April 26, 2005

When Preferred Equity Doesn't Get Paid

Preferred Equity is Like a Mezzanine Loan in Sheep's Clothing

The preferred equity member in an LLC is a member, whose rights are guided by the LLC Agreement. The agreement will dictate what happens if the preferred return is not paid. Sometimes the preferred return HAS to be paid (like interest on a mezzanine loan), other times it could be accrued or paid when available.

If it has to be paid, and is not, this will trigger a default under the LLC Agreement and afford the preferred equity member certain rights and remedies that may include some or all of the following: (1) immediate replacement of the GP with a new GP of its choosing; (2) adjustment of the ownership percentages within the LLC to give the preferred equity member a higher ownership share and/or a higher preferred rate; (3) the unpaid preferred distribution becomes a high-rate partnership loan from the preferred equity member to the LLC which may have a due date or not.

There is no foreclosure procedure; the change is automatic as dictated by the LLC agreement. This is sometimes the reason why some lenders are choosing to making preferred equity investments rather than mezzanine loans, but there are usually other factors involved as well.

C-Loans would like to thank Arthur Nevid of Mountain Funding for contributing this article. Mountain Funding makes construction loans, mezzanine loans, and preferred equity investments on major commercial projects nationwide. Developers and borrowers can apply to Mountain Funding, as well as other structured finance lenders, by using C-Loans.com.