Workouts 101, Part 4: Lenders’ Leverage

Having discussed previously what leverage a borrower has in a workout, here’s  a brief overview of some of the lender’s points of leverage, and what the lender needs to know before starting a workout.  While some of these points should be obvious, it’s always a good idea in a workout to return to the basics to check each of the usual elements of a possible resolution for holes and issues.

The lender has the right to enforce the loan and take the property back.  At the risk of stating the obvious, if the borrower does not repay the loan it borrowed, the lender has the right to take back the real property collateral for the loan.  This may be done in different ways depending on the state where the property is located, but ultimately this is the lender’s big stick. 

Often the lender and borrower cannot agree whether there would be any real value (equity) left in the property after repayment of the loan.  If the lender and borrower both know there will be no equity left after repayment, neither side has much incentive to instead do a workout unless the borrower is willing or able to put in more money in hopes of realizing a long term gain on the property.  (Or unless the lender does not want to take the property back, for some reason, like a property that is severely environmentally contaminated.) However, if the lender and borrower do not agree whether there’s equity remaining in the property, then one side or the other will be motivated to work out the deal if possible — and the other, less motivated.

The lender may have the right to go after the borrower’s other assets, or those of a guarantor.  This is the lender’s second biggest stick.  Or maybe this is the biggest, if the borrower has significant other assets or the guarantor is an attractive collection target.  While most lenders don’t want to wipe out a reputable borrower or guarantor who has been a good customer in the past, and is facing difficulties now, they want to get repaid.  (One lender told me that, while he did not want to wipe borrowers out, he had no qualms about repayment of a loan that would require a borrower to scale back his standard of living.  In my experience primarily working as lender’s counsel, that’s pretty typical.)

In fact, a lender’s representatives owe a duty to its investors and shareholders to collect as much as possible on the loan and any guaranties.  While most if not all lenders can be reasonable if the borrower plays fair and is doing its best, some borrower tactics are not welcome.  If the borrower or guarantor starts playing games, such as hiding information or lying, or taking money generated by the property to pay other debts, or opposes foreclosure where there’s no or little equity in the property, the lender will be more likely to aggressively press forward with enforcing the loan against all available assets of the borrower and any guarantors. 

Obviously, there’s a cost to enforcing a loan;  depending on the difficulty under the applicable state law of collecting on a particular asset, a lender may elect not to bother going after that asset.   For example, in California, a lender may not pursue any other judicial cause of action, such as suing the borrower directly, without foreclosing on the real property collateral.  But such a lender usually may start either or both of a nonjudicial foreclosure sale (a/k/a a trustee’s sale) which takes less time and is cheaper, and cuts off the borrower’s redemption rights . . .  or a more formal judicial foreclosure proceeding, which takes a lot longer, is a lot more expensive, and allows the lender to seek a “deficiency” — the amount still owed in excess of the purchase price for the property paid at the nonjudicial foreclosure sale — against the borrower, but gives the borrower redemption rights for up to a year.   To decide which way it wants to enforce the California loan, a lender and its counsel must figure out:

  •  what the real estate collateral (and any other collateral) is worth,
  • whether the loan is of a type where getting a deficiency is allowed,  
  • if the borrower has other assets available to satisfy a deficiency,
  • if a guarantor has assets available to repay the loan or a deficiency,  and several other issues. 

This typically takes some time and effort, because a wrong move can seriously impair, or even cut off, the lender’s rights to its collateral.   In some other states, where the lender can elect to sue the borrower directly, a lender may do so instead of foreclosing on the real property first, especially in a down market if the property is worth less than the debt but the borrower has significant assets.

The lender should know what its documents say.  Just like the borrower, the lender should hire new counsel to review its loan documents.  The point of bringing in a fresh set of eyes is that lawyers, like other humans, tend to see what they expect to see.  A lawyer who negotiated a deal may not see the flaws in the documents (and has an incentive to avoid disclosing any such flaws to the lender client).    The lender usually has enough money to hire good counsel.   If competent and experienced local counsel is hired, she or he should be able to find any flaws in the documents.   Then, if a workout or extension is done, the lender can typically fix any loan documentation problems as part of that deal. 

I may sound like I’m harping on the problems in loan documents.  But it’s surprising how often loan documents, particularly those done in the late stages of a boom, contain very serious errors.  And courts will penalize lenders for documentation errors.  Some years ago, I successfully foreclosed on a loan (not documented by my firm) where the legal description of the property was seriously incorrect.  The foreclosure was touch and go, and we only prevailed after having to bring in a litigator and arguing for months through a judicial foreclosure for reformation of the legal description, making a motion “nunc pro tunc” .  That’s translated loosely as “Holy buckets, your honor, we gave them the money — put it back the way it should have been! and please let us take the collateral back.”  I can’t possibly overstate how many times there are typos in names, amounts, or other key parts of the loan documents, primarily because no one wanted to do the work properly the first time (or perhaps no one wanted to pay for the work to be done properly then, because they did not anticipate any collection problems).  Since many foreclosure laws are persnickety exercises in form over substance, those little mistakes can kill a lender’s rights to collect the collateral stone dead.  Bottom line:  hire lawyers who can, and do, proof their work.

To guard against some of the most obvious documentation and origination mistakes, here are some things a lender and its counsel should check up front when considering a loan modification, workout or foreclosure.  Any request from a borrower for an extension or other modification provides an opportunity for a forward- thinking lender to confirm that its documents are in good shape so that if the borrower ultimately cannot or will not pay the loan, the lender can foreclose . . .  or to fix them if the documents contain errors — long before a more serious default occurs or foreclosure is imminent:

  • Review all loan documents without reading any summaries first (so you see what’s actually written on the controlling documents);
  • Note any changes from the lender’s standard provisions (such as extended cure or notice periods);
  • Ask whether any changes have been allowed but have not been documented, or whether the lender has entered into any other agreements with borrower parties, which might give rise to lender liability;
  • Check for common defects/deficiencies, such as incorrectly identified parties, lack of or incomplete suretyship waivers, incorrect collateral descriptions and UCC financing statements, defective cash management agreements, missing or unattached allonges if the note has been modified, undated or not fully executed documents, missing exhibits, unfinished post-closing items, missing title insurance policy, missing original note;
  • Confirm the real estate collateral is correctly described and matches the survey;
  • Check to see if any Subordination, Nondisturbance and Attornment Agreements have been signed by major tenants, or should be;
  • Confirm that all needed consents for personal property collateral were obtained,  that all descriptions of that collateral are complete and correct, and that all steps necessary to perfect and preserve the lender’s security interest have been taken;
  • Review status and priority of advances over mechanics’ liens;
  • Review evidence of environmental condition of property;
  • Investigate any changed circumstances of the borrower, guarantor or property or ownership of the collateral;
  • Analyze the applicability of any changes in the law;
  • Confirm that the lender actually has in its possession all needed original documents;
  • Check to determine whether all post-loan closing items have been finished;
  • Review updated title information to determine if any new title issues or claims have arisen since the loan funded;
  • Conduct and review updated searches of UCC, tax and judgment liens concerning borrower and any guarantor;
  • Check to see if any circumstances have changed (such as the borrower’s name or jurisdiction of organization) and investigate any other issues relevant to the particular borrower, loan or property.

 Business Reviewthe lender usually knows what the property is worth (or can find out).  The lender will typically hire an appraiser to evaluate the property, and the value will guide the lender’s business and strategic enforcement and workout decisions.  A good appraiser, who is competent to testify in court if needed, is absolutely vital.  It is not uncommon for workout and even bankruptcy outcomes to be determined utterly by a dispute over the actual value of the underlying real estate.  So don’t go into that possible battle unarmed.

More about lender’s positions and strategies will appear in the next post.  For further reading, one of my partners in Seyfarth’s LA office, Jim Cochran, has just co-authored an article (with William Hoffman of the well-known receivership firm Trigild and others) about how to obtain maximum returns when recovering on commercial loans, including real estate loans; you can find it on Trigild’s website.

Advertisements

11 Responses to “Workouts 101, Part 4: Lenders’ Leverage”


  1. 1 Scott D Remphrey July 13, 2009 at 5:38 pm

    Maura:

    I am just passing along a very heartfealt ‘THANKS” for the general pointers on your ‘Practical Counsel’as I am a develper/owner who is going through many workouts and negotiations on properties here in Texas and these pointers are so invaluable in our thoughts as we progress.

    Thanks again,

    Scott Remphrey

  2. 3 Phil Marino July 22, 2009 at 4:27 am

    Maura,

    Great piece of work! As a former lawyer and bit out of touch, you saved me years of research and brought me current overnight Since the collapse of Wall ST, I have been basically doing loan mods for a specific client. I realize this is a diffferent animal than workouts but I have not seen to much to work out and very little if any cooperation amongst the lenders. Your narrative has been exceptional and I enjoyed it tremendously. Thank you and well done Maura

  3. 4 Kamil Homsi July 29, 2009 at 6:02 pm

    Hello Maura,
    i enjoy your blogg and recieve thank you notes from friends and coleaqgues directed to it.
    pleae consider writing about the case where the land lord in delinquency and what should tenants do.
    regards,
    Kamil

  4. 6 Debt Settlement Program August 25, 2009 at 3:30 am

    punctilious post. simply one detail where I quarrel with it. I am emailing you in detail.

    • 7 mauraboconnor August 26, 2009 at 12:03 am

      Dear Sir or Madam:

      If you send me an email detailing where you disagree with me, I’ll be happy to respond and/or clarify as needed.

      Best regards,

      Maura

  5. 8 Martha March 17, 2010 at 7:40 am

    If a lender unwittingly accepted collateral that was unmarketable due to lack of deeded access, but had obtained a professional appraisal and title insurance, what are the lenders options other than foreclosing on a piece of property they can’t sell? (Let’s assume no fraud on the part of the borrower was involved.)

    • 9 mauraboconnor March 17, 2010 at 10:52 pm

      Dear Martha:

      If a lender accepted California real estate as collateral for a loan, and the real property collateral did not have legal access, the lender still would be required to foreclose on the property in order to enforce the loan. The lender could enforce the loan through a judicial foreclosure, prove that the value of the property was low at the “fair value” hearing then seek a deficiency judgment against the borrower for the difference between the fair value of the property and the amount owed by the borrower.

      In states other than California, the lender might have other options (the laws concerning foreclosure vary from state to state).

      Your hypothetical highlights the need for due diligence when making a loan secured by real estate (or really any other collateral, also). In frothy times like 2004 – 2007, some lenders skimp on their diligence, choosing not to spend the time or resources to properly investigate all aspects of the collateral on the assumption that they can always sell it in a market that appears to only go up. Unfortunately, that’s not true. When making a loan, the lender and its advisors should underwrite the loan based on its predicted performance if everything goes right, and based on the liquidation value of the collateral less the costs to enforce the loan if the borrower can’t pay. To value real estate collateral based on its liquidation value, one must do due diligence about the specific piece of property to make sure that collateral is marketable. Due diligence is dull and expensive, like insurance, but like insurance can save your bacon if the unthinkable happens.

      Best regards,

      Maura


  1. 1 Twitted by DebbieRuvo Trackback on July 13, 2009 at 11:02 am
  2. 2 equity loan foreclosure Trackback on October 8, 2009 at 3:10 pm

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s




Archives

July 2009
M T W T F S S
« Jun   Aug »
 12345
6789101112
13141516171819
20212223242526
2728293031  

RSS GlobeSt.com’s Top Stories

  • An error has occurred; the feed is probably down. Try again later.


Attorney Advertising. This blog is a periodical publication of Maura O'Connor, a partner of Seyfarth Shaw LLP and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. You are urged to consult a lawyer concerning any specific legal questions you may have. The contents are intended for general information purposes only and represent the individual views of Maura O'Connor only. Any tax information or advice contained herein is not intended to be and cannot be used by any taxpayer to avoid tax penalties that may be imposed on the taxpayer.

%d bloggers like this: