Calling the 21st century: Competition, consolidation, and convergence

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In the typical real estate bankruptcy proceeding, a secured creditor will oppose substantive consolidation, but the special facts of a Portfolio Loan might lead a Lender to favor it - at least in dealing with Property Owners that obtained the Portfolio Loan. A Lender might not be as enthusiastic about bringing other unrelated affiliates into the bankruptcy proceeding. While a court might be receptive to Lender's position, it might also conclude that a Lender cannot assert it after having dealt with the separate Property Owners as separate entities. Finally, if all the Property Owners are insolvent when considered as a group, Lender might disfavor substantive consolidation.

7). Common General Partner - Lender might insist that Property Owners restructure their internal ownership to assure that all Property Owners are general partnerships and they all have the same general partner, with the general partner having recourse liability for the entire Portfolio Loan. That general partner would therefore already be liable for all debts and obligations of every Property Owner, including the Portfolio Loan. It could pay that liability from any of its assets, including its partnership interests in all Property Owners.

If not paid, Lender could always proceed against that common general partner, directly, in its capacity as general partner of all Property Owners, without having to consider issues that arose because the general partner had somehow assumed liability for some other entity's indebtedness. In a typical case, the use of a common general partner would substantially diminish whatever incremental "fraudulent transfer" concerns might arise from crosscollateralization with separate Property Owners.

A borrower may resist the use of a common general partner or single entity to hold all assets. A borrower might express concern that such a structure would be inconsistent with its business needs and desires, and would make it incur significant transaction costs and probably tax exposures.

8). Guaranty - An upper-tier, deep-pocket entity might execute a narrow and limited guaranty, designed to protect Lender only against the risk that any Property Owner's obligations or Property-Specific Mortgage were ever invalidated based on fraudulent transfer theories.

As an alternative, such a guaranty might be even more narrow, applying only if Property Owner's management, through skillful manipulation of the bankruptcy process (and its control of the "debtor-in-possession") ever tried to invalidate any Property-Specific Mortgage on fraudulent transfer grounds. Such a guaranty would give higher-level ownership an incentive to prevent any Property Owner from manipulating the bankruptcy process to Lender's detriment.

As long as the ownership used its control in a way that did not hurt Lender, the guaranty would never trigger. Thus, Lender would continue to bear whatever risks might arise from any fraudulent transfer actions that other creditors (e.g. trade creditors, slip-and-fall plaintiffs, and environmental claimants) might take to set aside the PropertySpecific Mortgages. An upper-tier guaranty would, however, give some protection against bad faith on the part of the very parties most likely to exercise it - Property Owner's management.

A guaranty of this type should raise few legal issues or problems of its own, such as questions about its validity. And if the borrowing group is proceeding in good faith, it is hard to see how the borrowing group can make any good arguments for not giving such a guaranty, other than general aversion to contingent obligations and personal liability of any kind.

9). Purchase Agreement - As a variation on the theme, Lender might request that some higherlevel entity agree to purchase the Portfolio Loan at par (plus a prepayment fee) from Lender if anyone ever tries to invalidate any Property-Specific Mortgage as a fraudulent transfer. An obligation to purchase the Portfolio Loan would eliminate potential issues about measurement of Lender's damages and hence about the amount of Lender's claim under a limited guaranty - but perhaps raise issues about whether the arrangement is really a guaranty after all.

If a Lender adopts some or all of the deal structures suggested above, this should significantly diminish the likelihood that Property Owner's management could use the bankruptcy and fraudulent transfer process as a creative technique to leverage Lender. A borrower's reaction to any of these structures might include the following arguments:

This is a nonrecourse loan without any credit enhancement, period, paragraph.

Assuming a multi-branch ownership structure, no branch of ownership can control another. (Lender would respond that these branches can and should, without much trouble, negotiate appropriate covenants and internal indemnities. Lender would be happy to help all ownership branches solve their "internal imbalance" problem by obtaining the same good-guy guaranty from all branches. Lender might even agree to allocations of liability rather than joint and several liability. And, if the branches of ownership are not comfortable enough with one another to stand shoulder-to-shoulder on this type of risk, Lender may legitimately ask larger questions about the group as a whole.)

There is no single upper-level entity that indirectly has the benefit of all the equity in all the assets and thus is an appropriate guarantor.

No upper-tier entity in any branch of ownership is otherwise interested in assuming any potential exposure for any of these risks.

The rest of the world closes multi-property, multiborrower secured loans without worrying about these problems, or by adopting only some of the measures suggested above - and, in particular, does not require guaranties to address this issue. (But, is this really true? . . .)

How far these arguments will go may depend on such considerations as how badly Lender wants to make the Portfolio Loan; whether the borrower has other financing sources; and how the borrower would behave under stress (considering the borrower's possible obligations to third-party investors that might preclude the borrower from behaving reasonably). Also, some of the structures suggested above might incur significant extra transaction costs (e.g., a doubling of the number of mortgages), and these costs might be regarded as excessive compared against the likely risk being addressed.

As a reasonable middle ground, Lender might settle for: a). limitations on the liability of each Property Owner; b). some form of simple contribution agreement; and/or perhaps 0. equity pledges. As noted, these three measures do not eliminate the issue, but should diminish it.

Finally, Lender might simply decide that given the large number of things that need to go wrong and the number of arguments that need to fail for Lender to suffer any loss as a result of the risks described in this manuscript, Lender might decide to treat this risk as background noise the functional equivalent of the risk of being run over by a bus if one decides to cross the street. This would, of course, be a business decision that should first reflect an understanding of the risk, which this manuscript has attempted to provide. That business risk would need to be analyzed in light of the overall financial strength of the parties and whatever level of financial pressure the transaction itself will create, i.e., whether the overall loan-to-value ratio is 45 percent or 90 percent.

The real issue might not be the size of the risk, but rather who should bear it. Why should this problem be Lender's risk at all, even if it is very small?RI

source: find articles.com

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