Environmental Issues in Foreclosed Properties

State Bar of Michigan

Environmental Issues When Buying
Foreclosed Properties and Notes

Presented By:

Nicholas G. Maloof, Esq., RPG
President and General Counsel
Associated Environmental Services, LLC

July 20-23, 2011

Grand Traverse Resort and Spa
Traverse City, Michigan

Page 1 of 12
6001 North Adams Road, Suite 205
Bloomfield Hills, Michigan 48304
Tel: (248) 203-9898
Fax (248) 203-9372
Environmental Services Email: ngm@associatedenvironmental.net
Land Development Web: www.associatedenvironmental.net
Real Estate Consulting
Copyright©2011 Associated Environmental Services, LLC. All rights reserved.

Environmental Issues When Buying Foreclosed
Properties and Notes
Workouts, Foreclosures and Bankruptcies are the ugly side to the commercial real estate industry.
They happen in both good times and bad; however, their presence and impact are most distressing in
the midst of financial crisis and recession such as we have experienced the past several years.

General Terms used in today’s discussion:

Distressed Property – Commonly viewed as a property that is the subject of a workout, foreclosure or
bankruptcy proceeding. Definitions of “distressed property” on the Web via Google Search:

A. 1. Property that is in poor physical condition. 2. Property owned by an individual who is in
poor financial condition. debbie.canequity.com/mortgage-resources/
B. A property which is to be sold in order to pay arrears on a mortgage. www.gibbons-
realty.com/dictionary/D.html
C. Property which either is in a dilapidated physical condition or is owned by an individual who is
undergoing a period of economical instability. www.dreamtown.com/mortgage/mortgage-
terms.html
D. A mortgaged property which has been foreclosed on. www.bettisu.com/
E. Real estate that is under foreclosure or impending foreclosure because of insufficient income
production or mortgage payment. www.propertyaxess.com/GlossaryofTerms.htm
F. Property that is under a foreclosure order or is advertised for sale by its mortgagee. Distressed
property usually fetches a price that is much below its market value.
http://www.businessdictionary.com/definition/distressed-property.html

Mortgage-Backed Note (or Note) – “A type of promissory note that is associated with a particular
mortgage loan. Mortgage-backed notes represent the legal promise to repay a mortgage loan. These
notes specify the terms of the loan, including the amount of interest and principal that must be repaid.
They also obligate the borrower to make the payments.”
http://www.investopedia.com/terms/m/mortgage-backed-note.asp

Default by a Borrower – Commonly viewed as the failure to perform a task or fulfill an obligation,
especially failure to meet a financial obligation. Two general types of default are appropriate to our
conversation today:

1. Technical Default – “A deficiency in a loan agreement that arises not from a failure to make
payments as promised, but from a failure to uphold some other aspect of the loan terms.
Technical default indicates that the borrower may be in financial trouble, and can trigger an
increase in a loan's interest rate, foreclosure or other negative events.”
http://www.investopedia.com/terms/t/technical-default.asp; and

Page 2 of 12
Tel: (248) 203-9898
Fax (248) 203-9372

2. Financial Default – “The failure to promptly pay interest or principal when due. Default
occurs when a debtor is unable to meet the legal obligation of debt repayment. Borrowers may
default when they are unable to make the required payment or are unwilling to honor the debt.”
http://www.investopedia.com/terms/d/default2.asp

In the event of Default by a borrower (whether financial or technical), the lender has several alternative
courses they can pursue:

1. Take no action and hope that the default remedies itself;
2. Require additional collateral and/or guarantees from the borrower;
3. Restructure the indebtedness with a longer amortization, lower interest rate, principal only
payments or other loan alteration(s);
4. Temporarily suspend pursuing additional remedies against the borrower by agreeing to a
forbearance. Forbearance is refraining from doing something that one has a legal right to do.
In this case, it would be to not to enforce a claim(s) upon loan maturation and/or provide
additional time for repayment of the loan;
5. Accept a discounted payoff of the indebtedness;
6. Foreclose on the loan and sell the collateral (real property) by taking physical possession and
title and marketing the property;
7. Another alternative is to have a Receiver appointed by the courts to manage, marshal and/or
sell the asset(s); or
8. Selling the Note (typically at a discount) to another party. These other parties can include
another lender, an investor and, yes, sometimes the debtor itself.

Items 1-5 referenced above are typically encountered in the “workout” phase of a potential foreclosure
and are a joint attempt by the borrower and the lender to salvage a valuable property and avoid the
delays and expense generated in a foreclosure. If a deal can be made, it will likely benefit both parties
to the loan (lender and borrower).

A workout can also preclude any potential harm that may mar a project's reputation due to a default.
The risk of harm to a project from a default due to lost sales or shaken confidence may eventually lead
to a foreclosure or a bankruptcy filing.

An effective and successful workout requires that both parties take reasonable steps to protect the
value of the collateral in order to maximize its ultimate worth and thereby protect the investments of
both the borrower and the lender in the project.

In the event that both parties determine that a workout is appropriate, it is imperative to act as
expeditiously as possible or there is a risk of one or both parties changing their minds or the value
further declining and throwing off the deal parameters. The longer it takes to get the deal closed the
higher the likelihood of losing the purchaser due to market forces, changes in value of the
collateral or both.

Page 3 of 12
Tel: (248) 203-9898
Fax (248) 203-9372

Bankruptcy – Commonly viewed as a legal mechanism to erase legitimate debts and allow a
corporation or person a “fresh start.” The process assumes the corporation or person is honest and is a
“victim of unique circumstances.”

Definitions of “Bankruptcy” on the Web via Google Search:
I. “The condition of being unable to pay debts, with liabilities greater than assets. There are two
types of bankruptcy: involuntary bankruptcy, where one or more creditors bring a petition
against the debtor; and voluntary bankruptcy, where the debtor files a petition claiming
inability to meet his or her debts.” BNET Business Dictionary
http://dictionary.bnet.com/definition/Bankruptcy.html
II. “A legally declared inability or impairment of ability of an individual or organization to pay its
creditors. Creditors may file a bankruptcy petition against a debtor ("involuntary bankruptcy")
in an effort to recoup a portion of what they are owed or initiate a restructuring. In the majority
of cases, however, bankruptcy is initiated by the debtor (a "voluntary bankruptcy" that is filed
by the insolvent individual or organization). http://en.wikipedia.org/wiki/Bankruptcy
III. “Legal process that is available for an individual who is overextended financially and is unable
to pay his debts. The individual can file for bankruptcy in order to seek to legally eliminate
some or all of his debts.” http://en.mimi.hu/business/bankruptcy.html
IV. “…provides a legal method for an individual or commercial enterprise (business) to either wipe
out (discharge) the debts by liquidating assets and distributing them among creditors or resolve
them by developing a court-approved reorganization plan, or other plan involving the
repayment of creditors over time.”
http://www.statelawyers.com/Practice/Practice_Detail.cfm/PracticeTypeID:13

Remember that a Bankruptcy filing may allow a borrower to discharge its obligation to repay the Note.

Due Diligence – is generally defined as “1. An investigation or audit of a potential investment. Due
diligence serves to confirm all material facts in regards to a sale;” and “2…the care a reasonable person
should take before entering into an agreement or a transaction with another party.” Due diligence is a
way of preventing unnecessary harm to either party involved in a transaction.”
http://www.investopedia.com/terms/d/duediligence.asp

There are also legally required instances of due diligence that if not undertaken by a purchaser or
lender, may result in status liability. An example of this type of due diligence is environmental
liability arising from a party failing to take advantage of legal “safe harbors” for existing
environmental contamination or conditions on a real property.

Page 4 of 12
Tel: (248) 203-9898
Fax (248) 203-9372

Questions and Answers Related to Foreclosed Assets and Notes

What is an REO property? What does that term really mean to a lender/bank? What does it
mean to a potential buyer?

 An REO property is any real estate that a lender/bank owns that it is not using for operation of
the lender/bank;
 Lenders are motivated to sell these properties, as a lender’s income is derived from collection
interest on loans. These are non-income producing assets, and a drag on lender earnings;
 Lender REO departments are responsible for marketing and selling these properties at the
highest reasonable value to the lender.

How does a Lender typically acquire title to a property?

 Non-payment or technical default on a loan leading to foreclosure of the collateral;
 Borrower offers to deed property to lender (deed-in-lieu of foreclosure) as part of a
resolution of a troubled loan;
 Lender decides to close one of its branches or other buildings.

Why would a Receiver be appointed to dispose of an asset?

A Receiver is used to insulate the lender from liability as well as allow the lender to usurp operational
control from the borrower/operator through a court sanctioned process.

A Receiver who is appointed by the court is charged with preserving value of the estate. The court
may or may not empower the Receiver to sell the asset. If empowered to sell the asset on lender’s
behalf, the lender avoids ownership issues such as liability for environmental concerns, unpaid claims,
and other responsibilities inherent in owning property.

My personal experience has been that the lender typically requests the court to appoint a Receiver
based upon the Receiver’s relationship with the lender and lender’s legal counsel as well as the
Receiver’s ability to manage the specific asset class and, hopefully, maintain or create new value for
the lender.

Many times there are environmental or other liabilities, whether ripe or contingent, associated with a
particular property. By having a Receiver appointed through judicial process, the lender can avoid
dealing with the liability directly and the risk for additional loss that may be associated with the
liability.

In addition when the asset is disposed, the lender avoids being placed in the chain-of-title as the
Receiver directly transfers title to the purchaser, typically through a Fiduciary Deed offering limited or
no warranties (Quit Claim in disguise?).

Page 5 of 12
Tel: (248) 203-9898
Fax (248) 203-9372

Disadvantage of receivership is it can be expensive and a lender does not ultimately control who the
judge picks to be the Receiver. A lender may request an individual, but the judge may decide to go a
different direction, and the lender will be stuck with that decision.

If a property becomes REO, how will that affect value?

REO property is typically not well managed or maintained as asset managers are overworked, have too
many properties to manage, are inexperienced, retain the wrong firms to assist them manage and
market the asset or a combination of any of the foregoing issues.

As the property is not well managed or maintained, occupancy will typically fall and additional repairs
are then deferred due to a downward spiraling of cash flow. This can create valuation issues from a
cash flow analysis standpoint as well as from a cost to cure the deferred maintenance. In addition,
some problems can compound others (e.g., poor HVAC operation leads to roof stress or frozen pipes
leading to water infiltration leading to mold growth).

How can a buyer best position itself to purchase a bank asset? What are the important
factors to consider so that the chances for success are improved?

Contact real estate brokers or lenders directly, search websites, etc. Most lenders retain a property
manager and a broker – sometimes they are the same firm.

Have your financing squared away before contacting the lender – cash is king! I have seen assets
worth $2-3M based upon current cash flow sell for 1/3 the value for an all cash offer.

Lenders say that a buyer should be willing to buy the property “as-is, where-is.” Expect that the lender
will provide as little reps and warranties as possible – often none. This can be dangerous for a buyer –
be very careful…the lender is looking out for its own best interests!

Show your ability to close, either in terms of bank statements, letters of comfort from a lending
institution, etc.

The lender views the deals that are quicker to close and having less in the need for due diligence and
inspection periods as more attractive than offers requiring lengthy due diligence.

What information can be obtained regarding the condition of the property? What due
diligence will the bank allow?

Buyer will be expected to do their own due diligence. Some Lenders are reluctant to share their third
party reports (Environmental Assessments, Property Condition Assessments, Appraisals, Land
Surveys, Title Work, etc.) because of potential liability from the buyer if one of lender’s reports turns
out to be wrong. The Lender will try to protect itself by having purchaser sign a broad release of all
liability should there be errors in the third party reports.

Page 6 of 12
Tel: (248) 203-9898
Fax (248) 203-9372

Two recent cases regarding the transfer of an interest in real property and failure to disclose the
“facility” status of that real property are a shot across the bow for anyone purchasing, selling, leasing
or financing real property. 1031 Lapeer, LLC v Rice (Mich. Ct. App. No. 290995; August 5, 2010,
assigned for publication October 7, 2010) is a published case establishing a clear remedy for violation
of Section 324.20116. A very short time later A. D. Transport, Inc. v Michigan Materials &
Aggregates Company, Inc. (Mich. Ct. App. No. 290236, September 30, 2010, Unpublished) an
unpublished case discussed the differing causes of action and remedies for failure to comply with a
statutory obligation.

These two court cases greatly impact a lender or any other owner of real property if they are leasing or
selling contaminated property. Essentially the lender MUST disclose the fact, if it knows or has
sufficient reason to know, that the property is contaminated or may be contaminated in excess of
MDEQ Generic Residential Cleanup Criteria. The remedy under the 1031 Lapeer, LLC v Rice
case for failing to disclose is that the transaction was void and damages were payable to the
injured party!

What hurdles will buyers face when looking to purchase a bank owned retail or other
development? How can these hurdles be addressed?

 Low occupancy
 Poor management
 Deferred maintenance
 Possible environmental issues from dry cleaner tenants (either past or current)
 Lender not likely to re-loan on asset – wants it “off their books.”

Summarize the available financing options for purchasing bank owned property.

Slim to none…no matter what the federal government says, large lending institutions are still not
lending on investment properties in large volumes!

Some Community Banks, Credit Unions and Life Insurance Companies are lending on investment
properties, but they are scrutinizing deals closely.

If owner occupied, SBA lending is occurring, but lead time is long and paperwork intensive.

Some lending is coming back into the market with the CMBS market just starting to re-open. A
borrower will need, at a minimum, 60% LTV with a DSCR of 125%. Need highly qualified sponsors
with strong balance sheets and liquidity.

What information can be obtained regarding the condition of the property? What due
diligence will the bank allow?

As part of an REO purchase, depending upon whether you are purchasing the Note or the
Asset itself, you need to perform the proper due diligence in order to identify the property's

Page 7 of 12
Tel: (248) 203-9898
Fax (248) 203-9372

difficulties and whether they can be overcome. Due diligence activities must include a review
and analysis of the following in order to better understand the property:

1. loan documents;
2. leases, if any;
3. construction documents, if any;
4. development and construction financing documents, if any;
5. current title and available land survey;
6. environmental reports; and
7. engineering reports.

Always do your own due diligence – the lender has conducted due diligence for its
own purposes that may directly conflict with your best interests!

What consultants should be used for the purchase?

The single most important thing is conduct thorough due diligence. Lenders sometimes don’t give a
large window, so you need to have a solid team you trust at the ready. Your team should include the
following skill sets (some areas of expertise may be covered by the same professional):

 Legal Counsel
 Valuation Specialists
 Financing Specialists
 Physical Due Diligence
o Environmental
o Property Inspection/Building Contractor
o Structural/Civil
o Land Surveyor
 Property Manager
 Title Company
 Real Estate Broker

What types of properties are available in Michigan? How does the Michigan market differ
from other parts of the country?

We have been involved in all types of properties on behalf of foreclosing lenders:
 Industrial
 Warehouse
 Office
 Medical
 Retail
 Multifamily
 Mobile Home Parks

Page 8 of 12
Tel: (248) 203-9898
Fax (248) 203-9372

Environmental Due Diligence Questions

 What is the current condition of the collateral?
 Was environmental due diligence conducted when the loan was made? Was it
conducted properly (was all of the research conducted or was it a “white wash”)?
 Was the collateral contaminated when the loan was made?
o If so, by the borrower or a prior owner/operator (historical impact)?
o If the impact is historical, did the borrower conduct appropriate due diligence
(Phase II ESA, BEA, 7a Due Care Plan, etc.)?
 Are the current operations of a high-risk nature (gas station, dry cleaner, industrial,
etc.)?
 Are there any adjacent high-risk uses to the collateral that could have a direct or
indirect impact?
 Are there any issues that could impact the value of the collateral or require out of
pocket costs by the lender if the property is foreclosed upon?
o If there is impact, can the impact be used as a selling feature to attract a new
developer or purchaser by positioning the property for development incentives?
 Is the lender planning to take title, is a Receiver going to be appointed or is the Note
being sold at a discount?
o If the Note is being sold, the lender may only need a cursory investigation to
evaluate the value of the underlying collateral;
o If a Receiver is being appointed, it may make sense for the Receiver to conduct
pre-acquisition due diligence to determine the condition of the collateral prior to
or within a short period of time of being appointed Receiver;
o If the lender is foreclosing and taking title, a thorough investigation should be
undertaken to determine the condition of the property and whether the lender
needs to prepare a Baseline Environmental Assessment (BEA) prior to taking
title, possession or occupancy.
 Are there any issues that could impact the value of the collateral or require out of
pocket costs by the lender if the property is foreclosed upon?
o If there is impact, can the impact be used as a selling feature to attract a new
developer or purchaser by positioning the property for development incentives?

When should the buyer bring in its professional team when looking at a distressed
asset?
a. As early as possible. If we are contacted early in the process, we can help them with
identifying potential issues, possibly deal killers, price reduction points, and sources of
grants, loans and other funding/reimbursement
b. We just obtained a grant for one of our clients purchasing an industrial property to
conduct a Phase II ESA, BEA and 7a Due Care Plan (worth about $23K) with no
additional out of pocket cost to our client (he hired us to conduct a Phase I ESA and
we prepared the application for the grant)

Page 9 of 12
Tel: (248) 203-9898
Fax (248) 203-9372

c. We also just obtained a grant for one of our clients developing a retail property to
conduct a Phase I & II ESA, BEA and 7a Due Care Plan (worth about $30K) with no
additional out of pocket cost to our client (he hired us to prepare the Brownfield Plan
and we prepared the application for the grant at no additional cost)

Why should a buyer conduct environmental due diligence and a property condition
assessment?
a. Legal protection under both State of Michigan and Federal Law
b. Determine the condition of the asset
c. Identify issues that can be used as negotiating points
d. Make sure you are not overpaying for the asset
e. Why is bank selling note vs. foreclosing? Many times a receiver is appointed or
the note sold to avoid known environmental issues or potential tort liability for
existing conditions!

Case Studies in Foreclosure, Workout and Receivership Properties
Example #1 - Multi-family Residential Rental Complex
Scenario: AES was retained by a foreclosing lender to review a previously prepared Phase I
Environmental Site Assessment (ESA) and determine whether a Phase II ESA was necessary for pre-
foreclosure due diligence purposes. AES reviewed the report and concurred with the Phase I ESA
recommendation that a Phase II ESA was necessary to investigate off-site historically contaminated
adjacent sites with known releases of chlorinated solvents, petroleum hydrocarbons and heavy metals
that may have impacted the property. AES prepared a scope of work to assess the suspected areas in
order to determine the impacted areas, if any. In addition, AES was requested to prepare a rough cost
estimate for further investigation and remediation of the impacted areas.

From a non-environmental standpoint, AES also observed the property to be poorly managed and
maintained by the debtor in possession with water infiltration issues, low occupancy and some units
with mold or other impacts.

Issue: No effective Property Management (PM), high vacancies, needed repairs were not being made
further de-valuing the asset.

Buyer Opportunity: Provide PM services to manage asset, possible redevelopment of asset, project
manage repairs, reposition asset, redevelop asset for LIHTC/Section 8, redevelop entire site to new
use, etc.

Example #2 - Recreational Property
Scenario: AES was retained by legal counsel representing a Court Appointed Receiver, appointed
at the request of a lender, to prepare a Phase I ESA for a potential sale of the collateral, a recreational
property. AES did not identify any RECs related to the property and recommended no further site
investigation.

Page 10 of 12
Tel: (248) 203-9898
Fax (248) 203-9372

Issue: Property being well managed by Receiver and increasing its’ value, but has limited marketing
capabilities.

Buyer Opportunity: Purchase a well managed asset that is increasing in value at a substantial
discount to the original debt as well as to the replacement cost for the improvements.

Example #3 - Multi-tenant Industrial Property
Scenario: AES was retained by a foreclosing lender to prepare a Phase I ESA, Phase II ESA,
Baseline Environmental Assessment (BEA) and 7a Due Care Plan for a multi-tenant industrial
property as part of pre-foreclosure due diligence.

From a non-environmental standpoint, AES also observed that there was no local person/entity charged
with managing the property. The current broker was a “sign only” and not paying attention – doors
unlocked, maintenance issues, etc. All of the remaining tenants were in the dark on the situation and
still sending rent to the former owner who lost property via foreclosure. The special servicer is
overwhelmed and needs local help.

Issue: No effective PM. Property is 50% occupied and maintenance was being deferred.

Buyer Opportunity: PM services (collect rents, maintain and repair property), market property, likely
opportunity for leasing fairly high due to location of nearby national defense hub. Purchase asset at a
substantial discount to (1) original debt; (2) the replacement cost for the improvements; and (3) a very
high Cap Rate based upon the current NOI at 50% occupancy.

Remember that each deal is unique and that the asset condition, type of investment being made,
motives of the parties, timing and a multitude of other factors are never the same.

Critical Take Away Points for the Potential Buyer of Foreclosed
Properties or Notes
 Understand the motives of all parties in a Workout, Foreclosure or Bankruptcy transaction;
 Understand the needs of the party you are approaching for representation – if you are working
for the Special Servicer their needs and motives may be different from that of a Receiver. If
the debtor has filed bankruptcy, this adds another layer of complexity to the representation as
well as motivations due to the Bankruptcy Trustee’s involvement to maximize recoveries in an
expeditious manner;
 It is imperative to have a team of trusted advisors to assist you in understanding the myriad of
issues with a Workout, Foreclosure or Bankruptcy transaction. Remember each representation
opportunity is unique and requires a team of advisors to identify the service opportunities for
the team (just make sure to vet each member to ensure that they really know what they are
talking about!).

Page 11 of 12
Tel: (248) 203-9898
Fax (248) 203-9372

 Understand the current market conditions, the property, its condition, and the process track the
property is following – know that it could change at any time;
 Make sure to understand the position of all parties involved in the transaction and know whom
they are working for (i.e., where does their fiduciary duty lie?)
 Remember, even if you are buying the Note, the underlying value of the real property directly
impacts the value of the Note. If there are known or potential liabilities, they can substantially
impact the value!
 Also, as a Note purchaser you are stepping directly into the shoes of the lender – whys I the
lender not foreclosing? Do they know something that you don’t?
 Explore the options available for the property from an Economic Incentive standpoint – what
about this property (its location, condition, etc.), the deal, the parties, etc. make the property
unique, the deal unique, or make the property eligible or could make the property or deal
eligible for incentives?

For questions or to discuss a matter in confidence, please feel free to contact me at (248) 203-
9898 or via email ngm@associatedenvironmental.net.

Nicholas G. Maloof, RPG, Esq., is President and General Counsel of Associated
Environmental Services, LLC (AES), an environmental services, land development and real
estate consulting firm based in Bloomfield Hills, Michigan. Mr. Maloof is an active member of
the State Bar of Michigan and has over thirteen years of experience as a transactional real
estate and development attorney and over twenty-two years of experience in the field of
environmental and real estate consulting. A majority of his work is conducted with or on
behalf of attorneys, financial institutions, real estate brokers, developers, investors and
property owners. Mr. Maloof is a licensed Real Estate Broker (Associate Broker), a
Registered Professional Geologist in the State of Tennessee and a licensed Title Insurance
Resident Producer in the State of Michigan.

Over the past 20 plus years, Mr. Maloof has been involved in thousands of real estate
transactions and land development projects from a site selection, due diligence, development
incentive and development entitlement standpoint, as well as numerous Workout,
Foreclosure and Bankruptcy related real estate transaction throughout Michigan.

Workout, Foreclosure and Bankruptcy related transactions have included retail centers,
industrial and warehouse sites, multi-family residential, mobile home parks, medical facilities
and office buildings on behalf of CMBS servicers, CMBS special servicers, Court appointed
Receivers, banks, legal counsel and purchasers.

Page 12 of 12
Tel: (248) 203-9898
Fax (248) 203-9372

Environmental Issues in Foreclosed Properties

Recommended

Recommended

More Related Content

Similar to Environmental Issues in Foreclosed Properties

Similar to Environmental Issues in Foreclosed Properties (20)

Recently uploaded

Recently uploaded (20)

Environmental Issues in Foreclosed Properties