managing member." For "limited partner," one can substitute "passive member.")
The use of multiple Property Owners can create problems for a Lender if a single Property Owner ends up in bankruptcy, or otherwise suffers financial problems that lead its unsecured creditors to look for ways to improve their positions. The first thing any unsecured creditor will do under these circumstances will be to scrutinize Property Owner's secured debt and try to convince a court to convert a secured loan into an unsecured one or invalidate it entirely. The mere threat of doing so can increase the leverage that might be applied against Lender. While this hypothetical may seem unlikely, it does describe one risk that can actually hit. And protection from precisely this risk - the risk of being an unsecured creditor - is a principal reason why any lender takes security for a loan. If under any circumstance a "secured" loan ultimately might not stay secured, then the "security" exercise may have failed to achieve its fundamental purpose.
Other creditors are not the only parties who might try to set aside Lender's security or to obtain leverage by threatening to do so. If any Property Owner goes into bankruptcy, that Property Owner's own management - the principals of the borrowing group - could threaten to try to set aside the Property-Specific Mortgage or the bankruptcy trustee might try to raise the issue.
The theory for setting aside any Property-Specific Mortgage would proceed from the perspective of any bankrupt or financially distressed Property Owner as follows. When that Property Owner signed on to the Portfolio Loan, it incurred debt that far exceeded both a). the value of Property Owner's assets (the Property) at that particular moment; and b). the benefits Property Owner received from the transaction. In other words, Property Owner "got ripped off." And, in legal parlance, the transaction might be deemed a "fraudulent transfer."
WHAT CONSTITUTES A "FRAUDULENT TRANSFER"?
In a bankruptcy or a state law "fraudulent transfer" proceeding affecting just one Property Owner, a court might look closely at transactions like this one. If the court concludes that the transaction made the particular Property Owner "insolvent" without providing "fair consideration" or "reasonably equivalent value" to that Property Owner, then the court might decide the Property-Specific Mortgage legally constituted a fraudulent transfer. And courts have the power to set aside any fraudulent transfer.
In deciding whether a Property-Specific Mortgage is a fraudulent transfer, the court might not consider the benefits of the Portfolio Loan to the borrowing group as a whole. Although as a realworld credit matter, Lender makes the Portfolio Loan to the entire borrowing group, a court might very well decide to conduct a separate fraudulent transfer analysis for each Property Owner. (This assumes the multiple Property Owners are not substantively consolidated in bankruptcy, a possibility discussed below.)
A court will typically evaluate Property Owner's solvency based on a balance sheet analysis - a comparison of assets vs. liabilities. In the alternative, a court could find a fraudulent transfer if it decides that a Property Owner did not receive fair consideration or reasonably equivalent value and at the time of the Portfolio Loan closing was unable to pay its debts or had "unreasonably small capital" given the nature of its anticipated business. The court would perform this analysis with the benefit of 20 / 20 hindsight at a moment when (presumably) Property Owner is in financial distress. If the court finds "insolvency" but no "fair consideration" or "reasonably equivalent value" to Property Owner, the court might set aside the Site-Specific Mortgage or some or all of Property Owner's liability for the Portfolio Loan.
The outcome of the "fraudulent transfer" analysis of this transaction is by no means hopeless for Lender.
For example, a court sympathetic to Lender might say that if Lender forecloses on a Property-Specific Mortgage and forces one Property Owner to pay the entire Portfolio Loan, then that Property Owner would have a legal right to require the other Property Owners to contribute their shares of the Portfolio Loan. This legal right of each Property Owner is called a "contribution right."
The court could attach a value to a Property Owner's contribution right. The court could then say that the value of the contribution right represents an asset that balances out Property Owner's possible liability for the entire Portfolio Loan; therefore the Portfolio Loan did not make Property Owner insolvent; therefore the Portfolio Loan was not a fraudulent transfer at all.
A court might also recognize that in the real world, a Lender will almost certainly enforce the Portfolio Loan against all Property Owners at once, rather than just single-out a lone, hapless Property Owner as victim. Based on that practicality, the court might discount the prospective liability of any one Property Owner.
Although supported by some of the decided cases, neither a discount for contribution rights nor a discount for improbability is uniformly accepted. A court trying to rescue only a single distressed Property Owner from its financial plight might instead compare the assets and liabilities of that particular Property Owner; decide Property Owner's new liabilities (the Portfolio Loan) overwhelmed Property Owner's assets; and conclude that Property Owner became insolvent as a result. While this outcome is possible, Lender could certainly argue that it would be improper.
source: find articles.com
next>> |
