The New York City Council approved a bill on Thursday, November 30, that impacts thousands of small business owners located south of 96th Street in Manhattan. The bill modifies the threshold that businesses must meet in order to be exempt from paying the 3.9 percent New York City commercial rent tax, which is imposed upon businesses located south of 96th Street in Manhattan. Businesses operating in the Bronx, Queens, Brooklyn and Staten Island are not subject to the tax and are not impacted by this legislation. Though Mayor Bill de Blasio initially opposed the bill as it is projected to remove $38.6 million in revenue in fiscal year 2019, it is expected that he will sign the bill into law. The measure also had the support of Council Speaker Melissa Mark-Viverito. Once signed, it will become effective July 1, 2018.

Prior to the bill’s passage, businesses who paid more than $250,000 a year in base rent were required to pay the tax. The bill will raise this threshold, allowing businesses who make $5 million or less in annual income and pay less than $500,000 in annual rent to be exempt from the tax. The bill also provides a partial, sliding credit for (1) businesses making $5 million or less a year and paying between $500,000 and $550,000 a year in rent and (2) businesses making between $5 million and $10 million a year and paying less than $550,000 in annual rent.

The bill also provides exemptions for not-for-profit organizations and businesses located in certain areas, such as the World Trade Center area or those areas impacted by the Lower Manhattan Commercial Revitalization Program.

A credit for businesses that pay between $250,000 and $300,000 in annual rent, without consideration of annual income, is left unchanged.

On September 23, 2011, New York Governor Andrew Cuomo signed into law Senate Bill 5203A and Assembly Bill 7358A, codified as the “Private Transfer Fee Obligation Act” in Article 15 of the New York Real Property Law. The new law imposes a ban on all new private transfer fees (“PTFs”), and provides notice, disclosure and remedy procedures for existing private transfer fee obligations. With the passage of this law, New York has joined the majority of states which have enacted legislation that completely bans, limits and/or requires the disclosure of PTFs.

In practice, PTFs have also been dubbed “Wall Street home resale fees,” “private transfer taxes,” “reconveyance fees,” “capital recovery fees,” “residential transfer fees,” and “transfer fee covenants.” These charges, whatever they may be called, usually amount to one percent (1%) or more of the sales price and are automatically inserted into the contract of sale on real property, to be paid by the seller to the original developer of the property or their designee, oftentimes a third party that holds no ownership interest in the property, every time the property is transferred for up to 99 years. They are usually buried within dozens or hundreds of pages of documents, or, in some instances, are found in a separate declaration affecting the property filed by the original developer. Prospective buyers and owners may not be aware of these fees until closing or, worse, when they try to sell the home years later and the fee shows up in a document obtained in connection with a title search of the property. The failure to pay the PTFs at closing typically results in a lien being imposed on the property.

Unlike traditional deed covenants, PTFs run with and burden the land without benefiting it. Although the fees may benefit a homeowners’ association, conservation land bank, non-profit organization, etc., they have been found to not be proportional or related to the purposes for which the fees were to be collected. Furthermore, PTFs are also used by builders and developers to provide themselves with an income stream long after a development is complete. The American Law Institute has described such PTFs as “unconscionable;” the U.S. Department of Housing and Urban Development has publicly opposed the use of PTFs, stating that “PTFs violate HUD’S regulations at 2 C.F.R. 203.41, which prohibit ‘legal restrictions on conveyance,’ defined to include limits on the amount of sales proceeds retainable by the seller.” In addition, the Federal Housing Finance Agency, determining that “such covenants are adverse to the liquidity and stability of the housing finance market and to financial safety and soundness,” has issued a proposed rule, published at 76 F.R. 6702 (Feb. 8, 2011), that would restrict the regulated entities – the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”), and the Federal Home Loan Banks – from investing in most mortgages on properties encumbered by PTFs.

Similarly, the New York State Legislature has determined that PTFs conflict with a preferred state public policy favoring “the marketability of real property and the transferability of interests in real property free of title defects or unreasonable restraints on alienation.” The legislature also declared that “a private transfer fee obligation shall not run with the title to property or otherwise bind subsequent owners of property under any common law or equitable principle.”

Real Property Law Section 472 defines a private transfer fee as “a fee, charge or any portion thereof, required by a private transfer fee obligation and payable, directly or indirectly, upon the transfer of an interest in real property, or payable for the right to make or accept such transfer, regardless of whether the fee or charge is a fixed amount or is determined as a percentage of the value of the property, the purchase price, or other consideration give for the transfer.” Expressly excluded from this definition are: (a) the purchase price of the real property being transferred; (b) any real estate broker commissions; (c) the interest, fees and charges associated with a loan secured by a mortgage against real property; (d) rent payable under a lease; (e) payments to holders of options to purchase and rights of first refusal or purchase; (f) any taxes, fees, assessments, etc. imposed by governmental authorities; (g) fees paid to homeowners’, condominium, cooperative, mobile home or property owners’ associations that use them to directly benefit owners of the encumbered property; (h) fees payable for the benefit of certain non-profit organizations; and (i) fees pertaining to the purchase or transfer of a club membership relating to real property owned by the member. “Transfer” means “the sale, gift, conveyance, assignment, inheritance, or other transfer of an ownership interest in real property located in [New York] state.” 

The Private Transfer Fee Obligation Act prohibits entering into or recording PTFs after its effective date, and declares all such new PTFs void and unenforceable, not running with the land, and not binding on subsequent purchasers. Anyone who records or enters into an agreement imposing a private transfer fee obligation in their favor after the effective date would be liable for any damages resulting from that obligation, including the PTFs, attorneys’ fees and other costs to quiet title. Notwithstanding this strict prohibition and repercussions, section 475 further underscores the significance of disclosing any  PTFs by requiring the seller to furnish to the buyer, prior to closing, a written statement memorializing their existence, describing the PTFs and referencing the new law.

Moreover, PTFs entered into and/or recorded prior to the new law’s effective date of September 23, 2011, are not to be presumed valid and enforceable. The new law requires the receiver of the PTFs to give notice to subsequent buyers by recording, within six months of the law’s effective date, a document disclosing the existence of PTFs along with the additional information required under section 476, including the PTFs’ amounts and purposes. Failure to record would result in the agreement being unenforceable, and the real property could then be conveyed free and clear of the PTFs.

The Private Transfer Fee Obligation Act also sets up a mechanism by which an individual transferor can free the property of private transfer fee obligations currently burdening his real property. If a receiver of the PTFs does not provide a written statement of their payment within thirty (30) days of the written request asking for such a disclosure, then the transferor, after recording an affidavit describing its efforts to reach the receiver, may convey any interest in the real property to any transferee without paying the PTFs. From that point on, the real property would be free and clear of the PTFs.

Supported by the New York State Association of REALTORS, New York Taxpayers for Economic Justice, Inc., Consumers Union, Consumer Federation of America, and the Coalition to Stop Wall Street Home Resale Fees (formed by the National Association of Realtors and the American Land Title Association), among many others, Private Transfer Fee Obligation Act became effective immediately. 

In the wake of the economic crisis and distress of the real estate markets, issues related to the foreclosure of mezzanine loans have become the subject of much discussion. A mezzanine loan put simply is a loan given to a business entity which is secured by the ownership interests in that business entity. In real estate transactions, the most frequent structure involves a pledge of the membership interests in a limited liability company. This limited liability structure is primarily the result of special purpose entity requirements imposed by commercial lenders to conform to securitized lending guidelines. Mezzanine loans provide an opportunity for an entity which owns commercial real estate to leverage its equity in instances in which the entity’s real estate lender does not allow subordinate mortgage financing.

As a result of the current economic climate and percipitous decline in real estate values, many mezzanine loans are now in default due to reduced cash flow or the inability to refinance the loans. Many mezzanine lenders assume that if they foreclosed on the ownership interests in the entity they could assume management control of the real estate asset including the right to dispose of the asset. That assumption is not necessarily correct.

If the foreclosure is contested, the lender must concern itself with the requirements of the applicable Uniform Commercial Code (“UCC”) and other applicable laws. Section 9-610 of the Uniform Commercial Code requires that a mezzanine foreclosure be conducted in a “commercially reasonable manner.” Every aspect of a disposition of collateral must be commercially reasonable. This requirement explicitly includes the method, manner, time, place and other terms of the disposition. However, the UCC does not define what type of sale is commercially reasonable.

The law of the jurisdiction in which the business was formed, together with the organization documents of the business entity, control what rights a transferee of an ownership interest acquires. Many partnership agreements and operating agreements of limited liability companies limit the rights of a transferee of a partner or member’s interest to an assignment of economic rights including a right to share in the profits and losses. However, many partnership agreements and operating agreements of limited liability companies prohibit a transferee the right to participate in the management of the entity or to take actions which legally bind the entity. Many lenders are aware of this but don’t consider it a problem because the UCC, as adopted in most states, overrules such anti-assignment provisions, so that you can take assignment of economic rights notwithstanding a prohibition in the organizational document. However, the UCC as adopted in some jurisdictions would not protect the lender under the anti-assignment provisions. For example, Delaware, the governing law for many of these agreements, is different. Under Delaware’s UCC, as well as its Partnership Act, Limited Partnership Act and Limited Liability Company Act, if an entity’s organizational documents prohibit assignments of economic interests, the provisions in those documents will control. This means that you need to ascertain which state’s law will govern the assignment of the economic interests. The UCC contains mandatory choice of law rules governing the perfection and priority of security interests, which do not apply to the granting of an assignment of economic interests. Moreover, it is uncertain whether a choice of law clause contained in loan documents will be effective on this question, even though such clauses are generally enforceable. This is because it is doubtful that a lender and a borrower can dictate which law will apply to govern the relationship between the borrower and the entity in which the borrower is invested. Therefore, a lender may not be able to avoid the application of Delaware law, because the applicable law may well be determined by choice of law rules which generally require a rational nexus analysis as well as other factors many of which are outside of the control of a lender.

Whether a mezzanine loan can been foreclosed such that the foreclosing mezzanine lender can gain control of the real estate controlling entity and have proper authority to operate and transfer the assets is not always apparent from an examination of the applicable loan collateral documents, entity organizations or formation documents, public records and applicable laws. In addition to reviewing the laws of the jurisdiction governing the loan collateral documents to ensure the foreclosure is done properly and the organization or formation documents of the transferring entity to be certain that proper authority for the transfer exists, you need to have a thorough understanding of the applicable laws relating to real estate transfers by the particular type of entity. The foreclosing mezzanine lender should also determine if the foreclosure including the control and/or ownership of the entity owning the real estate will result in transfer tax or other tax consequences to the foreclosing mezzanine lender.

In light of these restrictions and impediments, title companies are reluctant to insure any real estate transaction involving a transfer of property by a conveyance from the foreclosing mezzanine lender and will scrutinize the loan collateral documents as well as the entities corporate governance documents and the laws of the jurisdiction of formation. Accordingly, great care must be exercised any time a foreclosing mezzanine lender attempts to exercise its rights under the mezzanine loan documents or agrees to accept an assignment or other transfer in lieu of foreclosure. And, if the mezzanine lender intends to insure the transfer it is recommended that the mezzanine lender get the title company involved early in the process to confirm the transfer is insurable and before any of the lender’s rights are compromised.

The Emergency Economic Stabilization Act of 2008 (the “Stabilization Act”) was signed into law on October 3, 2008 to provide, in part, a rescue plan (or as some have called it, a “bailout”) for the U.S. financial markets. The Stabilization Act created a Troubled Asset Relief Program (“TARP”), under which the Secretary of the Treasury is authorized to purchase, insure, hold, and sell a wide variety of financial instruments, particularly those that are based on or related to residential or commercial mortgages issued prior to March 14, 2008.

On February 17, 2009, President Barack Obama signed into law The American Recovery and Reinvestment Act of 2009 (the “Recovery and Reinvestment Act”), a $787 billion spending and tax relief program, which by any measure is the largest appropriations bill in U.S. history. The Recovery and Reinvestment Act is an emergent attempt to restore confidence in the faltering U.S. economy by, among other measures, preventing further systemic problems in the economy resulting from residential foreclosures and unemployment and creating job growth through public works projects, tax incentives and tax cuts for small businesses and individuals, and aid to states.

It has been estimated that approximately $400 billion of commercial mortgages will mature in 2009, and another $800 billion will mature in 2010 and 2011 combined. The shutdown of the commercial mortgaged-backed securities (“CMBS”) market together with decreasing market values and the historic tightening of credit standards by banks provide an enormous obstacle to refinancing these commercial mortgages. Despite capital infusion from the U.S. Treasury by programs promulgated under the Stabilization Act, banks have increased reserves and are skeptical about making loans secured by commercial real estate.

One possible solution to jump start the CMBS market is the expansion of the Term Asset-Backed Securities Loan Facility (“TALF”) to newly originated secured loans on commercial real estate properties. TALF is a Federal Reserve credit facility which was established by the U.S. Treasury under the Federal Reserve Act and is part of TARP. The Federal Reserve created TALF to address certain credit needs of individuals and small businesses by supporting the issuance of asset-backed securities (“ABS”) collateralized by student loans, auto loans, credit card loans, loans guaranteed by the Small Business Administration and the recent addition of securities backed by commercial mortgage loans.Pursuant to the Financial Stability Plan which was unveiled by the U.S. Treasury on February 10, 2009, the Federal Reserve plans to expand TALF to $1 trillion from the $200 billion which was originally committed. If approved, the $1 trillion credit facility would be available to eligible owners of certain AAA-rated ABS collateralized by the aforementioned asset classes, including new commercial mortgage loans.

TALF loans are non-recourse secured by eligible ABS collateral and will have three (3) year terms. TALF loans will either be at a fixed or floating interest rate as elected by the borrower, and may be prepaid in whole or in part during the loan term without penalty. Substitution of collateral during the loan term generally will not be allowed. Borrowers are required to pay the Federal Reserve an administrative fee equal to 5 basis points of the loan amount upon closing of the loan. Unless extended by the Federal Reserve Board, TALF will cease making new loans on December 31, 2009.

An important aspect of TALF for its borrowers is the loans are not subject to mark-to-market or re-margining requirements. These two risk factors have caused turmoil in the CMBS market as investors worried about volatility in CMBS and a return to wider spreads face increased prospects of a loss on their investments.

TALF will commence operations on March 17, 2009, the initial subscription date, and the loans will be funded March 25, 2009. TALF loans will be funded monthly through December 2009, or longer if the Federal Reserve extends the facility. The subscription dates will be the first Tuesday of every month.

TALF loan will not be available for CMBS in the March funding. However, The U.S. Treasury and the Federal Reserve anticipate that TALF will accept ABS collateralized by new commercial mortgage loans for the April funding. In addition, specifics regarding eligibility criteria for CMBS collateral, including the type and investment-grade rating category are not yet available. Once the specifics regarding TALF lending initiative for CMBS is available, we will provide an update.

A maturity default occurs when the borrower under a mortgage loan fails to pay the lender the balloon payment, or principal balance, when due at the maturity of the loan. This term, which has not seen widespread use in recent years, seems to be on everyone’s lips in real estate and banking circles.

While you can have a maturity default on a loan which was already in default for failure to pay debt service or breach of covenant, it is now not uncommon to see loans which were fully performing up to the maturity date, but the borrower is unable to pay off the loan at maturity. This is the type of maturity default addressed in this article.

Few borrowers have the financial resources to pay off a substantial balloon payment on a commercial mortgage with their own funds. The traditional source of repayment is through a refinancing loan, either from the same lender or a new lender. Many borrowers facing maturity are now finding that refinancing loans are unavailable. CMBS is moribund. Large banks and other traditional lenders have no liquidity as a result of the credit freeze. Other lenders are not making loans because of the uncertainty of the value of real estate assets in the current market. There is some mortgage money out there, particularly from regional and local banks, which have lower lending limits. But wherever capital is available, the rules for real estate lending have changed dramatically. The name of the game now is lower leverage and skin in the game. It is not uncommon to see lenders offering terms which include 60% to 65% loan to value; 1.30% to 1.35% debt service coverage; and partial, if not full, recourse. With higher equity requirements and lower real estate values, many borrowers cannot come up with the cash now required to refinance.

Borrowers in these circumstances do have options. The number one option is to negotiate a restructuring and extension of the loan with the existing lender. The lender will not be happy to hear that the borrower is looking to extend the loan. After all, the borrower contracted to pay off the loan at maturity. This will not, however, come as a surprise to the lender, who is now spending most of his time dealing with defaulted loans. A number of factors may cause the lender to favorably consider a restructuring and extension. This has been a fully performing loan, unlike many others, and ideally the property is generating sufficient net operating income to continue to pay debt service as well as leasing costs and capital expenditures. The lender wants to avoid a maturity default, which will require him to take a substantial write-down of the loan. In a real estate market with increasing supply and decreasing demand, the lender doesn’t want the property stigmatized as “in foreclosure” or “REO property”. The number of foreclosures is at an all time high, and in New Jersey an uncontested foreclosure may take 12 – 16 months. The lender really doesn’t want to take the property back. He has lots of other properties he has taken back or will be forced to take back, and there are not a lot of buyers out there. He knows that you can manage your own building better than third party management hired by the lender. Finally, with several trillion dollars of commercial mortgage maturities occurring over the next few years, he knows that things are likely to get worse.

If the lender is inclined to extend the loan, he will squeeze the borrower to put some skin in the game with additional equity to pay down the loan and a partial guarantee. The borrower should count to ten and think carefully before responding. If the original loan was made five years ago at 75% of the then value of the property, current value may not exceed the loan balance. The borrower must understand that, at this point, he has no equity in his building, other than emotional equity. Emotional equity has no value and should not be a factor in what is in reality a new investment decision. The borrower has nothing tangible to lose, but the lender has a lot to lose and knows that he will likely take a substantial haircut if he has to take back the building. The borrower should resist any guarantee, and offer to put up equity so that he does have skin in the game, but insist that the lender forgive some substantial portion of principal. Here is where the negotiation gets interesting. Every deal is different, and not all lenders can or will write down principal as part of a restructuring and extension, but some have and many more will. Other factors to be negotiated include interest rate, amortization, reserves, fees and term. If you are going for the extension, you want five years. Don’t count on the credit markets returning to normal, or real estate values recovering, in a year or two.

Some borrowers are interested in negotiating a payoff of their maturing mortgages at a substantial discount. Many lenders today would be happy to sell defaulted mortgages at a substantial discount, and are doing so. The amount of any discount will depend upon the lender’s perception of the value of the property, NOI, rent roll, condition of the property and other factors. Discounts usually require immediate payment in cash. If the borrower doesn’t have the ready cash, and wants the lender to agree to a discount and then give the borrower time to come up with the money, it is a harder sell but by no means impossible. Many lenders are anxious to be taken out, and will give the borrower a forbearance period during which the lender will agree to accept a specified amount in satisfaction of the mortgage debt.

For the reasons given above, lenders are under siege. This is good news and bad news. The good news is that a borrower may well be able to get relief. The bad news is that it may not be the relief the borrower is looking for. Lenders may be inclined to do the minimum needed to avoid the impending maturity default, and then sweep the problem under the rug. They are likely to offer an extension of six months or so, charge the borrower a fee and increase the interest rate. Remember, things are likely to get worse, and this is only postponing the inevitable. It is in the interests of both parties to deal with reality, and many lenders are beginning to see the light.

What if your mortgage is maturing in a year or two or even three? If you have a performing loan, it is not too early to talk to your lender about extending the loan. Some lenders will understand that this makes sense. Unfortunately, in most circumstances, it may prove difficult to get the lender’s attention.

As always, a borrower should do his homework, understand his options and the lender’s options, and put together the best possible negotiating team.