Often, a mezzanine or subordinate lender is relegated to taking pledges of collateral in the form of a borrower’s membership, ownership and/or financial interests in business entities. The actual value, worth and liquidity of this type of collateral is usually difficult to ascertain with any certainty, which is one of the reasons why mezzanine lenders typically charge interest rates and fees higher than those charged by a more conventional lender.
Unlike a conventional lender, whose collateral consists of tangible and intangible assets or real property, upon a default by a borrower who has pledged these types of interests the mezzanine or subordinate lender is forced to look to these pledged interests to satisfy its debt. This may not be such a simple proposition, as it may necessitate the lender to step into the borrower’s shoes and, in effect, becoming one of numerous owners of an entity. Thorny and difficult issues can arise in connection with the actual transfer of ownership of the pledged interests to the secured creditor. One example is if the operating, partnership or shareholder’s agreement of the underlying entity precludes or restricts a transfer of ownership.