Buying Distressed Real Estate Debt


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This presentation expalins the nuances of acquiring distressed debt secured by real estate or mezzanine debt secured by the ownership interests in an entity owning real property, including the process of foreclosure, intercreditor issues, and other key points.

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Buying Distressed Real Estate Debt

  1. 1. Buying Distressed Real Estate Debt Practical and Legal Issues Regarding the Acquisition and Sale of Distressed Debt
  2. 2. Mortgage vs. Mezzanine Debt
  3. 3. History/Background <ul><li>A mortgage loan is a financing secured by a lien on the real estate granted by the borrower or owner of the real estate. By contrast, a mezzanine loan is a financing secured by a pledge of the ownership interests in the borrower or real estate owning entity rather than security in the real property itself. </li></ul><ul><ul><li>Mezzanine financing was developed in the early 1990s as a response to the savings and loan crunch, which highlighted the threat posed by junior mortgages, which had been the traditional form of subordinate financing, to the senior debt. </li></ul></ul><ul><ul><li>Instead of through a mortgage foreclosure, enforcement of a mezzanine lender’s remedies is through a UCC foreclosure of the mezzanine lender’s interest: (i) in the mezzanine borrower’s ownership interests in the property owner or (ii) in the “securities” controlled or held by the mezzanine lender, if the mezzanine collateral was “certificated.” </li></ul></ul><ul><ul><li>Mezzanine financing typically has a lower lien priority, earns a higher interest rate, amortizes more quickly, shares more of the risk of equity investment and is considered to be in the “first loss” position. </li></ul></ul>
  4. 4. Mortgage and Mezzanine Loan Components <ul><li>The standard components of a real estate loan include: </li></ul><ul><ul><li>Loan Documents : The loan documents for mortgage loans and mezzanine loans are generally very similar, except as modified to reflect the different form of collateral. </li></ul></ul><ul><ul><li>Due Diligence : As the source of security’s value for both loans lies in the real estate, a thorough review of the real property is necessary. </li></ul></ul><ul><ul><li>Special Purpose, Bankruptcy Remote Entities : To avoid certain bankruptcy-related risks, senior borrowers and mezzanine borrowers should be structured as bankruptcy remote, special purpose entities, with independent directors/members. </li></ul></ul><ul><ul><li>Mortgage Lien : A senior borrower must grant a mortgage lien on the real estate. The mortgage will also include an assignment of borrower’s rights to enforce leases against and collect the rents from any tenants. </li></ul></ul>
  5. 5. Mortgage and Mezzanine Loan Components (continued) <ul><ul><li>Membership Pledge : A mezzanine borrower must pledge 100% of the beneficial ownership interests in the senior borrower as collateral pursuant to a pledge agreement, so that any foreclosure of the mezzanine loan will result in a transfer of all of the equity interests in the senior borrower/property owner. </li></ul></ul><ul><ul><li>Cash Management : Often times, mezzanine lenders require the mezzanine borrower to implement a cash management system (such as a hard lockbox) to be in place, in which all property-related cash flow is deposited after payments required by the senior lender, to pay mezzanine debt service and other related loan payments. </li></ul></ul><ul><ul><li>Maturity : Rating agencies prefer that the maturity of a mezzanine loan be coterminous with the maturity date of the senior loan. </li></ul></ul><ul><ul><li>LTV : Coupled with the senior loan, the LTV may increase up to 90% (as compared to 40-70% LTV of senior loans). </li></ul></ul><ul><ul><li>Interest Rate Caps : To mitigate the risks of the floating interest rate that is common in mezzanine loans, mezzanine lenders typically require that the mezzanine borrower enter into an interest rate cap agreement and pledge the agreement to the mezzanine lender. </li></ul></ul>
  6. 6. Structuring Issues and Concerns
  7. 7. Subordination of Mezzanine Debt to Mortgage Debt <ul><li>Since a mezzanine lender does not have a lien on the real property in a transaction, the mezzanine loan is structurally subordinate to the senior loan. Foreclosure or acceptance of a deed in lieu of foreclosure by the senior lender will wipe out the mezzanine borrower’s direct or indirect interest in the real property. Similarly, in transactions involving multiple tiers of mezzanine debt, the foreclosure or acceptance of a deed in lieu by a senior mezzanine lender will wipe out a junior mezzanine borrower’s indirect interest in the real property. </li></ul><ul><li>When buying a mezzanine loan (or an interest in a mezzanine loan) it will be important to review the transfer provisions in the loan documents and the non-recourse carveout guaranty given in connection with the mezzanine loan to make sure it covers transfers of the property (and direct and indirect interests therein) that are not made in accordance with the provisions of the mezzanine loan documents. </li></ul><ul><li>The senior lender and junior lender(s) will typically enter into an Intercreditor Agreement which will contractually subordinate the junior loan(s) to the senior loan(s) and govern the rights and obligations of the lenders. </li></ul><ul><li>When buying a mezzanine loan that is part of a structure involving multiple mezzanine loans it will be important to understand where the mezzanine loan sits in the capital stack and the rights and obligations of the mezzanine lender with respect to the senior loan(s) and any subordinate loan(s). Today’s discussion focuses on a structure involving a mortgage loan and one mezzanine loan. </li></ul>
  8. 8. Intercreditor Agreements <ul><li>Some key provisions to understand in an Intercreditor Agreement when buying a distressed mezzanine loan (or an interest in a distressed mezzanine loan) are discussed below </li></ul><ul><ul><li>Transfer Provisions : Intercreditor Agreements typically contain restrictions on transfers of more than 49% of the interests in the mezzanine loan unless the transferee is a “Qualified Transferee.” If the proposed buyer does not meet the definition of a “Qualified Transferee,” rating agency confirmation (if the senior loan has been securitized) or the consent of the senior lender may have to be obtained. </li></ul></ul><ul><ul><li>Notice and Cure Rights of Mezzanine Lender with respect to the Senior Loan : Intercreditor Agreements typically require the senior lender to give notice to the mezzanine lender of a default under the senior loan and provide the mezzanine lender an opportunity to cure the default. There is typically a limit on the number of times a mezzanine lender can cure a senior loan default unless the mezzanine lender is exercising its enforcement rights with respect to its collateral. </li></ul></ul>
  9. 9. Intercreditor Agreements (continued) <ul><ul><li>Option to Purchase Senior Loan : The mezzanine lender typically has an option, exercisable upon the occurrence of certain events of default under the senior loan, to purchase the senior loan at the “defaulted mortgage loan purchase price.” It is important to understand the mechanics of how the purchase option works (i.e. what notices are required to be given by the senior lender to the junior lender, when the option terminates, etc) and the definition of “defaulted mortgage loan purchase price.” </li></ul></ul><ul><ul><li>Restrictions on Modification of the Senior Loan and Mezzanine Loan : Intercreditor Agreements typically contain restrictions on modifications of the senior loan and the mezzanine loan without the consent of the other lender. It will be important to understand the consent rights of the senior lender in connection with a workout or other modification of the mezzanine loan, as well as the consent rights of the mezzanine lender in connection with a workout or other modification of the mortgage loan. </li></ul></ul>
  10. 10. Intercreditor Agreements (continued) <ul><ul><li>5. Mezzanine Lender Enforcement Action : Intercreditor Agreements typically permit the mezzanine lender to commence an enforcement action following a default under the mezzanine loan, including, a foreclosure its equity collateral (in which event the mezzanine lender or its nominee will become the indirect owner of the real estate) as long as the mezzanine lender complies with certain conditions. The conditions may include the following: </li></ul></ul><ul><ul><ul><li>(a) Transferee that takes title to the equity interest must be a &quot;Qualified Transferee&quot;; </li></ul></ul></ul><ul><ul><ul><li>(b) Transferee or an affiliate may have to deliver replacement guarantees and indemnities to the senior lender if the original guarantors under the senior loan are being released;  </li></ul></ul></ul><ul><ul><ul><li>(c) Mezzanine lender or the transferee will typically have to cure defaults under the senior loan (as a condition to the foreclosure) or as soon as reasonably practicable if it cannot effect a cure until it has foreclosed on the equity pledge; </li></ul></ul></ul><ul><ul><ul><li>(d) Transferee may have to replace the property manager with a “qualified property manager”; </li></ul></ul></ul>
  11. 11. Intercreditor Agreements (continued) <ul><ul><ul><li>(e) Transferee may have to institute certain cash management procedures if not already in place;  </li></ul></ul></ul><ul><ul><ul><li>(f) Transferee will have to cause the borrower to reaffirm its obligations under the mortgage loan; </li></ul></ul></ul><ul><ul><ul><li>(g) Transferee may have to deliver non-consolidation and other opinions; </li></ul></ul></ul><ul><ul><ul><li>(h) Mezzanine lender or the transferee will be responsible for the payment of costs and expenses of senior lender and possibly a transfer or assumption fee set forth in the mortgage loan documents. </li></ul></ul></ul><ul><li>The disposition of the mezzanine collateral will be governed by the Uniform Commercial Code which provides that “every aspect of a disposition of collateral, including the method, manner, time, place, and other terms, must be commercially reasonable.” </li></ul>
  12. 12. Perfection <ul><li>Perfection of a security interest in the mezzanine loan collateral </li></ul><ul><li>Unlike perfection of a lien on real estate which is accomplished by recordation of a mortgage or deed of trust in the county (or in some cases city) where the real property is located, perfection of a security interest in a membership interest or partnership interest is accomplished under Article 8 or Article 9 of the Uniform Commercial Code, depending on whether the collateral is a “general intangible” or a “security.” </li></ul><ul><ul><li>Article 9 of the Uniform Commercial Code : Perfection of a security interest in a “general intangible” under Article 9 is accomplished by filing a UCC financing statement against the pledgor of the pledged interest in the appropriate jurisdiction (i.e. where the pledgor is “located”). </li></ul></ul>
  13. 13. Perfection (continued) <ul><ul><li>Article 8 of the Uniform Commercial Code : In order for a membership interest or partnership interest to be a security for Article 8 purposes, the issuer of the interests must expressly provide that its securities are to be governed by Article 8 of the UCC. An election to “opt-in,” to Article 8 must be made in the operating agreement or limited partnership agreement of the issuer of the membership interests or partnership interests that are being pledged as collateral. Perfection of a security interest under Article 8 is accomplished by (i) filing a UCC financing statement against the pledgor of the pledged interest in the appropriate jurisdiction and (ii) obtaining “control.” Control is obtained by a control agreement or, if the interest is certificated, by taking possession of the certificate evidencing the interest. </li></ul></ul><ul><li>The recent trend has been to require the issuer of the mezzanine loan collateral to opt in to Article 8 and certificate its membership interests, and for the mezzanine lender to take possession of the certificate indorsed either to lender or in blank and file a UCC. </li></ul><ul><li>Order UCC searches to see if any other financing statements are filed against the collateral. </li></ul>
  14. 14. Due Diligence Considerations for the Purchase of Debt
  15. 15. Due Diligence Considerations for the Purchase of Debt <ul><li>It is critical to review the due diligence and documentation, particularly in times of possible distress. In today’s volatile real estate market, it is completely unknown whether credit will be available in the near or long term or at the specific time a balloon payment may be due. </li></ul><ul><li>This outline addresses possible issues and strategies to consider when purchasing distressed debt, whether prior to or at a foreclosure sale. The goal is to anticipate problems before they ripen into defaults with other credit parties, and to try to prevent the problems from escalating. </li></ul><ul><li>Many of these points are common sense “reminders” that will enable your ability to address them as quickly and efficiently as possible. </li></ul>
  16. 16. Big Picture Issues <ul><li>Know the capital stack </li></ul><ul><ul><li>Who are the potential adverse interests? </li></ul></ul><ul><li>Expectations of what you are buying </li></ul><ul><ul><li>Construction loans, first liens, mezz loans </li></ul></ul><ul><li>Representations? </li></ul><ul><ul><li>Principal balance, paid to date, no unfunded amounts, no defenses, escrow balances, all loan documents </li></ul></ul>
  17. 17. Loan Documents <ul><li>Collect, Audit and Review All Loan Documents </li></ul><ul><ul><li>It is crucial to obtain all senior and mezzanine loan documents and any correspondence among the lenders and borrower provided in connection with the loan documents. Additional considerations include assessing: </li></ul></ul><ul><ul><ul><li>Default provisions, remedies notice and cure rights </li></ul></ul></ul><ul><ul><ul><li>Intercreditor Agreement obligations and rights with respect to other lenders or credit providers including: </li></ul></ul></ul><ul><ul><ul><ul><li>Notice and cure rights of the lenders </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Mezzanine lender’s right to purchase senior loan (qualification as a “qualified transferee”) </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Requirement of replacement guaranties </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Requirements of replacement property managers </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Delivery of legal opinions </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Consent rights of senior lenders to loan modifications </li></ul></ul></ul></ul><ul><ul><ul><li>Requirements resulting from securitizations or participations </li></ul></ul></ul><ul><ul><ul><li>SPE requirements </li></ul></ul></ul>
  18. 18. Status of the Real Estate <ul><li>Assess Status of Collateral </li></ul><ul><ul><li>A potential purchaser of distressed debt must review the existing real property due diligence. Depending on the date of the original close, some due diligence should be updated: </li></ul></ul><ul><ul><ul><li>Collateral : Confirm senior lender’s collateral by reviewing and updating the senior lender’s mortgagee title insurance policy and exception documents. An update should confirm the vesting information, that no additional encumbrances or liens exist and that property taxes have been timely paid. Confirm mezzanine lender’s collateral in terms of interests pledged, the existence of a UCC title insurance policy and whether the interests were certificated or uncertificated. </li></ul></ul></ul><ul><ul><ul><li>Lien Searches : Appropriate lien searches should be ordered to confirm no judgment, tax or UCC liens or bankruptcy petitions have been filed. It is critical to confirm no additional parties claim a lien on either lender’s collateral. </li></ul></ul></ul>
  19. 19. Status of the Real Estate (continued) <ul><ul><ul><li>Survey : A copy of any existing surveys should be reviewed to confirm no unsatisfactory encroachments or zoning issues. To the extent borrower recently constructed any material improvements, the survey should be updated to show such improvements. </li></ul></ul></ul><ul><ul><ul><li>Third Party Reports : Existing environmental, engineering, property condition and appraisal reports should be reviewed, including the right to rely on such reports. </li></ul></ul></ul><ul><ul><ul><li>Insurance : Existing insurance policies should be reviewed to confirm appropriate coverage types and amounts. </li></ul></ul></ul>
  20. 20. Entitlement Due Diligence – Development Deals <ul><li>Responsibilities of the Borrower as a Master Developer / Manager / Bond Obligations / Letters of Credit/Other Project-Specific Obligations: </li></ul><ul><ul><li>In development projects and in projects that require sale and rehabilitation work, the borrower/developer is frequently one with the broad responsibility for infrastructure – streets, sewers, utilities, landscaping and other public improvements. </li></ul></ul><ul><ul><li>It is critical to assess the progress of those public improvements so as to avoid litigation later with adjacent landowners that are part of the development, home builders who have purchased part of the land tracts, or subsequent owners or tenants. </li></ul></ul>
  21. 21. Entitlement Due Diligence – Development Deals (continued) <ul><ul><li>These obligations are also frequently a part of a development agreement with the local municipal government. All of these types of agreements should be reviewed. </li></ul></ul><ul><ul><li>In addition, a project owner may have become liable to surety companies on bond obligations given to secure performance of work required for the project. It is critical to be aware of and to gauge performance levels under such obligations on a regular basis. </li></ul></ul><ul><ul><li>A project owner may also have paid significant deposits to utility companies or may have given letters of credit to secure performance on any number of obligations. Borrowers may not have kept adequate records of these obligations, but a default under them could result in significant loss and delay to the project. </li></ul></ul>
  22. 22. Borrower’s Financial Statements and Performance <ul><li>Borrower Reporting Obligations and Financial Performance: </li></ul><ul><ul><li>Lawyers take great pains to draft elaborate reporting obligations of the borrower/developer: regular balance sheets, financial statements, rent rolls, profit and loss statements, audits, etc. As part of the due diligence process, it is wise to review these provisions carefully, and determine if the existing lender required strict conformance with these requirements. If the existing lender did not require strict compliance, upon an occurrence of a default, the borrower may argue that the lender had modified the terms of the loan documents by the lender’s actions simply through inadvertence or inattention to the reporting obligations. </li></ul></ul><ul><ul><li>Of course, it is equally important to review the reports, and, once again, to ask the relevant questions. The review of the reports should also serve to highlight potential problems – tenant default rates, change orders, increasing maintenance costs, overly generous tenant improvement allowances or brokerage commissions. </li></ul></ul><ul><ul><li>An important consideration is the cash on hand. That cash can be used later to fund a Chapter 11 filing. A potential purchaser should be asking why the cash is not being put to use – or why it isn’t being used to pay the existing lenders or to make distributions to the equity. </li></ul></ul>
  23. 23. Borrower’s Financial Statements and Performance (continued) <ul><ul><li>Although it may sound trivial, it is also important to confirm that the notice provisions of the loan documents are current and ensure that all notices were legally proper during the course of the loan. </li></ul></ul><ul><ul><li>Even though the borrower/developer may not be in default with respect to the maintenance of debt service coverage ratios, loan to value ratios and, if applicable, EBITDA loan covenants, a periodic review of those numbers remains important. </li></ul></ul><ul><ul><li>First, if the property’s performance has declined, that is reason enough to be concerned, thus necessitating further discussion with the borrower/owner. The loan documents should be reviewed to specifically determine lender’s audit rights. </li></ul></ul><ul><ul><li>Second, a declining performance might also make it difficult to refinance the existing debt in an era of strict lending standards. Thus, it is both a review of the numbers and an analysis of current or anticipated loan underwriting standards that are important measures to consider. </li></ul></ul>
  24. 24. Leases and Other Third Party Contracts <ul><li>Review All Material Third Party Contracts: </li></ul><ul><ul><li>A potential purchaser should review all material third party contracts in order to assess contingent and other liabilities in which the borrower/developer may become subject. </li></ul></ul><ul><ul><li>With respect to leases, it is important to confirm compliance with the loan or joint venture document provisions on the approval of leases. A borrower/developer could become more desperate as market conditions change, with overly generous tenant improvement packages and other rent concessions. These could have a deleterious effect on market value. In addition, a review of the creditworthiness of the new and existing tenants on a continuing basis is important. </li></ul></ul>
  25. 25. Leases and Other Third Party Contracts <ul><ul><li>In many states, if a lease is entered into after the date of the recordation of the mortgage or deed of trust, the lease could be terminated automatically, thus allowing the tenant to find space elsewhere. Confirming the existence of subordination, non-disturbance and attornment agreements from each tenant is an essential part of insuring that the tenant will remain in place – and continue to pay rent – even after a foreclosure of the existing mortgage or deed of trust. </li></ul></ul><ul><ul><li>With respect to property management agreements, it is essential to assess termination rights. Ideally, the borrower should have the right to terminate the agreement upon 30 days notice without cause. As with leases, property management agreements should be subordinate to the lien and rights of the existing lenders and their successors. </li></ul></ul><ul><ul><li>Finally, potential purchasers should be wary of any “affiliate” transactions, in which the borrower/developer may have an interest that would divert property-related funds for the borrower/developer’s separate purposes. </li></ul></ul>
  26. 26. Distressed Hotel Assets
  27. 27. General Overview <ul><li>Current Hotel Financing </li></ul><ul><ul><li>Likely to combine mortgage loan financing with one or more tiers of mezzanine financing </li></ul></ul><ul><ul><li>During the last cycle, hotels became one of the most highly leveraged asset classes, in part due to industry innovation and sustained overall industry performance </li></ul></ul><ul><ul><li>Hotels no longer stood alone, they were combined with new products and new components: residential condominiums, luxury amenities such as spa and upscale retail, and &quot;executive chef&quot; food and beverage destination venues </li></ul></ul><ul><li>Due Diligence </li></ul><ul><ul><li>The keystone of hotel asset analysis for all parties </li></ul></ul><ul><ul><li>Typically, hotels are managed by a third party manager who brings brand expertise and support to the location such as a Hilton, Marriott, Starwood, or Wyndham </li></ul></ul><ul><ul><li>The brand manager is also likely, domestically, to employ all employees of the hotel and to hold all operating licenses, such as liquor or in some cases, gaming </li></ul></ul>
  28. 28. General Overview (continued) <ul><li>Analyzing </li></ul><ul><ul><li>Analyzing the hotel asset requires a full understanding of the interaction between all constituencies --- mortgage lender, mezzanine lender, third party manager, and owner </li></ul></ul><ul><ul><li>Restructuring a distressed hotel asset also requires full appreciation for performance projections, cost and inventory control, and financial reporting </li></ul></ul><ul><ul><li>Restructuring or repositioning a hotel asset is effectively a restructuring of an operating business </li></ul></ul><ul><li>Cash is King </li></ul><ul><ul><li>A complete understanding of the places for entry of revenues into the operating hotel business, its deployment by the initial party in control (the hotel manager or residential condominium sales machine), and the manner in which costs and expense are paid is an initial and paramount analysis </li></ul></ul><ul><ul><li>Secondly, the extent to which each of the parties in interest -- mortgage lender, mezzanine lenders, hotel manager, and owner -- has agreed to direct payment of the amounts available to debt service, expense or distribution through cash management agreements is essential </li></ul></ul>
  29. 29. The Troublesome Triangle – Hotel Manager, Lender, Potential Acquiror <ul><li>Three players triangulate any hotel restructure: Hotel Manager, Lender, and Potential Acquiror </li></ul><ul><li>The Hotel Manager </li></ul><ul><ul><li>Typically a national or international operator of hotels and resorts, commonly know by the name of the brand each has created and exploited: Hilton, Marriott, Wyndham, or in the case of Starwood, &quot;W,&quot; St. Regis or Sheraton. </li></ul></ul><ul><ul><li>These national brand managers (for simplicity here, a &quot;Brand Manager&quot;) share several characteristics. First, through a document known as the Management Agreement, executed between the Hotel Owner and the Brand Manager, the Hotel Owner grants to the Brand Manager the authority to enter into possession of the hotel and operate and manage the facility. The Management Agreement gives the Manager broad authority, as an independent contractor, to undertake all activities necessary or appropriate to manage the hotel as a &quot;Brand Manager&quot; hotel, all at the sole cost and expense of the Hotel Owner, subject only to specific (but narrow) rights of the Hotel Owner to approve an annual budget and certain costs and expenses. In exchange for these activities, the Brand Manager receives a base fee, typically 2-4% of gross revenues, and an incentive management fee, which is typically a percentage (10%-20%) of the hotel's adjusted gross operating profit. </li></ul></ul>
  30. 30. Manager Issues <ul><li>The Hotel Manager through the base management fee, is compensated for running the Hotel and permitting the use of its name, technology, reservation systems, and other practices and proprietary expertise which together create the signature of the Brand Manager. The incentive management fee is a profit sharing mechanism designed to incentivize the manager to achieve success on behalf of the Hotel Owner, and to share in the rewards. </li></ul><ul><li>The Hotel Manager occupies a central but conflicted role in the triangle necessary to operate and finance a hotel. While in theory the only party to whom they are legally obligated to respond is the Hotel Owner, the counterparty to the Management Agreement, the practical world of financing (and the power of the golden rule) resulted in mortgage lenders and mezzanine lenders taking active interest in the review and performance of the asset. </li></ul><ul><li>The chief negotiated protection of mortgage lenders and the mezzanine lender is a perfected security interest in the revenues derived from the operation of the hotel. The chief objective of the Hotel Manager is to limit the ability of a mortgage lender and any mezzanine lender from receiving any portion of the revenues generated from the hotel until all operating expenses, and the Hotel Manager's base fee, and in many cases, incentive management fees, are paid. </li></ul><ul><li>This order of priority of payment naturally subordinates the payment of debt service to the expenses of owning and operating the hotel and the compensation of the Hotel Manager. </li></ul>
  31. 31. Lender Objectives <ul><li>Objective: The Lender (or in most cases, a lender group consisting of a mortgage lender and various senior and junior tiers of mezzanine lender) restructures the cash flow to create additional cash available for debt service throughout the capital stack </li></ul><ul><li>First, the Lender will analyze the Hotel Management Agreement in conjunction with the mortgage loan documents and the mezzanine loan documents to determine: </li></ul><ul><ul><li>All sources of cash flow from the operation of the facility; </li></ul></ul><ul><ul><li>Order of priority of payment of operating expenses, if any, including lienable items, employee taxes and withholding, and payment of management fees; </li></ul></ul><ul><ul><li>Determination of reserve accounts mandated by Hotel Management Agreement, and Loan Documents, and any &quot;cross over&quot; or &quot;duplication&quot; that the documents may include; </li></ul></ul><ul><ul><li>Steps to access amounts in excess of operating expenses; </li></ul></ul><ul><ul><li>Location of the Hotel Manager's credit card deposit systems and location of cash payments received through credit card providers (i.e., how are the individual unit and hotel accounts maintained); </li></ul></ul><ul><ul><li>Potential &quot;leakage&quot; of cash from system; and </li></ul></ul><ul><ul><li>Elements of sell down, if applicable, of residential condominium units, or income stream, if any, from rental of hotel condominium units </li></ul></ul>
  32. 32. Lender Objectives (continued) <ul><li>Once the Lender has located all sources of revenue, it then looks to determine if there are any steps that can be taken to revise and realign the expense of operating the hotel. This step requires the collaboration of the Hotel Manager. The Hotel Manager is cautious on all steps relating to its control of operating standards </li></ul><ul><li>If successful, additional cash has been made available for the payment of debt service. If cash is not available, then negotiations between the Lender, Owner, and Hotel Manager are required to determine if any revision to the payment of management fees, the injection of a capital contribution, or the deferral or suspension of certain payments or fees can be made. </li></ul><ul><li>If unsuccessful, the hotel may be the subject of receivership or foreclosure proceedings, or possibly a bankruptcy. In each instance, the Lender, Hotel Manager, and interested third parties have been reading the Subordination, NonDisturbance and Attornment Agreement executed by the Hotel Manager, Lender, and Hotel Owner at the time of the mortgage loan financing, and possibly a &quot;Recognition Agreement&quot; benefiting one or more members of the additional tiers of mezzanine financing </li></ul>
  33. 33. Intersection: Lender and Acquiring Party <ul><li>A Subordination, NonDisturbance and Attornment Agreement (&quot;SNDA&quot;) with an existing Hotel Manager and the Lender may significantly affect the ability of the Lender to deal with the hotel location, as a hotel asset or as an alternative use, following an unsuccessful cash restructure. Depending upon the negotiating power of the Hotel Manager at the time of the closing of the financing, the SNDA may permit the Hotel Manager to remain in possession, operating the hotel without challenge following the Lender's exercise of remedies with few contractual rights to terminate the Hotel Manager's services. </li></ul><ul><li>The SNDA may also require parties accepting title to the location by or through the Lender to respect the Hotel Management Agreement and permit the operation of the hotel in accordance with the terms of the Management Agreement. This continuity of operation requires a careful review of operating cost and expense risk allocation and liability, as in some cases a Lender will seek to limit its liability as to past operating deficits incurred during the Owner's period of ownership which may then be &quot;tacked on&quot; or assumed by a future owner. </li></ul><ul><li>In some cases, the Lender may have reserved a right to acquire the Hotel Property from the Borrower upon default of the Loan, or negotiated rights of first refusal with respect to the property (consensual deed in lieu provisions) </li></ul>
  34. 34. Intersection: Lender and Acquiring Party (continued) <ul><li>In some cases, the Lender may have reserved a right to acquire the Hotel Property from the Borrower upon default of the Loan, or negotiated rights of first refusal with respect to the property (consensual deed in lieu provisions) </li></ul><ul><li>While the SNDA may be perceived as creating stability as to the future operation of the Property following a foreclosure, the SNDA may be counterproductive to the extent it restricts marketability of the property if the &quot;highest and best use&quot; is no longer a hotel </li></ul><ul><li>In the current market, the facts are further complicated by the licensing agreement that may be in place with regard to the marketing and sale of condominium units at the hotel location. Typically the right to name and brand the condominium units in the same family as the hotel brand requires the Hotel Management Agreement to remain in place </li></ul>
  35. 35. Intersection: Lender and Acquiring Party (continued) <ul><li>Hotel Management Agreements and SNDA agreements were traditionally regarded as executory agreement terminable in bankruptcy. Recent drafting provisions to the forms of SNDA and Hotel Management Agreements have attempted to circumvent this result by consensual agreements of the parties to refrain from treating the Hotel Management Agreements as executory. </li></ul><ul><li>Unlike other Loan Documents which terminate by operation of law or contract on the conclusion of a foreclosure or bankruptcy, the Hotel Management Agreement may prove in some circumstances the lone survivor. This fact is likely to create more legal and practical issues. </li></ul>
  36. 36. Lawyer Biographies
  37. 37. <ul><li>Charles Thornton concentrates his practice in matters related to real estate, including the negotiation of joint ventures, the representation of institutional providers of funds for real estate investment and development, the representation of developers of office, housing, retail and industrial properties, and purchase and sale, financing and leasing transactions. He serves as outside general counsel for real estate companies, advising on issues related to capital markets, governance and, working with tax, corporate and ERISA counsel in the Firm, the structure of investment vehicles and funds. </li></ul><ul><li>Mr. Thornton helped to found the Firm's San Francisco office in 1997, served as its first chair and is the chair of its real estate practice. He has been listed in The Best Lawyers in America for over 20 years, is listed in Chambers USA as a California Leading Lawyer and is designated as a Northern California Super Lawyer by Law and Politics and San Francisco Magazine . He is active in community affairs, currently serving as the Chair of the Board of the YMCA of San Francisco, a member of Lambda Alpha, active in fundraising for the Michigan Law School and a former member of the Executive Committee of the United Way of Los Angeles. </li></ul><ul><li>Current clients and selected recent transactions include: </li></ul><ul><li>The Morgan Stanley Real Estate Funds in their acquisition of the San Francisco office building portfolio of the Blackstone Group (formerly Equity Office Properties) (2007) </li></ul><ul><li>The Morgan Stanley Real Estate Funds in their acquisition of Glenborough Realty Trust (2006) </li></ul><ul><li>Lennar Corporation in its development of the former Hunters Point Shipyard, and adjacent Candlestick Point, in San Francisco (ongoing) </li></ul><ul><li>Rockwood Capital LLC affiliates in the acquisition, development and disposition of office and retail properties, including the development of the Nut Tree Village in Vacaville, California </li></ul><ul><li>Fairfield Residential LLC in financing, joint venture and governance matters </li></ul><ul><li>Chileno Bay Development Partners in joint venture, capital market and governance matters relating to a resort property near Cabo San Lucas, Mexico (ongoing) </li></ul><ul><li>Hines Interests in the acquisition, disposition and financing of office and development properties </li></ul><ul><li>Spear Street Capital in the formation of its real estate funds and the acquisition and disposition of office properties </li></ul><ul><li>IDS Realty in the formation, capitalization and governance of two joint ventures with the California State Teachers Retirement System </li></ul>Attorney Photo Here 2” height Charles V. Thornton Partner, San Francisco Office (415) 856-7001
  38. 38. <ul><li>Kevin Fisher advises financial institutions and companies in complex transactions with a focus on restructuring, insolvency and leveraged finance. He has represented private equity firms and hedge funds in structuring joint ventures as investment vehicles, acquisition finance matters and restructuring portfolio companies. Mr. Fisher has extensive experience in acting for creditors and debtors in cross-border transactions and restructuring matters. </li></ul><ul><li>Honors & Peer Recognition </li></ul><ul><li>Fellow, American College of Commercial Finance Lawyers </li></ul><ul><li>Member, American Law Institute </li></ul><ul><li>Leading Restructuring & Insolvency Lawyer, Euromoney </li></ul><ul><li>Recommended Banking & Finance Lawyer, PLC Which Lawyer </li></ul><ul><li>Recommended Lawyer, PLC’s Cross-Border Finance: Secured Lending Handbook </li></ul><ul><li>Listed in The Best Lawyers in America </li></ul><ul><li>Northern California Super Lawyer </li></ul><ul><li>Representative Engagements </li></ul><ul><li>Restructuring Transactions </li></ul><ul><li>Committee of Foreign Creditors in the SK Global restructuring - this matter was the first major case filed under Korea’s new insolvency regime and involved ancillary insolvency proceedings in the US, Japan and Europe </li></ul><ul><li>Canadian subsidiary of US independent power producer in Canadian insolvency proceedings </li></ul><ul><li>Rabobank as lender in the US and UK restructuring and insolvency proceedings of a multi-national agribusiness company </li></ul><ul><li>Agent bank in the restructuring of $700 million credit facility to a publicly traded company in the construction industry </li></ul><ul><li>Wells Fargo Bank in the restructuring of $250 million in indebtedness of a large agribusiness company and the deed-in-lieu acquisition of over 5,000 acres of farmland </li></ul><ul><li>Largest West Coast grower cooperative in out-of-court restructuring of over $1 billion in debt </li></ul><ul><li>The Bank of New York, as indenture trustee for bondholders, in various restructuring transactions and insolvency matters </li></ul><ul><li>National developer of apartment and condominium projects in restructuring many of its joint ventures and financings </li></ul><ul><li>Real estate developer in restructuring its residential development projects and debt obligations </li></ul><ul><li>Financing Transactions </li></ul><ul><li>MSREF in the $2.4 billion financing for its acquisition from Blackstone of EOP’s San Francisco office building portfolio </li></ul><ul><li>MSREF in the $1.7 billion acquisition and financing of Glenborough Realty Trust </li></ul><ul><li>MSREF in the $575 million acquisition and financing of the Maui Prince Hotel & Resort </li></ul><ul><li>Catholic Healthcare West in multiple loan and bond financings, including $1.2 billion credit facility to acquire its auction rate securities </li></ul><ul><li>UK-based hedge fund as borrower in a $750 million multi-currency credit facility </li></ul><ul><li>Hedge fund as lender in $130 million secured loan facility to gaming company </li></ul><ul><li>Hedge fund as mezzanine lender in real estate projects </li></ul><ul><li>Agent bank in $500 million secured acquisition finance facility to a timber company </li></ul><ul><li>Agent bank in $500 million secured multi-currency credit facility to a technology company </li></ul><ul><li>Agent bank in $375 million secured acquisition finance facility to a technology company </li></ul>Attorney Photo Here 2” height Kevin B. Fisher Partner, San Francisco Office (415) 856-7219
  39. 39. <ul><li>Stephen I. Berkman is a partner in the real estate practice of Paul Hastings’ San Francisco office. His practice primarily consists of representing institutional owners, investors and users of various types of real estate assets, both nationally and internationally. </li></ul><ul><li>Mr. Berkman has extensive experience representing buyers and sellers of major office, retail, apartment, industrial, gaming and hospitality projects, whether in single asset or portfolio transactions. He also spends significant time representing major corporate users of real estate, advising on headquarters and other facilities leasing, sale/leaseback transactions and disposition of excess property. As part of his real estate practice, Mr. Berkman has developed a specialty representing both major Internet companies and real estate developers with respect to the development, leasing and operation of data centers. </li></ul><ul><li>Representative clients include Alexandria Real Estate Equities, Citigroup, Harrah’s, IAC/InterActiveCorp, The McGraw-Hill Companies, and Yahoo! </li></ul><ul><li>Mr. Berkman has been named one of the leading lawyers in real estate by Chambers USA (2008). Prior to joining Paul Hastings, Mr. Berkman was named one of the &quot;Top 20 Under 40&quot; lawyers in California by both the San Francisco Daily Journal and the Los Angeles Daily Journal . </li></ul><ul><li>Mr. Berkman received his J.D. from the UCLA School of Law in 1992 and a B.S. in business administration, with honors, from the University of California at Berkeley in 1987. Mr. Berkman is a member of the State Bar of California. </li></ul>Attorney Photo Here 2” height Stephen I. Berkman Partner, San Francisco Office (415) 856-7215
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  41. 41. Our Offices For further information , you may visit our home page at or email us at [email_address] . Brussels Avenue Louise 480 Boîte 5B 1050 Brussels, Belgium Telephone: +32 2 641 7460 Facsimile: +32 2 641 7461 Frankfurt Siesmayerstrasse 21 D-60323 Frankfurt am Main, Germany Telephone: +49 69 907485 0 Facsimile: +49 69 907485 499 London Ten Bishops Square, 8th Floor London E1 6EG United Kingdom Telephone: +44 203 023 5100 Facsimile: +44 203 023 5109 Milan Via Palestro, 24 20122 Milan, Italy Telephone: +39 02 30414 000 Facsimile: +39 02 30414 005 Paris 96, boulevard Haussmann 75008 Paris, France Telephone: +33 1 42 99 04 50 Facsimile: +33 1 45 63 91 49 Beijing 19/F, Yintai Center Office Tower 2 Jianguomenwai Avenue Chaoyang District Beijing, 100022 China Telephone: +86 10 8567 5300 Facsimile: +86 10 8567 5400 Hong Kong 22/F, Bank of China Tower 1 Garden Road Hong Kong Telephone: +852 2867 1288 Facsimile: +852 2526 2119 Shanghai 35/F Park Place 1601 Nanjing West Road Shanghai, 200040 China Telephone: +86 21 6103 2900 Facsimile: +86 21 6103 2990 Tokyo Ark Mori Building – 34F 12-32 Akasaka 1-chome Minato-Ku, Tokyo 107-6034, Japan Telephone: +81 3 6229 6100 Facsimile: +81 3 6229 7100 Palo Alto 1117 S. California Avenue Palo Alto, CA 94304 Telephone: +1 650 320 1800 Facsimile : +1 650 320 1900 San Diego 4747 Executive Drive, 12th floor San Diego, CA 92121 Telephone: +1 858 458 3000 Facsimile: +1 858 458 3005 San Francisco 55 Second Street, 24th Floor San Francisco, CA 94105 Telephone: +1 415 856 7000 Facsimile: +1 415 856 7100 Washington, D.C. 875 15th Street, N.W. Washington, DC 20005 Telephone: +1 202 551 1700 Facsimile: +1 202 551 1705 Atlanta 600 Peachtree Street, N.E. 24th Floor Atlanta, GA 30308 Telephone: +1 404 815 2400 Facsimile: +1 404 815 2424 Chicago 191 North Wacker Drive 30th Floor Chicago, IL 60606 Telephone: +1 312 499 6000 Facsimile: +1 312 499 6100 Los Angeles 515 S. Flower Street 25th Floor Los Angeles, CA 90071 Telephone: +1 213 683 6000 Facsimile: +1 213 627 0705 New York Park Avenue Tower 75 East 55th Street, 1st Floor New York, NY 10022 Telephone: +1 212 318 6000 Facsimile: +1 212 319 4090 Orange County 695 Town Center Drive, 17th Floor Costa Mesa, CA 92626 Telephone: +1 714 668 6200 Facsimile: +1 714 979 1921 EUROPE ASIA NORTH AMERICA