Real Est Fin Jrnl V26 #2

Structured & Real Estate Finance Case Update Willard Moore, Jason DeJonker, and Joshua Kurtz* This update reports on recent legal opinions of relevance to commercial real estate lenders, developers and owners, with particular focus on state and federal court decisions involving litigation with respect to distressed or nonperforming assets. In re Tousa1 vent, unless the transfer is for “reasonably The South Florida Bankruptcy Court in the equivalent value.” Fraudulent conveyances Tousa case ordered various creditors that may deprive a borrower's pre-existing credi- had benetted from a fraudulent conveyance tors of recourse to assets that they relied on to disgorge $421,000,000 to the jointly- in making loans to the borrower. Fraudulent administered Tousa bankruptcy estates. The conveyances are legally reversible because court also ordered the avoidance of liens on they remove assets from the borrower's bal- the assets of various Tousa subsidiary enti- ance sheet without replacing them with other ties who were also debtors in the bankruptcy assets of “reasonably equivalent value.” proceedings. This case may raise increased The parent debtor company in Tousa, focus upon the legal theory of fraudulent called Tousa Inc., had previously incurred conveyance, which was the rationale used by $500,000,000 in debt in an unsuccessful the bankruptcy court to order the money business venture. To renance that debt, it returned. arranged for itself and its subsidiaries to receive loans and to give liens in order to The two major elements of a fraudulent raise the money to repay its business debts. conveyance are that (1) a debtor makes a The subsidiaries, however, were not liable for transfer for less than reasonably equivalent the business debts being repaid. Conse- value and (2) the transfer either makes the quently, the Tousa subsidiaries did not bene- debtor insolvent or occurs at a time when t from the liabilities they incurred and the the debtor was already insolvent. In a nut- liens they gave in the debt renancing and shell, the doctrine of fraudulent conveyance loan transaction. (or fraudulent transfer) gives a legal remedy to pre-existing creditors when a borrower As Tousa has conrmed, the liabilities and makes transfers to third parties while insol- obligations incurred by subsidiaries in sup- *Willard Moore and Jason DeJonker are partners at Seyfarth Shaw LLP. Mr. Moore represents lenders, developers, owners, and investors in a variety of real estate nancing transactions. Mr. DeJonker concentrates his practice on bankruptcy cases, pre-bankruptcy workout negotiations and compositions, troubled borrower restructur- ing and forbearance, and general commercial litigation. Joshua Kurtz is an associate in the Real Estate Practice Group. The authors may be contacted at [email protected], [email protected], and jkurtz@seyfarth. com, respectively. The Real Estate Finance Journal E Fall 2010 © 2010 Thomson Reuters 59 The Real Estate Finance Journal port of their parent companies, often called fact, the junior lender had previously as- “upstream” obligations, are especially vulner- signed its note to another bank, Sovereign, able to fraudulent conveyance attack by and therefore no longer had an interest at disgruntled junior or unsecured creditors of a stake in the legal proceedings. The junior bankruptcy estate. As in Tousa, subsidiaries lender apparently did not notify either MERS may not fully benet from loans and liabilities or Sovereign when it received notice of the incurred for the sole benet of parent lawsuit. corporations. Thus, subsidiaries do not The use of MERS as a nominee is intended receive “reasonably equivalent value” for to facilitate the purchase and sale of mort- incurring liabilities or giving lien-backed gage loans. Lenders who put mortgages in guaranties of such loans. Moreover, such MERS's name retain equitable and economic new liabilities and obligations can render sub- ownership of their loans as well as servicing sidiaries insolvent if they are not so already. rights and obligations. MERS allows lenders to buy and sell interests in mortgage loans The court ruled that the business creditors with other MERS participants without having who had been repaid from the proceeds of to publicly record those transactions with the fraudulent loan transaction had to return county real estate oces. $421,000,000 of principal and interest received. Section 550 of the Bankruptcy Senior lender did not serve process upon Code allows for the disgorgement of pay- MERS or Sovereign. The foreclosure action ments made to a secondary transferee of a eventually culminated in a motion to conrm fraudulent transfer, or to the “entity for whose the results of a sheri's sale. Sovereign and benet such transfer was made.” Here, Sec- MERS at that point became aware of the tion 550 allowed for recourse to the parties foreclosure proceedings and led motions to whose business debts had been repaid with intervene and to vacate the default judgment. the loan proceeds even though the fraudu- Because Sovereign has no recorded interest lent transfer itself was received by the lend- in the mortgaged property, its motion was ing banks. The liens placed on the subsidiar- denied. ies' assets were also avoided. At issue before the Kansas Supreme Court Landmark National Bank v. Kesler2 was whether the trial court had abused its discretion in ruling that MERS, as a non- A Kansas Supreme Court ruling concerned lender and holder of the junior mortgage in a dispute between real estate lenders with name only, was not a necessary party to the claims on the same collateral. In Kesler,a foreclosure proceedings and therefore not senior bank initiated a foreclosure action that entitled to join the proceedings or to seek to eventually terminated a junior mortgage on vacate previous court orders. By holding that the same property. The junior mortgage MERS was not so entitled, the trial court al- named Mortgage Electronic Registration lowed the foreclosure sale to stand and the Systems, Inc. (“MERS”) as mortgagee, but junior mortgage to be extinguished. only as “nominee” for the actual junior lender. Senior lender properly served process upon The Kansas Supreme Court in Kesler af- the junior lender, who failed to answer and rmed the lower ruling, holding that parties had a default judgment entered against it. In who do not hold a full range of substantive The Real Estate Finance Journal E Fall 2010 © 2010 Thomson Reuters 60 Structured & Real Estate Finance Case Update economic rights in mortgage loans—such as borrowers put the loans in default at its “nominees” like MERS—are not “lenders” outset, triggering the repurchase obligations and therefore do not have economic interests of UBS under the UBS loan purchase that are prejudiced by default judgments. As agreement. such, there was no “abuse of discretion” in denying MERS's motions to vacate the UBS was not the originator of these loans, default judgment or to intervene in the case. but acquired some of them from Love Fund- ing Corporation pursuant to a separate loan The procedural posture of this case makes purchase agreement. Like the UBS loan it appear more unfriendly to nominees and purchase agreement, the Love Funding loan organizations like MERS than it actually is. purchase agreement contained an analogous The precise legal issue in Kesler was whether representation that none of the loans were in a trial court had “abused its discretion.” This default at the time of the transfer to UBS. question the court answered in the negative. The agreement also provided that Love The Kansas Supreme Court acknowledged Funding would indemnify UBS for any loss that MERS may have been technically entitled related to said breach. to receive service of process, but reasoned As part of the settlement arrangement be- that this precise question was not before it. tween the Trust and UBS, UBS assigned to The case calls renewed attention to the the Trust its rights under the Love Funding administrative and enforcement issues raised loan purchase agreement. The Trust subse- by the use of MERS as a nominee, issues quently sued Love Funding under the as- which some lenders may not have focused signed agreement from UBS. The U.S. District on during the origination process and Court for the Southern District of New York thereafter. ruled that the assignment was void for champerty because the Trust's primary Trust for the Certicate Holders of purpose in taking the assignment was to the Merrill Lynch Mortgage Investors, bring a lawsuit against Love Funding. The Inc. Mortgage Pass-Through decision was appealed to the U.S. Court of Certicates, Series 1999-C1 v. Love Appeals for the Second Circuit, which certi- Funding Corporation3 ed to the New York State Court of Appeals New York State's highest court claried certain questions relating to New York State's New York State's “champerty” statute and champerty statute. conrmed that the statute will not generally The New York State Court of Appeals prevent buyers of distressed debt from stated that New York's champerty statute is enforcing their remedies through litigation generally limited in scope and largely directed when pursuing a legitimate claim. toward preventing attorneys from ling suit In Love Funding, a REMIC Trust sued UBS merely as a vehicle to obtain costs. The court Real Estate Securities, Inc. to enforce its conrmed that the concept of champerty remedies under a loan purchase agreement, does not, therefore, apply when the purpose alleging that UBS's predecessor sold the of the assignment is the pursuit of a legiti- Trust several defaulted loans, and demand- mate claim. In the instant case, the court ing that they be repurchased. The Trust as- found the champerty doctrine inapplicable, serted that certain frauds committed by the because the Trust, as holder of a defaulted The Real Estate Finance Journal E Fall 2010 © 2010 Thomson Reuters 61 The Real Estate Finance Journal loan, would directly suer the damages of a receiving J-51 benets, not to properties that default.

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