In August 2020, a bill was introduced in the New York State Legislature that would tax mezzanine debt (the Mezzanine Debt Bill). The Mezzanine Debt Bill has now been reintroduced in both the Assembly and the Senate and is likely to be enacted in April 2021 as part of the state's budget bill. The Mezzanine Debt Bill would impose the mortgage recording tax on mezzanine debt and preferred equity investments as well as require that the mezzanine lender or preferred equity holder file a Uniform Commercial Code financing statement (UCC-1) to perfect its security interest in its collateral (i.e., the membership interests or shares of the borrower.)
Overview
The bill amends Section 291-k of New York's Real Property Law to define "mezzanine debt" and "preferred equity investments" as
"debt carried by a borrower that may be subordinate to the primary lien and is senior to the common shares of an entity or the borrower's equity and reported as assets for the purposes of financing such primary lien. This shall include non-traditional financing techniques such as a direct or indirect investment by a financing source in an entity that owns the [equity] interests of the underlying mortgage where the financing source has special rights or preferred rights such as: (i) the right to receive a special or preferred rate of return on its capital investment; and (ii) the right to an accelerated repayment of the investor[']s capital contribution."
The reference to "non-traditional financing techniques" is troubling for many in the financial services industry because it is so open ended and could allow virtually any relationship to become subject to the mortgage recording tax.
The Mezzanine Debt Bill also modifies Section 250 of the New York State Tax Law and Section 9-601 of New York's Uniform Commercial Code to specify that "whenever a mortgage instrument is recorded in the office of the recording officer of any county, any mezzanine debt or preferred equity investment related to the real property upon which the mortgage instrument is filed shall also be recorded with such mortgage instrument." The Mezzanine Debt Bill also provides that "mezzanine debt and preferred equity investments" are taxable, and that the tax will be measured by the amount of "principal debtor obligations" that may be secured by a security agreement "in relation to real property upon which a mortgage instrument is filed." A consequence of the recording requirement is that counties and cities could also impose a tax on the recording of the financing statement, which would make the effective tax rate equal to the mortgage recording tax rate, which is 2.85 percent of the "debt" secured for commercial real property located in New York City and having a value over $500,000.
The Mezzanine Debt Bill also amends Section 9-601 of the UCC to provide a new requirement that recording of a financing statement in the relevant county records is required to perfect "a security interest in mezzanine debt and/or a preferred equity investments." This is particularly troubling for industry stakeholders because Section 291-k of the Real Property Law provides:
"No remedy otherwise available to a secured party under article nine of the uniform commercial code shall be available to enforce a security agreement pertaining to mezzanine debt financing and/or preferred equity investments in relation to real property upon which a mortgage instrument is filed that is evidenced by a financing statement, unless that financing statement is filed and the tax imposed pursuant to the authority of subdivision four of section two hundred fifty-three of the tax law, has been paid."
Takeaways and Considerations
Although the Mezzanine Debt Bill targets real estate transactions, there is a very real possibility that it could be interpreted to include any financing transaction that even indirectly involves real estate, which could include corporate transactions in which the target company or its subsidiaries include real estate utilized in its operations. There is also the problem of multistate transactions that either involve parties that own real estate in New York or elsewhere, which also raises issues as to which state's laws would govern real estate in New York in a transaction having a nexus with another state.
In reviewing the Mezzanine Debt Bill, it is clear that, if enacted, it will make New York more expensive and is likely to make mezzanine debt and preferred equity less available than in the other 49 states.
Now that the $1.9 trillion American Rescue Plan has been enacted, wiping out New York's state budget deficit, many are asking if this is the time for the New York Legislature to experiment with an untested concept that will make it harder for New York-sited real estate to recover.
