Commercial Real Estate Mezzanine Loan Foreclosures

Practical Guidance

Commercial Real Estate

Mezzanine Loan Foreclosures

A Practical Guidance

Practice Note by

Kristen E. Andreoli and Steven E. Coury, White and Williams LLP

Kristen E. Andreoli

White and Williams LLP

Steven E. Coury

White and Williams LLP

This practice note discusses mezzanine loan foreclosures,

including methods of and defenses to foreclosure under

Uniform Commercial Code (UCC) Article 9, as well as

practical and strategic considerations for borrowers and

lenders relating to UCC Article 9 enforcement actions

and conducting a commercially reasonable mezzanine loan

foreclosure sale in the midst of a global pandemic.

For more information about mezzanine financing, see

Mezzanine Financing Resource Kit, Commercial Real Estate

Mezzanine Financings, Mezzanine Financing, Mezzanine

Lending, Intercreditor Agreements (Mortgage Lender and

Mezzanine Lender), Mezzanine Loan Closing Checklist,

Mezzanine Loan Structure Diagram (Real Estate Transaction),

Mezzanine Workout Checklist, Irrevocable Proxy Agreement

(Mezzanine CRE Loan), Intercreditor Agreement (Mezzanine

Financing) (NY), and Control Agreement (Mezzanine CRE

Loan).

For more on foreclosures, see Foreclosure of Real Property,

Commercial Real Estate Loan Defaults and Remedies,

Workouts of Commercial Real Estate Loans, and Mezzanine

Workout Checklist.

A mezzanine loan is a loan made to the owner of the equity

interests of a single-purpose property owning entity that is

a borrower under a mortgage loan. The mortgage borrower

must also be a single-purpose entity with real property as its

sole asset. Unlike a mortgage loan that is secured by a lien

on the real property itself, a mezzanine loan is secured by a

pledge of the mezzanine borrower’s 100% equity interests in

the mortgage borrower. These equity interests are personal

property; therefore, the pledge is governed by the UCC,

rather than real property law. Upon a default under the

mezzanine loan, which is cross-defaulted with the mortgage

loan, the mezzanine lender will commence a foreclosure

under the UCC. When a mezzanine lender forecloses on its

mezzanine loan, the mezzanine lender is foreclosing on the

pledged equity interest in the mortgage borrower, and not

the real property itself. A UCC foreclosure of a mezzanine

loan indirectly secured by real property could take as little

as 10 days but is typically a 45- to 90-day process. On the

other hand, in states like New York where a foreclosure of

a mortgage on real property requires a judicial process, a

mortgage foreclosure can take well over a year to complete.

Advantages of Mezzanine

Loan Foreclosure

While the relative speed of a mezzanine loan foreclosure is

a definitive advantage to a mezzanine lender, a mezzanine

loan foreclosure requires the foreclosing mezzanine lender

to take title to the collateral subject to all intervening liens. As

the collateral is the ownership and control of the mortgage

borrower, the mezzanine lender not only becomes the 100%

owner of the mortgage borrower, it also effectively becomes

the owner of the underlying real property. It should be

noted that the underlying real property will remain subject

to all liens and encumbrances (including the mortgage loan

itself), which, by contrast, would have been extinguished in a

mortgage loan foreclosure process.

Mezzanine loans are attractive to real estate owners as they

provide the opportunity to borrow funds at a greater loan-to-

value ratio than is typically available with mortgage financing

alone; however, the speed of a mezzanine loan foreclosure

can put the property owner at a disadvantage if it seeks to

challenge it.

Intercreditor Agreements

In a financing transaction that involves both a mezzanine and

mortgage loan, the lenders will enter into an intercreditor

agreement at or around the time of the closing of the loans,

which will govern their respective rights and obligations

toward each other, including the strict conditions that the

mezzanine lender must satisfy to complete a mezzanine loan

foreclosure. These conditions include, but may not be limited

to the following:

• Curing all mortgage loan defaults either before or

simultaneously with foreclosure

• The equity transferee being a qualified transferee meeting

certain financial and experience requirements

• The appointment of a qualified property manager

• The posting of a replacement guarantor (for any

nonrecourse carve-out guaranty, environmental indemnity,

completion guaranty, carry guaranty, or payment guaranty)

–and–

• The establishment of a hard cash management system

For additional discussion of mezzanine loan intercreditor

agreements, see Intercreditor Agreements (Mortgage Lender

and Mezzanine Lender), Mezzanine Financing Resource Kit,

and Intercreditor Agreement (Mezzanine Financing) (NY).

UCC Foreclosure Procedures

Article 9 of the UCC provides a process for foreclosing on

secured collateral outside of a judicial process. Mezzanine

lenders are customarily required to take to actions to

exercise their remedy to foreclose on equity collateral under

the terms of most market mezzanine loan documents and

intercreditor agreements. Mezzanine lenders should review

and comply with the specific foreclosure requirements

in the applicable loan documents and intercreditor

agreement. Mezzanine lenders will have other rights and

obligations under an intercreditor agreement not related

to its foreclosure rights and obligations, such as the right to

consent to loan document modifications and mortgage loan

purchase rights.

Default Notice

To commence a UCC foreclosure, the mezzanine lender must

send the mezzanine borrower and any guarantor a default

notice under the mezzanine loan agreement. This default

notice must include a reservation of rights and remedies by

the mezzanine lender. The mezzanine lender must notify

the mortgage lender, and any other senior or subordinate

mezzanine lenders, of the event of default and the mezzanine

lender’s intention to foreclose on its collateral. In the event

that there are holders of subordinate mezzanine loans,

the mezzanine lender will also be required to provide such

subordinate mezzanine lenders with the opportunity to cure

the defaults under, and/or purchase, the mezzanine loan at

issue.

Once the default notice has been sent, the mezzanine

lender must keep the mortgage lender and any junior

mezzanine lenders reasonably informed of the status of the

foreclosure, including providing copies of all material notices,

pleadings, motions, and briefings. If the mortgage lender

or any senior mezzanine lender provides the mezzanine

lender with a notice of default under such senior loan,

the mezzanine lender must consider exercising its rights

under the intercreditor agreement to cure such defaults

under the senior loan until the mezzanine lender completes

its foreclosure. Under the terms of most intercreditor

agreements, a junior lender is afforded the right to cure

defaults for nonpayment of monthly debt service under

a senior loan for a stipulated period of time (e.g., four

consecutive months) and to cure nonmonetary defaults. A

mezzanine lender will not have the ability to cure a maturity

default—although, in states where a mortgage foreclosure

can be completed quickly, a mezzanine lender may try to

negotiate a short standstill period upon a maturity default,

providing the mezzanine lender sufficient time to foreclose

on its mezzanine loan before a mortgage loan foreclosure.

The mezzanine lender must cure defaults under any senior

loan, or exercise its rights to purchase the senior loan, in

order to prevent the holder of the senior loan from exercising

its remedies (e.g., foreclosure or deed in lieu of foreclosure)

which would leave the mezzanine lender with a pledge in an

entity that no longer has any assets.

A mezzanine loan is evidenced and secured by loan

documents that are similar to the mortgage loan and often

also on similar forms. Instead of a mortgage or deed of trust,

the lender’s interests in the mezzanine loan are secured by a

pledge and security agreement that pledges the mezzanine

borrower’s 100% equity interests in the mortgage borrower

to the mezzanine lender. Pledge agreements usually require

that the mezzanine lender provide at least 10 days’ prior

written notice to mezzanine borrower, as pledgor, of the

time and place of any public or private sale of the equity

collateral under the UCC. It is generally recommended that

the mezzanine lender provide a minimum of 30 days’ prior

written notice of any public sale to provide potential bidders

adequate notice and opportunity to conduct due diligence

and participate in the auction to help demonstrate to a

court—if the sale is challenged—that the sale was conducted

in a commercially reasonable manner.

New York UCC

New York law is generally selected as the governing law for

mezzanine loan documents, regardless of the location of

the real property. Under the New York UCC, the mezzanine

lender, as a secured party, may sell the equity collateral by

public or private sale provided that the method, manner,

time, place, and other terms of such sale are commercially

reasonable. N.Y. U.C.C. Law § 9-610(b). It should be noted,

however, that the mezzanine lender may acquire the equity

collateral only at a public sale because equity collateral is not

“customarily sold on a recognized market or the subject of

widely distributed standard price quotations.” N.Y. U.C.C. Law

§9-610(c).

In some instances, pledge agreements themselves may

stipulate what procedures will constitute a commercially

reasonable sale. Under U.C.C. § 9-603(a), “the parties may

determine by agreement the standards measuring the

fulfillment of the rights of a debtor or obligor and the duties

of a secured party under a rule stated in Section 9-602 if

the standards are not manifestly unreasonable.” For example,

the mezzanine lender may require the mezzanine borrower

to agree in the pledge agreement as to the governing law of

the sale, time and location of the sale, the auctioneer and/

or the auction process, notice procedures, and publication

requirements. Notwithstanding this advance agreement,

a mezzanine borrower may still raise a commercial

reasonableness challenge even if the mezzanine lender

strictly followed the agreed-upon procedures. For example,

if a pledge agreement designates that an auction must occur

on a business day in New York City, but the sale occurred

on the day of a blizzard or during a global pandemic, the

mezzanine borrower may have grounds to challenge the sale

as commercially unreasonable.

Reasonable Authenticated Notice of Sale

The mezzanine lender must send reasonable authenticated

notification of the sale to the following parties:

• The mezzanine borrower and any guarantors

• Any person from which the secured party has received,

before the notification date, an authenticated notification

of a claim of an interest in the equity collateral –and–

• Any other secured party or lienholder that, 10 days before

the notification date, held a security interest in or other

lien on the equity collateral perfected by the filing of a

financing statement

N.Y. U.C.C. Law §9-610(c)(1)–(3).

Reasonable authenticated notification means the notice

must be reasonable as to the manner in which it is sent, its

timeliness (i.e., a reasonable time before disposition is to take

place), and its content. N.Y. U.C.C. Law § 9-611 comment 2.

Under the safe harbor provision, the mezzanine lender

complies with the notification requirement if the following

takes place:

• Not later than 20 days or earlier than 30 days before the

notification date, the secured party requests information

concerning financing statements indexed under the

debtor’s name in the office which to file a financing

statement against the debtor covering the collateral as of

that date. –and–

• Before the notification date, the secured party either:

o Does not receive a response to the request for

information –or–

o Receives a response and sends an authenticated

notification of disposition to each secured party

or other lienholder named in that response whose

financing statement covered the collateral

N.Y. U.C.C. Law §9-611.

A notice of sale sent after default and 10 days or more before

the earliest time of disposition set forth in the notification is

deemed to be sent within a reasonable time before the sale

(N.Y. U.C.C. Law § 9-612(b)); however, sending a 10-day sale

notice, especially for a public sale of equity collateral in real

property, is generally held by courts to be an insufficient

period of advance notice. Generally speaking, however, the

contents of the notice of sale are sufficient if the notice does

the following:

• Describes the debtor and the secured party

• Describes the equity collateral that is the subject of the

intended disposition

• States the method of intended disposition (e.g., public sale)

• States that the debtor is entitled to an accounting of the

unpaid indebtedness and states the charge, if any, for an

accounting –and–

• States the time and place of a public disposition

See N.Y. U.C.C. Law §9-613(a).

Conducting the Foreclosure Sale

The mezzanine lender will take additional actions to prepare

for and conduct a public foreclosure sale of the equity

collateral. While these actions may not be expressly required

under the relevant mezzanine loan documents—generally,

the mezzanine loan agreement, pledge, and intercreditor

agreement—or the UCC, custom shaped by New York case

law dictates that the following steps are critical to protect

the mezzanine lender’s interests and to help ensure that the

foreclosure sale is conducted in a commercially reasonable

manner:

• Due diligence. The mezzanine lender will conduct due

diligence on the underlying project, the mortgage loan,

and mortgage borrower, and review the mortgage loan

documents, including any guaranties relating to the

mortgage loan, or any third-party consent rights, such as a

ground lessor.

• Formation of transferee. The mezzanine lender will

form an entity that satisfies the requirements of the

intercreditor agreement and obtain rating agency

confirmation if required. Such an entity is generally defined

as a qualified transferee under the intercreditor agreement.

• Replacement guarantors. Replacement guarantors will

need to be identified and will need to sign replacement

guarantees as required by the intercreditor agreement.

The replacement guarantor will further be subject to any

liquidity and net worth requirements in the mortgage loan

documents.

• Auctioneer and marketing. The mezzanine lender will

engage a professional auctioneer and investment banker/

broker to develop and implement a plan to market and sell

the equity collateral at auction to qualified bidders.

• Data room. The mezzanine lender and its professionals will

need to prepare bid package or set up a virtual data room

to include, among other things:

o A description of the equity collateral and the

underlying real property

o The mezzanine loan documents and mortgage loan

documents

o The organizational documents of mortgage borrower

o Financial information relating to the real property,

mezzanine borrower, and mortgage borrower, to the

extent available

o The terms of sale, bidder eligibility, and bidding

procedures

o A confidentiality agreement with prospective

purchasers

o A bill of sale and purchase agreement

o Appraisals of the project –and–

o Title, survey, leases, and other property level due

diligence, such as any payment in lieu of tax (PILOT)

agreements, ground leases, condominium documents,

and/or hotel franchise agreements

• Advertising. The mezzanine lender must also advertise

the sale of the equity collateral in industry journals/

publications and/or send targeted mailings of the sale of

the equity collateral to prospective purchasers.

• Credit bid. The mezzanine lender will credit bid its debt at

public auction or require a third-party bidder to outbid the

mezzanine lender and pay off the mezzanine loan.

• Deposit. A third-party bidder will need to post a deposit in

connection with a winning bid, typically equal to 10% of the

amount of the bid.

• Closing. The mezzanine lender and its professional

advisors will conduct a closing shortly following the public

sale of the equity collateral, at which the winning third-

party bidder must pay the balance of its bid and satisfy all

remaining requirements in accordance with the terms of

the sale.

• Communications with mortgage lender. The mezzanine

lender will communicate with the mortgage lender during

the foreclosure process and negotiate amendments to the

mortgage loan documents. Such amendments may include

resetting milestone dates for performance obligations.

• Organizational documents. The mezzanine lender or a

winning third-party bidder and the mortgage lender will

also need to cooperate to amend the mortgage borrower’s

organizational documents following the equity foreclosure

sale.

• Title insurance. The mezzanine lender or a winning third-

party bidder may desire a new title insurance policy in

connection with the foreclosure of the equity.

• Transfer taxes. If a transfer tax is imposed by the

jurisdiction in which the underlying property is located,

consideration must be given to whether the recourse

carve-out guarantor is obligated to pay such transfer tax

liability.

• Property-specific concerns / other third-party

agreements. Additional documentation is likely to be

required with respect to certain types of real property.

For example, if the underlying real estate is a hotel

property, the mezzanine lender will also need to review the

franchisor documentation, comfort letters, and recognition

agreements.

For more on foreclosure sales, see Foreclosure of Real

Property.

Commercial Reasonableness

and COVID-19

While the above guidance as to what constitutes a

commercially reasonable sale gives mezzanine lenders an

idea of the steps to follow, conventional wisdom provides

little guidance on how the concept of commercially

reasonableness may change in the instance of outside events

beyond the parties’ control—such as a global pandemic. As

a result of COVID-19, mezzanine borrowers have begun

to ask New York courts to enjoin scheduled public sales of

equity collateral on the basis that the sales were not being

conducted in a commercially reasonable manner. In one

recent case, D2 Mark LLC v. OREI Investments LLC, 2020

N.Y. Misc. LEXIS 2978 (Sup. Ct. Jun. 23, 2020), the borrower

challenged the reasonableness of the mezzanine lender’s

sale notice issued 36 days before the initial scheduled date

of the public sale of equity collateral, the majority of such

time occurring during the governor’s stay-at-home orders

preventing potential bidders from in-person inspection

of the property. The mezzanine lender issued a notice of

UCC foreclosure sale after only a single missed payment,

and while the mezzanine lender and mezzanine borrower

were actively engaged in workout negotiations. The court

ordered the mezzanine lender to reissue notice of the sale

for an additional month, holding that the COVID-19-related

conditions, including the then-current lockdown, failed to

provide potential buyers with sufficient time to conduct their

due diligence and attend the auction, and therefore, rendered

the proposed sale under the initial notice commercially

unreasonable.

In another New York case, 1248 Associates Mezz II LLC v.

12E48 Mezz II LLC, 2020 N.Y. Misc. LEXIS 5099 (Sup. Ct.

May 18, 2020), the court granted a temporary restraining

order preventing a public sale of collateral securing a junior

mezzanine loan, ruling that the borrower’s request for relief

in having its case considered by the court was essential in

the current environment. The junior mezzanine loan at issue

was secured by equity interests in the entity which owns

and controls the owner of a 161-key hotel/time-share and

retail property under construction in Manhattan. The junior

mezzanine lender argued that the failure of the borrower

to cause the mortgage borrower to achieve substantial

completion of the project pursuant to the terms of the junior

mezzanine loan documents no later than December 31, 2019,

was an event of default thereunder. The mezzanine borrower

argued, in part, that not only had the property achieved 80%

of the substantial completion threshold cited in the loan

documents, but that it had attempted to find replacement

financing and had been actively engaged in discussions

regarding same with the mezzanine lender.

The sale of the collateral was advertised in a subscription-

only industry publication inviting potential bidders to the

auction to be held at the offices of the junior mezzanine

lender’s counsel 14 days later. One factor cited by the

borrower in disputing whether such a sale would be

commercially reasonable was the lack of mention in the

published notice of the possibility of participating in the sale

without being physically present in an office at a time when

all nonessential gatherings were banned and the offices of all

nonessential businesses were closed in New York State. The

sale notice did not contain mention of measures to protect

health and safety including virtual bidding, as more recent

sale notices do. The mezzanine borrower argued that in the

COVID-19 environment, the planned manner of the sale

was intended to prevent potential qualified bidders from

having the meaningful opportunity to conduct customary due

diligence and to bid on the collateral at a public auction for

the highest possible price. The mezzanine borrower further

alleged that the nature of the sale was constructed so that

the junior mezzanine lender could ensure that it would be the

only qualified bidder present, in order to gain control of the

collateral (and as such, control of the underlying property).

Ultimately, in the 1248 Associates Mezz case, the court

(declining to address a number of the borrower’s arguments

as to the commercial reasonableness of the sale) permitted

the sale to go forward. The New York State Supreme Court

has held that the standard for permanently halting a UCC

foreclosure sale is for the junior mezzanine borrower to

demonstrate that the holding of the sale would cause it

irreparable harm which could not be cured by the payment

of monetary damages. As a result, the junior mezzanine

borrower would have to seek recourse following the UCC

foreclosure in a cause of action to recover its monetary

damages resulting from the sale.

In New York State, Governor Andrew Cuomo has issued

a series of executive orders creating and subsequently

extending a moratorium on commercial mortgage

foreclosures and evictions, most recently under Executive

Order 202.64, issued on September 18, 2020, and extending

the moratorium until October 20, 2020. As New York courts

have held in several recent cases, including those discussed

above, the foreclosure moratorium does not apply to sales

governed by the UCC, allowing mezzanine lenders to

continue to pursue their foreclosure rights in New York. Due

to the fact that New York law is often selected in mezzanine

loan documents regardless of the location of the property,

the decisions of New York courts will continue to have far-

reaching implications on these issues.

The COVID-19-related economic downturn has put pressure

on mezzanine borrowers, causing defaults or imminent

defaults absent their lenders agreeing to restructure the

terms of their loans. Some sectors of real estate, such

as hospitality and retail, have been hit much harder than

other sectors, such as multifamily, industrial, and logistics

properties. Courts are likely to continue to assess the

commercial reasonableness of UCC foreclosure sale

challenges on a case-by-case basis as the pandemic continues.

Mezzanine lenders should take appropriate actions to ensure

that their UCC foreclosure sales are difficult to attack as

commercially unreasonable.

We further expect the courts’ assessments of valuation

under current market conditions to continue to play heavily

into their review of challenges to future UCC foreclosure

sales in New York and elsewhere. However, as the pandemic

continues and resets the commercial real estate market in

the long term, it will become increasingly difficult for courts

to stay UCC foreclosure sales based on perceived current

value reductions due to the pandemic. As a result, mezzanine

lenders faced with a current or pending default under the

mezzanine loans in their portfolio should engage qualified

counsel and professional sales and marketing teams to

engage in efforts to plan, market, advertise, and conduct their

UCC sales so as to attract the attention of as many qualified

bidders as possible and to afford them adequate time to

perform due diligence in advance of the sale.

For more information about mezzanine financing, see

Mezzanine Financing Resource Kit, Commercial Real Estate

Mezzanine Financings, Mezzanine Financing, Mezzanine

Lending, Intercreditor Agreements (Mortgage Lender and

Mezzanine Lender), Mezzanine Loan Closing Checklist,

Mezzanine Loan Structure Diagram (Real Estate Transaction),

Mezzanine Workout Checklist, Irrevocable Proxy Agreement

(Mezzanine CRE Loan), Intercreditor Agreement (Mezzanine

Financing) (NY), and Control Agreement (Mezzanine CRE

Loan).

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Kristen E. Andreoli, Associate, White and Williams LLP

Kristen E. Andreoli focuses her practice on commercial real estate transactions, including acquisitions and dispositions, financing transactions,

leasing, development, and ownership matters ancillary to ongoing real property holding and management. She represents institutional lenders,

developers, and other equity stakeholders in real property transactions. In this capacity, she also advises clients on real property ownership

structures to fit their evolving needs, including the formation of entities and trusts to protect real property interests.

Ms. Andreoli has extensive experience in many types of commercial real estate finance matters, including traditional mortgages, CMBS loans,

mezzanine and other forms of equity-based financing, construction loans, cross collateralizations, spreader agreements, loan modifications,

and loan defeasance transactions. She regularly drafts and negotiates leases, financing documents, tenant estoppels and SNDAs, title-related

agreements, as well as acquisition/disposition related agreements.

Steven E. Coury, Partner, White and Williams LLP

Steven Coury concentrates on highly structured real estate finance and capital markets transactions, general real estate law and corporate

matters. His real estate finance practice includes representing lenders and borrowers in CMBS origination and securitization, balance sheet

lending, mezzanine lending, preferred equity investments, hard money lending, EB-5 lending, agency loans, and real estate debt secondary

markets transactions (loan and participation sales and purchases) and debt syndications. In connection with real estate financing, Steven

routinely represents clients in negotiating intercreditor agreements, co-lender agreements and participation agreements, as well as workouts,

foreclosures and restructurings.

As part of his general real estate practice, Steven represents real estate investors, developers, landlords and tenants in real property

acquisitions and assemblages, dispositions, financing, leasing and subleasing in all asset classes (including hospitality, office, retail, multifamily

and residential). As part of this practice, Steven frequently represents joint venture partners in negotiating joint venture agreements. He

also represents clients in sale/leaseback transactions, master leases, ground leases, REIT based transactions, and is experienced in Sharia law

compliancy.

Steven’s corporate law experience includes representing clients on corporate acquisitions/M&A matters and general corporate law (including

company formation, operating agreements, and joint venture agreements). Steven also routinely issues legal opinions, including nonconsolidation

opinions, Delaware bankruptcy law opinions and state law enforceability opinions.

Steven creates long-lasting relationships with his clients through creative legal solutions and a deep understanding of his clients’ business

objectives. He has represented and advised major institutions, including Brookfield Asset Management, Penn National Gaming, The Georgetown

Company, John Hancock Life Insurance Company, Walker & Dunlop, Deutsche Bank, Cantor Fitzgerald, Hunt Investment Management, Atalaya

Capital Management, American Immigration Group, Citigroup, DLJ, and Fortress.

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