The Virginia General Assembly will consider a bill in its 2021 session that would provide a “safe harbor” as to when an amendment to an existing mortgage is required if the loan documents secured by the mortgage are amended after the mortgage was executed and recorded, in order to be certain that the mortgage would continue to secure the loan as so amended and with the priority the existing mortgage would have absent amendment. If adopted, the proposed law would have implications for opinion practice in financing transactions involving real estate collateral in Virginia, particularly with the increasing number of loan amendments and restructurings that are anticipated due to the current economic distress. The proposal may also be of interest to lawyers in other states.
The proposed legislation will be useful for many commercial mortgage loan amendments but particularly for amendments to large corporate credit facilities that are secured by various assets of the corporate borrower, including real property in multiple states. In the typical multistate transaction, the amendments to the credit agreement or other loan documents are negotiated and executed first, with a provision in the loan amendment documents requiring the borrower to execute and record any mortgage amendments, to obtain endorsements to the lender’s title insurance policies and to obtain local counsel opinions on the mortgage amendments. Often, satisfaction of the latter requirements related to mortgage amendments are deferred for 90 or 120 days after the loan documents are amended. In many cases, the loan amendment documents allow the borrower to avoid satisfying such requirements if local counsel in each state in which a mortgage is recorded is willing to opine that the previously recorded mortgage securing the credit facility is adequate to secure the credit facility as amended and that the priority of the mortgage will not be impaired on account of the amendment to the credit facility.
But will local counsel be willing to issue such an opinion?
Many, and perhaps most, real estate lawyers in Virginia are reluctant to do so. The reasons for such reluctance vary, but there seems to be a perception that the case law on the subject is sparse, that the opinion giver would need to make a judgment call whether the loan amendment would prejudice potential junior creditors and/or would constitute a novation of the loan and, perhaps most importantly, that lawyers just don’t give opinions as to the priority of mortgages. Even if a lawyer believes that, for a given loan amendment, a separate mortgage amendment is not necessary or that lien priority would be preserved, it is quite another matter for a lawyer to issue a formal opinion to that effect. By contrast, the priority of future advances secured by a mortgage that complies with a specific Virginia statute on the subject, is not generally problematic. However, there is no comparable statute in Virginia that codifies existing case law and the Restatement’s position (discussed below) as to the priority of mortgage loan amendments, and the future advance statute by its terms does not expressly include loan amendments.
As a result, the borrower who is amending its credit facility secured by a mortgage on property in Virginia may be required to incur the delays and expenses of preparing and recording mortgage amendments, obtaining title insurance endorsements or title updates to confirm that there are no intervening parties with an interest in the mortgaged property, as well as the expense of obtaining customary legal opinions as to the mortgage as amended, in addition to the expense and time already incurred in previously amending the credit facility secured by such mortgage. If the law on the subject of mortgage modifications were reasonably clear by statute, perhaps such delays, expenses and other inefficiencies in the mortgage amendment process could be avoided.
As a general rule, if a mortgage or the obligation it secures is modified by the parties, the mortgage loses its priority as against junior interests in the mortgaged property if the modification is “materially prejudicial” to the holders of such junior interests and the mortgage did not reserve the right to make such a modification. Unfortunately, it is not entirely clear what constitutes “material prejudice.” Increasing the principal amount of the debt secured would probably fall into that category, but otherwise there is little guidance on the subject. Many lawyers might regard an extension of the maturity date, an increase in the interest rate or a postponement of principal amortization as materially prejudicial if a junior lienor relied upon the stated maturity date, the stated interest rate or the continuing amortization of the loan in making a second mortgage loan on the property.
On the other hand, how much knowledge as to the terms of the existing secured debt (which presumably is a predicate for determining whether such party has been “materially prejudiced” by an amendment to the debt) should be imputed to the junior lienor? It has become more common in recent years for mortgages, particularly multi-state mortgages securing large corporate credit facilities such as syndicated loans and debt securities, to provide, within the four corners of the recorded mortgage, very few terms of the debt secured other than the names of the lender or other secured parties and the maximum principal amount of the debt secured. Many states do not require the maturity date to be stated in the mortgage (although that may affect the application of the statute of limitations). Under such circumstances, it’s difficult to see how subsequent lienholders or other third parties are prejudiced by amendments to the terms of the secured debt if they were unaware of, and therefore had no basis to rely on, terms that can only be found in unrecorded debt instruments.
However, almost all well-drafted mortgages, especially those securing large corporate credit facilities, will state that they secure not only the original loan documents but also such documents as they may from time to time be amended, supplemented, extended, restated, etc. The Restatement states that a mortgage that reserved the right to make modifications is effective to secure the modified loan without affecting the priority, even in the case of a modification that increases the principal amount of the secured loan. Is this not sufficient for a lawyer then to be comfortable that no mortgage amendment is required when the original mortgage expressly contemplated amendments to the credit facility? Should this also be sufficient comfort that lien priority is preserved? Perhaps—but for many real estate lawyers, a lingering concern over “material prejudice” to junior lienors may cause them to hesitate, even though the cases citing material prejudice apparently do not involve a mortgage that contemplated amendments (except where the secured debt is increased).
Beyond increases in the secured debt, lawyers may also worry that junior lienors will argue that other specific amendments to the debt were not of the type contemplated by the language in the mortgage that authorized amendments to the secured debt.
Equally important to many lawyers is the issue of potential novation. Even if the mortgage by its terms states that it secures debt as it may be amended from time to time, if an amendment to the debt (especially an amendment and restatement) is extensive enough to constitute a “novation,” the mortgage may need to be amended to confirm that it secures the debt as novated, and, in any event, the priority of the original mortgage may be lost. In theory, a novation of debt results in an extinguishment of the mortgage lien, with the debt secured deemed to be paid off and replaced by the novated debt. Failing to modify the mortgage after the secured debt is novated, including perhaps also re-mortgaging (or re-conveying, in the case of a deed of trust) the property to secure the amended debt and ratifying the terms of the existing mortgage as amended, would seem fatal to any concept that the original mortgage continued to enjoy the same priority or even that the original mortgage continued to secure the amended debt at all—and fatal to an opinion about this as well. Novation is largely dependent on the parties’ intention and does not occur merely because loan documents are substantially modified, but many lawyers are reluctant to make the judgment call that a particular loan amendment transaction is not a novation.
By contrast, consider debt secured by a security interest in personal property perfected by filing under Article 9 of the Uniform Commercial Code. Once a UCC-1 financing statement has been filed, most lawyers would agree that the financing statement does not need to be amended on account of any changes to terms of the documents evidencing the debt secured unless changes are also being made as to the matters disclosed by the financing statement, i.e., the name of the debtor, the name of the secured party or the description of the collateral. The financing statement constitutes a “notice filing” of the security interest in the collateral but not of the terms of the secured debt. In fact, how would one amend a financing statement if the information set forth on the financing statement is not changing?
At least one state already has a law addressing mortgage amendments. A Maryland statute provides that “any change or modification to a mortgage or deed of trust or to an obligation secured by a mortgage or deed of trust does not extinguish the existing lien of the mortgage or deed of trust or otherwise adversely affect the existing lien priority of the mortgage or deed of trust,” subject to the qualification that the priority of the lien of the mortgage or deed of trust as to any increase in the principal amount of the secured debt dates from the date of the amendment. A Louisiana statute provides that, “[a]s to all obligations, present and future, secured by the mortgage, notwithstanding the nature of such obligations or the date they arise, the mortgage has effect between the parties from the time the mortgage is established and as to third persons from the time the contract of mortgage is filed for registry.” The comments accompanying the Louisiana statute make it clear that the statute is intended to permit a mortgage to secure not just future advances under a line of credit but also obligations that may not then be contemplated by the mortgagor “except in the broadest sense of an expectation that he may some day incur an obligation to the mortgagee.”
However, statutes in other states specifically addressing the priority of mortgages securing future advances may not apply to the priority of a mortgage when the debt secured by the mortgage is amended or restated (as opposed to the priority of advances under the original credit facility). As noted above, a Virginia statute on future advances expressly provides that a “credit line deed of trust,” if properly drafted and subject to certain exceptions, will secure future advances with the priority established on the date and time of recordation of the deed of trust. However, it is by no means clear if that priority applies to indebtedness that is amended after the deed of trust is recorded, and, in any event, “credit line” deeds of trust are not generally used to secure term loans and other credit facilities that don’t contemplate future advances of principal.
Regardless of whether the reluctance of lawyers to issue such opinions is well-founded, the legislation to be considered by the Virginia legislature attempts to provide clear guidance to lenders and borrowers (and their counsel who may be asked to give an opinion on the subject) as to whether a mortgage does or does not need to be amended in order for the mortgage to secure the amended debt with the same priority that the mortgage enjoyed without the amendment. As proposed, even if the amendment constitutes a novation of the debt, the mortgage would not need to be amended and would retain its lien priority. However, the following elements must be satisfied:
Other exceptions or limitations may be considered as well. For example, if the loan amendment documents amend any terms that are also set forth in the mortgage—such as the interest rate or the monthly payments of principal and interest, a junior lienor may have relied upon those terms and therefore may be materially prejudiced if they are amended without any record notice. On the other hand, if the mortgage does not set forth any specific terms of the secured debt, other than the principal amount and perhaps the maturity date, it may be presumed that junior lienors have not relied on those terms and therefore would not be prejudiced by any changes to them.
If the proposed legislation or something substantially similar is adopted by the Virginia General Assembly, lawyers practicing in Virginia should be less reluctant to render an opinion that an existing mortgage is effective to secure loan obligations as amended and that the mortgage priority will not be impaired by the loan amendment, or the statute itself may be clear enough to avoid the need for any opinion at all. In addition, the borrower in such a transaction should be able to avoid the delay and expense associated with preparing, negotiating and recording a mortgage amendment and obtaining a title insurance endorsement that insures the amended mortgage through the date of recordation of the mortgage amendment. Alternatively, borrower’s counsel may be able to persuade the title insurance company that issued the lender’s title insurance policy to issue an endorsement insuring that the mortgage secures the amended loan, without requiring execution and recordation of a mortgage amendment, which would eliminate the need for such a legal opinion. Of course, the golden rule of lending still being very much in effect, borrower’s counsel may be required to issue such an opinion in addition to obtaining an endorsement to the lender’s policy—but at least borrower’s counsel should not suffer the angst in giving such an opinion that it suffers currently in those states without such legislation.
The Uniform Law Commission has established a committee to study the proposed Virginia legislation for consideration as a uniform law that other states may wish to adopt as well. No formal action has been taken by ULC on the proposal as of the date of publication of this article.
The following is the legislation as originally proposed by the Virginia Bar Association:
A deed of trust which has been recorded and which states that it secures indebtedness or obligations under a note, loan agreement, credit agreement or other loan documents (collectively, the “Loan Documents”) and that it also secures indebtedness or other obligations under the Loan Documents as they may be amended, modified, supplemented or restated, or words of similar effect, shall secure such Loan Documents as so amended, modified, supplemented or restated from time to time, without the necessity of recording an amendment to such deed of trust and without regard to whether any such amendment, modification, supplement or restatement may otherwise constitute a novation of the indebtedness or other obligations under the Loan Documents, and shall have the same priority as the priority of the original deed of trust recorded; provided, that foregoing shall not apply to any amendment, modification, supplement or restatement of Loan Documents if (a) the deed of trust securing such Loan Documents conveys an interest in residential real estate containing not more than one dwelling unit or (b) such amendment, modification supplement or restatement of Loan Documents (i) increases the aggregate amount of the principal of the indebtedness secured by the original deed of trust, (ii) changes or substitutes the noteholder, lender, or agent of any lender named in the original Loan Documents or (iii) extends the maturity date of the indebtedness or obligation secured if such maturity date was set forth in the original deed of trust, and the effect of any such amendment, modification, supplement or restatement shall be governed by the law that would otherwise apply without regard to this statute.
