April 1, 2020
BUYING AND SELLING PERFORMING AND NON-PERFORMING MORTGAGE LOANS A DUE DILIGENCE CHECKLIST
Banks are anticipating an increase in residential and commercial mortgage loan defaults related to the covid-19 pandemic crisis and lenders shall be forced to sell non-performing loans to cover such losses related to consumer and business defaults.
By Hugo Dorta, Founder + Principal of Brickell Capital
Brickell Capital represents many private investors in the sale and purchase of performing (and non-performing) mortgage loans, and in this regard, this article shall serve as a helpful guide and due diligence checklist for private investors. Therefore, when selling and purchasing performing (and non-performing) loans, sellers and buyers must keep in mind the following issues:
1. Business Relationship. The parties must first consider the nature of the loan transaction … will there be just one transaction, or will there be a series of loan transactions in the future? If the parties contemplate the sale and purchase of multiple mortgage loans in the future,then the parties should consider implementing a master loan agreement that shall dictate the terms and conditions that shall apply to all future transactions between the Buyer and the Seller. A properly written Master Agreement should establish the role and responsibilities of the Seller (and Servicer), identify all Seller warranties and guaranties, indicate the Seller(or Servicer’s) obligation to provide servicer advances (of any nature) and identify all possible conflict of interests and scenarios to prevent future disputes and disagreements between the parties.
2. Establish the Nature of the Interest Sold or Purchased. The parties should identify the nature of the interest being assigned to the Buyer (i.e., whether one hundred percent or less is being sold or transferred, and whether the Seller shall retain any rights and interest in the mortgage loan sold, such as servicing rights). If Seller retains any interest in the mortgage loan, the parties should consider signing additional documents (for example, inter-creditor agreement, co-lender agreement, or participation agreement) to establish rights and responsibilities, loan administration, lien rights, right to purchase in the event borrower defaults.
3. Servicing Rights. The Seller and Buyer should decide which party shall service the mortgage loan and whether the Seller will retain any servicing rights and obligations, or in the alternative, shall the rights be transferred, or released, to the Buyer. It should be clear whether the loan shall be sold with “servicing-retained” or “servicing-released”. In either case, parties need to document their arrangement and agree on the nature of the loan servicing and servicing fees. In this regard, we always recommend that the parties sign a separate Trade Confirmation Agreement that establishes the rights and responsibilities for each mortgage loan sold (or transferred).
4. Buyer’s “Good Faith” Deposit. Regarding the Sale and Purchase Agreement, the Buyer and Seller must determine whether the Buyer shall be required to tender a “good faith” deposit. If a buyer deposit is required, the parties need to establish how it will be delivered and returned if the Buyer decides not to purchase the mortgage loan. In this regard, we propose an alternative option, which is for the parties to foregothe deposit altogether and agree to a “sign and close” purchase and sale agreement where all the loan documents are signed, and monies are exchanged at closing.
5. Representations and Warranties. Due to the nature of mortgage loans and how affirmative defenses can affect the outcome in a mortgage foreclosure, it would be prudent for the parties to discuss and establish their respective representations and warranties at the beginning of the transactions. In this regard, identifying the extent of the Seller’s representations and warranties, allows the parties to ascertain certain assurances and liabilities and avoid costly litigation. Moreover,discussing the type and extent of representations and warranties allows the parties to determine whether the Buyer shall receive formal, corporate-level representations and warranties, or a minimum level of representations and warranties in the transaction. Finally, the parties should discuss the post-closing duration of the Seller’s representations and warranties and the Buyer’s remedies if, after closing, the representations and warranties are breached.
6. Loan Document File. During the due diligence period, Seller should provide Buyer with full access to the loan document folder for the Buyer to inspect all the loan documents folder and other pertinent information and documents related to the sale and purchase transaction. Well-organized document folders shall facilitate the Buyer’s due diligence process. The Seller, as well as any other entity on the Seller’s side, such as a loan broker should make sure that the document folder includes all legal, title policies, and insurance documents as well as appraisal, environmental and zoning reports. For non-performing loan transactions, Seller should include default letters and litigation pleadings, if any, providing a complete document folder to the Buyer shall also serve as a defense to any future claim that Seller failed to disclose any information certain pertinent information or documents regarding the loan.
7. Transferability. Before selling or purchasing a mortgage loan, parties should make sure that the mortgage loan in question can be freely transferred to a third party. Although the majority of mortgage loans are freely transferable, under some circumstances (for example, mezzanine loans, B-Notes) can contain restrictions limiting their transferability.
8. Due Diligence Considerations. As part of the due diligence inspection, it is prudent to seek estoppel certificates from existing borrowers confirming the terms and conditions of the loan, the outstanding mortgage balances, and whether any claims, waivers, or affirmative defenses exist between the parties. In addition, since the Buyer shall be responsible for litigating any future affirmative defenses alleged by the borrower, it is usually practical to conduct a name, lien and judgment search of the borrower to assess the borrower’s past litigation and bankruptcy history.
Conclusion
Dueto COVID-19 and the unpredictability surrounding the financial markets and specific asset classes (i.e., hotels, retail, etc.), we anticipate potential opportunities to arise in the purchase of performing (and non-performing mortgage loans). Lastly, while not exhaustive, this article and the issues discussed shall serve as a preliminary guideline that sellers and buyers should consider when selling or buying performing (or non-performing) mortgage loans.
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Hugo Dorta, the author of this article, is the Founder and Principal of Brickell Capital.
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For the last 3 years, Brickell Capital was voted “Top 20” Commercial Lenders and Brokers by the South Florida Business Journal (South Florida’s leading news outlet for residential and commercial real estate, banking, finance and business news).
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