Negotiating Loan Commitments from the Borrower’s Perspective
National Real Estate Investor
Lending activity for commercial real estate remains robust with an improved (or improving) economy and persistently low interest rates. With many CMBS loans maturing — estimated at approximately $300 billion between the years 2015 and 2017 — refinances or take-out loans also continue to fuel the commercial real estate lending landscape.
Most permanent, life company or CMBS loans begin with a non-binding term sheet or loan application followed by a binding commitment letter. The term sheet is customarily a non-binding representation of the negotiated terms. The commitment letter is usually binding, coming after the lender's loan committee or credit committee has approved the negotiated terms. The commitment letter also typically requires the deposit of non-refundable monies from the borrower. Traditional bank lending, depending on the circumstances and the bank, oftentimes skips the loan commitment, but relies upon the non-binding term sheet to draft the loan documents.
While loan commitments are negotiated agreements, they are based on business terms from the term sheet, but almost always drafted on the lender's form. In other words, loan commitments are one-sided in favor of the lender.
Commercial mortgage brokers have the most experience negotiating loan commitments. However, commercial mortgage brokers typically focus on business terms and material business issues, not on legal issues. As such, negotiable legal issues are often not negotiated at the loan commitment stage of the lending process.
But the negotiating position or power of the borrower is strongest at this stage, and missing the opportunity to negotiate relevant legal issues — which may become business issues in the sense that they involve liabilities imposed upon the borrower — is not in the best interest of the borrower. For example, many specific obligations of the borrower will become important in the event that adverse circumstances arise. Involving legal counsel, therefore, early in the loan commitment process is prudent business practice even though there will be additional transactional costs as a result.
Timing is usually the driving force behind a borrower's ability to negotiate fully a loan commitment, as the borrower will have contractual deadlines if buying property, or maturity dates looming if refinancing. Regardless, a few negotiating points are worth noting.
Fees. Fees are the most obvious concerns. The borrower must be careful to confirm the timing of these fees, the applicability of the fees, and whether they are refundable or non-refundable and under what circumstances they are held. While this seems blatantly obvious, many times these issues arise after the loan commitment has been executed.
Conditions Precedent. Commitment letters will stipulate that the funding by the lender is determined upon certain conditions precedent being satisfied. Borrowers are wise to confirm that these condition precedents, sometimes referred to as "cps" or "outs," are realistic and reasonable. For example, with improved properties, obtaining a certain percentage of estoppels or SNDAs may be difficult to achieve.
Transfers. A common problem arises with respect to transfer of interests, or change in control, within a borrowing entity, or the members or partners that comprise that entity. Lenders underwrite their commitments partially based upon the financial worth of the borrowing entity and, usually, guarantors. Addressing potential changes in those entities is crucially important, as it is most likely a violation of the loan documents to make transfers not specifically approved.
Lenders are presumably comfortable with the management expertise and style of those in control, therefore changes to management are difficult to effect, but borrowers should be careful to negotiate permitted transfers that would not violate the lender's primary concern.
Carveouts. Non-recourse carveouts, or so-called "bad boy" provisions, are the most negotiated provisions in loan documents and are usually included in broad terms within the loan commitment. Borrowers would be well advised to receive advance copies of the carveouts, if they are not included within the loan commitment or a schedule or exhibit thereto.
These provisions have resulted in a great deal of litigation over the years, and identifying exactly what the parties intend and expect early in the process can be advantageous to a borrower from a negotiating perspective, but also cost-saving for both sides in the long term.
Escrows. From a borrower's viewpoint, a lender's requirement of escrows is a significant business issue typically discussed early in the process. The waiver of tax and insurance escrows is commonplace, but lenders may require escrows for tenant improvement costs, projected vacancies or anticipated capital repairs and improvements. However, the commitment letter often does not detail sufficiently the manner in which these escrowed monies will be released. The release requirements should be adequately addressed for the borrower to operate in a customary fashion. This is typically not the case, and it is not unusual for escrows to remain dormant because some one or more release requirement is impractical to achieve.
Prepayment. If a loan commitment is silent on prepayment, that it not necessarily beneficial to a borrower. Courts have held that absent such a provision, a commercial lender is entitled to the benefit of its bargain and thus the borrower will be liable for the lender's loss. The practical and prudent solution is to negotiate the ability to prepay early in the loan commitment process.
Lenders may impose a lockout period, a yield maintenance provision or some other prepayment penalty, but borrowers should negotiate these provisions carefully. Of course, no one is privy to a crystal ball view into the future, but borrowers too often find an opportunity to sell an asset at a favorable price is hindered by a poorly negotiated, or non-negotiated, prepayment penalty.
Opinion Letters. Finally, legal opinion letters are rarely negotiated in a loan commitment but can drive up a borrower's costs if left unattended. Borrowers should require that the loan commitment list the opinions its local counsel will be required to provide, and the custom is that each law firm issuing an opinion would provide the opinion letter on that firm's form with its various assumptions, qualifications and limitations. Some opinion requests can be problematic, which can result in an unproductive and unnecessarily expensive argument between legal counsel.
Consideration of the foregoing matters will help a borrower with a successful loan transaction.
Republished with permission. This article first appeared in National Real Estate Investor in July 20, 2015.