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Fairness pledges in mortgage lending – inspecting the “clogging” protection | | События

For tons of of years, mortgage lenders have been on the lookout for methods to keep away from each the procedural delays of the mortgage foreclosures course of and the borrower’s equitable proper of redemption (ie, the proper to redeem property secured by a loan that has been accelerated previous to foreclosures).  Within the 1600s, English courts protected a borrower’s proper of redemption by creating the doctrine in opposition to “clogging the fairness of redemption,” which had the impact of invalidating any mortgage time period that restricted the borrower’s proper of redemption. By way of the next centuries and into trendy instances, courts have proven a robust inclination to protect this proper.i

In in the present day’s mortgage lending world, the most typical method that lenders try to skirt foreclosures (and its potential delays) is by taking a pledge of the fairness pursuits within the borrower, permitting the lender to foreclose on the fairness pursuits by means of a UCC sale (which is a fast course of that may sometimes be accomplished in 90 days) as a substitute of foreclosing on the true property collateral (which in some jurisdictions can take longer than a 12 months).  That is sometimes called the “twin collateral” strategy or an “lodging pledge.” Nevertheless, even after tons of of years, the parameters of the “clogging” doctrine stay unclear, and the worth of an fairness pledge could also be outweighed by the potential litigation that might come up in reference to an tried enforcement of the pledge.

The Twin Collateral Strategy

If foreclosing on an fairness pledge is faster and extra environment friendly than foreclosing on a mortgage, why don’t lenders skip the mortgage altogether?  Regardless of the longer course of, mortgages present a few distinctive benefits over fairness pledges.  Encumbering the property with a mortgage lien ensures that if the borrower transfers or encumbers the property with out the mortgage lender’s consent, the mortgage might be there to guard the lender in opposition to such prohibited actions.  Moreover, if a mortgage lender forecloses on its mortgage lien, such foreclosures won’t solely wipe out junior liens but in addition be sure that the foreclosing entity doesn’t step into any of the borrower’s different obligations and obligations. Foreclosing on the fairness of the borrower would topic the lender to many of the liabilities of the borrower; the lender will step into the borrower’s footwear. 

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The true worth of the twin collateral strategy is {that a} lender can resolve on the time of foreclosing whether or not it could be extra useful to foreclose shortly by way of UCC sale or to extinguish subordinate liens by way of mortgage foreclosures.  Moreover, until prohibited by statute or the courts, after foreclosing on the pledge, the lender can elect at a later date to foreclose on its mortgage with a purpose to care for junior lien points.

A pair of selections by the Supreme Court docket of the State of New York has additional obfuscated the enforceability of fairness pledges for loans additionally secured by mortgages. 

HH Cincinnati Textile L.P. v. Acres Capital Servicing LLC

In HH Cincinnati, a borrower was concerned within the acquisition and redevelopment of business properties and obtained a loan from a lender that was secured by each a mortgage on considered one of its industrial properties and a pledge of the fairness within the borrower. After the borrower defaulted, the lender tried to foreclose on the fairness pledge by way of a UCC sale. The borrower filed swimsuit to acquire an injunction to halt the UCC sale, arguing that, amongst different issues, the lender unlawfully “clogged” the borrower’s proper of redemption.

The court docket denied the borrower’s movement for preliminary injunction however didn’t rule on the borrower’s clogging declare. Nevertheless, in an announcement within the court docket’s opinion indirectly associated to the ruling, the court docket acknowledged that as a result of the borrower retained redemption rights underneath the UCC, the borrower’s proper of redemption underneath industrial foreclosures legal guidelines was not clogged. 

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HH Mark Twain LP v. Acres Capital Servicing LLC

About two years after the HH Cincinnati determination, in HH Mark Twain, a case arising out of the identical transaction as HH Cincinnati, the borrower introduced new claims in opposition to the lender following completion of the UCC sale that was at concern in the HH Cincinnati determination, alleging that the sale of the fairness by the lender was “commercially unreasonable” and violated its proper of redemption. The lender filed a movement to dismiss the claims. 

In deciding on the lender’s movement to dismiss, the court docket dominated that many of the borrower’s claims might proceed, and the court docket particularly acknowledged that it had not dominated on the borrower’s clogging claims in its HH Cincinnati determination.  Thus, any readability lenders might have discovered within the HH Cincinnati determination was undone by the ruling in HH Mark Twain.  Even after efficiently finishing the UCC sale, the lender nonetheless discovered itself embroiled in litigation.

Structuring options

As a doable different, a lender can construction a transaction as separate mortgage and mezzanine loans, with the mezzanine loan secured by an fairness pledge. After a default, the lender might select to implement its treatments underneath both the mortgage loan by means of the mortgage foreclosures course of or its treatments underneath the mezzanine loan by means of the UCC sale course of.  Nevertheless, this strategy doesn’t essentially relieve the lender of the danger posed by the twin collateral strategy, as case regulation has made clear that courts usually see by means of any try to clog the proper of redemption. Lenders using this construction ought to make each effort to ascertain that the mezzanine loan is a separate transaction made for impartial and priceless consideration.ii

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Moreover, a mortgage lender using the twin collateral strategy might add as a non-recourse carveout any losses suffered by the lender as results of the borrower elevating the clogging protection.  Whereas the enforceability of such a carveout has not been examined, together with such a carveout might trigger a borrower to pause earlier than elevating the clogging protection because of the potential legal responsibility to the non-recourse carveout guarantor.

Conclusion

The choices in HH Cincinnati and HH Mark Twain make it clear that the twin collateral strategy features a important threat that debtors will increase the clogging argument as a protection to any UCC foreclosures of the fairness, resulting in a probably lengthy and expensive authorized battle.  Whereas structuring options exist, the clogging protection nonetheless poses a threat. If an expeditious foreclosures course of is the lender’s main aim, the lender could also be leaping out of the frying pan and into the hearth by making an attempt to foreclose on an fairness pledge.


i See eg, Humble Oil & Ref. Co. v. Doerr, 303 A.2nd 898, 907-08 (N.J. Tremendous. Ct. 1973)

ii See eg, Russo v. Wolbers, 323 N.W.2nd 385, 390 (Mich. Ct. App. 1982); Nau v. Vulcan Rail & Constr. Co., 36 N.E.2nd 106, 110 (N.Y. 1941)