CHAPTER 9.04. Due on Sale

• Jurisdiction: United States

9.04. Due on Sale

A due-on-sale or anti-transfer provision in a loan document states that the borrower is prohibited from transferring the collateral and serves the purpose of triggering a default by the debtor if title to the collateral is transferred to another person.²³ As a prohibition on transfer, a due-on-sale provision constitutes what is generally referred to as a restraint on alienation. Restraints on alienation were traditionally disfavored under common law.²⁴ Even when enforced, they are nonetheless subject to strict construction.²⁵ If there is ambiguity or uncertainty, the restraint will not be enforced.²⁶

Federal law since 1982 has pre-empted state law with respect to prohibitions on transfer of real property in real estate loans. However, federal law applies only to restrictions on transfers of the property itself, leaving state courts to interpret the permutations of transfers that may not be regulated. In particular, two areas for state law consideration are the scope of the due-on-sale clause relative to transfers of ownership interests in the property owner and the intersection of a due-on-sale clause and prepayment limitations.

In 1982, Congress enacted the Garn-St Germain Depository Institutions Act of 1982,²⁷ adopted in response to concern by lenders that, in an era of increasing interest rates, states had enacted laws and state courts had issued decisions that limited lenders' ability to accelerate loans in the event of a transfer and thereby relend their capital at higher interest rates, either to new borrowers or by consenting to the transfer and loan assumption by the transferee on new terms. The Garn-St Germain Act applied to all real estate loans, whether made by commercial lenders or private indi-viduals.²⁸ Under the act, due-on-sale clauses, and the attendant acceleration remedy, are enforceable as a matter of federal law, subject to a few exceptions.²⁹ One exception was for states that had enacted limitations on due-on-sale provisions to have a grace period during which those state restrictions would be enforced.³⁰ Delaware was not such a state. The older case law, which generally examined whether the restraint was reasonable as a protection of lender's security³¹ or whether the lender had the right to rely on the identity, capability, and integrity of a specific borrower,³² was apparently no longer relevant.

Lenders in commercial real estate loan transactions will almost always expect the due-on-sale limitations to include prohibition of so-called "indirect" transfers, including changes in the equity ownership of the borrower. Especially with the growth of securitized, non-recourse financing and the employment of so-called bankruptcy-remote entities in commercial real estate financing, lenders' concern with change of ownership or change of control of the mortgagor has heightened. This concern is usually addressed by a covenant that the loan may be accelerated should certain specified principals of the borrower entity own less than a specified percentage ownership interest in the equity.³³ Although courts in various jurisdictions have determined that such "indirect" transfers are not violations of a prohibition of the transfer of the property, given the language of the Garn-St Germain Act³⁴ such prohibitions are likely outside the scope of the act and therefore subject to state law construction, including analysis of the clause as an unreasonable restraint on alienation.

Almost all the Delaware cases addressing anti-assignment provisions are in the context of restrictions on the transfers of stock or partnership interests and not in the context of a purported transfer of real property. The sole reported real property case involved an anti-assignment provision in a lease.³⁵ However, the cases are...