The past few weeks have been very difficult for borrowers, especially in the hospitality and retail sectors. While there are many unknowns surrounding COVID-19 and its impact on our health and economy, we know that the impact on the operations and economic performance of real estate assets will be profound. Many homeowners are already struggling to meet their debt service and fund their reserve requirements. As the COVID-19 restrictions and layoffs materialize, the resulting impact on real estate appraisals is likely to result in otherwise performing loans that will not meet debt service ratios, the yield of debt, LTV and other covenants.
To overcome this crisis, borrowers and lenders will have to work together. Here we summarize what lenders should ask borrowers in order to restructure or extend a loan or to agree to refrain from taking enforcement action.
The first step: the pre-negotiation agreement
Before entering into forbearance or practice discussions with a borrower, the lender should require the borrower to sign a pre-negotiation agreement. Even if the loan is not yet in default, but the borrower has indicated that default is likely or wishes to discuss forbearance or possible loan restructuring terms, a pre-negotiation agreement is a good idea. important first step. A pre-negotiation agreement simply recognizes that both parties have agreed to engage in negotiations and that neither party is obligated or committed to a course of action until a final written agreement is reached. and executed by all parties. Pre-negotiation agreements will usually require the borrower to acknowledge that the loan is in default (if any), the exact amounts owed, and that the loan agreements are still in full force. A form of pre-negotiation agreement is attached in Annex 1.
Examine the loan file
Simultaneously with signing a pre-negotiation agreement with the borrower, the lender must also review all documents in their loan file to ensure that all of their rights have been properly perfected and that in the case of loans CMBS / CLO, all rights have been properly assigned or transferred to a trust entity. Along with home assets, the lender should ensure that he has a comfort letter from the franchisor and also that the rights under the comfort letter have been assigned or transferred to the appropriate party. A formal review of all loan documents should be undertaken to identify deficiencies that need to be corrected.
Declare a default value
If and when a borrower defaults on the loan documents, the lender must send (or have their legal advisor sent) a default letter. The lender must be clear in the default letter; this means expressly using the word “default” and citing the applicable provision (s) of the loan documents. Failure to follow this step could clear the fault after a certain period of time. Where applicable, a default letter will also begin any applicable notice and / or cure period. After any Healing Period has expired, or if there is no Healing Period, the Lender must send an Accelerator / Default Event Notice requiring full payment of the Debt. The acceleration / default event notice may also revoke the rent collection license (frequently setting the start date in case of exclusion of recourse liability for subsequent misapplication). Reserves can also be applied at this time, and offsets with other accounts that the borrower has with the lender can be made. In addition to other benefits, putting the loan in default increases the lender’s leverage for the practice negotiations. A default letter form is attached as Annex 2.
The next step (option 1): Restructuring or modifying the loan
From a business perspective, each party should contribute something that is generally beneficial to the other party in a loan restructuring. The essential economic aspects are generally changed. the borrower’s “wish list” for a loan modification usually consists of one or more of the following:
- Capital reduction / discounted reimbursement
- Reduced interest rate
- Reduced or deferred amortization
- Canceled or deferred payments
- Waiver or reduction of performance maintenance and other financial covenants
- Modified (more realistic) guidelines on the rental or sale of condos
- Access to reserves held by the lender
- Flexibility for new partners or subordinated debt
the lender’s “wish list” for a loan modification usually consists of one or more of the following:
- Loan repayment or other infusion of cash
- Additional guarantee
- Increase the interest rate or amortization; shorten the period to maturity
- Add guarantors or use a non-recourse loan
- Establish future receiverships (taxes, insurance, capital and debt service reserves, tenant work)
- Activate or set up a cash management lockbox that controls cash flow
- Obtain / require additional property information or reports
- Reduce / eliminate borrower rights such as partial releases / substitution of collateral
- Increase / improve lender rights such as budget approval or leasing
- Correct legal weaknesses / deficiencies in existing documents
- Waive any compensations, defenses or liability claims of existing lenders
- Change of property management / leasing agent
The next step (option 2): forbearance agreements
Forbearance agreements are different from loan modifications. In forbearance, the lender (i) sees little chance for a borrower to return the property; a restructuring would simply delay the inevitable and could lead to a further deterioration in property value or (ii) believes that property struggles are fairly short-term or result from broad systemic disruptions (such as the current COVID crisis). 19); a “pause” in enforcement action could give the borrower (and the economy as a whole) a chance to turn around the property. In a forbearance, the parties acknowledge that the loan is in default and that the loan remains in default, but the lender also “refrains” from enforcing the remedies and perhaps makes further concessions for a relatively short period of time. so that the borrower can try to find a way out of the problem, without giving up the underlying defaults. The abstention agreements come in short and long term variants (reinstatement).
The “short-term” forbearance agreement
Short-term forbearance agreements are fairly straightforward. Following a default, borrowers may request a short period of time to allow the economy to recover or to arrange for repayment of the loan. A borrower may request a short-term waiver or deferral of loan payments, or a waiver of: (i) default interest; (ii) exit costs; (iii) early redemption premium; or (iv) a combination of the above. In exchange for additional time, the borrower makes forbearance payments and may pay the lender other negotiated fees. In this situation, both the borrower and the lender feel that the property issues will be resolved in the short term and that more elaborate arrangements are not necessary. The documentation itself does not need to be elaborate. Faced with a high volume of delinquent loans triggered by the COVID-19 crisis, lenders may just need something simple enough to allow time for an economic recovery. A form of short-term forbearance agreement is attached in Annex 3. In exchange for the extra time, the borrower makes forbearance payments, perhaps with reduced monthly loan payments, and accepts basic acknowledgments, including the validity of the loan and its terms and all amounts due. , as well as waivers confirming that there is no current dispute with the lender (these should include a release from the lender until the date of signing of the agreement). This agreement has the added benefit of avoiding the transaction costs typically associated with the formal modification of loan documents and can also be used to address loopholes in loan documents (including completeness and assignment issues) that are discovered during the review of loan documents.
The “longer term” or “reinstatement” abstention agreement
When cash flow issues are short to medium term issues, such as those that may be triggered by the current COVID-19 crisis, and the borrower is otherwise unable to continue paying the loan but has the potential, over time, to make up for missed payments, the parties may be able to reach a more comprehensive agreement to reinstate the loan. This is sometimes referred to as a “reinstatement / forbearance” agreement. This situation can occur most often in the context of a securitized loan in which the manager’s discretion to modify the loan is limited. Often the PSA will allow the manager to give the borrower time to catch up and will also allow the manager to waive late fees and late interest. The parties may be able to come to an agreement on the reinstatement of the loan whereby regular loan payments are resumed at one point, default charges are reimbursed, and missed payments are reimbursed over an interim period at the time. means of additional monthly payments. A non-recourse loan can also be converted to a recourse loan in this scenario in order to provide additional collateral and protection to the lender. A form is attached as Annex 4.
Depending on the extent of the restructuring or loan forbearance, the original debt and debt as restructured, or for which forbearance is granted, could be treated as “materially different” for federal income tax purposes. returned. If so, the transaction could be treated as a trade resulting in a taxable gain or loss. Typically, these exchanges result in a loss for the lender. SeeCottage Savings Association v. Commissioner, 499 US 554 (1991) and Treasury Regulations under Section 1001 of the Internal Revenue Code of 1986, as amended.
Disclaimer for materials and attached forms
The content of this article contains general information about legal issues. Nothing in this article should be taken as legal advice or a recommendation regarding any matter or thing, with the understanding that the authors did not take into account your legal status, goals, financial situation or special needs. . Before acting on any information, you should consider whether and to what extent it may apply to your situation and, in particular, you should seek independent legal and financial advice. The opinions expressed in this article are solely those of the authors.