Mortgage Loans: Buying and Selling
By Anthony La Malfa
One fallout from the real estate crash is the development of market for the sale of existing mortgage loans. Banks and other lenders are motivated to sell troubled paper in order to avoid the time and expense of renegotiating or foreclosing loans. In particular, the sale of non-performing loans enables lenders to remove them from their books. This eliminates the need to tie up capital to satisfy risk-based capital requirements and maintains the lender's reputation in the marketplace.
Many investors, on the other hand, see opportunities in buying both performing and non-performing mortgages at substantial discounts. Investors intend to seek control of properties through foreclosure, restructure the loans on favorable terms, or securitize the loans for sale to the public. However, both parties in a sale of mortgages should be aware of the many legal and economic pitfalls in such purchases.
Lender Liability
One important concern for a lender is the potential liability arising from the disclosure of confidential information about the borrower. The "due diligence" obligation of the buyer often requires an inspection of the loan documentation. Generally speaking,
the lender will not be liable for showing such documentation. However, it is often the case that the loan documents contain restrictions regarding the disclosure of confidential information (e.g., financial statements of borrowers or guarantors). In order to avoid liability, the lender should review the loan documents first to determine if any such restrictions exist. The lender also should require the prospective buyers to execute confidentiality statements and screen the buyers for interests adverse to the borrower.
Sale Limitations
In some loans, the lender is barred from selling the loan to a third party or the borrower has a right to arrange for the purchase of the loan. A sale inconsistent with such provisions opens the lender to potential liability. In particular, the lender should consider a possible contention by the borrower that there had been ongoing negotiations or a commitment to structure the loan when the sale to the third party was made. In such instances, the borrower may claim that the sale is in breach of an agreement to restructure, with resulting damage to the borrower. One way for a lender to avoid such a claim is to initially offer to sell the loan to the borrower (i.e., permit prepayment) on the same terms and conditions as would be offered to a third party.
Future Funding Obligations
Yet another consideration for the lender to consider is whether any obligations continue to bind the lender following sale of the loan. For example, a lender may continue to be bound by any future funding requirements set forth in the loan. In that event, the lender should be satisfied that the buyer can do the funding (and the lender may want to secure that obligation by a guarantee, indemnity, or other form of security). Alternatively, the lender may consider retaining the obligation for future funding and adjust the loan purchase price accordingly.
Due Diligence by Investor
Perhaps the most important concern from the investor's perspective is the availability of full information relating to the loan, including the loan documents, borrower profile information, and the condition of the real property. The investor should insist on access to all loan documents in addition to the note and mortgage, i.e., pledge agreements, guarantees, letters of credit, indemnification agreements, assignments of stock or partnership interests, and lockbox agreements. A variety of ancillary documentation also should be inspected, e.g., title policies and surveys, environmental reports, permits and licenses, and information about any threatened or pending lawsuits.
Loan Purchase Agreement
The critical document in the transaction is the loan purchase agreement that sets forth all the terms and conditions of the purchase. The clause covering the presentations and warranties to be given by the lender is likely to be heavily negotiated. At a minimum, the lender should represent its authority to enter into the agreement, that the loan has not already been sold and is not in default, and that no litigation is pending relating to the loan or the property. Additional representations might cover the priority of the mortgage or deed of trust, the absence of any defenses by the borrower, and the accuracy of information given to the purchaser.
For more information, please contact our Real Estate and Construction Group at 440-449-6800.
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