While issues such as interest rates, principal loan amounts, underwriting requirements, etc., generally are included in a loan commitment, many issues are often not addressed until after the prospective borrower has signed the loan commitment, paid the nonrefundable loan commitment fee and funded, in advance, a deposit for expenses related to the underwriting of the prospective loan. Because of the sunken investment and passage of time-related to the loan commitment and underwriting process, the prospective borrower is often at an extreme disadvantage in regard to critical items that are not addressed until drafts of the loan documents are provided. In most instances, this occurs after the loan commitment is signed and required deposits have been advanced.
In the initial stages of a commercial loan transaction, there may be multiple concerns not discussed or negotiated until after the proposed borrower has paid the commitment fee and valuable time has passed. Addressing those issues before considering financing options obviously will be more advantageous for a commercial real estate venture.
Issues that may not be addressed in a draft loan commitment, but which regularly arise, include the following:
1. NOTICE AND CURE PERIODS
Will the lender be required to give notice? Will the prospective borrower have a cure period before a default can be declared? When will a default rate of interest or late charge be imposed?
2. WHAT HAPPENS WHEN A DEFAULT IS CURED
If a default occurs, but is later cured, will such things as the interest rate, impound requirements, financial reporting requirements and reserve requirements revert to the lender’s pre-default requirements, or will they remain in a “post-default” status?
3. RESTRICTIONS ON LEASES
Often, loan documents include provisions requiring a borrower to comply with term, rent, tenant qualifications, etc., when entering into a lease or when using specific forms for leasing commercial property units. A violation of these provisions can result in the lender declaring a default even if there are substantial economic advantages to a lease transaction outside the specified terms and conditions. Depending on the restrictions imposed, they may create serious economic consequences for a borrower, especially if economic or area concerns arise after the loan is in place.
4. CHANGE IN MANGEMENT OR MARJORITY OWNERSHIP
Loan documents always include some restrictions as to a change in management and, more often than not, a change in management is prohibited under any circumstance. Similarly, loan documents may prohibit or limit a change in majority ownership of the borrower entity. Since a significant number of circumstances may arise after the loan is made, mandating a change in management or majority ownership and defining these terms in advance of signing a loan commitment should be considered.
5. ASSUMPTIONS OF THE LOAN
Circumstances may arise after the loan is made that require a borrower to consider conveying a business or portions of the loan collateral to a third party. If such circumstances arise, the borrower’s ability to enter into such a transaction with the loan remaining in place may be a critical factor.
6. FORM OF GUARANTY
If a guaranty of the loan is required, instead of an unconditional guaranty, the potential borrower may attempt to negotiate a guaranty limited in time or amount or that is based solely on “bad boy” events as opposed to a full and absolute guaranty.
7. COLLATERAL RELEASE
If there are multiple items of collateral, the prospective borrower may wish to request that the lender define the terms and conditions under which one or more of these collateral items can be released.
8. RESERVES AND IMPOUNDS
The loan documents may include broad powers and wide discretion on the part of the lender to impose reserves or impound requirements during the term of the loan to address a wide variety of potential concerns. Defining these potential reserves and impound requirements and the conditions under which they may be imposed should be considered before the loan commitment is entered.
9. INSURANCE PROCEEDS
Loan documents can significantly vary in how casualty losses will be addressed and whether insurance proceeds will be available to make repairs or held until the repairs and concluded or applied to reduce the loan balance. Since these provisions can dramatically vary between lenders, a prospective borrower may wish to inquire about casualty losses and insurance proceeds before signing the loan commitment.
10. INSPECTION, APPRAISAL AND FINANCIAL REPORT REQUIREMENTS
The frequency and terms under which the lender can inspect the property, require an appraisal of the property or audit the borrower’s books and records (including, perhaps, reviewed or audited reports) should be addressed prior to signing the loan commitment. Since these requirements can result in significant losses of time and expense, concerns as to who pays the costs associated with these inspections, appraisals and audits and what controls the form and frequency of such requirements should be discussed with the lender before a loan commitment is signed by the prospective borrower.
11. REAL PROPERTY TAX DISPUTES OR INSTALLMENT PAYMENT PLANS
Disputes often arise between a property owner and taxing authority that may take an extended period of time to resolve. Property owners may reach a tax installment payment plan with taxing authorities. Since these concerns often arise during the term of a loan, a prospective borrower may inquire about the lender’s requirements.
While these types of issues are typically addressed in loan documents, they are often not addressed in loan commitments. It is my suggestion that the real estate investor or property owner make a checklist of items, such as the issues listed above, before proceeding with a prospective loan transaction. It is important to pay close attention to these issues, and raise them with the lender before expending a substantial amount of money or allowing a significant amount of time to pass after the loan commitment is signed. Thereafter, the prospective borrower’s available options are extremely narrow.
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