ALI-ABA Course of Study Commercial Real Estate Defaults ...

57 

ALI-ABA Course of Study 

Commercial Real Estate Defaults, Workouts & Reorganizations 

April 20 - 22, 2006 

Hilton Head Island, South Carolina 

Real Estate Defaults Investigation Check List and Issue Summary 

for Lender's Counsel (Annotated) 

By 

Marvin Garfinkel 

Wolf, Block, Schorr and Solis-Cohen LLP 

Philadelphia, Pennsylvania 

Updated by 

Diana C. Liu 

Wolf, Block, Schorr and Solis-Cohen LLP 

Philadelphia, Pennsylvania 

© Copyright 1996 - 2002 Marvin Garfinkel. All rights reserved.

58 

REAL ESTATE DEFAULTS 

INVESTIGATION CHECK LIST AND 

ISSUE SUMMARY FOR LENDER'S COUNSEL (ANNOTATED) 1 

TABLE OF CONTENTS 

PAGE 

0.0...................................................................................................................Immediate Attention 

0.1 Collateral 

0.1.1 Primary Collateral 

0.1.2 Ancillary Collateral 

0.2 Conflicts Issues 

0.3 Letters of Credit 

0.4 Guarantees - Third Party Liability 

0.5 Notice Requirements 

0.6 File Assembly 

0.7 Environmental Risks 

0.8 Rent Assignment - Tenant Issues 

0.9 Information To Be Requested from Borrower 

0.10 Personal Liability 

0.11 Estoppel - Nondisturbance & Attornment 

0.12 Related Projects 

0.13 Lender's Past Experience with Borrower 

0.14 Participation Issues 

0.15 Existence of Default 

0.16 Wrap-Around Mortgages - Calculation of Deficiency 

0.17 Debt Assignment Notice 

0.18 Interim Advances from the Mortgage Lender 

0.19 Mortgagee in Possession and Receivership Issues 

0.20 Escrows 

0.21 Transfer Taxes on Foreclosure 

1.0 Parties 

1.1 Owner of Property 

1.2 Secured Creditors 

1.3 Unsecured Creditors 

1.4 Recorded and Potential Mechanics' Lien Claims 

1 This checklist is regularly updated by the author Marvin Garfinkel to reflect his own experience and that of users of 

this checklist. Comments are therefore solicited since this document is continuously being revised. At any time there 

may be incomplete references and footnotes, unofficial citations that should be superseded with official citations, etc. 

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1.5 Other Lenders and Participants 

1.6 Title Insurer 

1.7. Closing Attorneys 

1.8 Bonding Company 

1.9 Casualty and Property Loss Insurance Carriers of Borrower 

1.10 Tenants 

1.11 Guarantors 

1.12 Any F.D.I.C. or RTC 

1.13 Partners, Shareholders, Directors, and Officers of Owner 

1.13.1 Corporate Veil Piercing 

1.14 Lessors 

1.15 Appraisers 

2.0 Public Record Searches 

2.1 Title Reports and U.C.C. Searches 

2.2 Partnership and Other Entity Filings 

3.0 Document Assembly and Examination 

3.1 Mortgages, Deeds of Trust and Loan Agreements 

3.2 Notes and Other Evidences of Indebtedness 

3.3 Guarantees and Surety Documents 

3.4 Legal and Any Other Closing Opinions 

3.5 Closing Attorneys Summary of Transaction 

3.6 Construction Documents 

3.6.1 Cost To Complete Estimates 

3.6.2 Construction Quality 

3.6.3 Assignment of Construction Document 

3.6.4 Lien Priority Issues 

3.6.5 Claims to Unpaid Proceeds and Retainage Under Construction 

Contract 

3.7 Permits, Governmental Licenses and Approvals, Zoning, Subdivision, 

Environmental and Other Land Use Documentation. 

3.8 Title Insurance Policy and Marked Up Title Report or Commitment. 

3.8.1 Review 

3.8.2 Liability Theories 

3.8.3 Rights of Parties in Possession 

3.9 Leases and Lease Related Documents. 

3.9.1 Generally 

3.9.2 Application of Rents 

3.9.3 Sublease Issues 

3.9.4 Lease Assignment Issues. 

3.9.5 Collateral Rent Assignment 

3.10 Notice and Other Procedural Requirements 

3.11 Assembly of Client's Document 

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3.12 Partially or Wholly Unfunded Loan Commitments 

3.13 Letters of Credit. 

3.13.1 Considerations 

3.13.2 Non-Documentary Conditions 

3.13.3 Subrogation 

3.13.4 Independence Doctrine. 

3.13.5 Fraud in the Transaction 

3.13.6 Injunction Proceedings 

3.14 U.C.C. Security Documents, Perfection 

3.15 Jury Waiver Provisions 

3.16 Casualty and Liability Insurance Policies, Certificates, Mortgagee 

Endorsements 

3.17 Prior Workout, Interim Forbearance and Collateral Enhancement 

Arrangement Documents 

3.18 Subordination Agreements. 

3.19 Document Modification and Alteration 

4.0 Status of Property 

4.1 Physical Condition 

4.2 Property Income 

4.2.1 Leases 

4.2.2 Other Possible Sources of Income 

4.2.3 Security Deposits 

4.2.4 Earnest Money Deposits 

4.2.5 Limited Partners and Shareholders of Debtor Entity 

4.3 Costs and Expenses 

4.3.1 Operating Expenses 

4.3.2 Possible Third Party Claims 

4.3.3 Deferred Maintenance 

4.3.4 Major Repairs 

4.4 Project Valuation 

4.4.1 Review Closing Appraisal and Compare with Current 

or Recent Appraisal 

4.4.2 Review Original Market Analysis 

4.5 Construction Loan Evaluation 

4.6 Reciprocal Easement Agreements 

4.7 Environmental Concerns 

4.7.1 Contamination - Hazardous or Toxic Substances - Clean 

Up Liability - CIRCLA Issues 

4.7.2 Coastal Regulations 

4.7.3 Wetlands Issues 

4.7.4 Asbestos 

4.7.5 Lender's Right to Enter Upon Property and Conduct 

Tests 

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5.0..........................................................................................................Review of Applicable Law 

5.1 Realization Procedures 

5.2 Right of Redemption and Deficiency Judgment Limitations 

5.3 Yield Maintenance Provisions, Prepayment Charles, Default Interest 

and Liquidated Damages 

5.4 Equal Credit Opportunity Act ("ECOA") 

5.5 Statutes Limiting Alleged Oral Modification of Loan Commitment 

5.6 Multi-State Collateral 

5.7 Partnership Issues 

5.7.1 Direct Action by Creditor Against General Partners 

5.8 Additional Advances to Protect Collateral 

5.9 Fair Debt Collection Practices Act. 

5.10 Right to Financial Privacy Act 

5.11 Drug Forfeiture Laws 

5.12 Foreclosing Partnership Interests 

5.13 D'Oench Duhne, Langley, Federal Holder in Due Course Doctrine 

5.14 Waiver 

5.15 Lien Priority Issues 

5.15.1 Future Advances 

5.15.2 Equitable Subordination 

5.15.3 Erroneous Payoffs of Prior Lien 

5.15.4 Revival of Junior Liens 

5.15.5 Purchase Money Mortgage States 

5.16 Jury Trial Waivers 

5.17 Choice of Forum and of Law Provisions of Loan Documents 

5.18 Participation in Co-Lending Arrangements 

5.18.1 Lead Lender's Standard of Care 

5.18.2 Implied Covenant of Good Faith and Fair Dealing 

5.18.3 Conflict of Interest 

5.18.4 Applicability of Security Laws 

5.19 Clogging Equity of Redemption -- Equitable Mortgages 

5.20 Rent Assignments. 

5.21 FIRREA Claim Procedure 

5.22 Amount Due Issues 

5.22.1 Late Charges 

5.22.2 Prepayment Premium 

5.23 Marshalling 

5.24 "Fixtures" v. Personalty 

5.25 Waste 

5.26 Fraudulent Transfers 

5.26.1 "Upstream" and "Cross-Stream" Financing 

5.26.2 Collapsing a Transaction 

5.26.3 The Granting of a Lien for an Antecedent Debt May be a 

Fraudulent Transfer 

5.27 Recharacterization 

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5.28 Default Interest 

5.29 Unconscionability 

6.0 Deficiencies in Documentation 

7.0.....................................Lender Liability Claims, Statutory, Public Policy and Other Issues 

7.1 Theories of Lender Liability 

7.1.1 Contractual Rights of Borrower - Loan Commitments 

7.1.2 Negligent Misrepresentation 

7.1.3 Duress. Business Compulsion 

7.1.4 Breach of Implied Covenant of Good Faith and Fair 

Dealing 

7.1.5 Recharacterization of Transaction 

7.1.6 Fraud and False Lender Representations 

7.1.7 Regulatory or Statutory Violations by Lender 

7.1.8 Damage to Borrower During Period of Control of 

Borrower by Lender 

7.1.9 Collateral Inducements and Undertakings 

7.1.10 Prima Facie Tort 

7.1.11 Negligent Loan Administration 

7.1.12 Tortious Interference with Contact or Prospective 

Economic Advantage 

7.1.13 Breach of Oral Commitment To Lend or To Forestall 

Resort to Default Remedies 

7.1.14 Breach of Fiduciary Duty 

7.1.15 Unjust Enrichment 

7.1.16 Loan Prohibited by Borrower's Partnership or 

Corporate Governing Documents 

7.1.17 "Demand" Instrument Containing Acceleration 

Provisions 

7.3 Review of Lender's Files, Memoranda and Correspondence 

7.4 Alleged Course of Dealing Modifications 

7.5 Breach of an Oral Commitment 

7.6 Fraudulent Transfers 

7.7 Usury 

7.8 Personal Exemptions 

7.9 Waiver as Defense to Lender Liability Claims 

7.10 Lender Liability Claim Defenses 

7.10.1 Borrower's Breach of Implied Promise Not to Make 

Lender Liability Claim in Bad Faith 

7.11 Arbitration Provisions 

7.12 Jury Trial Waivers 

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8.0 Relevant Bankruptcy Considerations 

8.1 Recharacterization 

8.1.1 Purported Leases 

8.1.2 Purported Financing Arrangement 

8.1.3 Title Insurance 

8.2 Rent Assignment 

8.3 Preferences 


8.3.2 Triangular Preference - DePrizio - Reversed by 1994 

Act 

8.3.3 Standing 

8.3.4 Payment to Unperfected Secured Creditor 

8.4 Stays 

8.5 Reciprocal Easement Agreements 

8.6 Fraudulent Transfer Issues 

8.7 Effectiveness of Bankruptcy Oriented Prepetition Workout 

Agreements by Debtor 

8.8 Plan Approval, "Cram-Down" Possibility, Absolute Priority Rule, 

New Value Exception 

8.8.1 Undersecured Lender 

8.8.2 Requirements 

8.8.3 "Artificial Impairment\ 

8.8.4 Purchase of Trade Claims by Secured Creditor 

8.9 Collection of Interest, Costs and Fees by Secured Creditor 

8.9.1 §502(b)(2) Unmatured Interest 

8.9.2 506(b) Fees and Costs of Collection (State v. Federal Standard) 

8.10 "Pre-Bankruptcy Planning" By Debtor 

8.10.1 Foreign Situs Trusts 

8.11 Bad Faith Chapter Filing - Two Party Disputes - New Debtor 

Syndrome 

8.12 Entry into Possession by Mortgagee 

8.13 Single Asset Case Issues 

8.13.1 Bad Faith Filing 

8.13.2 Absolute Priority Rule 

8.13.3 Classification of Claim Issues 

8.13.4 "Single Asset Real Estate" Provisions of the 

Bankruptcy Code 

8.14 Third Party Releases Plan Provisions 

8.15 Landlord's Rent Claim 

8.15.1 Rent Recovery Cap 

8.15.2 Post Petition Rent 

8.16 Post-petition Credit - Bankruptcy Code Section 364 

8.17 "Strong Arm Clause" Section 544(a) - Trustee's Avoiding Power 

8.18 Valuation Issues 

8.19 § 363 Free and Clear Sale of Asset of Debtor Subject To Lender's 

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Lien 

8.20 Discharge Issues 

8.21 Equitable Subordination 

8.22 Successor Liability 

8.23 Bar Dates 

8.23.1 Bank 

8.24 Section 365 Rejection of Leases and Executory Agreements 

8.24.1 Rejection by Debtor Lessee 

8.24.2 Rejection by Debtor Lessor 

8.24.3 Assumption 

8.24.4 REA - CC&Rs 

8.25 Letters of Credit 

8.26 Ipso Facto Clauses 

8.27 Partnership Issues 

8.28 Substantive Consolidation 

9.0........................................................................... Effectiveness of Assignment of Future Rents 

9.1 Generally 

9.2 Notices to Tenant of Rent Assignment 

9.3 Hotel Receipts 

10.0........................................................... Review of Condominium and P.U.D. Documentation 

10.1 Declarant's Rights 

10.2 Mortgagee Provisions 

10.3 Association Financial Statements 

10.4 Association Activities 

10.5 Developer Assessments 

10.6 Association's Director Liability 

10.7 Timeshare Issues 

11.0............................................................................................... Borrower's Tax Circumstances 

11.1 Issue 

12.0.........................................................................................................................Advice to Client 

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REAL ESTATE DEFAULTS 

INVESTIGATION CHECK LIST FOR LENDER'S COUNSEL 

(ANNOTATED) 2 

By Marvin Garfinkel 

NOTE: 

A separate Investigation Check List should be prepared for each material 

real estate parcel. 

0.0 Immediate Attention 

0.1 Collateral 

0.1.1 Primary Collateral - List mortgages, notes 3 , personal property 

security interests, securities provided by parties other than the debtor, 

letters of credit, guarantees, pledges, cash collateral accounts and any other 

primary collateral. 

0.1.2 Ancillary Collateral - List ancillary collateral including rent and 

lease assignments, security agreements, assignments of management and 

construction related documents, hotel license, liquor licenses, escrow 

accounts, franchise and management agreements and related 

nondisturbance and recognition agreements, comfort letters, partnership 

interests 4 , etc. 

0.2 Conflicts Issues - Seek to determine identity of principals of borrower, 

parties to any syndication, other lenders that may be impacted by the 

various possible outcomes, lessees, other lien holders, significant creditors 

of borrower, and others that may be impacted by outcome of default. It is 

important that this be done at the earliest possible occasion as the 

identification of a conflict later in the case may prove very costly to the 

2 This checklist is regularly updated by the author to reflect his own experience and that of users of this checklist. 

Comments are therefore solicited since this document is continuously being revised. At any time there may be 

incomplete references and footnotes, unofficial citations that should be superseded with official citations, etc. Reference 

to "Dunaway Text" is to Dunaway, The Law of Distressed Real Estate (Clark Boardman Collaghan 1985-1997) which 

includes a copy of this Check List updated from time to time. 

3 Is note recourse or exculpated - if exculpated what are exceptions to the exculpation 

4 If a lender holds a lien on the ownership interests in borrower it may discourage initiation by the borrower of Chapter 

Proceedings. Such security interest may be based on guarantees by partners of borrower of the borrower's obligation to 

the lender with such guarantee collateralized by a lien on the partner's interest in the borrower. See U.C.C. §8-321 and 

definitions of "Security", "Certificated Security" and "Uncertificated Security" at U.C.C. §8-102. Under U.C.C. §8-321 

no filling is required to perfect a security interest in a "Security" as defined at U.C.C. §8-102. Under U.C.C. §8-313 the 

Security Interest in an Uncertified Security is perfected by registration with the issuer. Thus if a partnership interest is 

for purposes of the U.C.C. a "Security" the Security interest is perfected by notice or registration with the partnership 

otherwise Article 9 applies and a U.C.C. 1 is probably appropriate. If in doubt (as is usually the case) both approaches 

are usually followed. See item 5.11 below on foreclosing partnership interests. 

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client and possibly ultimately to the lawyer both in terms of client 

retention, disgorgement of fees received and recovery of accrued fees. 

0.3 Letters of Credit - List letters of credit, if any, location of originals, 

expiration dates and specific documentation required for presentation. 

Calendar dates. See discussion at 3.13 below. 

0.4 Guarantees - Third Party Liability 5 - 

0.4.1 List guarantees, expiration dates, notice requirements, possible 

limitations on liability or enforcement thereof or other activity 

that may be basis of guarantor defenses. Are there any 

limitations upon guarantor's liability Consider nature of each 

guarantee -is it primary or is it limited to deficiencies or limited 

in some other manner 

0.4.2 Will a release of collateral or release or compromise of the 

liability of the principal debtor or others that are also secondarily 

liable impact upon enforceability of the guarantees 6 

0.4.3 Are there any ambiguities such as limitation of guarantor's 

liability to "top one million dollars". 7 

0.4.4 Consider strategy to realize on each guarantee and possible 

application of deficiency judgment statutes. 8 Seek to secure 

current financial statement of each guarantor. Are the guarantees 

secured If so, in what manner Is security adequate Is it 

5 See discussion at item 3.3 below. 

6 See Agribank, FCB v. Whitlock, 251 Ill. App. 3d 299, 621 N.E. 2d 967 (Ill App. Ct. 4th Dist. 1993). Appeal 

Denied, 154 Ill. 2d 557, 631 N.E. 2d 705 (1994). See also See Stumpf v. Hibernia Nat. Bank, No. 02-CA-1254 (5th 

Cir. Apr. 29, 2003) where the lender's release of funds in debtor in possession account at the request of the 

bankruptcy trustee instead of petitioning bankruptcy court to offset debt against debtor's accounts in lender's 

possession resulted in an impairment of security held for the principal obligation and operated to extinguish the 

obligations of the surety. 

7 This common and ambiguous limitation has at least four possible meanings. In the context of a ten million dollar 

loan these are (1) the guarantee is limited to one million dollars and that limit is reduced on a dollar for dollar basis 

for principal paydowns. (2) The guarantee is only for any deficiency and further subject to the limit provided for by 

(1) above. (3) A deficiency guarantee limited to one million dollars. (4) A primary guarantee of one million dollars 

with the guarantor being reimbursed if the actual realization by the lender exceeds nine million dollars ($9,000,000) 

upon sale of the collateral. 

8 See discussion at item 5.2 below and Annotation, Mortgages: Effect Upon Obligation of Guarantor or Surety of 

Statute For Forbidding or Restricting Deficiency Judgment, 49 A.L.R. 3d 554 (1973). 

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available Is it feasible in context of a restructuring of the debt 

to achieve additional collateral to backup the guarantees 9 

0.4.5 Consider possibility of "piercing the corporate veil," especially 

of subjecting to personal liability the shareholders, directors and 

officers of any corporate general partners or managing members 

of an L.L.C. 

0.4.6 Are defense waivers complete and effective. 10 

0.5 Notice Requirements - Prepare schedule of notice and grace periods for 

specific remedies and list entities and persons who must be notified and 

those persons who possibly should be notified. Have client confirm 

whether it has any change of address notices or other indications that 

addresses of persons to be notified may have changed. Is the required 

notice a prerequisite to declaration of default or does it merely afford the 

borrower an opportunity to reinstate 11 

0.6 File Assembly - Determine location of all possibly relevant files. 

Determine whether any of client's personnel maintain informal or 

"working files" or keep notes or other data on personal computer media. 

0.7 Environmental Risks 12 - Review all environmental reports in file. If 

foreclosure or entry into possession by lender is a real possibility 

consider securing an update on existing reports. 13 Determine whether an 

environmental agency review is required in the particular jurisdiction 

prior to foreclosure. 

0.8 Rent Assignment - Tenant Issues - Do the rent assignments permit the 

lender to direct the tenants to pay future rent to it whether or not there 

has been a default on the loan Is there a need to make “choate” 

"inchoate", "unvested" or "unperfected" rent assignments 14 Do 

9 See Discussion of upstream and sidestream guarantees at items 3.3 and 5.2.6 below 

10 See §15 of the Restatement Third, Suretyship. Suretyship Status - defenses of Secondary Obligor against 

Obligee. 

11 This may be important in a variety of settings, especially in those cases in which the lender would be adversely 

impacted by a Chapter 11 filing prior to its being able to exercise remedies to protect its right to rents. See item 9.0 

below. 

12 See Discussion at item 4.7 below. 

13 Because of lead time that may be required and the impact that an unanticipated environmental problem may have 

on the lender's strategy the procuring of appropriate environmental reports should be considered as soon as feasible. 

14 See discussion at Item 9.0 below. This activity may be referred to as "vesting" or even, although probably 

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documents impose a trust on rents received by borrower and not used 

first to pay taxes, insurance, debt service and reasonable operating 

expenses or subject borrower or its principals to personal liability for the 

same Are there any tenant security deposits and under whose control 

0.9 Information To Be Requested from Borrower - Current financial 

statement of borrower and guarantors, cash flow statement of Borrower, 

recent income tax returns, rent rolls, copies of current leases, receivables 

and schedules for time share and lot sale projects. 

0.10 Personal Liability - Explore various basis of asserting possible 

personal liability if loan is non recourse or with a limited liability entity. 

Possible trust fund theories, piercing corporate veil, acts within 

exculpation exceptions such as rent diversions after default. 

0.11 Estoppel - Nondisturbance & Attornment - Review tenant estoppels 

and non disturbances and attornment agreements. Have tenants agreed 

to pay rent directly to the lender following notice from the lender of 

default 

0.12 Related Projects - Are there related projects - any cross 

collateralization -status of other projects - any related contingent 

obligations of Borrower. 

0.13 Lender's Past Experience with Borrower - Any previous defaults on 

this or other loans Any business interrelationships - (Common 

directorships, etc.) Has borrower been on any lender committees Any 

possible breach of applicable anti-tying statutes 

0.14 Participation Issues - If this is a participated loan immediately consider 

the relative right of lead vs. participating lenders. Who must agree to 

what and who must be notified of what 15 

0.15 Existence of Default. Review interrelationship of documents - Has a 

"Default" or "Event of Default" actually occurred Is the default language 

and nomenclature consistent throughout the various documents Is notice 

required Are there cure periods What is required under the 

circumstances for the borrower or a guarantor to "commence" to cure, if 

that is relevant Are defaults sufficiently material to warrant exercise of 

all remedies or of specified remedies 16 If the loan documents provide 

incorrectly as "perfection". The 1994 amendments to the Bankruptcy Code have reduced the significance of the 

issue. 

15 See Discussion at item 5.18 below. 

16 Late payment alone may not be adequate to warrant foreclosure. See Sahadi v. Continental Illinois National Bank & 

Trust Co., 706 F.2d 193 (7th Cir. 1983) 

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both for payment on demand and acceleration upon default, courts are split 

on whether the right to accelerate is subject to good faith limitations. 17 

0.16 Wrap-Around Mortgages - Calculation of Deficiency. This issue must 

be considered in depth prior to commencing foreclosure proceedings on a 

wrap-around mortgage. Determine whether in the particular jurisdiction 

the sale price on foreclosure is credited against the outstanding balance of 

the wrap-around note (including underlying debt) or only against the 

amount of the debt exceeding the underlying debt. 18 

0.17 Debt Assignment Notice. Has borrower been notified of assignment In 

most jurisdictions an assignee is charged with any good faith payment by a 

debtor to the assignor prior to receipt by the debtor of notice of the 

assignment. 

0.18 Interim Advances from the Mortgage Lender. If it may be advisable 

for the mortgage lender to make interim advances to the borrower pending 

a refinancing or a workout and if the mortgage lender is willing to make 

such advances will the amount of such advances be added to the lender's 

lien position or is it feasible for the lender to secure a first lien position for 

such advances 19 

0.19 Mortgagee in Possession and Receivership Issues. Are there any 

provisions in the documents that will effectively expand local law as to 

rights and protections afforded to the mortgage lender if it enters into 

possession or to such lender and a receiver if a receiver is appointed on 

application of lender 

0.20 Escrows. Consider application of automatic stay to any attempt to realize 

on escrows. 20 

0.21 Transfer Taxes on Foreclosure. Will the transfer of title on foreclosure 

trigger any transfer taxes. If so, are there any approaches available to 

avoid or reduce such impact especially if there may be a double impart. 

1.0 Parties 

17 See item 7.1.4 below. 

18 Id., and See Summers v. Consolidated Capital Special Trust, 783 S.W. 2d 580 (Tex. 1989) and Lee v. Key West 

Towers, Inc., 783 S.W. 2d 586 (Tex 1989). 

19 See discussion at items 3.12 and 5.7 below. See also, §27.05 “Future Advances Clauses” in Dunaway, The Law of 

Distressed Real Estate (Clark Boardman Callaghan 1985-1997. Hereafter referred to as the "Dunaway Text." 

20 See T.B. Byrne, Escrows and Bankruptcy, 48 Bus. Lawyer 761, 786 (1993). 

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For each party indicate to extent known the names of principals and other responsible 

persons and of contact persons with positions held; the type of entity (general partnership, 

limited partnership, corporation, land trust, individual ownership, co-tenants). For each 

entity and person, indicate proper name, and if known address and telephone number, fax 

number and name and details for each attorney representing such person or entity. 

Reconfirm lack of conflicts after identifying all of the parties in interest. 

1.1 Owner of Property 

Consider structure. For instance, if the borrower is a partnership, who are the 

general and limited partners Are there any layered or multi-tier entities 

involved Is there any pending litigation involving the debtor 21 

1.2 Secured Creditors 

Is there a possibility of a marshalling claim by junior lenders 

1.3 Unsecured Creditors 

Seek to determine amount owed. In any workout arrangement seek to require 

general creditors to be kept current since the existence of a substantial general 

creditor class may adversely impact on ability of a secured creditor to lift 

automatic stay and may increase possibility of a successful cram down. 

1.4 Recorded and Potential Mechanics' Lien Claims 

Review local law and title policy to determine whether there is any real possibility 

of mechanics' liens that might prime our client's mortgage. If so review divestment 

statute if there is one or local case law. 

1.5 Other Lenders and Participants 

Are there other lenders to the same borrower or to other entities with common 

guarantors Consider possibility of a joint workout strategy and possible conflict 

problems. Is there need for a joint defense and common defense agreement in 

regard to client-attorney and work product privileges Consider impact of any 

modification of loan documents upon priority position of subordinate lien 

holders. 22 

21 The existence of a significant number of pending law suits against the borrower is usually a significant adverse 

factor to effectuate a workout since a significant creditor can usually frustrate a workout and will often be able to 

secure benefits not warranted by the relative or record priorities of the parties. 

22 In some jurisdictions a modification of the obligation (or in some cases, the security) may be treated as a "novation" 

and thus result in the priority of the mortgage lien being reestablished as of the date the restructuring becomes effective. 

See title insurance discussion at 1.6. 

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1.6 Title Insurer 

Consider possibility of claims against title insurer. 23 If there is to be a forbearance 

or reinstatement arrangement it is desirable to have the title insurer either endorse 

the existing policy to confirm that notwithstanding the reinstatement or 

forbearance arrangement the title insurance remains in place or down date the 

policy. 24 It is important that there be a full disclosure of all pertinent 

circumstances to the title insurer if such title insurer is to issue any such 

endorsement. In most jurisdictions this is particularly so if additional advances 

are to be made after a default. 

1.7. Closing Attorneys 

Indicate party represented by each. 

1.8 Bonding Company 25 

1.9 Casualty and Property Loss Insurance Carriers of Borrower. 

1.10 Tenants. See discussion at item 3.9 below as to protecting existence of 

advantageous leases and terminating adverse leases. 

1.11 Guarantors. 26 

1.12 Any F.D.I.C. or RTC Relationships to Loan. 

1.13 Partners, Shareholders, Directors, and Officers of Owner 

1.13.1 Corporate Veil Piercing 

Although courts have held that a proper purpose of incorporation is to 

permit shareholders to limit their liability for the corporation's obligations 

to their contribution, an abuse of the corporate shield or its use to commit 

fraud or for an other improper purpose may subject all or certain 

shareholders to personal liability. 27 

23 See discussion at Item 3.8 below. 

24 See discussion at Item 5.14 in regard to lien priority of additional advances. 

25 See generally, Chapter 27A Dunaway Text, “Liability of Bonding Companies” . 

26 See items 0.4 above and 3.3 below. 

27 See Beale v. Kappa Alpha Order, 192 Va. 382, 64 S.E.2d 789, 796 (1951). The veil may be lifted in extraordinary 

cases. Among the factors considered by courts are whether corporate formalities were observed, whether the corporation 

was treated as a mere instrumentality, domination or control or inadequate capitalization. These factors alone are generally 

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1.14 Lessors 

1.14.1 Consider liability of a lessee that has assigned a lease to a party that later, 

as a debtor in a chapter proceeding, rejects the lease under §365 of the 

Bankruptcy Code. 28 

1.15 Appraisers 

A real estate appraiser may be liable for negligent misrepresentation to a thirdparty 

purchaser of a mortgage. 29 

2.0 Public Record Searches 

2.1 Title Reports and U.C.C. Searches 

Order title reports, U.C.C., and other pertinent public record searches for debtor, 

collateral and guarantors. 

2.2 Partnership and Other Entity Filings 

If considered relevant, check partnership and other entity filings to determine if all 

requisite filings have been made and if there were any unreported transfers of 

entity interests. This information may be relevant in uncovering breaches of 

warranties and covenants and may lead to approaches to piercing corporate and 

limited partner liability veils. 

3.0 Document Assembly and Examination 

The immediate objective is to evaluate rights and remedies of the parties against known 

and developing circumstances and to seek to identify deficiencies in documentation that 

might be corrected in the course of any workout documentation. Possible basis of delay 

in realization to be considered. Objective is to evaluate each parties' vulnerability under 

various scenarios. 

held not to be sufficient to support piercing of the veil. Generally the corporate veil will be pierced if the corporation is "a 

device or sham used to disguised wrongs obscure fraud, or conceal crimes." See Cheatkem, 360 S.E.2d (get cite), 

Perpetual Real Estate Services, Inc., v. Michaelson Properties, Inc. 974 F.2d 545 (4th Cir. Va. 1992). Corporate veil was 

pierced under Missouri law where substantial purchases were made by insolvent store operator on brink of bankruptcy in 

Fleming Companies v. Rich 1997 W.L. 610053 (E.D. Mo.) 

28 Bond St. Assocs. v. TJX Cos. (In re Ames Dept. Stores), 148 B.R. 756 (Bankr S.D.N.Y. 1993) the court held that 

rejection is a breach of lease, not a termination and that pursuant to a specific provision of the lease the tenant 

assignor remains liable. 

29 Soderberg v. Mekinney, 52 Cal Rptr 635 (Cal. App. 2d Dist. 1966). 

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3.1 Mortgages, Deeds of Trust and Loan Agreements 

3.1.1 Consider available default remedies, notice requirements, crosscollateralization, 

cross default provisions, possible personal liability for 

physical or economic waste, application of debtor protection jurisprudence 

and statutes, possible choice of law and other conflicts issues especially in 

multi-state transactions. 

3.1.2 Compare legal descriptions against survey. If feasible have loan officer 

that made loan review survey to be sure that the property covered by the 

mortgage is the entire property intended by the lender to be the security for 

the loan. 

3.1.3 Consider ability of lender to rely on document based discretionary right - 

is there local law or have courts of the jurisdiction held that there exists an 

implied obligation to act in good faith in exercise of remedies and 

administration of loan 30 

3.1.4 Review document provisions and local law as to ability and procedure for 

lender to enter into possession of property or secure appointment of a 

receiver. This may be advantageous to "perfect", "vest" or "make choate" 

the right of the lender to future rents. 31 

3.1.5 Consider nature of obligation that is secured by the lien of the mortgage 

and the priority of such lien as to each component of such obligation. If 

there is a "Dragnet Clause." 32 Does the priority of the later advances run 

from the recording of the mortgage or the date of the advance. 

3.1.6 Consider whether the language of the mortgage document actually 

implements the apparent intention of the parties. 33 

3.2 Notes and Other Evidences of Indebtedness 

30 See discussion at Item 7.1.4 below. 

31 See discussion at item 9.0. 

32 A Dragnet Clause" extends the obligation secured by the lien of mortgage to all obligations (related and unrelated) of 

the mortgagor to the mortgagee. See G. Nelson and D. Whitman, Real Estate Finance Law §12.8 (3d ed. 1994). They 

are generally enforceable. See In re Cara Corp., 148 B.R. 779 (Bkrtcy. E.D. Pa. 1992). However, the courts tend to 

construe them narrowly against the mortgagee. See Nelson id. 

33 In Balch v. Leader Federal Bank for Savings, 315 Ark 444, 446, 868 S.W. 2d 47 (Ark. 1993) the court held that 

language in a lease and separate subordination certificate that the net ground lease is "subject and subordinate to the lien 

of" a first mortgage did not make the lessor's fee interest in the land subject to the later first mortgage, but merely 

subordinated to the later mortgage the interest of the fee owner in the lease of which it was the lessor. The relevant 

paragraph of the lease was captioned "Mortgage of the Fee". 

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3.2.1 Confirm computation of actual amount owing; 

3.2.2 Determine extent of defaults - monetary and nonmonetary - 

3.2.3 What cure or notice periods are applicable. Have default notices been 

given 

3.2.4 Review prepayment and other premium provisions and yield maintenance 

provisions, if any. Consider possible treatment of yield maintenance 

provisions as unenforceable liquidated damage provisions. 34 Will 

prepayment premiums be collectable under applicable law if debt is 

accelerated 35 

3.2.5 Review default provisions; specifically consider interrelationship of 

default provisions among various loan documents. Any inconsistencies of 

terminology: are terms such as "breach", "default" and "event of default" 

adequately defined Do notice and opportunity to cure provisions 

dovetail 

3.2.6 Check signature and effectiveness of execution; if powers of attorney are 

used, are they effective 

3.2.7 Consider any usury issues. 

3.2.8 If provision is made for interest accruals consider possible applicability of 

§502(b)(2) of the Bankruptcy Code regarding "unmatured interest." 36 

3.2.9 Defenses, offsets - was the loan fully disbursed 

3.2.10 Review nonwaiver provisions of the note and mortgage. 37 

3.3 Guarantees and Surety Documents 

34 See Fisher, Make-Whole Prepayment Premiums Under Attack, 45 Bus. Lawyer 15 (Nov. 1989); In re Skyler Ridge, 80 

Bankr. 500 (Bankr. C.D. Cal. 1987); In re Kroh Bros. Dev. Co., 88 Bankr. 997 (Bankr. W.D. Mo. 1988). In McCae 

Management Corporation v. Merchants National Bank and Trust Company of Indianapolis, 553 N.E.2d 884 (Ind.Ct. App. 

1990) the Mid-America court sustained a yield maintenance fee required by the lender without any authority in the loan 

documents as a condition to permitting prepayment of a note that specifically prohibited prepayment. 

35 See Matter of LHD Realty Corp., 726 F.2d 327 (7th Cir 1984); American Fed. Sav. & Loan Assn of Madison v. Mid- 

America Service Corp. 329 N.W. 2d 124 (S.D. 1983). 

36 See item 8.9 below. 

37 See discussion at item 5.14. 

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3.3.1 Are guarantor's liabilities primary or secondary 

3.3.2 What notice must be given to guarantors 

3.3.3 Are there any time limits on guarantor's liability. 38 

3.3.4 If only part of debt is guaranteed is there any problem in regard to 

application of collateral For instance, if only interest is guaranteed, 

should proceeds be applied against principal or interest 39 Does the 

guarantor's obligation under an "interest only" guarantee continue after 

realization on collateral 40 Is the guarantor entitled to a credit for the 

value of the mortgaged property See §5.2.3 below. 

3.3.5 Are there any "upstream" or "sidestream" guarantee or collateral 

problems A typical "upstream" guarantee is a guarantee by a subsidiary 

of an obligation of a parent. A variation is a guarantee by a corporation or 

partnership of an obligation of a shareholder or partner. A "sidestream" 

guarantee is in guarantee by in entity of an obligation of other entity under 

common control. A further variation is the upstreaming or sidestreaming 

of collateral. That is the use of an entity's assets to collateralize the 

obligations of the shareholder, partner or entity under common control. 

This devise is often used to collateralize the acquisition obligation, 

especially where it is sought to avoid transfer tax or other taxes or transfer 

limitations in leases or mortgages by transferring a real estate owning 

entity rather than the real estate asset itself. 41 

3.3.6 Consider any applicable deficiency judgment law - statutory or common 

law 42 

38 In Phoenix Acquisition Corp. v. Campcore, Inc., 81 N.Y.2d 138 (1993), the court rejected the guarantor's 

assertion that lender's claim was time-barred, holding that the six-year statute of limitations for breach of contract 

actions accrued on the date that the lender elected to exercise the acceleration clause under the note (which was 

payable in installments, as opposed to a demand note) and not on the date upon which the election to accelerate 

was based (i.e., the date the first installment payment was missed). The Phoenix case was followed by Breeden v. 

Erie Island Resort & Marina (In re Bennett Funding Group), No. 03-MC-06 (N.D.N.Y. Apr. 28, 2003) where the 

borrower asserted that the statute of limitations had run on the lender's claim. 

39 See discussion at item 0.4 above. See Barnett, Limited Guarantees: Variations, Limitations and Lamentations; 

Banking L.J. 244 (May 1987). 

40 If so, is the interest base reduced by the amount of the realization or might the realization be applied first against 

interest if, under the loan documents, payments are to be so applied 

41 See the discussion of fraudulent conveyances at item 8.6 below. 

42 See discussion at item 5.2 below. See Chapter 14 of Dunaway Text “Confirmation of Sale and Deficiency 

Judgments” . 

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3.3.7 Consider possible application of any guarantor defenses 43 and the 

adequacy of any waivers. 44 Defenses that may be available to guarantors 

include (1) impairment by lender of collateral; (2) disposition of collateral 

in commercially unreasonable manner 45 and (3) failure of guarantee 

documents to satisfy the applicable statute of fraud requirements. 46 

3.3.8 Allegations of oral modification of guarantees will be sustained in most 

jurisdictions even where the guarantee contains a prohibition against oral 

modification and in several cases even where the alleged oral modification 

was not supported by additional consideration. 47 

In many, if not nearly all jurisdictions, absent an applicable statute, 48 an 

agreement prohibiting non-written modification may be modified by a 

subsequent oral agreement, especially if the parties' conduct clearly shows 

an intent to waive the requirement that amendments be in writing." 49 In 

43 See §15 Restatement Third, Suretyship. 

44 In National Westminster Bank N.J. v. Lomker, 277 N.J. Super. 491, 649 A.2d 1328 (N.J. Super.Ct. App. Div. 1994), 

the defense of a bad faith impairment of collateral was held not to have been waived by the waiver in the guarantee 

which the court considered not to be sufficiently specific. 

45 In First N.H. Mort. Corp. v. Greene, 139 N.H. 321, 653 A.2d 1076 (N.H. 1995) the court found that the obligation of a 

lender not to be affirmatively negligent could not be waived by the guarantor. 

46 See Reyes v. Admin of U.S. Small Business Admin., 1995 W.L. 46380 (D.D.C. 1995)(not reported in F. Supp.) (14 

million dollar guarantee is not enforceable because it did not contain essential terms as required by Texas statute.) 

47 In Beal Bank S.S.B. v. Krock, 187 F.3d 621 (1 st Cir. Mass. 1998) (Unpublished Table Decision), (reported in full at 

201 F.3d 426 (1st Cir. Mass. 2000)), the First Circuit affirmed the district court determination that under Massachusetts 

law an agreement that bars subsequent oral modification may be modified by a subsequent oral agreement. Allan 

Farnsworth, Contracts § 7.6 (2d Ed. 1990) ; L.W. Severance & Sons, Inc. v. Angley, 332 Mass. 432, 125 N.E. 2d. 

415, 420 (Mass 1955); Cambridgeport Savings Bank v. Boersner, 413 Mass 432, 597 N.E.2d 1017 , 1022 (Mass 

1992) ; Wagner v. Graziano Construction Co., 390 Pa 445, 136 A.2d 82, 83 (Pa 1957) the court stated that “The 

most INSERT AA 

48 California Civil Code § 1698(c) provides that "[u]nless the contract otherwise expressly provides, a contract in 

writing may be modified by an oral agreement supported by new consideration." See Conley v. Matthes ,56 Cal. 

App. 4th 1453, 66 Cal. Rptr. 2d 518, 526 (Cal. App. 2d Dist. 1997). Although a New York statute enforces no oral 

modification clauses and prohibits oral modification when the original written agreement provides that modifications 

must be in writing and signed, 48 even in New York, there are exceptions in two circumstances--where there has been 

(1) partial performance, or (2) reliance if the subsequent performance or reliance is "unequivocally referable to the 

modification." Towers Charter & Marine Corp. v. Cadillac Ins. Co., 894 F.2d 516, 522. 

49 Tadros v. Kuzmak, 277 Ill. App.3d 301, 213 Ill. Dec. 905, 660 N.E. 2d 162, 170 (Ill. App. Ct. 1st Dist. 1995), 

Appeal Denied 166 Ill. 2d 541, 664 N.E. 2d 642 (1996). See Wagner v. Graziano Const. Co., 390 Pa. 445, 136 

A.2d 82, 83 (1957). ("The most ironclad written contract can always be cut into by the acetylene torch of parol 

modification supported by adequate proof.... The hand that pens a writing may not gag the mouths of the assenting 

parties."). A. W. Wendell & Sons, Inc. v. Qazi, 254 Ill. App. 3d 97, 193 Ill. Dec. 247, 626 N.E. 2d 280, 287 (Ill. 

App. Ct. 2d Dist. 1993), Appeal Denied 156 Ill. 2d 555, 638 N.E. 2d 1112 (1994); E. A. Cox Co. v. Road Savers 

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those jurisdictions that permit oral modification notwithstanding a no oral 

modification clause, the standard for permitting admission of the alleged 

oral modifications varies. It is important that a draftsperson consider on a 

jurisdiction to jurisdiction basis possible approaches to better 

“bulletproof” such a provision. Since the issue of whether an integrated 

document was in fact orally modified is one of fact, a lender has good 

reason in a contested loan document enforcement proceeding to seek to 

avoid such an issue from reaching a jury. 50 One relevant consideration 

may be whether the parties acted in a manner consistent with a claim of 

oral modification. Lenders should consider seeking to establish early in 

workout negotiations whether it is likely that a borrower may assert a 

claim of oral modification and if it appears that such a claim may be 

asserted determine whether there is any credibility to such claim and if it is 

clear to the lender that there was not in fact any such modification the 

lender must be sure not to act in an ambiguous manner that might be used 

by the borrower of evidence that the lender acted as if there was in fact 

such a modification. 

A so-called "zipper" clause combines integration and no oral modification 

clauses. It is intended to foreclose claims of any representations outside 

the written contract aside from those made in another written document 

executed by the parties simultaneously with or subsequent to the subject 

document. 51 In those jurisdictions that permit modification 

notwithstanding a non-oral modification clause in the subject document, 

the standard for permitting admission of an alleged oral modification 

varies. 

Oral Modification may be prohibited by a Statute of Frauds, if 

applicable. 52 

Int'l Corp., 271 Ill. App. 3d 144, 207 Ill. Dec. 815, 648 N.E. 2d 271, 277 (Ill. App. Ct. 1995). See New England 

Factors v. Genstil, 322 Mass. 36, 76 N.E. 2d 151, 154 (Mass. 1947) (holding that the parole evidence rule does not 

apply "where the terms of a written agreement have been modified by subsequent oral agreement"). L.W. Severance 

& Sons, Inc. v. Angley, 332 Mass. 432, 125 N.E. 2d 415, 420 (Mass. 1955). Cambridgeport Sav. Bank v .Boersner, 

413 Mass. 432, 597 N.E. 2d 1017, 1022 (1992) cf. E. Allan Farnsworth, Contracts § 7.6 (2d Ed. 1990). "the 

evidence of a subsequent oral modification must be of sufficient force to overcome and presumption and the 

integrated and complete agreement, which requires written consent to modification, expresses the intent of the 

parties." See Boersner, 597 N.E. 2d at 1022 n. 10. 

50 See discussion of waiver of jury trial at Item 3.15 and 5.16 below. 

51 See, Pace v. Honolulu Disposal Serv., Inc., 227 F.3d 1150, 1159 (9th Cir. Haw. 2000). 

52 See Tex. Bus. & Com. § 26.01 which requires that the original contract be in writing, and the oral modification 

does not alter the character or value of the consideration. See Horner v. Bourland, 724 F.2d 1142, 1148 (5th Cir. 

Tex. 1984) (interpreting Texas law and collecting cases). 

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California Civil Code § 1698(c) provides that "[u]nless the contract 

otherwise expressly provides, a contract in writing may be modified by an 

oral agreement supported by new consideration." 53 

3.3.8 If the spouse of a principal of the Borrower has joined in a guarantee 

consider application of the Fair Credit Opportunity Act 54 

3.3.9 Develop information on financial condition of guarantors. 

3.3.10 Review choice of law and venue provisions of guarantee and confirm law 

of controlling jurisdiction. 

3.3.11 §365(e) of the Bankruptcy Code 55 has been held not to protect guarantor 

from liability conditioned on bankruptcy of mortgagor. 56 

3.3.12 Consider possible right of a guarantor under Sections 9.207(i), 102(3), 9- 

504(3) and 9-507 of the UCC. 57 

3.4 Legal and Any Other Closing Opinions 

The opinions of the debtor's closing counsel oftentimes focus attention on 

documentation deficiencies, and possible limitations on enforceability of 

document provisions. This preliminary review of the opinions of closing counsel 

is generally not for the purpose of focusing on possible attorney liability but rather 

for the purpose of possibly identifying issues and defenses. 58 

53 See Conley v. Matthes, 66 Cal.Rptr.2d 518, 526 (Cal.Ct.App.1997). 

54 15 U.S.C. §1691(b) - See discussion at items 5.4 and 7.1.7(1) below. 

55 See Item 8.24 below. 

56 First Nationwide Bank v. Brookhaven Realty Ass., 223 A.D. 2d 618, 637 N.Y.S.2d 418 (N.Y.App.Div. 2nd Dept. 

1996). App. Dis. 88 N.Y. 2d 963, 670 N.E. 2d 1347, 647 N.Y.S. 2d 715 (1996). 

57 See Morris v. Shawmut Bank, 1997 WL 772920 (Conn Super 1997) 

58 An interesting real estate workout case is Hetos Investments, Ltd. v. Kurtin, 2003 WL 21498918 (Cal. App. June 

30, 2003) in which the California Appeals Court, as a matter of law, denied the lender's motion to have the 

attorney for the borrower disqualified on the ground that an attorney who prepared the note cannot later challenge 

its validity - the lender alleged violation of ethical rules and the appearance of impropriety for giving advice 

inconsistent with usury laws. Here, the borrower's counsel had been instructed by the lender to prepare the note at 

the borrower's expense, there was no legal opinion issued by borrower's counsel at closing and the borrower 

subsequently sued (using the same attorney) alleging the note to be usurious. The California court noted that the 

lender and not the borrower was violating usury laws and stated that "[w]hile it may be awkward for [attorney], 

having prepared the promissory note, to turn around and argue in a court of law that one of its provisions violates 

the usury laws, it is not apparent how it could affect the outcome of the proceedings whether the usury argument is 

made by attorney's firm or by replacement counsel following attorney's disqualification." Query whether the 

outcome would have been different had the borrower's attorney issued an opinion at closing. What ethical issues 

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3.5 Closing Attorneys Summary of Transaction 

This can be a valuable document for fresh counsel attempting to understand the 

parameters of the transaction and its relationship to other transactions. It is also 

useful to understand the closing attorney's view of the transaction. Since the 

significance of ancillary documents is often not immediately apparent, a review of 

this summary may lead to additional collateral or other circumstances that are not 

immediately obvious from the closing binder. 

3.6 Construction Documents 

3.6.1 Cost To Complete Estimates 

If there is any construction of substance in progress a rough estimate 

should be made of the probable cost of completion. If completion may be 

divided into phases, each of which will produce incremental income, the 

construction costs should be estimated both on a phase by phase approach 

and also on an overall project approach. 

3.6.2 Construction Quality 

Determination should also be made as to the quality of construction and its 

conformity to plans and specifications and contract requirements and 

whether there may be claims for construction defects. 

3.6.3 Assignment of Construction Document 

Consider whether there was an assignment to the lender of construction 

related contracts and whether or not the work is completed under such 

contracts. The lender may succeed to certain or all of the rights of the 

borrower against the contractors and possibly the subcontractors for 

defective or incomplete construction and against design professionals for 

inadequate construction documents or possibly even grossly erroneous cost 

estimating. 

3.6.4 Lien Priority Issues 

Application of Obligatory Advance Doctrine. Is there an applicable state 

statute 59 

might there be 

59 See discussion at Item 5.8. 

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3.6.5 Claims to Unpaid Proceeds and Retainage Under Construction 

Contract. 

State law will determine whether or not earned but unpaid construction 

consideration and retainage are assets of a debtor in a Bankruptcy Code 

proceeding. 60 Payments held by the federal government as owner of a 

construction project do not become part of the bankruptcy estate and, as a 

result, may be available to a bonding company or other claimants such as 

subcontractors. 61 Language of contracts may determine relative rights of 

the parties to undisbursed contract proceeds. 62 

3.7 Permits, Governmental Licenses and Approvals, Zoning, Subdivision, 

Environmental and Other Land Use Documentation. 

Review documents and opinion letters to be sure the mortgaged property is zoned 

for current intended use and that the current or intended use is authorized as 

required by local law. A mortgagee's taking title by a foreclosure or deed in lieu 

thereof to improperly permitted property may subject the lender or its personnel to 

civil or in some cases to criminal proceedings. 

3.8 Title Insurance Policy and Marked Up Title Report or Commitment. 63 

3.8.1 Review 

Was policy actually issued Is the policy as issued consistent with marked 

up report Any special endorsements Compare title policy descriptions 

with closing documents. Compare a current title report with the policy 

issued for closing. 

3.8.2 Liability Theories 

It has been held that a title insurer may be held liable for failure to disclose 

a title defect of which it has knowledge even if the defect is of the type 

excluded by the terms of the policy. 64 

60 Universal Bonding Ins. Co. v. Gittens & Sprinkle Enterprises,. Inc., 960 F.2d 366 (3rd Cir. N.J. 1992); Mullins v. 

Burtch, 249 B.R. 360 (D. Del. 2000) Criticized at 368 although it is followed in part at 371. 

61 Pearlman v. Reliance Insurance Co., 371 US 132 (1962). 9 L.Ed 2d 190, 83 S.Ct., 232. See also, North Am. 

Speciality Ins. Co. v. Chichester Sch. Dist., 2000 U.S. Dist. LEXIS 10745 (E.D. Pa. 2000), Ins. Co. v. United States, 

243 F.3d 1367, 1375 (Fed.Cir. 2001). 

62 See In re Modular Structures, Inc., 27 F.3d 72 (3rd Cir. N.J.1994); Pics No. 94-0899; Stevlee Factors, Inc. v. State, 

136 N.J.Super 461, 346 A.2d 624 (N.J. Super. Ct. 1975). 

63 See discussion also at Item 1.6. 

64 Crawford v. Safeco Title Ins. Co., 585 So.2d 952 (Ct. of App. 1st Dist. 1991). 

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3.8.3 Rights of Parties in Possession 

A lender will be generally charged with that which it would have 

discovered had it made reasonable inquiry of any parties in possession. 65 

3.9 Leases and Lease Related Documents. 


Review copies of leases in possession of lender and seek to secure leases 

of material tenants not in possession of lender. Secure rent roll and seek to 

confirm that it is current, possibly by inspection of property. Review 

estoppel certificates and attornment and nondisturbance agreement to seek 

to determine whether, in the event of foreclosure the tenant has basis to 

contend that the lease has terminated and it has no continuing obligation. 66 

Determine the obligations the landlord has under each lease. In the case 

of construction loans it may involve substantial tenant improvements to be 

paid for by the landlord which may have to be funded by the lender after 

foreclosure. 

3.9.2 Application of Rents. 

Determine whether under any document signed by the tenant such tenant is 

required to pay rents directly to the lender upon receipt of lender's notice 

of owner's default. See discussion at 9.0 below on effectiveness after 

bankruptcy of future rent assignments and discussion at 8.6.4 as to 

possibility of certain lease terminations on assignment being fraudulent 

transfers. 

3.9.3 Sublease Issues. 

Is there a lessor's nondisturbance undertaking under which the sublessee 

has a contractual right to a new direct lease with the prime lessor in the 

event of rejection of the prime lease by debtor sublessor. A rejection does 

not terminate a Lease. It does constitute a default. Consider possible 

claim by sublessee against sandwich lessor (prime lessee - sublessor) 

where prime lessor is debtor in reorganization proceeding. 

65 See Claflin v. Commercial State Bank of Two Harbors, 487 N.W. 2d 242 (Minn App. 1992). 

66 Under the Statute of Ann which has been received into the law in many jurisdictions where a lease precedes the 

mortgage the tenant is obligated to pay rent to the foreclosing mortgagee after transfer of title. In many jurisdictions, 

absent an attornment agreement, a tenant under a lease that is made after the mortgage is recorded is not required to pay 

rent to the new owner after the foreclosure and may vacate the premises unless it has made at least one payment to the 

new owner, in which case it may have constructively attorned to the new owner. 

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3.9.4 Lease Assignment Issues. 

Consider issues arising from rejection in a bankruptcy code proceeding of 

lease by assignee debtor. These include claim against assignor and ability 

of assignor to do something other than pay the lost rent to the landlord. 

3.9.5 Collateral Rent Assignment. 

See §5.20 below. 

3.10 Notice and Other Procedural Requirements. 

Examine licensor and franchisor nondisturbance and recognition agreement where 

collateral includes hotel, fast food restaurant, etc. to determine the specifics of 

notice and other procedural requirements and lender's rights and procedures. 

3.11 Assembly of Client's Document 

3.11.1 If the closing binder consists of copies of executed documents compare the 

documents in the binder with the actual executed documents, if available. 

Determine if client's personnel maintain "working" or other personnel files. If so 

review these files for possible basis of debtor claims or defenses. 67 Also check 

copies of computer mail that may be retained in lender' computer system or PC 

hard disks or on storage disks including any notes, files and backup disks on 

which old items may not have been deleted. 68 

3.12 Partially or Wholly Unfunded Loan Commitments. 

Review to determine if a reasonable basis exists for lender to avoid funding. Be 

careful of lender liability claims if funding is stopped. If the lender does make 

additional advances, will it be entitled to its lien priority for funds so advanced. 69 

Is there an appropriate future advance statute Is it necessary in order for the 

lender to secure priority over liens subordinate to initial mortgage that the 

advances be "obligatory" 

67 See item 7.0 below 

68 "Documents" for discovery purposes under current practice may include all written, recorded, or graphic materials of 

any kind including memoranda, reports, studies, contracts, letters, telegrams, diaries, meeting minutes, pamphlets, 

handwritten notes, charts, tabulations, records of telephone conversations, maps, photographs, tapes, slides, and any 

information, including data and software, stored in or accessible through any computer or other information retrieval 

system, together with all instructions and other materials necessary to use or interpret such documents. 

69 See discussion at item 5.8 below and statutory note on future advances at Restatement of the Law of Property-Security 

(Mortgages) 57, Tentative Draft No. 1 (March 22, 1991). 

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Will the purpose of the proposed advance come within authorizing language of 

the mortgage or deed of trust and does applicable law enforce such provisions 

Will any part of such advance be used to pay wages of employees of the 

borrower. 70 

3.13 Letters of Credit. 

3.13.1 Considerations. 

Consider: 

(1) What is the solvency and credit rating of issuing 

institution 

(2) Is the letter of credit is clean or documentary 71 

(3) What is the possibility of requiring borrower to replace a 

letter of credit with a better quality obligation if issuing 

institution has been or may be liquidated or taken over by 

the R.T.C. or F.D.I.C. or does not have a top credit rating 

(4) Is there is any realistic possibility of presentation or 

payment being enjoined by account party 72 

(5) Has the L/C been transferred 73 or the proceeds assigned 74 

70 Under 26 U.S.C. 3505 a party that controls the payment of wages is obligated to insure that withholding taxes are 

paid with respect to such wages. Under 31 U.S.C. 3713 a person who fails to recognize a U.S. Government priority 

claim may be held liable to the extent any payments are made other then in accordance with applicable priority rules 

and to the detriment of the U.S. Government. 

71 A "clean" letter of credit requires only a draft for presentment. A documentary letter of credit conditions payment 

upon presentation of specified documents. A "standby" letter of credit is an adaptation of a mercantile letter of credit 

used as collateral in a real estate loan transaction or other non mercantile transactions. See discussion in Baker v. 

National Boulevard Bank of Chicago 399 F.Supp. 1021, 1024. (N.D. Ill. 1975) Itek Corp. v. First National Bank of 

Boston, 730 F.2d 19, 24 (1st Cir. Mass. 1984). 

72 The "Account party" is the individual on whose application the issuer has issued the letter of credit and the party that 

will be liable over to the issuer upon a draw on the Letter of Credit. The UCC refers to this person as the "Applicant" or 

"Customer." See discussion at items 3.13.4, 3.13.5 and 3.13.6 below. 

73 An assignment of proceeds of an L/C to a mortgage lender is accomplished by an acknowledgement of the issuer 

that the assignee is entitled to all or a portion of the proceeds (see UCC § 5-114(c). See revised UCC § § 9-107, 9- 

312(b)(2) and 9-314(a) and (b). 

74 A transferee is entitled to act as if it were the beneficiary and draw on the L/C in accordance with its terms. To 

be transferable, the L/C must on its face so specify. The applicable customs and practices may limit the beneficiary 

to a single transfer unless the L/C provides otherwise on its face. 

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84 

3.13.2 Non-Documentary Conditions. 

The proposed revision of U.C.C. Article 5 broadens the definition of 

"Document" to include "other record, statement or representation of fact" 

to recognize the use of letters of credit other than in trade related 

transactions. Non-documentary conditions must be disregarded by the 

issuer. 

3.13.3 Subrogation. 

Section 5-117 of the revisions to U.C.C. Article 5 as proposed in June 

1995 subrogates an issuer that honors a presentation to the rights of the 

beneficiary as if such issuer were a secondary obligor of the underlying 

obligation. 75 This section endorses the holding in Tudor Development 

Group, Inc. v. U.S.F.&G. 76 

3.13.4 Independence Doctrine. 77 

The basic principal of letter of credit law is the so called "Independence 

Doctrine" that the letter of credit transaction is intended to be independent 

of the underlying transaction with respect to which the letter of credit has 

been issued. 78 

3.13.5 Fraud in the Transaction. 

Courts are not consistent as to whether particular circumstances amount to 

fraud such that a court may enjoin presentment or honoring of a letter of 

credit. 79 Sections §5-114 of the U.C.C. 80 is considered to be a codification 

of the Stzejn case "Fraud in the Transaction" exception in providing that 

75 See Restatement of the Law Third, Suretyship §1 (1995). 

76 968 F.2d 357 (3rd Cir. Pa. 1992). 

77 See Note, The Independence Rule in Standby Letters of Credit, 52 Univ. of Chicago L.R. 218 (1985). 

78 In the classic case of Stzejn v Henry Schroeder Banking Corp., 177 Misc 719, 31 N.Y.S. 2d 631 (N.Y. Sup., 1941) 

an exception was carved out of the common law rule of absolute independence of the credit and underlying transaction 

by holding that the issuer is not required to honor the beneficiaries demand for payment if there has been "fraud in the 

transaction". In that case the fraud was in the beneficiary shipping junk under a bill of lading for bristles. Article 5 of 

the Uniform Commercial Code deals with Letters of Credit. 

79 For references to cases that have permitted an injunction on various grounds see Grounds Air Transfer v. Westgate 

Airlines, 899 F.2d 1269, 1273 (1st Cir. 1990). 

80 See footnote immediately above. 

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the issuer must honor the draft unless the documents don't conform with 

the warranties provided for by UCC §7-507, the documents are forged or 

fraudulent or "there is fraud in the transaction" and that a bank may honor 

a letter of credit despite notification by the customer of fraud, forgery or 

other defect not apparent on the face of the instrument, but a court of 

appropriate jurisdiction may enjoin such honor 81 

3.13.6 Injunction Proceedings. 

Courts have generally applied the same standards to attempts to enjoin a 

beneficiary from presenting a letter of credit that they have applied to 

attempts to enjoin an issuer from funding the letter of credit. 82 

3.14 U.C.C. Security Documents, Perfection. 

3.14.1 Check evidence of filing of U.C.C. 1's or other perfection documents-is 

there any particularly valuable non-real estate U.C.C. type collateral such 

as franchises, licenses and management agreements, etc. 

3.14.2 Perfection of U.C.C. Security Interests. Determine proper filing place. 

This will usually be the state capital and possibly also locale of debtor's or 

executive office. 83 This may not be in the same state or locality as the 

project site. 

3.14.3 In case of time-share and lot sale projects, consider whether lien of timeshare 

reservable paper itself has been properly perfected. 

3.15 Jury Waiver Provisions. 

3.15.1 Although jury waiver provisions are, absent applicable statutes, generally 

upheld in most jurisdiction's, local law and the directions of decisions 

must be reviewed if such waiver is considered significant in context. 84 

81 Although Section 5-114 does not purport to provide the standard to be applied in an action by the account party to 

enjoin the presentment by the beneficiary of the letter or credit, courts often apply the same fraud in the transaction 

standard to actions to enjoin presentment on the theory perhaps that it is an indirect attempt to achieve the same 

objective as a payment injunction. See J. Doland, The Law of Letters of Credit (1981). 

82 See Jupiter Orrington Corp. v. Zweifel, 127 Ill. App. 3rd 559, 469 N.E. 2d 590 (1984); Harris Corp. v. 

National Iranian Radio and Television, 691 F.2d 1344, 1353-55 (11th Cir. 1982). 

83 See U.C.C. Sec. 9-103 (Perfection in Multi-state Transactions) and Sec. 9-401 

84 If the applicable law is not clear consider whether the waiver is bilateral and supported by consideration, who drafted 

the document, whether the waiver is prominently displayed in the document and not buried in small type, the relative 

bargaining position of the parties, whether existence or terms of the waiver were separately or specifically acknowledged 

by the waiving party and the existence of informed consent to the waiver by the waving party. 

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Determine whether the jury trial waiver of a loan agreement may extend to 

enforcement of other loan documents. 85 The 4th Circuit in Leasing 

Service Corp. v. Crane, 86 placed the burden on the party seeking to enforce 

waiver to establish that the waiver was knowing and voluntary, while in 

K.M.C. Co. v. Irving Trust Co., 87 the burden is on the party opposing 

enforcement of the jury trial waiver. 

3.16 Casualty and Liability Insurance Policies, Certificates, Mortgagee 

Endorsements. 

If property is or may become vacant, check vacancy provisions of policies - does 

coverage continue notwithstanding vacancy; is any notice required Are there any 

Change of Risk clauses. 

3.17 Prior Workout, Interim Forbearance and Collateral Enhancement 

Arrangement Documents. 

These documents may consist not only of those used to fully document prior 

restructuring with the current lender of this or other loans with the same borrower 

or an affiliate of such borrower, but may also consist, for instance, of 

communications from a loan officer or of documents confirming interim 

forbearance arrangements or even memorandum in the lender's files of phone 

conversations and loan officer or asset manager originated interoffice memoranda. 

The more formal documents will often contain wavers by the borrower of claims 

based on prior acts or omissions of the lender and that workout negotiations do 

not constitute a waiver of any of the lender's rights under the loan documents. 88 

Economic duress may be an effective defense available to the borrower to resist 

enforcement of a waiver in workout documents. 89 Failure of the lender to make a 

85 In Hulsey v. West and Federal Deposit Ins. Corp. 966 F.2d 579 (10th Cir. Okla. 1992) the court, on the basis of the 

language of the waiver provision, would not extend a waiver in a corporation's loan agreement that was signed by the 

corporation's president to such individual's personal guarantee. The Georgia Supreme Court in Bank South, N.A. v. 

Howard, 264 Ga. 339, 444 S.E. 2d 799, 42 A.L.R. 5th 763 (Ga. 1994) refused to enforce a jury waiver in a guarantee 

holding that a pre-litigation waiver of jury trial cannot as a matter of law be sufficiently knowing and voluntary since the 

guarantor cannot prior to the institution of litigation be aware of the basis and circumstances of any future claim on the 

guarantee. 

86 804 F.2d 828, 833 (4th Cir. N.C. 1986) 

87 757 F.2d 752, 758 (6th Cir. Tenn. 1985) 

88 In Travelers Ins. Co. v. Corporex Properties, Inc., 798 F.Supp. 423 (E.D. Ky 1992) the district court granted 

summary judgment on the basis of a nonwaiver provision of a pre-workout letter against a borrower's claim that the 

lender was obligated to continue with workout discussions. 

89 See Freedlander, Inc Mortg. People. v. NCNB Nat'l Bank of N.C., 706 F.Supp 1211 (E.D. Va. 1988), aff'd. 921 F.2d 

272 (4th Cir. Va. 1990). 

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full disclosure to the borrower may also be the basis of a defense to enforcement 

of a borrower waiver contained in workout documents. 90 

3.18 Subordination Agreements. 91 

3.18.1 Is the senior debt to which subordination applies and the junior debt that is 

subordinated clearly defined 

3.19 Document Modification and Alteration. 

4.0 Status of Property 

3.19.1 Undisclosed revision of documents prior to execution may constitute 

fraud. 92 

4.1 Physical Condition 

4.1.1 In a substantial situation consideration should be given to updating the pre 

closing inspection report or physical condition survey. 

4.1.2 Review of maintenance and operational contracts. Must obligations be 

assumed under existing contracts to achieve continuity of operations 

4.2 Property Income 

4.2.1 Leases 

(1) A spreadsheet may be prepared indicating anticipated income from 

existing executed leases. Differentiate between tenants in occupancy, and 

occupancies anticipated under executed leases. Consider broker 

commissions on lease collections and renewals. 

(2) Review leases advantageous to landlord such as those at or in 

excess of market value or leases in a competitive market to evaluate any 

tenant escape clauses or other outs and seek to relate to them. 

(3) Lease being negotiated - consider probability of the negotiations 

resulting in additional tenants entering into occupancy. 

90 See Parrish v. United Bank of Ariz, 164 Ariz 18, 790 P.2d 304 (Ariz Ct. App 1990). 

91 See Nassberg, What to Watch for in Drafting Subordination Agreements, 32 Prac. Lawyer 73 (April 1986). 

92 See Fairfax Sav. F.S.B. v. Ellerin, 94 Md. App. 685, 619 A.2d 141 (1993) aff. in part and vacated in part was 

remanded 337 Md. 701, 652 A.2d 117 (1995); See Fairfax Sav. Fund v. Weinberg and Green, 112 Md. App. 587, 685 

A.2d 1189 (1996). 

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(4) Evaluate liabilities of the landlord under leases to which lender 

may succeed as a successor to the landlord - borrower. These may include 

unpaid tenant allowances, lease inducements including moving expenses 

and prior space lease assumptions and buyouts. 

(5) Determine if any free rent periods will burden the projected income 

flow. 

(6) In residential leases, the lender may as a practical matter have to 

reestablish escrow accounts for tenants if the borrower depleted these 

funds. Consider possible claims by tenants under state unfair trade 

practices procedures. In addition, unless there is an escrow tenants may 

have no inducement to leave premises in proper condition upon 

termination of lease or to pay last month's rent. 

(7) Review Estoppels and Subordination, Attornment and 

Nondisturbance Agreements. Are tenants obligated to pay rents directly to 

the lender on notice of borrower's default from lender How are such 

provisions phrased Is there any provision for lender or borrower 

indemnification to tenants in the event of an improper claim by lender 

Does the indemnification go beyond repayment of any amount paid to 

lender but ultimately determined to belong to the borrower 

4.2.2 Other Possible Sources of Income 

(1) Insurance Recoveries - Review mortgage clauses and assignments 

of proceeds. Do leases require proceeds to be used for reconstruction 

(2) For-Sale Assets Such as Condominium Units or Houses - 

Consider the ability of the lender to convey houses or condominium units 

to contract purchasers. Will the debtor's cooperation be required or 

helpful Do contract purchasers have outs Any change in market since 

the agreements were executed Any relevant notice requirements 

Evaluate obligations of Seller under existing unit or house sale 

agreements. Is it important for your client to be a successor declarant 

Who is in control of the Association 93 

(3) Recently Terminated Leases. Consider whether lease 

terminations may constitute fraudulent conveyances. Were any attempted 

terminations without the consent of the mortgagee valid as against the 

mortgagee to whom significant leases (rather the merely rents) were 

assigned What happened to any termination fees paid by the tenant 

93 See Van Atta, What Every Developer's Successor Should Know (part 1 and 2), The Practical Real Estate Lawyer, 24 

(May 1990) (Vol. 6, No. 3). 

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4.2.3 Security Deposits - Determine location and amounts. Are they adequate 

If not, as a practical matter security deposits on residential leases may 

have to be reinstated by the lender after a foreclosure. Determine local 

practice in regard to the liability of a foreclosing lender for missing 

deposits. 

4.2.4 Earnest Money Deposits - Determine location, amounts conditions to 

disposition. 

4.2.5 Limited Partners and Shareholders of Debtor Entity. Does any entity 

or person other than the Debtor own or have an interest in any collateral 

that such other entity or person may seek to protect 

4.3 Costs and Expenses. 

4.3.1 Operating Expenses 

4.3.2 Possible Third Party Claims 

(1) Liens that may prime the mortgage. (review updated title policy - 

and compare with policy as of closing on loan). 

(2) Subordinate liens 

(3) Mechanics' lien claims 

(4) Unsecured liquidated claimants 

(5) Unsecured unliquidated or contingent claims 

(6) Mechanics' lien claims 

(7) Ground or Master Lessor - If collateral is a leasehold interest. 

(8) Obligations for professional service and need of continuity of such 

services. 

(9) Payments required to assume continuity of services 

4.3.3 Deferred Maintenance 

4.3.4 Major Repairs - Including costs to conform with local codes - are there 

any upgrades of life safety systems required under the local codes upon a 

transfer of title or making of substantial improvements or repairs 

4.4 Project Valuation 

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4.4.1 Review Closing Appraisal and Compare with Current or Recent 

Appraisal - Consider basis of the variance, if any Are there any 

erroneous assumptions in the closing appraisal 

4.4.2 Review Original Market Analysis 

4.5 Construction Loan Evaluation - Determine state of completion. Have 

construction documents been assigned to lender What is the status of debtor's 

accounts with contractors and material supply people Do they have right to file 

lien claims Confirm status of permits, approvals, variances, land use 

proceedings. 

4.6 Reciprocal Easement Agreements - Review REAs if they are of value or a 

detriment to the mortgaged property. Consider the possibility of a rejection of any 

REAs in a bankruptcy code proceeding. See discussion at item 8.5 below. 

4.7 Environmental Concerns 

4.7.0 Possibly Relevant Federal Statutes include the following: 

(a) 

(b) 

(c) 

(d) 

(e) 

(f) 

(g) 

(h) 

(i) 

(j) 

(k) 

The Clean Water Act, 33 U.S.C. §1251 et seq.; 

The Clean Air Act, 42 U.S.C. §7401 et seq.; 

The Resource Conservation and Recovery Act, as amended by the 

Hazardous and Solid Waste Amendments of 1984, 42 U.S.C. 

§6901 et seq.; 

The Safe Drinking Water Act, 42 U.S.C. §300f et seq.; 

The Toxic Substances Control Act, 15 U.S.C. §2601 et seq.; 

The Federal Insecticide, Fungicide and Rodenticide Act, 7 U.S.C. 

§136-136y; 

The Emergency Planning and Right-To-Know Act, 42 U.S.C. 

§11001 et seq.; 

The Environmental Quality Improvement Act, 42 U.S.C. §4371 et 

seq.; 

The National Flood Insurance Act, 42 U.S.C. §4001 et seq.; 

The Fish and Wildlife Coordination Act, 16 U.S.C. §1451; and 

The Wild and Scenic Rivers Act, 16 U.S.C. §1271 et seq. 

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4.7.1 Contamination - Hazardous or Toxic Substances - Clean Up Liability - 

CERCLA 94 Issues 95 - Superliens. 

(a) Conditions of particular concern to lenders include (1) hazardous 

substances, (2) petroleum substances, particularly leaking underground 

storage tanks ("LUST"), (3) polychlorinated biphenyls ("PCB's") and (4) 

asbestos. Liability may arise under federal and state statutes and also 

under common law principles of nuisance, trespass, negligence and strict 

liability. 

(b) Consider the impact of cases such as United States v. Maryland 

Bank and Trust Co., 632 F. Supp. 573, (D. Md. 1986), 24 Env't Rep. Cas. 

(BNA) 1193, United States v. Mirabile, 1985 WL 97, 15 Envtl L. Rep. 

20,992, 20,995-96 (Envtl L. Inst.) (E. D. Pa 1985) The holding of the 

Mirabile court that for a lender to be liable for borrower's acts the Lender 

must be involved in the borrower's "day to day" operation has not been 

followed in cases such as United States v. Fleet Factors Corp., 901 F.2d 

1550 (11th Cir 1990); reh'g denied, 911 F.2d 742 (11th Cir. Ga. 1990) cert 

denied, 498 U.S. 1047, 112 L.Ed. 2d 772, 111 S.Ct. 752 (1991). 96 

(c) The EPA regulations issued on April 29, 1992 on the CERCLA 

§101 [42 U.S.C. §9601(20)(A)] secured lender exemption (57 FR 18344) 

have been invalidated by the Court of Appeals for the District of Columbia 

Circuit which held that the federal courts and not the EPA are the 

designated adjudicators of the scope of CERCLA liability. 97 The EPA and 

Department of Justice announced in 1995 their intention to apply the " 

Rule as guidance" in determining whether to bring enforcement actions. 98 

In September, 1996, Congress re-authorized CERCLA with the Asset 

94 Comprehensive Environmental Response, Compensation and Liability Act of 1980, 42 U.S.C. §9601 et seq. 

("CERCLA") as amended by 1986 Superfund Amendments and Reauthorization Act ("SARA"). 

95 CERCLA imposes liability for hazardous substance release from a site upon the following potentially responsible 

parties ("PRP's"): (1) present owner or operator of a generating site, (2) owner or operator of site at time of release and 

(3) persons who arrange for disposal or transport to site selected by such person. 

96 In Fleet the court seems to say that mere capacity to influence management of hazardous substances is sufficient 

to create liability, although in Fleet there may well have been sufficient affirmative acts by the lender to in fact 

exercise its capacity. In Bergsoe Metal Corporation v. The East Asiatic Corporation, Ltd., 910 F.2d 668 (9th Cir. 

Or. 1990) the court held that more then mere capacity to influence is required to subject the lender to liability. See 

Environmental Hazards: A Real Estate Lender's View, Mortgage Bankers Association of America, 1988. For later 

history, see 819 F.Supp. 1079, (S.D. Ga. 1993); 821 F.Supp. 707 (S.D. Ga. 1993). 

97 Kelley v. E.P.A., 25 F.3d 1088 (C.A. D.C. 1994), Reher. Den. 306 U.S.App.D.C. 382 (C.A. D.C. 1994). 

98 60 Fed.Req. 63, 517 (1995). 

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99 42 USC §§9601(20)E),(F),(G) 

Conservation, Lender Liability and Deposit Insurance Protection Act of 

1996, 99 which adopted much of the EPA Secured Creditor policy and 

minimized potential liability of fiduciaries, 100 who had previously been 

unprotected under the statute. 101 

(d) In U.S. v. McLamb 102 the court concluded that "the Safe Harbor 

Exceptions" applied to a mortgage that acquires the contaminated property 

through foreclosure of its mortgage. In Walterville Ind. v. Finance 

Authority of Maine 103 the First Circuit concluded that the Secured Creditor 

Exception applied to a sale-leaseback financer that held title at the time of 

the contamination. 

(e) Many states have enacted their own versions of CERCLA, 

requiring cleanup of contaminated properties and most of these states have 

included lender exemption provisions like the federal statute. 104 Of 

special interest, however, are so-called “superliens” enabled by the state 

statutes, which allows the state to recoup cleanup costs via a lien placed on 

the contaminated property, which lien has priority over all pre-existing 

claims, even those of secured creditors. 105 The validity of the superliens 

has been upheld by state courts. 

4.7.2 Coastal Regulations 

4.7.3 Wetlands Issues. Not limited to coastlines, property on bodies of water, 

tidal lands, swamps, marshes, etc. Consider possibility that lands 

apparently dry most of the year may be saturated during a wet season. 

Applicable statutes include Rivers and Harbors Act of 1899, 1033 U.S.C. 

§403, Federal Pollution Control Act (Clean Water Act) Pub. L. 92-500, 86 

Stat. 816 See 33 C.F.R. 323-330 106 . Delineation errors may be expensive 

100 42 USC §§9607(n) 

101 See, for example, City of Phoenix v. Garbage Services Co., 816 F. Supp. 564 (Az 1993); see also Monarch 

Tile, Inc. v. City of Fiorano, 212 F.3d 1219, 1222 (11th Cir. Ala. 2000), for discussion of effect of statute on Fleet 

Factors. 

102 5 F3d 69, at 72 (4th Cir 1993). 

103 984 F.2d 549 (1st Cir 1993). 

104 See, for example, New Jersey and Pennsylvania statutes, N.J.S.A. 58:10-23.11g6 and 35 P.S. §6020103, 

respectively. 

105 See, for example, New Jersey’s statute at N.J.S.A. 58:10-23.11(f). 

106 See U.S. v. Riverside Bayview Homes, Inc., 474 U.S. 121 (1985), Bailey v. U.S. Army Corp. Of Engineers, 647 

F.Supp. 44 (D.Idaho 1986). 

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to cure or mitigate and construction within wetlands due to erroneous 

delineation may result in substantial fines and remediation costs. 

Enforcement may be on local, state and federal levels. 107 

4.7.4 Asbestos, Lead Paint and Radon 

4.7.5 Lender's Right to Enter Upon Property and Conduct Tests. Even if 

not specifically authorized by the loan documents a lender may be entitled 

to so enter on the basis of a general authorization in the loan documents 

for the lender to make repairs, alterations and improvements to protect the 

security. 108 

5.0 Review of Applicable Law 

5.1 Realization Procedures. Consider judicial v non-judicial approaches to realizing 

or acquiring the collateral. Is there any statutory or case law establishing the right 

of debtor to notices and to cure periods. Many states, especially in the west, have 

a "one-action" rule that limits a creditor to one form of action for recovery of a 

debt. 109 

5.2 Right of Redemption and Deficiency Judgment Limitations. 

5.2.1 See also item 5.6 below on multistate collateral. Review any applicable 

deficiency judgment statute, rules or common law. 

5.2.2 Among the deficiency statutes are those of California and other western 

states that permit only one recovery on a debt secured by a mortgage and 

those that precondition a deficiency action upon specific acts by the 

mortgagee such as bringing a valuation proceeding within a specified 

relatively short period of time following the foreclosure. 

5.2.3 Deficiency judgment law may preclude proceeding against other collateral 

or guarantees 110 after execution against real estate, at least until the amount 

107 See Federal Wetlands Delineation Manual issued by The Department of Army, E.P.A., Fish and Wildlife Service 

and Soil Conservation Service. See Avoyelles Sportsman's League v. Marsh, 715 F.2d 897(5th Cir. 1983) (vegetation 

criteria)., Leslie Salt Co., v. U.S., 700 F.Supp 476 19 Envtl. L. Rep. 20420 (N.D. Cal 1988) (soil criteria) remanded, 896 

F.2d 354 (9th Cir. Cal. 1990), cert. den. 498 U.S. 1126, 112 L. Ed. 2d 1194, 111 S.Ct. 1089, on remand reconsideration 

denied, affd. 55 F.3d 1388 (9th Cir. Cal. 1995) cert. den. Cargill, Inc. v. United States, 516 U.S. 955, 133 L. Ed. 2d 325, 

116 S.Ct. 407 (1995). 

108 See First Capital Life Ins. Co. v. Schneider, Inc., 608 A.2d 1082 (Pa Super 1992); RTC v. Polmar Realty, 780 

F.Supp. 177 (S.D.N.Y. 1991) 

109 See Zeller, Deighan, Practical Consideration Affecting California Non-Judicial Foreclosures, 14 Shopping Center 

Legal Update 6, Issue 2 (Summer 1994). 

110 See Adams v. Cooper, 340 N.C. 242, 460 S.E.2d 120 (N.C. 1995). 

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of deficiency has been established in an ancillary proceeding. The 

determination of market value of the foreclosed real estate may limit the 

amount that may be recovered against other assets of the debtor or against 

guarantors or partners of the debtor. 111 This may even apply in seeking to 

proceed against other primary collateral such as the furniture, fixtures and 

equipment (FF&E) on a hotel loan. 

5.3 Yield Maintenance Provisions, 112 Prepayment Charges, Default Interest and 

Liquidated Damages 113 

5.3.1 Yield maintenance provisions are prepayment fees intended to compensate 

the lender for income lost as a result of a premature payment of all or part 

of the loan principal. The more recently drafted yield maintenance 

provisions clearly impose the premium 114 in the event of prepayment as a 

result of an acceleration following a default 115 . 

5.3.2 In bankruptcy code proceedings several courts have treated yield 

maintenance provisions as liquidated damage clauses 116 and then 

characterized the specific provision as an unenforceable penalty provision 

on the basis of the computational approach used that would yield to the 

lender more then the court determined to be appropriate. 117 

111 In Fed. Home Loan Mort. Corp. v. Arrott Associates, 60 F.3d 1037 (3rd. Cir. 1995) the Court reduced the amount 

due under a limited guarantee by the market value of the mortgaged property and thus found there to be no liability 

under a 10% guarantee. 

112 On prepayments generally see Note, Prepayment Penalties: A Survey and Suggestion, 40 Vand L. Rev. 409 (1987). 

113 Also see Item 5.28 below on default interest. 

114 A careful draftsman will not refer to these payments as "penalties". Perhaps the best characterization in the 

document is as a "yield maintenance payment" or an "interest differential adjustment." 

115 See Stark, Enforcing Prepayment Charges: Case law and Drafting suggestions, 22 Real Prop. Prob & Trust J., 549 

(1987). 

116 Whether a provision is a penalty or a liquidated damage clause must be decided under state law. In re Tastyest, 

Inc., 126 F.2d 879, 881-882 (3rd Cir. 1942), cert den. 316 U.S. 896, 86 L.Ed 1766, 62 S.Ct. 1291 (1942). 

117 See In re Skyler Ridge,80 B.R. 500, 16 Bankr.Ct.Dec. 1122 (Bankr. C.D. Cal 1987)(Kansas Law Applied); In re 

Kroh Bros Development Company, 88 B.R. 997 (Bankr. W.D. Mo. 1988). Complaint dismissed. 148 B.R. 97 (Bankr. 

P. Mass 1992) (Court concluded formula used was unreasonable by reason of being based on lower yield treasury 

bonds and not on a first mortgage interest yield index and because interest loss was not reduced to present value) In re 

Imperial Coronado Partners Ltd. v. Home Federal Savings & Loan Assn, 89 C.D.O.S. 1871 (Bankr. C.D. Cal. 1989). 

Courts have disallowed a portion of the formula computed amount rather then disallowing the entire premium. In re 

Morse Tool, Inc. (Ferrari v. Barelays Business Credi)t, 87 B.R. 745 (Bank. D. Mass. 1988). 

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5.3.3 Determine whether under the documents the prepayment premium is due 

following default and acceleration 118 . 

5.3.4 A prepayment fee equal to six months interest payable only if the loan is in 

default at the time of the payoff has been held to be a late charge and as 

such an unenforceable penalty. Had the charge not been contingent on the 

existence of a default it might have been treated as a permissible 

alternative mode of performance. 119 

5.4 Equal Credit Opportunity Act ("ECOA"). 15 U.S.C. §1691(a); Reg. B, 12 

C.F.R. §202.7(d) (1990) prohibits a "creditor" from discriminating against an 

applicant in a "creditor transaction" on basis of race, color, religion, national 

origin, sex, marital status, or age and has been construed to limit circumstances 

under which a borrower's spouse may be required by certain lenders to assume 

liability for the borrower's debts. 120 A "creditor" is defined at §1691a(e) as 

including any person who regularly extends credit. When an applicant has 

individually qualified for a loan, requiring a spouse's signature on a note or 

otherwise requiring a spouse to guarantee the borrower's obligation is a violation 

of the ECOA. Punitive damages may be awarded for breach. 121 A breach of 

ECOA has been held to be a valid defense to a suit on the underlying debt even 

when the holder of the note is a successor to the RTC. 122 

118 Where prepayment clause did not clearly provide that the premium was due on acceleration upon default courts 

have often held the premium on prepayment not to be applicable. See In re LHD Realty Corp., 726 F.2d 327 (7th Cir. 

1984); Nutman, Inc. v. Aetna Business Credit, 453 N.Y.S. 2d 586 (1982). Where the prepayment clause by its terms 

applies to an acceleration on account of default it will generally be so enforced. See Pacific Trust Co TTEE. v. Fidelity 

S&L Ass'n, 184 Cal. App. 3d 817, 229 Cal. Rptr. 269(1986). In Teachers Ins. &Annuity Ass. v. Butler, 626 F.Supp. 

1229 (S.D.N.Y. 1986) Diss. w/o opinion 816 F.2d 670, (2d Cir. NY 1987), the court did not consider the inclusion of 

such a clause by a lender in the required loan documents to be a reasonable basis for the borrower to refuse to close a 

loan. 

119 Ridgley v. Topa Thrift & Loan Ass’n., 17 Cal. 4 th 970, 953 P.2d 484, 73 Cal. Rptr. 2d 378 (1998) (California 

Supreme Court). 

120 Anderson v. United Finance Co., 666 F.2d 1274 (9th Cir, 1982), but see Bank of America Nat. Trust and Savings 

Ass'n v. Hotel Rittenhouse Association, 595 F.Supp 800 (E.D. Pa 1984), Evans v. Centralfed Mortgage Co., 815 F.2d 

348 (5th cir. 1987). See also Comptroller of Currency Letter; No. 5 Cons. Cred. Guide (CCH) 42,100 (Oct. 27, 1977) 

and U.S. v. Amodeo, 44 F.3d 141 (2d Cir. NY 1995). 

121 In Eure v. Jefferson Nat. Bank, 448 S.E. 2d 417 (Va.1994) the Virginia Supreme Court voided a wife's guarantee 

under the ECOA. The wife was not a joint applicant on the loan and she had no interest in the borrower. The bank 

officer asked for the wife's guarantee did so because it was "common practice". The Court concluded that, the evidence 

supported the conclusion that the wife was asked to guarantee the loan only because of her marital status. Note that the 

statute provides solely for damages and does not provide for invalidation of a proscribed guarantee. See also Anderson 

v. United Finance Co., 666 F.2d 1274, 1278 ( 9th cir. 1982). 

122 Silverman v. Eastrich Multiple Investor Fund, LP 51 F.3d 28 (3rd. Cir. 1995). In Silverman the Circuit Court also 

held that the two year statute of limitation in the ECOA is not applicable to the use of the statute as a defense. Calaska 

Partners, Inc. v. Corson, 672 A.2d 1099 (ME 1996). But see The Riggs Nat'l Bank of Wash. v. Linch, 829 F.Supp. 163 

(E.D. Va. 1993). 

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5.5 Statutes Limiting Alleged Oral Modification of Loan Commitment 123 . 

5.6 Multi-State Collateral. 124 Consider application of deficiency judgment statutes 

and case law relating to recovery of deficiencies and enforcement of claims 

against multiple collateral. 125 A detailed analysis has to be made of the law in 

each jurisdiction in light of the choice of internal law applicable to the obligation 

and to any guarantees and the order of realization on the actions in each 

jurisdiction. 126 

5.7 Partnership Issues. 

5.7.1 Direct Action by Creditor Against General Partners. Many 

jurisdictions have interpreted the Uniform Partnership and the Uniform 

Limited Partnership Act to permit an action by a creditor directly against a 

general partner without the need for the creditor to first proceed against the 

partnership. 127 

5.8 Additional Advances to Protect Collateral. Although as between lender and 

borrower future advances will generally be secured if the parties so agree the law 

is diverse and often confused among the jurisdictions as to the rights of those 

recording liens after recording of a mortgage but prior to specific advances by 

such mortgagee. 128 

5.9 Fair Debt Collection Practices Act. 15 U.S.C. §1692 relates to abusive debt 

collection practices and includes lawyers as "debt collectors" subject to the Act. 

123 See discussion at Item 7.1.13 below 

124 See Restatement (Second) Conflict of Laws §229. 

125 See Annotation, 44 ALR 3rd 922 (1972). Although the prevailing rule generally looks for conflict purposes to the 

deficiency law of the situs of the foreclosed property, this rule is subject to exceptions and is not universally followed. 

See United States v. Stewart, 523 F.2d 1070 (9th Cir. 1975) (California law applied by Washington court where 

property was located in California, Contra, Gate City Federal Sav. & Loan Asso. v. O'Connor, 410 N.W. 2d 448 (Minn 

App. (1987) (although land located in Minnesota the law of North Dakota applied. The parties were North Dakota 

residents); Ould v. Stoddard, 54 Cal 613 (1980); (plaintiff that sued in Ohio on note was barred from foreclosing in 

California under the California "one action" rule. 

126 See Guttenberg and Sherlin, a Lender's Guide to California Antideficiency Laws in Multistate Transactions, 14 

CEB Real Prop. L. Rep. 1, 54 (Jan,Feb 1991). 

127 See Revised Uniform Limited Partnership Act §403 See U.S. Trust Co. of N.Y. v. Bamco, 183 A.D.2d 549, 585 

N.Y. Supp. 2d 186 (App. Div. 1992), TPS Technologies, Inc. v. Rodin Enterprises Inc.,816 F.Supp. 345 (E.D. Pa. 

1993).. 

128 See Chapter 2 of the Restatement of the Law Property-Security (Mortgages) and especially the statutory note at 60. 

Nelson & Whitman, Real Estate Finance Law §12.7 (1993); §27.05 “‘Future Advances’ Clauses” . 

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5.10 Right to Financial Privacy Act. See 12 U.S.C. 3401, et seq. Providing 

information regarding bank customer's accounts is limited to disclosures 

authorized by customer or in response to legal process. Under FIRREA a bank is 

limited in advising customers of the existence or content of grand jury subpoenas. 

5.11 Drug Forfeiture Laws. Innocent mortgagee exception to 19 U.S.C. §1614 

requires that lender have no knowledge of drug activity. 129 

5.12 Foreclosing Partnership Interests. The lender may seek to avoid liability as a 

successor general partner by taking title to the general partnership interests in a 

properly funded and established subsidiary. 130 A lien may have been provided on 

partnership interests in the owning entity either as additional ancillary collateral 

on what was basically a loan on the real estate owned by such entity or as the 

primary collateral for a "working capital" loan. 131 

5.13 F.D.I.C. Superpowers, D'Oench Duhne, 132 Langley, 133 Federal Holder in Due 

Course Doctrine. 134 Although cases hold that the only defenses that may be 

129 See In re Newport Sav. and Loan Association, 928 F.2d 472 (1st Cir. 1991). The U.S. Court of Appeals for the 

11th Circuit held on June 18, 1991 in a case of first impression that the innocent owner defense (21 U.S.C., §881) will 

not protect one that adds her own funds to a pot that she knows includes drug source funds. U.S. v. One Single Family 

Residence located at 15603 85th Avenue, North Lake Park, Florida, 894 F.2d 1511 (11th Cir. 1990). It has been held 

that a transferee who was unaware of drug activity at the time it occurred but had knowledge afterwards at any time 

property was acquired may nevertheless avail itself of the innocent owner defense. U.S. v. One 1973 Rolls Royce, CA 3, 

No. 93-1417. 11/25/94; See also U.S. v. Parcel of Land Known as 92 Buena Vista Ave., 507 U.S. 111, (U.S. 1993); 

U.S. v. Parcel of Real Property known as 6109 Grubb Road, 886 F.2d 618 (CA 3 1989). 

130 Before using a subsidiary to seek to shield partner liability the local law in regard to "piercing of the corporate veil" 

should be reviewed. The standards for shareholders avoiding environmental claims may be stricter than the law 

generally. 

131 In some jurisdictions the holder of a security interest in a partnership interest which does not represent materially the 

entire interest in the partnership may be limited to securing a charging order although in other jurisdictions the right to a 

charging order may be cumulative of other remedies especially in the case of a consensual lien. In a number of 

jurisdictions even a judgment creditor may be able to expose a limited partnership interest to foreclosure if a charging 

order is not likely to satisfy the debt within a reasonable time period. A security interest in a partnership interest may 

entitle the purchaser at the realization sale to becoming an assignee of a limited partnership interest and not to be come a 

substitute partner. 

132 D'Oench, Duhme & Co., Inc. vs. FDIC, 315 U.S. 447 (1942) See also 12 U.S.C. §1823(e). See Chapter 27E “The 

D'Oench, Duhme Doctrine and 12 U.S.C. §1823(e)” . 

133 Langley v. FDIC, 484 U.S. 86, 108 S.Ct. 396, 98 L.Ed,2d 340 (1987). 

134 The Federal Holder in Due Course Doctrine bars makers of negotiable promissory notes from asserting original 

defenses against the F.D.I.C. or those that succeed to the interests of the F.D.I.C. in connection with the purchase and 

assumption transactions involving troubled financial institutions. In Sunbelt Savings, FSB Dallas, Texas v. 

Montross, 923 F. 2d 353, 355 (5th Cir. 1991) the court cited Rep. No. 1269, 81st Congress 2d Session that 

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asserted as against the F.D.I.C. 135 or an institution being liquidated by either the 

F.D.I.C. or an assignee of any of them are those defenses that are obvious from the 

face of the note or possibly from other loan documents. 136 The DC Circuit has 

held that under the doctrine of O'Melveny & Myers v. F.D.I.C., 114 S.Ct 2048 

(U.S. Sup. Ct. 1994) the detailed regulatory regime of FIRREA supersedes the 

D'Oench and other federal common law doctrines. 137 The 11th circuit has held 

otherwise. 138 

5.13.1 D'Oench and §1823(e) have been held not to apply to agreements found in 

the loan documents themselves. 139 

5.13.2 D'Oench has been held not to bar recovery from F.D.I.C. for escrow 

arrangement that was not recorded on banks books. E. I. DuPont de 

Nemours and Co. v. F.D.I.C., 45 F.3d 458 (D.C. Cir 1995) 

5.13.3 In Langley, the Supreme Court held that the D'Oench doctrine extended to 

set-off claims against successors to insured institutions based on alleged 

fraud in the inducement by a predecessor. 140 

"the F.D.I.C. enjoys this protection as a matter of federal common law so that it 

may achieve the congressional mandate of the sound effective and uninterrupted 

operation of the [nations] banking system with resulting safety and liquidity of 

bank deposits. . . " and stated that, "The federal holder in due course doctrine 

facilitates uninterrupted operation of the banking system by allowing the 

F.D.I.C. to complete purchase and assumption transactions quickly and based on 

the face value of a failed bank's negotiable instruments, obviating the need to 

scrutinize the instruments for personal defenses. The doctrine also prevents 

makers from using personal defenses to gain priority over the failed bank's 

creditors' and depositors' rights to the note proceeds." The doctrine applies to 

"personal defenses" as differentiated from "real defenses". 

135 This was also applicable to the RTC prior to it being liquidated. 

136 In F.D.I.C. v. Meyer, 755 F. Supp. 10 (D.D.C. 1991) involving notes held by F.D.I.C. as receiver for the National 

Bank of Washington the court referred to Section 3-305 (2)(b) of the Uniform Commercial Code to the point that not all 

form of duress void a transaction as distinct from making the transaction voidable and that economic duress is not a 

valid defense against the F.D.I.C. since it is not a real defense but rather is a personal defense. 

137 DiVail Insured Income Fund, L.P. v. Boatmen's First National Bank of Kansas City, 69 F.3d 1398 (8th Cir. 1398); 

Murphy v. FDIC, 61 F. 3d 34 (D.C. Cir. 1995); E.I. DuPont DeNemours & Co. v. FDIC, 32 F. 3d 592, 597 (D.C. Cir. 

1994). See §27E.04[3] of Dunaway Text. In Federal Financial Co. v. Hall, 108 F.3 rd 46 (4 th Cir 1997) the Court in 

following O'Melveny held that an assignee of the RTC does not stand in the shoes of the RTC with respect to the six year 

statute of limitations in FIRREA. See §27E.04[3] of Dunaway Text. “Federal Holder in Due Course Doctrine” . 

138 Motorcity of Jacksonville Ltd. v. Southeast Bank, N.A., (call) (In Banc No. 93-4634-5-8-96). 

139 134 See F.D.I.C. v. McFarland, 33 F.3rd 532 (5th Cir. 1994). 

140 The Supreme Court expanded application of the D'Oench, Duhme doctrine by interpreting 12 U.S.C. Sec. 1823(e) 

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5.13.3 D'Oench has been held not to bar reformation of a loan agreement under 

doctrine of mutual mistake. 141 

5.14 Waiver. Consider possible basis of claims that lender has waived right to assert 

certain default remedies or right of acceleration. Courts have generally honored 

nonwaiver provisions 142 

5.15 Lien Priority Issues 

5.15.1 Future Advances 143 

5.15.2 Equitable Subordination 144 

5.15.3 Erroneous Payoffs of Prior Lien. A junior creditor may under certain 

circumstances be prevented from obtaining a windfall from a mistake of a 

new lender which without knowing of the existence of a junior lien paid 

off the prior lien rather than accepting the assignment of the obligation and 

lien that primed the junior line. 145 

5.15.4 Revival and Divesture of Junior Liens. Under the law of many states 

the reacquisition of a property by the mortgagor following foreclosure will 

revive a divested junior mortgage. 146 Under the laws of most states, where 

to be applicable to preclude a misrepresentation defense from being advanced by the maker of notes against a claim on 

the notes by the F.D.I.C. as successor in interest to a closed bank. See Brookside Associates v. Rifkin, 49 F.3rd 490 (9th 

Cir. 1995). In Brookside at 497, the Court distinguished so-called "Freestanding Tort Claims" such as slip and fall 

cases. Since such matters do not relate to an ordinary banking transaction and so will not usually be recorded in 

documents inspected by bank examiners. The Court also held in Brookside that D'Oench does not bar suits against bank 

officers in their individual capacities, "at least insofar as public funds administered by the federal banking authority 

would not be affected." (at 498). See §27E.04[1] of Dunaway Text - “Langley Decision: Fortification of the D’Oench, 

Duhme Doctrine” . 

141 R.T.C. v. Midwest Federal Savings Bank of Minot, 4 F.3d 1490 (9th Cir. Sept. 21, 1993). 

142 See Kirkham v Hansen, 583 A.2d 1026 (Maine 1990) Payment to lender of twenty-seven late payments over a four 

year period (five of which late payment were beyond fifteen day grace period) was not a waiver since conduct of lender 

did not mislead borrower in light of clause in loan documents that authorized acceleration during period of default 

"regardless of prior forbearance". See generally, §11.03[9][c] “Lender’s Waiver or Estoppel” . 

143 See discussion at Item 3.6.4. 

144 See Item 8.21 below. 

145 See United States v. Baran - 996 F.2d 25 (2nd Cir. 1993). 

146 Old Republic Insurance Co. v. Currie, 665 A.2d 1153 (N.J. Super Ct. Chancery Div 1995). 

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a Mortgagor acquires a prior mortgage directly or through an agent, the 

foreclosure of such mortgage will not divest the junior lien. 147 

5.15.5 Purchase Money Mortgage States. Several federal circuit courts have 

held that under specified circumstances rewriting, extending or modifying 

loan terms may, under the "Transformation Rule," constitute a novation 

that results in loss of purchase money mortgage status. 148 The minority 

rule is that the loan is treated as being, in effect, two loans one of which 

retains its special lien status. 149 

5.15.6 Circular Lien Priorities. Circular lien issue may arise where a party with 

a prior lien is on actual notice of the rights of one of several later lien 

holders. Conflicts among statutory priority provisions may also create 

circular lien issues. For a rational analysis of a solution see Tile House v. 

Cumberland Fed. Sav. Bank. 150 

5.15.7 Personal Property and Fixture Issues. 151 

5.16 Jury Trial Waivers. Although these are generally upheld 152 where it is 

established that the waiver was knowing and intelligent. Several states had held 

pre-litigation waivers to be unenforceable. 153 

147 Ray v. Atkins 421 S.E.2d 317 (205 Ga App 85 (1992) 

148 Dominion Bank of Cumberland v. Nuckolls, 780 F.2d 408 (4th Cir. 1985); In Re Manuel, 507 F.2d 990 (5th 

Cir. 1975); In Re Freeman, 956 F.2d 252 (11th Cir. 1992). 

149 See Pristas v. Landaus, 742 F.2d 797 (3rd Cir. 1984). 

150 942 S.W. 2d 904 (Ky 1997). 

151 See Philip Ebling & Steven Weise, What a Dirt Lawyer Needs to Know about New Article 9 of the UCC, 37 

Real Prop., Prob. and Trust Jr. 191 (Summer 2002). 

152 See Phoenix Leasing, Inc. v. Sure Broadcasting, Inc., 843 F.Supp. 1379 (D.Nev. Jan. 13, 1994). 

153 See also discussion at Item 3.15. 

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5.17 Choice of Forum and of Law Provisions of Loan Documents. 

Contractual choice of forum and of law 154 provisions will generally be upheld if 

the chosen forum has a reasonable contact with the transaction. For discussion of 

arbitration provisions see Item 7.11 below. 

5.18 Participation in Co-Lending Arrangements 

5.18.1 Lead Lender's Standard of Care. If not specified in the participation 

agreement such standard may be that the lead lender must exercise at least 

the same care and management as it would generally in a transaction solely 

for its own account. 155 

5.18.2 Implied Covenant of Good Faith and Fair Dealing. 156 Application of 

this requirement should not supersede express terms of any agreement 

between lender and borrower. 157 

5.18.3 Conflict of Interest. Consider implications of any other lending 

relationships lead lender may have with the borrower. 

5.18.4 Applicability of Security Laws. Participation interests in pools of 

mortgages have been held not to be securities subject to federal securities 

laws when sold to other banks 158 but by application of the "family 

154 In National Glass, Inc. v. J. C. Penney Properties, Inc., 336 Md. 606, 650 A.2d 246 (Md. 1994), the court would 

not look to Pennsylvania mechanics lien law to uphold validity of mechanics lien waiver that would not be enforceable 

in Maryland when work was performed in Maryland on a Maryland project by a Maryland corporation and the only 

Pennsylvania contact was a Pennsylvania contractor. 

155 See Royal Bank of Canada v. Interfirst Bank Fort Worth, civ. action CA-4. 84-0161-D (1988 WL 192369 (N.D. 

Tex. April 4, 1988)(not reported in F.Supp); Clinton Federal Sav. & Loan Ass'n. v. Iowa-Des Moines Nat. Bank, 391 

N.W. 2d 712 (Iowa App. 1986); First Nat. Bank of Louisville v. Continental Illinois Nat. Bank & Trust Co. of 

Chicago, 933 F.2d 466 (7th Cir. 1991). Consider discovery implications in litigation regarding the application of such 

standard since the standard may open up an investigation of the leading institutions' loan policies generally and a 

detailed investigation of other unrelated transactions in which the lead bank was the lender solely for its own account. 

The actual standard may be "prudent investor" standard. In Sterling National Bank v. Israel Discount Bank of N.Y., 

No. 1109 (N.Y. App. Div. 1st Dep't May 8, 2003), a New York appeals court affirmed the trial court's denial of the 

lead bank's motion to dismiss claims by the participants for breach of fiduciary duty, fraud and negligence, holding "[i]t 

is no longer acceptable, if it ever was, to conclude in knowing silence, a transaction damaging to a party who is 

mistaken about its basic factual assumptions when … he would reasonably expect a disclosure [citations omitted]. 

New York has joined other jurisdictions in limiting the privilege to take advantage of ignorance." 

156 See Discussion at item 7.1.4 below. 

157 In re Continental Resources Corp. 799 F.2d 622, 625 (10th cir 1986). 

158 Banco Espanol de Credito v. Security Pac. National Bank, 973 F.2d 51, 55 (2nd Cir. 1992). 

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resemblance test enunciated in Reves v. Ernst & Young 159 to be securities 

for such purposes when sold to individuals. 160 

5.19 Clogging Equity of Redemption -- Equitable Mortgages. Although a deed in 

favor of a lender that has been escrowed subject to being recorded in the event of 

a default by the grantor borrower will usually be treated as a "equitable 

mortgage", 161 courts have on occasion enforced such arrangements when entered 

into following a default as part of a work-out arrangement. 162 

5.20 Rent Assignments. 163 

5.20.1 In the bankruptcy context Sec. 552(b) of the Bankruptcy Code now makes 

it clear that post-petition rents are cash collateral for a mortgage holding a 

valid pre-petition assignment. Certain hotel revenues may also be treated 

as post-petition rent. 164 Broad language has in the non-bankruptcy context 

been held to cover such items. 165 

5.20.2 In Credit Lyonnais v. Getty Sq. Assoc. 166 the collateral assignment in 

present tense was construed to be effective immediately upon the 

occurrence of the default and result in the general partner of the exculpated 

borrower being personally liable as a trustee of the diverted rents. 

5.21 FIRREA Claim Procedure 167 Claims against depository institutions for which 

RTC or F.D.I.C. is receiver must be presented through administrative claims 

procedures with a very short bar date. RTC and F.D.I.C. may repudiate 

burdensome contracts and leases of failed financial institutions. 168 

159 494 U.S. 56 (1990), 110 S.Ct. 945, 108 L.Ed. 2d 47 (1990). 

160 Pollack v. Laidlaw Holding, Inc., 27 F.3d 808 (2nd Cir. 1994). 

161 See Star Enterprises v. Thomas, 783 F.Supp 1564 (D.R.I. 1992). 

162 See Ringling Joint Venture II v. Huntington National Bank, 595 So.2d 180 (Fla. 1992). 

163 See discussion at 9.0 below on assignment of future rents in context of a Bankruptcy Code proceeding. 

164 See Bankruptcy Code Sec. 552(b). 

165 Great-West Life Assur. Co. v. Raintree Inn, 837 P.2d 267 (Colo.App. 1992). 

166 876 F. Supp. 517 (S.D.N.Y. 1995) 

167 12 USCA §1821(d)(6)(A) and (d)(13)(D). See §14.02[5] “Claims Against Institutions Liquidated by Receiver” in 

Dunaway, FIRREA Law and Practice (Clark Boardman Callaghan 1992-1994) and §31.11[4] “Claims Procedures”. In 

Dunaway, The Law of Distressed Real Estate (Clark Boardman Callaghan 1985-1996. 

168 12 U.S.C.A. §1821(e)(1). See Chapter 16 “Repudiation Under 12 U.S.C. §1821(e) of Contracts and Leases” in 

Dunaway, FIRREA Law and Practice (Clark Boardman Callaghan 1992-1994). In Resolution Trust Corp. v. Diamond, 

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5.22 Amount Due Issues. 

5.22.1 Late Charges. Determine whether under local law and provisions of 

document, late charges may be received for payments not paid when 

otherwise due after acceleration. 169 

5.22.2 Prepayment Premium. 170 Is prepayment premium collectible when the 

loan is accelerated as a result of a default 

5.23 Marshalling. A Junior lien creditors may under certain circumstances require 

holders of prior liens to exhaust other collateral that is free of other liens or, under 

some applications of the doctrine subject other subordinate lien creditors to later 

in time or non pari passu claims. 171 

45 F.3d 665 (C.A.2d N.Y.) it was held that in New York this included rent controlled tenancies. 

169 In Security Mut. v. Contemporary Real Estate, 979 F.2d 329 (3rd Cir. 1992) the court deemed that such charges 

were not collectable based on what it believed Pennsylvania law would be if the matter were presented to a Pennsylvania 

court. It distinguished Orix Credit Alliance, Inc. v. Pappas, 946 F.2d 1258 (7th Cir 1991) a lease case on basis of 

specific provisions of the document. The New Jersey Supreme Court reversed a intermediate New Jersey court of 

appeals that has held that a 5% late fee was an unenforceable penalty intended to induce a borrower to make timely 

payment and also that a default interest charged at 5% above the prime rate that results in a default interest rate that 

was 3% above the fixed rate otherwise due was also a penalty. Metlife Capital Financial Corp. v. Washington Ave. 

Association, 199 WL 436126 (NJ 6/30/99) Reversing 713 A.2d 527 (1998). See also Velenchik v. First Union 

National Bank, No. CV00 037 25 15 (Conn. S. Ct. May 7, 2003) where the Connecticut Superior Court held that a 

late fee of 4% of the balloon balance was exorbitant (especially since the lender received the benefit of a default 

interest rate) and awarded the borrower damages in the amount of the late fee plus $15,000 for emotional distress. 

170 Also see discussion of yield-maintenance provisions at 3.24. For questions regarding prepayment penalties, see 

§17.04 “Transfer Free of Mortgage and Prepayment Penalties” and §17.05 “Federal Restrictions on Prepayment 

Penalties in Due-on-Sale Situations” . 

171 See annotation, 35 ALR 1307. Pro rata marshalling was applied in In re Wilmot Min. Co., 167 B.R. 806 

(Bankr.W.D. Pa. 1994) (Ohio law applied). For marshalling, see Dunaway Tex Supra N. 2 §12.08 “Marshalling of 

Assets” . 

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5.24 "Fixtures" v. Personalty. 172 

5.24.1 Intent. 173 

5.25 Waste - Impairment of Security. 174 Third parties, otherwise exculpated 

mortgagors and transferees of the mortgaged property may be personally liable to 

the mortgagee for waste which may include not only physical damage and 

improper maintenance of the mortgaged property, but also intentional 

"impairment of security" which may exist as in the case of a diversion of rental 

income and failure to pay taxes or maintenance expenses and other items. A 

claim by a mortgage against a third party contractor of the mortgagor 175 has been 

sustained. An action for impairment of security where permitted may be brought 

either before foreclosure 176 or if the full debt is not satisfied after foreclosure on 

the theory that a mortgaged is entitled at all time prior to foreclosure to 

unimpairment security. 

5.26 Fraudulent Transfers. 

5.26.1 "Upstream" and "Cross-Stream" Financing. 177 Corporate guaranties 

of and providing collateral for parent and shareholder debt or for debt of 

sibling entity 178 may be subject to avoidance or be invalidated as a 

fraudulent conveyance under the Uniform Fraudulent Conveyances Act or 

Uniform Fraudulent Transfer Act, §§548 and 544(b) of Bankruptcy Code, 

or under Model Business Corporation Act, or similar statute, if it does not 

172 See Garfinkel, 1 Pract. Real Estate Lawyer, Jan. (l985). Lighting in a store has been held to be a trade fixture and 

not part of the real estate. Roebel v. Kossenyans, 629 N.E. 2d 241 (Ind. App. Ct. 1994). 

173 In In re International Bldg. Components, 159 B.R. 173 (Bankr.W.D. Pa. 1993) the court, by applying Pennsylvania 

law, determined that a floor joist system removed and sold by the debtor was personalty and that therefore since the 

financing statements filed at the situs of real estate rather than at the location of the debtor's principal place of business 

did not perfect the security interest, a payment to the secured party of the proceeds of the sale of the collateral was a 

preference. 

174 See Leipziger, The Mortgagee's Remedies for Waste, 64 Calif. L.Rev. 1086 (1976) and Dunaway Text Supra N. 

2Chapter 8 “Actions for Waste” . 

175 Turner v. Kerin & Associates, 283 Mont. 117, 938 P.2d 1368, 1997 WL 325907 (Mont., Jun 11, 1997) (NO. 

96-002) 

176 W& R Inv. Co. v. Edwards Supply Co. 24 N.E. 2d 518 (MA. 1939) 

177 See Item 3.3.5 above and the discussion of fraudulent conveyances at Item 8.6 below. See Dunaway Text Supra N. 

2 Chapter 18 “Law of Fraudulent Transfers” . 

178 See Rubin v. Manufacturers Hanover Trust Co., 661 F.2d 979 (2nd Cir. 1981), Weintraub & Resnick, Indirect 

Economic Benefit as Fair Consideration in Fraudulent Conveyance Cases, 15 UCC LJ 75, 76 (1982). See In re Duque 

Rodriquez, 77 BR 937, 939 (Bankr. S.D. Fla, 1987). This may also be referred to as a "sidestream" guarantee. 

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further a corporate purpose or otherwise or if a court determines that the 

benefit received by the guarantor did not equal the value of what was 

extended by the guarantor. 179 

5.26.2 Collapsing a Transaction - A court will often "collapse" a transaction 

and treat its various phases as a single transaction when the consideration 

received by a debtor from a party that has knowledge (actual or 

constructive) of the scheme 180 in the first phase is in a later phase 

transferred for less than fair consideration or with intent to defraud 

creditors. 

5.26.3 Lien for Antecedent Debt. This may be a fraudulent transfer 181 

5.27 Recharacterization. See items 7.1.5 and 8.1 below. 

5.28 Default Interest. 

5.29 Unconscionability . 

5.29.1 Generally - Unconscionability is a "defensive contractual remedy which 

serves to relieve a party from a unfair contract or from an unfair portion of 

a contract." 182 The party challenging a contract provision as 

unconscionable generally bears the burden of proving unconscionability. 

183 

5.29.2 Procedural Unconscionability - Procedural unconscionability pertains to 

the process by which an agreement is reached and the form of the 

agreement, including the use of fine print and convoluted or unclear 

language. 184 This type of unconscionability involves, for example, 

material risk-shifting contractual terms which are not typically expected by 

179 See In re Wes Dor, Inc., 996 F.2d 237 (10th Cir. 1993). 

180 See Orr v. Kinderhill Corp., F.2d 31, 35-36 (2nd Cir. 1993); HBE Leasing Corp. v. Frank, 48 F.3rd 623 (2nd Cir. 

1995). 

181 See Hasbro Inc. v. Serafino, 1999 W.L. 137752 (D. Mass.) 

182 Germantown Mfg. Co. v. Rawlinson, 341 Pa.Super. 42, 491 A.2d 138, 145 (1985) (quoting D. Dobbs, 

Handbook On The Law Of Remedies 707 (1973)). 

183 Bishop v. Washington, 331 Pa.Super. 387, 480 A.2d 1088, 1094 (1984); see also Argo Welded Products, Inc. v. 

J.T. Ryerson Steel & Sons, 528 F.Supp. 583, 592-93 (E.D. Pa. 1981). 

184 See, E. Allan Farnsworth, Contracts § 4.28 (2D ED. 1990). 

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the party who is being asked to 'assent' to them and often appear in the 

boilerplate of a printed form. 185 

5.29.3 Substantive Unconscionability – "Substantive unconscionability" refers 

to contractual terms that are unreasonably or grossly favorable to one side 

and to which the disfavored party does not assent. 186 Thus, 

"[u]nconscionability requires a two-fold determination: that the 

contractual terms are unreasonably favorable to the drafter and that there is 

no meaningful choice on the part of the other party regarding acceptance 

of the provisions." 187 

6.0 Deficiencies in Documentation 

6.1 Any unperfected liens Have renewal filings been made on U.C.C. security 

interests Have all appropriate filings been made Check U.C.C. 1's and any 

U.C.C. 3's for completeness and proper identification of parties, completeness of 

descriptions and filing offices. 

6.2 Any collateral intended but not received. 

6.3 Compare commitment with actual documents. 

6.4 Are there any conflicts between the binder documents and the commitment where 

the binder documents or the commitment provides that the commitment survives 

the loan closing 

6.5 Consider aspects of transaction that are not typical and seek to analyze whether 

the documentation actually accommodates the unusual aspects of the deal. If not 

will the deficiency result in any problem in realization on the collateral or in 

exercise of lender's remedies. 

6.6 Consider validity of powers of attorney. 

6.7 Confirm that important "boilerplate" actually says what is probably intended. 

7.0 Lender Liability Claims, Statutory, Public Policy and Other Issues. 

7.1 Theories of Lender Liability. More often than not there will be no basis for a 

borrower to assert a lender liability claim. Nevertheless because of the possibility 

185 Germantown Mfg. Co. v. Rawlison, 491 A.2d 138 at 145-46. (1985) 

186 See id., at 145-147; Delinger, Inc. v. Dendler, 415 Pa.Super. 164, 608 A.2d 1061, 1068 (1992). 

187 Bensalem Township v. International Surplus Lines Ins. Co., 38 F.3d 1303, 1312 (3d Cir. 1994) (quoting 

Worldwide Underwriters Ins. Co. v. Brady, 973 F.2d 192, 196 (3d Cir. 1992)). 

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of substantial punitive damages if a tort is established by the borrower and of 

damages based on possible lost profits, a lender is well advised before taking any 

action and in communicating with a borrower after or in anticipation of a default 

to always consider possible exposure to lender liability claims. Consider various 

lender liability theories such as the following: 188 

7.1.1 Contractual Rights of Borrower - Loan Commitments. Courts have 

imposed upon perspective lenders an obligation to use due care in the 

processing of loan applications. 189 See discussion at item 7.1.13 below on 

oral commitments and modification. 190 Absent unusual circumstances, a 

lender does not incur liability for strictly enforcing the terms of a loan 

commitment. 191 

7.1.2 Negligent Misrepresentation. Allegation may, for instance, be that the 

lender failed to disclose to the borrower adverse facts known to the lender 

in regard to the transaction for which the loan was made. 192 Liability has 

been based on a jury finding that a bank officer negligently misrepresented 

that the bank was willing to negotiate in good faith to restructure a loan. 193 

In Texas a bank may be liable for negligent misrepresentation if it gives 

"false information for the guidance of others in their business 

transactions". 194 A lender may have a basis to assert a claim of negligent 

misrepresentation against third party service providers such as 

accountants, lawyers or appraisers upon which the lender relied. 195 

188 See Chapter 4B “ Liability of Lender for Controlling Debtor and for Other Acts” in Dunaway, The Law of 

Distressed Real Estate (Clark Boardman Callaghan 1985-1996) 

189 See High v. McLean Finance Corp., 659 F. Supp. 1561 (D.D.C. 1987); Jacques v. First National Bank, 307 Md. 

527, 515 A.2d 756 (1986). 

190 See Shadur, Avoiding Lender Liability at the Loan Commitment Stage, The Practical Lawyer, May 1990, p.47. 

Clardy Manufacturing Co. v. Maine Midland Business Loan, Inc., 88 F.3d 347, rehearing denied, 96 F.3d 1447 (5 th 

Cir. 1996) 

191 On appeal in the infamous, Penthouse Int’l v. Dominion Fed. Sav. & Loan Ass’n. case (855 F.2d 963 (2d Cir. 

1988), the Court reversed the massive expectation damage verdict below in holding that the lender had no obligation to 

extend the loan closing date. 

192 See Sumitomo Bank of Cal. v. Iwasaki, 447 P.2d 956, 73 Cal Rptr. 564 (1968). Restatements Second, Torts §552 

(1977) MSA Tubular Prod, Inc. v. First State Bank & Trust Co., 869 F.2d 1422 (10th Cir. 1989) (Inaccurate response 

to credit inquiries). 

193 Richter, S.A. v. Bank of Am. Nat'l Trust & Sav. Ass'n, 939 F.2d 1176 (5th Cir. 1991). 

194 Federal Land Banks Ass'n v. Sloane, 793 S.W.2d 692, 695 (Tex.App. 1990). 

195 See Soderberg v. Mckinney, 52 Col Rptr. 635 (Cal App. 2 Dist 1996 (appraiser); Bily v. Arthur Young & Co., 3 

Cal 4th 370 (1992) (no claim against accountant) 

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7.1.3 Duress. Business Compulsion. If under local law it is an affirmative tort 

economic duress involves a threat by lender to commit an act it has no 

legal right to commit, such as refusal to meet a legal obligation to advance 

additional funds that results in the borrower doing something it is not 

obligated to do to avoid damage from lender's threatened illegal act. It is 

to be distinguished from hard bargaining. 196 These cases often involve the 

lender inducing the borrower to provide additional collateral. 197 

7.1.4 Breach of Implied Covenant of Good Faith and Fair Dealing. 

(1) Cases under this concept usually involve inappropriate exercise of 

default remedies. 198 

(2) Determine whether in the particular jurisdiction the concept actually 

exists or appears to be on the way to being developed by the courts. 199 

196 Sheehan v. Atlanta Int'l Ins. Co., 812 F.2d 465 (9th Cir. 1987). For instance in Tennessee "economic duress" 

consists of "imposition, oppression, undue influence, or the taking of undue advantage of the business or financial stress 

or extreme necessities or weakness of another." Crocker v. Schneider, 683 S.W.2d 335, 338 (Tenn. App. 1984). 

Sanders v. First National Bank & Trust Company of Great Bend, 936 F.2d 273 (6th Cir. 1991). 

197 See Gulf Oil Trading Co. v. Creole Supply, 596 F.2d 515 (2nd Cir. 1979); In re Osborne, 42 Bankr. 988 (W.D. 

Wis. 1984). 

198 In Duffield v. First Interstate Bank of Denver, N.A., 13 F.3d 1403 (10th Cir. December 23, 1993) the Court 

sustained a $6 Million jury verdict where the bank had allegedly agreed after a default to accept a prepayment to release 

a property and to apply a portion of the prepayment to past and future interest and instead applied the entire prepayment 

to principal and then notified the operators of oil and gas wells on which it held assignment as collateral to pay all 

production proceeds directly to it, the bank. This resulted in the borrower losing all his oil and gas interests for lack of 

cash flow to pay operating expenses. The Tenth Circuit on the basis of its analysis of Section 1-203 of the UCC 

concluded that the covenant of good faith overrode the express terms of the document. See also Big Horn Coal Co. v. 

Commonwealth Edison Co., 852 F.2d 1259 (10th Cir. 1988) where the court stated that: "Where a contract provision is 

exercisable only at some discretion of one of the parties, and expectations are created by the contract, good faith 

limitations are applicable to protect the non-exercising party from unexpected invocation of the option." See also Four 

Times Square Assocs., L.L.C. v. Cigna Invs., Inc., 306 A.D.2d 4, 764 N.Y.S.2d 1, 2003 N.Y. App. Div. LEXIS 6170 

(N.Y. App. Div. 1st Dep't 2003) (Court reversed the lower court's order denying the ground lessor/borrower's motion 

for preliminary injunction preventing the loan servicers from holding it in default for failing to obtain terrorism 

insurance) and Philadelphia Plaza-Phase II v. Bank of America National Trust and Savings Association, 2002 WL 

1472337 (Pa.Com.Pl.) (In overruling the lender's preliminary objections to the complaint, the court held that the 

borrower's complaint set forth a justiciable claim in alleging facts that demonstrated the existence of an active 

controversy involving the lender's breach of the implied covenant of good faith with respect to the provisions of the loan 

documents governing insurance; the lender had interpreted "other insurance" to include terrorism insurance, rejected 

borrower's request for time to investigate the feasibility of obtaining terrorism insurance and threatened to force place 

such insurance and demand reimbursement from borrower for the cost of the premium). 

199 See Fireman's Fund Mortgage Corp. v. Zollicoffer, 719 F.Supp. 650 (N.D.III 1989), K.M.C., Inc. v. Irving Trust 

Co. 757 F.2d 752 (6th Cir 1985); Barrett v. Bank of America, 183 Cal. App. 3rd 1362; 229 Cal Rptr. 16(1986); 

Restatement Second, Contracts §205; Section 1-203 of the Uniform Commercial Code provides that "every contract or 

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(3) The trend of the cases may be that although the lender may not 

interfere with right of borrower under document absent a contrary 

course of dealing, express or implied modification or other collateral 

circumstances, the lender is not required to accept material change to 

existing arrangement. 200 

(4) A substantial judgment has been recovered for lender's lack of good 

faith in not accepting property equal in value to debt and thus 

attempting to foreclose on all of the collateral although the value 

substantially exceeded the debt. 201 

(5) See discussion at Item 7.10 below on implied promise of borrower not 

to file lender liability suit in bad faith. 

(6) Several courts have refused to extend the implied covenant beyond 

what is specifically provided for by the U.C.C. 202 

(7) A related approach is for a court to deny the equitable remedy of 

foreclosure if it finds that the mortgagee engaged in conduct violative 

of the "clean hands" doctrine. 203 

duty within this Act imposes an obligation of good faith in its performance or enforcements." According to the Code, 

"good faith" is defined as "honesty in fact in the transaction concerned." U.C.C. §1-201(19). The Code renders 

unenforceable contracts deemed unconscionable.See Gillman v. Chase Manhattan Bank N.A., 73 N.Y.2d 1, 537 N.Y.S. 

2d 787, 534 N.E. 2d 824 (1988). 

200 Badgett v. Security State Bank, 807 P.2d 356 (Wash 1991) reversing the Court of Appeals decision at 786 P.2d 302 

(Wash. App. 1990). Courts generally have not imposed new obligations outside the parties’ agreement or modified 

legal rights under the guise of the implied duty of good faith; they have not imposed implied terms and/or covenants 

as to matters specifically covered by the contract between the parties nor invoked the duty to preclude a creditor 

from exercising its bargained for rights under a loan agreement. See USX Corp. v. Prime Leasing, Inc., 988 F.2d 433 

(3d Cir. 1993) (denying equipment-financier's claim for breach of implied covenant of good faith and fair dealing 

based upon the same acts alleged to be in breach of express covenants contained in collateral assignment of leases); 

Berry v. First National Bank of Mercer County, 892 F. Sup 127 (WD Pa. 1994), affirmed, 60 F.3d 813 (holding that 

implied duty of good faith in breach of contract action will not defeat lender’s express contract rights); Temp-Way, 

supra (denying borrower’s claim that lender breached financing agreement by not dealing with the borrower in good 

faith and by failing to comply with oral promises for financing, by refusing to impose duties upon creditors which 

would modify or defeat their legal rights); AAMCO Transmissions, Inc. v. Harris, 759 F. Sup 1141 (E. D. Pa.. 1991) 

(refusing to apply implied covenant to modify express terms of franchise agreement regarding the franchiser's duty to 

train franchisee or assist in the operation of the franchise); Sons of Thunder, supra (stating that implied duty cannot 

override an express termination clause; the only issue being whether the defendant exercised the right to terminate in 

good faith); Glenfed, supra (holding that implied duty did not require lender to cooperate with borrower's attempts to 

secure additional financing, or to consent to requests to waive defaults or extend maturity date). 

201 See Wells Fargo Realty Advisors Funding, Inc. v. Violi, Inc., 872 P.2d 1359 (Colo. Ct. App. Jan. 27, 1994). 

See also Dolton v. Capital Fed. Sav. & Loan Assn., 642 P.2d 21, 23-24, (Colo. App. 1981). 

202 People's Heritage Sav. Bank v. Recoll Management, Inc., 814 F. Supp 159 (D.ME. 1993). See Good Faith 

Acceleration Provisions of U.C.C. §1-208. 

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(8) The implied obligation has been imposed upon the F.D.I.C. despite the 

D'Oench Duhne Doctrine. 204 

7.1.5 Recharacterization of Transaction 205 . 

(a) Purported Leases. The borrower or general creditors in a chapter 

proceeding may seek to recharacterize a purported ground lease as being a 

joint venture and thus possibly subject the purported ground lessor to the 

liabilities of the debtor. 

(b) Purported Financing Arrangement. Mere sharing of profits will 

generally not be adequate basis for the recharacterization of a purported 

participating loan as a joint venture. 206 Lack of an obligation to reply on a 

specified date and power to control may be significant factors. 

7.1.6 Fraud and False Lender Representations. A false representation will 

usually support an action for fraud which being a tort may involve punitive 

damages. Lenders should be particularly careful not to make enforcement 

threats unless there is a real intention to take the specific action if the 

borrower fails to affirmatively respond. 207 False representation may also 

be made by a lender in connection with negotiation or performance of loan 

or negotiation of forbearance arrangements. 208 Cause of action may be 

based on lender's knowledge of falsity of representation or material 

concealment by lender and damage to borrower. A borrower may in some 

jurisdictions establish "promissory fraud" by establishing that a lender 

made a promise of future conduct with no present intention of performing 

the promise. 209 

7.1.7 Regulatory or Statutory Violations by Lender. 

203 Prudential Ins. Co. of America v. Jackson, 270 N.J.Super. 510, 637 A.2d 573 (N.J. Super. A.D. 1994). 

204 In re Beltzell & Co., Inc., 163 B.R. 637 (Bankr. D.Dist. Col. 1993). 

205 See also item 8.1 below. 

206 See Stone A. Michaud Ins. v. Bank Five for Savings 785.F Supp. 1065 (D.N.H. 1992) 

206 Threats of lender action that was in fact not intended but did induce a transfer of control to the lender was one basis 

for the successful lender liability claim in State Nat’l Bank v. Farah Mfg. Co., 678 S.W.2d 661 (Tex. Ct. App. 1984) 

208 For instance, fraudulent promise not to call loan: Stirling v. Chemical Bank, 382 F.Supp. 1146 (S.D.N.Y. 1974) 

Aff'd 516 F.2d 1396 (2nd Cir.); See Security Pacific National Bank v. Williams, 213 Cal. App. 3rd 927 (1989). 

(Depublished in Calif.) 

209 See Fowler v. Happy Goodman Family, 575 S.W. 2d 496 (Tenn. 1978). A mere subjective belief on the part of the 

borrower that the lender did not at the time of the promise intend to perform should not be adequate to support a 

promissory fraud case. 

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(1) Equal Credit Opportunity Act, 15 U.S.C. §1691(a); Reg. B, 12 

C.F.R. §202.7(d) (1990) limits circumstances under which persons 

(including a borrower's spouse) may be required to assume liability. 210 

(2) Anti Tying Provisions - TIRA- 12 U.S.E. §1464 (q)(1) prohibits a 

thrift from requiring a borrower to provide or obtain certain unrelated 

services in conjunction with a loan. 211 Similar provisions are found in the 

Bank Holding Company Act Amendments of 1970, §106(b) [12 U.S.C. 

§1972(1)]. 212 Requirements for liability include extension of credit or 

perhaps offer on condition that the customer obtain or provide some 

additional credit, property or service. To establish a claim under 12 

U.S.C. §1972(1)(b) the bank customer is not required to show that it was 

coerced to take some other action as a condition of receiving the loan. 213 It 

has been held that these anti-tying provisions bar only anti-competitive 

arrangements. 214 

(3) Securities Law Violations. 215 To establish a claim under federal 

securities law against a lender for aiding and abetting fraudulent activity, 

lender with knowledge of a fraud provided substantial assistance in 

perpetuating the fraud If the bank has a fiduciary duty to the defrauded 

party, recklessness rather than actual knowledge of the fraud may be 

adequate. A bank holding purchaser deposit escrows may thus owe a 

210 See discussion at item 5.4 above. 

211 See Tri-Crown, Inc. v. American Federal Savings & Loan Asso., 908 F.2d 578 (10th Cir 1990)(1990-2 CCH 

Trade Cases §69,159) Bruce v. First Federal Saving and Loan Association of Conroe, Inc., 837 F.2d 712 (5th Cir 

1988) . 

212 See Nordic Bank PLC v. Trend Group Ltd., 619 F. Supp. 542 (S.D.N.Y. 1985) and Amerifirst Properties, Inc. v. 

FDIC, 880 F.2d 821 (5th Cir 1989). 

213 Dibidale of Louisiana, Inc. v. American Bank & Trust Co. 916 F.2d 300 (5th Cir. 1990), (involved an allegation 

that the bank's encouragement of borrower's use of a particular contractor breached the anti-tying provisions of the Bank 

Holding Company Act. The court concluded that because of the banking industry's "aggregate economic power and 

unique economic "role" market power need not be established to provide requisite coercion since "power to coerce is 

inherent in the banking relationship itself." 

214 Graue Mill Development Corp. v. Colonial Bank & Trust Company Chicago,927 F.2d 988 (7th Cir. 1991) In 

Bieber v. State Bank of Terry, 928 F.2d 328 (9th Cir. 1991) the court required that (1) the banking practice in question 

must be unusual (2) an anti-competitive tying arrangement must exist (3) the arrangement must benefit the Bank. 

215 This has generally not been to fruitful for borrowers except where the banks actions have been the basis of a 

security offering as in the case of issuance by bank's of letters of confidence that a loan would be available which letters 

was allegedly issued with the intent to deceive, manipulate or defraud under Rule 10b-5. 

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fiduciary duty to the purchaser that was allegedly defrauded by the 

developer-seller client of the bank. 216 

(4) RICO (Racketeer Influenced and Corrupt Organizations Act). 18 

U.S.C. Sec.1962, 18 U.S.C.Sec. 1962 217 a "pattern" of "racketeering" 

activity must be established. Because of the banking industry's "aggregate 

economic power and unique economic "role" market power need not be 

established to provide requisite coercion since "power" to coerce is 

inherent in the banking relationship itself. 

(5) State Unfair Trade Practices Acts. These usually include triple 

or other multiple damage awards and possible award of attorney fees. 

Although often limited to consumer transactions they will in many 

jurisdictions also be applied to commercial transactions, especially where 

small businesses or individual liability may be involved. 218 

7.1.8 Damage to Borrower During Period of Control of Borrower by 

Lender. 219 Interference with corporate governance of debtor control 

might be alleged to have created a fiduciary duty on lender. 220 

7.1.9 Collateral Inducements and Undertakings. 

7.1.10 Prima Facie Tort. An intentional, unjustified act intended to cause injury 

and which in fact does cause injury. 221 In some states the plaintiff must 

216 See Schoepe v. Zions First National Bank, 750 Fed Supp 1084 (D.Utah 1990). See also Berry v. Meleod, 604 P.2d 

610 (Ariz. 1979); Powell v. H.E.F. Partnership, 793 F.Supp. 91 (D.Vt. 1992). 

217 In Fleet Credit Corp. v. Sion, 893 F.2d 441 (1st Cir. 1990) Lender's RICO claim against borrower was sustained 

where the borrower obtained three loans over a five year period and misappropriated collateral by use of 95 checks over 

the life of the loans. Cf. Kehr Packages, Inc. v. Fidelcor, Inc., 926 F.2d 1406 (3rd Cir. 1991). 

218 See Grigsby v. Thorp Consumer Discount Co. d/b/a ITT Fin. Servs., 127 B.R. 759 (E.D. Pa. May 15, 1991). 

219 In State National Bank of El Paso v. Farah Manufacturing Company, Inc., 678 S.W.2d 661 (Tex. App. 1984), the 

lender was held liable for over 18 million dollars of damages to the borrower as a result of wrongful control by lender of 

the borrower. The lender controlled the choice of the Board of the borrower, forced hiring of a consultant of lender's 

choice and forced the sale of assets of the borrower to reduce the indebtedness. The court found lender fraud in lender 

asserting an intent to call the loan if certain conditions were not accepted by the borrower when such intent did not in 

fact exist. See Ebke & Griffin, Lender Liability to Debtors: Toward a Conceptual Framework, 40 SW L.J. 775 (1986). 

See Cappello and Konoroske, Lender Liability Based on Undue Control over a Borrower, 28 Trial 19 (Dec. 1992). 

220 See discussion at 7.1.14(2). 

221 Porter v. Crawford & Co., 611 S.W. 2d 265 (Mo. App. 1980) This theory is most developed in New York and 

Missouri. Several Missouri cases have found lender's acts justified. See Centerre Bank of Kansas City, N.A. v. 

Distributors, Inc., 705 S.W.2d 42 (Mo. App. 1985). 

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also establish that the lender’s actions are tortious under a or subjective 

“Balancing of Interests” test. 222 

7.1.11 Negligent Loan Administration. May relate to failure of lender to inspect, 

procure insurance, etc. This is more commonly a guarantor or other third 

party defense. 

7.1.12 Tortious Interference with Contact or Prospective Economic 

Advantage. 223 This cause of action requires a lender’s improper or 

unjustified interference with a valid existing contract or opportunity on the 

part of the borrower that is known to the lender. 224 

7.1.13 Breach of Oral Commitment To Lend or To Forestall Resort to 

Default Remedies. Oral commitments to loan have been enforced. 225 

Legislation has been adopted in a substantial majority of the states to bring 

loan commitments within the statute of frauds. 226 Even when a statute of 

frauds is found applicable, it may be held inapplicable if, for instance, 

there is held to be part performance by the lender 227 or an allegation of 

lender fraud. 228 A Montana court on a merger theory 229 dismissed a claim 

of an oral commitment to lend. To be binding on a lender a loan 

222 Killion v. Bank Midwest, N.A., 1998 WL 863347 (Md. App. W.D. Dec. 15, 1998) (default attributable to refusal 

of bank to permit payoff unless the borrower paid an unenforceable claim for contingent interest. 

223 See Restatement (Second) Torts §767; Guard-Life Corp. v. Parker Hardware Mfg. Corp., 50 N.Y. 2d 183, 406 

N.E. 2d 445, 428 N.Y.S. 2d 628 (1980). 

224 Fury Importing, Inc. v. Shakespeare, 554.F 2d 1376 (5 th Cir. 1977); See Felsen v. Sol Cafe Mafg. Corp., 24 N.Y.2d 

682, 249 N.E.2d 459, 301 N.Y.S.2d 610 (1969) 

225 Champaign Nat’l Bank v. Landers Seed Co., 165 Ill. App. 3d 1090, 519 N.E.2d 957 (1988); Gold v. Vasileff, 

160 Ill. App. 3d 125, 513 N.E.2d 446 (1987). 

226 In St Sys. Corp. v. Maryland Nat'l Bank, 112 Md. App. 20, 684 A.2d 32 (1996) the court applied the Maryland 

Lender Liability Statute of Frauds (§5-317 of the Maryland Code) to sustain a dismissal of claims by a Borrower. In 

1986 Minnesota became the first state to adopt such a law, Min. Stat. Ann. §513.33 (West). See Drewes v. First Nat'l 

Bank of Detroit Lakes, 461 N.W. 2d 389 (Minn. Ct. App. 1990)(sustains application of Minnesota statute of frauds 

adopted in 1985 (Minn Stat. §513.33(2) on alleged 1981 oral modification of a loan arrangement where suit was 

initiated after the effective date of the statute. But see Beal Bank S.S.B. v. Krock, ___ F.3d ___ (1 st Cir. 1998), LEXIS 

22051 (oral modification of agreement to credit guarantor with sale proceeds upheld notwithstanding prohibition against 

oral modification) on the ability to orally modify an integrated document that prohibits subsequent oral modification. 

See Cambridge Sav. Bank v. Boersner, 413 Mass. 432, 597 N.E.2d 1017, 1021 (Mass. 1992) and Wagner v. Graziano 

Const. Co., 390 Pa. 445, 136 A.2d 81, 83 (Pa. 1957). 

227 Integra Nat'l. Bank v. Oakes Constr. Co., 1994 WL 68045 (Ohio App. 1994)(not reported in N.E.2d).. 

228 Brown v. Founders Bank & Trust Co., 890 P.2d 855 (Okla. 1994). 

229 Eislein v. Montana Bank of Roundup, 818 P.2d 365 (Mont. Sept. 9, 1991). 

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commitment must generally contain all material terms of the loan which 

probably include at least the identity of parties, amount of the loan and 

terms of repayment. 230 See Discussion at 3.3.8 on enforcement of oral 

modifications even where the document includes a prohibition of oral 

modification. 

7.1.14 Breach of Fiduciary Duty. 

(1) It has been held that despite lack of a written agreement evidencing 

a fiduciary relationship a prospective subordinate lender may be liable to a 

borrower for breach of fiduciary duty when to facilitate the purchase of a 

property by a third party it utilizes confidential information provided by 

the prospective borrower. 231 

(2) Although ordinarily a lender does not owe a fiduciary duty to a 

borrower 232 it has been held that a “confidential relationship” that creates a 

fiduciary duty on the lender with respect to the borrower may arise where 

the lender gains substantial control over the debtor’s business affairs. 233 It 

is important to distinguish between mere monitoring of a borrower’s 

operations 234 and the sort of control that may create a fiduciary 

relationship. Although absent at least a State National Bank v. Farah 235 

situation a court should not find a fiduciary obligation in the control and 

limitations often found in loan documents and especially in work out 

documents, it may not be difficult for a borrower by alleging such control 

to get beyond preliminary objections or a motion to dismiss and thus 

significantly delay a foreclosure proceeding. 236 

7.1.15 Unjust Enrichment. 

230 Lowe v. Mass. Mut. Life Ins. Co. (1976) 54 Cal App. 3rd 718, 127 Cal. Rep. 23; Patterson Dev. Co., Inc. v. Torrey 

Pines Bank, 284 Cal. Rep. 367 (1991). 

231 Wiener v. Lazard Freres & Co., 241 App. Div. 2d 114, 672 N.Y.S.2d 8, (N.Y.A.D. 1 Dept., Apr 16, 1998). 

Compare this with Northeast General Corp. v. Wellington Advertising Inc. 82 N.Y 2d 158, 624 N.E. 2d, 129, 604 

N.Y. 5, 2d 192 (1993) 

232 See GE Capital Mortgage Service v. Pinnacle Mortgage Inv. 897 F. Supp. 854 (E.D. Pa. 1995) citing Federal 

Land Bank v. Fetner, 410 A.2d 344 (Pa. 1979) cert. denied 446 U.S. 9187 (1980) 

233 Id. Citing Stainton v. Tarantino, 637 F. Supp 1051, 1066 (E.D. Pa 1986) 

234 see In re W.T. Grant Co., 699 F.2d 599 , 610-11 (2d Cir. 1983) 

235 see item 7.1.8 above . 

236 For instance see Rodin Properties-Shore Mall. N.V. v. Cushman & Wakefield of Pennsylvania , 49 F.Supp. 2d 

728 (D. N.J. 1999) 

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7.1.16 Loan Prohibited by Borrower's Partnership or Corporate Governing 

Documents. 237 

7.1.17 "Demand" Instrument Containing Acceleration Provisions. Courts 

are split on whether U.C.C. §1.208 is applicable to a "demand" instrument 

that also contains Events of Default and provision for acceleration on 

default. 238 

7.2 Punitive Damages. Wrongful foreclosure may be basis for punitive damages. 239 

7.3 Review of Lender's Files, Memoranda and Correspondence. Review all 

official and personal credit and collateral files - These may include not only the 

usual correspondence reports and studies but also memoranda, notes of meetings, 

phone conversations and, reminders. Be particularly sensitive to possible 

existence of files maintained by loan officers and others involved in processing 

and administration of the loan. Be sensitive to "aggressive" language. At a later 

phase of review it may be appropriate to review lender's approval manuals, 

guidelines and procedural memorandum of general applicability. Evaluate the 

lender officer's conduct. This includes consideration not only of what the lending 

officer says she did but what a fact finder might perceive the officer did. Consider 

possible existence of personality conflicts between lender personnel and borrower 

personnel 

7.4 Alleged Course of Dealing Modifications. Course of dealing modification - 

consider possible basis of any such allegation. 

7.5 Breach of an Oral Commitment. Consider basis for borrower to claim that there 

has been a breach of an oral commitment - These usually involve alleged 

agreements to extend payments or other borrower obligations or performance or 

alleged agreements to make additional loans or to arrange other financing, or for 

the lender to forestall action based on partial performance or specific borrower 

action in regard to another loan. 240 A number of states have amended their 

statutes of fraud to bar enforcement of oral agreements to lend. 241 

237 Whitney v. Citibank, 782 F.2d 1106 (2nd Cir. 1986) (Lender held to have induced breach of fiduciary duty by two 

of three partners). Interstate Properties v. Pyramid Co. of Utica, 581 F. Supp. 982 (S.D.N.Y. 1984). 

238 See Shawmut Bank v. Miller, 415 Mass. 482 (Mass. 1993); Reid v. Key Bank of Southern Maine, Inc., 821 F.2d 9 

(1st Cir. 1987); Bank One Texas, N.A. and F.D.I.C. v. Taylor, 970 F.2d 16 (5th Cir. 1992). 

239 First Union National Bank of Georgia v. Cook, 477 S.E.2d 649 (Ga Ct. of Appeals 1996). Sustained refusal of 

true count to give directed verdict in permitted damage claim. 

240 Landes v. Construction Co., Inc. v. Royal Bank of Canada, 833 F.2d 1365 (9th Cir 1987)(Oral Commitment to 

make advances); Kruse v. Bank of America; 202 Cal. App 3rd 38, 248 Cal Rptr 217(1988). As to commitment to issue 

letters of credit see Trans-Global Alloy Ltd. v. First Nat'l Bank of Jefferson Parish, 583 S.2d 443 (La. 1991). 

241 See, for instance §11.2(9) of the Code of Virginia which was applied in Riggs Nat'l Bank of Washington D.C. v. 

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7.6 Fraudulent Transfers. See discussion at §8.6 below. 

7.7 Usury. 242 

7.8 Personal Exemptions. Consider personal exemptions, life insurance policies and 

annuities, entireties property, community property 243 homestead exemptions 244 

7.9 Waiver as Defense to Lender Liability Claims. Execution by borrower of 

renewal note or other extension documentation may constitute a waiver of 

borrowers claims against the lender. 245 

7.10 Lender Liability Claim Defenses 

7.10.1 Borrower's Breach of Implied Promise Not to Make Lender Liability 

Claim in Bad Faith. This is a theory of tort liability similar to Rule 11 of 

the Federal Rules of Civil Procedure and is based on Section 205 of the 

Restatement (Second) of Contracts which applies to "assertion, settlement 

and litigation of contract claims and defenses". 246 Although this is a 

contract claim punitive damages may be available. 247 

7.11 Arbitration Provisions. 248 

Wrigley Field Ltd. Partnership, C.A. 1991 WL 342380 (No. 90-1357-A) (E.D. Va. 2-8-91). 

242 See Chapter 22 “Violation of Usury Laws” in Dunaway, The Law of Distreszsed Real Estate (Clark Boardman 

Callaghan 1985-1996). 

243 See discussion in United States v. ITT Consumer Financial Corp., 816 F. 2d 487 (9th Cir 1987) 

244 The homestead exemption in states such as Florida and Texas may protect property worth many millions of dollars 

from creditor claims. Consider possibility of setting aside as fraudulent conveyances midnight acquisitions of alleged 

exempt property by borrower, general partners of borrower or guarantors or the reduction of loans on exempt property. 

Notwithstanding favorable legislative history the courts have not recently been too kindly disposed to "pre-bankruptcy 

planning" of this nature where the planning was intended not merely to facilitate the debtors "fresh start" but to provide a 

"head start". See discussion at item 8.10 below. 

245 Austin Dev. Co. v. Bank of Meridian, 569 So.2d 1209 (Miss. 1990). See also, discussion of enforceability of 

waivers in workout documents at item 3.17 above. 

246 See Association Group Life, Inc. v. Catholic War Veterans of the United States of America, 61 N.J. 150, 293 A.2d 

382 (1972). See also Seaman's Direct Buying Service, Inc. v. Standard Oil Co. of California, 36 Cal. 3d 752, 686 P.2d 

1158 (1984). 

247 See Riveredge Assocs. v. Metropolitan Life Ins. Co., 774 F. Supp. 897 (D.N.J. 1991) which recognizes this cause of 

action. 

247 See item 5.17 above in regard to choice of forum and choice of law provisions in loan documents. 

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7.11.1 If the dispute involves “commerce” as defined in the Federal Arbitration 

Act 249 it comes within the scope of the act. It has generally been 

concluded that federal law favors the enforcement of arbitration 

agreements 250 and determines whether an issue governed by the federal 

act is referable to arbitration. 251 

7.11.2 Most of the federal courts that have considered the issue have concluded 

that mutuality of obligation is not required for an arbitration clause to be 

enforceable. 252 Thus is such jurisdiction, if federal law is applicable, one 

party to the agreement may be bound to arbitrate all disputes while the 

other party might be granted an election to either arbitrate or resort to the 

courts. Many state courts have come to the same conclusion. 253 

7.11.3 The California Court of Appeals has affirmed a trial court determination 

that an arbitration provision in an agreement was unenforceable as 

unconscionable. 254 The Third Circuit did not consider to be 

unconscionable a clause in a home improvement agreement that required 

the unsophisticated elderly and low income home owner to arbitrate all 

disputes but permitted the home improvement lender and contractor 

involved in an allegedly fraudulent scheme to arbitrate or go to court. 255 

249 9 U.S.C. § et. Seq. 

250 In re Prudential Insurance Company of America Sales Practice Litigation , 133 3d 225,231 (3 rd Cir 1998) 

251 Prima Paint Corp. v Flood & Conklin Mfg. Co., 338 U.S. 395, 401-403 , 87 S.Ct. 1801, 18 L.Ed.2d 1270 (1967) 

252 See e.g. Doctor's Associates, Inc. v. Distajo, 66 F.3d 438, 451-53 (2d Cir. 1995); Wilson Elec. Contractors, Inc. 

v. Minnotte Contracting Corp., 878 F.2d 167, 168-69 (6th Cir. 1989); Dorsey v. H.C.P. Sales, Inc., 46 F.Supp. 2d 

804, 806-07 (N.D. Ill. 1999); Randolph v. Green Tree Fin. Corp., 991 F.Supp. 11410, 1421-22 (M.D. Ala. 1997) 

(rejecting claim that arbitration clause that required one party to arbitrate all claims, while giving the second party 

the option not to arbitrate anything was invalid); Pate v. Melvin Williams Manufactured Homes, Inc., 198 B.R. 841, 

844 (Bankr. S.D. Ga. 1996) (rejecting argument that arbitration agreement lacked mutuality because defendant 

company could sue over certain issues, while consumer had to arbitrate all claims). 

253 See, e.g., Smith v. Sanderson Group, Inc., 736 So. 2d 604, 612-13 (Ala. 1999); Parker v. Green Tree Fin. Corp., 

730 So. 2d 168, 170-71 (Ala. 1999); Lackey v. Green Tree Fin. Corp., 330 S.C. 388, 498 S.E. 2d 898, 904 (App. 

1998); Ishmael v. Dutch Housing Inc., No. 96AP100084, 1996 Ohio App. LEXIS 3974 *4-6 (Ohio Ct. App. 1997). 

254 Paterson v. ITT Consumer Fin. Corp., 18 Cal. Rept. 2d 563 (1st Dist. 1993). 

255 Harris v. Green Tree Financial, 183 F.3d 173 (3d Cir. 1999). It is also true that (when arbitration clauses are 

embedded within a larger contract, there is no need to search for mutuality in the arbitration clause specifically if 

there is consideration beyond the promise to arbitrate). 

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7.12 Jury Trial Waivers. Waiver must be knowing and voluntary 256 to be enforced. 

Among the factors courts consider in determining the enforceability of a waiver 

are the negotiations of parties relating to the waiver, conspicuousness of the 

waiver provisions, relative bargaining power of the parties and whether the 

waiving party was represented by counsel 257 in executing the document containing 

the waiver. 

8.0 Relevant Bankruptcy Considerations 

8.1 Recharacterization. 

8.1.1 Purported Leases. A document that purports on its face to be a lease may 

be recharacterized as possibly either a mortgage or as a joint venture. 258 In 

the latter case the "Lessor" may be liable as a partner to the general 

creditors. If the "lease" is recharacterized as a mortgage it will not benefit 

from the favorable bankruptcy provisions applicable to nonresidential 

leases 259 and may be subject to a "cram down". 260 

8.1.2 Purported Financing Arrangement. Participating mortgages may be 

recharacterized as joint ventures. 

8.1.3 Title Insurance. It has been held that a title insurer need not defend a 

claim to recharacterization in a sale leaseback transaction. 261 

8.2 Rent Assignment. 

256 Aetna Ins. Co. v. Kennedy, 301 U.S. 389, 393 (1937). 

257 Bonfield v. AAMCO Transmission, 717 F. Supp. 589, 595-596 (N.D. Ill. 1989); Whirlpool Financial Corp. v. 

Sevaux, 874 F.Supp. 181 (N.D. Ill. 1994). 

258 See Frank Lyon Co. v. United States, 435 U.S. 561 (1978) see generally Faber, Determining the Owner Of An 

Asset For Tax Purposes, 61 Taxes 795, 803-804 (1983); Homburger and Andre, Real Estate Sale and Leaseback 

Transactions and The Risk of Recharacterization in Bankruptcy Proceedings, 24 Real Property, Probate and Trust 

Journal. 95 (Spring 1989); In the personal property context the recharacterization of a "lease" as or security device may 

result in the "lessor" losing all property right to the chattel. See also In re Valley Forge Plaza Associates v. Academy 

Life Ins. Co. 1990 WL 153999 (Bankr. E.D. Pa. Oct. 10, 1990) (unreported). See Kenneth P. Coleman, How to Tell if a 

Transaction is a True Lease or a Disguised Secured Transaction, 114 Banking C.J. 953 (Nov/Dec 1997). 

259 See 11 U.S.C. §365. 


261 Ticor Title Insurance Co. of California v. FFCA/11P 1988 Property Company, 898 F.S. 633 (N.D. Ind. 1995); 

TransAmerica Title Ins. Co. v. Alaska Federal S&L Association of Juneau, 883 F.2d 775 (9th Cir 1988); Bidart v. 

American Title Ins. Co. 734 P.2d 732 (Nev. 1987) 84 ALR 3d 515; Homberger and Gallagher, To Pay or Not To Pay: 

claiming damages for Recharacterization of Sale Leaseback Transaction Under Owners Title Insurance Policies, 30 

ABA Real Prop, Prob & Trust Journ. 443 (1995). 

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See 9.0 below on effect of assignment to lender of future rents. 

8.3 Preferences. 

8.3.1 Generally. Basic 90 day preference period is provided for by §547 (b) of 

the Bankruptcy Code. 262 Transfers made for "contemporaneous exchange 

of new value", in payment of ordinary course obligations within 45 days of 

the same being incurred and security for new value are excluded. A 

creditor may not invoke enabling loan exemption under section 547(e)(3) 

unless the lien has been perfected within twenty (20) days even if state law 

provides for a longer period 263 

8.3.2 Triangular Preference - DePrizio - Reversed by 1994 Act. Application 

of one year preference period. Levit v. Ingersoll Rand Financial Corp. (In 

re V.N. DePrizio Construction Co.), 874 F.2d 1186 (7th Cir 1989) applied 

the insider one year preference period to an unrelated lender where the 

debt was guaranteed by an insider. This was reversed by the Bankruptcy 

Reform Act of 1994. The ninety (90) day preference period now applies to 

all non-insiders. 11 U.S.C.A. §550(c). 

8.3.3 Standing. Under the Bankruptcy Code only a trustee or a debtor in 

possession may seek to avoid preferences. A lienholder or other creditor 

has no standing to initiate an action to avoid a preference. 264 

8.3.4 Payment to Unperfected Secured Creditor. A payment to a secured 

creditor within the applicable preference period may be recovered if the 

trustee can establish that the security interest was not properly perfected or 

was otherwise defective. 265 

8.4 Stays . 

8.4.1 Automatic Stay - Adequate Protection 

(1) Under Bankruptcy Code §362(a) upon commencement of case 

nearly all action by creditors to enforce or litigate rights against debtor or 

262 See Chapter 25 “Trustee’s Avoiding Powers” in Dunaway, The Law of Distressed Real Estate (Clark Boardman 

Callaghan 1985-1996) 

263 Fidelity Financial Services, Inc. v. Fink, 522 U.S. 211 118 S. Ct. 651, 139 L.Ed 2d 571 (U.S. 1998) 

264 See In re SRJ Enterprises, Inc. 151 B.R. 189 (Bnkrcy N.D. Ill. 1993) 

265 See In re International Bldg. Component, 159 B.R. 173 (Bankrtcy. W.D. PA) - (joist system determined to be 

personal property and not fixture and the payment of proceeds of pre-chapter sale of the system by debtor was a 

preference. 

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any of its assets are stayed. 266 See exception at 362(b) and elsewhere in 

the Code. Among the actions of a creditor to which the automatic stay 

may be applicable are the following: 

(a) 

Administrative stay that freezes debtor's account with depository 

institution that may assert §553 setoff right. 267 

(2) The automatic stay is extremely broad in scope. Violations are 

very serious and may even result in punitive damages in addition to actual 

damages, attorney fees, etc. 

(3) The automatic stay may be terminated, conditioned or modified 

upon showing of cause by a stayed party. 268 As to a secured creditor 

seeking to realize on its collateral, such cause may be lack of "adequate 

protection." Adequate protection may include 

(a) equity cushion 

(b) periodic cash payments 

(c) additional or replacement security 

(d) "indubitable equivalent" 269 

(e) discharge of liens prior to those of party seeking protection 

(f) segregation of cash collateral 

(g) insurance 

(h) third party guarantees 

(4) The F.D.I.C. is not exempt from the §362(a) automatic stay 

notwithstanding 12 U.S.C. §1821(d)(17) which provides for the rights of 

the F.D.I.C. to be superior to those of the bankruptcy trustee. 270 

Enforcement of governmental, police and regulatory powers is under 

266 See §23.05 in Dunaway “Automatic Stay” . 

267 The cases are in conflict as to whether an administrative stay violates the automatic stay. Those holding that it 

does include In re Strumpf, 37 F.3rd 155 (C.A. 4 Md. 1944); In re Patterson, 967 F.2d 505 (C.A. 11, Ala. 1992). 

Those cases to the contrary include In re Lough, 163 BR 586 (Bankrptcy. D. Idaho 1994); In re Moreira, (Bankr. D. 

Mass.); In re Edgins, 36 B.R. 480 (9th Cir. Bap-Cal 1984). 

268 For instance, a stay may be lifted to permit litigation to continue in another forum that may be better suited to 

adjudicate the issues although the bankruptcy court will in such cases control proceeding on any judgment that might 

be entered against the debtor. For standards the courts apply in such cases see In Re Sonnax Industries, Inc., 907 

F.2d 1280, 1285 (2 nd Cir. 1990); In Re Mazzeo, 167 F.3d. 139 (2 nd Cir. 1999). 

269 See Learned Hand's opinion in In re Murel Holding Corp., 75 F.2d 941 (2nd Cir. 1935). Section 361(3) of the 

Bankruptcy Code, contrary to Yale Express System, Inc., 384 F.2d 990 (2nd Cir. 1967), makes it clear that "indubitable 

equivalent" does not include mere administrative priority. 

270 F.D.I.C. v. Hirsch (In re Colonial Realty Co.), 980 F.2d 125 (2nd Cir. 1992). 

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362(b)(4) exempt from the stay. This may be the basis for stay avoidance 

by the F.D.I.C. or RTC in an appropriate situation. 271 

8.4.5 § 105(a) Stays Code § 105(a) authorizes the bankruptcy court to “issue 

any order, process or judgement that is necessary or appropriate to carry 

out the provisions of this title” has been construed to grant broad authority 

to the bankruptcy court in exercise of its equitable powers to implement 

the specific provisions of the Code so long as such action is consistent 

with the provisions and intent of the Code. Under this section a 

bankruptcy court may stay the action of a state court 272 , A common use of 

this provision is for the bankruptcy court to effectively bring a non-debtor 

(such as the general partner of a debtor partnership) that it determines is 

essential to a reorganization under the protection of a stay that may be as 

broad as the Automatic Stay under § 362(a). 

8.5 Reciprocal Easement Agreements. 273 Consider possibility of assumption or 

rejection. 274 An attempt of the debtor 275 to partially reject an REA should not be 

effective although it may be ineffective as against only those aspects of the REA 

that are non-executory because they are deemed to run with the land. 276 

8.6 Fraudulent Transfer Issues. Nearly any transaction that transfers an interest of 

an insolvent transferee for less than reasonably equivalent value may be treated as 

a fraudulent transfer. 277 

271 See Board of Governors of the Federal Reserve System v. MCorp. Financial, Inc., 499 U.S. 904, 112 S.Ct. 459, 

113 L. Ed 2d 212 (1991). 

272 See the Notes of the Committee on the Judiciary Senate Report No. 95-989. 

273 Reviewing a Shopping Center REA, 18 Real Prop. Pro. & Tr. J. 651 (1983). Reciprocal Agreements in Shopping 

Center Developments, 14 St. Mary's L.J. 541 (1983). M.Garfinkel, May all or Portions of a Recorded Shopping Center 

Reciprocal Arrangement be Rejected as an Executory Agreement under Section 365 of the Bankruptcy Code, 28 Real 

Prop. Pro. & Tr. J. 83 (1993). 

274 See Savage, Reciprocal Easement Agreement: Assumption and Rejection in Bankruptcy, 19 R.E. Law Journal 99 

(1990). See Countryman, Executory Contracts in Bankruptcy, 57 Minn. L. Rev. 439, 460 (1973). In Gouveia v. Tazbir, 

37 F.3d 295 (7th Cir. 1994) the court concluded that a reciprocal land covenant prohibiting any use of the debtor's land 

other than for single family dwelling was not an executory contract since once recorded no further performance was 

required by either party. See also In re Chestnut Ridge Plaza Associates L.P., 156 B.R. 477 (Bankr. W.D. Pa. 1993). 

275 The Bankruptcy Code uses the term "Debtor" for the subject of the proceedings instead of the term "Bankrupt" 

used under the old Bankruptcy Act. 

276 See Cook, Judicial Standards for Rejection of Executory Contracts in Bankruptcy Code Cases, 1980 Ann. Sur. 

Am. 689, 702 (1980); Net Realty Holding Trust v. Franconia Properties, 544 F.Supp., 759; Carlson, Successor Liability 

in Bankruptcy: Some Unifying Themes of Intertemporal Creditor Priorities Created by Running Covenants, Products 

Liability, and Toxic Waste Cleanup, 50 L. & Contemp Probs. 119,124 (1987). 

277 See Chapter 25 “Bankruptcy-Trustee’s Avoiding Powers” in Dunaway, The Law of Distressed Real Estate (Clark 

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8.6.1 See 11 U.S.C. §548 (1 year rule), and 11 U.S.C. §544 (strong arm 

powers), 278 Cook, Fraudulent Transfer Liability Under the Bankruptcy 

Code, 17 Hous. L. Rev. 263 (1980). Section 548 of the Bankruptcy Code 

(one year rule) and either the Uniform Fraudulent Conveyance Act or the 

Uniform Fraudulent Transfer Act 279 may be applicable. 

8.6.2 As to loans that arise in the context of leveraged buy outs (LBOs) see 

United States v. Tabor Court Realty Corp. 803 F.2d 1288 (3rd Cir 1986). 

The Third Circuit has limited the application of Tabor Court on the basis 

of the intangible benefits of the LBO to the borrower as being part of the 

required "reasonably equivalent value." 280 

8.6.3 Section 101(48) of the Bankruptcy Code defines "transfer" to include 

"every mode, direct or indirect, absolute or conditional, voluntary or 

involuntary of disposing of or parting with property or with an interest in 

property... ." The term "transfer" includes just about every possible means 

of transferring of a property interest. 

8.6.4 Prepetition Lease Terminations have been held to be fraudulent 

transfers. 281 Prepetition franchise termination for good cause has been 

held not to be avoidable since although it was a "transfer" it was neither 

"fraudulent" nor preferential. 282 

Boardman Callaghan 1985-1995). 


279 See Cook and Mendales, The Uniform Fraudulent Transfer Act: An Introductory Critique, 62 Am. Bankr. L.J. 

87(1988) 

280 Mellon Bank, N.A. v. Metro Communications, Inc. 945 F.2d 635 (3d Cir. 1991). 

281 See, In re Pinto, 98 B.R. 200 (E.D. Pa 1989) ( termination of lease); In re Edward Harvey Co., 68 B.R. 851 (D. 

Mass. 1987); In re Eastern Parlliament Corp., 67 F.2d 871 (2nd Cir. 1933); In re Queen City Grain, 51 B.R. (S.D.N.Y. 

1971) (month-to-month lease is a valuable right which may be subject to fraudulent conveyance); In re Ferris, 415 

F.Supp. 33 (W.D. Okla. 1976) (the termination of a leasehold for non-payment of rent where the tenant had paid a 

substantial amount of money for improvements); Fashion World, Inc., 44 B.R. 754 (Bankr.D.Mass. 1984) (voluntary 

termination of lease by tenant for no actual consideration constitutes fraudulent conveyance of leasehold) In re D.H. 

Overmyer Telecasting Co., Inc., (N.F. Ohio, E.D. 1983) (leases for lack of good consideration set aside as fraudulent 

conveyance) . The assignment of a leasehold may be considered a fraudulent conveyance if all the tests are met. See, In 

re 716 Third Avenue Holding Corp., 225 F.Supp 268 (S.D.N.Y. 1964). See, Robert E. Goodman, Jr., Avoidance of 

Lease Terminations as Fraudulent Transfers, 43 The Business Lawyer 807(1988). Contrary authority includes Haines v. 

Regina C. Dixon Trust, 178 B.R. 471 (W.D. Mo. 1995), Callia v. Original Great America Chocolate Chip Cookie Co., 

1994 W.L. 151091, 

282 In re Thompson, 186 B.R. 301 (Banktcy. N.D. Ga. 1995) 

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8.6.5 Although foreclosures 283 and tax sales 284 had been held to be fraudulent 

transfers, the United States Supreme Court in BFP v. Resolution Trust 

Corp., 285 in a 5 to 4 opinion held that the price received in a non-collusive 

foreclosure sale conducted in accordance with state law should 

conclusively be deemed to be "reasonable equivalent value". Justice 

Scalia, speaking for the majority, refused to read the phrase "reasonably 

equivalent value" to mean in its application to mortgage foreclosure sales, 

either "fair market value" or "fair foreclosure price". The dissent objected 

to the substitution of a procedural test for a substantive test. The BFP case 

has been held not to be applicable to termination of an agreement for deed 

or conditional sale agreement. 286 

8.6.6 An exercise of an option to extend a leasehold may be a fraudulent transfer 

where the debtor is the landlord. 287 

8.6.7 Relevant state law may be either the Uniform Fraudulent Conveyance or 

Act the Uniform Fraudulent Transfer Act. There may also be other 

specialized state law. 288 

8.7 Effectiveness of Bankruptcy Oriented Prepetition Workout Agreements by 

Debtor. 289 

283 Opposing approaches were those of Durrett V. Washington National Insurance Co., 621 F.2d 201 (5th Cir. 1980). 

In re BFP, 974 F.2d 1144 (9th Cir 1992) and Lawyers Title Insurance Co. v. Madrid, 21 B.R. 424 (Bnkr 9th Cir. 1982) 

aff'd on other grounds, 725 F.2d 1197 (9th Cir), cert. denied 469 U.S. 833, 105 S. Ct. 125, 83 L.Ed 2d 68 (1984) had 

adopted the irrebuttable presumption of reasonably equivalent value in regularly conducted noncalusive foreclosure sale 

approach sustained by the United States Supreme Court in the BFP case. 

284 In re Makeever, 132 B.R. 996 (N.D. ILL. 1991). 

285 114 S.Ct 1757 (1994). 

286 In re Grady, 202 B.R. 120 (Bkrtcy. N.D. Iowa) contra In re Vermillion, 176 B.R. 563 (Bkrtcy D. OR 1994) 

287 In re Thrifty Dutchman, Inc., 97 B.R. 101 (Bkty S.D. Fla. 1988). 

288 For instance New York Debtors and Creditor Law Section 278(1) provides in part that: "Where a conveyance or 

obligation is fraudulent as to a creditor, such creditor ... may, as against any person except a purchaser for fair 

consideration without knowledge of the fraud at the time of the purchase ... have the conveyance set aside or obligation 

annulled." 

289 For an extensive consideration of this issue, see Michael Baxter, Prepetition Waivers of the Automatic Stay: A 

Secure Lenders Guide, 52 Bus. Lawyer 577 (Feb. 1997). In Tampa Bay Briarwood Assoc., Ltd.,1990 Bankr. Lexis 

1841 (M.D. Fla.) the court enforced the provisions of a Ginnie Mae regulatory agreement to require bankruptcy counsel 

fees paid out of project rents to be reimbursed to debtor by general partner that so diverted the funds. See D.L. 

Campbell and Julie Lennon, Drafting Bankruptcy Relief Clauses in Loan Documents, 10 Prac. Lawyer, July 1994, 27; 

McFarland, Waivers Of Bankruptcy Rights In Workout Agreements, 8 Prob. & Prop. 15 (Nov/Dec 1994). For a 

discussion of pre-bankruptcy waivers see KUPETZ, THE BANKRUPTCY CODE IS PART OF EVERY CONTRACT: MANAGING 

THE IMPACT OF CHAPTER 11 IN NON DEBTOR BARGAINS, 54 Business Lawyer 55, 67 (Nov. 1998) 

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8.7.1 Pre bankruptcy waivers of the right to seek bankruptcy court protection are 

not enforceable. 290 There is though a split of authority on the 

enforceability of provisions of prebankruptcy agreements that limit a 

party's rights in the event such party should later become the debtor in a 

bankruptcy proceeding. 291 See In Re Powers 292 for extensive discussion of 

this issue. 

8.7.2 The pre-petition existence of a full workout agreement in which all 

material interests are represented may be adequate basis for a court to 

dismiss a Chapter 11 petition as having been filed in bad faith. 293 

8.7.3 It appears that personal liability may be conditioned on a default if 

bankruptcy action is commenced by or against obligor. 294 

8.8 Plan Approval, "Cram-Down" Possibility, Absolute Priority Rule, New 

Value Exception. 295 

8.8.1 Undersecured Lender. Consider whether the lender is undersecured. 296 

Cram-down must satisfy "fair and equitable" standards. 297 It is not clear 

290 See Fallick v. Kehr, 369 F. 2d 899, 905 (2nd Cir. 1986); re Tru Block Concrete Products, Inc., 27 B.R. 486, 492 

(Bankr. S.D.Cal 1983) (Agreement not to seek bankruptcy relief not enforceable); In re George, 15 B.R. 247, 248 

(Bankr. N.D. Ohio 1981) (Prepetition waiver of discharge right not enforceable); In re Markizer, 66 B.R. 1014, 1018 

(Bankr. S.D. Fla.1986) (Pre-petition discharge waiver not enforceable) 

291 The court In re Citadel Properties, Inc., 86 Bankr. 2nd 275 (Bkrtcy. M.D. Fla. 1988) enforced as sufficient "cause" 

under §362 (d)(1) a prepetition settlement agreement that the borrower would not object to a lifting of the automatic stay 

if the workout failed and the mortgagee went into a Chapter 11 proceeding. See also In the Matter of Gulf Beach 

Development Corp. 48 B.R. 40 (M.D. Fla. 1985); In re Philadelphia Athletic Club, Inc., 20 B.R. 322 (Bkrtcy. E.D. Pa. 

1982) - Contra - In re Sky Group International, Inc., 108 Bankr. 86, (Bkrtcy. W.D. Pa. 1989). In re Club Towers, L.P., 

138 B.R. 307 (Bkr. N.G. Ga. 1991). In Re Jenkins Court Associates, Ltd. Partnership, 181 B.R. 33 (Bankr. E.D. Pa. 

1995) (Enforcement prepetition waiver is in effect enforcement of restraint in filing a voluntary proceeding); In Re 

Powers, 170 B.R. 480 (Bankr. D. Mass. 1994). 

292 25 BCD 1586 (Bankr., D. Mass, E.D.) In Powers the court determined that a prepetition waiver of a debtor's 

opposition to a Motion for Relief from the Automatic Stay is not self executing but does shift the burden of proof from 

the creditor to the debtor. 

293 See 8.11 below. 

294 First Nationwide Bank v. Brookhaven Realty Associates, 637 N.Y.S.2d 418 (N.Y.A.D. 2nd Dept. 1996). 

295 See generally, Chapter 24 “Bankruptcy Reorganization Under Chapter 11" and Chapter 24C-”Bankruptcy Cram 

Down in Chapter 11" . 

296 The "Cram Down" is based on §1129(b) of the Bankruptcy Code where all of the requirements of §1129(a) other 

then 1129(a)(8) are met. In a Cram Down the creditor under the Reorganization Plan retains its lien and may receive 

deferred cash payments at least equal to the amount of the claim of a current value at least equal to the value of the 

creditor's collateral. See also Bankruptcy Code §1111(b)(2). It is rarely advantageous for the mortgagee to make this 

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whether partial interest deferral and negative amortization will satisfy this 

requirement. 298 

8.8.2 Requirements. A plan rejected by an impaired class may nevertheless be 

approved if (1) it does not "discriminate unfairly" and (2) it is fair and 

equitable. 299 The Absolute Priority Rule, 300 requires that a senior 

nonconsenting class must be satisfied in full before a juror or equity class 

may receive a distribution. In 203 N. LaSalle Street Partnership 301 the 

New Value Exception, if it exists, 302 that permits participants to acquire 

equity position as part of the plan for providing fresh contribution of 

reasonably equivalent value was severely limited by the United States 

Supreme Court. The Court applied a "market test" that may require either 

a right in parties other than the debtor to offer plans or at least a right of 

election. See generally, Chapter 24C “Bankruptcy-Cram Down . 

297 Bank Code §1129(b). See In re Bryson Properties, XVIII F.2d (4th Cir. 1992). The court rejected a plan based on 

a scheme of claim classification in involving a secured creditors deficiency claim being placed in a class separate from 

other general creditors. See also, In re Greystone III Joint Venture, 948 F.2d 134 (5th Cir. 1991). See Id. Chapter 24C. 

298 See In re McCombs Properties VIII, 91 B.R. 907 (U.S. Bank Ct. Calif. 1988); Great Western Bank v. Sierra Woods 

Group, 953 F.2d 1174 (9th Cir. 1992). Factors include: (1) does the plan offer a market rate of interest and present 

value of deferred payments; (2) is the amount and length of the proposed deferral reasonable; (3) is the ratio of debt to 

value satisfactory throughout the plan; (4) are the debtor's financial projections reasonable and sufficiently proven, or is 

the plan feasible; (5) what is the nature of the collateral, and is its value appreciating, depreciating or stable; (6) are the 

risks unduly shifted to the creditor; (7) are the risks borne by one secured creditor or class of secured creditors; (8) does 

the plan preclude the secured creditor's foreclosure; (9) did the original loan terms provide for negative amortization; 

and (10) are there adequate safeguards to protect lender against plan failure. A Debtor is not required to accept "pie in 

the sky" In re Pelham St. Associates, 134 B.R. 700. 

299 Bankr. Code § 1129(b)(1). Although § 1129(b)(2) provides examples of "fair and equitable" treatment the term is 

not defined other than by case law. Any modification of a non-consenting creditor's secured loan must be fair and 

equitable to such creditor. Adequate protection of the secured creditors property right may be required to meet the fair 

and equitable test. See In re Monnier Bros. 755 F.2d 1336 (8th cir. 1985), Vanston Bondholders Protective Co., 329 

U.S. 156 (1946). Significant negative amortization is generally not permitted. In re D&F Construction, Inc., 865 F.2d 

673 (5th Cir. 1989). But see In re Sierra Woods Group, 953 F.2d 1174 ( 9th Cir. 1992). 

300 In re Bonner Mall Partnership, 2 F.3rd 899 (CA 9th. Idaho 1993),Motion to Vacate Denied and Dismissed by 5 

U.S. Bancorp Mortg. Co. v. Bonner Mall Partnership, 115 S.Ct. 386 (1994), holds that the Absolute Priority Rule 

survived the enactment of the Bankruptcy Code; 

301 524 U.S. 975, 141 L.Ed. 2d 785, 119 S.Ct. 24 (1999) 

302 The exception was found applicable by the Ninth Circuit in Bonner Mall Partnership v. U.S. Bancorp. Mortgage 

Co. 2 F.3d 899 (9 th Cir. 1993), Motion to Vacate Denied and Dismissed by 5 U.S. Bancorp Mortg. Co. v. Bonner 

Mall Partnership, 115 S. Ct. 386 (1994). In In re A.V.B.I., Inc., 143 B.R. 738 (Bkrtcy.C.C.Cal. 1992) the court 

concluded that a New Value exception does not exist under the Bankruptcy Code since any such exception to the 

Absolute Priority Rule was intentionally omitted from the condification of the § 1129(b)(2)(B) Absoulte Priority 

Rule standard. In the majority opinion in 203 LaSalle Street Partnership Judge Souter found it unnecessary to 

decide whether the New Value Exception exists. 

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such other parties to bid for the right to reorganize the Debtor. 303 

number of cases have recognized the New Value Exception. 304 

A 

8.8.3 "Artificial Impairment". In the Eight Circuit, a Chapter 11 debtor may 

not "manufacture" an impaired class to accept the plan so as to permit a 

restructuring of the principal secured debt as part of a "cram down" 

plan. 305 

8.8.4 Purchase of Trade Claims by Secured Creditor. Since acceptance of 

the plan by the trade creditor class is usually required to "claim down" a 

plan, secured creditors will often attempt to acquire sufficient trade debt to 

vote against and defeat a plan proposed by the debtor that includes a 

"claim down." 306 

8.9 Collection of Interest, Costs and Fees by Secured Creditor. 

8.9.1 §502(b)(2) Unmatured Interest 307 may be a problem in case of deferred 

interest or contingent interest loans. 308 

303 Although the Supreme Court has in Northwest Bank of Worthington v. Ahlers, 485 U.S. 197 108 S.Ct. 963, 99 

L.Ed. 2d 169 (1988) noted the division of authority on whether its "New Value Exception" is viable under the 

Bankruptcy Code it has not determined its validity. For an analysis of Ahlers see In re Johnston, 21 F.3rd 323 (9th Cir. 

1994). The New Value Exception has been questioned in Kham & Nate's Shoes No. 2, Inc. v First Bank of Whiting, 908 

F.2d 1351 (7th Cir. 1990). The opinion in A.V.B.I., Inc. 143 B.R. 738 (Bkrc. C.D. Cal. 1992) considers not only the 

split of authority on whether there is a New Value Exception but also the legislature history. 

304 See In re Rocha, 179 B.R. 305 (Bkrtcy M.D. Fla. 1995) In BT/SAP Pool C. Ass L.P. v. Coltex, 1996 WL 684445 

(S.D.N.Y.) the court concluded that the New Value Exception survived codification of the Absolute Priority Rule in 

§1129 of the Code. 

305 In re Windsor on the River Associates, Ltd., 7 F.3d 127 (8th Cir. 1993). 

306 The purchase of $7,000 (99%) of trade claims at full value by a first mortgagee (FHMC) holding a $1.26 Million 

mortgage on property worth $800,000 was upheld over claims by the debtor that in doing so the mortgagee acted in bad 

faith. In re Kellogg Square Partnership, 160 B.R. 332 (Bankr. D.Minn.1993). In In Re: Three Flint Hill Ltd. 

Partnership 213 B.R. 292 (D.Md) a purchaser of debt was considered an insider and its vote disqualified for purposes of 

determining whether the plan had been accepted by one impaired class although the purchaser had no control over the 

Debtor. 

307 The meaning of the term "Unmatured Interest" is not clear except that it is intended to at least cover "post petition 

interest that is not due and payable:. In the Matter of Baldwin-United Corp., 55 B.R. 885, 894 (Bankr.S.D. Ohio 1985); 

Collier on Bankruptcy, 502.02, at 502-32 (15th ED. 1988) (H.R. Rep. No. 95-989, 95th Cong., 2nd Sess 62-63 (1978). 

The legislative history makes it clear that 502(b)(2) is intended to require that original issue discount attributable to the 

post-petition period should be disallowed. This would for instance be applicable to a zero interest coupon bond. See In 

re Allegheny Intern, Inc., 100 B.R. 247, (Bankr. W.D. Pa. 1989) (Proration of OID is part of §502(b)(2) legislative 

history) In re Chateaugay Corp., 109 B.R. 51 (Bankr S.D.N.Y. 1990). The problem is that it is not clear just how far the 

term "unmatured interest" goes beyond OID. 

308 These may include arrangements pursuant to which all or a portion of the stated interest at an accrual rate is 

postponed if cash flow is not adequate to serve debt at accrual rate, participation loans, deferral of front end fees, etc. 

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8.9.2. §506(b) Fees and Costs of Collection (State v. Federal Standard) 

8.10 "Pre-Bankruptcy Planning" By Debtor 309 

Inappropriate "planning" approaches may constitute grounds to bar debtor's 

discharge and possibly be the basis of claims against attorneys and other 

advisors. 310 Although there is a split among the circuits, courts in the Fifth and 

Seventh Circuits have held that actual fraud need not be established to deny a 

discharge under §727(a)(2). 311 Consummating a transfer within one (1) year of 

the filing for the purpose of hindering or defrauding a creditor is sufficient to 

come within §1141(d)(3). 312 Creditors may also object to claims that specific 

assets are entitled to state created exemptions. These exemptions vary from state 

to state and include the homestead exemption 313 which may or may not be limited 

as to value, and exemptions for entireties properties, musical instruments, 

antiques, life insurance policies, and annuities, bibles, tools, clothing, etc. 

8.10.1 Foreign Situs Trusts 

8.11 Bad Faith Chapter Filing - Two Party Disputes - New Debtor Syndrome. 

8.11.1 A single asset voluntary Chapter 11 proceeding may on occasion be 

dismissed for "cause" of the basis of it having been initiated in "bad 

309 See Alexander Bove, Asset Protection Strategies, ABA Section of Real Prop., Probate and Trust Law 

Publication (2002); Charles Fox IV and Michael Muft, Asset Protection and Dynasty Trusts, 37 Real Prop., Probate 

& Trust, Jr. in 287 (Summer 2002). 

310 A discharge may be denied in a Chapter 11 proceeding pursuant to Bankruptcy Code §1141(d)(2) as to specific 

obligations as provided for by §523 or as generally under §1141(d)(3) to the extent §1141(d)(3) incorporates §727(a). 

See NCNB Tex. Nat'l Bank v. Bowyer, 916 F.2d 1056 (5th Cir 1990). A discharge was denied in In re Johnson, (Bankr. 

Minn.March 1, 1991) CCH Bankruptcy L.Rep. 73,836 on the basis of In re Johnson, 880 F.2d 78 (8th Cir. 1989). 

There is a full discussion of the issue in the district court's decision of March 1, 1991. Compare Norwest Bank 

Nebraska, N.A. v. Tveten, 848 F.2d 871 (8th Cir. 1988). (Physician that guaranteed nineteen million dollar loan and 

transferred $700,000 of assets denied discharge) with Hanson v. First Na. Bank in Brookings, 848 F.2d 866 (8th Cir. 

1988) (Farmer that transferred $31,000 of property not denied discharge) 

311 In re Bouyer, 916 F.2d 1056 (5th Cir. 1990); In re Smiley, 864 F.2d 562 (7th Cir. 1989). Debtor's intent must be 

shown in the Eighth and Tenth Circuits; In re Johnson, 880 F.2d 78 (8th Cir. 1989); In re Carey, 938 F.2d 1073 (10th 

Cir. 1991). 

312 Ameritrust Nat'l Bank v. Davidson, 164 B.R. 782 (Bankrtcy S.D. Fla. 1994). 

313 A district court in Florida has determined that Florida's constitutional homestead exemption did not contain an 

exception for real property acquired in Florida for the sole purpose of defeating the claims of out-of-state creditors. 

(Debtor sold N.J. Home for $947,000 and purchased Florida home for $522,000 at about same time). Bank Leumi Trust 

Co. of N.Y. v. Lang, 898 F.Supp. 883 (S.D. Fla. 1995). 

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faith." 314 Issues include whether there is a realistic possibility of the 

debtor putting together a confirmable plan and whether the Court views 

the case as essentially a mere private dispute. 315 Cases have been 

dismissed on the basis of admissions in prepetition work out 

agreements. 316 

8.11.2 The "New Debtor Syndrome" typically invoices segregation of assets into 

the debtor 317 and other entities immediately prior to the filing. 

8.11.3 Involuntary petition allegedly induced by debtor to circumvent bankruptcy 

remote provisions was not dismissed in the Southern District of NY as 

being filed in bad faith. 318 

314 In Matter of Little Creek Development, 779 F.2d 1068, 1072 n.2 (5th Cir. 1986) the court deemed it the courts 

obligation to sua sponte look into the good faith of the Chapter 11 filing and listed indicia of bad faith to include a filing 

precipitated by a foreclosure of the entities single significant asset that is being foreclosed, lack of employees, cash flow 

and material unsecured creditor interests and recent transfer of principal asset to the debtor. Transfers of a property by 

the borrower from multi asset entity to a single asset entity immediately prior to the Chapter filing may not be 

disadvantageous to the lender since it may significantly simplify the Bankruptcy Court proceedings. See Chapter 24D 

Bankruptcy-Single Asset Real Estate Cases” . 

315 See In re Anderson Oaks (Phase I) Limited Partnership, 77 B.R. 108 (Bankr. Tex. 1987); In re Landmark Capital 

Company, 27 B.R. 273 (Bankr. Ariz. 1983); In re Volpe, 53 B.R. 46 (Bankr. 1985). See also In re Albany Partners, 

Ltd., 749 F.2d 670, 674 (11th Cir. 1984); In re Waldron, 785 F.2d 936 (11th Cir. 1986) cert. dismissed, 478 U.S. 1028, 

1065 S. Ct. 3343, 92 L.Ed.2d 763 (1986); In re Phoenix Piccadilly, Ltd, 849 F.2d 1393, (11th Cir 1988). In re Humble 

Place Joint Venture, 936 F.2d 814 (5th Cir. 1991) (Petition dismissed where Chapter 11 petition was filed to avoid 

foreclosure, although debtor had substantial bank accounts, unencumbered assets and no material debts other than the 

mortgage loan). 

The following factors are listed in In re Club Towers L.P. 138 B.R. 307,309 (Bkry. N.D. Ga 1991): 

1. The Debtor has only one asset, the Property; 

2. The Debtor has few unsecured creditors whose claims are small in relation to the claims of the 

secured creditor; 

3. The Debtor has few employees; 

4. The Property is the subject of a foreclosure action as a result of arrearages on the debt; 

5. The Debtor's financial problems involve essentially a dispute between the Debtor and secured 

creditor which can be resolved in a state court action; and 

6. The timing of the Debtor's filing evidences an intent to delay or frustrate the legitimate efforts of 

the Debtor's secured creditors to enforce their rights. 

316 In re Aurora Investment, Inc., 134 B.R. 982 (Bankr. M.D. Fla. 1991). 

317 See Carolin Corp. v. Miller, 886 F.2d 693 (4th Cir. 1989); In re Laguna Assoc. Ltd. Partnership, 30 F.3d 734 (6th 

Cir. 1994). In re Cherokee New York Investment, 27 Bankr. Ct. Dec. 1010 1995 WL 548182 (Bankr. E.D.N.Y.)(not 

reported in B.R.) a large number of fractional interests in mortgaged real estate were transferred to different entities. 

318 In Re: Kingston Square Associates, 214 B.R. 713, 1997 WL 594707, 31 Bankr.Ct. Dec. 615 (Bankr.S.D.N.Y., Sep 

24, 1997). 

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8.11.4 Successive Chapter 11 filings on eve of foreclosure sale may be basis for a 

bad faith dismissal with prejudice to refiling. In re Cassie, 219 B.R. 657 

1998 WL 197234 Bkrtcy. E.D.N.Y.) 

8.12 Entry into Possession by Mortgagee. If local law permits mortgagee to enter 

into possession, the advantages and disadvantages to lender of taking such action 

should be evaluated at the time the lender became sensitized to the possibility of a 

default. Such action prior to the institution of a Bankruptcy Code proceeding is 

no longer relevant to the lender's right to post-petition rent being treated as cash 

collateral 319 and lender may even be permitted to remain in possession of the 

property post-petition. 320 A major counterindication to the lender is the possibility 

of environmental clean-up exposure under CERCLA. 321 

8.13 Single Asset Case Issues. 322 Under Sec. 362(d) of the Code, special treatment is 

provided for a “Single Asset Real Estate” debtor having liquidated secured debt of 

less than $4,000,000. The following issues may arise in the context of a motion to 

dismiss, motions for relief from stay 323 and confirmation of a plan: 

8.13.1 Bad Faith Filing. Debtor's lack of good faith. 324 The "bad faith filing". 

8.13.2 Absolute Priority Rule. Absolute priority rule and so called Fresh 

Capital Exception. 325 

8.13.3 Classification of Claim Issues. 

(1) Debtor's in seeking to secure approval of a reorganization plan will 

often seek to place a secured creditor's unsecured claim in a class 

separate from that of other unsecured creditors notwithstanding 11 

U.S.C.A. §1122(a) 326 The purpose is to permit the debtor to secure 

consent to the plan by at least one class -- the general unsecured 

320 See Landau v. Western Pennsylvania National Bank, 445 Pa. 217, 282 A.2d 335 (1971). 

321 See Item 4.7 above. 

322 See Chapter 24D “Bankruptcy-Single Asset Real Estate Cases” in Dunaway Text; Carlisle III, Single Asset Real 

Estate in Chapter 11 - Need For Reform, 25 Real Property, Probate and Trust Journal, 673 (Winter 1969); see In re 

Anderson Oaks (Phase I), 77 B.R. 108, 112 stating that two party disputes have no place in the bankruptcy courts; Good 

Faith and the Single Asset Debtor, 62 Am Bankr. L.J. 131, 132 (Spring 1988). Bankruptcy Code §362(d). 

324 See item 8.11 above. 

325 See item 8.8 above. 

326 

See Chapter 24B.04[2] “Classification of Claims”. In Dunaway, The Law of Distressed Real Estate (Clark 

Boardman Callaghan 1985-1995). 

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creditors -- without the secured creditor using its unsecured claim 

to out-vote the other unsecured creditors who the debtor believes 

will approve the plan. 

(2) The debtor will often seek to provide a distribution to the general 

unsecured creditors that is better than that proposed for the 

unsecured claim of the under secured lien creditor. Courts have 

differed on whether to approve such classification schemes. 327 

(3) The debtor may use a lender liability counterclaim as basis of a 

claim that existence of such unliquidated offsets requires separate 

classification of the lender's unsecured portion of the loan from the 

claims of other general creditors. 

8.13.4 "Single Asset Real Estate" Provisions of the Bankruptcy Code. If the 

Debtor is the owner of a “Single Asset Real Estate” 328 Debtor as defined in 

Section 101 (51B) of the Code a reasonable possibility of reorganization is 

required under a plan that (unless extended) must be filed within 90 days 

after the commencement of the case. 329 At that time interest must start to 

be paid at market rate on the value of the secured creditors' interest in the 

real estate. 

8.13.5 A secured creditor's lack of adequate protection. 330 

8.13.6 Artificial Impairment. 331 

327 Separate classification was denied in John Hancock Mutual Life Ins. Co. v. Route 37 Business Park Assoc. 987 

F.2d 154 (3rd Cir. 1993) and Matter of Greystone III Joint Venture, 995 F.2d 1274 (5th Cir. 1991) but permitted in 

Matter of Woodbrook Ass., 19 F.3d 312 (7th Cir. 1994), In re ZRM-Oklahoma Partnership, 156 BR 67 (Bankruptcy 

W.D. Okl. 1993), In re D & W Realty Corp., 156 B.R. 140 (Bankr. S.D.N.Y. 1993). See In re Windsor on the River 

Associates, Ltd., 7 F.3d 127 (8th Cir.. Iowa 1993) and article by Weintraub and Resneck at 26 UCC L.J. 359 (Spring 

1994). This case may preclude confirmation in single asset cases (unless the mortgagee accepts the plan) due to 

difficulty of finding an impaired class. Notwithstanding contrary Court of Appeals authority in seven federal circuits, 

the court in In Re: Cross Creek Apartment Ltd. 213 B.R. 521, 1997 WL 606517 (Bkrtcy E.D. Tenn) permitted 

separate classification of a secured creditors unsecured claim of over a million dollars and $26,000 of general creditor 

debt. 

328 A marina has been held not to be “Single-Asset Real Estate,” since it is a "business." In re K. Kemko, Inc., 181 

B.R. 47 (Bankr. S.D. Ohio 1995). A housing co-op corp has been held to fall within the 51B definition In In Re: 83-84 

116 th Owners Corp., 214 B.R. 520, 1997 WL 735677 (Bktcy E.D.N.Y.) (1977). See Chapter 24D of the Dunaway text 

on “Bankruptcy-Single Asset Real Estate Cases” . 

329 Section 362(d)(3) requires the Court to grant a motion for relief from the stay unless a feasible plan is filed within 

90 days of the entry of the Order for Relief. 

330 Bankr. Code §362(d)(1). See United Savings Ass. v. Timbers of Inwood Forest Ass., Ltd., 484 U.S. 365 (1988). 

See §24B.03 “Immediate Issues in Bankruptcy Reorganization” . 

331 See In re Windsor on the River Associates, Ltd., 7 F.3d 127 (8th Cir. 1993)(refusal to confirm plan which 

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8.13.7 New Value Rule. 332 

8.14 Third Party Releases Plan Provisions. 333 Under Bankruptcy Code §524(e) 

discharge of debtor does not effect other entities. The lead case is Union Carbide 

Corp. v. Newboles 334 which holds third party releases in plan ineffective. Courts 

have though permitted voluntary releases. 335 

8.15 Landlord's Rent Claim. 

8.15.1 Rent Recovery Cap. 336 The cap will apply where the debtor is a 

guarantor. 337 

8.15.2 Post Petition Rent. §365(d)(3) requires the trustee (subject to a 

performance extension by the court of not more than 60 days) to perform 

the debtors obligation, under a non residential lease, until the effective 

date of a rejection. There is a split of authority as to whether the rents that 

so accrue must be paid currently or may be postponed to confirmation and 

possibly lost to the landlord to the extent there are not sufficient funds to 

pay administrative claims in full. 338 

8.16 Post-petition Credit - Bankruptcy Code Section 364. Consider possibility of 

pre-petition lender securing cross collateralization in consideration of providing 

debtor in possession ("DIP") financing. 339 

artificially impaired a class of creditors). See §24C.01 “Introduction” and footnotes to that section . 

332 See Case v. Los Angeles Lumber Co., 308 U.S. 106 (1939); §24.10 “Cramdown, Absolute Priority and New 

Value” . 

333 See Kaplan & Harwood, Limits of Third Party Releases in Reorganizations, 9 Bankruptcy Strategist, No. 4, p. 3 

(Feb. 92). 

334 686 F.2d 593 (7th Cir. 1982). 

335 In re AOV Industries, Inc. 31 Bankr. 1005 (D.C.D.C., 1983), aff'd in part 792 F.2d 1140 (D.C. Cir. 1986); Monroe 

Well Service, Inc., 80 Bankr. 324 (E.D. Pa. 1987); In re Resorts Int., (No. 89-10119) (Bankr. N.J. 1990). 

336 Bank Code §502(b)(6). 

337 In re Clements, 185 B.R. 895 (Bankr. N.D. Fla. 1995). 

338 See In re Telesphere Communications, Inc. 148 B.R. 525 (Bankr. N.D. Ill 1992). 

339 Matter of Saybrook Mfg. Co., Inc., 963 F.2d 1490 (11th Cir. 1992) 963 F.2d 1490 (11th Cir. 1992) holds on basis 

of requirement for equal treatment of creditors within class that neither §105 nor §364 authorize pre-petition debt being 

cross collateralized and thus afforded a super priority. See D.G. Carlson, Postpetition Security Interests Under the 

Bankruptcy Code, 48 Bus. Lawyer 483 (Feb 93). 

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8.17 "Strong Arm Clause" 340 Section 544(a) - Trustee's Avoiding Power 

Bankruptcy Code §544(a) trustee or DIP may avoid any prepetition transfer or lien 

that is voidable by a judgment lien creditor or BFP at time of petition. 341 

8.18 Valuation Issues. Consider purpose and implications of valuation 

prior to securing appraisals. 

8.18.1 Valuation may determine extent of secured claim - under Code 

Section 506(a), secured creditor may hold a secured claim for value 

of asset and an unsecured claim for balance of amount due. 342 

8.18.2 Existence of equity cushion for lifting of stay and determination of 

existence of adequate protection. 

8.18.3 Classification of claim for Chapter 11 plan approval purposes. 

8.19 § 363 Free and Clear Sale of Asset of Debtor Subject To Lender's Lien. 

Courts are split on whether a bona fide purchaser at a bankruptcy sale gets good 

title over an existing lien where the lien holding secured creditor was not notified 

of the sale. 343 

8.20 Discharge Issues. 344 Consider the possibility that discharge may be denied under 

11 U.S.C. §523(a)(2)(A) 345 for an extension of credit to the extent obtained by 

340 See The Trustee's Strong Arm Power under the Bankruptcy Code, 43 S.C.L. Rev. 841 (Sum 1989). 

341 Trustee's status under Section 544(a)(3) is that of a hypothetical purchaser and as such will be subject to 

constructive or inquiry notice based on possession see McCannon v. Marston, 679 F.2d 13 (3rd Cir. 1982). See §25.04 

“Code Section 544(a): Avoidance Based on Hypothetical Unsecured Creditor Status” . 

342 In Associates Commercial Corp. v. Rash et ux, _____ US ___________, 117 S.Ct. 1879, 138 L.E.D.2d 148, 

No. 96-454 decided June 16, 1997, the U.S. Supreme Court applies Section 506(a) to conclude that a debtor under a 

Chapter 13 plan that retains assets must value such assets on the basis of its replacement value. 

343 In In re Edwards, 962 F.2d 641 (7th Cir. 1991) a Chapter 13 creditor listed a lien creditor in schedules with an 

erroneous address and although a correct address was provided in the lien creditor's proof of claim, the court by way of 

a practical analysis decided not to set aside a sale that has occurred more then a year prior to the filing by the lien 

creditor of motion to set aside the sale. See Rule 2002(g) as to use of address in proof of claim for giving notice to 

creditors and Federal Rule 60(b). Compare with MRR Traders, Inc. v. Cave Atlantique, Inc. (In re Cave Atlantique, 

Inc.), 788 F.2d 816 (1st Cir. 1986), 2 Collier on Bankruptcy 363.13 at p. 363-43, 1st Ed. 1991). 

344 See item 8.10 above on "Pre-Bankruptcy Planning" by Debtor. 

345 See Carrie Bland Field v. Mans and Justifiable Receiving Under Section 523(a)(2)(A) of the Bankruptcy Code 

Determining who is an experienced horseman, 52 The Bus. Lawyer 739 (Feb. 1997). 

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false representation or actual fraud subject to reliance considered at 8.20.1 

below. 346 

8.20.1 - Reliance element under 11 U.S.C.A. §523(a)(2)(A) may be satisfied by 

reliance of FDIC, RTC or assignee of either upon D'Oench Duhme Doctrine. 347 

Although the standard for excepting debt from discharge is not "reasonable 

reliance" but rather the lesser standard of "justifiable reliance" 348 Courts often 

refer to a reasonable reliance standard. Ignoring “red flags” may negate the 

reasonableness of reliance in specific situations. 349 

8.20.2 - On use of consent and default judgment see Stewart, Use of Default and 

Consent Judgment to Prevent the Discharge of Debt in Bankruptcy, 33 N.H.B.J. 

40 (Dec. 1992). 

8.20.3 - Several cases have denied discharges to the innocent parties on the basis 

of a partner's fraud. 350 

8.21 Equitable Subordination 351 - A power of federal bankruptcy courts, as courts of 

equity, to subordinate the claim of the creditor to those of another. The principal 

of Pepper v. Litton 352 is codified at 11 U.S.C. §510(c). 353 

8.22 Successor Liability 

8.23 Bar Dates 

346 See Cohen v. DeLa Cruz et al., 523 U.S. 213, 118 S.Ct. 1212, 140 L.Ed. 2d. 341 (1998). 

347 See contra, F.D.I.C. v. Smith, 133 B.R. 800 (N.D. Tex. 1991) Note, 23 Tex. Tech L. Rev. 935 (June 1992). 

Yarbow v. FDIC, 150 B.R. 233 (9th Cir. 1993) No. cc - 92-1315. 

348 Field v. Mans, 116 S.Ct. 437, 133 L.Ed.2d 351 (1995). 

349 First National Bank of Olathe, Kansas v. Portow, 111 F.3d 604 (8 th Cir. 1997); Coston v. Bank of Malvern, 991 

F.2d 257 (5 th Cir. 1993 (en banc.)) In re Eckert, 221 B.R. 40 1998 WL 229825 (Bkrtcy S.D.FLA.) 

350 In re Ledford, 970 F.2d 1556 (6th Cir. 1992); In re Luce, 960 F.2d 1277 (5th Cir. 1992); see Strang v. Bradner, 

114 U.S. 555, 561, 5 s. et. 1038, 1041, 29 L.ed. 248 (1885) 

351 See Scott M. Browning, Note, "No Fault Equitable Subordination," 34 Wm. & Mary L. Rev. 487 (1993); Helen D. 

Chaitman, "The Equitable Subordination of Bank Claims," 39 Bus. Law 1561 (1984); see also Stoumbos v. Kilimnik, 

988 F.2d 949 (9th Cir. 1993); HBE Leasing Corp. v. Frank, 48 F.3rd 623 (2nd Cir. 1995). 

352 Pepper v. Litton, 308 U.S. 295, 60 S.Ct. 238 (1939). 

353 See Chapter 26D “Bankruptcy-Equitable Subordination,” Dunaway, The Law of Distressed Real Estate (Clark 

Boardman Callaghan 1985 - 1996). 

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8.23.1 Rule 3002(a). Rule 3002(a) requires unsecured creditors to file proof of 

claims as provided for by Rules for claim to be allowed. 354 

8.24 Section 365 Rejection of Leases and Executory Agreements 

8.24.1 Rejection by Debtor Lessee. Rejection constitutes a default as of 

immediately prior to the filing of the petition. 355 In the case of a lease the 

landlord's claim against a rejecting debtor lessee will be limited by code 

§502(b)(6). 356 

8.24.2 Rejection by Debtor Lessor. 357 Under 11 U.S.C.A. §365(h)(2) the tenant 

may either remain in possession for the remainder of the lease term or treat the 

lease as terminated. The extent of the tenant's rights to enforce under various 

lease provisions clarified under the 1994 amendments. These include use, 

possession, quiet enjoyment, transfer and for shopping centers, exclusive use and 

tenant mix provisions. 358 If tenant remains in possession, the tenant can offset 

its damages against rent otherwise due. 

8.24.3 Assumption. 359 

(a) 

Requirements for Assumption. Under §365(b)(1) where there 

has been a default under an executory contract or lease, the debtor 

to assume must: 

(1) Cure the breach or provide adequate protection of prompt 

cure. 360 

354 In re Rago, 149 B.R. 882 (Bkrtcy N.D. Ill. 1992). Consider relationship of Rule 3002(a) and Code §§502 and 746 

and 746 and compare holdings of various circuits on impact of filing of claim. 

355 A repudiation by the RTC under 12 USC 1821(e)(ii) cuts off the lessor's right to obtain damages. (See 12 U.S.C 

1821(e)(4)(A)) even out of collateral provided to secure the failed institution's lease obligation. See Unisys Finance 

Corp. v. Resolution Trust Corp. 979 F.2d 609 (7th Cir. 1992). 

356 See 8.15.1 above. 

357 See 11 U.S.C.A. §365(h). 

358 See Grohsgal, Landlord's Lease Rejection under the Bankruptcy Reform Act of 1994, 13 ABI J. 20 (Dec./Jan. 

1995) 

359 A lease may be assumed under 11 U.S.C.A. §365(a) unless it has expired, provided that under state law the Debtor 

had as of the commencement of the Chapter preceeding some leasehold interest. For the distinction between 

"expiration" and "termination" see Matter of DiCamillo, 206 B.R. 64 1997 WL 123015 (Bkrtcy D.N.J.) 

360 If the breach was a non-curable (non-monetary) default it may not be possible to cure and under such circumstances 

the lease or other executatory agreement may not be assumable by the Debtor. See In re Claremont Acquisition Corp. 

Inc. 1997 WL 236282 (9th Cir.) 113 F.3d 1029 and 113 F.3d, 1240 (9th Cir 1997) as to application of Bankruptcy Code 

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(2) Compensate non-debtor party for actual loss from default. 

(3) Provide actual assurance of future performance. [Note: if 

no default adequate assurance not required.] 

(b) 

Shopping Center Leases 

(1) See 11 U.S.C.A. §365(b)(3) that establishes special 

provisions for adequate assurance for leases in "shopping 

centers" 361 

(2) A debtor has been precluded from assigning a shopping 

center lease where the court found that the nature of the proposed 

assignee's was such as would disrupt the tenant mix. 362 

(c) 

(d) 

Administrative Expense Priority For Rent Obligation. The 

Second Circuit Court Of Appeals has held that a landlord's claim 

for future rent damages as a result of rejection of an assumed lease 

is entitled to administrative expense priority under code 

§503(b)(1)(A) and is not subject to the §502(b)(6) cap. 363 

Sale of Assumed Asset - Mootness. The Mootness Doctrine may 

preclude appellate review of an assignment of a lease following an 

assumption. 364 

8.24.4 REA - CC&Rs. For treatment of Reciprocal Easement Agreement 

(REA's) Covenants, Conditions and Restrictions (CC&Rs) and other servitudes 

see Garfinkel, May All or Portions of a Recorded Shopping Center Reciprocal 

Arrangement Be Rejected as an Executory Agreement under Section 365 of the 

Bankruptcy Code. 365 . It has been held that under Indiana law restrictive covenants 

§365(b)(2)(D). 

361 No "shopping center" in cases of In re Goldblatt Bros. Inc., 766 F.2d 1136, 1140-41 (7th Cir. 1985) (Strip Center - 

no consistent hours or other focus or marketing uniformity); Hoffman v. 905 International Stores, Inc., 57 B.R. 786 

(E.D. Mo. 1985) (strip center - no interdependence); In re Joshua Slocum Ltd., 922 F.2d 1081 (3rd Cir. 1990) 

(establishes 14 criteria), In re Ames Department Stores, Inc., 127 B.R. 744 (Bankr. S.D.N.Y. 1991). 

362 In Matter of Federated Dept. Stores, Inc. 135 B.R. 941 (Bankr. S.D. Ohio 1991) (assignment of Jordan Mash Store 

lease to Mervyn's). 

363 In Re Kleins Sleep Product, Inc. 78 F.3d 18, 1996 WL 70233 (2nd Cir - NY) See also In Re Amber's Stores, Inc. 

1996 WL 138 125 (Bkrtcy ND Tex. 1996). 

364 See Pittsburgh Food & Beverages, Inc. v. Ranallo, 1997 WL 216499 112 F. 3rd 645 (3rd Cir 1997) 

365 28 Real Prop, Prob and Trust Jr. 82 (Spring 1993). 

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being primary property interests are not executory contracts and thus not subject 

to rejection under §365. 366 

8.24.5 Definition of an Executory Contract 367 

8.25.5.1 In Robert L. Helms Construction & Development Co. Inc. v. 

Southmart Corp. 368 the Ninth Circuit reviewing a prior determination that 

all option agreements are executory agreements 369 adopted the view of the 

Ninth Circuit Bankruptcy Appellate Panel to hold that each option contract 

must be analyzed on its individual characteristics. 

8.24.6 Effect of Determination that Contract is not Executory. A contract 

with obligations due on only one side is an asset or liability of the estate. If 

performance is due to the debtor, the contract is an asset, which becomes estate 

property, and which the trustees may reject if burdensome. 370 If the performance is 

due by the debtor, it is a liability of the estate and the nondebtor is an unsecured 

creditor. When a contract is rejected under Section 365(a), the nondebtor has a 

claim for damages. 371 

8.25 Letters of Credit. 372 

366 Gouveia v. Tazbir, 37 F. 3d. 295 (7th Cir. 1994) 

367 See Discussion of the Countryman definition at Garfinkel, May All or Portions of a Recorded Shopping Center 

Reciprocal Arrangement Be Rejected as an Executory Agreement under Section 365 of the Bankruptcy Code.. 

Professor Countryman defines executory contracts, as those where the obligations of both parties "are so far 

unperformed that the failure of either to complete the performance could constitute a material breach, excusing the 

performance of the other." Benevides v. Alexander (In re Alexander), 670 F.2d 885,887 (9 th Cir 1982). 

368 110F. 3rd 1470 (9 th Cir. 1997) (the circuit court panel nevertheless held that: 

"despite the clear logic and persuasive reasoning of the B.A.P. decision, the B.A.P. erred in straying from 

binding Ninth Circuit authority. Given the plain language of Easebe, the B.A.P. was not free to take a contrary 

position in accordance with its own, albeit better reason, analysis. 

The decision of the B.A..P. is therefore reversed. The validity of appellate South Meadows' free and clear 

title on the property, pursuant to 11. U.S.C. §363(f)(4), was not affected by these proceedings, and therefore its 

appeal is moot. 11 U.S.C. §363(m); Ewell v. Diebert (In re Ewell), 958 F.2d 276, 280 (9 th Cir. 1992)." 

369 Gill v. Easebe 900 FC.2d 1417 (9 th Cirr. 1990) 

370 T.G. Motors, Inc. v. C.M. Turtur Investments, Inc. (In re C.M. Turtur Investments, Inc.) 93 B.R. 526, 532-33 

(Bankr. S.D. Tex. 1988.). See 11 U.S.C. §§542, 554. 

371 C.M. Turtur, 93 B.R. at 532-33. 

372 See Item 3.13 above for a discussion of treatment of Letters of Credit in Bankruptcy. See Wysko Inv. Co v. Great 

American Bank, 131 B.R. 146 (D. Ariz 1991). 

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8.26 Ipso Facto Clauses. Under 11 USCA §365(e) a lease or executory agreement of 

the debtor may not be terminated or modified after commencement of bankruptcy 

case because of provision conditioned on bankruptcy or financial condition of 

debtor. 

8.27 Partnership Issues. The First Circuit Court of Appeals has held that provisions 

of the Uniform Limited Partnership Act and of a limited partnership agreement 

that purported to divest a bankrupt general partner of control were ineffective 

under the 11 U.S.C.A 365(e) prohibition against enforcement of Ipso Facto 

clauses. 373 

8.28 Substantive Consolidation - Enforcement of Bankruptcy Remote Provisions - 

These have evolved through case law, rather then by statute. 374 

(1) Common Ownership or Control; Identical or Overlapping Officers or 

Directors. 375 

(2) Consolidated Tax Returns or Financial Reporting. 376 

(3) Inter-Entity Debts or Guarantees. 377 

(4) Undercapitalization. 378 

(5) Commingling of Assets or Business Functions. 379 

(6) Failure to Maintain Organizational and Other Corporate Formalities. 380 

373 Summit Inv. and Dev. Corp. v. Leroux, 69 F.3d 608 (1st Cir) the court also held that the general partner acting as 

debtor-in-possession is the same person as the pre-chapter general partner in applying state law which limits right of 

assignee to act as a general partner. See item 8.26 above. 

374 11 USCA 302 and 1123(a)(5) do not provide a standard for substantive consolidation. Bankruptcy Rule 

1015(b) expressly permits the "joint administration" of separate debtors' estate, but the Official Advisory Committee 

Note to Rule 1015(b) makes clear that Rule 1015(b) does not deal with, much less authorize substantive 

consolidation. 

375 See, e.g., Bruce Energy Centre Ltd. v. Orfa Corp. of America (In re Orfa Corp. of Philadelphia), 129 B.R. 

404, 415 (Bankr. E.D. Pa. 1991) (citing cases); In re Paolo Gucci, 174 B.R. 401 (Bankr. S.D.N.Y. 1994). 

376 In re Apex Oil Co., 118 B.R. 683, 693 (Bankr. E.D. Mo. 1990). Compare Saccurato v. Shawmut Bank, N.A. 

(In re Mars Stores, Inc.), 150 B.R. 869, 880 (Bankr. D. Mass. 1993) (consolidated financials in 10-Q weighed in 

favor of consolidation) with In re Auto-Train Corp. Inc., 810 F.2d 270, 278 (D.C. Cir. 1987) 

377 See, e.g., Standard Brands, 154 B.R. at 568, 572; In re Snider Bros., Inc., 18 B.R. 238 n.5. 

378 See, e.g., In re 1438 Meridian Place, N.W., Inc., 15 B.R. 89, 96 (Bankr. D.C. 1981) See Brunswick Corp. v. 

Waxman, 599 F.2d 34 (2d Cir. 1979). 

379 Augie/Restivo, 860 F.2d at 519; In re Drexel Burnham Lambert Group Inc., et al., 138 B.R. 723 (Bankr. 

S.D.N.Y. 1992) Standard Brands, 154 B.R. at 572. 

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(7) Fraudulent or Preferential Transfers Involving a Related Entity. 381 

(8) Fraudulent or Inequitable Use of Related Entity. 382 

(9) Prejudice or Benefit to Creditors. 383 

(10) Reliance on Separate Credit of Entity Sought to be Consolidated. 384 

(11) Degree of Difficulty in Segregating Assets and Liabilities. 385 

(12) Economic Benefits of Consolidation By the Court. 386 

9.0 Effectiveness of Assignment of Future Rents. 

9.1 Generally. 

9.1.1 Under the 1994 amendment to the Bankruptcy Code, the effectiveness of 

rent assignment to create "cash collateral" in bankruptcy is no longer 

dependent on state law. Code §552(b) now provides that post-petition 

rents will be treated as cash collateral if the mortgage lender holds a valid 

pre-petition assignment of rents. 

9.1.2 An example of the decisions that are becoming more common is that of 

the United States Court of Appeals for the Fifth Circuit which affirmed the 

determination of a bankruptcy court 387 that under Mississippi law a 

380 In re Snider Bros., Inc., 18 B.R. 230, 234 (Bankr. D. Mass. 1982); Soviero v. Franklin Nat’l Bank, 328 F.2d 446, 

448 (2d Cir. 1964) Walter E. Heller & Co. v. Langenkamp (In re Tureaud), 45 B.R. 658, 660 (Bankr. N.D. Okla.) 

aff’d, 59 B.R. 973 (N.D. Okla. 1986); Central Claims Serv., Inc., BDS v. Engle-Picher Indus., Inc., et al. (In re 

Eagle-Picher Indus., Inc.), 192 B.R. 903 (Bankr. S.D. Ohio 1996). 

381 Tureaud, 59 B.R. at 977; Standard Brands, 154 B.R. at 571. Lease-A-Fleet, 141 B.R. at 875-76. 

382 This is a typical basis for “piercing the corporate vail” under the laws of many states especially found in 

conjunction with gross under-capitalization. 

383 E.g., Augie/Restivo, 860 F.2d at 517-19. In re Murray Indus., Inc., 119 B.R. 820, 828 (Bankr. M.D. Fla. 1990) 

(citing In re Commercial Envelope Mfg., Co., 3 B.C.D. 647 (S.D.N.Y. 1977)). 

384 Auto-Train, 810 F.2d at 277-78; Augie/Restivo, 860 F.2d at 515. Eastgroup, 935 F.2d at 249 n.11 (citing Snider 

Bros., 18 B.R. at 235, 237, 238). Munford, 115 B.R. at 395-96 In re Crown Machine & Welding, Inc., 100 B.R. 25, 

28 (Bankr. D. Mont. 1989) 

385 Augie/Restivo, 860 F.2d at 519; Apex Oil Co., 118 B.R. at 693. But see DRW Property, Co. 82, 54 B.R. 489. 

386 In re Vecco Construction Indus., Inc., 4 B.R. 407, 410 (Bankr. E.D. Va. 1980) Orfa, 129 B.R. at 414-15 (citing 

In re F.A. Potts & Co., 23 B.R. 569, 572 (Bankr. E.D. Pa. 1982)) 

387 In the matter of: Thomas Shannon Millette, 186 F.3d 638 (C.A. 5 (Miss.) 1999) 

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mortgage that has obtained an assignment of rents obtains a perfected lien 

on rents when it properly records the mortgage or deed of trust document 

that includes the assignment. 388 In doing so the court upheld the lien of the 

mortgage over that of a judgement creditor that attached the rents prior to 

the mortgage taking possession of the rents by notifying the tenants of the 

assignment and demanding direct payment. In reaching its decision the 

circuit court concluded that since there was no relevant Mississippi law 

that the Mississippi courts would adopt what the circuit court refereed to 

as the “modern approach” that the recording of a mortgage document 

containing an assignment of rents “gives the mortgagee rights superior to 

any subsequent third party who would seek to take a security interest in the 

leases and rentals …” 389 

9.1.3 Whether the state law that eliminates the need to further “perfect” or 

“make coate” the interest of the mortgage in the rents is based on a 

priorities theory or an ownership theory may be quite significant in 

determining whether the rents are “merely” cash collateral or are 

completely out of the grasp of the bankruptcy court. Under recent 

discisions in a number of states, an "absolute and unconditional 

assignment" of rents that is effective without regard to default assigns 

present title to future rents and as a result future rents belong to the 

assignee and are not the property of the debtor in the mortgagor’s Chapter 

11 proceeding. 390 Some courts will characterize the assignee as the 

"owner" of assigned rents if the assignment is by its terms absolute with 

the debtor granted a limited license to collect the collateral. 391 

388 In its opinion in distinguishing several Mississippi bankruptcy courts that adopted the “old rule” the Circuit 

court concluded (at 644) that Mississippi is an “intermediate theory” state rather then a “lien theory state” 

389 186 F.3d 638, 642 . This opinion includes an extensive discussion of the public policy considerations that weigh 

in favor of rejecting the old rule and the various approaches that courts have taken to come to effectively the same 

result. The opinion also includes extensive citations to the decisions under the “old” approach and under the “new” 

approach. See also RESTATEMENT (SECOND) OF PROPERTY-MORTGAGES § 4.2(b) (1997) cited by the court in 

Millette. 

390 See In re Carretta, 220 B.R. 203, 1998 WL 237689 (D.N.J.) In In re Guardian Realty Group, LLC, 1997 WL 

50183 (Bartly D.D.C.), the court determined that future net rents were estate property although the assignment 

language was absolute where the mortgagee could collect the rent from the tenant only after a Loan Default and the 

Lender could not collect rent after the Loan was paid in full. 

391 See In re Jason Realty, 59 F.3 rd 423 (3 rd Cir. 1995 - N.J.). In In Re Guardian Realty Group, LLC, 1997 WL 

50183 (Bkrtcy. D.D.C.) Where the mortgagee could collect the rent from the tenant only after a loan default and the 

judgment creditor could not collect rent after the loan was paid in full the Court determined that future rents were 

estate property although the assignment language was absolute. 

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9.1.4 In a bankruptcy context consider possibility of rent diversions being 

treated as nondischargeable under 11 U.S.C. §523(a)(2)(A) see Item 8.20 

below. 

9.2 Notices to Tenant of Rent Assignment. Does the rent assignment in the 

mortgage or in a separate assignment document irrevocably authorize the tenant to 

pay rents to the lender upon mere receipt from the lender of notices of default 

under the loan documents 392 . Review loan document to determine if in the lease, 

estoppels or attornment and nondisturbance agreements the tenant agrees upon 

notice from lender to pay rent directly to lender. 

9.3 Hotel Receipts. Although hotel receipts from room charges and restaurants are 

not generally considered to be "rent and profit" under a mortgage, 393 several courts 

have held otherwise. 394 Revenues for use of self-storage space have been treated 

as "rent". 395 Under Section 552(b)(2) of the Code adopted in 1994 security 

interests in post petition hotel receipts in favor of mortgagees will be enforced 

"except to the extent the court based on the equities of the case orders 

otherwise." 396 

10.0 Review of Condominium and P.U.D. Documentation 

10.1 Declarant's Rights. Does lender have right to succeed to Declarant's Rights 

392 A form of such provision might be "Landlord irrevocably authorizes and directs Tenant, upon receipt from Lender 

of written notice to do so to pay all rents and other monies payable by Tenant under the Lease to or at the direction of 

Lender. Landlord irrevocably releases Tenant of any liability to Landlord for all payments so made, and Landlord 

agrees to defend, indemnify and hold Tenant harmless from and against any and all claims, demands, losses, or 

liabilities asserted by, through, or under Landlord (except by Lender) for any and all payments so made. Tenant agrees 

that upon receipt of such notice it will pay all monies then due and becoming due from Tenant under the Lease to or at 

the direction of Lender, notwithstanding any provision of the Lease to the contrary. Such payments shall continue until 

Lender directs Tenant otherwise in writing. Tenant agrees that neither Lender's demanding or receiving any such 

payments, nor Lender's exercising any other right, remedy, privilege, power or immunity granted by this document or 

the Assignment, will operate to impose any liability upon Lender for performance of any obligation of Landlord under 

the Lease unless and until Lender elects otherwise in writing or unless Lender takes possession of the Premises and 

assumes the functions of a landlord." 

393 Financial Sec. Assur., Inc. v. Tollman-Hundly Dalton, L.P., 165 B.R. 698 (N.D. Ga. 1994) (Applied law of 

Georgia). 

394 See In re Punta Gorda Associates, 137 BR 535 (Bankrtcy M.D. Fla. 1992) and In re GGVXX, Ltd., 130 B.R. 322 

(Bankr. D.Colo. 1991). In re T-H New Orleans Ltd, Partnership, 5 F.3d 86 (5th Cir. 1993) reversed 148 B.R. 592 

(Bankruptcy E.D. L.A. 1992) on the basis of Louisiana law that under Code §552(b) the court determined "rent" to 

included revenues generated by hotels for use and occupancy of space. 

395 In re Safeguard Self-Storage Trust, 2 F.3d 967 (9th Cir. 1993). 

396 See §7.09[2][g] “Assignment of Rents as Including Hotel Revenues” . In Dunaway, The Law of Distressed Real 

Estate (Clark Boardman Callaghan 1985-1996). 

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10.2 Mortgagee Provisions. Describe any provisions regarding mortgages applicable 

to major lenders. 

10.3 Association Financial Statements. Secure recent financial statement of 

Association. 

10.4 Association Activities. Review board meeting minutes. 

10.5 Developer Assessments. Determine if all developer assessments have been paid. 

10.6 Association's Director Liability. If there is evidence of association related 

developer irregularities, consider possible liability of developer appointed 

association directors and availability of director liability insurance. 

10.7 Timeshare Issues. 

11.0 Borrower's Tax Circumstances. 

11.1 Issue. Consider whether foreclosure or bankruptcy code proceeding may result in 

significant realization of taxable income to the borrower, its partners or 

shareholders 397 . If so this may be inducement for such individuals to contribute 

additional capital to avoid or postpone foreclosure. 

11.2 §61(a)(12) of the IRC provides that gross income includes income from 

cancellation of indebtedness. See Kirby Lumber v. United States, 284 U.S. 1 

(1931). 

11.3 IRC §108 provides an exception for cancellation of debt in a Chapter 11 

proceeding. Under IRC §108(a)(3) insolvent debtors are permitted to exclude 

forgiveness income to the extent of insolvency. 

12.0 Advice to Client 

12.1 Lender Liability Cautions. 398 

12.2 Avoid undocumented forbearance. 

397 The general rule is that discharge of partnership indebtedness results in income at the partnership level under IRC 

§61(a)(12) and 64 that is passed through to the partners as ordinary income under IRC §702(a) and as a §752(b) 

deemed distribution of money. See Commissioner v. Tufts, 461 U.S. 300 (1983) I.R. Regs. §1001-2. Kalteyer, Real 

Estate Workouts - Original Issue Discount Implications of Troubled Debt Restructuring, 43 Tax Lawyer 579 (Spring 

1990). See Chapter 28 “Tax Consequences to Borrowers, Investors and Lenders” . 

398 

See Chapter 4B “Liability of Lender for Controlling Debtor and for Other Acts” . In Dunaway, The Law of 

Distressed Real Estate (Clark Boardman Callaghan 1985-1996). 

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12.3 Be careful in exercising control and approval rights and seek to avoid depending 

on discretion provisions. Seek always to act "reasonably." 

12.4 Consider possible adverse implications of characterizations of the lender's action 

or lack of action as being based on ulterior motives and thus breaching an alleged 

obligation of good faith and fair dealing even if in fact the action is not so 

motivated. 399 

12.5 Remember that discovery rules are very broad and privilege may be narrow. So 

be careful what you say or write if it can be misconstrued out of context. 

12.6 Deeds In Lieu. 400 

399 See discussion at item 7.1.4 above. 

400 See Appleby, N., Counseling the Lender on Friendly Foreclosures and Deeds in Lieu, 10 Prac. R.E. Law (March 

1992) 21. 

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