STUART ROSSMAN: Foreclosure rescue scams revolve around various types of schemes targeted at homeowners already facing foreclosure and in financial distress. Typically a "rescuer" identifies potential victims through public foreclosure notices in newspapers or at government offices. The homeowner is then contacted by phone, mail or personal solicitation.

Several varieties of foreclosure rescue scams involve homeowners, knowingly or unknowingly, transferring title to their homes to another individual or a trust. In some cases, homeowners surrender title to their home believing that they will be able to repurchase the home at a later time. In other situations, the homeowner may simply believe that they are signing documents for a new loan to bring their mortgage current. In either case, these homeowners become tenants in their own homes on terms that are often oppressive and unaffordable.

Such transactions may give rise to state and federal statutory claims, such as violations of state Unfair and Deceptive Acts and Practices (UDAP) laws and the Truth in Lending Act (TILA), or common law claims including fraud, conspiracy, unconscionability and breach of fiduciary duty. For homeowners whose primary goal is to regain ownership of their home, bankruptcy may provide an alternative route. Under the Bankruptcy Code certain transfers of property made by the debtor may be voided in a bankruptcy proceeding by either the bankruptcy trustee or the debtor.

Also injurious are scammers who, for a substantial fee, promise advice and assistance that either never materializes or turns out to be useless, leaving the homeowner with little time or resources to obtain real help. Some assist the homeowner in filing a bankruptcy case that is ultimately dismissed, subjecting the homeowner to various restrictions on repeat filing.

For these scammers who offer assistance, but do not steal the home, a number of existing remedies can be very effective, particularly state and federal credit repair organization acts (which can recover all the consumer's money, and also award punitive damages and attorney fees) and state UDAP statutes (which can provide for minimum, multiple or punitive damages in some states, and usually attorney fees).

Eleven states (California, Colorado, Georgia, Illinois, Maryland, Michigan, Minnesota, Missouri, New York, Rhode Island and Washington) have responded to this epidemic by passing special statutes providing protections against foreclosure rescue scams.

A key feature of foreclosure rescue statutes is that they allow the homeowner to cancel the transaction, typically during a three to ten-day cooling-off period. This allows for cancellation of any transfer of the property to the rescuer. The cancellation period typically runs from the date that the rescuer gives the consumer notice of the right to cancel and a written contract that complies with the statute. Where the consumer was not given these documents, the practitioner should take the position that the right to cancel is a continuing one, at least until the proper documents are provided. Many decisions interpreting comparable language in state home solicitation statutes and the TILA's rescission right recognize such a continuing right to cancel.

A homeowner has potential cancellation rights under a number of different statutes, including Truth in Lending rescission, state credit repair organization statutes, and even some state home solicitation statutes. While all of these should be explored in an attempt to save a home, state foreclosure rescue laws offer certain advantages.

Unlike TILA rescission, most state foreclosure rescue laws do not specify any requirement that the consumer tender back the amount paid by the rescuer. Those that do specify generally provide the homeowner 30 or 60 days to provide tender. Where tender is required, the homeowner should cancel and then immediately explore various financing options to provide the tender, or perhaps even file a bankruptcy case.

Another advantage of these new statutes is that Truth in Lending only covers rescuers who have engaged in a certain number of credit transactions. Many rescuers may not fall under the TILA, while they clearly are covered by the foreclosure rescue statutes. State foreclosure rescue laws also have advantages over canceling under home solicitation and credit repair organization laws. The applicability of those statutes to equity strippers is less explicit, and home solicitation statutes generally offer weaker remedies.

Foreclosure rescue statutes also provide other potent remedies, often more powerful than those available under the state's UDAP statute. In addition to actual damages, they usually authorize attorney fees, and unlike some UDAP statutes, these laws typically make attorney fees mandatory for prevailing consumers. The statutes also often offer mandatory multiple damages for any violation, and may also provide for punitive damages. Some statutes specify that remedies are those under the state credit repair organizations act, which are generally quite potent as well. A few statutes merely provide for remedies under the state UDAP statute.

Most foreclosure rescue statutes also provide for criminal prosecution of rescuers who violate the statute. Criminal prosecution can protect future homeowners from victimization, and may also result in restitution orders for homeowners who have already been harmed.

The typical foreclosure rescue statute caps fees or interest rates, or requires that a rescuer who purchases the property pay at least a certain percentage of its fair market value. Some of the states prohibit foreclosure rescue consultants from acquiring any interest in a residence in foreclosure from an owner with whom the consultant has contracted. Several of the statutes prohibit the rescuer from entering into an agreement to re-convey the home to the homeowner unless the homeowner has a reasonable ability to meet the requirements for re-conveyance.

A significant advantage of foreclosure rescue law claims is their clear, explicit prohibition of an array of deceptive, unfair, and abusive practices. Violations may not only be actionable under the state foreclosure rescue law, but may also help make a case for fraud or a UDAP violation.

The typical rescue scam involves several different parties, such as appraisers, closing agents, investors, and lenders, many of whom are individuals looking to make a quick profit on a relatively small number of property transfers. TILA, credit repair organization acts, and even UDAP statutes may be unclear whether they apply to all of these players.

The typical foreclosure rescue scam statute, on the other hand, is explicitly drafted to cover rescue scammers and many of the subsidiary players. The statutes cover "foreclosure consultants" or some similar term, defined to include anyone who offers or performs any service for compensation that is represented to stop or postpone a foreclosure sale; obtain forbearance; assist the owner in exercising or getting an extension of a right of reinstatement, obtaining a loan, obtaining a waiver of an acceleration clause; lessen the impact of the foreclosure on the owner's credit rating; or save the home from foreclosure. "Service" is typically defined to include providing advice or assistance about foreclosure and serving as an intermediary between the homeowner and creditors.

Most state foreclosure rescue statutes have separate provisions regulating foreclosure purchasers, i.e., those who obtain a deed to the home with a promise to re-convey it at some future date. In addition, Maryland and California explicitly cover surplus buyers, i.e., those who induce homeowners to sign over the surplus proceeds from the foreclosure sale. The general definition of "foreclosure consultant" in most states is broad enough to cover these variations of the scam.

The statutes thus will cover subsidiary players in foreclosure rescue scams who receive compensation and represent that their services will help the homeowner obtain a loan, save the home, or stop or delay the sale. For example, a closing agent who reinforces the rescuer's statements about the purpose of a sale-leaseback transaction may meet the definition.

A key question will be whether the rescuer and any subsidiary players fall into a statutory exemption. Foreclosure rescue statutes usually exempt certain licensed or chartered lenders. They also usually exempt holders of licenses, such as attorneys and realtors, at least in some circumstances. But, even if they do not meet the statutory definition, subsidiary players may be liable on an aiding and abetting theory for the principal's violation of the state foreclosure rescue law.

PLI: The asset-based loan has become an important capital markets tool in today's world of acquisition financings, recapitalizations and restructuring of corporate credits, and, as you have noted, sometimes replaces existing cash flow loans. Can you explain the asset-based loan?

SETH JACOBSON: Broadly speaking, asset-based financing is a type of working capital financing that is based primarily on the value of collateral that is relatively easy to value and liquidate as opposed to being based primarily on the enterprise value and projected cash flows of the borrower.
While historically these types of financings were more common in small- and middle- market financings, over the last several years they have become a broadly accepted corporate financing tool in the capital markets. In fact, asset-based loans have been combined with high yield issues as an important part of the capital structure in acquisition financings, and have been used by traditional corporate borrowers to replace cash flow loans and avoid leverage and other financial covenants.

The distinguishing feature of an asset-based loan is that the amount that a borrower may borrow at any one time is limited by both the total commitments of the lenders under the applicable credit facility and by the borrowing base. This is in contrast to the traditional cash flow loan where, so long as the borrower is in compliance with the applicable loan documents, a borrower may borrow the entire committed amount of the facility. By limiting the outstanding balance of the loans to a borrowing base, asset-based lenders are more comfortable with the likelihood that they will be repaid in full from the value of the collateral. This comfort level with collateral coverage often allows asset-based lenders to be more flexible in other areas of the loan documents, including mandatory prepayments, operating covenants and financial covenants.

In fact, many asset-based loans in today's market have only a single financial covenant – the minimum fixed charge coverage ratio – and even that often does not apply unless "excess availability" (i.e., the excess of (a) the lesser of the commitments and the borrowing base over (b) the outstanding loans) is less than a negotiated minimum. This "covenant-lite" structure has proven to be an effective marketing tool for lenders because it offers borrowers the ability to obtain committed facilities for their working capital needs without burdening the borrowers with ongoing financial maintenance covenants.

Borrowing Base: The borrowing base in an asset-based loan may consist of accounts receivable, inventory, equipment and even real estate, depending on the borrower's needs, credit quality and industry. Each deal is different and lenders are constantly looking at the quality of the collateral and the ease with which it can be converted into cash in order to set appropriate advance rates. A typical borrowing base definition might read as follows:

• "Borrowing Base" means, as of any time, the sum of (a) 85% of the borrower's eligible accounts receivable, plus (b) the lesser of (x) 65% of the value of the borrower's eligible inventory valued at the lower of cost or market, determined on a first-in, first out basis and (y) 85% of the net orderly liquidation value of the borrower's inventory determined by the most recent appraisal delivered pursuant to the loan documents, minus (c) reserves.

The sample borrowing base definition works well in situations where the collateral value of inventory and receivables generates sufficient availability to meet the borrower's liquidity needs on a day-to-day basis. If that is not the case, many lenders are willing to include a so-called fixed asset component consisting of equipment and/or real estate subject to lower advance rates. This so-called fixed asset component often amortizes from the borrowing base on a monthly basis over a five to seven year period. The required amortization reflects the increased risk that asset-based lenders perceive in the fixed assets as well as any actual depreciation in asset value. It also reflects the asset-based lender's desire to have a high percentage of borrowing base consist of the more liquid inventory and receivables. In fact, some lenders limit the fixed asset component to no more than 25% of the borrowing base.

Before a borrower seeks to include fixed assets in the borrowing base, it should consider all available options to determine how best to unlock the value of the collateral. For example, a fixed asset term loan secured by a first lien on fixed assets and a second lien on working capital assets may provide the most efficient solution. Alternatively, in transactions where the asset-based lender requires a first lien on all assets but is not willing to include fixed assets in the borrowing base, a second lien term loan may be an effective solution. "Covenant-lite" solutions with reciprocal first liens (i.e., asset-based lenders have a first lien on working capital assets and a second lien on fixed assets while the term lenders have a first lien on the fixed assets and a second lien on working capital assets) have added to the general acceptance of the asset-based loan product in the marketplace.

Once a lender and a borrower have agreed upon the asset classes and advance rates that determine the borrowing base, it is time to examine the eligibility standards and the concept of reserves, as it is only when these are established and applied to a borrower's specific situation that the lender and the borrower will be able to determine how much may be borrowed over the life of the facility.

Eligible Receivables: As previously discussed, the ability of the lenders to extend credit in the asset-based financing context is based on the relative liquidity and value of the collateral. Receivables are the most liquid of the asset classes typically found in the borrowing base, but even these are discounted by lenders. A typical advance rate on receivables is 85% of those that are eligible – the key phrase being "those that are eligible." In order for a receivable to be eligible, it generally must be an account receivable that is (i) generated in the ordinary course of business and subject to a first priority perfected security interest in favor of the administrative agent or the collateral agent, (ii) not more than a specified period of time overdue or past the original invoice date, (iii) not owing from an account debtor that has more than a specified percentage of accounts that are ineligible, (iv) not in excess of concentration limits and credit limits, (v) not a progress billing or otherwise contingent on future performance, (vi) not owing from an insolvent account debtor, (vii) owed by an account debtor that maintains its chief executive office in the United States or Canada, (viii) not owed by a government agency unless the borrower complies with the United States Federal Assignment of Claims Act and any similar state or local law, (ix) not subject to offset or counterclaim or owed by any affiliate of the borrower and (x) not determined to be ineligible by the administrative agent in its permitted discretion. Each lending institution has its own standards of eligibility and will likely have requirements in addition to those listed above.

Eligible Inventory: Following receivables, inventory is the next asset class that is relatively easy to value – although the ability to liquidate may depend on several factors, including access to the collateral, the ability to continue to use brand names in a liquidation sale and whether further investment is required to realize the value of the collateral. Inventory appraisals are typically done on an "as is- where is" basis in an attempt to arrive at the true liquidation value of the collateral. A typical definition of Eligible Inventory includes inventory only if it is (i) subject to a perfected first priority security interest in favor the administrative agent, (ii) not slow moving or obsolete, (iii) finished goods, (iv) at a location owned by the borrower or at a leased location or third-party warehouse if the administrative agent has received satisfactory lien waivers and access rights, (v) located in the United States of America, (vi) of a type that may be sold by the administrative agent without infringing on the intellectual property rights of others or requiring the administrative agent to pay additional royalties in connection with a sale, and (vii) not determined to be ineligible by the administrative agent in its permitted discretion.

Reserves: Most asset-based loan agreements grant the administrative agent the right to establish reserves against the borrowing base or the commitment in its permitted discretion. These reserves may relate to costs required to liquidate the collateral (such as potential payments to landlords and third-party warehouses, payment of taxes, protection and preservation of collateral and costs of preparing collateral for sale), reserves for dilution of accounts, shrinkage reserves for inventory and other items that affect the value or liquidity of the collateral. Reserves are an important tool for asset-based lenders that may be used to ensure that credit exposure (which often includes not only the outstanding loans and letter of credit reimbursement obligations, but also cash management and hedging obligations) does not exceed the likely value of the collateral upon liquidation. While borrowers may argue against reserves and try to establish parameters, any hindrance on the ability to establish reserves may result in reduced flexibility elsewhere in the loan agreement.

Amendment of the Borrowing Base: As discussed, the concept of the borrowing base is the cornerstone of an asset-based loan. Given that the credit decisions of many lenders in the syndicate will be based on their analysis of the collateral included in the borrowing base and the advance rates associated with that collateral, it is not surprising that syndicate members attempt to limit the discretion of the administrative agent to include new items in the borrowing base and are hesitant to allow amendments to the definition of borrowing base and related terms. A typical asset-based loan agreement will require either super-majority or unanimous lender consent to change the definition of the borrowing base, increase advance rates or add new classes of eligible assets to the borrowing base.

Download Asset-Based Financings for Acquisitions–Counting on Your Assets.