INSIGHT: Dual Collateral—A Way to Avoid Foreclosures?

The reference to “dual collateral” sometimes called an “accommodation pledge” in connection with a mortgage loan does not refer to a mortgage secured by two separate pieces of real property. Rather this term relates to two different pieces of collateral obtained by a mortgage lender, one on the real property and the other on an equity interest in the borrower.

Typically, mortgage borrowers are single-asset entities consisting of either a limited liability company or a limited partnership. A mortgage lender taking “dual collateral” secures its loan with both a mortgage on the real estate owned by the borrowing entity and a pledge of the ownership interest in the borrowing entity. This form of double security only works when the borrower is not otherwise pledging its ownership interest to obtain additional mezzanine financing. It also is employed only in those states that provide that property financing is secured by a mortgage rather than a deed of trust.

The purpose of this dual security is to avoid undertaking a lengthy mortgage foreclosure process which can take a year or more. Instead, a Uniform Commerical Code foreclosure can be accomplished in within 30 to 60 days. In deed of trust states, a typical enforcement proceeding by the lender may take from several weeks to a few months obviating the need to try to accelerate the process with dual collateral.

In states requiring a mortgage foreclosure, a pledge of the borrower’s ownership interest allows a lender to pursue its remedies on an accelerated timetable. The UCC requires only 10 days’ notice to be given to the borrower following a default but typically a UCC foreclosure proceeding, which requires some form of publication, can be completed within 30 to 60 days.

The problem with a UCC foreclosure is that it does not extinguish liens or other title issues against the property: a situation not uncommon when there is distress in the project. However, once a lender acquires the ownership interest, it may be able to proceed with a judicial foreclosure action unopposed by the original borrowing party and dramatically reduce the time to complete such an action.

From a borrower’s perspective, there are two important negatives if a lender requires dual collateral.

First, it almost certainly extinguishes the borrower’s right to exercise its right of redemption recognized under state law: the right to pay off the lender and retain its property. In a typical judicial foreclosure, the borrower will have at least six months to a year to try to obtain alternative financing, either debt or equity, to protect its ownership in the property. Although a UCC proceeding also permits a right of redemption, this right exists only on paper. The truncated timeframe makes it virtually impossible to provide takeout financing.

Second, a mortgage foreclosure action is a proceeding in equity. A court must determine whether or not it is equitable to allow borrower’s equity to be extinguished by reason of some default under the financing arrangement. Therefore, it is improbable that a court would allow a foreclosure to proceed as a result of some minor default under the loan documents such as failure to provide financial statements. But a UCC foreclosure is a nonjudicial proceeding, there is no court involved, nor are there any principles barring the lender from proceeding for some minor failure to adhere to the loan documents.

In effect, dual collateral allows the lender to make an end-run around the mortgage foreclosure statute. A state which has determined that there is significance in protecting a borrower’s equity and equity of redemption should not permit the use of dual collateral. This appears to be another in the line of attempts employed by lenders for generations to try to avoid foreclosure such as taking a deed to secure a debt or entering into a contract for deed as the borrower pays the purchase price over several years. In both cases, lenders’ attempts to claim ownership, upon the borrower failure to make all payments when due, were rebuffed with a requirement to foreclose. Similarly, dual collateral should be recognized for what it is, an artifice, to avoid complying with state foreclosure laws.

Case law in this area is almost nonexistent. In HH Cincinnati Textile LP v. Acres Capital Servicing LLC, the court allowed a UCC foreclosure when the lender also had a mortgage loan in place. Although this case was hailed by those favoring dual collateral, a recent case from the same court involving the same principal parties, HH Mark Twain LP v. Acres Capital Servicing LLC, has opened the door to a reconsideration of the result.

This column doesn’t necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.

Author Information

Marty, Florida Bar Board Certified in Condominium and Planned Land Development, represents developers, lenders, borrowers, landlords and tenants in all aspects of commercial real estate. He services clients throughout the entire development process, from land acquisition and financing to leasing and debt restructuring. Additionally, Marty has been constantly at the forefront of reshaping Florida’s condominium law.