Published February 12, 2010 California RE law , Real Estate Finance
As more borrowers default on commercial RE loans, more lenders are starting to sell either the defaulted notes or, after foreclosing on the property securing the loan, the REO (real estate owned) properties. These deals are typically “as is” deals, subject only to certain negotiated representations and warranties from the lender/seller to the buyer.
I thought it might be useful to outline some of the typical representations and warranties we’re seeing in these deals; and also to set forth a reminder about the due diligence that should be done by buyers so they know what they are getting, and don’t just become knife catchers. In today’s post, I’ve outlined typical reps and warranties. I’ll outline typical due diligence issues in the next post.
First, at the risk of stating the obvious, there’s a big difference between buying foreclosed REO and buying a distressed note. If you’re buying REO property, the borrower has already been foreclosed upon, and therefore you as buyer will not have to either foreclose the loan or take the risk that the borrower will file for bankruptcy. If you are buying a note, however, you as buyer are taking those risks. This means that a buyer of a note must take additional precautions and do additional diligence in order to make sure that the distressed note is actually worth what the buyer is willing to pay for it.
One way to determine the value of a distressed note, is to evaluate the market value of the underlying real estate collateral, then to take a discount from that in the amount estimated to reflect the likely cost to enforce the loan (possibly all the way through a borrower bankruptcy), adjusted by the likelihood that the borrower (and guarantors, if any) will fight the foreclosure. This requires both a business and a legal analysis — the latter to determine if there are any defects in the loan documents that would make the loan harder or easier to enforce.
In purchases and sales of distressed REO, the terms of the deal are basically like other purchases and sales of real estate, with a few exceptions. The seller of REO, typically a lender which has foreclosed upon the property, will not usually make a lot of representations about the property because it is not as knowledgeable as the typical seller — the lender’s position is usually that it made a loan, and will make representations about its ownership of the loan, but not about the underlying real property. So most sellers of REO will generally represent and warrant as follows:
1. that the lender/seller has the authority to enter into the sale of the REO, and that the agreement to sell the REO is enforceable against it;
2. that no interests in the REO have been previously conveyed to others by the lender/seller;
3. that there is no litigation concerning the REO other than as disclosed in writing in an exhibit to the purchase and sale agreement;
4. that the information provided by the lender/seller is true, complete and correct to the extent it has been created by the lender/seller (note that a lender/seller will usually provide copies of third party reports, such as environmental reports, but expressly will not accept liability for their accuracy — buyers need to either engage the provider of such original reports for downdates of them so that they can rely on such reports, or to have new reports done for them); and
5. other representations typical in CRE purchase and sales agreements may be included.
If a distressed note is being sold, rather than REO, additional representations of lender/seller may include:
6. that the lender/seller has provided to the buyer copies of all of the contents of its loan file, including all loan documents, modifications and copies of all correspondence relating to the loan;
7. that the lender/seller is selling the whole loan (or, if the sale is of part of a loan, what part);
8. that the lender/seller owns the distressed loan, and has not conveyed any interests in it to any third party (except as disclosed in writing in the agreement).
In both REO and distressed note sales, there may be more representations and warranties running from the buyer to the lender/seller than in a typical CRE purchase agreement. In a sale of REO property, in addition to the standard representations that the purchase contract is enforceable against the buyer and the buyer’s signatory has the authority to execute the contract, the following representations may be included:
1. that buyer has investigated and completed its due diligence on the property, and will rely only on that diligence in electing to purchase the property;
2. that the buyer expressly agrees its purchase of the REO is “as is, where is”;
3. that the buyer complies with the Patriot Act;
4. that the buyer is not an insider or affiliate of the lender/seller.
Sometimes in distressed note sales, a buyer will also represent that it is a sophisticated investor, and can bear the risks of purchasing a distressed note. These lists of representations are not exhaustive, but should give you an idea of the sorts of reps you’ll typically see in these deals.
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