Distressed real estate markets sometimes cause defaults in even the best mortgage loans. In those circumstances, unless the relationship between the borrower and the lender has deteriorated beyond repair, both may benefit from restructuring the loan.
Benefit to Borrower
The primary benefit to the borrower is the obvious one of avoiding foreclosure or bankruptcy. Additionally, the lender might be willing to lower the interest rate, defer a portion of the interest to a later date, extend payment terms or even advance additional funds for tenant finish or necessary repairs that will increase the rental stream.
Benefit to Lender
Most lenders prefer a performing loan, even at a below market rate, to owning and managing property. Restructuring a loan may also afford the lender an opportunity to obtain additional collateral or an additional guaranty, and to correct deficiencies in earlier documentation.
Issues to Consider
There are several issues which should always be evaluated when considering a workout.
Third-Party Consent. It is always advisable to obtain consent to the terms of a workout from guarantors or others who have liability under the loan. Failure to do so may discharge the guarantor. It is also advisable to obtain the consent, or confirm the subordination, of any junior lienholders if restructuring the loan adds debt or otherwise increases the burden on the loan collateral.
Bankruptcy Protections. Consider adding provisions insulating the lender from bankruptcy problems, including requiring the collateral and the debt be transferred to a single purpose entity or a bankruptcy remote entity, and modifying the borrower's governing documents to require independent director and/or unanimous board action to approve any bankruptcy filing.
Pre-Negotiation Agreements. Once the prospect of a workout is on the table, it is advisable to have a preliminary agreement between the lender and the borrower regarding the ground rules for negotiations. For example, if any loan modification requires approval of a loan committee, this limitation on the loan officer's authority should be expressly stated and acknowledged in writing by the borrower.
Title Insurance. Title insurance protections available in connection with a workout agreement include: endorsements for usury, non-imputation, shared appreciation, and interest on interest and compounding of interest, variable interest rates, negative amortization, deletion of an exception for creditor's rights, and deletion of the arbitration provision.
The Troubled Credits & Distressed Properties practice group has substantial experience in the areas of credit workouts, including consensual modifications, foreclosures, receiverships and bankruptcy. For more information on this Client Alert or for help evaluating your current situation, contact any of the attorneys in the Troubled Credits & Distressed Properties practice group (for a listing, click here).
Our lawyers are pleased to present timely, topical issue alerts on the latest legal developments, trends and other subjects of interest to our clients and colleagues. Otten Johnson publishes Client Alerts on a monthly basis.
This Client Alert has been prepared for informational purposes only and does not constitute legal advice or the opinion of Otten Johnson. Receipt of this summary does not create an attorney-client relationship between you and Otten Johnson. You should not act or rely on any information in this article without seeking the advice of an attorney. Otten Johnson provides legal advice only after being engaged to do so by a client with respect to particular facts and circumstances. Click here to read our full disclaimer.