Buying Distressed Assets

Most investors in distressed real estate know several ways to acquire promising assets. These include: buying foreclosed REO properties from lenders; bidding at foreclosure sales; buying notes (whether performing or not); and buying borrowers, membership interests or stock in borrowers. However, another old-fashioned structure is coming back with a twist: buying properties subject to their existing loans. In a modification, sale and assumption transaction, a troubled property is sold to a new buyer who assumes the existing loan (rather than the lender foreclosing and selling the property as REO). When new financing is hard to find, the existing loan can provide a source to new buyers willing to tackle the real estate problems. In a typical MSAT, the lender modifies the loan by reducing the principal or making other concessions, the old borrower and any guarantor are released and the new buyer assumes the existing loan and takes over the real estate project. Frequently, the assuming buyer provides some amount of fresh cash to the servicer (to pay down part of the loan). The modified loan and its lien remain in place.

MSATs are becoming popular with servicers seeking to enforce defaulted loans held by a CMBS trust. Unlike a bank lender, a CMBS servicer that forecloses on a property does not have the power to provide a new loan to facilitate a sale to a new buyer. However, the servicer generally can modify the terms of a defaulted loan and permit whether or not it is in default to be assumed by the buyer. When both techniques are used in a single transaction, the servicer is able to provide the functional equivalent of a loan-to-facilitate made by a bank, effectively providing financing for the new buyer's purchase. From the servicer's point of view, by providing financing for an acquisition, an MSAT expands the universe of prospective buyers and increases the servicer's probable recovery.

MSATs can be rather complicated and time-consuming to complete. Further, some servicers are doing MSATs only through receiverships, in order to insulate themselves from liability to the original borrower. Closing an MSAT through a receivership requires that the servicer or lender first file a lawsuit to have a receiver take possession of the mortgaged property and then arrange for the receiver to market and sell the property subject to the loan. After an assuming buyer is found, the receiver typically must obtain a court order approving the sale.

Some, but not all, states allow this process. For example, in California, the one-action rule makes accomplishing an MSAT through a receivership more complicated: it provides that a lender may bring only one type of court proceeding (a judicial foreclosure) to recover on a loan. Although there are certain exceptions to that rule for receivers in the California Code of Civil Procedure, the receivership exceptions expressly state only that an action by a lender to appoint a receiver is not considered an "action." Even though the receivership exceptions give receivers the right to sell property in their possession pursuant to a court order and to confirmation by the court, the precise interpretation of these statutes is a gray area: the language of the statutes governing receivers does not expressly state that the receiver has the right to sell mortgaged real property belonging to the original owner to an assuming buyer, while leaving the existing loan and its lien in place. In other words, a non-consensual MSAT is not expressly authorized in California. For this reason, if a servicer wishes to enforce a defaulted loan in California by arranging for an MSAT through a receivership without the current borrower's consent, it must be carefully structured to minimize the legal risks. In California, several steps must be taken, such as obtaining appropriate court orders or waiting to close the MSAT, until all applicable orders are final and non-appealable. Similar structuring and timing requirements exist, or may be advisable, in other states.

Of course, obtaining title insurance is an essential requirement for any MSAT. After some initial difficulty, we have found a number of national title insurers who will insure both the lender and the assuming buyer for an MSAT if the deal is properly structured. Obviously, discussing these issues as early as possible with the insurer's underwriters is advisable to ensure all requirements. While buying a property subject to an existing loan may be rather time-consuming and cumbersome, it offers a way to obtain financing to acquire distressed real estate. For that reason, the MSAT presents an option worth considering.

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