Reduce liability for losses on commercial accounts by adhering to four requirements.
Before You Take the Keys …
A lender has a loan secured by real property that is in default and has tried to work with the borrower to resolve the default amicably to no avail. The lender has had enough and wants to move forward with acceleration and foreclosure. Prior to making those moves the lender should take a step back, thoroughly assess the situation and obtain as much information as possible about the cause of default, stability of the property and other issues that might be affecting the property to make an informed decision regarding the desire and necessity to foreclose.
First, the lender should determine the cause of the default and its goal for resolution. Depending on the facts of the situation, a modification agreement or forbearance agreement might be the appropriate solution, rather than foreclosure. If the cause of default is due to a tenant bankruptcy, a tenant vacating the property or an economic downturn that has impacted occupancy, resolution could be attained by restructuring the loan through certain modifications to the loan documents, rather than acceleration and foreclosure.
If the property is producing adequate proceeds to pay operating expenses, but the borrower has diluted proceeds from the project or has failed to perform maintenance or otherwise manage the property in a prudent manner, the lender might want to implement a cash management arrangement, gain immediate control of the funds, or take a stronger stance and gain actual control of the property through a receiver, and ultimately foreclosure.
In determining the best way to secure the proceeds of the property, the lender should analyze the alternatives available under the applicable loan documents and local law, and also determine what other parties (i.e., subordinate lenders, participants, servicers, rating agencies) might have approval rights regarding enforcement decisions.
If the lender decides to proceed with the non-foreclosure route and negotiate a modification or forbearance agreement, the lender may want to consider requiring additional collateral and requiring additional personal liability from the principal of the borrower. If additional collateral is to be required, the lender should take into consideration the effect a borrower’s bankruptcy would have on the retention of such collateral.
Whether or not foreclosure is the ultimate goal, when entering into the modification, forbearance or other workout transaction, the lender should try to obtain as much information as possible upfront, so that if a foreclosure does later occur, the lender will have a much smoother transition to ownership.
A title search should be ordered to confirm no litigation has been filed against the borrower, that no new liens have been filed against the property, and to confirm payment of property taxes. Credit searches can also be run against the owner to see whether other creditors might have claims. An inspection of the property should be completed to confirm proper or deferred maintenance and a thorough review of the books and records of the owner and property should be reviewed to determine if cash flow is sufficient to cover operating expenses. Engineering and environmental inspections should also be completed, together with a current appraisal to confirm the value of the property.
Items the lender will want to obtain as part of its review of the property:
- All bank account information, credit card receipts, demand deposits, security deposits and all other forms of accounts, accounts receivables and payment rights.
- All keys to the property.
- Copies of all leases, communication and correspondence files with all tenants.
- An accounting of all security deposits, rent, prepaid rent and operating expenses.
- A current rent roll and trailing 12-month rent roll.
- All documents pertaining to any ongoing litigation.
- All documents pertinent to any licenses and permits maintained in connection with the property and all communications and correspondence pertinent thereto; and all documents pertinent to any third-party agreements in connection with the maintenance, operation and management of the property.
- All contracts in connection with the property and correspondence in connection therewith.
- All payroll records, employee files, applications and other materials relevant to those persons employed by or at the property.
- All contracts, bids, other materials relating to contractor work at the property.
- Other records pertaining to the management of the property.
- Insurance information, policy certificates and contacts regarding insurance.
The request for this information can occur simultaneously with the execution of a forbearance or modification agreement so that the lender is fully informed about the status of the property and can have sufficient information to cause a smooth transition to a receiver or other change in operations of the property.
Marla R. Bell is a shareholder in the real estate finance practice area at Polsinelli Shughart PC. She can be contacted at mbell(at)polsinelli.com or 816-360-4268.
Copyright © November 2009 BankNews Publications