An Industry in Distress
Loan defaults and financial distress among long term care (LTC) facilities, such as skilled nursing facilities (SNFs), assisted living facilities (ALFs) and memory care facilities, are on the rise. The COVID-19 pandemic has compounded many of the pre-existing and long-recognized challenges within the LTC industry, and such facilities are experiencing unprecedented financial distress as a result. The precipitating factors driving this financial distress include:
- Increased operating costs due to labor costs and inflation;
- Staffing shortages;
- Low reimbursement rates and reimbursement issues;
- Declining occupancy;
- Technological changes, including the advent of telehealth, home health-monitoring devices and smart devices, permitting more seniors to age at home;
- Negative operating margins generally;
- Overbuilding in some markets; and
- Many seniors in need of services who cannot afford to pay for them.
In this environment, it is prudent for lenders to proactively monitor their loan portfolios and to be prepared to respond to their LTC borrowers in financial distress. In anticipation of financial headwinds for their LTC borrowers, lenders with LTC assets should take the following prophylactic actions:
- Prepare a watchlist of borrowers at high risk of financial distress.
- Maintain consistent communication with LTC borrowers.
- Review the financial condition of LTC borrowers, particularly those on the watchlist.
- Require strict compliance with financial reporting requirements and closely monitor financial covenants.
- Obtain and review census information regularly.
- Review loan documents, including loan covenants and reporting requirements. Identify whether there are missing loan documents or drafting deficiencies that can be corrected prior to a default.
- Confirm that security documents are properly drafted, executed and recorded; liens and security interests are perfected; and financial statements are current.
What to Do in the Event of a Loan Default
In the event of default by a LTC borrower, a lender should take the following actions:
- Immediately engage competent workout and restructuring counsel with experience handling distressed LTC assets. Delays are almost always prejudicial to the lender’s position.
- Promptly reserve lender’s rights and remedies by issuing a written notice to the borrower and other loan parties, even if the lender is waiting to formally provide a notice of default, demand cure of the default or exercise any other rights and remedies.
- Investigate and evaluate the source of the default and true financial condition of the borrower:
- Are the borrower’s problems fixable or fatal?
- Do the borrower and its current management have the financial ability and know-how to right the ship?
- Can a qualified turnaround consultant add value?
- Evaluate lender’s rights, remedies and collateral position:
- Is the lender over-secured or under-secured?
- Does the borrower have other lines of credit or mezzanine loans?
- Is the borrower cooperative or combative?
- Does the lender have recourse guaranties?
- Have any recourse carve-out events — such as fraud, misrepresentation, failure to pay taxes or maintain insurance, criminal conviction, or misappropriation of funds, among others — been triggered under any non-recourse guaranties? The lender should familiarize itself with default remedies under the loan documents and applicable state law.
- If a negotiated workout or restructuring is being pursued, consider entering into a pre-negotiation agreement with the borrower. This is particularly appropriate if litigation appears likely or the borrower is threatening counterclaims or is otherwise adversarial with the lender.
- Determine what a successful outcome means under the circumstances and develop a strategy to achieve it. Useful tools and remedies worth consideration include:
- Loan modification agreements or amendments to loan documents (particularly if a self-correction by the borrower is a possibility) modifying financial covenants, requiring additional reserves or paydown of the loan, or modifying guaranty limitations;
- Forbearance agreements (particularly if pursuing a sale, refinancing or other consensual exit from the loan);
- Extra-judicial enforcement actions against the borrower provided under the loan documents (to exercise control over the borrower’s cash, accounts receivable, and other cash in-flows);
- Judicial enforcement actions against the borrower or guarantors (to obtain a monetary judgment and/or equitable relief);
- Foreclosure (to take ownership of the facility or the borrower); and/or
- Receiverships (to obtain a court-appointed neutral party to supervise operations, preserve going-concern value and market the facility for sale).
- Finally, confer with counsel about how a bankruptcy filing will affect lender’s rights and remedies and develop a contingency plan in the event of bankruptcy. If a bankruptcy petition is filed, the lender will need to move quickly to protect its position.
Despite the precarious LTC environment, proactive lenders can take measures to protect their positions in the LTC assets in which they’ve risked their capital by ensuring their legal rights and remedies are preserved in advance. Lenders should dust off those closed loan files in the coming months and work to narrow any gaps in their documented rights.