In a recent decision, the US District Court in Arizona ruled on a dispute between a senior (real-estate-secured) lender and the mezzanine (ownership-interest-secured) lender on a resort property in Arizona, granting the senior lender's request for a preliminary injunction to prevent the mezzanine lender from conducting a UCC sale of its collateral. The ruling in U.S. Bank National Association, Trustee v. RFC CDO 2006-1 Ltd. has drawn a lot of attention among lenders and their lawyers because of its implications in the many such disputes now or anticipated to be engaged.
The ruling turned on the interpretation of provisions in the intercreditor agreement that the two lenders signed when the project financing originally was put into place. Based on a widely used form of intercreditor, the agreement was the mechanism by which the two lenders structured their respective rights and obligations with respect to each other. With the project in trouble and the loans in default, the mezzanine lender sought to realize on its collateral by conducting a UCC sale and thus acquiring the ownership interest in the entity that owns the project (that is, the senior lender's borrower). The senior lender objected, claiming that the mezzanine lender could not enforce its rights to its collateral without first curing outstanding defaults under the senior loan. In analyzing the agreement, the Court agreed with the senior lender, finding that the intercreditor agreement's clear language prohibited the mezzanine lender from conducting a UCC sale without, among other things, first curing all outstanding borrower defaults under the senior loan.
The Court looked carefully at the agreement's language, including verb tenses in the relevant sentences, to find the requirement that the cure of senior loan defaults must have been cured as of the time that the mezzanine collateral (i.e., ownership interests in the senior lender's borrowing entity) is transferred. The Court enjoined the mezzanine lender from conducting the sale unless and until all requirements of the intercreditor are satisfied.
This ruling is a reminder of something that contract parties (and their lawyers) should already know: language matters. One can assume that a lot of lenders' attorneys will be reviewing their intercreditor forms and rethinking the provisions analyzed by the Court in this case.
For a copy of this ruling, or to discuss its implications for your past or present loan transactions, please feel free to contact me.
Effective as of February 1, 2010, the Texas Department of Insurance adopted various changes to the Title Insurance rates, rules, and forms. Many of the changes were corrections to typographical errors or references to outdated forms or revisions to become more consistent with ALTA language, but some of the changes will affect day-to-day transactions. A few are summarized below.
New T-24.1 Non-Imputation for Mezzanine Financing Endorsement: Similar to the existing non-imputation endorsement, the T-24.1 also will act as an assignment of rights to receive payments under the applicable owner's policy. Issuance of this endorsement requires signature of both the insured under the owner's policy and the mezzanine lender. The T-24.1 will not be available until an amended Rate Rule R-31 becomes effective. The proposed premium is 5% of the Basic Rate for the associated owner's policy, with a minimum premium of $25.
New T-25.1 Contiguity Endorsement: The most significant distinction between this endorsement and the existing T-25 Contiguity Endorsement is that the new endorsement may be issued only if the subject property is comprised of at least four parcels or irregularly shaped parcels, and it does not require that the tracts' contiguous boundaries be specifically identified. As with the T-25 endorsement, the T-25.1 may be issued only with respect to non-residential property. No rate rule has yet been proposed, but watchers anticipate that it will be the same as the premium for the T-25.
Loan Policy Endorsement: The T-2 Loan Policy form has been modified to remove a redundant T-30 endorsement for taxes and to delete the option of deleting insuring paragraphs of certain endorsements.
Insured Closing Letter: The form has been modified to conform with the corresponding ALTA form. The main differences are that it now protects warehouse lenders and liability under the letter terminates if written notice of claim is not received within two years after the applicable closing date.
A recent 5th Circuit case, Achee Holdings, LLC v. Silver Hill Financial, LLC, Slip Copy, 2009 WL 2610797 (5th Cir.), Aug. 26, 2009 (not published in Federal Reporter), provides an interesting discussion of usury law in Texas and its application to a fee designated in the relevant loan documents as a "Lockout Fee."
Briefly, the facts are: Achee executed an adjustable rate promissory note (the "Note") in favor of Silver Hill. The Note provided for two prepayment penalties for prepayment of the principal during the first 36 months of the loan period (the "Lockout Period"): (1) an amount equal to the interest that would have accrued on the unpaid principal balance during the Lockout Period (labeled the "Lockout Fee") and (2) an amount equal to 5% of the then outstanding principal balance (labeled the "Prepayment Consideration"). During the Lockout Period, Achee sought to prepay the loan. Achee refused to pay the Lockout Fee and filed this lawsuit alleging that the Lockout Fee was disguised interest that exceeded the allowable amount under Texas usury law. The trial court dismissed the suit for failure to state a claim and the 5th Circuit, hearing the case on Achee's appeal, affirmed.
The Court's opinion summarized the essential elements of a usurious transaction as (1) a loan of money, (2) an absolute obligation that the principal be repaid, and (3) the exaction from the borrower of a greater compensation than the amount allowed by law for the use of money by the borrower. Under Texas Finance Code sec. 301.022(a)(4), "interest" is defined as "compensation for the use, forbearance, or detention of money . . . [but] does not include compensation or other amounts that . . . are permitted to be contracted for, charged, or received in addition to interest[.]" Where a contract grants the borrower a prepayment right, Texas courts have held that a prepayment penalty is not interest because it is not compensation for the use, forbearance, or detention of money, but is instead "a charge for the option or privilege of prepayment." This concept is codified at Texas Finance Code sec 306.005: "a creditor and an obligor may agree to a prepayment premium . . . whether payable in the event of voluntary prepayment . . . or other cause that involves premature termination of the loan, and those amounts do not constitute interest."
Lenders can, however, violate usury law by charging fees that constitute "disguised interest." Whether a particular fee is disguised interest depends on the substance of the transaction, not how the parties label the fee. Specifically, a fee will not be considered interest if it is not a charge for the use, forbearance, or detention of money, but a fee might be considered interest if it is not supported by separate and additional consideration.
Achee contended that the Lockout Fee was disguised interest and therefore usurious. The 5th Circuit disagreed. Though the interest rate on the loan was used as part of the formula for calculating the Lockout Fee, the Court found that the substanceof the transaction indicated clearly that the Lockout Fee was a prepayment penalty: The Note granted Achee the option of paying the loan off early (and also paying the Lockout Fee) in exchange for avoiding the 27 years of interest that otherwise would have accrued over the remaining loan term. In other words, the Lockout Fee acted as consideration for the privilege of paying the loan off during the first three years and thereby avoiding further interest.
The Court noted that the fact that the Note included two types of prepayment penalties, one of which applied only to a prepayment during the Lockout Period, didn't change the fact that the Lockout Fee operated, in substance, as a penalty for very early prepayment. Also relevant to the Court's analysis was the fact that Achee could avoid the Lockout Fee entirely by waiting until after the Lockout Period expired to pay off the loan (the Court cited its holding in an earlier case where this type of fact had been recognized as the rationale for the rule that prepayment penalties are not interest).