NY's New Status Quo For Mezzanine Foreclosures

By Marc Hamroff and Danielle Marlow
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Law360 (April 5, 2021, 5:56 PM EDT) --
Marc Hamroff
Marc Hamroff
Danielle Marlow
Danielle Marlow
With the onslaught of the COVID-19 pandemic, lenders have sought means to address the growing number of pandemic-related defaults, including by means of Uniform Commercial Code Article 9 sales.

Such sales provide lenders with a nonjudicial means to sell the collateral securing the subject defaulting loans — often mezzanine financing. Such nonjudicial recourse has been invaluable to lenders during the many months of foreclosure bans during the pandemic.

In response, a number of borrowers have sought to enjoin or otherwise avoid such sales, including by bringing emergency motions seeking temporary restraining orders.

While during the spring and summer of 2020, such motions had some success — very much depending on the specific judge deciding motion — there has been significant change in the tide of the courts' views of UCC Article 9 sales, from the more critical view expressed by some courts over the spring and summer of 2020, to a view of decreased leniency and increased sympathy for the plight of lenders expressed during the fall of 2020 and the winter of 2021.

The most recent pronouncement by the New York Appellate Division, First Department, on March 3 in the case of Shelbourne BRF LLC v. SR 677 Bway LLC[1] now imposes an even more significant stumbling block in the path of borrowers seeking to delay or stop UCC Article 9 sales — by holding that under no circumstances can the threatened loss of equity interests securing mezzanine or other financing constitute irreparable harm.

This effectively means that it will be difficult, if not impossible, for borrowers to obtain a temporary restraining order enjoining a UCC Article 9 sale, as such borrowers will not be able to demonstrate irreparable harm — one of the three essential prerequisites for obtaining injunctive relief.

The First Department's Shelbourne decision reviewed the Aug. 3, 2020, ruling by Justice Jennifer Schecter of the New York State Supreme Court, New York County Commercial Division, enjoining a lender from conducting a UCC Article 9 sale — despite the borrower's clear default.

In her decision, Justice Schecter suggested that UCC Article 9 sales could never be fair during the pandemic, holding that: "Severe turmoil in the real estate market due to the pandemic makes the notion of a sale resulting in payment of fair market value highly uncertain" and "[b]ids will likely be discounted due to uncertainty about the continued length and severity of the pandemic."

This ruling certainly created significant concern among secured lenders, as it suggested they could not avail themselves of the tools provided by Article 9 during the pandemic.

Notably, in October 2020, when upon expiration of the temporary restraining order, the Shelbourne borrower again sought to enjoin the Article 9 sale, Justice Schecter reversed herself and denied the motion, noting the increased reopening following the prior shutdowns and the fact that mezzanine foreclosures were proceeding.

But notwithstanding this change in Justice Schecter's stance, the lender in Shelbourne appealed her prior August 2020 decision granting the injunction. The Appellate Division, First Department, reversed, noting that the threatened loss of the equity interests that were the subject of the UCC Article 9 sale does not constitute irreparable harm, as the loss of the equity interests could be compensated by money damages:

As to the propriety of the preliminary injunction, we find that plaintiffs failed to demonstrate the requisite irreparable harm. Notwithstanding the existence of the COVID-19 pandemic, the feared loss of an investment can be compensated in money damages (see Broadway 500 W. Monroe Mezz II LLC v Transwestern Mezzanine Realty Partners II, LLC, 80 AD3d 483 (1st Dept 2011).

The cited Broadway 500 case makes clear that the threatened sale of equity interests in an entity holding real property, as opposed to the threatened sale of real property itself, does not constitute irreparable harm:

Since "[plaintiffs'] interest in the real estate is commercial, and the harm [they] fear[] is the loss of [their] investment, as opposed to loss of [their] home or a unique piece of property in which [they have] an unquantifiable interest," they can be compensated by damages and therefore cannot demonstrate irreparable harm.[2]

Put simply, these decisions make clear that a borrower seeking to enjoin the sale of equity interests securing mezzanine or similar financing may never be able to obtain injunctive relief because the borrower cannot show the required threat of irreparable harm (which, in addition to likelihood of success on the merits and balance of the equities in the plaintiff's favor, are the three requirements for obtaining an injunction).

The Shelbourne decision has significant implications for borrowers and lenders alike. From the borrower's perspective, where the loan in question is secured by equity interests in an entity owning real estate, as opposed to real estate itself, borrowers will likely no longer be able to avail themselves of an injunction to avoid a threatened UCC Article 9 sale.

Even where the injunction is ultimately denied, the delay such motion practice provides is a valuable tool for borrowers — particularly where their inability to meet their obligations is only temporary.

Borrowers can and likely will still sue for damages where a borrower believes a UCC Article 9 sale was unwarranted because, for example, there was no event of default under the loan documents, or the UCC Article 9 sale was not conducted in a commercially reasonable manner as required.

But where the borrower does not have the means to wait until the sale is completed and then sue later, the unavailability of an injunction may also lead borrowers to seek refinancing and/or workouts more frequently and potentially earlier. In the worst-case scenario, the unavailability of an injunction in response to a UCC Article 9 sale may lead to more borrowers seeking Chapter 11 protection.

From the lender's perspective, the Shelbourne decision is certainly beneficial in that it would appear to preclude borrowers' ability to enjoin a UCC Article 9 sale.

But lenders need to be wary and ensure that any such sale is conducted in a commercially reasonable manner as required — including by providing significant notice of the sale, advertising the sale in well circulated periodicals, providing the ability for potential purchasers to review the underlying assets virtually, and providing the ability to participate in the ultimate auction virtually.

Otherwise, lenders may be subject to a claim for damages for failure to conduct the sale in a commercially reasonable manner. Such damages can consist of the difference between the price obtained for the equity interests and the proceeds that would have been obtained had the sale been conducted appropriately.

In addition, inflexibility among lenders could lead to increased bankruptcy filings, as borrowers may not see any alternative other than resorting to bankruptcy protection.

In sum, the Shelbourne decision may alter the relative bargaining stance of borrowers and lenders, particularly as the COVID-19 pandemic eases. Borrowers and lenders may need to alter their strategies when facing potential defaults in light of the fact that this decision effectively takes injunctive relief off the bargaining table.

Marc Hamroff and Danielle Marlow are partners at Moritt Hock & Hamroff LLP

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Shelbourne BRF LLC v. SR 677 Bway LLC Case No. 2020-03604.

[2] Broadway 500 W. Monroe Mezz II LLC , 80 AD3d 484.

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