NY Court Blocks Mezzanine Lender’s UCC Foreclosure Sale in Light of COVID-19 Pandemic

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On June 23, the New York County Supreme Court issued a rare preliminary injunction temporarily halting a mezzanine lender’s UCC foreclosure sale of the Mark Hotel in New York City because the procedures for the foreclosure sale were not commercially reasonable in light of conditions caused by the COVID-19 pandemic (D2 Mark LLC v. Orei VI Investments LLC, 2020 WL 3432950 (2020)).

This case bucks a line of established New York cases that deny preliminary injunctions preventing foreclosure sales. It may be the first preliminary injunction granted in connection with a mezzanine loan to block a UCC foreclosure sale in New York. It is also the first New York decision involving a lender seeking to foreclose on a property that was financially sound before the COVID-19 pandemic.

Background

The Mark Hotel was, until the COVID-19 worldwide pandemic, a highly profitable landmark hotel on the Upper East Side of Manhattan. D2Mark LLC (the borrower) owns D2 Mark Sub LLC, which owns the Mark Hotel and its related restaurants and bars. As a result of COVID-19, the Mark Hotel was forced to close its operations on March 27, 2020, and on May 1, the borrower failed to make a payment under its $230 million senior credit facility, which is secured by real estate. During this time, New York Gov. Andrew Cuomo issued and renewed executive orders staying evictions and foreclosures, which prevented the senior lender from initiating any foreclosure proceedings until August 20, 2020.

The default for non-payment under the senior credit facility resulted in a cross default under the borrower’s $35 million mezzanine credit facility in favor of its mezzanine lender, OREI VI Investments LLC (OREI VI). While finalizing a forbearance agreement to provide relief to the borrower from the financial impact of COVID-19, OREI VI notified the borrower that, pursuant to the New York Uniform Commercial Code (the NY UCC), it planned to sell the collateral securing the facility - 100% of the membership interests in D2 Mark Sub LLC -- at a sale 36 days later.

Notice of the sale, which was to be held either virtually or in the offices of a New York City law firm, was provided to 700 potential bidders. A third-party consultant was hired by OREI VI to conduct the sale. The sale was advertised in major publications, including for a week in the Wall Street Journal. Of the 115 entities that signed non-disclosure agreements in connection with the sale, two filed financial proof, which establishes that an entity is eligible to provide a bid.

Section 9-610 of the NY UCC requires all aspects of the sale of collateral in a UCC foreclosure sale to be commercially reasonable. On June 6, 2020, the borrower filed an action alleging, among other things, that the sale was a violation of Section 9-610(b) of the NY UCC and seeking an order providing for injunctive relief.

Analysis

On June 23, 2020 the court granted an injunction in favor of the borrower, who argued that the proposed sale was a “predatory attempt to capitalize on the COVID-19 pandemic.” The requirements for the issuance of a preliminary injunction are establishing (1) a likelihood of success on the merits of the case, (2) irreparable harm would result if a preliminary injunction is not issued, and (3) a balancing of equities favors the borrower.

The borrower persuaded the court that it was likely to succeed on the merits of the case based on the proposed foreclosure sale being commercially unreasonable. The determination that a sale under UCC Section 9-610(b) is commercially reasonable is a fact-intensive inquiry that must demonstrate that “[e]very aspect of a disposition of collateral, including the method, manner, time, place, and other terms, must be commercially reasonable.”

In finding that that the sale may not be commercially reasonable, the court highlighted that while 700 potential bidders were notified of the sale, only two bidders were ultimately in a position to make a bid. In addition to the short, 36 day notice period, potential bidders also faced hurdles in doing meaningful due diligence. For example, because of the “stay at home” order, bidders could not inspect the hotel, which was closed until June 15, 2020.

To meet the irreparable harm requirement, the borrower persuaded the court that because the lender probably acted unreasonably in a foreclosure sale under the NY UCC, the borrower’s only remedy was injunction. In contrast to monetary damages, a sale would lead to irreparable harm to the borrower.

In determining in which direction the equities in this action tipped, the court balanced the unique nature of the hotel as a landmark property and sole asset of the borrower, including its ability to control both the public’s perception of the hotel and its actual operation and management, with deterioration of the collateral from the effects of the COVID-19 pandemic on the New York economy. Ultimately, the court sided with the borrower, observing that any injury to the lender is conjectural.

The court stayed the sale for 30 days, during which time OREI VI was ordered to re-notice the sale and develop a commercially reasonable plan for the sale. The court noted that the sale must comport with Centers for Disease Control and Prevention guidelines, as well as state and local health guidelines. The court stated that the market must be informed that bidders can participate virtually given the hesitancy to use public transportation during COVID-19.

Takeaways

In a commercial transaction, the highest hurdle for a borrower in obtaining preliminary injunctive relief is establishing that irreparable harm would result from a foreclosure sale, where monetary damages are typically an adequate remedy. Here, monetary damages were not available to the borrower as a remedy under the mezzanine loan agreement if the lender acted unreasonably in the foreclosure sale. In making its decision, the court took into account Gov. Cuomo’s executive orders, and required the lender to advise bidders in the revised notice of sale that virtual participation was permitted. Lenders who use the UCC foreclosure process should re-evaluate their procedures. Actions considered commercially reasonable before the COVID-19 pandemic may not be acceptable because of current business conditions and heath directives.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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