presents Title Insurance Risks in Distressed Real Estate Transactions Evaluating and Dealing With Liens and Other Encumbrances During Title Due Diligence ALive90A Live 90-Minute Teleconference/Webinar with Interactive Q&A

Today's panel features: David Weissmann, Partner, Weissmann Zucker Euster, Atlanta Patricia “Trish” Brown, Assistant Vice President, Regional Underwriting Counsel, First American Title Insurance Company, Kansas City, Mo. Ren R. Hayhurst, Partner, Bryan Cave, Irvine, Calif. Wednesday, June 16, 2010 The conference begins at: 1 pm Eastern 12 pm Central 11 am Mountain 10 am Pacific

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4 Bankruptcy Avoidance Powers Risk Loss of Title

• Primarily concerned: – fraudulent conveyances under Section 548 – preferences under Section 547 • Equitable subordination is also a risk

5 Fraudulent Conveyances

• A transfer made within two years before bankruptcy if (i) the transfer was made “with actu al intent to hinder, delay, or defraud” a then exitiisting or subtbsequent creditor, or (ii) the debtor was insolvent or had insufficient capitalatthetimeof the transfer, and received less than the reasonable equivalent value of the transferred property

6 Section 548(c): transferee “for value” and “in good faith”:

• Retains lien up to value notwithstanding fraudulent conveyance concerns • GdfihGood faith means h hiaving suffi ffiicient knowledge to place transferee on inquiry notice of the debtor’ s possible insolvency , or abstaining from unconscionable behavior to the detriment of other creditors

7 Fraudulent transfer risks to the len der:

• Foreclosures • Deeds in lieu of foreclosure especially if value of property is more than lender would receive in Chapter 7 liquidation • Mortgages granted as additional security

8 Preferences: insolvent, and made within 90 days of the filing of the petition generally, or within 1 year of the filing

• Transfers of interest in property, to or for the benefit of a creditor, for or on account of a pre-existing debt debt made, made when when the debtor the debtor was was

ofthf the titi petiti bon i id by insiders, whbthdithereby the creditor obtains property valued in excess of what would have been received in a Chapppyter 7 bankruptcy

9 Preferences:

• Uncertainty whether a foreclosure made within the statutory period could constitute a preference, especially if the secured claim is substantially less than the value of the foreclosed property, because the creditor receives dramatically more than it would receive in a Chapter 7 liquidation

10 Preferences:

• Issue on time of recordation. Does preference period relate back to date of deed, or date of recording? • Statute now grants 30 days grace period to record to retain relation back to date of deed and transaction

11 Exclusions to title coverage provide protection to insurers • No coverage for damages which “would not have been sustained if the [insured] had paid value for ” mortgage/property (covers a failure of consideration) (Exclusion 3(e) ALTA 2006)

12 Exclusions to title coverage provide protection to insurers

• Exclusion for matters “attaching or created subsequent to the Date of the Policy” (Exclusion 3(d) ALTA 2006 – the “post-policy exclusion”) – Bankruptcy is always a matter created subsequent to the date of the policy

13 Specific bankruppytcy creditors’ rights exclusionsexclusions::

• 1990 ALTA Policy: excludes liability for claims arising under the operation of federal bankruptcy, state insolvency, or similar creditor’s rights laws – Deletion was often done by endorsement at little or no charge with little review – In later years, there was more attention to detailed financial information

14 ALTA offered specific creditor’s rights c overage in 2006, iiinsuring the “invalidity, unenforceability, lack of priority or avoidance of” the insured lienlien:: • Resulting from fraudulent transfer occurring prior to the transaction creating the lien; or • Resulting from failure to timely record lien (preference issue)

15 Creditors’ rights exclusion also modified, excluding coverage if transaction creating lien:

• is a fraudulent conveyance or transfer • is a preferential transfer (other than if due to a failure to timely record)

• Even if not specifically excluded, other exclusions arguably still apply

16 ALTA Endorsement 2121--0606 (Creditors’ Rights) insures against loss: • Sustained by reason of avoidance due to an occurrence on or bfbefore t he eff ect ive date of the policy of a fraudulent transfer or preference – unless fraudulent nature was “known” to the ididiinsured or insured is not a purch hi“d”ase in “good” faith

17 ALTA Endorsement 2121--0606 is decertified in Feb ruary 2010

• Business risk shifts back to business players • Title companies reviewed upcoming defaults and determined risk was too great

18 Mortgage modifications on the rise • Extensions of maturity • IiitttIncrease in interest rate • Payment modifications • Additional collateral • Cross default/cross collateralize • Partial releases

19 Modifications can prime junior liens

• Is modification materials or substantially prejudicial so as to jeopardize the junior lien holder – Increase in interest or ppyayment p ut stress on the property – Changes in maturity date may not be prejudicial but case law is mixed – Cross collateralization/cross default increase risk to junior lien holder

20 Original mortgage language or idiintercreditor agreement can protect

• Future advance clauses provide some protection, depending on local law • Language that note secured includes amendments and renewals helps • Cut-off letter from junior lender may be required nonetheless

21 Intercreditor and subordination agreements

• Generally contain broad provisions which prohibit modifications – Can be limited to “major” modifications such as interest, payment terms, principal amount

22 Restatement of Property (Mortgages):

• 7.3(b) – Senior mortgage if modified is effective aggjainst junior lien holder unless modification is materially prejudicial and is not within the scope of reservation of right to modify

23 Restatement of Property (Mortgages):

• Assumption that extensions are also for the benefit of junior lien holders • Assumption that courts will view increase in interest rate or principal detrimental to junior lien holders

24 Restatement of Property (Mortgages):

• Should respect language in senior mortgggage allowing for modifications unless “cutoff notice” is provided

25 Title insurance does not always cover modificat ion unless insured obtains endorsement • Policy jacket exclusions may apply: – Exclusion for risk voluntarily assumed by insured – Exclusion for liabilityy, created, suffered or assumed by insured – Exclusion for post-ppyolicy actions

26 Types of endorsements – Date down

• Brings forward the effective date and revises description of mortgggage to include modification • Any creditors ’ rights protection in the policy would be brought forward as well

27 Types of endorsements – ALTA Form 1111--0606

• Insures priority of mortgage as modified but does not bring forward the effective date • Contains specific exclusions for creditors’creditors rights (fraudulent transfer and preference)

28 Word of caution: To endorse or not to endorse

• Title companies may deny coverage even on simple modifications such as extensions • Getting title companies to agree that they will continue coverage under the original policy without the endorsement is a problem

29 Handling Distressed Real Estate Foreclosure, Deed-In-Lieu and Bankruptcy Foreclosure

Procedure by which lender can gain title to the collateral upon borrower default on the mortgage loan .

31 Typically results in liens subsequent and subordinate to lender’smortgage s mortgage being wiped out.

• deeds of trust and mortgages entered into after the lender’s mortgage • judgment liens • mechanics’ liens (to some extent, in some states)

32 Some liens have superpriority and may not be extinguished or may only be extinguished by following specific procedures.

• mechanics’ liens (in some states these liens will prime the lien of the mortgage if such mortgage was fffor construction or if work commenced prior to granting the mortgage) • Liens i n f avor of th e U ni ted S tates government (28 U.S.C. 2410)

33 • Subdivision assessments • Condominium assessments • Real Estate taxes and special assessments • Vendor’s and Vendee ’ ssLiens Liens • UCC’s • Sewer assessments • IRS liens (if proper notice of foreclosure is gg,iven, then IRS has 120 day s to redeem; if proper notice not given, then lien remains and purchaser at foreclosure will be subject to the lien)

34 Title Insurance • Insures the state of title post foreclosure. • It is important to request a title commitment specifically for foreclosure at the commencement of the foreclosure proceeding. • Title insurance company will set forth specific requirements that must be met in order to insure.

35 Deeds-in-Lieu of Foreclosure • Arrangement between borrower and lender whereby lender can obtain title to the collateral without goi ng th rough th e f orecl osure process. • The mort gage i nst rument i s t ypi call y not released so in the event borrower challenges the deed -in-lieu transaction and it is set aside, the lender may still be able to foreclose.

36 • Also, if there are subordinate liens, once lender takes title, it can foreclose those liens prior to selling the property. This may be advantageous if there is ongoing litigation involving the property (such as mechanics’ liens enforcement).

37 • Due to the nature of the deed-in-lieu transaction, the documentation used for the transaction should be very detailed. Lender should not pursue or be willing to accept a deed-in-lieu conveyance unless the documentation meets the requirements.

38 Quick Guide to Title Company Requirements to Insure a Deed-in-Lieu Transaction

39 Deed • reference that it is a deed-in-lieu of foreclosure transaction • include non-coercion language

40 Deed-in-Lieu/Settlement Agreement • include amount of outstanding debt • include covenant not to sue or release of personal liability under the note • include non-coercion langgguage • include non-merger language for deed of trust/mortgage

41 • include statement that borrower is delivering possession of the property at or before closing • borrower cannot retain any interest in the property, including a lease, right of repp,p,urchase, options, etc.

42 Affidavit of Borrower • Used in the event the settlement agreement does not adequately address all of th e requi rement s

43 Value of Property • objective information that the value of the property is less than or equal to the amount of d ebt b ei ng rel eased • important to establish that borrower has no equity in the property

44 Copies of any other documentation between lender and borrower with respect to the deed-in-lieu transaction

45 For sample documentation and other helpful information:

http://title.firstam.com/resources/reference- information/john-c.-jack-murray-law- library/foreclosures,-deeds-in-lieu,-and- workouts/documenting-a-consensual-transfer-of- distressed-real-estate.html

46 Deeds in Escrow • Deed held in escrow (usually by a title company) whereby borrower conveys title tlto lend er, b btthdut the deed di is not record dded unless and until the occurrence of a subsequent default on the loan pursuant to the workout or settlement agreement. • These deeds in escrow are considered executory contracts rejectable in bankruptcy.

47 Bankruptcy • Federal Code and Rules which allow borrower/debtor time to liquidate or reorganiithtize without pressure of enforcement actions.

48 Automatic Stay § 362 • Upon filing of bankruptcy, all collection activities of creditors are temporarily hltdhalted.

49 Relief from the Automatic Stay • Creditor can request relief from the automatic stay under certain circumstances. If relief is grantdted, credit or can proceed with ithit its enforcement action (foreclosure).

50 Sale under § 363 • Allows debtor to institute bidding to sell property of the bankrupt estate. Lender can credit bid th e d ebt and if th e hi gh est bidd er, can obtain title to the property.

51 Most 363 sales are done free and clear of all liens and require a court order stating that the sale is free and clear of all liens and that anyyp lien attach to the proceeds from the sale. From a title company perspective, “all liens” may not necessarily be all of the liens.

52 Judgment Liens • Judgment liens that attach prior to the debtor filing bankruptcy are not dischargeable in bank rup tcy. The personal li abilit y of th e debtor is discharged but the lien is not extinguished. It is important that any order relating to judgment liens also releases the lien.

53 Preferential Transfers § 547 (and applicable state statutes)

• A transfer of an interest of the debtor in property may be avoided if the transfer was made within 90 days prior to debtor filing for bankruptcy (one year if creditor is an insider) and if certain criteria exists:

54  made for the benefit of the creditor for an antecedent debt; and

 debtor was insolvent or becomes insolvent as a result of the transfer; and

 creditor received more than it would have in a Chapter 7 liquidation

55 Fraudulent Transfers § 548 (and applicable state statutes)

• A transfer of an interest of the debtor in property may be avoided if the transfer was made within one year prior to debtor filing for bankruptcy and if certain criteria exists:

56  debtor had actual intent to hinder, delay or defraud creditors; or  transfer was made for less than reasonably equivalent value; and • debtor was insolvent or becomes insolvent as a result of the transfer; or • debtor intended or believed it was incurring debts beyond its ability to repay; or • debtor maintained an unreasonably low level of capital

57 Handling Distressed Real Estate Foreclosure, Deed-In-Lieu and Bankruptcy REO Proppgerties: Legal Strategies for Lenders and Purchasers Ren Hayhurst (Irvine,CA) 949-223-7125; [email protected] Overview of Note and REO Sales • Note Sales – Acquire Debt, Not the Underlying Asset – Seller is the Lender, Not the Borrower/Debtor – Subject to Defects in Documentation, Title, etc. – Must Complete Foreclosure Process Before Assuming Control of the Property – Know Your Enforcement Options • REO Sales – Tak e Titl e t o th e A sset ; D eal Di rectl y with O wner – Must Wait for Remedies to be Completed – Uncertainty Pending Foreclosure

60 Due Diligence Issues

• Due Diligence Challenges – Note Sales Require Due Diligence on: • The Loan, • Condition of Title, and • Condition of the Property. – REO Sales Requires Standard Property Purchase Due Diligence: • Condition of Title, and • Condition of the Property.

61 Due Diligence – Note Sales

• Loan Issues – Must Understand Risk of: • Borrower Bankruptcy, • Lender Liability Claims, • Defects in Loan Enforcement • Title Issues – Must Understand Effect of Foreclosure On Title • Eliminate Junior Liens • Effect on Development Rights? • Property Due Diligence

62 Due Diligence – REO Sales

• Focus On Property – Title Report • Which rights eliminated by foreclosure and which rights survive the sale – Market Research • Effect of Foreclosure on Market • Tenant Issues – Co-Tenancy Clauses, Rent Reductions, Etc. – Environmental Report – Effect of Judicial Foreclosure vs Non-Judicial Foreclosure on Redemption Rights

63 Alternative Transaction Options

• Alternatives to Foreclosure – Deed in Lieu of Foreclosure • Title Subject to Competing Liens and Other Defects • Potential Creditors’ Rights Issues • Consensual Foreclosure – Permits a Lender to “Clean Up” Title, And Can Speed Up the Process • Consensual Bankruptcy – Risk Of Trustee Or Judicial Interference

64 Holding and Operating REO Properties • Survey and title • Land use • Successor liability • Construction defect liability risks for unfinished projects • When REO is unit of larger project

65 Survey and Title Considerations

• Use of Prior Survey – Update or Re-Certify Survey – Alternatives – Title Company Products (Plotted Easement Map, Etc.) • Title Policy – Binder if Foreclosing Owner – New Title Policy for Purchaser • Potential Problems – Easement, Setback and Parking Issues – Mechanics’ Liens, CC&R Assessments

66 Survey and Title Considerations II: Emerging Title Issues • Creditor's Rights Issues – Consideration for Upstream and Downstream Guarantors – Solvency Representations/Source of Equity • Broken Priority – Financial Statements From Borrower/Guarantors – Signed Indemnity Agreement from Borrower/Guarantor – Construction loan agreement • Cost Break Down and Loan Budget – Cash Deposit/Letter of Credit

67 Land Use Considerations

• Entitlements – Unstarted Project – Beware of: • Moratoriums, • Changes in Developments Plans, • Expiring Development Agreements, and • Replacement Bonds • Rent Control – Typically Survive Foreclosure

68 Successor Liability

• Assignment of Title Policy – Should be done in any sale of a loan – Even applies to asset sales for failed banks • HOA/CC&R Defaults and Assessments – Typically Do Not Survive Foreclosure • Profit Participation/Marketing Fees – Controlled by Agreements and Subordinations

69