Wednesday, December 24, 2008

NYT: Loans on Distressed Properties Become a Burden and an Opportunity

Published: December 23, 2008

When the New York developer Harry B. Macklowe acquired the Drake Hotel almost three years ago and began buying up surrounding properties, market specialists expected him to include the site in a mammoth luxury office development.

Robert L. Freedman’s firm in Manhattan is forming a group to handle loan sales. “We are expecting a flurry of deals,” he said.

After the downturn in credit markets, however, Mr. Macklowe defaulted on his loans, and bidders are now vying for the Park Avenue site at fire-sale prices.

But the Drake site is not for sale directly. What is available is a $200 million mortgage for the swath of land, which covers a third of a city block between Park and Madison Avenues and 56th and 57th Streets. The buyer of this note will own a majority of the most senior piece of the debt, and so will most likely be paid back first should Mr. Macklowe have enough funds. If he defaults, the owner of the note will be in the best position to take ownership of the underlying property through a foreclosure.

This deal highlights a shift in the commercial real estate market, away from brick-and-mortar properties and toward the buying and selling of debt. “We are expecting a flurry of deals like the Drake Hotel site, where it is the loan that is for sale, not the actual real estate,” said Robert L. Freedman, the executive chairman of Williams Real Estate, a New York firm. The company is now creating a distressed-property group to handle such transactions.

During the real estate boom of recent years, developers increasingly used debt to finance their acquisitions. Now, with the market cooling, some of these borrowers are beginning to default. This is leaving lenders — including banks, private equity firms and hedge funds — in the position of owning the real estate.

Many lenders are looking to offload these loans because they need to cash out quickly, or because they are not in the business of selling real estate and lack the necessary resources and expertise. This means that commercial brokers, who regularly negotiated the acquisition and sale of properties, are now marketing mortgages and other loans.

“I am being inundated with calls from banks who want to sell their loans,” said David Schechtman, a senior director at the commercial brokerage firm Eastern Consolidated. “In just the last few weeks, I have also collected a list of about 30 clients — primarily high-net-worth individuals, long-established real estate families and small opportunity funds — who want to buy up these loans.”

As the market tumbles, the delinquency rate for bonds backed by commercial properties has surged. It measured 0.71 percent as of Dec. 5, compared with 0.26 percent a year earlier, according to the research firm Trepp L.L.C. While the actual number of defaults is still quite low, it is expected to increase.

“Loans don’t typically go into default immediately when there is a downturn in the market,” said Robert Knakal, the chairman of the brokerage firm Massey Knakal. “In the beginning, owners continue to make payments on their loans, hoping things will turn around, or if the loan is relatively new, it may have a significant interest reserve that is still carrying the note. So defaults on mortgages are a lagging indicator of market conditions.”

Despite this delay, there are early indications of an increase in loan sales. “Clearly, there has been a pickup in sales volume,” said David F. Dorros, a managing director at CB Richard Ellis.

To handle this uptick, brokerage firms like Eastern Consolidated are expanding their distressed-debt teams. Some firms are also requiring that their real estate brokers get broker-dealer licenses, which allows them to sell financial instruments.

Cash-rich developers and wealthy individuals are maneuvering to take advantage of the shift. Some are buying performing loans, where the borrower is continuing to pay interest on the debt. In this case, the buyer acquires the loan at a discount, but continues to receive interest payments. Then, when the loan comes due, the buyer is paid back the full face value.

Others are snatching up nonperforming loans, where the borrower has defaulted on the payments. In this case, patient buyers, including developers and private equity firms, may acquire the debt at a discount and eventually take ownership of the underlying real estate — usually after court action.

This is the strategy that the New York developer Time Equities Inc. is pursuing. “Rather than buying properties from conventional owners, we are looking to buy discounted debt on nonperforming properties,” said Francis J. Greenburger, the founder of the firm.

Time Equities is establishing a joint venture with the KOR Companies of Jersey City to buy nonperforming loans on land in the New York area, with an emphasis on New Jersey. It hopes to take ownership of the vacant sites at a discount, and develop them.

While there is a noticeable increase in this type of vulture investing, the buying and selling of commercial real estate loans is not a new strategy. CB Richard Ellis, for example, began a national loan sale advisory group five years ago.

“The business has become more visible now, but lenders have always understood it as a viable option to proactively manage their loan portfolios,” Mr. Dorros said.

In the current environment, however, the volume and complexity of deals are expected to be much greater than in the past because so many of the loans were grouped together and converted into bonds.

“The cash bind that many lenders are in is much more acute today than in the early 1990s,” when the previous major downturn in commercial real estate occurred, Mr. Knakal said.

As the market grows accustomed to the sale of loans, many eyes will be trained on the Drake Hotel site.

“It will set a floor price, establishing new benchmark metrics for the new economic realities,” Mr. Freedman said. “The Drake is just the tip of the iceberg; stay tuned, there is more to come.”

Copyright 2008 The New York Times Company. All rights reserved.

Monday, December 22, 2008

WSJ: Burned Investors Won't Find Strong Safety Net


Investors who lost money with Bernard Madoff shouldn't count on the Securities Investor Protection Corp. riding to their rescue.

The federally mandated SIPC has a narrow requirement as to what it covers -- generally theft in brokerage accounts.

Furthermore, securities attorneys say the nonprofit organization, which is supported by brokerages' membership fees, has a miserly track record of paying out claims and its current reserves may not be nearly big enough to handle potential losses from the Madoff case.

On Monday, SIPC started the process of liquidating Bernard L. Madoff Investment Securities LLC. The case is by far, the biggest one that SIPC has ever handled. Madoff reported that it held more than $17 billion at the start of this year.

Indeed, since its creation by Congress in 1970, SIPC has had to spend only $508 million to reimburse investors after recovering assets. The Madoff case alone is likely to dwarf that.
Ceiling on Coverage

SIPC covers losses up to $500,000 per customer, which includes $100,000 on claims for cash.

Virtually all broker dealers registered with the Securities and Exchange Commission are required to have SIPC coverage, and most brokerage firms carry excess coverage for losses above this amount.

When a brokerage firm files for bankruptcy, SIPC will typically step in to help transfer investors' holdings to another firm. With Madoff's firm, however, it's not likely that SIPC and the trustee will be able to transfer the customers accounts to a solvent brokerage firm. That means that it could be months, even years, before SIPC starts paying out claims, experts say.

"We don't have any faith or reliability in the firm's statements," says SIPC's president and chief executive Steve Harbeck.

"The individual victims will have to file claims asserting and proving what they gave to Madoff securities, and we'll have to compare that to records that we have on hand," Mr. Harbeck says. "We don't know how much people gave to this organization, and we don't know how much realistically they think they're owed."

Losses from theft and proven unauthorized trading are generally covered. Losses from fraud, churning or manipulation of stock prices are usually not. SIPC also doesn't cover investment losses or some holdings, such as currencies, hedge funds and limited partnerships not registered with the SEC.

"Our job is really elegantly simple: It's to return the contents of your account," says Mr. Harbeck.

Securities attorneys say SIPC often takes a narrow definition of what is covered by its statute, the Securities Investor Protection Act. "Literally, you have to prove that someone reached into your brokerage account and wrote a check to themselves," said Robert Uhl, a securities attorney in Beverly Hills, Calif.

Mark Maddox, an Indianapolis attorney, has represented about 300 investors from 1997 to 2001 who struggled to get SIPC to pay their claims after they lost money when the Stratton Oakmont brokerage firm filed for bankruptcy in 1997. Of those clients, he says that SIPC initially denied about 90% of his claims, forcing him to file appeals. In most cases, SIPC took the position that it would be responsible only for losses up to its $100,000 cash limit.

"SIPC doesn't like to pay claims and when they do pay a claim, they try to pay as little as possible," he says.

SIPC says only 349 customers through 2007 have failed to get their entire portfolios back.

Some industry watchers question whether SIPC has enough in reserves to cover potential claims in the Madoff liquidation. Currently, the SIPC Fund has about $1.6 billion to cover potential claims and SIPC can borrow up to $1 billion from an international consortium of banks and another $1 billion from the Securities and Exchange Commission.

"There are so many different things that we don't know that it's impossible to determine what the SIPC exposure is," says Mr. Harbeck.
Annual Fee: $150

SIPC's reserve is funded by its member brokerage firms, which all pay a flat fee of $150 a year. SIPC used to charge an assessment fee based on the firm's net operating revenues but moved to a flat annual fee of $150 in 1996 after its fund hit $1 billion.

SIPC's reserves are tiny compared to what's held by the Federal Deposit Insurance Corp., which covers bank deposits up to $250,000. The FDIC's reserves totaled $34.6 billion as of the third quarter. But SIPC says its coffers don't need to be big because brokerage firms are supposed to keep investors' stocks and bonds segregated from the firms' assets.

Banks, by contrast, lend out customers' money to other customers, who might default on those loans.

Now that SIPC has started the liquidation process, the court-appointed trustee will compile a mailing list of the company's customers. After the court has approved the claim forms and authorized the publication of notice, the trustee will mail out the claim forms to customers.

Investors will typically have six months to file their claims, which must be sent by certified mail, from the time the notice is published. Eventually, the trustee will set up a Web site with more information.

For now, any investors with brokerage accounts at Mr. Madoff's firm should save any documentation, such as monthly statements and investor reports going back as far as possible, says Steven Caruso, a securities attorney in New York.

"Those statements show what was supposed to be in your account or what the value was," says Mr. Caruso, who worked with about 500 investors to file claims with SIPC in the Stratton Oakmont case.

In many of those cases, his clients had to provide detailed paper trails -- such as documentation proving that they complained to the firm about unauthorized trades at the time of the trade -- in order to show that their trades were unauthorized.

Copyright 2008 News Corp. All rights reserved.

Friday, December 19, 2008

New York Times: Tax Rules for Theft Losses Could Help Some Investors

Published: December 18, 2008

For the legions of investors who appear to have been swindled by Bernard L. Madoff, there could be some relief.

Tax rules allow investors who fall prey to criminal theft perpetrated by their investment advisers or brokers to claim a tax deduction stemming from their losses.

The rules, which are intended to aid investors cheated through embezzlement, pyramid schemes, extortion or robbery, could potentially put hundreds of millions or even billions of dollars back into the pockets of Mr. Madoff’s stunned investors. They include the publishing magnate Mort Zuckerman; the owner of the New York Mets, Fred Wilpon; a foundation run by the filmmaker Steven Spielberg; and wealthy clients and banks from Palm Beach to Switzerland.

But it is unclear whether the Internal Revenue Service will see things that way. “We are aware of the situation, but beyond that, we have no comment,” Bruce Friedland, an I.R.S. spokesman, said on Thursday.

Gary A. Zwick, a tax lawyer at Walter & Haverfield in Cleveland, said, “It’s fair to say that many people will take the position that the theft loss rules will apply, but the government may not take that approach.”

Investors who can prove they were cheated may also be able to claim a refund for federal taxes paid over the last two years on “phantom” interest income from their investments with Mr. Madoff. But they cannot claim a refund for taxes paid on any capital paid back to them. Mr. Madoff, who was arrested last Thursday, ran what prosecutors contend is history’s largest Ponzi scheme.

On the tax front, a formal declaration that Mr. Madoff’s investment funds are bankrupt would help investors. “Embezzlement followed by bankruptcy is a pretty good indication that you’re not going to get your money back and will have a theft-loss claim,” said D. Matthew Richardson, a tax lawyer at Sheppard Mullin Richter & Hampton in Los Angeles. Mr. Madoff’s firm, Bernard L. Madoff Investment Securities, is currently being liquidated by a court-appointed trustee.

But before investors can claim the deduction, they have to clear a tall hurdle: they have to be reasonably certain that they will not recover their money. Proving that could take years, as investigators and regulators pore over Mr. Madoff’s books and a wave of lawsuits emerges.

It is unknown whether Mr. Madoff used investors’ money not just to pay early investors but also to stash in his personal bank accounts overseas or to underwrite a lavish lifestyle. Any such assets, as well as insurance, could be a source of recovery for investors — and could dilute any tax write-offs. The charities that fell victim to Mr. Madoff would not be eligible for any relief because they are exempt from taxes.

“I think it’s 100 percent certain that investors will get the theft-loss deduction, but nobody’s going to get it right away, and it may take five years,” said Alvin Brown, a tax lawyer and former manager in the I.R.S.’s chief of legal department.

Under theft-loss rules, investors can generally deduct 90 percent of their losses against their adjusted gross income, according to Robert Willens, a tax and accounting authority. Investors who argue that the loss arose from a for-profit transaction — the point of investing — may be able to deduct 100 percent. “Investors in programs sponsored by Mr. Bernard Madoff may find that their losses will be mitigated by certain ameliorative provisions of the tax code,” Mr. Willens said.

The rules permit losses stemming from theft to be deducted in the year in which the loss is discovered by the investor, even if it took place earlier. They also allow investors to carry back theft-losses for three years — one more year than under the rules for capital losses — and to carry losses forward for 20 years. Investors compute losses according to the adjusted basis in their investment, not the current fair-market value.

The theft-loss deduction is not the same as the more commonly used capital loss deduction, which applies to securities that decline in value.

In 2006, the I.R.S. processed more than 206,000 claims for theft-loss and casualty deductions — the I.R.S. groups the two — worth more than $5.1 billion. Claims filed under the Madoff scheme would most likely dwarf that dollar figure.

Copyright 2008 The New York Times Company. All rights reserved.

New York Times: In Madoff, Winners May Still Lose Out

Published: December 18, 2008

Amid the thousands of people caught up in the apparent multibillion-dollar fraud of Bernard L. Madoff, some investors stand out.

They made money.

One client said he invested more than $1 million with Mr. Madoff over a decade ago. As his portfolio rose in value, he took out several million dollars. While his statements showed several million dollars in his Madoff account when the fund collapsed last week, the client still ended up ahead.

How many clients of Bernard L. Madoff Investment Securities profited unwittingly on what Mr. Madoff described as a big Ponzi scheme isn’t known. But given the structure of Ponzi schemes, which use money from later investors to pay early investors, many longtime clients may actually have wound up ahead.

“In a Ponzi scheme, not all investors lose,” said Tamar Frankel, a law professor at Boston University who has written on Ponzi schemes. “Those who manage to get out in time retain their investments and some of their gains.”

But previous court rulings regarding financial frauds suggest the winners could be forced to give up some of their gains to losers.

One of the unanswered questions so far is precisely how much investors lost over all.

When Mr. Madoff confessed and was arrested last week, he told F.B.I. agents that the losses might be $50 billion, according to court filings. Various institutions and individuals so far have reported losses totaling more than $20 billion, but it is unclear how much of that is cash they actually invested and how much represents paper profits based on the falsified returns Mr. Madoff said investors were earning.

Mr. Madoff regularly delivered returns of 10 to 17 percent to investors, a very good year-in, year-out return but on the low end of the 10 to 100 percent a year typically dangled by promoters of Ponzi schemes.

But assets that can guarantee those returns year after year without risk simply do not exist. Instead of profitable investments, Ponzi schemes repay initial investors by raising more money from new investors. The schemes typically collapse when the promoter cannot bring in enough money to pay existing investors seeking redemptions.

Joel M. Cohen, the deputy head of litigation for the Clifford Chance law firm and a former federal prosecutor who specialized in business and securities fraud, said that payments to early investors were an integral part of any Ponzi scheme.

“You need to deliver returns in the range that you promised to attract investors,” Mr. Cohen said.

Yet even Mr. Madoff’s most fortunate clients may wind up having to give back some of their gains, as investors might have to do in another recent financial fraud, the collapse of the hedge fund Bayou Group in 2005.

In the Bayou case, in which investors lost $400 million, a bankruptcy judge ruled that investors who withdrew money even before Bayou collapsed might have to return their profits, and possibly some of the initial investments, to the bankruptcy trustee overseeing the unwinding of Bayou.

The returned money is to be distributed among all investors, who are expected to receive only about 20 to 40 percent of their original investments.

Mr. Madoff’s winning clients are likely to face similar legal challenges. In fact, the Madoff client who profited from his investment spoke on the condition that he not be identified, out of concern that he might be sought out to repay some of his gains to the receiver or bankruptcy trustee for Mr. Madoff.

Jay B. Gould, a former lawyer at the Securities and Exchange Commission who now runs the hedge funds practice at Pillsbury Winthrop Shaw Pittman, said the client was correct to be concerned. New York State law may allow the receiver or bankruptcy trustee to demand that Mr. Madoff’s investors return money they received from the scheme any time in the last six years, Mr. Gould said.

Such so-called clawbacks may occur even if the client had no idea that the gains were fraudulent, he said.

“The idea is that the whole thing was a fraudulent undertaking, so nobody should profit from it, and everybody should be put on equitable footing,” Mr. Gould said.

But in a sign of the complexity of securities law, Mr. Cohen said he did not agree with Mr. Gould’s interpretation.

“I don’t think it’s that easy to claw back money from something that happened six years ago,” Mr. Cohen said. “There’s no level of fiduciary duty between investors. If someone put in a million dollars five years ago, and made 11 percent, and took their money out after one year, are they required to give back the 11 percent? I think that’s inaccurate.”

Even determining which investors made money will be enormously complicated.

Mr. Madoff’s practices appear to have gone on for many years and entangled thousands, perhaps tens of thousands, of clients, who invested both directly with him and through third-party hedge funds. Some of those investors never took out a cent, while others took out only a fraction of what they invested and a few took out more than they put in.

Jesse Gottlieb, a life insurance broker in New York, said his account statements show that he had about $17 million at the Madoff firm when it collapsed.

Mr. Gottlieb declined to say how much cash he had invested, but he said he had taken out only a small amount of money from his investments with Mr. Madoff, which were held in trusts for his sons.

Mr. Gottlieb said he knew of other investors who regularly cashed out portions of their accounts. In most cases, they were retirees who left their principal with Mr. Madoff, but lived off the annual 10 to 17 percent returns he provided, Mr. Gottlieb said.

The complexity of situations like the one that Mr. Gottlieb described means that investors may wind up suing each other, as well as the hedge funds and banks that brought them into Mr. Madoff’s funds and the auditors who worked for those hedge funds.

“This is so big, and there are so many people situated differently,” Mr. Gould said. “Everybody is potentially averse to everybody else.”

Copyright 2008 The New York Times Company. All rights reserved.

Wednesday, December 17, 2008

Season's Greetings

President John F. Kennedy said “Change is the law of life.” And 2008 has been a year full of change-in the markets, in politics and in all of our lives.

In these uncertain and changing times, everyone at Shenwick & Associates wishes you and your family happy holidays. Wherever the changes of life take you, we will be there to help guide you through.

We hope you enjoy the warm spirit of this season with much joy in the coming year.

Wishing you the very best during the holidays and throughout the New Year.

Jim & Staff

Wednesday, December 03, 2008

New York Times: Manhattan Awash in Open Office Space

Square Feet


Last year, when the New York real estate market was still frothy, large blocks of office space were hard to come by. Not anymore.

Almost 16 million square feet is currently listed as available in large blocks in 68 office buildings in Manhattan, according to Colliers ABR, a commercial brokerage firm. That is nearly double the space available a year ago, both in terms of the number of large office blocks — which in New York usually means 100,000 square feet or more — and in terms of total square feet.

Those figures are widely expected to go much higher, said Robert L. Sammons, the managing director of research for Colliers ABR. He said it was difficult to get a handle on exactly how much space financial companies alone might put back onto the Manhattan office market over the next year or so.

“Honestly, I don’t think any of these financial firms know how this is going to play out,” he said. “They are trying to figure out how many people they will need on staff, and in some cases how they are going to stay in business.”

Pending layoffs in the financial industry certainly account for some of the space on the market. But there are other factors. Some companies are moving into new headquarters — which were first planned years ago — while others are disposing of real estate that they came into through acquisitions.

By far the biggest increase in availability has been in the sublease market. Currently, at least 16 large office blocks are being marketed for sublease in Manhattan, up from just 3 listed at this time last year, according to Colliers ABR.

Michael Colacino, the president of Studley, a real estate brokerage firm that specializes in representing office tenants, said the sublet space that had come onto the market recently was attractively priced.

He said some tenants might do better by shopping the sublet market rather than trying to renegotiate a better rent with their current landlords. “A lot of landlords are still in denial,” Mr. Colacino said, “but the sublease space is priced realistically for the actual market conditions.”

Mr. Colacino estimates that the actual rents on deals signed in the last three months are down by as much as 20 to 30 percent from the going rents at the end of the summer — to around $75 to $80 a square foot annually in Midtown and around $45 a square foot downtown.

Among current offerings — including both subleases and direct leases from owners — roughly a quarter of the space in the Midtown and downtown office markets became available because a financial company either did not renew its lease or decided to market the space for sublet.

But the picture could become much starker next year. Among large office blocks that brokers expect to hit the market, Mr. Sammons estimates that the financial industry will account for roughly one-third of the new space coming on the market in Midtown and more than half of the new space downtown.

Lehman Brothers, Merrill Lynch and Deutsche Bank all have leases that Mr. Sammons counted among the potential new listings of large office blocks. And that list does not include Citigroup — although the banking giant has announced that it will lay off more than 50,000 employees worldwide — because Mr. Sammons said it was too soon to know if Citigroup would give up any large office blocks in Manhattan.

So far this year, brokers say, the main event in Midtown has been the completion of One Bryant Park, a 54-story office tower that recently opened at the corner of 42nd Street and the Avenue of the Americas.

As the main tenant, Bank of America, which is based in Charlotte, N.C., moves employees into this new building, it is giving up earlier leases for hundreds of thousands of square feet in other prominent Midtown office buildings, like 9 West 57th Street. Brokers also widely expect the bank to offer for sublet more than 300,000 square feet that it currently leases in 50 Rockefeller Plaza.

JPMorgan Chase has already put some large blocks of space on the sublet market near its world headquarters, at 270 Park Avenue, between 47th and 48th Streets. Chase is marketing sublets for 140,000 square feet at 320 Park Avenue, and 195,000 square feet at 237 Park Avenue. The bank acquired the lease at 237 Park Avenue when it bought Bear Stearns in March.

Chase plans to keep the former Bear Stearns headquarters, though, which is at 383 Madison Avenue, between 46th and 47th Streets. Chase plans to move its investment banking unit into that building, which is just one block from its own headquarters.

“We are looking to make the most economical use of the space that we have for our employees, businesses and shareholders,” said Darlene Taylor, a spokeswoman for JPMorgan Chase.

Downtown, some large blocks of space are expected to become available late next year, when Goldman Sachs completes its new 2.1-million-square-foot 43-story world headquarters at 200 West Street in Battery Park City. When Goldman starts moving into its new building, it plans to allow earlier leases for more than 1.5 million square feet in Lower Manhattan to expire. The bank is also marketing for sublet 600,000 square feet of space that it leases at 77 Water Street.

There is also a great deal of speculation swirling around the ultimate destination of Merrill Lynch, which is to be acquired by Bank of America. The merger could close this month or early next year.

Some brokers suggest that Bank of America might decide to move Merrill Lynch from its headquarters at 4 World Financial Center, where Merrill leases 2.1 million square feet, to be closer to the bank’s new Bryant Park headquarters. If that happens, it would shift even more of the financial industry from Wall Street to Midtown, following what has been a long-term trend.

Copyright 2008 The New York Times Company. All rights reserved.

Tuesday, December 02, 2008

Unsecured Mortgages in Chapter 13 bankruptcy

In our current falling real estate market, Shenwick & Associates has been receiving many calls regarding saving homes from foreclosure. One possible solution may be Chapter 13 bankruptcy. In a Chapter 13 bankruptcy, an individual with regular income can retain their property and make installment payments to their creditors over a period of three to five years, if they have unsecured debt of less than $336,900 and secured debt of less than $1,010,650.

Due to declining real estate values, many homeowners (over 7.5 million, according to a recent CNN Money report) are “underwater”-in other words, the value of their property (the collateral) is less than the balance due on their mortgages. In 2001, the Second Circuit Court of Appeals held in Pond v. Farm Specialist Realty et al. (In re Pond), 252 F. 3d 122 (2d Cir. 2001), that an unsecured mortgagee’s interest in a Chapter 13 debtor’s principal residence is voidable where there is insufficient equity in the property to cover any portion of their lien.

The debtors, Richard and Lorrie Pond, filed for bankruptcy under Chapter 13 of the Bankruptcy Code in the U.S. Bankruptcy Court for the Northern District of New York. The Court held a hearing and determined that the debtors’ residential property was valued at $69,000. The Court also determined that there were four liens on the property, which had to be discharged in the following order of priority: (1) $1,505.18 for real property taxes; (2) $48,995.63 for the mortgage of the Farmers Home Administration; (3) $20,000 for the mortgage of the New York State Affordable Housing Corporation; and (4) $10,630.58 for the mortgage of Farm Specialist Realty and Charles Livingston, Jr. (the Defendants). The first three liens amounted to an encumbrance of $70,500.81, so the Ponds’ property had insufficient equity to cover any portion of the Defendants’ lien.

The Ponds then commenced an adversary proceeding to dissolve the Defendants’ lien under Section 1322(b)(2) of the Bankruptcy Code, which provides:

“A Chapter 13 plan may modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor's principal residence . . . .” (emphasis added)

The Ponds argued that the Defendants' lien was wholly unsecured under Section 506 of the Bankruptcy Code, which provides:

“An allowed claim of a creditor secured by a lien on property in which the estate has an interest . . . is a secured claim to the extent of the value of such creditor's interest in the estate's interest in such property, . . . and is an unsecured claim to the extent that the value of such creditor's interest . . . is less than the amount of such allowed claim. Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor's interest.”

The Bankruptcy Court held that defendants' lien could not be modified because, even though there was insufficient equity to cover any portion of the lien, the underlying security interest was the Debtors’ principal residential property, and, therefore, the lien was protected from modification under Section 1322(b)(2).

The U.S. District Court for the Northern District of New York reversed, holding that the statutory prohibition against modification does not apply to a holder of a wholly unsecured lien under Section 506, because such a lien is not "secured" by a residential property within the meaning of Section 1322 (b)(2). According to the District Court, the Defendants' lien was wholly "unsecured" under Section 506(a) because there was no equity in the Ponds’ property to cover the lien; therefore, the lien was not protected under the antimodification exception of Section 1322(b)(2) and could be voided.

The Defendants challenged this holding on appeal, and the 2nd Circuit Court of Appeals affirmed the District Court.

In its discussion of its holding, the Court reviewed the Supreme Court’s holding in Nobelman v. American Savings Bank, 508 U.S. 324 (1993), in which a Chapter 13 debtor sought to split a creditor's undersecured residential mortgage lien into a secured lien and an unsecured lien, so that only the secured portion of the mortgage was protected under the antimodification exception of Section 1322(b)(2).

The Supreme Court rejected that proposal, holding that, as long as some portion of the lien was secured by the residence, the creditor was a holder of "a claim secured only by . . . the debtor's principal residence," and its rights in the entire lien were protected under the antimodification exception. Accordingly, the debtors' Chapter 13 plan could not void the unsecured component of the creditor's mortgage lien.

However, the Nobelman opinion left open the issue presented in this case- namely, whether its holding extended to a holder of a wholly unsecured homestead lien. The issue has sharply divided Bankruptcy and District Courts, but the majority view (which the District Court adopted in this case, and the Second Circuit Court of Appeals affirmed) is that the antimodification exception of Section 1322(b)(22) applies only where a creditor's claim is at least partially secured under Section 506(a).

For more information about how Chapter 13 bankruptcy can protect your home, please contact Jim Shenwick.

Monday, December 01, 2008

New York Times: An End Run Around Realogy's Lenders


It was as badly timed a takeover as there was during the private equity boom.

At the end of 2006, Apollo Management, the private equity firm headed by Leon Black, agreed to buy Realogy, a conglomerate with a number of franchised real estate businesses, among them Century 21 and Coldwell Banker, for $7 billion in cash.

That was a few months after house prices peaked. By the next spring, when the deal closed, subprime mortgage lenders were starting to go broke. The great housing bubble was bursting, and that was very bad news for a company whose revenue was based on how many homes it could sell and how high the prices were.

Now a struggle is emerging over how the unfortunate lenders should be treated. Realogy, under the direction of Apollo, is using a classic divide-and-conquer strategy. Bondholders are screaming that the tactics are illegal.

The strategy is simple: Just tell one group of bondholders that they can move up in the capital structure (and thus be more likely to be paid if the company goes broke). But first, they have to agree to forget about collecting most of the money they are owed. They are being asked to trade in old bonds for new loans with much smaller face values.

Overindebted consumers can only look on with envy, wishing they could pull off something similar, perhaps by telling one credit card company that they will pay another card company first unless the first company agrees to forgive most of what it is owed.

No owner of Realogy bonds has to make the exchange, of course. But if a bondholder turns it down, and others do make the exchange, that bondholder may find that he is much farther back in line, with even less probability of being paid anything.

Part of what makes the tactic irritating is that it is being planned by the people who are supposed to be at the rear of the line in case of bankruptcy — the people who own the equity. In theory, they should not get anything unless all the creditors are first paid in full. In reality, they often can get away with changing the rules.

Realogy wants to make up to $650 million in debt disappear, trading $500 million of new loans for $1.15 billion of old bonds.

The new loans have no guarantee of being paid off, either, but they are not only senior to the old ones, they also mature a few months earlier. There is a possibility that the bondholders who refuse the deal will receive nothing in the end.

All this is possible because companies, in most cases, do not owe fiduciary duties to their bondholders, as they do to their creditors. This transaction is a contractual one, and if a tactic is allowed by the contract, the courts generally will not stop it.

Realogy claims it has the approval of senior creditors to issue more debt, and says that is all that is needed. Of course, those creditors have no reason to care. Their claims will remain senior to everyone else’s. It is sort of like getting Jimmy’s permission to hit Bobby. Bobby may not think Jimmy was the right person to ask.

Realogy has yet to violate the covenants on its bonds, but its business is suffering and it is reasonable to think that covenant violations are possible. Revenue so far this year is down 21 percent, and the company has not been able to cut costs that fast. Losses are rising.

One part of Realogy’s business is faring well. Revenue is soaring at a subsidiary that sells foreclosed homes. It reports that in the third quarter business was up 91 percent compared with a year earlier in the Sacramento area. But that is not enough to offset the growing problems in other operations.

The bonds are trading as if disaster is all but certain, all at prices under 20 cents on the dollar. Some of them are going for prices that assure a profit if the bond simply pays interest for the next 18 months before becoming totally worthless.

Realogy disclosed this week that a lawyer claiming to represent owners of a majority of one class of bonds had threatened to sue, arguing the offering violated bond indentures. The company did not identify the lawyer, but one person involved in the case said Carl C. Icahn, the financier, owned the bonds. Mr. Icahn declined to comment.

Realogy became an independent company in July 2006, just a few months before Apollo swooped in to buy it. It began trading when Cendant, a franchising conglomerate that had fought back from what was, before Enron, the largest accounting fraud in American history, split into four pieces.

Realogy was the only one of the four that worked out for shareholders, selling to Apollo for 19 percent more than the shares were worth just after the split-up. The other three — PHH, a mortgage services company; Wyndham Worldwide, which franchises hotel brands like Days Inn and Ramada; and Avis Budget, the car rental company — have all plunged in the recession. PHH, with a 72 percent decline, is the best performer of the three. Avis Budget, down 97 percent, is the worst.

As it turned out, Cendant split up not long before bad times arrived at virtually all of its businesses. Apollo, which did not see what was coming, now wants those who lent it money to share the pain.

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