NOTE 8 — DEBT, NOTES PAYABLE AND SPECIAL ASSESSMENT OBLIGATIONS

At December 31, 2013 and 2012, our debt, notes payable and special assessment obligations consisted of the following (in thousands):



	December 31,
	2013		2012
			(restated)

Convertible note payable dated June 7, 2011, secured by substantially all Company assets, bears contractual annual interest at 17%, of which 12% is payable in cash and 5% may be deferred, matures June 2016, carrying amount net of discount of $5.4 million and $7.5 million at December 31, 2013 and 2012, respectively	$	54,975	$	49,961
Note payable assumed on May 14, 2013 in connection with a deed-in-lieu of foreclosure acquisition, secured by two operating hotel properties, bears annual interest of 12%, matures March 28, 2014 (extended to March 2017 subsequent to year end)	24,618		—
Exit fee payable in connection with $50 million convertible note payable dated June 7, 2011, matures June 2016, related discount being amortized into convertible loan balance	10,448		10,448
Note payable dated February 15, 2013, secured by an operating commercial building and other real estate, bears annual interest of 12%, matured February 19, 2014 (paid off subsequent to year end)	10,000		—
Note dated December 31, 2009, secured by residential lots, non-interest bearing (12% imputed interest), matured December 31, 2012, unamortized discount of $0 at December 31, 2013 and 2012. In accordance with bankruptcy ruling, $3.1 million of principal is subject to 5% annual interest commencing October 1, 2012	5,220		5,220
Liens secured by residential property acquired in 2013 in connection with a guarantor settlement	3,787		—
Community facility district bonds dated 2005, secured by residential land located in Buckeye, Arizona, annual interest rate ranging from 5%-6%, matures April 30, 2030	3,465		3,699
Settlement payable dated June 2012 with a municipality for outstanding property tax and related obligations for certain parcels payable over five and ten years, bearing annual interest of 10%, maturing in June 2017 and 2022, respectively.	2,268		3,308
Special assessment bonds dated between 2002 and 2007, secured by residential land located in Dakota County, Minnesota, annual interest rate ranging from 6%-7.5%, maturing various dates through 2022	1,874		2,332
Development assistance note payable to Apple Valley Economic Development Authority, dated March 29, 2013, secured by developmental real estate, annual interest rate 6%, maturing December 31, 2016. Expected to be forgiven upon completion of Apple Valley, MN development project, subject to various requirements	150		—
Note dated September 26, 2012 secured by commercial land with a carrying value of $1.3 million, bears annual interest at 4%, matures September 26, 2015.	—		850
Totals	$	116,805	$	75,818

Interest expense for years ended December 31, 2013, 2012 and 2011 was $19.2 million, $15.2 million and $9.8 million, respectively. As discussed in note 15, subsequent to December 31, 2013, the Company repaid outstanding indebtedness in the amount of $10 million.

Convertible Notes Payable/Exit Fee Payable

On June 7, 2011, we entered into and closed funding of a $50.0 million senior secured convertible loan with NW Capital. The loan matures on June 6, 2016 and bears interest at a rate of 17% per year. The lender elected to defer all interest due through December 7, 2011 and 5% of the interest accrued from December 8, 2011 to December 31, 2011. Thereafter, the lender, at its sole option, may make an annual election to defer a portion of interest due representing 5% of the total accrued interest amount, with the balance 12% payable in cash. The lender made its election to defer the 5% portion for the years ended December 31, 2013 and 2012 and subsequent to year end, the lender also elected to defer for the year ending December 31, 2014. Deferred interest is capitalized and added to the outstanding loan balance on a quarterly basis. As of December 31, 2013 and 2012, deferred interest added to the principal balance of the convertible note totaled $10.4 million and $7.4 million, respectively. Interest is payable quarterly in arrears beginning on January 1, 2012, and thereafter each April, July, October and January during the term of the loan.

In addition, we are required to pay an exit fee (“Exit Fee”) at maturity equal to 15% of the then outstanding principal, unpaid accrued and deferred interest and other amounts owed under the loan agreement. The Exit Fee is considered fully earned under the terms of the loan agreement and has been recorded as a liability with an offsetting amount reflected as a discount to the convertible note payable. The Exit Fee and corresponding discount of $10.4 million was estimated assuming the lender elects its annual interest deferral option over the term of the loan. This amount is being amortized to interest expense over the term of the loan using the effective interest method. As of December 31, 2013 and 2012, the unamortized discount totaled approximately $5.4 million and $7.5 million, respectively. The amortized discount added to the principal balance of the convertible note during the years ended December 31, 2013 and 2012 totaled approximately $2.0 million and 2.0 million, respectively.

Debt issuance costs incurred in connection with the NW Capital closing are being amortized over the term of the loan using the effective interest method. With the contractual interest, and the amortization of the Exit Fee and related deferred financing costs, the effective interest rate under the NW Capital loan is approximately 23%. The loan is severally, but not jointly, guaranteed by substantially all of our existing and future subsidiaries, subject to certain exceptions and releases, and is secured by a security interest in substantially all of our assets. The loan may not be prepaid prior to December 7, 2014 and is subject to substantial prepayment fees and premiums. At the time of prepayment, if any, we would also be required to buy back all of the common shares then held by NW Capital or its affiliates which were acquired from our former CEO or from any tender offer by NW Capital at a purchase price equal to the greater of (a) NW Capital’s original purchase price and (b) the original purchase price plus 50% of the excess book value over the original purchase price.

The proceeds from the loan may be used: for working capital and funding our other general business needs; for certain obligations with respect to our real property owned, and, as applicable, the development, redevelopment and construction with respect to certain of such properties; for certain obligations with respect to, and to enforce certain rights under, the collateral for our loans; to originate and acquire mortgage loans or other investments; to pay costs and expenses incurred in connection with the convertible loan; and for such other purposes as may be approved by NW Capital in its discretion.

Conversion Feature

The loan is convertible into IMH Financial Corporation Series A preferred stock at any time prior to maturity at an initial conversion rate of 104.3 shares of our Series A preferred stock per $1,000 principal amount of the loan, subject to adjustment. The Series A preferred stock has a liquidation preference per share of the greater of (a) 115% of the $9.58 per share original price, plus all accumulated, accrued and unpaid dividends (whether or not declared), if any, to and including the date fixed for payment, without interest; and (b) the amount that a share of Series A preferred stock would have been entitled to if it had been converted into common stock immediately prior to the liquidation event or deemed liquidation event. Each share of Series A preferred stock is ultimately convertible into one share of our common stock. The initial conversion price represents a 20% discount to the net book value per share of common stock on a GAAP basis as reported in our audited financial statements as of December 31, 2010.

Dividends on the Series A preferred stock will accrue from the issue date at the rate of 17% of the issue price per year, compounded quarterly in arrears. A portion of the dividends on the Series A preferred stock (generally 5% per annum) is payable in additional shares of stock. Generally, no dividend may be paid on the common stock during any fiscal year unless all accrued dividends on the Series A preferred stock have been paid in full. However, the lender agreed to allow the payment of dividends to common stockholders for up to the first seven quarters following the loan closing in an annual amount of up to 1% of the net book value of the Company’s common stock as of the immediately preceding December 31.

All issued and outstanding shares of Series A preferred stock will automatically convert into common stock upon closing of the sale of shares of common stock to the public at a price equal to or greater than 2.5 times the $9.58 conversion price in a firm commitment underwritten public offering and listing of the common stock on a national securities exchange within three years of the date of the loan, resulting in at least $250.0 million of gross proceeds.

Mandatory Redemption

We are obligated to redeem all outstanding shares of Series A preferred stock on the fifth anniversary of the loan date in cash, at a price equal to 115% of the original purchase price, plus all accrued and unpaid dividends (whether or not earned or declared), if any, to and including the date fixed for redemption, without interest. In addition, the Series A preferred stock has certain redemption features in the event of default or the occurrence of certain other events.

Restrictive Covenants

The loan agreement also contains certain restrictive covenants which require NW Capital’s consent as a condition to our taking certain actions. The restrictive covenants relate to our ability to sell or encumber our assets, issue additional indebtedness, restructure or modify our ownership structure, settle litigation over $10.5 million, enter into new material agreements and other operational matters.

Deferred Financing Costs

In connection with the NW Capital closing, we incurred approximately $8.0 million of debt issuance costs, which is included in deferred financing costs, net of accumulated amortization, on the accompanying consolidated balance sheet. These costs include legal, consulting and accounting fees, costs associated with due-diligence analysis and the issuance of common stock to an outside consultant directly associated with securing the $50.0 million in financing. These costs are being amortized over the term of the loan using the effective interest method.

Other Notes Payable Activity

As described in Note 4, during the year ended December 31, 2013, we assumed a note payable with a balance of $24.6 million at December 31, 2013 from a bank in connection with a deed-in-lieu of foreclosure that is secured by the related hotel operating properties with a gross asset basis of approximately $83.0 million at December 31, 2013. The note payable bears annual interest of 12%, with required monthly payments of principal and interest and the outstanding principal due at maturity. The note matures on March 28, 2014. We obtained approval from NW Capital in connection with this financing. Subsequent to December 31, 2013, we negotiated with the lender to extend the maturity date of the loan for a three year period at a reduced annual interest rate of 8.0%, with interest only payments for the first year of the loan, and monthly payments of approximately $0.2 million thereafter until maturity.

During the year ended December 31, 2013, we secured financing of $10.0 million from CanPartners that is secured by certain REO assets with a carrying value of $24.8 million at December 31, 2013. The note payable bears annual interest of 12%, with required monthly payments of interest and the outstanding principal due at maturity. The note matured in February 2014 at which time the balance was repaid in full. Under the terms of the loan, we were required to maintain a minimum $5.0 million balance of cash and cash equivalents. We obtained approval from NW Capital in connection with this financing.

During the year ended December 31, 2013, we acquired a residential property with a fair value of $3.8 million in connection with a judgment obtained against a former guarantor on certain mortgage loans. The residential property is subject to four liens which have sole recourse to the residential property. Such liens aggregate approximately $22.4 million in principal, exclusive of unpaid interest. We have recorded such liens at their fair value, which was determined to be the fair value of the related asset which totals $3.8 million at December 31, 2013.

In connection with our proposed development to construct a multifamily housing development in Apple Valley, Minnesota, during the year ended December 31, 2013, we entered into, among other agreements, a business subsidy agreement and related loan agreement dated March 29, 2013 with the Apple Valley Economic Development Authority (EDA). Under the terms of the business subsidy agreement, the EDA has agreed to advance to us up to $1.1 million in the form of a loan. The amount of the loan shall not exceed the amount received from Dakota County for the statutory penalty and interest on special assessment taxes, which were assessed in the tax years 2007 through 2011, for which we have recorded a liability. If we complete the development project as intended no later than December 31, 2015, and certain other conditions are satisfied, and no event of default occurs, the EDA is expected to forgive the loan in its entirety. The loan bears interest at the rate of 6.0% per annum and shall accrue until the loan is satisfied or paid in full. If we do not meet the specified goals, the loan and all accrued unpaid interest must be repaid on or before December 31, 2016. In addition, under the agreement, we are not allowed to sell, transfer or otherwise convey all or part of the property for a period of five years following completion without the prior written consent of EDA. As of December 31, 2013, the total amount advanced to us under the loan agreement was $0.2 million.

In conjunction with our Apple Valley, Minnesota development project described above, we also entered into a settlement agreement in June 2012 with the municipality with respect to outstanding past due property taxes, penalties and interest on various parcels totaling $3.7 million and bearing annual interest of 10%. Under the terms of the settlement agreement, we are required to make annual payments over either a five or ten year period, depending on the parcel. Upon execution of the agreement, we were required to make an immediate payment for the first annual installment totaling $0.4 million. During 2013, we sold certain parcels to the City of Apple Valley, the proceeds of which were required to be used to pay the related settlement balance due on such parcels of $0.7 million. We also paid the annual installment for remaining parcels in 2013 in the amount of $0.3 million. The outstanding balance of the settlement obligation totaled $2.3 million and $3.3 million at December 31, 2013 and 2012, respectively.

Under the terms of a previous settlement agreement in 2010, we executed two promissory notes for certain golf club memberships totaling $5.2 million. The notes are secured by the security interest on the related residential lots, were non-interest bearing and matured on December 31, 2012. Due to the non-interest bearing nature of the loans, in accordance with applicable accounting guidance, we imputed interest on the notes at our incremental borrowing rate of 12% per annum and recorded the notes net of the discount. The discount was being amortized to interest expense over the term of the notes and totaled approximately $0.6 million and $0.5 million during the years ended December 31, 2012 and 2011, respectively, and was fully amortized as of December 31, 2012. During the years ended December 31, 2013 and 2012, we made principal payments of $0 and $90,000 under the note of in connection with the sale of residential lots. We are continuing to accrue interest at the default rate of 10% per annum. At December 31, 2013 and 2012, the net principal balance of the notes payable remained unchanged at $5.2 million and default interest reflected in accrued interest payable totaled $1.1 million and $0.5 million at December 31, 2013 and 2013, respectively. The notes are secured by certain REO assets that have a carrying value of approximately $4.8 million as of December 31, 2013. During the year ended December 31, 2012, we defaulted for strategic reasons on the terms of an agreement related to the loan, which resulted in an acceleration of the maturity date of such debt. The lender filed a notice of delinquency and a notice of trustee sale was scheduled for June 12, 2012. The subsidiary that owns these assets was placed into bankruptcy which stayed the trustee sale. In addition, since this strategic default and bankruptcy constituted an event of default under the NW Capital loan, management obtained a waiver from NW Capital regarding this action. During the year ended December 31, 2013, the bankruptcy court rejected our proposed plan of reorganization and lifted the stay on the trustee sale. However, we sought and obtained leave to appeal with the district court which stayed the bankruptcy court's order. As a result, the lender is presently stayed from conducting its trustee sale until the district court decides the appeal, the timing of which is undeterminable at this time. The related REO asset is currently stated at its net realizable value. Should the creditor take title to the REO asset as a result of the lift of the stay of the trustee sale, the carrying value of the REO will be charged to operations and the debt obligation and accrued interest will be credited to operations to the extent it is legally defeased by such action.

During the year ended December 31, 2012, we entered into a note payable with a bank in the amount of $0.85 million in connection with the acquisition of certain land situated adjacent to another property owned by us. The note payable was secured by the land purchased, had an annual interest rate of 4% and was to mature in September 2015. We obtained approval from NW Capital for this new indebtedness. The note required interest only payments through September 2013, with principal and interest payments commencing in October 2013 through maturity. The note payable was repaid in full in the first quarter of 2013.

CFD and Special Assessment Obligations

We have recorded certain obligations assumed for the allocated share of CFD special revenue bonds and special assessments totaling approximately $5.3 million and $6.0 million at December 31, 2013 and 2012, respectively, secured by certain real estate acquired through foreclosure in prior years. These obligations are described below.

One of the CFD obligations had an outstanding balance of approximately $3.5 million and $3.7 million as of December 31, 2013 and 2012, respectively, and has an amortization period that extends through April 30, 2030, with an annual interest rate ranging from 5% to 6%. The CFD obligation is secured by certain real estate held for sale consisting of 171 acres of unentitled land located in Buckeye, Arizona which has a carrying value of approximately $4.9 million at December 31, 2013. In addition, during the year ended December 31, 2012, we defaulted for strategic reasons on the obligation payment due and the taxing authority filed a notice of potential sale of the related real estate. Such real estate assets are owned by a wholly owned subsidiary of the Company, which was placed into bankruptcy, and management obtained approval from NW Capital regarding this action. Management engaged appropriate advisors to work towards a resolution of this issue. In connection with a proposed sale of the project, the bankruptcy case was dismissed and the lender provided a forbearance on the debt default until December 2013, at which time a payment of approximately $0.8 million was paid to bring the debt balance current.

The other CFD obligations are comprised of a series of special assessments that collectively had an outstanding balance of approximately $1.9 million and $2.3 million as of December 31, 2013 and 2012, respectively. The CFD obligations have amortization periods that extend through 2022, with annual interest rates ranging from 6% to 7.5%. The CFD obligations are secured by certain real estate held for development consisting of 15 acres of unentitled land located in Dakota County, Minnesota which has a carrying value of approximately $5.7 million at December 31, 2013. Such real estate assets are owned by a wholly-owned subsidiary of the Company. During the year ended December 31, 2013, we made a principal repayment totaling $0.3 million in connection with the sale of certain lots to the municipality.

The responsibility for the repayment of these CFD and special assessment obligations rests with the owner of the property and, accordingly, will transfer to the buyer of the related real estate upon sale. Accordingly, management does not anticipate that these obligations will paid in their entirety by the Company. Nevertheless, these CFD obligations are deemed to be obligations of the Company in accordance with GAAP because they are fixed in amount and for a fixed period of time.

Our debt, notes payable, CFD and special assessment obligations have the following scheduled maturities (in thousands):



Year	Amount (1)
Past due and in default	$	5,220
2014	14,490
2015	1,203
2016	67,000
2017	24,039
2018	630
Thereafter	4,223
Total	$	116,805

(1) The foregoing table reflects the extension of the maturity date of the $24.6 million loan for a three year period that was negotiated with the lender subsequent to December 31, 2013.