by Erich Paetsch, Chair, Financial Services Industry Group
In its semi-annual Monetary Policy Report to Congress, the Federal Reserve on February 19th issued a warning about insolvency risk to Congress. The Report identifies business leverage at historic highs given the economic and financial struggles firms have encountered due to COVID-19. In particular, the Federal Reserve highlighted risks tied to business bankruptcy and potential drops in commercial real estate prices. The Monetary Policy Report highlights that the economic impacts from COVID-19 and the social changes it created have not fully materialized.
Because of the systemic risks created by the pandemic, the importance of practical steps financial institutions can take today to avoid a loss of priority or a charge off election tomorrow is growing. For example, in the commercial real estate context, lenders should evaluate policies and practices surrounding landlord lien waivers, assignment of leases and rents, use and monitoring of covenants and subordination, nondisturbance, and attornment agreements.
Because many landlords delayed acting against distressed small businesses struggling to pay rent throughout the pandemic, the potential for a landlord lien claim looms large. At the same time, landlords may alter historic practices surrounding lien waiver requests due to increased economic pressures caused by underperforming tenant portfolios. Obtaining an agreed-upon form of subordination, attornment, and non-disturbance agreement can be difficult and time-consuming. In the current environment, however, doing so is an important tool to secure financing of tenant improvements, for example. Finally, it remains prudent to think beyond the value of the commercial real estate and consider the value of the performing tenant relationship to that real estate. Ensuring assignments of leases and documenting an assignment of rents has greater importance during periods of commercial real estate distress.
Outside of commercial real estate, a recent Oregon Supreme Court Case highlights the separate importance of monitoring liens and other notices to preserve and protect a lender’s priority position in pledged collateral. In Bank of New York Mellon Trust Co. v Sulejmanagic, the priorities between a trust deed and a condominium association lien were explored extensively. In a relatively unique factual situation, the Court determined that the presumption about the priority of a first position mortgage lien can be lost when certain conditions are satisfied.
The Oregon Supreme Court explored in detail the legislative history and policy considerations the Oregon legislature contemplated in creating the priority scheme surrounding condominium association liens. The Court noted that the legislature elected to provide an association lien with priority over all other liens and encumbrances, except tax liens and a first position mortgage or trust deed. Because lenders may lack an incentive to foreclose quickly during periods of decreasing property values, the legislature attempted to strike a balance by creating circumstances where an association lien can obtain priority over an existing first position mortgage or trust deed.
Under Oregon law, a lender’s priority is lost in certain circumstances. In essence, the legislature determined that lenders are not entitled to delay foreclosure and retain priority. The legislature did this by requiring an association to provide the lender 90 days written notice. If a lender fails to foreclose within 90 days of receipt of the notice, the association’s lien for unpaid assessments obtains priority over the lender.
The Oregon Supreme Court in the Sulejmanagic case evaluated whether the foreclosure activities of Bank of New York Mellon and its predecessors were sufficient to retain priority over the homeowner’s association lien of Tanglewood Hills Condominium Association. The Court ultimately found a prior foreclosure proceeding initiated by the lender before the 90-day notice was received from the association was insufficient to preserve the lender’s priority. Consequently, the association’s assessment lien obtained priority over the lender’s trust deed.
The recent opinion of the Oregon Supreme Court highlights the value of monitoring statutory lien and other notices received by lenders. The case provides a current reminder about the many lien statutes in Oregon that include notice provisions to lenders and the balance struck by the legislature under such statutes. In some cases, receipt of a required notice triggers obligations to act by the receiving lender, like the statutes discussed in Sulejmanagic. Actively monitoring lien notices, identifying the nature and type of statutory lien involved, and determining how such notices impact a lender’s priority in pledged collateral becomes increasingly important during periods of economic uncertainty.
The extent and areas of the economic impact caused by COVID-19 are slowly becoming more apparent. Reviewing existing policies and procedures in anticipation of the risks identified by the Federal Reserve today can help minimize risks to financial institutions from business bankruptcy and disruption in the commercial real estate markets.
Erich Paetsch is a partner in the Creditor’s Rights and Bankruptcy Practice Group and chair of the Financial Services Industry Group. The information in this article is not intended to provide legal advice. For professional consultation, please contact Erich at Saalfeld Griggs PC. 503.399.1070. © 2020 Saalfeld Griggs PC