New York State Senators have proposed Bill S-318, w c would, f adop ed, levy a "mor age recording ax" o mezza e deb a d preferred equ y ve me . T b ll re urrec earl er fa led le la ve efforts to pass virtually identical bills in 2020 and 2021. Supporters of the bill claim that mezzanine debt and preferred equity investments are used for the same purpose as traditional mortgage financing without the same transparency and tax revenue for the state, and that the additional tax revenue would help close the funding gaps for affordable and low-income housing in New York
Specifically, the proposed legislation would:
- Require mezzanine lenders and preferred equity investors to file a UCC-1 financing statement with the New York State Secretary of State to perfect their security interests in the mezzanine deb a d/or preferred equ y ve me "rela ed o e real proper y upo w c e mor a e rume f led"; and
- Impose a state-level recording tax, similar to the current mortgage recording tax, upon the filing of such a financing statement. Cities and counties would also be authorized to impose local recording taxes in addition to the state-level tax.
Mezzanine lenders and preferred equity investors would be precluded from enforcing remedies (i.e., exercising a mezzanine loan foreclosure or control-shift remedies) unless they had filed and paid the tax. Perfection of a security interest for mezzanine debt could only be accomplished through the filing of financing statements, which would put New York at odds with other states, where control via possession of a certificated interest is not only sufficient but is a superior method of perfection as compared to the filing of a financing statement. The bill furthermore does not specify how these perfection requirements would work in multi-property transactions across multiple jurisdictions and where pledges of equity in New York real estate otherwise indirectly secures corporate credit facilities. Given that Delaware is the primary
jurisdiction in which commercial real estate entities are formed and that UCC filings must be made in the state of formation, this bill leaves many questions unanswered as to how that critical fact will be addressed – surely New York cannot assess a tax on Delaware filings. Additionally, New York is the governing law for many real estate transactions that secured real estate wholly outside of the State – would enforcement of such a pledge now also require a tax be paid to New York?
The uncertainty created by the bill extends beyond its perfection requirements. The concerns surrounding the definitions of mezzanine debt and preferred equity investments from the 2020 and 2021 bills still remain. The definitions are overly broad and, as currently written, could be interpreted to capture any mezzanine debt and preferred equity investments secured by entities that indirectly own property. This lack of clarity would have a chilling impact beyond the commercial real estate market, deterring investment in companies that own or ground lease real property in New York.
In addition, while the bill does not extend to pre-enactment transactions, questions remain as to whether the creation of a new mezzanine loan pursuant to the common secondary market provisions found in many existing loan agreements, or the filing of UCC-3 continuation statements for pre-enactment transactions, would trigger the tax.
The bill is more likely to disincentivize secured financing activity, potentially resulting in unintended consequences. Mezzanine debt and preferred equity financings would become more expensive, adding up to an additional 2.8% cost to transactions. In our current interest rate environment, this places a higher burden on real estate investors, who would be incentivized to invest in more tax-friendly jurisdictions to generate required returns. In any event, these higher costs will likely be passed on to borrowers, and then to their tenants, and then to the consumer.
While many are focusing on the failures of the past proposals in 2020 and 2021 as a sign that the current bill is unlikely to pass, the previous concerns precipitated by COVID-19 have dissipated and the need for tax revenue is dire given the current economic situation. The motivation behind support for the bill, however, is misguided given the current nature of New York mortgage recording taxes which, consistent with common practice in commercial transactions, are o ly pa d o a y "exce " deb prov ded over existing debt such that the proposed ax would crea e o ly a "o e- me" a o e bud e a d be unlikely to yield the recurring income sought by the proponents of the bill. Additionally, investors and practitioners will be certain to devise other means of addressing this situation. For example, given that most entities are formed in Delaware, perhaps governing law provisions of pledge agreements will simply shift to Delaware law and Delaware courts. The quest o are ma y...
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