Mortgage Loan Term Sheets Are So Long; So, Why Are They Missing All Of The Provisions Borrowers Should Be Looking For? Part 1.

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 We think it’s called “document creep.” When documents were hand-written, they were pretty short and the world survived. Then, along came the typewriter, and a three page mortgage and a five page lease were probably seen to be somewhat burdensome by the party most burdened. Then, as typing got faster, the documents got longer. Rudimentary word processors, such as memory typewriters, made it easy to go even longer. Modern word processing allows for 100-plus page mortgages, leases, and other documents. Yes, now, we’re able to craft super-long documents “in a single bound.”

Even the term sheets for loans have succumbed to this “document creep.” A dozen or more pages? – No sweat. Doesn’t this benefit everyone, having a complete set of loan terms right up front so that the lawyers don’t wind up negotiating important items while the “outside closing date” looms close? Wish that were the case, because, as lengthy and detailed loan term sheets are getting (call them commitment letters, loan applications or whatever), for some reason they don’t exactly cover all of a borrower’s concerns. Ruminations doesn’t mean “all of a ‘particular’ borrower’s concerns.” We mean all of the concerns that any (or every) borrower should or does have. Like what, you ask? Like, the kinds of items we’ll be covering this week and next (and maybe even the one after that).

Interest on Reserves. With serious and, increasingly, with less than serious loans, the borrower is required to fund reserve accounts. These accounts might be to cover repairs that must be done shortly after the loan closing. They might be required to cover capital repairs. They might be required to cover re-letting expenses (including for expected fit-up costs and brokerage fees) down the road. Almost always, they might be used to fund tax and insurance payments. These funds should be held in interest bearing accounts, with interest to be added to the reserve balance. Lenders are generally amenable to this, though less so when it comes to tax and insurance escrows. If you don’t ask for interest, you won’t get it. So, ask. Be prepared for a surprise.

Caps on Reserves. Some reserve requirements, such as for re-letting expenses, call for monthly payments into the reserve account. If the Loan Term Sheet forgot to set a cap on the amount to be held in the reserve, ask for one.

Reserves for Taxes and Insurance. For a fair number of loans, this “knee-jerk, standard” loan requirement can be waived until an Event of Default occurs.

Transfers. There are two kinds of these – those related to a sale of the property (and transfers akin to those), and those involving transfers of the interests held by the owners of the borrowing entity. We’ve never seen any commercial loan (as contrasted with a seller-loan) bar the sale of the mortgaged property, but such a sale would trigger any applicable pre-payment monetary obligation (3-2-1, yield maintenance, defeasement, whatever). So, ask for the right to have a (qualified) purchaser acquire the property and assume the loan (and any guarantor) requirements. And, don’t settle when the lender says, “OK, but only once.” There will be a (negotiable) assignment fee (often starting at 1%), but that beats the pants off of a yield maintenance payment requirement. Be aware, however, if the price of the mortgaged property has risen “too much” since the time of the initial loan, assumption of the existing “smaller” loan, with the restrictions that the existing loan will almost certainly have on secondary financing, may make this approach unworkable or greatly limit the number of possible buyers (who would have to come up with more cash than otherwise would be required with a new, larger, replacement loan).

Loan Term Sheets (now) almost always bar transfers of the ownership interests in the borrowing entity without first obtaining the lender’s consent. On its face, that restriction can make sense because such transfers could effectively mimic a sale of the mortgaged property. Ruminations isn’t going to get into the issue as to “so what” if the loan is a no-recourse loan, the non-recourse carve out guarantor remains unchanged or is replaced with one just as good, and the property is professionally managed on a day-to-day basis, because that’s for another day. Nonetheless, when written in such an absolute way, a borrower’s owner would need the lender’s approval before scheduling a funeral. More importantly, such requirements adversely impact estate planning or the resolution of “partner” disputes.

To address these issues, Ruminations suggests that borrowers tell prospective lenders that the loan should permit inter-owner transfers and transfers to spouses and issue and spouses of issue (directly or through entity vehicles) for estate planning purposes. Borrowers should expect an affirmative response, though it will be conditioned on some limitations as to quantum and some assurances as to continuing control by a key person.

Oh, yes – watch out for the “fee” a lender proposes to charge for one of those “permissible” transfers. The cost should be a lot less than for approval of a loan assumption by a buyer of the mortgaged property.

Changes in Control of Borrower. A close relative of the overall issue of permissible transfers, is the common Loan Term Sheet requirement that a designated individual remain in “control” of the Borrower. Ask yourself, “Why that person”? If the success of the property is truly dependent on the named individual, then the lender has a basis for insisting that it have the right to decide on the qualifications of any replacement. If, on the other hand, the property is really run by a day-to-day property manager, then almost any honest person, not on any of the exclusion lists, should be acceptable to the lender provided that the property manager is qualified to run a property of that type and scope. Borrowers should ask that the Loan Term Sheet reflect that reality

Changes in Guarantor. A loan guarantor has enough stake in seeing that the guaranty trip wires are not triggered that she or he (or it) doesn’t need to have control over the borrowing entity or even a financial stake in the borrowing entity (so long as there is some other consideration to support the validity of the guaranty). Further, on the death of a guarantor, her or his estate succeeds to the decedent as guarantor. So, a Loan Term Sheet should make clear that the loan is not triggered on the death of a guarantor. In such a case, and where the guarantor can find someone or some entity to “take over” the guaranty obligations (which might be needed if there is a “partner” buy-out), the lender should be required to accept a substitute guarantor reasonably satisfactory to lenders in general.

Recourse Guaranties. This is too complex for a short-hand treatment. Perhaps, when time and confidence allow, Ruminations will “go there.” For today, all we will describe is how to handle the two basic categories of items for which a “Recourse Guarantor” will be liable under a “Bad Acts” or “Recourse Guaranty” as well as one other “little” aspect of this topic. Of course, these comments apply to non-recourse loans. What is a “non-recourse” loan? To us, these are loans where the lender has agreed to assume the “credit” risk, but not the risk that the borrower, or someone related to the borrower, will impair the lender’s ability to collect the debt or realize upon the collateral.

What kind of items might those be for which a guarantor will stand behind all or part of the loan? They could include the borrower putting itself into bankruptcy or cooperating with a creditor who does so. They could include not paying the real estate taxes when there are funds to pay those taxes. In the first case, a voluntary or conspired bankruptcy filing, the Recourse Guarantor would be expected to cover the entire loan. There are other, similar, “big problem” triggers like that. In the second case, unpaid real estate taxes that could have been paid from the property’s cash flow, the Recourse Guarantor shouldn’t be expected to assume the entire loan, only what it costs the lender by reason of the taxes going unpaid. Generally, where a lender would only be exposed to the need to make an out-of-pocket disbursement or to the loss of “diverted” funds that would have gone to pay the mortgage, the Recourse Guarantor’s liability should be limited to those amounts and not answer for the entire unpaid loan balance.

The limited examples above are just that, limited. Expect that of 15 or so obligations a Recourse Guarantor is expected to answer for, only five should trigger full liability for the loan.

Those two examples bear upon the “little” aspect we promised to touch upon. Recourse Guaranties should not be triggered by the borrower’s inability to pay the loan from the cash flow of the mortgaged property. So, a “trigger” based on the borrower “admitting its inability to pay its debts as they come due” shouldn’t trigger a Recourse Guarantor’s guaranty obligations. Similarly, the failure to pay taxes or repair the property or other items like those shouldn’t be “guaranteed” by the Recourse Guarantor if the borrower didn’t have the money to pay those items or fix those things. Borrowers, watch out for Loan Term Sheets that say or imply otherwise. Even where a Loan Term Sheet doesn’t explain the terms of a “Recourse Guaranty,” it might be wise to ask that it be amended to cover the foregoing concepts.

It is now time for some caveats. We have made no attempt to set out the kinds of legitimate responses that might come from a lender. That’s because lenders don’t need much help from the likes of us. They engage talented counsel who have heard all of this before. If a particular lender doesn’t engage talented counsel, it should. Otherwise, it isn’t be good for them, and isn’t fair to borrowers.

Also, don’t expect to find, on the lender’s shelves, all of the items of concern to a borrower we’ve put on our shopping list. And, borrowers, pick your battles.

Most importantly, don’t miss next week’s carton of Ruminations milk picturing other missing provisions from Loan Term Sheets.


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