Chapter 43 - § 43.6 • ENCUMBERING REAL PROPERTY

• Jurisdiction: Colorado

§ 43.6 • ENCUMBERING REAL PROPERTY

§ 43.6.1—Real Estate Financing Generally

Real estate financing is its own industry, generally separate from corporate finance or business lending. Most banks, life insurance companies, and other financial institutions, which have long been the major source of funding for real estate, generally have separate units to handle real estate lending because of its many unique features. At one time, Wall Street had little to do with real estate financing, but with the advent of commercial mortgage backed securities (CMBS) in the 1980s (leading to many catastrophes in 2008, but now having made a resurgence), Wall Street is the dominant source of funds for real estate lending. In addition, real estate investment trusts (REITs), syndications, joint ventures, and other real estate investment vehicles are now making real estate the "fourth asset class," joining stocks, cash, and bonds.

Real estate lending is somewhat separated between acquisition, development, and construction loans on the one hand, and permanent loans on the other. One also finds mini-perms (five years or less, often added to the tail-end of a construction loan) and mezzanine loans, which are loans secured by owners' interests in the special purpose entity that owns the real property (see § 43.6.4) and subordinate to any senior loan secured by the real property.

§ 43.6.2—Basic Loan Documents

The typical real estate loan includes the following documents:

Loan Commitment Letter

Colorado's statute of frauds contains a special provision relating to "credit agreements," stating that a credit agreement involving a principal amount exceeding $25,000 must be executed in writing to be enforceable. C.R.S. § 38-10-124.¹²⁷ A "credit agreement" is defined to include any contract, offer, promise, or commitment of a financial institution to lend money or to make any other financial accommodation; any amendment, waiver, or substitution of any of the terms or provisions thereof; and any representation, warranty, or omission in connection with the negotiation, execution, administration, performance of, or collection of sums due under a credit agreement. C.R.S. § 38-10-124(1)(a). Thus, as a matter of law, reliance placed on oral representations or promises in connection with credit agreements cannot be reasonable or justifiable.¹²⁸ The statute further provides that a credit agreement may not be implied under any circumstances or by performance, partial performance, or promissory estoppel. C.R.S. §§ 38-10-124(2) and (3). Hence, the issuance of a loan commitment letter is critical in most commercial transactions involving financing and, from a borrower's perspective, should cover material terms including duration, interest rate, principal security, special covenants, and guarantees.

Loan Agreement

In residential and smaller commercial loans, the obligation to pay a loan is fully stated in the note and, often, there is no separate loan agreement. In larger commercial loans, and certainly in loans involving construction, a separate loan agreement is typical. Loan agreements can vary in length from 20 pages to hundreds of pages, depending on the size and purpose of the loan and, often, the size and sophistication of the lender. Generally speaking, the loan agreement will cover (1) the indebtedness, including amount, how funded, calculation of interest rate, and repayment obligations; (2) making advances (including the conditions for obtaining an advance) and loan administration matters; (3) conditions to making the loan and advances; (4) representations and warranties of the borrower; (5) negative covenants (things the borrower cannot do); (6) affirmative covenants (things the borrower must do); (7) releases and indemnities (including, perhaps, as to environmental matters); (8) defaults; (9) the lender's remedies; and (10) typical miscellaneous matters (i.e., "boilerplate"). Some lenders forego a promissory note (see discussion below) and use only a loan agreement, in which case the loan agreement should be specifically identified in the deed of trust as the "evidence of debt."

Promissory Note

A deed of trust or mortgage must secure an obligation. C.R.S. § 38-35-117.¹²⁹ As a practical matter, a deed of trust must identify the evidence of debt it secures, as the evidence of debt must be displayed to the public trustee in order to obtain a release or to initiate a foreclosure (unless the holder is a "qualified holder"). The most common evidence of debt is a promissory note. At one time, lenders were careful to assure that the promissory note was drafted to be a "negotiable instrument" so as to make the holder of the note a "holder in due course." Under the Uniform Commercial Code, a holder in due course who received the note by an endorsement was free from certain defenses of the maker of the note. Today, lenders seem less careful about negotiability and, often, the note is merely a separate instrument that evidences the debt, but all the substantial terms of the loan are contained in the loan agreement.

Deed of Trust

A deed of trust is a security instrument containing a grant to a trustee with a power of sale. C.R.S. § 38-38-100.3(7).¹³⁰ Although a deed of trust is fashioned as conveyance to the named trustee, it constitutes a lien, not a conveyance. C.R.S. § 38-35-117. A deed of trust with a power of sale granted to the public trustee of the county in which the encumbered real property is located is foreclosed by a proceeding and according to a timeline of approximately 125 to 140 days that is statutorily prescribed. C.R.S. § 38-38-701(4). Because public trustee foreclosures are accomplished faster, and afford fewer opportunities for the debtor to assert defenses and delay the foreclosure, deeds of trust to the public trustee of the county in which the real property is located (designated by office rather than by the trustee's name) are the favored lien instrument in Colorado. A deed of trust granting a power of sale to the public trustee without specifying how the power is to be exercised is neither void nor voidable and may be foreclosed either through the public trustee or by judicial foreclosure. Id. A deed of trust may name a private trustee, but then it must be foreclosed judicially as a mortgage. C.R.S. § 38-39-101. In some circumstances, a deed of trust may be treated as a mortgage, such as¹³¹ circumstances in which the beneficiary of a deed of trust cannot meet all the statutory requirements for a foreclosure by the public trustee, or if the beneficiary otherwise elects to do so.¹³² If the deed of trust describes both real and personal property, the public trustee may be able to foreclose on both at the same time. C.R.S. § 4-9-604(a)(2).¹³³

A unique but important feature of a deed of trust is the requirement that the original evidence of debt be presented to the public trustee to initiate a foreclosure or to obtain a partial or full release. "Qualified holders," as defined in C.R.S. § 38-38-100.3(20), are exempt from the requirement to produce the original evidence of debt, but instead, are required to provide a copy of the evidence of debt, certify that the copy is true and correct, and, as to a foreclosure, "shall, by operation of law, be deemed to have agreed to indemnify and defend any person liable for repayment of any portion of the original evidence of debt in the event that the original evidence of debt is presented for payment to the extent of any amount, other than the amount of a deficiency remaining under the evidence of debt after deducting the amount bid at sale, and any person who sustains a loss due to any title defect that results from reliance upon a sale at which the original evidence of debt was not presented." C.R.S. § 38-38-101(2). As to a release of the deed of trust, the qualified holder "shall be deemed to have agreed to indemnify and defend the public trustee against any claim made . . . for damages resulting from the action of the public trustee taken in accordance with the request [for the release of the deed of trust]." C.R.S. § 38-39-102(3)(a). "Qualified holders" include savings and loan associations; supervised lenders; public entities that issue voting securities listed on a national exchange; federally chartered credit unions; agencies or departments of the federal government or an entity created or sponsored by same that originates, insures, guarantees, or purchases loans; and certain community development financial institutions, among others. For beneficiaries who are not qualified holders and who are not able to produce the original evidence of debt, the consequences are quite dire. Although a title insurance company may be able to obtain the release in some circumstances, generally a beneficiary who is unable to produce the original evidence of debt is required to furnish the public trustee with a corporate surety bond (a so-called lost instrument bond) "in an amount equal to one and one-half times the original principal amount recited in the deed of trust. . . ." C.R.S. § 38-39-102(3)(b). Such a bond can be very costly.

Colorado law does not require a specific form of mortgage or deed of trust; however, a short form mortgage is included in the statutes. C.R.S. § 38-30-117.

A mortgage or deed of trust must be executed with the statutory formalities and must be recorded in the office of the clerk and recorder of the county in which the property is located. A deed of trust to the public trustee must be recorded in order to institute foreclosure; accordingly, a deed of trust to the public trustee is not deemed effective unless recorded. See C.R.S. § 38-38-101(1)(c). A mortgage is effective without recording, however. C.R.S. § 38-30-117(3).

Once recorded, a mortgage or deed of trust remains effective for 15 years after the date on which the final payment or performance of the obligation secured thereby is due as shown by such mortgage or deed of trust, or if no such date can be determined from the...