Breakfast Presentation by POLSINELLI and Prime Finance to the Mortgage Bankers Association of New York

1. Mezzanine Finance:
Real Estate Loan Concepts and
Security and Intercreditor Issues

2. Mezzanine Finance
I. Basic Structure – What is Mezzanine Finance?
 A mezzanine loan is a loan by a Mezzanine
Lender to the corporate entity which owns
the Mortgage Borrower

3. Mezzanine Finance
I. Basic Structure – What is Mezzanine Finance?
 Typically, an LLC - Even if the Mortgage Borrower has a
number of investors, typically a Mezzanine Lender will
require the Mortgage Borrower to be dropped into to
a single purpose single member entity, preferably a
Delaware limited liability company which itself will be
owned by a single purpose single member limited
liability company.

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Basic Structure – What is Mezzanine Finance?

5. Mezzanine Finance
I. Basic Structure – What is Mezzanine Finance?
 Collateral - (i) a lien on any distributions by the
Mortgage Borrower to the Mezzanine Borrower and
(ii) a security interest in and pledge of the Mezzanine
Borrower’s ownership interest in the Mortgage
Borrower, including voting rights, which translates into
the value of the real property above the amount of
the mortgage loan commonly known as the “equity.”

6. Mezzanine Finance
I. Basic Structure – What is Mezzanine Finance?
 Known as a “Soft Loan” - has no direct pledge of the
mortgaged property, a “hard” asset, but instead has a
pledge of the ownership interests in the Mortgage
Borrower, a “soft” asset, the loan is typically categorized
as a “soft” money loan. The right to cash flow from the
Mezzanine Borrower not the ability to own or control the
“hard” asset is the source of repayment.

7. Mezzanine Finance
II. Loan Documents
A. The Loan Agreement
1. Loan Terms. Agreement will set amount, interest rate, maturity
date, and prepayment rights. In most cases a separate promissory note
is also used to evidence the amount of the loan but the material terms
will be contained within the Mezzanine Loan Agreement. In many
instances the Mezzanine Loan Agreement is duplicated from the
Mortgage Loan Agreement unless the parties have opted for specific
forms like a combined mortgage and mezzanine loan structure from
one lender.

8. Mezzanine Finance
II. Loan Documents
A. The Loan Agreement (Cont’d)
2. Covenants. The Mezzanine Loan Agreement will also contain
mortgage borrower level covenants typically found in mortgages.
These covenants will be documented as prohibitions against and
requirements by Mezzanine Borrower to cause or prevent specific acts
as the owner of Mortgage Borrower, respectively.

9. Mezzanine Finance
II. Loan Documents
A. The Loan Agreement (Cont’d)
The following are typical mezzanine covenants:
i. Prohibition on additional indebtedness;
ii. Requirement to make distribution of excess cash flow in
accordance with the Mezzanine Loan Agreement;
iii. Requirement to comply with standard property level
operational covenants; and
iv. Requirement to enter into and comply with cash
management with respect to excess proceeds and in
particular providing for all excess cash flow after payment
of debt service and operating expenses to go to a Mezzanine
Lender controlled lockbox;

10. Mezzanine Finance
II. Loan Documents
B. The Pledge and Security Agreement
1. An agreement by Mezzanine Borrower in
favor of Mezzanine Lender where the Mezzanine
Borrower pledges (the “Pledge”) its ownership
interests (typically 100%) in the Mortgage
Borrower (the “Collateral”) to Mezzanine
Lender.

11. Mezzanine Finance
II. Loan Documents
B. The Pledge and Security Agreement (cont’d)
2. Opt in to Art. 8 – Typically, a requirement to
Opt into Article 8 and require Mezzanine
Borrower to issue “physical” securities in the
membership interests in Mortgage Borrower so
Mezzanine Lender may perfect by possession
(Opt-in language included).

12. Mezzanine Finance
II. Loan Documents
B. The Pledge and Security Agreement (cont’d)
3. Control Agreement (form included) – a separate
control agreement can be added along with a
proxy/stock power and an irrevocable proxy (form
included). This is particularly important for
Delaware entities since Delaware law does not
include voting rights and control for the purpose of
pledged interests unless clearly specified.

13. Mezzanine Finance
II. Loan Documents
C. Environmental Indemnity Agreement
1. In many cases the Guarantors for the Mezzanine
Loan and the Mortgage Loan are the same. As a
result, the Mortgage Lender will typically require
the Mezzanine Lender to subordinate any claims
against the Guarantors under the Environmental
Indemnity to its claims until such time as the
Mortgage Lender has been paid off.

14. Mezzanine Finance
II. Loan Documents
D. Deposit Account Control Agreement (“DACA”)
1. Only necessary where Mezzanine Lender has set
up reserves at the Mezzanine Loan level. Typically,
where “hard” money management is used at the
Mortgage Loan level Mezzanine Lender will
negotiate a “bucket” for mezzanine loan debt
service to be paid out of the “waterfall” with excess
going to the Mezzanine Borrower.

15. Mezzanine Finance
II. Loan Documents
D. Deposit Account Control Agreement (“DACA”)
2. There also instances where DACA can spring
into effect in the event that “hard” or “soft”
money management is no longer maintained at
the Mortgage Level.

16. Mezzanine Finance
III. Title Insurance/UCC Policy
A. UCC-9 Policy (form included)
1. Mezzanine loan version of title insurance
2. Insures first priority security interest in mezzanine collateral
3. Insurance Provider will perform due diligence:
a. UCC searches
b. Review of loan documents and organizational documents
c. Confirm no other membership interest certificates outstanding
d. Confirm lender’s possession of membership interest certificate
4. Endorsements are available to delete certain standard exclusions from coverage
5. Should have UCC-9 insurer sign an escrow instruction letter similar to that signed
by the title company

17. Mezzanine Finance
III. Title Insurance/UCC Policy
B. Mezzanine Endorsement (form included)
1. Endorsement to Owner’s (not Lender’s) title insurance policy
2. Provides for the following:
a. assignment to Mezzanine Lender of the Owner’s right to receive
title insurance proceeds, up to an amount of outstanding mezzanine
indebtedness
b. no amendments to the Owner’s Policy are permitted without the
Mezzanine Lender’s consent
c. additional coverage for certain exclusions from coverage that apply
to the Owner, including non-imputation
d. agreement by title company not to deny liability on the ground
that ownership interests in the Owner have been transferred to
the Mezzanine Lender
3. Requires execution by Mezzanine Lender

18. Mezzanine Finance
IV. Perfection of Security Interest
A. In general, there are two (2) typical methods
of perfecting a security interest:
1. Perfection by Filing: Filing a UCC-1 Financing
Statement under Article 9 of the UCC
2. Perfection by Possession and Control of the
Collateral

19. Mezzanine Finance
IV. Perfection of Security Interest
B. In Mezzanine Financing, since the collateral consists
of a “general intangible” under the UCC, there are two (2)
ways to perfect a security interest in the Mezzanine
Collateral.
1. Method 1 : Filing under Article 9 of the UCC as
“Investment Property” within the meaning of §9-102
together with rights to proceeds, distributions, etc. It
requires the LLC agreement of Mortgage Borrower to
absolutely prohibit the issuance of physical interests since
physical possession under Article 8 takes priority over
perfection by filing under Article 9.

20. Mezzanine Finance
IV. Perfection of Security Interest
2. Method 2: Opting into Article 8 of the UCC
and perfecting by taking possession of the
Collateral as a “Security” within the meaning
of §8-102.
In Mezzanine Financing, we perfect our security
interest using both methods in order to ensure
“protected purchaser” status under the UCC.

21. Mezzanine Finance
V. Intercreditor Agreement
A. Parties – Mortgage Lender and Mezzanine
Lender (not Borrower)
B. Purpose – “provide for the relative priority”
and “evidence certain agreements”
C. Basic Structure of Agreement

22. Mezzanine Finance
V. Intercreditor Agreement (Cont’d)
C. Basic Structure of Agreement
1. Reps and warranties
2. Transfer provisions
3. Foreclosure of mezzanine collateral
4. Loan modifications
5. Subordination provisions; bankruptcy rights
6. Cure rights and purchase rights
7. Other agreements

23. Mezzanine Finance
VI. Enforcement
A. Special attention must be paid to the Intercreditor
Agreement
B. Key Considerations:
1. Is Mortgage Lender consent required to transfer the
Mezzanine Loan or any interest therein?
2. Is a Replacement guarantor required?
3. Who has the ability to exercise cure / purchase rights?
4. Does any modification of the Mezzanine Loan
Documents require consent of the Mortgage Lender?

24. Mezzanine Finance
VI. Enforcement
B. Exercise of Remedies
1. Loan Workout
2. Assignment in lieu / strict foreclosure
3. UCC Sale
4. Bankruptcy issues

25. Polsinelli provides this material for informational purposes only. The
material provided in this presentation is general and is not intended to be
legal advice. Nothing in this presentation should be relied upon or used
without consulting a lawyer to consider your specific circumstances,
possible changes to applicable laws, rules and regulations and other legal
issues. Receipt of this material does not establish an attorney-client
relationship.
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