Note Sales Unwrapped

Many lenders are selling discounted notes as a way to reduce their portfolios of distressed real estate loans. While these can be very good deals for a buyer seeking to invest in distressed assets, it's important to know exactly what you are getting when you buy a note. Since the lender will usually make only a few representations in its note-sale documents and give you only a short time to review its files and records, careful due diligence can make the difference between making and losing money on the deal click here.

When your legal counsel is well organized and your diligence business processes well-defined, your review can be efficient, effective and scale up quickly for portfolio transactions. When you buy a distressed note, you become the lender's successor, collecting payments from the borrower, assuming the borrower is performing. If the borrower is in default, you have the lender's rights to foreclose, enforce guaranties or seek a modification or workout-but those rights are only as good as the original loan documents. If the loan paper has flaws, the original underwriting was bad or the borrower has defenses against the selling lender, you inherit those weaknesses.

So smart note buyers must do a thorough property review, including checking for known environmental contamination, looking at the asset's physical condition, checking its rent rolls and confirming that it can be used legally for the intended use, as well as some special due diligence about the loan documents.

A note sale means the sale of a promissory note secured by real estate, the deed of trust or mortgage securing the note, the guaranties and all related documents and amendments. Confirming that all the relevant loan documents are included is key. Sometimes lenders want to sell only parts of their loans, which can interfere with the note buyer's rights.

Other diligence involves confirming the identity-and existence-of the borrower and guarantor, confirming that the mortgage encumbering the property actually encumbers the right real estate and has the proper title priority, ensuring that the lender actually has the right to sell the loan and has not sold it previously, and confirming that the documents and guarantees have not been modified by other documents.

Also, review the lender's loan files. Before you take over, you need to know if the borrower is in default, if the lender has started foreclosure or has entered into any modification or forbearance agreement or if there are any possible promises to the borrower that might undermine your later rights.

Many commercial real estate loans originated during the recent boom decade were hasty and may have flaws that make them unenforceable-or, at least, give the borrower or guarantor leverage in court to delay enforcement. The note should include the basic terms needed to create a real estate loan: what amount is owed, a promise to repay the borrowed money and interest at a certain time and acceleration provisions. Names, dates and numbers are key-and often incomplete.

Also, any guarantee should be checked to make sure it is enforceable, which means that it is signed by the guarantor, states the scope of guarantee clearly, states what conditions trigger the guaranty and includes any required waivers. If the loan has been modified, the guarantor should generally have given signed consent. If the guarantor's credit is important to the note purchaser, it may be prudent to confirm through an asset search that the guarantor has adequate unencumbered assets. The mortgage or deed of trust and assignment of rents must include adequate enforcement provisions.

If the lender selling the note did not originate it, the seller may not have all the rights needed for enforcement. The loan documents must be transferred properly in writing, through an endorsement on the note or a proper allonge, signed by each prior lender. If the loan has not been properly transferred, there's a risk that the borrower can avoid or delay enforcement of the loan. Although other issues will likely arise depending on the specifics of the loan transaction, the process of due diligence can be handled quickly and efficiently by a well-organized commercial real estate lawyer who should be able to help you determine whether the price you are paying in a note sale makes sense in light of what you're really getting in your specific deal.

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