Trapped between tax and foreclosure law: a receiver's power to sell mortgaged real estate and its effect on the CMBS industry.

• Author: Soles, Gary
• Position: Commercial mortgage-backed securities

In recent years, lenders and special servicers in the commercial mortgage-backed securities (CMBS) industry have been frustrated by Florida case law developments that preclude receivers in foreclosure cases from selling the mortgaged real estate. These developments have a significant effect on the CMBS industry, and it is, therefore, important for lawyers representing such lenders to understand the rationale and limits of the case law.

The Fourth District Court of Appeal ruled in Shubh Hotels Boca, LLC v. Federal Deposit Ins. Corp., 46 So. 3d 163 (Fla. 4th DCA 2010), that a court presiding over a foreclosure case in which a receiver has been appointed does not have the power to order sale of the mortgaged property by the receiver prior to entry of a final judgment of foreclosure. Mortgage foreclosure practitioners will not find that result particularly surprising and may question why a mortgagee would even bother to make such an argument, given that a successful foreclosure of the mortgage results in a judicial sale of the mortgaged property in any event.

The answer is that in this age of securitization, the laws pertaining to real estate mortgage investment conduits (REMICs) oftentimes make such a procedure desirable. A REMIC is a business structure defined by the Internal Revenue Code (IRC)--essentially a pool of mortgages in which securities representing fractional interests have been issued. Absent the REMIC provisions of the IRC, a mortgage pool in which multiple classes of fractional interests have been issued would be treated for tax purposes as a corporation, and as a result, the income from the mortgages would be double taxed, first when it was earned at the pool level, and again when it was paid to the holders of the fractional interests. Double taxation of the income would make it economically unfeasible to issue fractional interests in mortgage pools.

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As a result, in 1987, Congress amended the IRC to allow mortgage pools to be set up as REMICs. If it is done correctly, the income is taxed as a pass through to the holder of the residual securities issued by the REMIC, while payments to those holders of securities having a higher priority are deductible at the pool level and taxed to the recipients as payments on a debt. In general, then, there is no taxation at the pool level and hence, no double taxation.

As is often the case with tax benefits, however, Congress created a burden in exchange for the tax benefits that it extended to REMICs. To qualify, a REMIC must follow the tightly regulated structure that Congress prescribed. In particular, a REMIC must be a passive structure with no business other than the ownership and collection of specific mortgages, which must be transferred to the REMIC shortly after the creation of the pool. As a result, the REMIC cannot freely dispose of mortgages or acquire new mortgages. (1)

The IRC permits a REMIC to own foreclosed property for up to three years, with the possibility of an extension, but as a result of its inability to acquire new mortgages, the REMIC cannot offer purchase money financing. That might reduce what can be obtained by liquidation of the foreclosed property, especially in a down market wherein buyers might be willing to pay a higher percentage of the appraised value in anticipation of future appreciation but are unable to secure financing based on such a valuation. However, a result similar to seller financing might be achieved if the property can be sold subject to the mortgage, without foreclosing. That is when the receiver's sale becomes useful. If the receiver is able to sell the real estate subject to the mortgage, the REMIC servicer might be able to enter into a modification of the mortgage with the purchaser that would not run afoul of the IRC.

The sale of mortgaged property by a receiver is a procedure that has been used successfully in other states. (2) Prior to Shubh, title insurance companies were being asked to insure such properties in Florida, and as a result, some of the title insurance companies issued underwriting policies announcing that due to the lack of specific reported Florida case law authority, no such policy could be issued in the absence of a supporting deed from the mortgagor to the purchaser. (3) Obviously, such a requirement greatly reduces the value of a sale by the receiver, since no such receiver sale would be required in the first place if the mortgagor were cooperative.

The decision in Shubh seems to have vindicated the judgment of the title insurers in declining to underwrite such transactions. (4) However, given the benefits that might be derived from this procedure, it is worth looking at Shubh to see whether that case completely closed the door to a sale of the property by a receiver. (5)

Shubh and Its Limits

In Shubh, the court explained that the trial court had appointed a receiver in a mortgage foreclosure action, and ultimately, the lender sought court approval of a sale of the mortgaged property by the receiver. The owner/ mortgagor objected to the sale, "arguing there is no legal authority for the receiver to sell the property and that he could not convey good title." (6) Nevertheless, the trial court approved the sale, and the owner appealed.

The Fourth District Court of Appeal reversed. In setting up the discussion, the court noted that the "lender has not cited any statute specifically applying to the circumstances we face here and authorizing a court appointed receiver in a foreclosure case to sell the mortgaged property ...." (7) The court stated in a footnote: "To lender's argument that [section] 608.4492, Florida Statutes (2009), authorizes the receiver to sell the property here, we note there is no claim seeking dissolution of owner, a limited liability company. Nothing in that statute remotely purports to give mortgage foreclosure receivers such general authority." (8)

The referenced statute, F.S. [section] 608.4492, is part of the Florida limited liability company law that authorizes a court presiding over a dissolution proceeding to appoint a receiver to liquidate the assets of a dissolved limited liability company. Thus, from the start, the court drew a clear...