Legislation has been reintroduced in the New York State Assembly (A.3009-B Part VV) and Senate (S.2509-B Part SS) which, if enacted, will require (i) the registration of certain mezzanine debt and preferred stock investments; and (ii) payment of mortgage registration tax (TMR) on these debts or investments. The stated purpose of the law is to provide income for public and affordable housing. While it is not clear whether the legislation will be enacted, New York lenders and borrowers should be aware of the potential negative implications.

The proposal expands the scope of Section 291-k of the New York State Real Property Act and makes changes consistent, as described below, with Section 250 of the State of New York Tax Law. New York and section 9-601 of the New York State Uniform Commercial Code. . Initially, the bill provides that “whenever a mortgage instrument is registered in the office of a county registrar, any mezzanine debt or preferred capital investment related to the building on which the Mortgage instrument is deposited must also be registered. with such a mortgage instrument.

The proposal defines mezzanine debt and preferred stock investments as:

debt carried by a borrower that may be subordinate to the primary lien and has priority over the common shares of an entity or over the borrower’s equity and presented as an asset for the purpose of funding that primary lien. This includes non-traditional financing techniques such as direct or indirect investment by a finance source in an entity that holds the interests of the underlying mortgage when the finance source has special rights or privileged rights such as : (i) the right to receive a special or preferential rate of return on its capital investment; and (ii) the right to accelerated reimbursement of the capital contribution from investors.

In addition to amending the Real Property Act, the bill also amends the New York State Uniform Commercial Code (UCC) by adding a new subdivision to section 9-601 to provide that “a security interest on mezzanine debt and / or equity investments in the building on which a mortgage title is deposited, can only be made perfect by filing a financing statement under subpart 1 of part 5 of this article and only after payment of all taxes due under article two hundred and ninety-one k of real estate law.

Finally, the bill amends New York tax law to clarify that “mezzanine debt and preferred stock investments” are taxable, and that tax will be measured by the amount of “principal debtor’s obligations” that may be. guaranteed by a security agreement. “Relating to real estate on which a mortgage instrument is deposited”. This means that, if the legislation is passed, mezzanine debt and preferred stock investments in New York City commercial property in the amount or value of $ 500,000 or more would be taxed at the rate of $ 2. , 85%.

The bill is flawed for a number of reasons, including the following:

I. The proposed legislation is vague and ignores the purpose and nature of mezzanine debt.

Mezzanine debt has become an integral and common part of real estate financing and investing, not primarily as a way to avoid MRTs, but as a way to leverage more of an asset beyond senior mortgage financing. . A mezzanine borrower typically pledges the equity owner’s equity to the mezzanine lender as security for the loan. A UCC financing statement is usually filed at the same time as the closing. If the owner of the property raises capital in the form of preferred stock, there is no UCC deposit.

The purpose and rationale set out in the Promoter’s memorandum in support of the legislation incorrectly indicates that mezzanine debt is used to finance real estate purchases. This is generally not true, as mezzanine debt is used in a wide variety of contexts, including in recapitalization, construction and rehabilitation operations. In practice, mezzanine real estate debt is now used in a variety of contexts: for construction, development and rehabilitation, as bridge financing. These loans, which are secured by a pledge of the interests of the general partnership or the limited liability company, have a higher interest rate because they are not secured by real estate and represent a riskier position. in a pile of debts. Mezzanine debt offers the flexibility necessary for modern real estate financing. Mezzanine debt is typically used because a primary lender will not want to lend more than a certain loan at the value of the property or more than a certain loan at the cost of a project. Investors looking for additional leverage would go to mezzanine markets to find lenders willing to lend in these riskier positions for additional return.

The meaning of “mezzanine property debt” is unclear, and this language may inadvertently encompass other forms of debt. For example, is an unsecured business loan to an entity that owns real estate with a registered mortgage considered mezzanine debt? It is also unclear what the provision “and declared as an asset for the purpose of funding such a primary lien” is intended to mean or capture. Mezzanine debt is generally separate and distinct from any mortgage debt, held by a different lender, and has a different risk profile than mortgage debt.

The vague and broad definition of “privileged equity” could subject investments unrelated to the financing of real estate to the MRT. For example, is a partner who provides services to a partnership that owns mortgaged real estate required to register the partnership agreement and pay MRT on their investment? Likewise, what if a partnership agreement contains a provision for the return of capital to one investor sooner than another or includes a provision for deferred interest? Could these investments be considered “preferred equity” if the partnership has mortgaged property?

The new subdivision proposed in Section 9-601 of the UCC also reflects a fundamental misunderstanding of preferred shares. Perfection, in fact all of UCC Article 9, applies to secured transactions. UCC funding statements are not filed in preferred stock transactions not because the parties seek to avoid MRT, but because preferred stock transactions are not guaranteed transactions and are created and exist outside the l article 9 of the UCC. In addition, the bill prohibits the seizure of mezzanine debt or preferred shares in New York courts unless the MRT has been paid. New York law cannot prevent foreclosure in another jurisdiction if, following the enactment of that law, agreements made provide for the opening of foreclosure proceedings in another jurisdiction. Preferred equity is not enforced by foreclosure, which is an inapplicable legal remedy to equity transactions. Preferred equity investments are not and cannot be cured by foreclosure. So, in the case of both mezzanine debt and preferred stocks, the tax revenue expected to be generated by this proposal might never be realized.

II. The proposed legislation will increase the cost of owning, developing and rehabilitating New York properties.

Investing in real estate, including debt to buy, develop and rehabilitate, is a huge part of the New York economy. Adding a large MRT undoubtedly increases costs for both for-profit and non-profit owners and developers, since the MRT does not exempt non-profit organizations from this tax. Limiting the use of mezzanine debt reduces the flexibility owners and developers need to finance projects and could make needed projects in various sectors less economically viable.

Today’s real estate market is dynamic and energized; having maximum flexibility to finance investment and real estate development is essential. Borrowers must have access to capital and be able to access multiple sources to build competitive and viable debt pools. This legislation will hamper development by limiting the availability of debt and increasing the cost of debt that remains available.

III. The bill violates the Constitution of the State of New York.

Article XVI Section 3 of the Constitution of the State of New York states: “Intangible personal property shall not be taxed ad valorem, and no excise duty shall be levied solely on the ownership or possession of these, except that the income from them may be taken into account in the calculation of any excise tax measured by income in general.

The purpose of this provision of the Constitution is to insure non-residents of New York who have bank deposits (debts owed to depositors by the bank) and those whose share certificates were held in brokerage houses of New York that they would not be subject to a state or local tax on these intangibles. New York does not and cannot impose a tax on a mortgage note (or mortgage document), but rather imposes the MRT, which is an excise tax on the privilege of registering a mortgage.

In Franklin Soc. for Home Building & Savings v. Bennett, et al., 282 NY 79, (12/28/1939), the Court of Appeal stated that “the validity of the tax depends on whether it is properly labeled or classified as a ‘registration tax’, which no It is not levied solely on account of ownership or possession of a mortgage or, as the Applicant argues, an ad valorem tax on property, as defined in the constitutional provision. The Court ruled that the TMR was “a tax payable only when a mortgage is registered to obtain the benefit of the deeds of registration or to rid the mortgage or its owner of penalties and drastic restrictions resulting from the failure to do so. save “.

This proposed legislation requires the registration of mezzanine debt and preferred stock investments so that MRT can be imposed. Also, registering a note reflecting mezzanine debt does not offer any of the benefits of a registered mortgage. Compelling the registration of a document reflecting an intangible asset in order to impose the TMR turns the excise tax on the registration privilege into an unconstitutional tax on an intangible asset.