Mezzanine Foreclosures in the Time of Coronavirus: Chapter 2

May 12, 2020

As a follow up to our OnPoint from last week, Mezzanine Foreclosures in the Time of Coronavirus, regarding a New York County Supreme Court’s halting of a mezzanine UCC foreclosure sale, here is our promised update. 

In that case, 1248 Associates Mezz II LLC (“Borrower”) sought a stay to prevent the sale of various indirect pledged equity interests in the entity that owns the commercial property located at 12 East 48th Street in Manhattan. The Borrower alleged that the terms of the UCC sale were not commercially reasonable in light of the COVID-19 pandemic and that the New York Governor’s moratorium on foreclosures of commercial properties precludes a mezzanine sale under the UCC.

On Friday, May 8th, the foreclosing lender, 12E48 Mezz II LLC (“Lender”) filed an opposition memorandum, in which it asserted that a mezzanine “foreclosure” pursuant a non-judicial UCC sale is not subject to the restrictions on foreclosures in New York and the underlying mezzanine loan default predated (and was unrelated to) the pandemic.

In its response, the Lender specifically argued that a sale of equity interests under the UCC is not a “foreclosure” and that a pledge of equity interests is not a “mortgage”, and therefore, the sale is not prohibited under Executive Order 202.8. The Lender noted that “Executive Order No. 202 did not suspend the UCC, and did not create any restrictions on the exercise of contractual rights between private parties”. The Lender further asserted that its interpretation is consistent with the Governor’s directive to limit court operations to “essential matters”, pointing out that a UCC sale is not a court proceeding and therefore not a drain on judicial operations.

As an added plot twist, on May 7th Governor Cuomo issued Executive Order 202.28, which prohibits the “initiation of a proceeding or enforcement of . . . a foreclosure of any residential or commercial mortgage, for nonpayment of such mortgage . . . by someone that is . . . facing financial hardship due to the COIVD-19 pandemic”, for a period of 60 days beginning on June 20, 2020 (i.e., through August 19, 2020).

However, even if the Court were to hold that a UCC sale does constitute a “foreclosure” which is subject to the current 90 day moratorium, new Executive Order 202.28 may not apply. According to the Lender, the Borrower’s defaults relate to a failure to substantially complete the project (not payment defaults), and pre-date the COVID-19 situation by months.

For other lenders, however, new Executive Order 202.28 could have more significant implications as it explicitly prohibits the “initiation of any proceeding” as well as the enforcement of any foreclosure. This clarifies a gray zone in the previous order over whether the prohibition on foreclosures only applied to the completion (as opposed to commencement) of a foreclosure. If the Executive Orders on foreclosures are determined to extend to non-judicial UCC sales, it remains to be seen what step of the customary UCC sale process will be considered to be the “initiation” of the foreclosure.

The hearing remains scheduled for May 18th and the Borrower will no doubt submit a reply brief in advance of that date. Stay tuned for the next chapter in the saga.