As the sheer quantity of lending activity continues its inevitable augmenting climb away from the recession, lenders are making significant efforts to avoid a repeat of past mistakes. In this environment, it is not uncommon for lenders to seek all possible combinations of material credit enhancement, more stable and predictable security, and optionality to convert existing loans to mezzanine or equity status. The lending community should be aware that there are risks that arise from the exercise of such caution, however. Among other things, lenders must be careful not to violate legal principles which could operate ultimately to render their protective efforts void.
Specifically, lenders must be wary of violating (also known as “clogging”) the “equity of redemption,” which protects a defaulting borrower’s rights of repayment during the period of time between a default and a foreclosure sale. The equity of redemption, if deemed “clogged” by a court, may serve to nullify offending mortgage provisions and may, ultimately, prevent a lender from obtaining access to the property or equity interest secured by their loan agreements and collateral documents.
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