Daily Development for Monday, June 13, 2005
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
MORTGAGES; DUE ON SALE; EXIT FEE; CORPORATE REORGANIZATIONS: Refinancing, restructuring, reorganization and initial public offering of the debtor's properties and its equity interests in such properties did not collectively constitute a "sale of all or any portion of the property" under the loan agreement so as to trigger an exit fee, based upon the consideration received by the debtor, when no consideration is received for the transfer..
Anthracite Capital, Inc. v. MP-555 West Fifth Mezzanine, LLC, 2005 U.S. Dist. LEXIS 9179 (S.D.N.Y. May 17, 2005)
The court here refused to award the lender a "supplemental exit fee" pursuant to a provision in a mezzanine-loan-financing loan agreement that required the payment of the fee upon the "sale" of the properties above a given price.
To determine the payment of the exit fee, the documents defined "Supplemental Exit Fee Purchase Price"as the “gross purchase price of all or a portion of the Property, including without limitation all cash proceeds, non-cash proceeds, any over-market purchase money financing or any other consideration to the Companies or the Borrowers (provided that any and all consideration received shall be payable only to the Companies or the Borrowers) that is reasonably attributable to the Property . . . .”
The court found that there was undisputed evidence that the transfer of title in the properties was made without consideration, so that the plaintiff's breach-of-contract claim failed as a matter of law. The court noted that the transfer-tax declarations filed by the debtor with respect to the properties conveyed pursuant to the debtor's reorganization claimed full exemption and stated that, "The Grantor and Grantee in this conveyance are comprised of the same parties who continue to hold the same proportionate interest in the property." It ignored the fact that the ownership of the entities holding the properties had substantially changed through an IPO that resulted in almost $700 million in proceeds that were used for debt relief and release of guarantees for the original principles.
The court also rejected the plaintiff's claim alleging a breach of the implied covenant of good faith and fair dealing, because the fee was never due in the first place. Furthermore, the court dismissed the plaintiff's fraudulent-transfer claim because the plaintiff could not establish that it was a creditor entitled to collect the exit fee.
The court also noted that the plaintiff acknowledged that it had full notice of, and approved, the prepayment by the defendants at the time of refinancing, and only caused the loan servicer to claim that the supplemental exit fee was due five days after completion of the transaction. (The loan was a part of a securitized package of loans transferred to a trust that issued certificates representing beneficial interests in the assets of the mezzanine trust).
Reporter’s Comment 1: This case highlights the importance of clearly and comprehensively setting forth, in the mortgage loan (or mezzanine loan) documents, the conditions that will trigger the payment of a prepayment fee or exit fee. The court in the Anthracite case pointed out that, "the Loan Agreement unambiguously stipulates that the Supplemental Exit Fee is payable upon a sale of the 'Property,' not a sale of interests in the property." The court also noted that although the Loan Agreement did not define the term "sale," the "ordinary meaning of that term is 'the transfer of property or title for money or other consideration.'" The court further noted that the Loan Agreement (which was more than 80 pages in length) was heavily negotiated by sophisticated parties, and that separate provisions in the Loan Agreement "clearly contemplate[d] transfers of direct or indirect interests in Companies or Borrowers as distinct from transfers of the Property itself."
Reporter’s Comment 2: The lender in this case certainly made a strategic mistake by not demanding payment of the fee until five days after the transaction had been completed; this certainly did not endear it to the court or appeal to the court's sense of equity. The court noted that the payoff letter the borrower requested from the loan servicer before the transaction was consummated did not include the imposition of the supplemental exit fee, and in fact the loan servicer "continued to provide updated quotes to [the borrower] over the next few months with notice to, and no objection from, the lender. At no point before the IPO on June 27, 20003, did [the loan servicer's] quotes include the requirement that [the borrower] pay the Supplemental Exit Fee."
Reporter’s Comment 3: With the advent of securitized and conduit financing and the use of bankruptcy-remote borrowing entities to comply with rating-agency requirements, it has become more common for mortgage due-on-sale and prepayment clauses to contain a "change of control" provision, i.e., a prohibition against certain "direct or indirect" changes in the equity ownership, control or management structure of the mortgagor (usually a limited partnership or limited liability company). This provision usually provides that if certain principal individuals or entities at any time own less than a specified percentage of the management, ownership, membership, general partnership, or voting interests of the borrowing entity, or if the borrowing entity sells, conveys, or assigns more than a specified percentage of such interests, a default will have occurred under the loan documents and the mortgagee may accelerate the loan and/or collect the prepayment premium.
The parties, of course, heavily negotiate permitted transfers. Assuming that a senior mortgage note is securitized, rating agency affirmation may be required, even for permitted conveyances and transfers. Also, the lender on a junior note in a securitized transaction may want a separate approval right. If the mortgage lender does not draft the due-on-sale or prepayment clause specifically to include these types of equity and control transfers, a court likely will determine that such transfers do not constitute a violation of the clause. See, e.g., Fidelity Trust Co. v. BVD Associates, 196 Conn. 270, 491 A.2d 180 (1985) (change of membership occasioned by withdrawal of general partners of limited partnership, which was distinct legal entity and remained so after change in general partnership interests, was not sufficient to constitute a "sale or conveyance" under applicable due-on-sale clause); In Hodges v. DMS Co., 652 S.W.2d 762 (Tenn. App. 1982) (in the absence of expre!
guage covering such a transfer, the withdrawal of two partners of partnership mortgagor, while business was continued in lieu of liquidation, did not amount to sale or transfer of the secured property even though entity had changed by operation of law, and did not activate due-on-sale clause).
The Reporter for this item was Jack Murray of First American Title Insurance Company, Chicago Branch. The editor has made substantial revisions and additions, so don’t blame Jack if there are problems.
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