Imagine this. Your institution, along with four others, purchased participation interests in a loan to a hotel secured by liens on all of the hotel’s real and personal property. So far you are thinking, “So what?”
Now imagine that the loan goes into default and the borrower surrenders its collateral to the lead. Nothing yet, huh?
Then the lead and the participants enter into a management agreement with a hotel management company. Still looks ok?
The lead on the eve of failure sells all of its right, title and interest to Bank2 via a quitclaim deed and then surrenders its assets to a trustee. Got your interest now? It gets more interesting.
Bank2 then brings an action against the trustee and the 5 participants seeking a declaratory judgment that Bank2 owns the entire fee interest in and to the hotel and its personality. To make matters worse, Bank2 acknowledges that it knew about the participations yet insists that its purchase was for the entire interest.
The question arises whether the participants merely had an interest in the payment intangible – the flow of funds and any funds to be derived from the liquidation of the collateral. Once the borrower surrendered the collateral to the lead, and the lead sold the collateral, did the participants retain an interest in the proceeds received by the lead or its trustee? Did they retain their undivided interest in the fee transferred to Bank2? Did Bank2 buy its interest free and clear of or subject to the interests of the participants?
These are the underlying facts and issues addressed in the March 2, 2017 decision of the Supreme Court of Iowa. Central Bank etc. v Thomas C. Hogan, as Trustee et al, 2017 WL 836824.
Central Bank (Bank2 in our intro) claimed that the participations were not true sales but instead merely a loan. The Court disagreed finding that the participation agreement contained the requisite indicia of a true sale.
It is also noteworthy that the lead sold its right, title and interest and not the entirety of the fee interest. Clearly the lead lender believed that it was buying the entirety and possibly paid a steep price for a roughly 55% undivided interest when it may have thought it was getting a bargain.
In November 2015, the FDIC published its Advisory on Effective Risk Management Practices for Purchased Loans and Purchased Loan Participations. That is a MUST READ for those of you trading in participations.
A significant case concerning the rights of participants and lenders has been pending in the Bankruptcy Court for the Eastern District of New York (in re Oak Rock Financial LLC). Oak Rock was a lender that borrowed funds from a syndicate of lenders and also sold participation interests to others. This litigious matter has already put down some significant decisions but the big question remains: were the participations subject to or free of the liens of the loan syndicate? You can expect to see more on these cyber pages once a decision comes down.
I am seeing more participation activity than I have seen in years. For quite a while it appeared that participations had given way to syndications – and after some ugly situations a decade or two ago, perhaps they should. Notwithstanding, lenders continue to sell and investors continue to buy participation interests.
If you want to learn more about participations I (and some really smart lawyer friends) will be presenting a webinar on the subject on Tuesday, March 21 at 1 pm ET. Register at Webinar (If you miss the live presentation it will be available on demand) or you can attend in person if you write to me at [email protected]