Sovereign Immunity Meets HUD-insured Financing – a Tale of Two Nations

HUD-insured debt may be a narrow field within the broader realm of commercial real estate finance, but it never ceases to amaze me the variety of issues that I encounter within the relatively small HUD sandbox.  Dinsmore’s work as lender’s counsel on a recent multifamily 223(f) loan had me grappling with issues related to sovereign immunity, a legal concept that had barely entered my consciousness since graduating from law school.

What is sovereign immunity?

Sovereign immunity is a legal principle under which a government enjoys immunity from being sued.  HUD, as an agency of the federal government, is protected from lawsuits under this principle, although Congress has waived the agency’s immunity in many areas.  However, in the case at hand, it was not HUD’s sovereign immunity that created issues, but rather the Borrower’s.

The setup

The Section 223(f) loan at issue was fairly straightforward, except for one thing:  the single-asset Borrower was created by a sovereign nation: specifically, a federally recognized Native American Nation (the “Nation”). 

The issue

The Borrower’s formation document contained various provisions that granted the entity sovereign immunity from litigation to the same extent as the Nation.  Those provisions were concerning to HUD Counsel, who wanted to ensure that HUD would have the ability to sue the Borrower for failure to abide by the HUD regulatory agreement.  Accordingly, the firm commitment contained the following additional condition:

The Borrower org docs must be amended for closing to strike out any provisions relating to tribal rules or laws.

The conflict

Not surprisingly, the Nation balked at removing references to tribal rules and laws in the Borrower’s formation document.  It became clear, when speaking with the Nation’s legal department, that it took pride in its status as a sovereign entity and its unique legal system, including sovereign immunity.  Even though the Nation itself was not the Borrower, it was wary of allowing any language in the Borrower’s organizational documents that could open the door to tribal liability.  Nevertheless, in recognition of HUD’s concerns, the Nation was willing to grant a limited waiver of sovereign immunity in the transactional documents (e.g., the regulatory agreement and security instrument).

Anyone who’s worked with HUD knows that the Department generally does not accept changes to their standardized transactional documents.  HUD’s position, vis-à-vis its loan documents, and the Nation’s position, vis-à-vis the Borrower’s formation document, created a conflict between two sovereign nations that Dinsmore and its client needed to resolve in order for the deal to move forward.

The resolution

After extensive emails, telephone calls and Zoom conferences with the Nation and HUD Counsel, the parties were able to reach a compromise.  The Borrower’s formation document would be left alone, as would the boilerplate language in the HUD loan documents.  The limited waiver of sovereign immunity was memorialized as follows:

• HUD, Dinsmore and the Nation drafted Riders to the Security Instrument and Regulatory Agreement.  Here’s an excerpt from the agreed upon language:  “Borrower hereby waives its sovereign immunity from suit only for actions which: (1) are brought against it by HUD or the Lender . . . (2) arise under the Loan Documents; and (3) provide that the recourse sought is limited to the Collateral . . . .”
• HUD collected a standalone certification from the Borrower confirming its limited waiver of sovereign immunity.
• The Nation’s legal department provided an Opinion, separate from the standard Opinion of Borrower’s Counsel, stating that the limited waiver of sovereign immunity was valid and enforceable.

This combination of documents allowed us to resolve the conflict between HUD and the Nation and proceed to closing.