Distressed real estate in Denmark: Four things investors should know
In the wake of the global financial crisis in 2007-08, distressed real estate yielded generous returns to investors that managed to pick the right cherries at the right times.
Although the Danish real estate market has coped relatively well with the coronavirus crisis, and the general situation is different from 12 years ago, an adverse impact has been felt in a number of sub-sectors. As a result, some Danish and international investors are looking for distressed opportunities. While many aspects of distressed real estate are substantially the same in different jurisdictions, a few factors are specific to Denmark. An international investor should understand these differences before looking at opportunities here.
Four key areas are explored below. They include issues that are relevant for buyers who prefer to acquire distressed debt positions as a way to eventually gain control of the underlying assets.
1. How is real estate handled in a bankruptcy process?
When a company owning real estate assets goes bankrupt, its board of directors and executive management are relieved of their duties. All control over the affairs of the estate passes to a bankruptcy receiver, typically a lawyer, appointed by the probate court.
From the bankruptcy decree there is an automatic stay on enforcement against the debtor, with a few exceptions, and any pending enforcement will be invalidated. This is to give the receiver the opportunity to explore possibilities for the sale of the debtor’s assets, including property mortgaged beyond its actual value. If successful, the receiver will charge a fee for this service on behalf of the estate to be paid in preference to debt secured on the property. A receiver can sell properties, including mortgaged properties, without sanction from the probate court or creditors in general.
If within six months of the bankruptcy decree a mortgaged property has not been sold or the receiver has not petitioned for a forced auction, any mortgagee in the property may require the receiver to make such petition without delay.
If a property is sold by voluntary agreement to a buyer, the estate will grant no representations or warranties and accept no liability of any kind regarding the property, and it must generally be expected that the mortgagee will be equally reluctant to grant any recourse. This needs to be factored in to the pricing.
Importantly, the receiver cannot compel any mortgagee to take a haircut on the secured debt or compel mortgagees to discharge their mortgages that sit above the value of the property. This can only be achieved through a forced auction via the courts. The effect of this is that where a property is mortgaged beyond its actual value, a sale other than by forced auction will require the consent of all mortgagee in that property that do not receive full coverage.
2. Who do you deal with?
To identify the most likely sources of distressed assets and the relevant stakeholders, investors need to understand the dynamics of a Danish bankruptcy process as well the specific circumstances surrounding the property in question.
In some cases, the owner will still be in control of the process even though the sale is distressed e.g. due to covenant default on the financing. However, and particularly where a property is financed by a single lender, it is not uncommon for Danish lenders to require a power of sale once a financing has reached a certain level of distress. This typically means that the lender will drive the process for as long as the power of sale is in force. However, due care should be given to whether the particular power of sale is actually sufficient to complete the sale and complies with all requirements under corporate law. It should also be noted that a power of sale will automatically become void if/when the grantor of the power goes bankrupt.
If bankruptcy proceedings have commenced, the receiver will often take an active role but as explained above, any agreement for the sale of the property will need the approval from any mortgagee not fully covered by the sale price.
When there is stack of secured debt on a property and the sale price is insufficient to fully cover one or more marginal mortgagees, there is no legal mechanism available to cram down the marginal mortgagee(s) except by way of a forced court auction. This may take considerable time and costs. In the absence of appropriate intercreditor arrangements, this may give the marginal mortgagee(s) a certain degree of leverage that may necessitate a separate negotiation on compensation to the marginal mortgagee(s).
3. Forced auctions
A forced auction is conducted by the local bailiff’s court. A forced auction over a property may be petitioned by any creditor once execution has been levied. Such execution may be levied on the basis of a mortgage over the property but also other types of debt. Once execution is levied, the process involves the following steps (simplified):
- petition to the court
- compilation of sales presentation and info pack regarding the property
- public announcement
- first auction
- second auction
The second auction may be requested by the debtor and any rights holder that does not receive full coverage from the best bid on the first auction. The duration of the entire process from initial application for execution to the second auction varies but often is around five months if straightforward. Notably, secured creditors may credit bid their own debt piece on a forced auction.
In cases where the primary stakeholders agree regarding the terms of sale but there is a need to clear the property of non-cooperative mortgagees or other rights holders, the primary mortgagee and the buyer sometimes elect to enter into a pre-auction agreement. This lays down commercial agreement on price and certain procedural mechanics.
4. What claims rank in priority over mortgage debt?
In many contexts, the recovery projections for a particular mortgage debt rely on a proper understanding of its ranking if the property went through a forced auction. Under Danish law, certain claims rank in priority over mortgage debt. These include unpaid amounts of property taxes (but not corporate taxes), unpaid fire insurance premiums and certain types of mandatory contributions.
In addition, from time to time the statutory rights of residential and commercial tenants may be asserted against the owner of the property regardless of any interim sale. Such rights include the tenant’s monetary rights against the landlord in respect of rent deposit and prepaid rent for a total amount of up to half of the annual rent. Unlike other countries, rent deposits received from tenants are not paid into designated bank accounts of the landlord. Rather, they are absorbed into the landlord’s ordinary cashflow.
The rights of tenants that exceed their statutory rights must be registered in the land registry in order to be protected in case of a forced auction over the property. Examples could be a lease provision whereby the landlord renounces the right to apply for statutory rent review or the tenant is granted a purchase option. Such tenant rights will receive priority after pre-existing mortgages. In practice, this means the rights may extinguished at a forced action. The mechanism is the one applied to easements and similar rights ranking behind mortgage debt. If the best bid does not fully cover a higher ranked mortgage and the right is believed to have an adverse impact on the property value, the unfulfilled (and higher ranked) may demand that alternative bids on the property excluding the rights in question are invited at the auction. If the best alternative bid is higher, the unfulfilled (and higher ranked) mortgagee may demand that the alternative bid is accepted, in which case the rights in question are extinguished.
Although Denmark’s real estate market has coped relatively well with the coronavirus crisis, an adverse impact has been felt in a number of areas. Distressed investment opportunities are therefore very likely to present themselves. Whether buying distressed assets or debts, investors will find it easier to navigate the marketplace if they understand not only the commercial dynamics of the market but also the underlying legal factors that drive some of those dynamics.