When The Workout Hasn’t Worked
Authors: Lynn A. Soukup, Susan Ormand Berry

Finance partner Lynn Soukup and finance associate Susan Berry, co-authored this article, which originally appeared in Institutional Investor’s Real Estate Finance & Investment, May 15, 2009.

When a mortgage or mezzanine lender has concluded that a loan modification or workout won’t resolve a problem loan or the lender is a loan to own market participant, the focus turns to remedies against the collateral. Where the collateral consists of a mix of real and personal property, such as a hotel, apartment, office building or industrial facility or exclusively personal property, including a real estate mezzanine loan secured by a limited liability company or partnership interests, non-real estate law will be a consideration.

Most real estate-secured loans will include some personal property in the collateral. The most obvious case is a hotel, where the personal property—such as franchise rights, furniture, restaurant equipment, dishes, sheets and towels—are essential components of the value of and ability to operate the real estate. It is unlikely that a purchaser will close a sale without some or all of these assets.

Other real estate loans also may include necessary or valuable personal property, such as security, HVAC and other building systems, equipment and contracts necessary for operation of the building and provision of tenant services, at least in the short term. Real estate mezzanine loans, of course, are secured entirely by personal property.

Because only a small minority of real estate-related loans have no personal property in the collateral, personal property and its impact on how to proceed needs to be evaluated from both a business and a legal perspective.

In foreclosing on a mixed real and personal property collateral loan, the first issue to evaluate is whether the collateral is to be sold as a whole or whether some or all of the personal property is to be sold separately. This will, in turn, require evaluation of state real property foreclosure laws (which may be used for sales of mixed real and personal property collateral), as well as whether any rights will be lost if multiple remedies are pursued.

For example, California’s one form of action rule applies to loans secured by real property and requires lenders to look first to their collateral before pursuing any other actions against the borrower, limits their rights to obtain deficiency judgments and imposes harsh penalties such as loss of lien rights if the rule is violated. State real estate foreclosure statutes vary, often imposing specific notice and advertising requirements before a sale can be concluded by the lender and sometimes allowing sales to be challenged if procedures are not strictly followed.

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