Log in Sign up for free
Legal glossary

REMIC related covenants: Overview, definition, and example

REMIC (real estate mortgage investment conduit) related covenants refer to specific contractual provisions included in the formation or operation of a REMIC that govern the actions of the issuer, servicer, or other parties involved in the investment structure. REMICs are a type of special-purpose vehicle (SPV) used for pooling and securitizing mortgages, and the covenants related to REMICs are designed to ensure compliance with the tax and legal requirements associated with such structures. These covenants typically address issues such as the treatment of the mortgage pool, the allocation of income and expenses, and restrictions on the transfer or disposition of assets in the REMIC. The goal of REMIC related covenants is to maintain the tax-advantaged status of the entity, typically under Section 860D of the Internal Revenue Code, which allows REMICs to avoid certain taxes if they adhere to the prescribed rules.

REMIC related covenants are important because they ensure that the REMIC structure remains compliant with tax laws, thereby preserving its status as a tax-exempt entity. The covenants help to prevent activities that could result in the disqualification of the REMIC, which could expose the REMIC and its investors to unwanted tax liabilities. These covenants also protect the interests of investors by establishing clear rules for the management of the mortgage pool, the distribution of income, and the handling of defaults or prepayments. Without these covenants, the REMIC structure could be at risk of violating tax rules, potentially leading to penalties or a loss of the tax benefits associated with the structure.

For example, a REMIC is created to pool together residential mortgage loans and issue mortgage-backed securities (MBS) to investors. One of the REMIC related covenants in the agreement may specify that the mortgage loans within the REMIC must remain in the pool for a certain period, and the servicer is prohibited from selling or transferring any of the loans to another entity without meeting specific conditions. This covenant helps ensure that the REMIC complies with the "qualifying mortgage" requirements under the tax code, which is necessary for maintaining its tax-exempt status.

In another example, a covenant may require that all mortgage payments received by the servicer be allocated to the specific class of securities held by investors in a way that meets the timing and payment priorities established in the REMIC’s governing documents. The purpose of this covenant is to ensure that income is distributed appropriately among the different classes of securities, protecting the interests of investors and ensuring compliance with tax regulations.

Here’s how a REMIC related covenant clause might appear in a pooling and servicing agreement or a trust indenture:

“The Servicer shall ensure that the mortgage loans held within the REMIC shall not be sold, transferred, or otherwise disposed of in any manner that would result in a violation of Section 860D of the Internal Revenue Code, and shall take all necessary steps to maintain the REMIC’s qualification for tax-exempt status under the applicable provisions of the Code. Any such transfer or disposition must be approved by the Trustee and comply with the guidelines set forth in this Agreement.”

Conclusion

REMIC related covenants are essential provisions that help maintain the tax-exempt status and operational integrity of REMICs. These covenants govern how the mortgage pool is managed, how income and expenses are allocated, and what actions can or cannot be taken by the parties involved in the REMIC. By ensuring compliance with the relevant tax laws and protecting the interests of investors, REMIC related covenants play a critical role in the successful operation of mortgage-backed securities and the broader real estate investment market.

This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.

Last updated