Real Property & Environmental Law Alert : New Jersey, New York, Pennsylvania & Delaware Lawyers & Attorneys for Real Estate Development & Environmental Law

Indeed, that’s precisely the response to Question 22:

22. Q: Suppose the purchaser is unsure if the bulk sale statute applies to her transaction? What should she do?

A: When in doubt, file a completed bulk sale C-9600 form notice in a timely manner. This does not automatically mean that the Division will treat the transfer as falling within the bulk sale law, but it guarantees that the purchaser will not incur any tax liability of the seller for failure to comply with the notice provisions of the law.

Process

The expanded FAQs and responses address many issues including some relating to process and many related to substance. On the process side, of particular note is the Division’s position that the Division has ten business days to reply to a bulk sale notice notwithstanding that the statute says that a reply must be forthcoming in ten days (see FAQ 13 and response). The extension in the reply period afforded by counting business days can be important in deals where, for example, the contract has provisions tied to the timeliness of the Division’s response to a bulk sales notice.

Deed in Lieu

In our last post on the Bulk Sales Act, we noted that in the normal course, there will be little question about whether or not a given transaction is covered by the Bulk Sales Act, and how much consideration is being paid for the transfer.

However, a conveyance by deed in lieu of foreclosure is not a typical real estate transaction between a willing seller and buyer paying a fair market price for the property in question. Therefore, the question arises: does the Bulk Sales Act apply when a borrower conveys title to realty to a lender by deed in lieu of foreclosure? We cautioned against relying on instinct suggesting not.

The expanded FAQs and responses directly address foreclosures and deeds in lieu.

54. Q: Is a foreclosure considered a bulk sale?

A: In a formal foreclosure process, a sheriff’s deed is used to transfer assets to a transferee free and clear without encumbrances. However, a deed in lieu of foreclosure is a conveyance from the actual title owner to the mortgagee, and thus, if the property is or has been used for income producing purposes, it is considered a bulk sale transfer requiring proper and timely notice to the Division from the mortgagee.

In our prior post, we asked the question:

If the Division of Taxation requires the transferee/lender to hold money in escrow to cover the transferor/borrower’s tax liability, including by way of example past due taxes, where will money come from to be held in escrow?

Again, the expanded FAQs and responses are somewhat informative:

30. Q: What if there are no proceeds from the sale or the proceeds are insufficient to meet the escrow amount required by the Division?

A: The bulk sale statute cannot protect a purchaser if he fails to follow procedures prescribed by the bulk sale section. However, the Division will determine escrow amounts to be held based on all the facts as presented by the parties.

Ordinary Course of Business

The Bulk Sales Act does not apply to transactions in the ordinary course of business. Many have asked what that means, and some have argued that if you are in the real estate business, all your transactions, or at least all sales, are in the ordinary course of business.

The expanded FAQs and responses attempt to address this issue:

4. Q: What is considered “in the ordinary course of business?”

A: It is a term whose exact meaning is determined by the type of business being conducted.

Three examples follow including one that provides that a developer who builds houses to sell on a regular day-to-day basis is not making a transfer subject to the statute if the developer sells a house it built.

A second example is the sale of pizza ovens by a pizzeria, which would fall under the statute because sale of food and beverages is the ordinary course of business, not selling appliances.

The third example is sale of a single residence that is rented, also deemed to be subject to the statute because the business is collecting rent, not selling the dwelling.

If there is a theme, perhaps it is that the “ordinary course” is the primary purpose of the endeavor.

Undoubtedly, there are many instances when “ordinary course” will be difficult to define. There will be cases where an endeavor pursues several different activities in the ordinary course, and there is no one, primary purpose.

Using the Division’s example of rental real estate, would the ordinary course exception apply if the property owner frequently bought and sold rental real estate?

The Division addresses this-possibly-in the following FAQ and response:

56. Q. Is a seller/title owner who buys for investment purposes and rehabilitates property not for rent and then sells it, selling in the ordinary course of business and thus subject to the bulk sales law?

A. If it is in the seller’s ordinary course of business to buy, rehabilitate and then sell properties (i.e. this is an activity that the seller does on a regular, as opposed to irregular, infrequent basis), then, generally speaking, these sales would not be subject to the reporting requirements of the bulk sales law. However, if in doubt, the buyer should file the C-9600 to obtain the protection against the potential of being liable for the seller’s tax liability.

Intent

So, if the seller derives no rental income, the statute should not apply (but what is meant by “generally speaking”?), but what if, in fact, the premises is rented for a period of time? Is the situation governed by the seller’s intent, i.e., if the property was bought to be rehabilitated and sold, and not to be rented, the statute does not apply although some rent was paid?

Intent can be tough to gauge and prove, but other responses to the FAQs suggest that it may be determinative. For example, the response to FAQ 51 states that “a title owner who is not ordinarily in the business of building new construction or selling real estate, may build new construction with the original intent of leasing it, which she does for six months. At the end of the six month lease, she decides to sell the property. She is not selling it in the ordinary course of business”.

The FAQs and responses cover lots of ground, include some surprises and provide plenty to consider going forward.

Russell B. Bershad is a Director in the Gibbons Real Property & Environmental Department.

The pricing of the loan sale undoubtedly will take into account the risk and hassle likely to be associated with collecting the loan, which will be significantly impacted by the availability of a deep pocket to pay the loan.

1. What is the reputation of the borrower and any guarantors? Is there a competent management team in place? You will want to run judgment and lien searches, bankruptcy and litigation searches, credit and other investigations to determine the ability of a borrower to repay the obligations.
2. Determine the nature and extent of personal liability for the loan. The borrower may have personal liability if the loan is recourse or even if it is non-recourse, to the extent of the carve outs, discussed below. However, most borrowers are single asset entities owning only the mortgaged premises, so the borrower’s personal liability is not giving the lender much of anything beyond what the lender already has by virtue of its mortgage collateral.
3. You may also have recourse under personal guaranties. Personal guaranties run the gamut from full recourse for the entire amount of the loan, partial recourse for a portion of the loan amount, recourse for completing construction in the case of a construction loan, recourse for environmental liabilities of the borrower and recourse for carve outs. You will scrutinize any personal guaranties to make sure they contain all the usual waivers of defenses and the like, and be particularly careful of partial guaranties to make sure the scope of liability is clear and unambiguous, which sometimes becomes an issue if not well drafted. For example, is a guaranty of fifty percent of the “loan” extinguished when half the loan is repaid, or does it remain outstanding for half of the unpaid principal balance until the loan is paid in full? As noted above, you will want to run judgment and lien searches, bankruptcy and litigation searches, credit and other investigations to determine the ability of a guarantor to repay the guaranteed obligations.
4. Few loans are completely non-recourse. Most so-called non-recourse loans have carve outs, i.e., exceptions to the non-recourse terms listing events that will result in personal liability of the borrower which, in turn, may be guaranteed by one or more guarantors. The carve outs can be very important if the borrower’s liability for breaching them is personally guaranteed, or in the unlikely event that the borrower has assets over and above the real estate collateral. Bankruptcy of the borrower is one of the most valuable carve outs if there is a deep pocket guarantor who most likely controls the borrower to a significant degree, because it reduces the likelihood of the borrower filing bankruptcy. Other carve outs similarly may be important, especially if and to the extent they impose liability for the full unpaid amount of the loan and not just for the actual losses resulting from breach of the carve outs.

B. Loan Status

The status of the loan, i.e., whether it is in default or not, and the stage to which it has progressed and the route taken to get there, is a consideration as critical as any others.

1. Is the loan in default? If so, how? Is the default material? What default notices are required by the loan documents? Have they been sent as required by the loan documents and do they conform with the requirements of the loan documents? Have notices been sent to guarantors? Has the lender elected to accelerate?
2. Are there other mortgage loans on the property? Are there intercreditor agreements? Mezzanine loans? Participants with the lender? What is the status of the foregoing?
3. Is the loan cross collateralized or cross defaulted with other loans? What is their status?
4. Have the lender and borrower entered into a pre-workout agreement? Have there been workout discussions?
5. Has the lender started exercising rights against the collateral? Does the lender collect or control rents?
6. Review the lender’s credit file, including internal memoranda. Review the loan administration history. Will loan officers be available as witnesses?
7. Is there any evidence that the borrower might be able to assert defenses to repayment? Has the lender exercised undue control over the borrower’s business or management? Has the lender agreed to forebear or conveyed a false sense of security to the borrower? The list of possible foreclosure defenses and lender liability claims is too long to enumerate here. It will be difficult at best to determine if any valid defenses or claims might exist based on a review of lender’s files, but you will want to be on the lookout for any evidence in the way of letters or notes that might suggest a problem.

Summary

In summary, due diligence on a distressed mortgage asset is akin to a doctor doing a physical on a patient. You may not have time to examine everything, you will not be able to get all the information that would be available when a loan is originated, you need focus on what is important first and report on issues. This is a diagnostic exercise; you cannot cure defects at this stage but you can evaluate them.

To the greatest extent you need to understand the status of the loan, the collateral, the borrower and any guarantors. You will then be able to assist your client effectively in strategizing how the asset can be dealt with if and when it is acquired and, bottom line, determining if the asset is worth buying at the price the lender is demanding or can obtain.

* Photo courtesy of Flickr.

Russell B. Bershad is a Director in the Gibbons Real Property & Environmental Department.

For an in-depth analysis of the expanded Act, see the article Peter Ulrich and I wrote for the New Jersey Law Journal, “Broad View of the Expansion of the Tax Bulk Sales Notification Requirements.”

In the normal course, there will be little question about whether or not a given transaction is covered by the Bulk Sales Act, and how much consideration is being paid for the transfer.

However, a conveyance by deed in lieu of foreclosure is not a typical real estate transaction between a willing seller and buyer paying a fair market price for the property in question. Therefore, the question arises: does the Bulk Sales Act apply when a borrower conveys title to realty to a lender by deed in lieu of foreclosure? Instinct suggests not, but don’t trust instinct in this case.

Prior to the expansion of the Bulk Sales tax provisions, there was a case that held that a conveyance of real estate from a borrower to a lender by deed in lieu of foreclosure constituted a covered transaction. New Jersey Hotel Holdings v. Director, Division of Taxation, 15 NJ Tax 428 (NJ Tax Ct. 1996). The Tax Court held that this was so even though an actual foreclosure would have extinguished the state's sales tax lien. The Tax Court found that the lender in fact gave up value in exchange for the deed in lieu and because the lender failed to file the required notice of transfer, it became liable for the borrower’s outstanding state tax liability.

So, following New Jersey Hotel Holdings, it can be expected that a deed in lieu is a transaction covered by the Bulk Sales Act, as expanded a few years ago.

Using a deed in lieu in a transaction raises two questions:

1. What does the transferee/lender state as the consideration on form C-9600 that must be filed when there is a covered transaction?
2. If the Division of Taxation requires the transferee/lender to hold money in escrow to cover the transferor/borrower’s tax liability, including by way of example past due taxes, where will money come from to be held in escrow?

Because a transferor/borrower that is giving up its realty by deed in lieu will rarely if ever be in a position to post money in escrow to cover any tax liability as required by the Division of Taxation in reply to the filing of a C-9600, the net effect if the Division insists on escrows may be to compel lenders to complete foreclosures rather than taking deeds in lieu.

Russell B. Bershad is a Director in the Gibbons Real Property & Environmental Department.