Real Estate

Real Estate Note Purchases

SettlePou’s Real Estate Section has, for the past few years, been very active in assisting its clients in acquiring real estate assets through opportunistic purchase of real estate secured promissory notes. In response to our clients’ inquiries we published three articles which detail the processes involved in these transactions in SettlePou’s periodic newsletters. We have consolidated these articles into this single publication for ease in understanding these processes.


Understanding Real Estate Secured Note Purchase Transactions

Since its inception in 1978, SettlePou has represented every imaginable type of party in real estate, lending, and commercial transactions. In that time, there has arguably never been a better environment for the opportunistic acquisition of real estate assets than the one that exists now. However, given the current status of the real estate and financial markets, parties seeking to take advantage of these circumstances must use non-traditional methods to acquire the real estate assets that they covet. One such method is through the purchase of notes secured by the desired real estate – whether commercial mortgage-backed securities (CMBS), commercial bank, or private notes.

SettlePou represents all manner of buyers in these transactions – from large private funds to individual investors. In evaluating a real estate secured note purchase, buyers must determine whether (a) the borrower and/or guarantors of the note being purchased are capable of honoring the terms of the note, and (b) the value of the property securing the note justifies purchasing a non-performing note (in the event that the purchaser ultimately forecloses on the borrower’s interest and becomes the owner of the property). Generally, for collateral to justify purchasing a non-performing note its value must exceed the amount paid for the note plus the expected incidental costs of acquiring the collateral under the terms of the loan documents.

A party investing in real estate secured notes must be prepared to wear two hats throughout the purchase process: that of (i) lender, and (ii) real estate investor. The due diligence associated with evaluating a note purchase must first determine the lender’s obligations and rights under the loan documents (including whether any further advances are due to the borrower), whether the borrower has any notice or cure rights which need to be addressed, and whether the lender has its full anticipated scope of remedies upon a borrower default, among other concerns and any lien priority issues. As a potential real estate investment, a proposed note purchaser must also address issues familiar to a more traditional real estate acquisition, such as title, environmental, and property management issues like leasing, among other issues.

The actual acquisitions process is fairly straightforward – at least in the initial stages – in that the purchaser will enter into a Note Purchase Agreement with a lender that has determined, for one of many reasons (including poor note performance, the note being under-secured, or pressure from regulators) that it must divest itself of the note. While the process has some similarities with a purchase and sale agreement that would be utilized in a traditional real estate transaction, there are also many differences. For example, a Note Purchase Agreement will often contain far fewer of the assurances to which purchasers of real estate are accustomed, for example, far fewer (if any) representations from the seller as to the status of the property.

In non-CMBS transactions, the loan files and documentation may be fairly bereft of records and historical data or have poor organization or retention of correspondence with the borrower, leading to lack of comfort as to the status of the property and, potentially, the note itself. In contrast, due to extensive regulation and oversight, CMBS transactions typically are more heavily detailed and complete in documentation, with up-to-date property records. This reality is one with which the note purchaser must become comfortable. However, the typical transaction generally involves a discount on the face value of the note, giving the purchaser an opportunity to offset the potential risk.

A carefully drafted Note Purchase Agreement is essential to ensuring a successful transaction.  The contract should provide for the seller’s unconditional agreement to sell the note and transfer its rights under all other loan documents relating to such note, including the loan agreement, deed of trust, assignment of leases and rents, all guaranties, and any other loan documents.  A purchaser must ensure that it can enforce the terms of the loan documents and exercise all remedies against the borrower, including foreclosure, deficiency collection, and actions against guarantors. 

The Note Purchase Agreement should contain certain provisions to specifically identify the interests assignable to purchaser. First, the agreement must clearly identify all loan documents and require that seller deliver such original loan documents at closing, including the seller’s loan file with all correspondence. The agreement must also provide for an assignment of the original lender’s title policy, for which purchaser will obtain a policy transfer endorsement from the title company.

As with a standard real estate purchase contract, the Note Purchase Agreement must identify an adequate inspection period in which the purchaser can perform all due diligence on the loan and property, and allow the purchaser to terminate the contract. The loan file must either be delivered to purchaser for review or made available for review at seller’s offices. To aid purchaser’s due diligence review, in addition to access to the loan files referenced above, the agreement should require delivery of seller’s existing property due diligence materials including a survey, copies of all leases, environmental reports, and other collateral assessment records.

Finally, the Note Purchase Agreement must provide certain protections to purchaser regarding the status of the loan. Ideally, the agreement will require the seller to deliver a certified payment history related to the note through the closing date and contain a provision whereby the seller represents and warrants: (a) that seller is the current owner of the note and there is no prior assignment to any third party, (b) that seller has no further financial obligations under the loan, such as further distributions or escrow requirements, and (c) that the note is free and clear of all claims and liabilities.

Understanding the key concerns and concepts involved in the purchase of a real estate secured note is only the first step. A potential purchaser must also understand the key differences between various types of note products, and be prepared for the possible paths that note ownership can follow after closing a purchase and how purchaser’s ability to exercise its rights as the new lender may be affected.

This article serves as the first in a series of three articles which will further address note purchase transactions. While this article addressed the general implications and structure of a note purchase transaction, part two of the series will address the processes and structure of both CMBS and standard commercial note purchase transactions. The third installment will address several common strategies used by note purchasers to realize a return on their investment, as well as potential pitfalls that can result.


CMBS Real Estate Secured Note Purchases


In the first installment of our three-part series of articles addressing the intricacies of real estate secured note purchase transactions, we addressed the general implications and structure of a note purchase. While the general framework we outlined in part one holds true for all note purchase transactions, prospective purchasers of commercial mortgage backed securities ("CMBS") notes must be aware of additional issues that make these transactions unique. In order to better understand how CMBS note purchases differ from standard portfolio loan purchases, one must first understand the structure of CMBS lending.


In a CMBS transaction, commercial mortgage loans of varying size, property type and location are pooled together and transferred to a trust. The trust then issues a series of bonds, which are purchased by investors, and each month the principal and interest payments received from all of the pooled loans is paid to the investors in tiers as bond payments based upon the priority of the investor’s bond. The document which controls how these loans are pooled, serviced, paid to the trust and otherwise handled is called the Pooling and Servicing Agreement ("PSA").


The primary party responsible for operating a CMBS pool is called the master servicer. The master servicer manages the flow of payments and information and is responsible for the ongoing interaction with each performing borrower. So long as the mortgages which make up the pool perform as intended, the trust will continue to operate under the Master Servicer. However, if a borrower fails to meet its payment obligations, or defaults under a separate covenant of its loan, the trust will assign that loan to a special servicer.


The special servicer is responsible for servicing the defaulted loans, whether such servicing involves a workout with the borrower, the acceleration of the debt, foreclosure of the lien, or the sale of the debt to a third party. Because purchasers of CMBS notes will generally be targeting defaulted loans, the special servicer will be the primary party with whom a purchaser interacts. In addition, one other party will have broad discretion over the fate of non-performing debt in the CMBS pool – the trustee.


Although the trustee’s primary role is to hold all the loan documents and distribute payments received from the master servicer to the bondholders, the trustee is often also given broad authority over the management of the loan pool under the PSA. Generally, the trustee will be an active party in the sale of any non-performing asset from the trust.


Purchases of CMBS notes can fall into one of two paths. First, CMBS pools often have classes of securities with certain prioritized rights, including a right of first refusal on the sale of any assets in the pool. If a priority investor elects to exercise its option, no other party will have the opportunity to purchase the non-performing asset. However, if the right of first refusal is assignable by the priority rights holder, a prospective note purchaser may be able to negotiate with the priority rights holder to have the purchase rights assigned to such prospective purchaser. In this scenario, certain notice requirements pursuant to the PSA must be satisfied and the special servicer and trustee will need to consent to the assignment of rights and ultimate sale of the note.


The second path results when no purchase option exists or, if it does exist, is not exercised. These sales tend to more closely mirror unsecuritized note sales. The special servicer will typically accept bids from prospective purchasers which account for not only the price of the note, but also the purchaser’s proposed due diligence timeline, requested representations from the seller, and other terms which will be unique to each offer. Once the bidding process has closed, the special servicer will consider the proposed offers and select a winning bidder. Upon approval from the trustee, the note purchase can begin in earnest, including any due diligence review and final closing document negotiations.


Once a transaction for the purchase of a CMBS note has closed, the purchaser is the holder of the note and the rights which accompany it. The note no longer has a CMBS character, because it is released from the confines of the PSA upon sale. A purchaser may proceed with post-acquisition activities as it would for any note which had never been part of a CMBS pool.


In the final installment of our three-part series on note purchases, we will evaluate the options available to a note purchaser post-purchase, highlight issues which can arise in servicing the note as its holder and in seeking to enforce rights in the property securing the note, and discuss some potential pitfalls for a note holder.


Real Estate Secured Note Purchases – You’ve Purchased the Note, Now What?


In the first two installments of our three-part series of articles addressing the various issues that arise in connection with real estate secured note purchase transactions, we first discussed the general framework and issues related to all note purchase transactions and then looked more specifically at issues unique to the purchase of commercial mortgage backed securities ("CMBS") notes. This article explores the options available following the acquisition of the note, and identifies some potential pitfalls that note purchasers should be prepared to address.


So, you’ve purchased a note secured by real property – what to do now? A purchaser acquires the note for any number of reasons, but it will (nearly) always lead to dealings with the borrower. Upon the completion of the note purchase, the purchaser typically sends the borrower a "hello" letter, putting the borrower on notice that the purchaser has purchased the note and providing the borrower with the contact information for payment and notice purposes pursuant to the loan documents. The purchaser will likely have determined how it intends to proceed with (or against) the borrower.


If the borrower declines to cure defaults and offers no agreeable methodology for settling claims, the primary option available to a note purchaser is to institute foreclosure proceedings to acquire title to the real property. A noteholder should be prepared for the borrower’s efforts to thwart lender’s attempts to secure its rights under the note such as seeking a restraining order or filing bankruptcy. Prior to undertaking foreclosure proceedings or other actions against the borrower, the noteholder should assure that it has analyzed all third party relationships and other property related matters (indeed, these activities are best undertaken prior to the purchase of the note as detailed in our prior newsletter articles). The completion of a foreclosure sale can, under certain circumstances, have unintended and potentially disastrous results. For example, certain leases may be terminated by a foreclosure unless preemptive actions are taken, thereby potentially impacting the value of the asset. If the noteholder has taken the proper precautions, it can exercise all of the remedies available by complying with all requirements imposed by the loan documents and applicable laws related to the foreclosure of real property, such as notices to borrower, filing of the foreclosure action, and undertaking the actual sale, for instance.


Immediately after the completion of a foreclosure sale, the noteholder will stand as the owner of the property and should immediately take all activities to secure the property and its valuable elements. For example, the noteholder (as the new "landlord" under any leases related to the property) should contact all tenants informing them of its acquisition of the property, directing that rent payments and notices to landlord be sent to the noteholder. In this regard, it is important to review the provisions of the leases prior to taking any actions to determine any specific language which needs to be included in the letter to assure that the leases are either retained or terminated pursuant to the specific case facts and desires of the landlord.

 It should be noted that dealing amicably with the borrower is often possible, and the particular circumstances of a relationship with the borrower may eventually lead to a settlement of a payment of the note at a discounted amount or a "friendly foreclosure" which will save all parties time, money and aggravation. An option available to all lenders is to determine if any workout can be achieved with the borrower. Given some of the pitfalls and delays which can be involved with the other options available to the purchaser, these types of borrower-friendly transactions can often be the best case scenario, as they can be more expeditious and economical than the more contentious alternatives.

We are hopeful that our three part series has been helpful in addressing the opportunities which can be realized in the acquisition of promissory notes which are secured by real property. The interested reader should understand that these articles have been general in scope given the depth of substance and the varying fact situations potentially involved in these transactions. We encourage any reader which has specific interest and inquiries to contact the authors at their convenience.

Author: By Jeffrey J. Porter and Jeff Mosteller 

Commercial Litigation Firm News

Rules of Civil Procedure: Potential Game-Changers


The Texas Rules of Civil Procedure (“TRCP”) and the Texas Civil Practice and Remedies Code (“CPRC”) are the predominant rulebooks for civil litigation in Texas state courts.  There are 822 rules in the TRCP that govern every stage of litigation, with many rules having numerous subparts and intricacies.  Likewise, the voluminous CPRC has many nuances affecting the outcome of civil lawsuits in Texas.
Generally every golfer, even a novice, will know the “major” rules of the game—how to keep score, how to penalize a ball hit out of bounds, etc.  But even some of the most experienced golfers are unfamiliar with rules that can lead to penalties or advantages on which success or failure can turn.
Like golfers, trial lawyers and many litigation-savvy parties know the “major” rules in the TRCP and CPRC—when to file an answer, what discovery is permissible, what is required for summary judgment, etc.  Familiarity with new, lesser-used, and nuanced rules of civil procedure, however, can give parties competitive advantages in litigation.
For example, Texas House Bill 274 (“HB 274”), enacted this past summer and effective as of September 1, 2011, broadens the availability of “interlocutory appeals,” those brought during the course of a lawsuit, before trial or even discovery.  Parties will now be able to file interlocutory appeals on controlling questions of law where the appeal “may materially advance the ultimate termination of the litigation.”  The new interlocutory appeal rules may help a party avoid the time and expense of full discovery and trial by having outcome-determinative legal issues finally decided through the court(s) of appeal.
Another significant change under HB 274 will be the adoption of “rules to provide for the dismissal of causes of action that have no basis in law or fact on motion and without evidence.”  The Texas Legislature has directed the Texas Supreme Court to adopt such rules (as part of the TRCP), although no deadline has been set and fairly broad discretion has been given on the mechanics of the new rules.  While the content and effective date of the new rules is thus uncertain, mandates in HB 274 ensure the new procedures will have a short time frame and will include a mandatory award of attorneys’ fees to the prevailing party.
HB 274 also imposes a new requirement for designating a “responsible third party”—a person or entity that is not actually made a defendant in the lawsuit, but whose responsibility a jury may consider in a comparative fault analysis thereby potentially reducing an actual party defendant’s liability exposure.  Specifically, a defendant cannot designate someone as a responsible third party if the defendant does not disclose the third party’s identity before the statute of limitations runs on claims against that party.  Failure to adhere to this requirement may prevent a defendant from taking advantage of the potential liability-reducing benefits of responsible third party practice.
In addition to new rules, some lesser-used and nuanced rules can afford parties significant advantages in litigation.  For example, Rule 167 of the TRCP puts in place settlement offer procedures that can make attorney’s fees and litigation costs recoverable where they might not otherwise be available.  For a more detailed discussion of Rule 167, please see Rule 167 Offers: Encouraging Early Settlement, by J. Allen Smith and Katherine L. Killingsworth, SettlePou Newsletter Volume 6, Issue 4, available at  Rule 167 was recently expanded by HB 274, which now allows a party to recover “reasonable deposition costs” in addition to attorneys’ fees, court costs, and reasonable fees for up to 2 testifying expert witnesses.
Other lesser-used and nuanced rules in the TRCP with potential strategic impacts include:
· Rule 1 – states that the purpose of the rules is to ensure that the parties receive a just, fair, equitable, and impartial adjudication of the rights.  This may serve as authority for equitable motions not specifically governed by other rules.
· Rule 6 – prohibits a lawsuit from being commenced or served on a Sunday.  This can be critical for default judgments or other issues related to perfecting service.
· Rule 12 – allows a party to challenge the authority of an attorney to represent a party and requires that the attorney respond by proving its authority to the Court.  This can be useful in cases where questions arise as to an opposing party’s actual authorization of an attorney to take certain actions on the party’s behalf.
· Rule 176.3 – states that a subpoena, when issued to a person or company that is not a party to the lawsuit, may not require the witness to appear or produce documents in a county more than 150 miles from where the witness resides or is served.  Given the size of the State of Texas, this can be an important limitation when either defending or prosecuting a lawsuit.  For instance, it can mean that a subpoena issued in Dallas would not be enforceable on a nonparty witness residing in San Antonio.  If the discovery deadline passes before the party issuing the subpoena realizes the error, the requested discovery could be prevented, which in certain instances could have a significant impact on the outcome of a case.
· Rule 202 – allows a person to obtain court permission to take a deposition to investigate a potential claim or in anticipation of a lawsuit, but before a suit is actually filed.  This rule can be very useful in obtaining information from third parties before a potential defendant is aware of a potential suit.
· Rule 263 – presents an alternative to a traditional trial by allowing parties to agree to the facts of a case in writing and submit those facts to the court for the judge to render judgment by applying the law to the agreed facts.  Although not practicable in every case, this rule can significantly reduce the time and expense of full litigation, can ensure judgment is rendered (which is not guaranteed with competing summary judgment motions), and can limit appellate issues.  For more detailed discussion of Rule 263, please see The Rule 263 Trial By Agreement, by J. Allen Smith and Bradley E. McLain, The Texas Lawyer Special Edition, Litigation and E-Discovery, April 18, 2011, Volume 27, Number 3, page 20; and A Trial Without Having a “Trial,” by Bradley E. McLain and J. Allen Smith, SettlePou Newsletter Volume 4, Issue 2, available at

By:  Michael R. Steinmark and Daniel P. Tobin



Firm News Insurance Defense

Update on Recent Insurance Law

There have been a number of recent court decisions which are of significance to the practice of insurance law. These include cases dealing with workers' compensation extra-contractual claims and lifetime benefits, the interpretation of "all risk" policies and toxic torts.

Always, each case involves different facts and law, and accordingly the following must be taken for general information purposes only, rather than for action upon any specific fact situation.

Workers' Compensation Insurance – Extra-Contractual Claims:  In Texas Mutual Insurance Company vs. Ruttiger, 08-0751 (Tex. 2011), the Texas Supreme Court examined earlier case law in light of Texas' current workers' compensation statutory scheme, and held that an injured worker has no claim under the Insurance Code against a workers' compensation insurer for unfair claim settlement practices.  However, the court also ruled that claims under the Insurance Code may be made by a plaintiff against an insurer for misrepresenting provisions of an insurer's policy of workers' compensation insurance.  Finally the court sent the case back to the intermediate court of appeals to determine whether or not the currently existing common law remedy for breach of the covenant of good faith and fair dealing ("bad faith") against a workers' compensation insurer should be overruled in light of the current workers' compensation statutory scheme.

"All Risks" Insurance Policy – Effect of Manuscript Deletions from Policy Form:  In The Houston Exploration Company and Offshore Specialty Fabricators, Inc., v. Wellington Underwriting Agencies, Ltd., 08-0890 (Tex. 2011), the Texas Supreme Court dealt with a London market "all risk" property damage insurance policy, wherein the parties thereto had manually stricken through, and thereby deleted, several provisions of the policy which would have otherwise provided coverage for certain items, e.g., coverage for certain "weather stand-by charges" in connection with damage to an offshore drilling platform.  In rejecting the insured's claims for coverage, the Texas Supreme Court held that deletions in a printed form agreement are indicative of the parties' intent, and that such changes in a printed form must be accorded special weight in construing the instrument.  For those reasons the court concluded that the manual deletion of the policy paragraph in dispute effected the removal of coverage for "weather stand-by charges" from the policy.

Pharmaceuticals – Products Liability – Toxic Torts – Causation:  In Merck & Co., Inc. v Garza, 09-0073 (Tex. 2011), the Texas Supreme Court discussed the evidence required to prove causation in products liability cases arising from pharmaceuticals in general and Vioxx in particular.  The Supreme Court revisited its decision in Merrill Dow Pharmaceuticals, Inc., v Havner, adhered to that decision, and held that properly designed and executed epidemiological studies may be part of the evidence supporting causation in a toxic tort case, but such studies must be analyzed closely by the court and such studies should show that there is at least a "doubling of the risk" between a pharmaceutical product and the claimed injury in order to satisfy Texas' "no evidence standard of review" as well as the plaintiff's burden of proof that the product in question "more likely than not" caused the injury.  A discussion of all aspects of this causation ruling is beyond the scope of this case note, but the court discusses in detail the required analysis of epidemiological studies which is required to validate such studies as proof of medical causation.

Workers' Compensation – Lifetime Income Benefits – Loss of Enumerated "Body Parts":  In Insurance Company of the State of Pennsylvania v Muro, 09-0340 (Tex. 2011), the Texas Supreme Court dealt with whether an award of lifetime income benefits could be made to an employee for loss of use of certain statutorily enumerated body part(s), where the loss of one's ability to use the enumerated body part(s) was not caused by physical loss to the specified body part itself, but is due to injury to a non-enumerated "body part."  In this case, the plaintiff claimed that injuries to her non-enumerated hips prevented her from walking normally, thereby effecting a loss of the use of her statutorily enumerated feet, entitling her to lifetime benefits for loss of her feet.  In reversing an award for the plaintiff, the Supreme Court noted expert trial testimony that the plaintiff's feet were "functioning fine" and "normal functioning" when taken alone.  Thus, the Supreme Court denied lifetime compensability, and stated that although "the injury to the statutory body part may be direct or indirect, … the injury must extend to and impair the statutory body part itself to … allow lifetime benefits."

By:  H. Norman Kinzy, Oliver B. Krejs, Kent D. Williamson