Since the start of the COVID-19 pandemic, borrowers and lenders alike have sought clarity regarding the permissibility of UCC foreclosure sales in the midst of the ongoing pandemic and the resulting economic fallout, as courts continue to grapple with vague legislation and the question of whether or not a "commercially reasonable" sale (a requirement for disposition of collateral under the UCC) is plausible under current circumstances. A recent decision by the Appellate Division, First Department ("First Department"), however, should provide a sliver of hope for mezzanine lenders seeking to proceed with a UCC foreclosure sale during these challenging times.
In August 2020, the New York Supreme Court issued a preliminary injunction to preclude a mezzanine lender from proceeding with the UCC foreclosure of membership interests in the owner of an office building in Albany, New York, citing an Administrative Order issued by the New York Court of Appeals on July 23, 2020 that prohibited residential and commercial foreclosure sales through October 15, 2020 (Shelbourne BRF LLC v. SR 677 BWAY LLC (New York Supreme Court, Aug. 3, 2020)).
Though the Administrative Order did not expressly apply to UCC foreclosure sales, the New York Supreme Court found that "valuation of an equity interest in a company that owns real estate is based on the value of the real estate itself," and UCC foreclosures should therefore not be treated separately from traditional mortgage foreclosures. In reaching its decision, the court further reasoned that the borrowers would suffer "irreparable harm" if the sale was to proceed and they lost their membership interests, particularly as a result of potentially discounted bids due to the uncertainty surrounding the real estate market.
While a finding of "irreparable harm" is a requirement to obtain a preliminary injunction, the First Department (the appellate court) previously held in Broadway 500 W. Monroe Mezz II LLC v. Transwestern Mezzanine Realty Partners II, LLC, 80 A.D.3d 483, 915 N.Y.S.2d 248 (1st Dept. 2011), that membership interests in an LLC were commercial investments, the loss of which could - unlike the loss of a "home or a unique piece of property in which [the owner has] an unquantifiable interest" - be compensated in money damages, and plaintiffs were therefore unable to demonstrate that they would suffer "irreparable harm" if their interests were disposed of through a UCC foreclosure sale.
The lower court Shelbourne decision also came as a departure from an earlier case during the pandemic, 1248 Assoc. Mezz II LLC v. 12E48 Mezz II LLC (New York Supreme Court, May 18, 2020), in which the court permitted a UCC foreclosure to proceed on the grounds that the plaintiff property owner's "anticipation of economic damage resulting from the noticing, the manner, or timing of the sale, particularly in light of the current economic shutdown and restrictions on travel as a result of the COVID-19 pandemic, [was] merely speculative," and could be properly remedied following the sale.
The First Department ultimately reversed the lower court Shelbourne decision earlier this month, finding that the preliminary injunction was unwarranted as plaintiffs had failed to demonstrate the requisite "irreparable harm." Citing Broadway 500 West Monroe Mezz II, the court held that "[n]otwithstanding the existence of the COVID-19 pandemic, the feared loss of an investment can be compensated in money damages." The case suggests that uncertainty in the real estate market as a result of the pandemic should not play into the court's analysis of or support a finding of irreparable harm. While the reversal provides some additional clarity for mezzanine lenders, few decisions have been rendered on the topic to date, and lenders would be wise to continue to proceed with caution.
We will continue to monitor court cases related to foreclosures of mortgage and mezzanine loans and will provide further updates on any noteworthy decisions in such cases.
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
© Morrison & Foerster LLP. All rights reserved