Loan Commitments: Borrowers should Negotiate Early and Often
Commercial Investment Real Estate
With an improving economy and persistently low interest rates, commercial real estate lending activity remains robust. It's estimated that approximately $300 billion in commercial mortgage-backed securities loans will mature over the next two years; refinances also continue to fuel commercial real estate lending.
Most of these loans begin with a nonbinding term sheet or loan application followed by a binding commitment letter. The commitment letter also typically requires the borrower to deposit nonrefundable monies. While loan commitments are negotiated agreements, they are based on the lender's term sheet and 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. Since the negotiating position of the borrower is strongest at this stage, it's a missed opportunity to not involve legal counsel and negotiate relevant legal issues at this time.
Here are seven loan commitment issues that borrowers should take into consideration during negotiations from a nonbinding to a binding agreement.
Fees. While this seems blatantly obvious, fee issues often arise after the loan commitment has been executed. Prior to finalizing the agreement, borrowers should confirm the timing of and applicability of the fees, whether or not they are refundable, and under what circumstances they are held.
Conditions precedent. Commitment letters stipulate that certain conditions must be satisfied before the lender will fund the loan. Borrowers should confirm that these conditions precedent, sometimes referred to as “CPs” or “outs,” are realistic and reasonable. For example, with improved properties, obtaining a certain percentage of estoppel certificates or subordination, non-disturbance, and attornment, or SNDA, agreements from tenants may be difficult to achieve.
Transfer of interests. 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 transfers of interest not specifically approved may violate the loan documents. 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.
Non-recourse carve-outs. So-called bad boy carve-outs are the most negotiated provisions in loan documents and are usually included in broad terms within the loan commitment. Borrowers should receive advance copies of the carve-outs, if they are not included within the loan commitment, a schedule, or an exhibit. Identifying exactly what the parties intend and expect early in the process can be advantageous to a borrower from a negotiating perspective. It is also cost-saving for both sides in the long term: These provisions have resulted in a great deal of litigation over the years.
Escrows. A lender's escrow requirement 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 provide sufficient information on how these escrowed monies will be released. In fact, it is not unusual for escrows to remain dormant because the release requirements are impractical to achieve. Borrowers should confirm that the release requirements are adequately addressed so they can operate in a customary fashion.
Prepayment. A loan commitment with no mention of prepayment is not necessarily beneficial to a borrower. Courts have held that, without 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, 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. Too often borrowers find that an opportunity to sell an asset at a favorable price is hindered by a poorly negotiated - or non-negotiated - prepayment penalty.
Opinion letters. While rarely negotiated in a loan commitment, legal opinion letters 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 lawyers.
Involving legal counsel early in the loan commitment process and considering these foregoing matters will help a borrower with a successful loan transaction.
Republished with permission. This article first appeared in Commercial Investment Real Estate in the July/August 2015 issue.