A Subtle New Pitfall For Mezzanine Loan Borrowers

Commercial real manor financing structures often include not only mortgage loans but moreover mezzanine loans. These latter loans are secured by pledges of ownership interests in the mortgage borrower. If the mezzanine loan defaults, the mezzanine lender can foreclose on the ownership interests in the mortgage borrower. Through that foreclosure, the mezzanine lender, or sometimes a third party, will reap ownership of the mortgage borrower, keeping the mortgage in place. The new owner of the mortgage borrower will need to deal with the mortgage. Mezzanine loans withstand interest rates higher than mortgage loans considering they entail increasingly risk.

Mezzanine loans are, however, full of surprises. Here’s one that many people in the merchantry haven’t considered.

After a mezzanine loan foreclosure, the new owner of the mortgage borrower gains legal tenancy of everything the mortgage borrower owns. Although the mortgage borrower’s real manor is the main event, the mortgage borrower moreover owns all its past communications, including any with its attorneys.

Those communications may include juicy discussions well-nigh the mortgage loan and mortgage lender that the former (post-mezzanine-loan foreclosure) principals of the mortgage borrower would not want any lender or other third party to see. The former principals’ communications with counsel are probably covered by the attorney-client privilege – but the ownership of that privilege stays with the mortgage borrower. Whoever acquires ownership of the mortgage borrower through a mezzanine loan foreclosure will thus proceeds the legal right of wangle to all communications of the former principals of the mortgage borrower with their counsel. That can’t be good, and it could be very bad, for the former principals. For example, in the worst specimen the mortgage lender or its unite could end up owning the mortgage borrower and could use the former principals’ emails to support theories for recourse liability versus a guarantor.

The problem the former principals would squatter looks much like the problem potentially faced by sellers of a corporation’s stock. In a corporate stock sale, the proprietrix of the stock will obtain tenancy of the corporation’s attorney-client privilege and email archives, which could be worrisome for the sellers. But parties to corporate deals and their counsel are typically increasingly attuned to these issues than real manor players and their counsel tend to be.

Careful mortgage borrowers can try to pension the potential new owner “enemy” out of their pre-foreclosure communications by making sure the mezzanine loan documents contain towardly exclusions and waivers. Since a mezzanine lender will probably not think of those communications as valuable collateral, the lender just might unbend the borrower’s request. Then the borrower will need to reassure that, at the time of any foreclosure, all communications are safely vastitude the reach of any potential “enemy,” i.e., any new owner of the mortgage borrower.

Can the principals protect themselves by never having any communications on behalf of the mortgage borrower? The mortgage borrower doesn’t need to have an email account. All sensitive communications can go directly to and from the principals without visibly involving the mortgage borrower. If, however, any communications relate specifically to the mortgage borrower and its affairs, the principals will have trouble arguing that the mortgage borrower entity doesn’t own those communications. And the principals probably won’t unchangingly remember, or be able, to dress up communications related to the mortgage loan in ways that separate them from the mortgage borrower.

It’s safer to deal with the issue in the mezzanine loan documents, by protecting ownership and tenancy of any communications on behalf of the mortgage borrower and any attorney-client privilege that should travel with them.

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