Loan workouts: First steps for commercial property owners

David A. Curfman
Shareholder, Brownstein
Hyatt Farber Schreck

Large numbers of commercial property owners are facing prospects of imminent default under their loans as a result of the current public health and economic crises. Sudden and precipitous drops in revenues, coupled with uncertainty as to the disruption’s duration, are forcing owners to make difficult decisions about how to deploy their limited capital to protect projects and avoid loan defaults. While hospitality and retail assets currently are experiencing the most acute stress, no asset type is fully immune. In response to these stresses, many borrowers who previously never faced a loan default are considering loan modification requests, or seeking workouts in response to loan default notices. For these borrowers, negotiating loan relief presents a new experience with unknowns and pitfalls. This article explains some early steps in the process that borrowers should understand and for which they should be prepared before reaching out to lenders with relief requests.

Sean M. Bahoshy
Shareholder, Brownstein
Hyatt Farber Schreck

Understand the financials. Prior to contacting any lender, a borrower should understand its current financial position and know specifically what it is asking its lender to do. Borrowers should anticipate the lender will require updated financial statements for both borrower and any guarantor, along with updated budget projections, taking into account the latest rent roll. In addition to focusing the borrower’s request to address its specific needs, preparing this information also shows the lender that the borrower has given serious thought to its request. Further, absent a complete accounting, the borrower may be unaware of even inadvertent errors relating to the loan balance.

Steven E. Abelman
Shareholder, Brownstein
Hyatt Farber Schreck

The borrower also should review its loan documents to identify any covenants from which it requires relief, aside from simply deferring or restructuring debt-service payments. Examples include suspending reserve deposit obligations, permitting reserve funds to be used for payment of operating expenses, waiving operating covenants to allow for compliance with any stay-at-home orders or required closures, expanding the borrower’s ability to amend leases in response to COVID-19 issues, and granting consent to Paycheck Protection Program loans or other government stimulus programs. Only after compiling this information should the borrower makes its request to the lender.

Prenegotiation agreements. Following receipt of a loan modification or forbearance request, most lenders will require that the borrower enter into a prenegotiation agreement as a condition to any discussions. These agreements serve multiple purposes for lenders, including making explicit that the lender’s entry into discussions with the borrower will not serve to waive any rights the lender has to pursue its remedies against the borrower. Borrowers should understand that lenders are not obligated to negotiate changes to the loan, can walk away from discussions at any time, and will not be bound by any discussions unless and until all parties enter into a definitive modification agreement. The lender will want every party to the loan documents to be bound by the prenegotiation agreement, so expect that any guarantors will be signatories alongside the borrower(s). The lender also will require that the borrower pay for the lender’s legal costs incurred with any negotiations (including negotiation of the prenegotiation agreement).

Some lenders include a general release and waiver of claims as part of their form prenegotiation agreement. Under this release and waiver, the borrower is asked to waive any claims or causes of action the borrower has, or may have, against the lender, whether known or unknown, as a condition to even discussing a loan workout. This type of waiver can be problematic for a number of reasons, primarily because there is no guaranty that the discussions will result in resolution of the underlying loan issues. The parties can terminate discussions at any time, for any reason. If discussions terminate without an agreed modification, the borrower will have waived potential claims without having actually obtained any benefit.

It is reasonable and typical for a lender to require a waiver of claims as a condition to entering into an actual workout of the loan, because the waiver serves as consideration for the lender’s agreed modifications. No lender wants to give concessions to a borrower in a workout, only to have the borrower turn around and subsequently assert a claim against the lender from a condition existing prior to the modification. The waiver and release can be seen as a cost of obtaining the borrower’s requested loan changes, something for which it bargained and received value. Similarly, it is not appropriate to require that same waiver as a condition to negotiations, since the borrower may not obtain anything.

One final item borrowers should consider adding into the prenegotiation agreement is an override of any notice provisions in the loan documents. Many loans require notices be sent by hard copy to a physical address. Because of stay-at-home orders in effect in many states, and the prevalence of businesses working remotely, there is a risk these notices are being sent to empty offices with no one to read them. It is safest for the borrower to add an override provision allowing for electronic notices by email during the period of negotiations (with an updated list of email recipients) to ensure notices actually are seen.

These are only preliminary steps in the process of obtaining a loan modification or workout. The real negotiations will start after these steps are taken, but borrowers should go into the process understanding the road ahead and preferably with counsel by their side to guide the way.

Featured in CREJ’s June 3-16, 2020, issue