Parties to a Defeasance and Their Roles: A Comprehensive Guide for Commercial Real Estate Investors

What is a Defeasance?

First, let’s quickly explain what a Defeasance accomplishes. Defeasance is a legal process commonly used in commercial real estate to facilitate a sale or refinance of your property when your loan agreement does not allow you to prepay your remaining obligations. This is usually because your loan has become part of a investment security know as a CMBS (Commercial Mortgage Backed Security). Defeasance is a contractual right you have which you exercise in order to release your property from its pledge as collateral for your loan. Defeasance releases your property from it’s mortgage obligation while simultaneously allowing the loan to continue on to maturity for the benefit of the CMBS security investors. This can be accomplished because defeasance lets you substitute a carefully constructed portfolio of securities for your property’s remaining loan payments. The CMBS investors are pleased because these US Government securities are lower risk than the value of your property. When your defeasance closes your loan becomes the responsibility of the Successor Borrower, who receives the cash produced by the portfolio of defeasance securities you provided. The CMBS investors are happy and you are released permanently from your mortgage.

Now we’re ready to delve into the key players in a defeasance, including you, various service providers and their legal counsel, and we’ll explain their responsibilities. You will get a solid understanding of the parties involved in defeasance transactions, enabling you to navigate this complex legal process with confidence. Let’s get started!

Defeasance Roles and Responsibilities

Defeasance transactions are complex and legally exacting, involving multiple participants with important roles and responsibilities.

The Master Servicer

The Master Servicer, the same firm you’ve been making loan payment to while you held the loan, is an important player in a defeasance transaction. They continue to represent the rights and responsibilities of the original lender. The Master Servicer will engage their own legal counsel to represent them throughout the defeasance. The Master Servicer continues to service the loan after a successful defeasance close releases you from the mortgage.

Master Servicer’s Counsel

Servicer’s counsel plays the most crucial role in the defeasance process. They are responsible for distributing a checklist of deliverable items to be provided by you and other participants to successfully close the defeasance. Based on these deliverables, they draft and distribute the defeasance documents for execution. The timing of the defeasance closing is driven by the underlying sale or refinance closing, so it is important to ensure that all deliverables are provided in a timely manner. When the defeasance closes the Master Servicer Counsel formally releases you from the mortgage once they have verified every step has been done to perfection.

Your Attorney

A key player on your team in a defeasance transaction is your real estate attorney. Their role is to review the defeasance documents and coordinate the delivery of the required deliverables. While you may think a specialized attorney is needed, a knowledgeable real estate attorney familiar with the defeasance process and your company can navigate it effectively. Defeasances follow a standardized process and checklist, minimizing the need for extensive negotiations. If your attorney has questions, guidance can be sought from Derivative Logic, the Master Servicer’s Counsel, or other third parties involved in the process.

Your Defeasance Consultant

To ensure a smooth and efficient defeasance borrowers turn to defeasance consultants like Derivative Logic. We play a crucial role in quarterbacking the process for you and ensuring that things are moving along as they should. We provide estimates, discuss timing considerations, and prioritize your best interests. And we have professional relationships with the service providers you need, like Capital Market Traders or AUP Accountants, to complete the process. Unlike some other advisors, Derivative Logic is an independent defeasance consultant, with no conflicts of interest, ensuring transparency and efficiency throughout all the steps.

Capital Markets Trader

A licensed Capital Markets Trader will be needed to assemble a portfolio of contractually allowed fixed income securities that will precisely satisfy the cash flows required to make the remaining payments of your defeased loan. The loan agreement specifies whether you or the Master Servicer has the right to select the trader. If you retain the right, Derivative Logic will engage the best trader for your situation on your behalf. The day before your defeasance closes the trader will purchase the portfolio at the market prices available that day. The next day, when your defeasance closes, the trader will transfer the securities to the Securities Intermediary.

Securities Intermediary

The Securities Intermediary houses the securities portfolio, which is purchased by you during the defeasance, in a custodian account. As the securities mature, the Securities Intermediary uses the proceeds to make your remaining debt payments to the Master Servicer as outlined in the collateral and loan agreement.

Successor Borrower

The Successor Borrower replaces you as the party responsible for the loan until it’s maturity. The Successor Borrower is a single purpose, bankruptcy remote entity created to assume your loan obligations at the defeasance closing. The right to select the Successor Borrower is specified in the loan agreement and is often at the discretion of the lender. The Successor Borrower legally takes over responsibility for the loan from you until its maturity date.

AUP Accountant

Another key participant is a Certified Public Accountant firm that conducts a AUP (Agreed Upon Procedures) examination of the securities in the defeasance portfolio. Per the loan documents, a review of the securities portfolio by a nationally recognized accounting firm is required. The designated CPA will evaluate the defeasance collateral and affirm that it generates sufficient cash on time and in accordance with the defeasance requirements to satisfy the scheduled debt payments as outlined within the loan documents. The participation of the Accountant is to protect the investors in the CMBS securitization.

Title/Escrow Agent

A Title/Escrow agent also plays a crucial role in the defeasance process. The Escrow Agent executes the Escrow Instruction Letter prepared by the Master Servicer’s Counsel, outlining the specific steps to be followed in order to successfully effectuate the defeasance closing. One of the most important requirements is the timely release of the wire to pay for the defeasance portfolio of securities. The defeasance wire must be received by the Securities Intermediary prior to the underlying sale/refi closing within a tight time window. Missing this window causes the defeasance to fail, so responsiveness and an understanding of defeasance mechanics are critical to ensure a smooth closing. You likely will have the right to designate your Title/Escrow Agents.

Overall, these professionals work together to ensure that the defeasance process is executed properly and that all necessary requirements are met to close on time. Their expertise and attention to detail are essential in facilitating a successful defeasance closing. By working together effectively, borrowers, loan servicers, counsel and securities intermediaries will make your defeasance transaction successful. And choosing Derivative Logic as your Defeasance Consultant will make your transaction a stress and worry-free experience.

You’re Probably Wondering, What Will Your Defeasance Cost?

The largest portion of the cost of a defeasance depends on the market prices for the securities in the defeasance securities portfolio. Usually it costs more to buy the necessary securities than what would have been the cost of paying off your remaining debt and interest, if you could prepay. The remaining costs are for professional fees charged by the participants we’ve discussed above based on their published standard fee schedules.

Derivative Logic, works for you, so we keep our eyes open for extraneous charges or inflated fee quotes that some participants try to sneak in, especially when their services have been engaged by the Master Servicer instead of by you.

The cost of the securities is directly tied market prices for Government fixed income securities and the remaining term of the defeased loan. Remember that you likely owe millions of dollars of principal and interest for the remaining term of your loan, and so you will need to purchase millions of dollars of low risk securities to fund those obligations. The good news is you are making this purchase under the strict provisions of a defeasance. Therefore you can buy securities without having a credit support agreement with the Capital Market Trader. That represents a huge savings in time, trouble and cost.

Summing Things Up

Understanding the roles and responsibilities of the parties involved in defeasance transactions is essential for commercial real estate investors. By familiarizing yourself with the key players, such as service providers and legal counsels, you can be assured that the process runs smoothly and efficiently. And when you hire an expert Defeasance Consultant like Derivative Logic, we’re there to answer all your questions throughly and understandably.

You Must Give Advance Notice to Officially Begin

Almost all loan agreements require you to provide a formal Notice to Defease to your Master Servicer at least 30 days before your desired closing date. You will also make a Servicer’s Deposit at that time. Once you complete both steps your defeasance if officially underway. You can successfully close with less notice, but you will be charged for expedited services by the Master Servicer and their Counsel. That means it’s important to reach out to Derivative Logic early on, so we can determine specific provisions in your loan documents, with the rights and responsibilities you must address. We will accurately estimate your costs and make sure you are on track for successful and timely close. Our team takes great pride in making your defeasance journey a stress and worry-free experience!