SELLER CARRIED-BACK FINANCING: AN ALTERNATIVE GREEN FOR COMMERCIAL REAL ESTATE FINANCE

By Gordon L. Gerson, Esq.

December 2007

While most industries have gone green in 2007, commercial lenders have less and less green to loan in the aftermath of the subprime meltdown on Wall Street.

Even during a period of a "credit crunch" for conventional lending as exists today (and will exist in future economic cycles) opportunity exists for both sellers and buyers of commercial real estate who engage in non-conventional lending strategies.

A seller motivated to sell, and a buyer determined to buy, may facilitate a transaction by seller carried-back financing. Seller carried-back financing may be in the form of either the seller providing all financing necessary for the buyer to acquire the property, or providing financing in addition to that being provided by an institutional lender whose tightened underwriting criteria may result in not enough loan dollars to the borrower to close an acquisition to loan. In either event, seller carried-back financing commonly is evidenced by a promissory note and a deed of trust. The promissory note and deed of trust in a seller carried-back transaction are sometimes referred to as a "purchase money note" and "purchase money deed of trust" or "purchase money mortgages." ¹

This article will summarize issues important to a seller engaging in seller carried-back financing, including loan documents, title coverage, and issues of law.

If a seller is going to be a lender, it should act like a lender. Common to seller carried-back financing transactions are simply a note and deed of trust, and no other documents nor consideration of any other issues. The prudent seller, however, will act like an institutional lender and think like an institutional lender when engaging in seller carried-back financing.

Institutional lenders approach loan transactions from the standpoint of exit strategies. That is, if the loan "goes bad", will the lender be protected? What protections may be given in the loan documents? What protections may be given in a lender's title policy? What issues of law may affect enforcement of the loan documents for any aspect of the transaction?

The desire to "keep it simple" will not well serve the seller in a seller carried-back financing transaction. Too often, when the loan goes into default, the "keep it simple" documented transactions may leave the seller with an inability to salvage its investment. And a seller carried-back loan in this instance must be viewed as an investment, and depending upon the circumstances, among the largest investments it will make. The seller should not engage in the carried-back financing transaction if it is not willing to at some future time own the property.

Documentation of seller carried-back financing transactions should take into consideration all issues relating to the real property being sold. For this reason, loan documents should not be simply the short form note and deed of trust document available at title companies, at no cost, but loan documents similar to those used by institutional lenders. Loan documents for a seller carried-back financing transaction should include at a minimum:

• Promissory Note
• Deed of Trust
• Assignment of Leases and Rents, Security Agreement and Fixture Filing
• Environmental Indemnity
• Guaranty (if applicable)
• Assignment of Management Agreement (if a manager will be managing the property for the buyer)
• Subordination Non-Disturbance Agreement (if commercial leases in place)
• UCC-1 Financing Statement

Additional loan documents may be required based upon other issues. Just as an institutional lender may require "reserves" or other credit enhancements in some instances even seller carried-back financing should include "reserves" or similar credit enhancements.

While many seller carried-back financing transactions are not properly documented, even more by lack of title coverage. While no lender would enter a loan transactions without a lender's policy of title insurance with proper endorsements, no seller should engage in carried-back financing without the same. All title policy considerations are too numerous to identify in this article, we suggest the following:

• Obtain a preliminary title report ("PTR") and all documents mentioned in the PTR.
• Cure title encumbrance issues by obtaining proper endorsements, and deleting an exception.

When reviewing the PTR and obtaining the final lender's title policy, it is important to look at title issues not as was done when the property was acquired, but in the eyes of a lender.

Issues of law should also be considered in the seller carried-back financing transaction. In California, the guaranty may not be enforceable, nor may the seller obtain a "deficiency judgment" against the buyer. In California, this means that the only way to satisfy the indebtedness will be by non-judicial foreclosure and accepting whatever is bid at the sale, or if no bidders, what will be available after the sale.

Sellers may also want additional issues covered in a seller carried-back financing transaction which require a more sophisticated level of loan documentation. A good example would be if the seller desires a "participation interest" in any profit from the sale of the property.

Seller should also monitor the property as with any lender post-closing. Well drafted loan documents will include the seller's right to receive reports relating to the property. The seller should also make inspections. The seller should be vigilant in making sure that the loan does not go into default, and if so, immediately invoke the remedies section of its loan documents.

A seller will also want to make sure that the transaction has been well-documented so that if seller desires to sell the loan to a third party, that beyond a normal discount a third party would require, it is not further discounted because of problems inherent in the seller carried-back financing loan.

Seller carried-back financing provides a unique manner in which to facilitate a loan closing in an economic environment where a buyer may not obtain good financing. Seller should proceed carefully, however, and never act in a manner that defies the basic rule, "to be a lender, act like a lender."

DISCLAIMER: This article is intended to provide a general overview of lending issues. It is not intended nor should it be relied upon as legal advice. Each loan is fact specific and as such different principles of law may apply, and counsel should be consulted. For additional information contact Gordon L. Gerson at GERSON LAW FIRM APC, ggerson@gersonlaw.com or call (858) 452-5400.

¹ A purchase money note, purchaser money deed of trust or purchase money loan may be terms also used to apply to a third party acquisition loan.