The effects of COVID-19 continue to unfold on a daily basis. For commercial real estate owners, the long term implications of this pandemic cannot yet be fully assessed, especially since the resulting economic recession has only recently been confirmed and the public health uncertainties resulting from COVID-19 continue to ensue. Since commercial real estate is a leverage business, many owners may need to restructure the loans secured by their properties to achieve more achievable economic terms and to avoid loan defaults, foreclosures and the loss of their properties. Here are ten key considerations to guide you generally in pursuing loan restructuring transactions with your lenders.
Identify the entire business problem
Identify the root causes of your property’s distress and why the property is facing challenges in complying with the requirements of your loan. One obvious cause is a borrower’s impaired ability to make debt service payments due to the severe and abrupt decline in its rental revenue due to the pandemic, the impact of “shelter in place” orders, ongoing business failures and increasing unemployment numbers. What other problems at or affecting your property need to be addressed through a loan workout (such as immediately needed repairs or structural defects that have been deferred due to the absence of necessary capital)? Your goal in this analysis is to develop a complete picture of what’s wrong so that in restructuring the loan, all looming issues can be addressed in a comprehensive manner, enabling the property to get back on track.
Know your lender
Lenders will approach loan restructuring requests differently depending on whether they are private lenders, CMBS lenders, government sponsored enterprises, life insurance companies, commercial banks or other types of regulated lending institutions. Private lenders are typically more willing and able to be creative and flexible in restructuring loans than are traditional institutional lenders constrained by regulatory and financial reporting requirements. CMBS lenders, i.e., special servicers, tend to be the least flexible in restructuring loans. Understand your lender’s likely approach to a workout transaction and factor these considerations into your loan workout proposal.
Get organized and be prepared
Do your homework and get organized before you approach your lender. This preparation should at a minimum include:
- reviewing your loan documents and the borrower’s governance documents to understand relevant provisions such as any approval rights that may be held by members of the borrower,
- identifying all stakeholders (i.e., other lenders, equity investors and major commercial tenants) who may have an interest in the loan restructuring terms so you can determine whether you should coordinate with them prior to or during your negotiations with the lender and
- obtaining a title report for the property to identify if there are outstanding mechanics’ liens or other title issues and developing a list of unpaid operating expenses, real estate taxes, insurance premiums, utilities or other property related expenses (including deferred maintenance and capital expenditures) so that you can negotiate modified loan terms that will enable these to be paid.
Beware of guaranty obligations
Understand and do everything within your control to comply with the terms of any loan guaranties given in favor of your lender. Your goal is to make sure you do not (inadvertently or otherwise) trigger either non-recourse “loss or damage” liability or full “springing recourse” liability (i.e., for the entire outstanding principal balance and unpaid accrued interest under the loan, plus the lender’s enforcement costs) for your loan guarantors. If you determine that you have already potentially triggered exposure under the loan guaranties, evaluate the strategies you can implement to minimize any resulting losses to the lender resulting from the guaranty breach and to cure the default.
Propose a comprehensive loan restructuring plan
Develop a comprehensive plan that you, in good faith, believe will address all the business issues the property is facing in meeting its obligations under the current loan terms. This plan should include proposed loan modification terms that you genuinely believe are achievable in light of the property’s current circumstances and will ultimately stabilize the property’s economic performance. One of the plans’ goals is to enable the lender to consider the loan in good standing and a “performing loan” once your plan is fully implemented. The plan should address who will bear any losses that may result from the implementation of the modified loan terms (and should minimize your lender’s losses). Include a range of possible solutions that could resolve the property’s issues under the loan including terms that vary with objective, easily measured economic factors impacting the property’s performance.
Act quickly and communicate often
The sooner you approach the lender and reach an agreement about the needed restructuring terms for your loan, the greater the likelihood that you can achieve this outcome before the property faces further deterioration in market value. Act in good faith in your communications and provide accurate information requested by your lender. Communicate frequently and consistently.
Cash is king
Wherever possible (i.e., without triggering guarantor liability and with the advice of legal counsel), you should endeavor to conserve the property’s cash where you control it in a separate account not subject to the lender’s UCC lien. Apply this cash only to pay the property’s obligations, using it first as needed to pay real estate taxes and insurance premiums — expenses that will avoid mechanics’ liens from being imposed on the property (which could trigger full springing recourse exposure under the loan guaranty) and then to operating expenses that keep the property safe for tenants (including from COVID-19 risks) and to avoid a lender claim that you committed “waste” at the property, even if necessary, at the expense of missing debt service payments. Don’t fund debt service payments from your personal assets or provide additional collateral for the loan until you have an acceptable and binding loan workout agreement. Having “dry powder” in the form of cash can also be used as leverage in your negotiations with the lender.
Understand the bankruptcy options and beware of tax ramifications
Every loan restructuring transaction presents considerable bankruptcy issues and tax ramifications, especially if you have owned the property a long time. It is essential that you evaluate your bankruptcy options and the tax impacts of your loan restructuring transaction with competent and experienced professional advisors.
Be prepared for the pre-workout agreement
The lender will likely require a pre-workout agreement to pursue a loan restructuring transaction with you. The agreement should impose an obligation on the lender to forbear from exercising any default remedies under the loan documents while the loan workout is being negotiated and tolls certain deadlines. In exchange you will be required to stipulate to any existing material defaults under the loan and to waive all claims you may have against the lender (without giving you any reciprocal waivers from the lender in return). Review this agreement in detail because it is binding and could have an adverse effect on the borrower, any loan guarantors and the loan at a later time.
Assemble a competent, experienced professional team
Engage a professional team that includes legal counsel (real estate, tax and bankruptcy attorneys), accountants and tax advisors experienced in commercial real estate loan restructurings and enforcement – this should not be their first real estate cycle. These advisors will be invaluable in guiding and protecting you in pursuing a loan restructuring transaction.