Nevada Supreme Court receives key commercial real estate debt case
28 October 2011
The Nevada Supreme Court was asked Wednesday to rein in companies that invest in defaulted commercial real estate loans, foreclose on the properties and then seek deficiency judgments against loan guarantors.
In a case potentially affecting hundreds of pending Nevada commercial real estate foreclosures — and likely with hundreds of millions of dollars at stake — the court was asked to clarify the intent of the Nevada Legislature in passing Assembly Bill 273 (AB 273) this summer.
Attorneys say AB 273 beefed up and clarified existing laws to make it clear that investors in distressed debt could collect deficiency judgments based not on the face value of the debt, but on what they paid for it. Such debt is typically purchased at a deep discount.
A company, for instance, may have paid $1 million for the right to collect on a defaulted loan with a principal balance of $5 million.
If the real estate backing the loan was foreclosed on and valued at $700,000, the note holder under AB 273 could seek a deficiency judgment of just $300,000 against the loan guarantors for a total collection of $1 million — not the $4.3 million deficiency based on the face value of the note.
Investors in distressed debt, typically companies that acquired the loans of failed Nevada banks, have been fighting AB 273 on several fronts. Some attorneys say the law is unconstitutional as it conflicts with federal financial laws. They also say the law can’t be applied retroactively to foreclosures that occurred before June 10, when Gov. Brian Sandoval signed AB 273.
Two judges in Clark County District Court, coincidentally on the same day, this month issued differing opinions on AB 273 and whether it can be applied retroactively.
The dual rulings prompted an attorney for an investor on the losing side of one of them to appeal the decision to the state Supreme Court on Wednesday.
"The court needs to move quickly on this," said Las Vegas attorney Frank Flansburg III, of the law firm Marquis Aurbach Coffing. Flansburg represents commercial real estate investors fighting distressed debt investors in several cases.
Flansburg said uncertainties over whether real estate investors can be hit with the deficiency judgments are causing many entrepreneurs to sit on the sidelines rather than pursue new developments needed to stimulate the struggling local economy.
Attorneys for the investors in defaulted loans, however, are arguing that AB 273 can’t stand, as it conflicts with longstanding federal law and the U.S. Constitution.
In a Clark County District Court case over loan guarantees of more than $4 million involving North Carolina-based Branch Banking and Trust Co., which purchased loans held by the failed Colonial Bank from the Federal Deposit Insurance Corp., Branch Banking attorneys attacked AB 273.
"To apply (AB 273) to pre-foreclosure sale or assignments of commercial loans in the commercial setting would create an absurd result by limiting the FDIC’s ability to transfer all the rights, title and interest in the assets of a failed institution and, in fact, obliterate the secondary market for the sale of all negotiable instruments," attorneys at the firm Sylvester & Polednak Ltd. wrote in a brief in that case.
They also said AB 273 is pre-empted by the federal Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA).
Under FIRREA, Congress empowered the FDIC to act, without state interference, as receiver of failed banks and to dispose of those banks’ assets in order to reduce losses when federally-insured banks fail, the bank attorneys argued in their brief.
"The act (AB 273) directly impacts the FDIC’s substantive rights to collection in full and thwarts its mission and purpose, which is to manage and dispose of the assets of a failed institution and to maximize replenishment of the insurance funds," their brief said. "The act imposes a mortgage loan assignment 'penalty’ on pre- and post foreclosure assignments. There would effectively remain no market for the purchase and sale of negotiable instruments of a failed institution as no purchaser/investor would acquire the asset if it was limited to the consideration paid."
They also argued the retroactive nature of AB 273 is unconstitutional as it violates the Contract Clause of the U.S. Constitution, which says states can’t ""make any law impairing the obligation of contracts."
In a final shot, they said AB 273 was aimed at helping homeowners and shouldn’t apply to commercial property developers.
"The legislative history is clear that the public purpose behind the law was an intent to protect the interests of homeowners in light of the economic crisis facing many homeowners who are losing their homes," the bank’s brief said. "To apply the act to sophisticated commercial investors would solely benefit a particular special interest: those that took the risk of the market. The defendants would then obtain a windfall."
In an Oct. 11 ruling, Clark County District Court Judge Elissa Cadish rejected the bank's arguments and upheld AB 273 — including its retroactive provisions.
She ruled AB 273 was not pre-empted by FIRREA and that it did not violate the Contracts Clause of the Constitution, as "the state has a significant, legitimate public purpose" in limiting deficiency judgments. Rather than benefiting special interests, she ruled, "the law is a reasonable response to conditions" and was driven by a public purpose.
"This is an important decision for Nevadans,’’ said attorney J. Michael Oakes of the Las Vegas law firm Foley & Oakes PC, which represented the borrowers.
The same day, however, Clark County District Court Judge Elizabeth Gonzalez ruled in a different case that AB 273 was not retroactive, meaning the holder of the $5.1 million note in her case involving the failed Silver State Bank could pursue the full deficiency judgment.
That was the ruling Flansburg appealed to the Supreme Court.
In his initial appeal brief, he complained the entity holding the debt in the case was looking to profit from the misfortunes of small borrowers who themselves had been harmed by the recession and local bank failures.
And profiting from the misfortunes of others is not what the Nevada Legislature had in mind when it limited the amount of deficiency judgments over the years, most recently with AB 273.
"Nevada law is clear — deficiency judgments should not be a profit center," Flansburg wrote in his brief.
He said the debt holder in the case was Multibank 2009-1 RES ADC Venture LLC, which was created in early 2010 by homebuilding giant Lennar Corp. of Miami and the FDIC to own a portfolio of $2.253 billion in distressed loans of failed banks.
The arrangement put Lennar in the loan collection business in Nevada and other states, he wrote.
"While Lennar was piling up conquered debtors by refusing resolution (offers) and reaping huge profits from its collection business, it was about to face the biggest challenge of all — the Nevada Legislature," his brief said. "Finally, Lennar’s recession profiteering had come to an end — in Nevada, at least."
Multibank has not yet filed its response to Flansburg’s opening brief. But when the case was in Gonzalez’s courtroom, attorneys for the loan owner argued, among other things, that AB 273 would violate the contracts clause of the U.S. Constitution.
"If (AB 273) applies to a situation in which a party acquires a loan secured by real property from an original creditor, or the FDIC, this would substantially impair the contractual relationship between the subsequent creditor and any debtor," Multibank attorneys with the Las Vegas law firm Santoro, Driggs, Walch, Kearney, Holley & Thompson wrote in a brief.
"The Nevada Legislature had no intention of limiting the rights of banks and others who acquired commercial or construction loans from the FDIC after the issuing bank failed, such as plaintiff; and parties who entered into contracts before AB 273 was enacted," their brief said.
Flansburg’s client, longtime local developer Stacey Yahraus-Lewis and her company Sandpointe Apartments LLC, have already accomplished one thing with their appeal.
The Supreme Court on Thursday at least temporarily stayed action in the lawsuit and Multibank’s collection actions — a stay that will remain in effect "pending receipt and consideration of any opposition" to it.
If there’s no opposition, the stay could remain in place until the Supreme Court decides on the merits of the appeal.
Typically, such appeals take many months or even years to resolve.
Complicating the issue, however, is that AB 273 has also become an issue in federal deficiency judgment lawsuits in Nevada.
That means that regardless of what the Nevada Supreme Court does, one or more of the Nevada federal judges could ultimately require that the constitutionality of AB 273 be litigated in federal court because of the federal questions presented in the lawsuits.
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