commercial mortgages, security deeds and deeds of...

Commercial Mortgages, Security Deeds and Deeds of Trust Securing Favorable Terms in a Conservative Underwriting Climate

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WEDNESDAY, APRIL 11, 2012

Presenting a live 90-minute webinar with interactive Q&A

M. Christine Graff, Partner, Winston & Strawn, Chicago

Thomas C. Homburger, Of Counsel, K&L Gates, Chicago

David H. Gunning, II, Partner, Roetzel & Andress, Cleveland

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©2012 Winston & Strawn LLP

Commercial Mortgages, Security Deeds and Deeds of Trust Securing Favorable Terms in a Conservative Underwriting Climate

• Perspectives and Negotiation Strategies • Strategies, Techniques, and Tactics for Borrowers

• Negotiating the Key Provisions of Mortgages, Security Deeds, and Deeds of Trust • Financial Terms and Impact of Loan Commitment • Prepayment and Defeasance Rights • Escrows • Due on Sale Clauses • Change of Control • Recourse Debt and Carve outs • Personal Guaranties • Cross-Collateralization and Cross-Default • Other Debts or Encumbrances

• Post-Default and Workout Considerations

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Copyright © 2011 by K&L Gates LLP. All rights reserved.

LENDER’S APPROACH TO CURRENT ISSUES AND PRACTICE IN COMMERCIAL

MORTGAGE SECURITY DEEDS AND DEEDS OF TRUST TRANSACTIONS

Thomas C. Homburger K&L Gates, LLP [email protected] (312) 807-4267

mailto:[email protected]�

mailto:[email protected]�

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A. Perspective and Negotiation Approaches 1. Times are changing – for the right borrower and the

right project, credit is available. a. There is actually competition for certain categories

of loans which lenders are interested in making. b. Beginning in 2011, life insurance companies began

competing to make loans on certain Class A properties – especially multi-family loans.

c. In 2012, even banks are competing to make certain types of loans. Areas where there is competition among bank

lenders include multi-family loans and healthcare loans.

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d. Other categories of loans are still more difficult to finance if the borrower is not the most credit worthy borrower. Retail and industrial loans are examples.

e. Even slightly less credit worthy borrowers with good commercial projects are able to access a revitalized CMBS market.

f. Lenders’ negotiation stances reflect stricter underwriting standards of today, even for most sought after types of loans and credit worthy borrowers.

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Higher equity requirements are imposed and Guaranty of payment is required except for

CMBS loans. g. Nevertheless, in the case of most sought after

categories of loans and more credit worthy borrowers, lenders are becoming more flexible and willing to take more risk. CMBS lenders are less willing to negotiate loan

document terms because of standardized loan documents requirements.

© 2012 Winston & Strawn LLP

Commercial Mortgages, Security Deeds and Deeds of Trust Securing Favorable Terms in a Conservative Underwriting Climate By Christi Graff

[email protected]

(312) 558-8073

April 11, 2012


Perspectives and Negotiation Strategies

• Perspectives and Negotiation Strategies • Strategies, Techniques, and Tactics for Borrowers

• In General – The credit markets are beginning to open up, but Lender’s have much

stricter underwriting standards today than ever before – Loan documents for CMBS, Freddie Mac and similar type loans, for

example, are now generally presented as “non-negotiable” unless changes are required because of the Borrower’s structure (buy-out options, for example) or to address specific property issues (legal non-compliance, access issues, etc).

– Smaller, less institutionalized lenders are beginning to appear, and these loans tends to be more negotiable

– Opinions are more heavily negotiated, and Lender’s frequently insist on starting with their form of opinion

– Even in the case of more competitive loans, in today’s client more equity is generally required higher guaranties are frequently required, and the debt service coverage ratios are more strictly monitored.

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• Going into the negotiations – Review and understand the commitment letter for the loan

» If anything is not correct, or any of the covenants cannot reasonably be met, flag these immediately.

» Frequently Lender’s will need to seek approval for any divergence from the terms of the commitment letter.

– Understand your client’s history with this lender » Have any other loans been recently negotiated with this Lender?

» Have any modifications to the loan documents been approved for this client?

– Understand your Borrower's organizational structure » Are there any Buy-out options or similar rights

» Is it a single purpose or multi-purpose entity

» Is it a newly formed or existing entity

» Is Guarantor the parent entity of Borrower?

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– Understand any issues with respect to the property being acquired or financed » Is it a non-conforming use?

» Are there any compliance issues? Access issues?

» Are there any tenants which would require estoppels and/or SNDAs?

– Understand the timing on the deal » Is existing debt maturing?

» Is this an acquisition with a set closing date?

» What are Seller’s obligations to provide SNDAs, estoppels, etc. that your Lender will require?

– Understand any issues particular to your client » Administratively, do they have issues with short time frames?

» What issues do they feel strongly about?

» How closely will they read the documents?

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B. Negotiating the Key Provisions of Mortgages, Security Deeds, and Deeds of Trust.

1. Financial terms and impact of loan commitment. a. Loan commitments, applications or credit

memoranda are important to set the basic economic terms of the loan transaction. Loan commitments are binding contracts to

make a loan subject to fulfillment of the conditions contained with loan commitment, including agreement upon, and execution of, loan document.

Once business terms are stated in loan commitments, these terms are usually “set in stone”.

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Loan commitments spell out basic terms of loan transaction – including special covenants - in some detail. Special covenants stated in loan

commitments often find their way almost verbatim into loan documents.

b. All loan commitments are subject to agreement on, and execution of, loan documents. Lenders have more flexibility in negotiating loan

documents as long as the documents do not conflict with the business terms contained in the commitment.

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c. Lately applications or credit memoranda become more common. Applications or credit memoranda are like loan

commitment but do not purport to be binding on the lender. Applications and credit memoranda state

business terms which the parties have been discussing.

Since most applications or credit memoranda require payment by borrower of an application fee in order for the lender to move forward, question as to whether they really constitute a contract with consideration.

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At a minimum, applications or credit memoranda where application fee is paid, might require negotiations in good faith by lenders in order to reach a final loan transaction.

d. More and more loan commitments are requiring borrowers to purchase interest rate swaps for loans with floating mortgage interest rates. In an interest rate swap, the floating interest rate

is exchanged for a fixed interest rate for the life of the loan.

The cost of the swap is a borrower expense.


Negotiating the Key Provisions of Mortgages, Security Deeds and Deeds of Trust

• Financial terms and impact of loan commitment • From a Borrower’s perspective it is very important to read and

understand the terms set forth in the commitment or memoranda • Changes frequently require new loan committee approval – even changes in

dates

• Make sure your client understands everything set forth in the loan commitment, and that nothing is incorrect

• More and more often correspondence or memoranda, rather than an actual commitment, will be all that reflect the agreed upon deal.

• Make sure you have copies of all correspondence regarding the loan exchanged between Borrower and Lender

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2. Prepayment and Defeasance Rights a. In the current low interest rate environment, a

lender which uses its own funds for a non-Libor loan is more likely to be flexible on borrower’s pre-payment rights. Interest rates are likely to rise in the future Lenders will be able to re-loan the prepaid

principal at higher interest rates in the future Pre-payment formulae, if any, are usually tied to

making up the loss which lender will incur by buying Treasury Obligations with a comparable maturity date to the prepaid loan’s maturity date

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b. The situation changes if the interest rate of the loan is tied to Libor or if the loan is a CMBS loan. In a Libor rate loan, the lender often purchases

Libor contracts. If there is a prepayment of the loan,

borrower’s right to prepay is subject to the borrower making the lender whole for any Libor contract “breakage costs.”

Situation also is different in the case of CMBS loans.

In the case of CMBS loans, the loans are pooled and used to secure marketable securities sold to investors.

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The investors are relying on the combined payment of the contract rates of the underlying loans until the maturity date of the underlying loans.

In the case of prepayment, the CMBS trustee will need to purchase securities to produce an equivalent rate of return for the balance of the term of the prepaid underlying loan. Any amount which is less than the return

from the securities purchased with the prepaid balance of the underlying loan must be paid by the pre-paying borrower so the return to the investors is equivalent.



• Prepayment and Defeasance Rights • Make sure you understand your client’s intent with respect to

holding or selling the property

• CMBS or Freddie Mac type loans frequently restrict prepayment • Make sure that casualty, condemnation, etc are excluded from prepayment

restrictions

• Typical secured loan transaction (non CMBS loan) will allow for the prepayment of the loan on a regularly scheduled payment date with notice

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3. Escrows a. Most standard form loan documents provide for tax

and insurance escrows. In most cases with credit worthy borrowers, this

requirement is often waived until a default occurs. Borrowers are required during the waiver

period to provide evidence of timely real estate and insurance premium payment.

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After a default, the requirement to make tax and insurance deposits is no longer waived. Since today’s financing is generally available to

only credit worthy borrowers, it is more likely that lenders will waive the requirements for tax and insurance deposits.

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b. Escrows are commonly used in the disbursement of construction loans. In earlier times, construction lenders would

review waivers and sworn affidavits (if required) and then look to title insurers for update of title insurance and possibly mechanic liens coverage.

Today, almost all construction loans involve escrows.

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Borrower submits waivers and sworn affidavits (if required) to the escrowee. When the escrowee, through its title insurer

affiliate, is prepared to deliver a clean update of the title insurance and, if required, mechanics lien coverage, the construction lender disburses its funds through the escrow.

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c. Escrows should not be confused with reserves. An escrow account involves an actual

disbursement by the lender into the escrow account, with interest accruing from the date of disbursement.

In the case of reserves, such as interest reserves, the amount is held as a budgeted line item not available for purposes other than the stated purposes. Interest only accrues when the funds are

actually disbursed for the stated purpose.



• Escrows • Frequently waived for Borrower’s with good credit

• For construction escrows, Borrowers typically request 30 day delay provisions allowing for a 30 day delay in the delivery of waivers

• Borrowers also frequently want the ability to negotiate indemnities over issues, if they arise, and need the flexibility to do this so long as clean date down endorsements are issued.

• Key is giving Borrower as much flexibility as possible so long as title company is able to give clean title

• For multi-family housing, loans also frequently require repair / capital expenditure escrows to address any inspection issues

• Make sure that money is released promptly after completion

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4. Due on sale clauses/change of control. a. In today’s historically low interest rate environment,

lenders are eager to control transfers of the mortgaged property or of change of control of the borrower. Borrowers are tempted to try and sell the

property or assign the right of control with low interest rate loans attached. A property with a low interest rate loan

attached increases the value of the property, especially if interest rates have increased.

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The same concern arises in the case of control of the borrower. A change of control of the borrower may be

an “end run” around a due on sale restriction. Most well-drafted loan documents will ensure

that there is no change of interest of the borrower. An exception is often made for transfers for

estate or tax planning purposes as long as the original principal is still in control.

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b. Lenders also have a general concern about a transfer of title to the mortgaged property or change of control. Lenders make loans in partial reliance on the

borrower and its principals. The lender does not want to lose the party on which

reliance has been placed unless lender consents to the property transfer or change of control (and in many cases, charges a fee or increases the interest rate.)

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c. Due on sale and restriction on sale of control provisions are not an absolute prohibition. An absolute prohibition will be a restraint on

alienation and probably invalid. Rather the violation of a due on sale or change

of control provision in the loan documents constitutes a default which triggers acceleration of outstanding principal balance.



• Due on Sale Clauses • In CMBS and similar deals, Borrowers are sometimes able to

negotiate a “one-time transfer” right which would allow the property to be transferred to a “permitted transferee”

• In traditional mortgage loans, there are generally no exceptions to the due on sale provisions, other than Borrower’s ability to enter into leases, easements, and similar type documents

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• Change of Control • Transfer / Change in control provisions are frequently heavily

negotiated • Borrowers want exceptions to prohibition on transfers

– To address existing buy-out and similar rights contained in Borrower’s organizational documents

– If the principal and/or Guarantor of Borrower is an individual, you want to provide for some mechanism to replace the individual in the event of a death or disability

» Ideally, Borrower has some time frame to propose a replacement principal / guarantor before the loan goes into default

– Transfers that do not change control should be permitted

• Borrower wants consent not to be unreasonably withheld

• If Borrower is publically held, public transfers must be permitted

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C. Recourse debt and carve outs.

1. Personal Guaranties a. Most real estate mortgage loans require

some degree of personal guaranties of payment in today’s lending environment. CMBS loans are an exception. In CMBS loans, guaranties are limited to

“bad boy” carve outs. Often with credit worthy borrower, guaranties

are limited to a percentage of the loan either initially or on the occurrence of a triggering event.

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b. Almost every loan with limited or no guaranties of payment include guaranties from the borrower or its principals in the case of a violation of “bad boy” covenants. Bad boy covenants include prohibitions against

waste, diversion of revenues from payment of operating expense and debt services, etc.

In some cases, a violation of a carve-out covenant requires the Guarantor to pay the damages which the Lender incurs because of a breach of the covenant.

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In other cases, especially CMBS loans involving single purpose entities, a violation of certain covenants involving separateness or solvency of the borrower triggers unlimited liability for the outstanding principal balance of the loan.

Usually (but not always) in the case of a violation of the separateness or solvency covenants in this kind of guaranty, the lender forecloses the mortgage and sues the guarantors for the deficiency remaining after the foreclosure sale.

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b. A series of Michigan based cases involving non-recourse CMBS loan and carve out guaranties have raised great interest in the lender community. In both of these cases, real estate market

values had declined and the borrowers were unable to pay debt service.

In both of these cases, the lenders foreclosed on the property without borrowers’ objection.

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In both of these cases, after the foreclosure sale, the lenders sued the borrower for the difference between the proceeds of the foreclosure sales and the unpaid principal amount of the loans, claiming that the borrowers had violated the solvency covenants triggering full recourses liability against the guarantors. The lenders argued that the borrowers were

insolvent because they could not pay their debts, including the mortgage debt, when it was due.

These lenders argued this triggered the full liability guaranties.

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The borrowers argued in both cases that such a construction would read the non-recourse language out of the loan documents. Borrowers also argued that they had done nothing

wrong, but were rather victims of the declining real estate market.

The courts concluded that the loan document must be read literally. The loan documents provided that an act of

insolvency triggered the full recourse guaranty. The borrowers and guarantors were represented

by legal counsel.

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If the borrowers and guarantors intended different results, they should have negotiated for different language before they signed the guaranties.

Judgment was awarded by for both lenders for the full amount of the deficiencies.

Judgments were upheld on appeal. • Legislation has been passed by the Michigan

legislature to try and reverse the principles enunciated in these courts opinion and is awaiting the governor’s signature.

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2. Cross-Collateralization and Cross-Default

a. Often, in the case of loans involving multiple properties, all of the properties that collateralize the loan are cross- defaulted.

A default with regard to one property or a default under the secured loan triggers a default against all of the properties.

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b. Often loans with multiple loan facilities also involve cross-collateralization and cross-default.

For example, in healthcare loans, there is often a mortgage loan made to one borrower and a line of credit loan made to an affiliated borrower. Each of these loans, although made to affiliated

borrowers, has different security. A default on one of the loan facilities will trigger a

default on all of the loan facilities entitling the lender to exercise its remedies against all of the security given for all of the loan facilities.

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c. Lenders often use cross-default and cross- collateralization in order to underwrite loans to borrowers where there is concern that the primary loan can not stand on its own from a credit standpoint.

d. Generally, a lender does not want to be forced to continue in a lender/borrower relationship with a borrower if an affiliated borrower is in default.

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e. Lenders need to focus on the consideration issues in cross-collateralization and cross-defaulted loans. Does the affiliated party receive adequate

consideration in order to pledge its assets as security for a loan made to another related borrower? Important to describe this consideration in the

instrument which evidences the pledge of security for the cross collateralized loan.

KEY PROVISIONS OF MORTGAGES

David H. Gunning II, Esq. Roetzel & Andress [email protected]

Cleveland: (216) 615-7404 Chicago: (312) 580-1200

Other Debts or Encumbrances

• Mortgage needs to cover Subordinate Liens

• Should not be permitted without prior written consent of Lender

• Should be Lender’s discretion • Borrower will not want consent

“unreasonably withheld”

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• Lender will want the Subordinate Mortgage to specifically set forth that it is subordinate to Senior Mortgage

• Lender may want an Inter-creditor Agreement or Subordination Agreement

• Can payments be made on subordinate mortgage?

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• Look to state-specific statutes regarding what a lender can do regarding priority (example in Ohio O.R.C. 1311.14)

• The Mortgage should also deal with debts and other in areas like Affirmative Covenants: – Payment and performance of obligations – Payment of Impositions (taxes, assessments, etc…) – Leases (existing and future

• SNDAS and Estoppels

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Other Debts and Encumbrances

• Mechanics’ Liens – Understand each State has different rules and

procedures: follow them to preserve rights – Mortgage should require removal or bonding

off – Mortgage should require a time frame to

remove or an event of default (Don’t want a lien claimant foreclosing)

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Post-Default and Workout Consideration

• What is going to happen in Default – Read Loan Documents to see remedies

available specifically and equitably – Default Judgment and then Foreclosure – Cognovit Judgments in certain States – Workouts

• Modification Agreements • Forbearance Agreements • Deed-In-Lieu Agreements

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• Workouts – Is loan in payment default? – Is loan-to-value off? – Are other covenants failing? – Other defaults? This is going to dictate the road Borrower and

Lender take.

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• Modification Agreements – Accurate recitals – Define the “Original Loan Documents” and

“Amended Loan Documents” and “Loan Documents”

– Set forth current Loan Balance – Set forth what are the modifications going to

be made

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– Set forth that there are no other defaults in existence – Have Borrower and all Guarantors confirm and ratify

the all representations and warranties and the changes to be made

– Lender will require that Borrower and Guarantor release Lender from all prior acts

– Lender will require that Borrower and Guarantor acknowledge that Lender has not waived any of its rights

– Leverage

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Post-Default and Workout Considerations

– Jury Waivers – Jurisdiction and Law – Signatures from Lender, Borrower and

Guarantor – Cognovit warning – Recordable form

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Post-Default and Workout Considerations

• Forbearance Agreements – Similar to Modifications – Background and Recitals – Acknowledgment of Default – Outstanding Balance – Modifications to current deal – Any Special Conditions of Forbearance – Forbearance Defaults

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– Representations and Warranties – Reaffirmation and Ratification – Waiver – Release – Conflicting documents – Governing Law – Jurisdiction – Venue – Cognovit

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• Deed-In-Lieu of Foreclosure – Parties – Background and Recitals – Default – Legal Description – Release – Conditions to Close – Representations and Warranties

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– Condition of Property – Existing Contracts or Leases – Non-Merger of Interests – Be sure this is what you want to do

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