Remedies for defaults under loans secured by real property varies on a state-by-state basis. In the eastern part of the country, enforcement is mostly by mortgage foreclosure. In the western states, there are enforcement proceedings by way of a deed of trust. There is a spectrum of debtor protections afforded to borrowers depending on the state involved. States like Georgia permit a lender to effect remedies against a defaulting borrower within four to six weeks. In California, a lender can complete an enforcement proceeding in 120 days. But there are states like Florida, where a contested foreclosure can run more than a year; some may take several years.
In each state, the state legislature has made a determination on the amount of protection afforded to real estate borrowers. States like Florida have adhered to a procedure established by the English Chancery Courts originally designed to prevent unsavory lenders from making loans to acquire ownership of real estate in anticipation of a default by borrowers where the law courts provided little protection in this regard.[1]The English Chancery Courts developed the concept of “equity of redemption” to allow a borrower to protect its equity in its ownership of real estate.The equity of redemption permits a borrower to pay the amount due the lender prior to the conclusion of the foreclosure sale to prevent the loss of his or her property.
The concept of equity of redemption is a significant right of borrowers in those states, like Florida, where loss of an interest in real property requires a judicial action in an equitable proceeding. In fact, Florida has codified the concept of equity of redemption by statute.
Right of redemption. At any time before the later of the filing of a certificate of sale by the clerk of the court or the time specified in the judgment, order, or decree of foreclosure, the mortgagor or the holder of any subordinate interest may cure the mortgagor’s indebtedness and prevent a foreclosure sale by paying the amount of moneys specified in the judgment, order, or decree of foreclosure, or if no judgement, order, or decree of foreclosure has been rendered, by tendering the performance due under the security agreement, including any amounts due because of the exercise of a right to accelerate, plus the reasonable expenses of proceeding to foreclosure incurred to the time of tender, including reasonable attorneys’ fees of the creditor. Otherwise, there is no right of redemption.[2]
Florida courts have characterized the right of redemption as a “mortgagor’s valued and protected equitable right to claim [the borrower’s] estate in foreclosed property.”[3] Foreclosure is an equitable proceeding and, as such, a court may determine not to extinguish a defaulting borrower’s interest in his or her property because of a minor, technical, or other default that may not adversely affect the lender’s collateral, especially where the borrower’s equity in the mortgaged property is substantial.[4]
Over the years, lenders have been frustrated by various acts of borrowers to delay foreclosure actions. The most common act was filing for bankruptcy on the eve of a foreclosure sale. This issue has been largely addressed by so-called “carveout” or “bad-boy” guarantees triggering full personal liability for the debt by a guarantor upon a bankruptcy filing. In today’s world, this practice is no longer a significant issue, although some borrowers may still engage in such conduct.
Despite the elimination or reduction of the bankruptcy defense, many lenders are still frustrated by the length of time it can take in a mortgage foreclosure state to acquire title to the mortgaged property since typically the mortgaged property is bid on by the lender.
Today, current complex financing arrangements often involve a stack of different debt in which a borrower may have a mortgage loan on its property and one or more mezzanine loans secured by ownership interests in the borrower. Securing debt with interests in the owner of the real estate, typical in mezzanine-level financing, has led lenders to realize that, in the absence of mezzanine financing, a lender making a mortgage loan could also require, as part of its security, a pledge of the ownership interest in the borrower. Through the pledge, a lender could avoid a laborious foreclosure process to obtain title to the real property collateral by pursuing its remedy on the pledge. A default under the loan secured by a pledge of the borrower’s ownership interest (stock, membership interest, or partnership interest) could permit the lender to acquire ownership of the property by acquiring ownership of the entity owning the property through a Uniform Commercial Code (UCC) foreclosure proceeding.These nonjudicial remedies may include either a public or private sale, which can, in most cases, be accomplished in as little as 30 to 60 days.[5]
This pledge of the borrower’s ownership interest to a mortgage lender is sometimes referred to as “dual collateral” and sometimes as an “accommodation pledge.” In these cases, a lender receives two separate pieces of collateral: a mortgage lien on the real property and a pledge of the ownership interest in the borrower. Some have argued that in a commercial transaction, the parties should be free to negotiate for any collateral available.[6] Others have contended that the dual collateral in a mortgage transaction unreasonably impairs or ”clogs” the borrower’s equity of redemption.[7]
Although this practice of requiring dual collateral or an accommodation pledge is likely about 10 years old, there is an absence of authority on the viability of such practice. There appears to be only a single case from New York dealing with this issue, HH Cincinnati Textile L.P. v. Acres Capital Servicing LLC, 2019 N.Y. Misc. LEXIS 2472 (N.Y. Sup. Ct. June 19, 2018).
HH Cincinnati involved a request by the borrowers for a preliminary injunction to stop a UCC sale of pledged interests in the borrowers where the borrowers had also granted mortgage loans on properties in Kansas City and Cincinnati. The court denied the request allowing the UCC foreclosure sales to proceed. The court’s reasoning was that the properties were not unique assets, and the borrowers could be compensated by money damages if they ultimately succeeded in challenging the sale. It also noted that there was no clogging of the borrowers’ right of redemption by reason of the right of redemption afforded under §9-623 of the UCC.
This case appears to fall in the category of bad facts make bad law. Here the loan in question had matured almost a year before the lawsuit was brought so it was difficult, if not impossible, for the borrower to demonstrate any type of inequitable conduct by the lender. In addition, the court distinguished between residential property and the two commercial properties involved, characterizing them as merely an “investment,” and not unique. The court also dismissed the borrowers contention that they were losing their equity of redemption because they had a redemption right under the UCC prior to sale. However, the court’s analysis appears at odds with generally accepted legal principles.
First, the holding that the properties were not a unique asset belies the entire rationale for affording specific performance as a remedy for failure to convey real property. The reason specific performance is available in the area of real estate is because the courts characterize each parcel of real property as a unique asset.[8]
Second, the court’s reasoning that the borrowers were not losing their right of redemption because there was a right of redemption under the UCC is true in name only. Foreclosures realistically cannot be completed in less than six months and typically take considerably longer. During the period of a foreclosure proceeding, a borrower can seek to refinance or otherwise raise funds to pay off the foreclosing lender. Section 679.612 of the UCC allows a lender to provide for a sale of the collateral following a 10-day notice to the borrower. In almost all cases, it would be virtually impossible for a borrower to raise the necessary funds in 10 days to redeem the property.
The result HH Cincinnati– a pledge of ownership interests in a mortgage transaction is enforceable-has been applauded by some New York commentators on the theory that the doctrine of clogging the equity of redemption should not apply in a commercial transaction between sophisticated parties and that the result was necessary to continue the viability of mezzanine loan financing.[9]
But why, as Florida lawyers, should we care about a New York lower court decision that has been praised by some New York legal practitioners? [10] Anyone who represents borrowers in larger commercial loan transactions knows that the lenders making such loans are typically represented by New York counsel, and the loan documents have New York governing law provisions. Therefore, lawyers in Florida handling a loan on Florida property originated by a lender using New York counsel may be dealing with a loan governed by New York law. In addition, the court’s blessing on the dual-collateral arrangement may only encourage lenders in Florida to employ this device. A response that borrowers may shop for a lender that does not require dual collateral may become illusory, just as attempting to obtain a commercial loan without some form of carveout or bad-boy guaranty has become.
The accolades heaped on this decision and the concept of dual collateral are surely misplaced in the nonlender world. First, this concept has nothing to do with mezzanine financing. The only collateral in mezzanine financing is a pledge of ownership interests. In addition, a mezzanine lender is in a less secure position than a mortgage lender. The mezzanine lender is subordinate to the mortgage lender and will be wiped out in any mortgage foreclosure. Furthermore, the typical mezzanine lender is lending at a much higher loan-to value ratio when its debt is added to the mortgage loan. In today’s market the mortgage lender may be making a loan equal to 50% or 60% of the value of the collateral. The mezzanine lender’s debt, when added to the mortgage loan, may be at 80% or above of the value of the property. Therefore, there is much less equity behind a mezzanine loan, and it is more important to allow the mezzanine lender to be afforded quick recourse, especially if a borrower’s default is likely to impair the value of the collateral.
Permitting dual collateral may be taking us back in time to an age before the English Chancery Courts upended the law courts’ enforcement of real property secured loans by requiring a foreclosure process. It may take us back to a time when any default gave the lender the right to take the real estate collateral.[11] A UCC sale is a nonjudicial process lacking any equitable or judicial oversight or restraint. A failure by the borrower to adhere strictly to covenants in the loan documents that have no material impact on the loan, such as providing an annual financial statement or other reporting requirements, are typically defaults under loan documents. In a dual collateral loan, the lender could accelerate the debt and schedule a UCC foreclosure sale solely by reason of failure to provide such documents. This could not happen in a judicial foreclosure. But in a UCC sale, there is no umpire; there is no court involved.
Over the years, lenders have sought to disguise a mortgage loan as some other type of transaction in order to avoid the necessity of a foreclosure proceeding. But in most cases, the courts have recharacterized the transaction for what was basically intended as a mortgage loan.[12] The concept of 44 dual collateral” or an Haccommodation pledge” is just another artifice in a long line to try to avoid a state-mandated foreclosure process.
This issue is more critical in light of two developments in the current lending industry. First, most mortgage lenders are lending only 50% or 60% of the value of the collateral. In many cases, the loans are at an even lower loan-to-value ratio.This means borrowers may be forfeiting a substantial equity interest upon any nonsubstantive default. A foreclosing lender may wind up with a windfall in connection with the acquisition of the property by acquiring an asset substantially more valuable than the debt. Second, nontraditional lenders have grabbed a large share of the mortgage market. Many of these lenders are also in the real estate business. While a bank may not want to own the borrower’s property because it is only a lender and, therefore, may be more anxious to assist a borrower upon a default, many of these nontraditional lenders may be happy to loan with the expectation that they may acquire the property upon a borrower’s default.
Hopefully, given the statutory recognition of the equity of redemption in Florida, state courts will continue to be protective of a real estate borrower’s equity against attempts to recharacterize a transaction as something other than a mortgage loan. Florida courts should not recognize the concept of dual collateral as a work around for a mortgage foreclosure and adhere to their expression, “once a mortgage, always a mortgage.” [13]
*This article was republished with permission from the Florida Bar Journal*
[1] Morris Shanker, Will Mortgage Law Survive?, 54 Case Western Reserve Law• Rev. 69,72-74 (2003).
[2] Fla. Stat. §45.0315.
[3] Sudhoffv. Federal National Mortgage Ass’n, 942 So. 2d 425, 426 {Fla.5th DCA 2006).See also Saida v. Wasko, 687 So. 2d 10 {Fla. 5th DCA 1996) {“The right of redemption is a valued and protected equitable right of the mortgagor to reclaim his estate in foreclosed property after it has been forfeited.”).
[4] See Summitbridge Credit Investments Ill v. Carlyle Beach, 218 So. 3d 486 {Fla. 4th DCA 2017).
[5] Of course, acquisition of title through a UCC sale would not eliminate subordinate interests secured by the property, such as construction liens, but following the UCC sale and acquisition of ownership, a lender would be in a position to engage in a friendly expedited judicial foreclosure.
[6] Hait & Fetty, An Answer to the Clogging Question Under NY Law, Law 360 (Mar.22, 2018).
[7] Hamilton & Nelson, Unclogging the Equity of Redemption Without Drano; Recent New York State Decision Sheds Light on Mortgage Loans Additionally Secured by Pledges, Cadwalader Clients & Friends Memo {July 27, 2018).
[8] Frank Silvestri v. Hilltop Developers, 418 So. 2d 1701; 294 Fla.Jur. Specific Performance §75.
[9] MacAvoy & Parrott, New York Court Confirms Enforceability of UCC Equity Pledge, New York Law J. {July 17, 2018).
[10] See id.; Hait & Fetty, An Answer to the Clogging Question Under NY Law, Law 360.
[11] See note 1.
[12] See La Boutique of Beauty Academy v. Meloy, 436 So. 2d 396 {Fla. 2d DCA 1983); Savarese v. Schoner, 464 So. 2d 695 (Fla. 2d DCA 1985); and Summitbridge Credit Investments, 218 So.3d at 486. But see MacArthur v. North Palm Beac Utilities, 202 So. 2d 181 (Fla.1967).
[13] Connor v. Connor, 59 Fla. 467(Fia. 1910); Haworth v. Ricketts, 47 So. 2d 545 (Fla. 1950).