Five Loan Document Tips For Borrowers During The Pandemic
Underwriting is more conservative now than it was at the beginning of 2020. While lenders are being cautious due to the economic impact of the COVID-19 pandemic and associated government-mandated shutdowns, a liquidity crisis does not exist now like during the 2007 global financial crisis. As a result, loans are still being made, particularly in the industrial and residential sectors. With this in mind, here are five tips for borrowers to consider when negotiating or administering their loan documents during these uncertain times.
Some loan documents include a debt service coverage ratio, loan-to-value or debt yield covenant that requires the borrower to make a margin call if the covenant is not satisfied. Before agreeing to this provision, a borrower should negotiate the right to cover the margin call with a letter of credit instead of a paydown of principal. This avoids a prepayment penalty, and also allows the loan to go back to its original size when the property’s income or value returns.
Loan documents typically include a cap on the number of days of delay a borrower may claim due to a force majeure event. Typically, there is a 60- to 90-day cumulative cap. A cap has always been unfair to borrowers, and the COVID-19 pandemic demonstrates why. As of this writing, the pandemic has been ongoing for more than four months and counting. In my negotiations with lenders, I am finding that they are increasingly willing to extend and in some cases eliminate the cap, and also have it apply to each separate force majeure event.
First drafts of loan documents often provide that the occurrence of a “material adverse change” constitutes a default by the borrower. These provisions allow a lender to exercise its remedies when the value of the real property is significantly impacted by events like a pandemic, even when the borrower is timely making its monthly payments and otherwise performing its obligations under the loan documents. Borrowers should push back against these provisions. I recently reminisced with a client about a loan we closed the day before Lehman Brothers collapsed in 2008 that demonstrates why. Removing the “material adverse change” default provision was our last remaining comment, and we had to go way up the chain of command at the bank in order to get the provision removed. Three months after the loan closed, the property’s value declined from $10 million to $7.5 million. Negotiating this provision out of the loan documents enabled my client to avoid a default notice and significant margin call.
In construction loan documents, borrowers should make sure that the balancing provision covers only the cost to complete construction and not a loss in value of the project. I had not seen a balancing provision cover loss in value until it appeared in loan documents I recently reviewed. The provision is a back-door attempt by the lender to impose a loan-to-value covenant on the borrower. The lender readily agreed to eliminate the requirement that the borrower deposit funds with the lender if the value of the project declined. If we had not asked for the change, the borrower would have been exposed to the risk of having to contribute unanticipated additional cash into the project.
Before agreeing with a tenant on a lease modification, borrowers should check their loan documents to determine if the lender’s consent is required. Failure to obtain the lender’s consent when it is required will not only constitute a default under the loan documents, but may trigger recourse liability in what is otherwise a non-recourse loan. This is because non-recourse carve-out provisions typically provide for loss liability, and in some cases the provisions trigger full recourse liability, when a borrower consummates a “transfer” without the lender’s consent, and loan documents typically define “transfers” to include lease transactions.
I have one last bonus tip in general for borrowers, which is to be proactive and transparent with your lenders. I think this leads to a “we’re on the same team” approach — especially when dealing with distress — and makes lenders much more willing to accommodate borrowers’ requests.
Steven Lurie is a partner at Greenberg Glusker in L.A. He has a national real estate law practice representing primarily developers, investors, borrowers, landlords and tenants. In the past year alone, Lurie has led more than $2.5 billion in transactions involving real estate located in California and 24 other states, including over 50 construction, permanent, bridge and line of credit loan transactions on behalf of borrowers.