Defeasance Information
Defeasance is used when a commercial mortgage has a lockout period or yield maintenance penalty that makes traditional prepayment prohibitively expensive. Instead of paying off the loan, the borrower purchases a portfolio of U.S. government securities (Treasury bonds) that generate cash flows matching the remaining scheduled loan payments (principal and interest). The securities are assigned to the lender as substitute collateral, and the property is released from the mortgage lien. The borrower effectively replaces the property with securities, allowing the sale or refinancing of the property while the original loan remains outstanding. Defeasance is complex and expensive (requiring a securities dealer, a successor borrower entity, and legal counsel), but may be less costly than a yield maintenance penalty.
Florida Legal Definition
Defeasance transactions in Florida involve multiple legal considerations. The original mortgage must expressly permit defeasance as a prepayment alternative. The partial or full release of the mortgage from the property must be recorded in the official records. Documentary stamp tax should not apply to the defeasance (because no new obligation is created), but the transaction must be structured carefully. The successor borrower entity (which takes over the existing loan secured by the government securities) must comply with Florida entity formation requirements. Florida courts have not specifically addressed defeasance in published opinions, but the transaction is governed by the loan documents and general contract law.
How It's Used in Practice
In practice, attorneys coordinate defeasance transactions when borrowers need to sell or refinance properties subject to loans with restrictive prepayment provisions. The attorney reviews the loan documents to confirm that defeasance is permitted, engages a defeasance consultant to calculate the required securities portfolio, coordinates with a securities broker to purchase the Treasury securities, establishes the successor borrower entity, prepares the defeasance documents (assignment and assumption agreement, pledge agreement, release of mortgage), and records the mortgage release. The total defeasance cost includes: the securities purchase price, the consultant's fee, legal fees, rating agency fees (for CMBS loans), and the lender's processing fee.
Key Takeaways
- Defeasance substitutes government securities for property as mortgage collateral.
- Alternative to yield maintenance or lockout period restrictions.
- Property is released from the mortgage lien.
- Complex and expensive but may cost less than prepayment penalties.
- Must be expressly permitted by the loan documents.
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Reviewed by the attorneys at Barnes Walker, Goethe, Shea & Robinson, PLLC