Kathleen Burtschi, Esq. Senior Attorney OGC – Office of Insured Housing U.S. Department of Housing and Urban Development Washington, DC Phone No.: (202) Charles C. Bissinger, Jr., Esq. Partner Vorys, Sater, Seymour and Pease LLP Cincinnati, Ohio Phone No.: (513) Use of Deposit Account Agreements In Section 232 Loan Transactions Western Mortgagee Advisory Council 10 th Annual Western HUD Lender’s Conference April 28, 2009

OIHCF has determined that the accounts receivable (“AR”) of the Operator of a project subject to a mortgage loan insured under Section 232 of the National Housing Act arising from the operation of the project constitute “project income” in which a security interest must be taken pursuant to a Security Agreement executed by the Operator. OIHCF has determined that the accounts receivable (“AR”) of the Operator of a project subject to a mortgage loan insured under Section 232 of the National Housing Act arising from the operation of the project constitute “project income” in which a security interest must be taken pursuant to a Security Agreement executed by the Operator. In cases where there is an operating lease and there is no identity-of-interest between the Mortgagor and Lessee, (i) the security interest may be granted by the Lessee to the Mortgagor to secure the obligations of the Lessee under the Lease and (ii) the Mortgagor must pledge its rights under the Lessee Security Agreement to the FHA Lender. In cases where there is an operating lease and there is no identity-of-interest between the Mortgagor and Lessee, (i) the security interest may be granted by the Lessee to the Mortgagor to secure the obligations of the Lessee under the Lease and (ii) the Mortgagor must pledge its rights under the Lessee Security Agreement to the FHA Lender. 2 AR of the Operator Will Be Treated as “Project Income”

In all other cases, the Lessee must grant a security interest to the FHA Lender in a Lessee Security Agreement. In all other cases, the Lessee must grant a security interest to the FHA Lender in a Lessee Security Agreement. In order to perfect the security interest granted to the FHA Lender (whether directly or by a pledge from the Mortgagor), one or more DACAs are needed. In order to perfect the security interest granted to the FHA Lender (whether directly or by a pledge from the Mortgagor), one or more DACAs are needed. Deposit account control agreements are being obtained for all LEAN Section 232 projects, including assisted living facilities. Deposit account control agreements are being obtained for all LEAN Section 232 projects, including assisted living facilities. 3

What is a Deposit Account Control Agreement (“DACA”)? 4

A DACA is an agreement made among: A DACA is an agreement made among: -a Secured Party (generally, the FHA Lender) -a Debtor (generally, the Operator, whether the mortgagor or lessee) -a Depositary Bank (the bank at which the Operator maintains its deposit accounts) A DACA is used to perfect the FHA Lender’s security interest under the Uniform Commercial Code (“UCC”) in the Operator’s deposit accounts, including the account(s) into which the Operator deposits the cash proceeds from its AR by giving the FHA Lender “control” (in a strictly legal sense) over one or more of the Operator’s deposit accounts. A DACA is used to perfect the FHA Lender’s security interest under the Uniform Commercial Code (“UCC”) in the Operator’s deposit accounts, including the account(s) into which the Operator deposits the cash proceeds from its AR by giving the FHA Lender “control” (in a strictly legal sense) over one or more of the Operator’s deposit accounts. 5

In those cases where there is AR financing, (i) the AR Lender will be a party to the DACA, (ii) the FHA Lender may or may not be a party to the DACA and (iii) there may be separate DACAs in favor of the AR Lender and/or FHA Lender. In those cases where there is AR financing, (i) the AR Lender will be a party to the DACA, (ii) the FHA Lender may or may not be a party to the DACA and (iii) there may be separate DACAs in favor of the AR Lender and/or FHA Lender. DACAs are referred to by various names, including Blocked Account Agreements, Lockbox Agreements and Springing Lockbox Agreements. DACAs are referred to by various names, including Blocked Account Agreements, Lockbox Agreements and Springing Lockbox Agreements. 6

What is the effect of a DACA on the Operator’s ability to control its funds? 7

The DACAs used in FHA-insured transactions contemplate what is commonly known as a "springing lockbox." Under such an arrangement, (i) the Operator retains the right to spend, and direct the disposition of, the funds in its operating accounts unless and until the FHA Lender exercises its rights to take "exclusive control" over such accounts, and (ii) the FHA Lender has "control" over the Operator's operating accounts in the legal sense under the Uniform Commercial Code ("UCC"). The DACAs used in FHA-insured transactions contemplate what is commonly known as a "springing lockbox." Under such an arrangement, (i) the Operator retains the right to spend, and direct the disposition of, the funds in its operating accounts unless and until the FHA Lender exercises its rights to take "exclusive control" over such accounts, and (ii) the FHA Lender has "control" over the Operator's operating accounts in the legal sense under the Uniform Commercial Code ("UCC"). DACAs do not grant the FHA Lender the right to control the disbursement of funds in the Operator's operating account until the FHA Lender notifies the Depositary Bank that the FHA Lender is taking sole control of the funds in such account. Typically, the FHA Lender would not so notify the Depositary Bank unless a default under the mortgage loan documents has occurred. DACAs do not grant the FHA Lender the right to control the disbursement of funds in the Operator's operating account until the FHA Lender notifies the Depositary Bank that the FHA Lender is taking sole control of the funds in such account. Typically, the FHA Lender would not so notify the Depositary Bank unless a default under the mortgage loan documents has occurred. 8

What about the “anti- assignment” provisions of the Medicare and Medicaid Laws? 9

10 Medicare and Medicaid laws contain "anti-assignment" provisions. Although not free from doubt, it is generally believed that requiring the Operator to direct the deposit of Medicare/Medicaid receivables into a bank account that is covered by a DACA that meets the requirements for control under the UCC violates these "anti-assignment provisions” by giving the FHA Lender the right to give instructions in connection with the account. Medicare and Medicaid laws contain "anti-assignment" provisions. Although not free from doubt, it is generally believed that requiring the Operator to direct the deposit of Medicare/Medicaid receivables into a bank account that is covered by a DACA that meets the requirements for control under the UCC violates these "anti-assignment provisions” by giving the FHA Lender the right to give instructions in connection with the account. Therefore, it is recommended that the Operator be required to maintain at least two separate bank accounts. Therefore, it is recommended that the Operator be required to maintain at least two separate bank accounts.

The first account (the "GHR Account") is an account into which all Medicare/Medicaid receivables are deposited. It is expected that the Operator, FHA Lender, Depositary Bank and, where applicable, the AR Lender will enter into a Deposit Account Instructions Service Agreement (“DAISA”) that requires the Depositary Bank to "sweep" the GHR Account daily (or less frequently with FHA approval) such that all funds deposited in the GHR Account are transferred to a second account of the Operator (the "Operating Account"). The first account (the "GHR Account") is an account into which all Medicare/Medicaid receivables are deposited. It is expected that the Operator, FHA Lender, Depositary Bank and, where applicable, the AR Lender will enter into a Deposit Account Instructions Service Agreement (“DAISA”) that requires the Depositary Bank to "sweep" the GHR Account daily (or less frequently with FHA approval) such that all funds deposited in the GHR Account are transferred to a second account of the Operator (the "Operating Account"). In view of the extended time period typically needed to redirect Medicare and Medicaid payments, the account used as the GHR Account will probably be the account that the Operator is currently using and into which Medicare/Medicaid payments are already being deposited. In view of the extended time period typically needed to redirect Medicare and Medicaid payments, the account used as the GHR Account will probably be the account that the Operator is currently using and into which Medicare/Medicaid payments are already being deposited. 11

In most instances, the Operating Account (which may be a newly opened account) will become the Operator's operating account. In addition to funds "swept" into the Operating Account from the GHR Account, all other income received by the Operator from the operation of the project is deposited into the Operating Account. The Operator pays project operating expenses, rent and/or debt service, as applicable, and distributions from the Operating Account. The Operator, FHA Lender, Depositary Bank and, where applicable, the AR Lender enter into a DACA that governs the Operating Account, thereby perfecting the FHA Lender's (and, where applicable, the AR Lender’s) security interest in the Operating Account. In most instances, the Operating Account (which may be a newly opened account) will become the Operator's operating account. In addition to funds "swept" into the Operating Account from the GHR Account, all other income received by the Operator from the operation of the project is deposited into the Operating Account. The Operator pays project operating expenses, rent and/or debt service, as applicable, and distributions from the Operating Account. The Operator, FHA Lender, Depositary Bank and, where applicable, the AR Lender enter into a DACA that governs the Operating Account, thereby perfecting the FHA Lender's (and, where applicable, the AR Lender’s) security interest in the Operating Account. 12

13

Does FHA require the use of specified forms of Deposit Account Agreements? 14

No. Sample forms of DACAs are posted at: No. Sample forms of DACAs are posted at: portal/page?_pageid=73, &_dad=portal&_schema=PORTAL portal/page?_pageid=73, &_dad=portal&_schema=PORTAL Most banks have their own forms of DACAs. It is acceptable to work from bank forms or forms prepared by the FHA Lender or the AR Lender, but FHA does expect all DACAs for projects without AR Financing to meet certain requirements, including the following: The DACA should provide that the Depositary Bank will comply with the FHA Lender's instructions as to the disposition of funds in the deposit account without further consent of the Operator (even if doing so contradicts the Operator's instructions or causes checks to be dishonored). The DACA should provide that the Depositary Bank will comply with the FHA Lender's instructions as to the disposition of funds in the deposit account without further consent of the Operator (even if doing so contradicts the Operator's instructions or causes checks to be dishonored). 15

The DACA should provide that the Depositary Bank may rely on the Operator's instructions regarding the deposit account until the FHA Lender delivers instructions to the contrary (sometimes referred to as a "Notice of Exclusive Control"). As a result, the Operator retains the right to direct disbursements from the deposit account until a Notice of Exclusive Control is delivered by the FHA Lender to the Depositary Bank. The DACA should provide that the Depositary Bank may rely on the Operator's instructions regarding the deposit account until the FHA Lender delivers instructions to the contrary (sometimes referred to as a "Notice of Exclusive Control"). As a result, the Operator retains the right to direct disbursements from the deposit account until a Notice of Exclusive Control is delivered by the FHA Lender to the Depositary Bank. Once a Notice of Exclusive Control is delivered, the Depositary Bank should agree to: (a) disregard any further instructions regarding the deposit account delivered by the Operator and block the Operator's access to the account; and (b) rely solely on the instructions of the FHA Lender regarding the deposit account, without further consent from the Operator. Once a Notice of Exclusive Control is delivered, the Depositary Bank should agree to: (a) disregard any further instructions regarding the deposit account delivered by the Operator and block the Operator's access to the account; and (b) rely solely on the instructions of the FHA Lender regarding the deposit account, without further consent from the Operator. 16

The Operator should not be able to terminate the DACA (or should be permitted to do so only if the FHA Lender consents). The Operator should not be able to terminate the DACA (or should be permitted to do so only if the FHA Lender consents). Any indemnification provisions should contain language indicating that HUD/FHA will not be subject to any indemnification obligations if the DACA is assigned to HUD/FHA. Such a provision may be necessary in order to comply with the federal Anti- Deficiency Act (31 U.S.C. Section 1341(a)(1)(B)), which provides that "An officer or employee of the United States Government or of the District of Columbia government may not... involve either government in a contract or obligation for the payment of money before an appropriation is made unless authorized by law….” Any indemnification provisions should contain language indicating that HUD/FHA will not be subject to any indemnification obligations if the DACA is assigned to HUD/FHA. Such a provision may be necessary in order to comply with the federal Anti- Deficiency Act (31 U.S.C. Section 1341(a)(1)(B)), which provides that "An officer or employee of the United States Government or of the District of Columbia government may not... involve either government in a contract or obligation for the payment of money before an appropriation is made unless authorized by law….” 17

The Depositary Bank should subordinate its right of setoff and security interest in the deposit account to the security interest of the FHA Lender. Typically, the FHA Lender agrees that the Depositary Bank can exercise its right of setoff to recover unpaid fees and returned items. The Depositary Bank should subordinate its right of setoff and security interest in the deposit account to the security interest of the FHA Lender. Typically, the FHA Lender agrees that the Depositary Bank can exercise its right of setoff to recover unpaid fees and returned items. Subject to limitations imposed by the Depositary Bank’s systems and procedures, the Depositary Bank should agree to provide the FHA Lender, upon the FHA Lender's request (which need only be made once), with: (a) whether by internet access or otherwise, on- line screen access to daily activity in the deposit account; and (b) copies of the periodic account statements delivered to Operator. The Operator's further consent should not be required for access to, or delivery of, such information. Subject to limitations imposed by the Depositary Bank’s systems and procedures, the Depositary Bank should agree to provide the FHA Lender, upon the FHA Lender's request (which need only be made once), with: (a) whether by internet access or otherwise, on- line screen access to daily activity in the deposit account; and (b) copies of the periodic account statements delivered to Operator. The Operator's further consent should not be required for access to, or delivery of, such information. 18

DACAs generally acknowledge that the deposit account is also subject to the terms of the agreements executed by the Depositary Bank and the Operator when the deposit account was opened. The DACA should provide, however, that, in the event of a conflict between the DACA and any other agreement, the terms of the DACA control. DACAs generally acknowledge that the deposit account is also subject to the terms of the agreements executed by the Depositary Bank and the Operator when the deposit account was opened. The DACA should provide, however, that, in the event of a conflict between the DACA and any other agreement, the terms of the DACA control. Standard provisions dealing with governing law, execution of counterparts, execution by facsimile (or other electronic) signature, successors and assigns, and similar provisions should be included. Standard provisions dealing with governing law, execution of counterparts, execution by facsimile (or other electronic) signature, successors and assigns, and similar provisions should be included. 19

What differences should there be between a DACA and a DAISA? 20

21 The DAISA should not grant the FHA Lender the right to direct disbursements from the GHR Account as in a DACA in order to avoid a conflict with the Medicare/Medicaid anti-assignment provisions. The DAISA should not grant the FHA Lender the right to direct disbursements from the GHR Account as in a DACA in order to avoid a conflict with the Medicare/Medicaid anti-assignment provisions. The DAISA should provide for the daily "sweep" of funds from the GHR Account into the Operating Account. Although it is preferable to provide for a daily sweep of funds into the Operating Account, the DAISA may, subject to approval by FHA, permit less frequent sweeping of the funds in the GHR Account if the cost of daily sweeps is excessive. The DAISA should provide for the daily "sweep" of funds from the GHR Account into the Operating Account. Although it is preferable to provide for a daily sweep of funds into the Operating Account, the DAISA may, subject to approval by FHA, permit less frequent sweeping of the funds in the GHR Account if the cost of daily sweeps is excessive.

22 Since the DAISA contains a sweep feature covering the transfer of all funds deposited in the GHR Account, it is not necessary to permit the Operator to continue to direct disbursements on the account nor to provide for delivery of a Notice of Exclusive Control. Since the DAISA contains a sweep feature covering the transfer of all funds deposited in the GHR Account, it is not necessary to permit the Operator to continue to direct disbursements on the account nor to provide for delivery of a Notice of Exclusive Control. Unlike a DACA, a DAISA should be terminable by the Operator in order to comply with the Medicare/Medicaid anti-assignment provisions. Unlike a DACA, a DAISA should be terminable by the Operator in order to comply with the Medicare/Medicaid anti-assignment provisions.

23 What related changes are needed to the other closing documents?

24 The Security Agreement (in the case of a mortgagor/operator) and the Lessee Security Agreement (in the case of a lessee/operator) (collectively, the "Security Agreements") should obligate the Operator to only open deposit accounts in connection with the FHA-insured project that are subject to a Deposit Account Agreement acceptable to the FHA Lender. The Security Agreement (in the case of a mortgagor/operator) and the Lessee Security Agreement (in the case of a lessee/operator) (collectively, the "Security Agreements") should obligate the Operator to only open deposit accounts in connection with the FHA-insured project that are subject to a Deposit Account Agreement acceptable to the FHA Lender. The Security Agreements should also provide that the Operator will not close a deposit account subject to a DAISA or terminate the DAISA without the prior written consent of the FHA Lender. The Security Agreements should also provide that the Operator will not close a deposit account subject to a DAISA or terminate the DAISA without the prior written consent of the FHA Lender. Note that the Security Agreement entered into with the mortgagor should include these provisions even if the project is being operated by a lessee in order to cover the possibility that the mortgagor might assume direct operation of the project in the future. Note that the Security Agreement entered into with the mortgagor should include these provisions even if the project is being operated by a lessee in order to cover the possibility that the mortgagor might assume direct operation of the project in the future.

25 So, what should an FHA Lender do?

26 Educate your borrowers and your borrowers’ lawyers. Educate your borrowers and your borrowers’ lawyers. As soon as you are engaged, analyze the Operator’s deposit accounts, determine if any new accounts will be needed and work with the Operator to assure that the proper accounts are in place. As soon as you are engaged, analyze the Operator’s deposit accounts, determine if any new accounts will be needed and work with the Operator to assure that the proper accounts are in place. As soon as you are engaged, work with your borrower and your borrower’s bank to obtain form deposit account agreements and then proceed to promptly negotiate the Deposit Account Agreements. As soon as you are engaged, work with your borrower and your borrower’s bank to obtain form deposit account agreements and then proceed to promptly negotiate the Deposit Account Agreements. Submit the Deposit Account Agreements to FHA for review well in advance of closing. Submit the Deposit Account Agreements to FHA for review well in advance of closing.

27 In those cases where there is a deposit account agreement in place in favor of a lender that is being paid off, arrange for the termination of such agreement at or promptly after closing. In those cases where there is a deposit account agreement in place in favor of a lender that is being paid off, arrange for the termination of such agreement at or promptly after closing. Monitoring duties of the FHA Lender (and OIHCF Asset Management) are under development. Monitoring duties of the FHA Lender (and OIHCF Asset Management) are under development. At a minimum, when you know that an Operator is opening a new account, obtain a satisfactory deposit account agreement for that account. At a minimum, when you know that an Operator is opening a new account, obtain a satisfactory deposit account agreement for that account.