January 29, 2014
Leasehold Mortgage vs. Collateral Assignment of Lease
by Starfield & Smith
If loan proceeds are to be used to finance existing or new improvements on a leased interest in land, the SOP 50 10 5(F) contains rather specific requirements as to the clauses that need to appear in the borrower’s ground lease. In most instances, a tenant/borrower under a long-term ground lease that intends to secure financing for construction or major renovations to the leased premises will be cognizant that its long-term ground lease has to be financeable, and that the ground lease must therefore contain certain provisions to protect the interests of any leasehold mortgagee. In a ground lease situation, where the tenant/borrower is developing the land with significant improvements (such as ground-up construction of a new building), its landlord should also understand from the start (i) that an encumbrance or lien on tenant’s/borrower’s interest in the ground lease will be conveyed to a lender as collateral for a loan to the tenant/borrower and (ii) that a leasehold mortgage or deed of trust will be required to allow the tenant/borrower to develop the improvements to the leased premises without spending all of its available assets. If the parties to a ground lease are aware that tenant/borrower intends to secure financing for construction or major renovations, commercial ground leases will typically include a provision that specifically allows the tenant/borrower to encumber all or any portion of its interest in the lease and the leasehold estate by mortgage, deed of trust or other security instrument upon obtaining the prior written consent of the landlord. Consequently, in the context of a tenant/borrower developed property under a ground lease, it is appropriate and much more likely that a lender can obtain a ground lease that meets the requirements of the SOP 50 10 5(F) and secure the loan with a leasehold mortgage.
In direct contrast to the ground lease situation, there are many instances where loan proceeds are to be used to finance existing or new improvements on a leased interest in a commercial property that is already improved (or will be improved) with a building or buildings that have been (or will be) constructed by a landlord with the intent of leasing out the building or buildings to one or more commercial tenants. In this situation, where the financing is typically for less significant improvements that fall with in a narrower scope of tenant’s/borrower’s fit out work for its unique use of the leased premises, it most likely not appropriate or possible for a leasehold mortgage to be placed on commercial property that has been already been (or will be) developed by a landlord. In the context of a landlord developed property, most likely neither tenant/borrower, nor its landlord will have anticipated that tenant’s leasehold interest will be encumbered with a leasehold mortgage and, consequently, a lease for a landlord developed property will not likely contain any provisions that protect the interests of a leasehold mortgagee. In fact, more likely than not, tenant/borrower in this context will be prohibited from encumbering its leasehold interest with any lien or any other encumbrance. To go back after the fact and try to get such protections in the lease for the benefit of a leasehold mortgagee can be difficulty, if not impossible, to obtain. The lender will have higher likelihood of success if, in the connect of a landlord developed property, it obtains a collateral assignment of the tenant’s/borrower’s lease and a waiver of landlord’s statutory lien on tenant’s trade fixtures, furnishings and equipment. Landlord’s waiver will allow the lender to enter the leased premises in the event of a tenant/borrower default under its loan in order to repossess tenant’s trade fixtures, furnishings and equipment. When coupled with a collateral assignment of lease, the lender will also have the right to occupy the leased premises and to subsequently assign tenant’s/borrower’s leasehold interest to a new tenant.
For more information regarding leasehold mortgages, please contact Joe at (215) 542-7070 or firstname.lastname@example.org.
Under a typical loan agreement, the lender provides cash to the borrower in exchange for a promise to pay the funds back with interest. The lender will typically also require some form of collateral as security for the promise to pay (i.e. if the borrower defaults on their obligation to pay, the lender gets to keep the collateral).
Most of the time the collateral is real estate encumbered by a lien of mortgage. It is also possible to pledge payments the borrower receives from a third party as collateral for their own loan. This becomes more clear in an example.
Collateral Assignment Example
John owns Lot 1. After purchasing the property, John borrows money from WP Investment Company and gives them a mortgage (lien on the real property) on Lot 1. This leaves WP Investment Co. with a security/asset/stream of payments coming in from John via the “Promissory Note” and lien of “Mortgage”. Let’s call John the “Original Borrower” and WP Investment Co. the “Original Lender”.
WP Investment Company owns Lot 72 – a risky commercial property. WP Investment Company is looking to borrow money from Bank of New York. The Bank is willing to loan WP money, but requires some additional security to compensate for the riskiness of the property. WP discloses that they have payments coming in from John (via the mortgage on Lot 1), and they’d be willing to pledge this to the Bank as additional security/collateral for the loan. Among other titles, WP would be known as the “Collateral Assignor” and Bank of New York would be both the “Collateral Assignee” and the “Collateral Lender”.
Keys to a Collateral Assignment
It is important to note that the Mortgage is not assigned to the Collateral Lender (it’s not an Assignment of Mortgage). Rather, the promissory note is what is assigned to the Collateral Lender (and should be physically delivered/possessed by them). This means that the loan is basically split in two, with the interest in the real property (Mortgage) remaining with the Original Lender and the personal property interest (Promissory Note) transferred to the Collateral Lender. Despite this (and as detailed below), satisfying and foreclosing the mortgage should be handled by both parties – as they both have interests in the underlying loan.
How to Satisfy a Collaterally Assigned Mortgage
There are two options when seeking to release a mortgage that has been subsequently collaterally assigned:
- Get a satisfaction of mortgage from both the Collateral Assignor and the Collateral Assignee. Both have an interest in the mortgage being satisfied, therefore, both are required to release it.
- Get a Collateral Assignment from the Collateral Assignee back to the Collateral Assignor (from Bank of New York back to WP Investment Co., in the above example). Then get the Satisfaction of Mortgage only from the original lender/Collateral Assignor (WP Investment Co, in the above example).
There are two foreclose scenarios to consider: 1) A default of the Original Borrower, or 2) A default of the Collateral Assignor.
A default of the Original Borrower will require both the Original Lender and the Collateral Lender/Assignee as co-plaintiffs to the foreclose proceedings. The property would then be either co-owned or divided pursuant to their interests in the real/personal property. Alternatively, the Collateral Lender could assign their interest back to the Original Lender – with the Original Lender then foreclosing out the property.
A default of the Collateral Assignor will not substantively affect the Mortgage. The Collateral Lender would be able to pursue its rights under the promissory note (under the Uniform Commercial Code, as the UCC governs personal property), possibly taking over the Original Lender’s interest in the Mortgage. This would leave the Mortgage still intact.
Insuring a Collateral Assignment of Mortgage
While the Collateral Lender/Collateral Assignee was not assigned the Mortgage, they do have an interest in it (as they hold the promissory note/obligation secured by the Mortgage). Therefore, the loan policy insuring the Mortgage may be endorsed or a new loan policy may be issued altogether. Most underwriters will allow either of the following:
- The Collateral Assignee to be listed as the only party insured. This would also require an exception for any rights the Collateral Assignor may have in the underlying mortgage.
- Both the Collateral Assignee and Collateral Assignor to be listed as the insured parties.
Collateral Assignment of Mortgage Form
Download a copy here.
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