A recent New York State Supreme Court judge has answered the question of whether Governor Andrew Cuomo’s Executive Order 202.8 precluding mortgage foreclosures for ninety (90) days, applies to Uniform Commercial Code (“UCC”) sales of equity interests collateralizing mezzanine financing.  According to at least one court, the answer is “No.”  In a May 18, 2020 order in the case of 1248 Associates Mezz II LLC v. 12E48 Mezz II LLC, Index No. 651812/2020 (New York State Supreme Court, New York County), presiding Justice Frank Nervo held that UCC sales are not subject to Executive Order 202.8, and may proceed.  Further, in the same decision, Justice Nuevo held that such UCC sales may be conducted virtually, as necessary in the COVID-19 environment, without running afoul of the requirement that such sales be “commercially reasonable.”  This decision resolves a significant debate in the mezzanine financing industry, and provides some assurance for mezzanine lenders who previously feared they may have no recourse as long as Executive Order 202.8 is in place.

In 2015 developer Hidrock Properties purchased property located at 12 East 48^th Street in Manhattan which it planned to develop into a Hilton Grand Vacations Club.  A subsidiary of Hidrock obtained mezzanine financing from a subsidiary of 54 Madison Partners to finance the project. The mezzanine financing was secured by an equity interest in the entity holding the property.  The loan went into default, the lender sent a default notice, and then noticed a UCC foreclosure sale of the equity interests collateralizing the loan for May 1, 2020.

The borrower then brought suit, and sought a preliminary injunction enjoining the sale. The borrower argued that Governor Cuomo’s Executive Order 202.8, which states “There shall be no enforcement of either an eviction of any tenant residential or commercial, or a foreclosure of any residential or commercial property for a period of ninety days,” precluded the UCC foreclosure sale.  Further, the borrower contended that the UCC foreclosure sale was “commercially unreasonable” in violation of the requirements of the Article 9 of the UCC, including because the notice suggested that the auction would be conducted in person at the offices of lender’s counsel (despite the current prohibition against public gatherings), while the notice also stated that “[i]n the event of the continuance of the mandate to avoid public assemblies due to the presence of the novel coronavirus COVID-19, then public auction will take place virtually and telephonically via a Cisco Webex teleconference.”

In his May 18, 2020 decision denying lender’s motion for a preliminary injunction, Justice Nervo agreed with the lender’s arguments that Governor Cuomo’s Executive Order does not apply to UCC sales because such sales are non-judicial dispositions of equity interests securing loans, not judicial foreclosures of mortgages upon real property.  Further, Justice Nervo held, citing several governing precedents, that any harm suffered by the borrower as a result of the sale would not be irreparable but rather could be addressed by money damages, stating “Where harm to a plaintiff’s commercial property interest is the loss of investment as opposed to a loss of an unquantifiable interest, damages suffice and irreparable harm does not befall plaintiff.”

In sum, this decision provides some answers to the current debate regarding whether Governor Cuomo’s Executive Order precludes UCC Article 9 foreclosure sales.  At least one court has answered that question in the negative.  Further this decision provides some assurance that UCC Article 9 foreclosure sales may proceed virtually as necessitated by the current COVID-19 pandemic.

Key Takeaways:

• • In the COVID-19 environment, there will likely be a number of defaults under mezzanine financing agreements. It is important to notice such defaults carefully and in compliance with the governing agreements. MH&H is experienced in preparing and serving such notices.
  • If such default continues and a disposition of equity is the next step, there is a strong argument that UCC Article 9 foreclosure may proceed even in the COVID-19 environment, despite Governor Cuomo’s Executive Order staying mortgage foreclosures for 90 days, as such sales pertain to equity interests, not real estate.
  • There is also a strong argument that such a sale does not constitute “irreparable harm” that would support a temporary restraining order or preliminary injunction, as such sales do not concern unique real estate but rather equity interests, and any harm can be remedied with money damages.
  • To ensure such sales are deemed “commercially reasonable” in the COVID-19 environment, there should be made available the option of conducting both the due diligence and the auction virtually.