Property Finance Jargon and Legal Documentation

Thursday 11 September 2008

Jonathan Lawrence, Partner, K&L Gates LLP

jonathan.lawrence@klgates.com

020 7360 8242

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Overview

Pack documentation introduction Property finance glossary Investment loan term sheet Development loan term sheet

Loan and security documentation Parties Provisions

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Borrower(s)

Borrower Trading entity; or Special Purpose Vehicle (SPV) company?

Single/Multiple Multiple borrowers for multiple properties Cross-collateralisation

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Obligors or Borrower Group

Obligors Guarantees may be required from shareholders in B /

other entities in B’s group Especially relevant where B is an SPV

Sponsor Individual or entity “behind” the real estate

acquisition, B and management of real estate Not usually a party to loan documentation

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The Finance Parties

Lender Lends / Advances the funds Identity of original lender may change during the term

of the loan Lender may reduce exposure to loan through

syndication, securitisation or sub-participation

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The Finance Parties

Facility Agent Day to day administration of loan

Security Trustee Holds security on trust for all Secured Parties Controls enforcement process

Hedge Counterparty B enters into a hedge with respect to all or part of its interest

rate exposure under the loan with the hedging counterparty e.g. fixed-to-floating interest rate hedge

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Documentation

Term sheet Loan agreement Security documentation Hedging documentation Fee letters

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The Loan Agreement

No standard format Long form / short form

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Purpose of the loan

Should always be set out in loan agreement L not obliged to monitor the loan to make sure it is

used for the purpose advanced Quistclose Trust established

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Tranching

Facility may be made up of a variety of loans / tranches

Together they are the facility Each may be used for a different purpose Greater flexibility – different terms

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Interest

Usually based on aggregate of: 1. Floating rate of aggregate of LIBOR/EURIBOR; 2. Margin agreed between L and B (fixed or variable);

and 3. Any Mandatory Cost

Paid on each interest payment date (end of interest period)

Interest period generally 1, 3, 6 or 12 months Interest may be capitalised

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Representations and warranties

Statements of fact made by B or Obligors about certain matters of fact relating to themselves, their status and the underlying real estate

If untrue, L may call an Event of Default Standard reps e.g. that it is solvent, that security

has not been granted in favour of another party Specific reps e.g. property specific concerns re

environmental issues

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Covenants

General General obligations imposed on Obligors Additional covenants for SPV Negative pledge

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Covenants

Property Ensure that property will not fundamentally change

during the term Restrict development, granting of leases etc. Insurance covenant

Application of insurance proceeds Damage Loss of rent

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Covenants

Information Delivery of information Financial statements, annual accounts Proceedings Property reporting requirements (rental income,

tenant details etc.)

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Covenants

Financial: Loan to Value (LTV) Day 1: L obtains credit sanction to lend up to a

maximum percentage of the value of a property Ongoing: Measures the ratio of current market value

of a property against the then principal amount of the loan outstanding

If max % is exceeded due to fall in property prices, B will have to bring the loan into compliance by prepaying proportion of loan/disposing of property

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Covenants

Financial: Interest Cover Ratio of net rental income (gross rental income less

certain deductions e.g. insurance premiums, tax) to B’s interest payment obligations

Test measures the ability of B to comply with its interest payment obligations

B’s interest payment obligations usually serviced from rental income

Can be “look back” or “look forward”

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Covenants

Financial: Debt Service Cover (DSC) Used when loan is amortising Ratio of net rental income received versus B’s

interest and principal payment obligations Can be “look back” or “look forward” Must be more than 1 to ensure B meets interest and

principal obligations under the loan

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Covenants

Financial Remedy a breach of financial covenants by B paying

additional funds into blocked reserve accounts Funds will be deemed to reduce outstanding balance

of the loans (LTV) or to supplement net rental income (Interest Cover and DSC)

May be released if B complies with financial covenants or applied to prepay loan if financial covenants not complied with

Restriction on number of times can remedy a breach in this way

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Events of Default

Trigger events which may mean L cancels commitments and declares all amounts owing and immediately payable - Acceleration

L under no obligation to accelerate loan following event of default – may waive/renegotiate

B often allowed grace period e.g. insolvency of obligor, non-payment of sums,

misrepresentation, breach of covenant, material adverse change

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Term and Prepayment

Term = length of lifespan of loan L cannot prevent B repaying the loan prior to end of

term Prepayment not favourable for L as misses out on

interest, therefore L imposes prepayment fees L may require mandatory prepayment e.g. proceeds

of sale

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Principal

Loans are interest only or amortising Interest only – B pays interest on each payment

date and principal paid as bullet repayment on maturity date

Amortising – B repays specific amounts of principal on regular basis during term of loan

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Payment mechanics

Property Managing Agent Rental income paid into segregated trust

account/held on trust by Managing Agent Managing Agent responsible for paying net rental

income into Rent Account Duty of care agreement – Managing Agent owes L

direct contractual duty of care On interest payment date funds are applied in order

– “waterfall”

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Default interest

Additional interest which accrues on overdue amount in event that B or Obligor fails to make a payment under the loan

Usually around 2%-3% above the interest rate usually payable on the loan

Rate must not be set too high as it may be considered a penalty and non-recoverable

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Security

Legal mortgage Fixed charge Assignment of rental income Floating charge Guarantees Negative pledge

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Legal mortgage

Over specified real estate Transfer of legal ownership from mortgagor to

mortgagee Mortgagor has right to return of property and

payment of any balance after satisfaction of mortgage (right of redemption)

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Fixed charge

All other freehold and leasehold property All buildings, fixture, plant and machinery on the property All future interests in land Benefit of all agreements relating to land Right and interest in proceeds of sale of charged property Amount standing to credit of all bank accounts Book debts and other receivables Goodwill and uncalled capital Right to recover VAT on any supplies relating to charged

property

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Assignment by way of security

Rental income Right to payment under all present and future

insurance policies over any charged property Rights against any tenants of property Benefit of any hedging documentation Rights under any development and acquisition

documentation Benefit of all contracts relating to property

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Other security

Floating charge Over all other assets of B not covered by the other

security Crystallisation

Share charge over shares in B L has opportunity to take control of B Choice to sell B rather than the property

Negative pledge

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Practicalities

Security documentation must be correctly registered (“perfected”) English company: Companies House Non-English company: Slavenburg register Land Registry

Deed of priority required? Governing law – location of assets?

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Guarantees

Especially relevant when dealing with SPV B with no trading history where real estate is sole asset

L should ensure the guarantor enters guarantee as a primary obligor and therefore has to immediately comply with any demand made on the guarantee without L having to first make demand of B

Guarantor likely to seek grace period

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Why is the security package so important?

Security Trustee has certain control over all assets of B

Ideally only security over property itself is needed to recover the principal amount of the loan

Remaining security satisfies L’s underwriting in case the LTV covenant is breached

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Conditions Precedent (CPs)

Prior to advancing funds, L will insist on receiving certain documents and/or B satisfying other requirements Corporate documentation and authorisations Financial information Property documentation and due diligence Legal opinions Miscellaneous

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Corporate documentation and authorisations

B and any Obligors must have taken necessary corporate action and obtained necessary approvals inc shareholder approval where necessary

Includes board minutes and directors’ certificates attaching constitutional documents

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Financial Information

L likely to insist on seeing full details of any equity, shareholder loans and other finance are received before any loan is made

L will require copy of pro forma balance sheet of B (in the case of an SPV) together with a sources and uses statement detailing how the loan advance, any shareholder loans, other finance and any equity is to be utilised

Evidence that bank accounts have been opened

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Property documentation and diligence

Report on title/certificate of title Details of any leases and tenants Copies of title documents Insurance details Physical inspection of property Valuation/structural survey/environmental report

(addressed to the Finance Parties)

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Legal opinions

Provided by law firms from all relevant jurisdictions Jurisdiction of incorporation of each Obligor and

governing law of any Finance Document Addressed to Finance Parties Confirm e.g. that Obligor exists and has legal

capacity to enter into Finance Documents Opinion provider will often attempt to limit reliance

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Miscellaneous

Evidence that L’s fees, costs and expenses in connection with transaction are paid upfront - usually deducted from gross advance

Deal specific CPs may be required e.g. documentation re any development or capital expenditure works

Sweeper CP – “any other documentation or evidence required by L”

If multiple drawdown is permitted certain CPs may be required for each drawdown

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Utilisation / Drawdown

Specific procedure for drawdown Notice to lender required Likely that initial drawdown must be made during an

agreed availability period Overall number of drawdowns likely to be limited CPs must be satisfied prior to drawdown

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Assignment, transfer and Qualifying Lenders

L usually reserves right to freely transfer its interest in the loan provided that B does not incur any tax liability on its interest/other payments due to change in status of transferee – “Qualifying Lender” concept

Crucial that L can assign interest freely if it intends to syndicate/securitise the loan

Often prohibited for B and Obligors to assign rights and obligations without written consent of Ls

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Tax

“Gross-up” obligation on B Where L is a Qualifying Lender, if any amounts paid

by B are reduced because withholding tax is imposed, B will have to gross-up so L receives amount it would have done notwithstanding the deduction of tax

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Amendments and waivers

Amendment usually allowed with written consent of Majority Lenders and Obligors

Some amendments e.g. a decrease in margin will require consent of all Ls as they fundamentally affect the loan terms

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