Written By: Eric D. Dean
In many instances, there will be similarities in the nature of the defaults occurring on different loans. However, the adoption of a loan specific, objective-oriented approach to the resolution of loan defaults will in most instances substantially enhance the prospect of a significantly enhanced outcome of the resolution of the default. Such an approach requires an objective analysis of the pertinent facts, documents and the nature and extent of the default and, based on this analysis, the adoption of stated objectives.
Once these objectives are defined, strategies may be focused on to achieve these objectives. As events unfold, objectives and strategies may be reevaluated depending upon such factors as the responsiveness and performance of the borrower, the improving or deteriorating condition of the loan collateral, general market conditions, available reserves, the financial strength of guarantors and possible solutions proposed by the borrower or junior lien holders.
DEFINING OBJECTIVES
Objectives can be focused around a number of factors that are not necessarily mutually exclusive including:
1. Curing Defects – If it is determined there have been accounting errors, defects or deficiencies exist in loan documents or in the description of the scope of the loan collateral, these must be identified and to the extent possible cured in the context of a work out.
2. Release of Potential Liability Claims – If potential liability claims exist against the lender or servicer, a release of these claims can be accomplished in the context of a work out.
3. Reserves and Guarantors – As part of a work out, additional guarantors or reserves may be mandated by the lender or server.
4. Preservation of the Loan Collateral – The strategy adopted in response to a loan default will depend to a significant extent on whether the borrower is committed to and capable of protecting or enhancing the loan collateral including, where necessary, making required repairs and improvements.
5. Property Management – In some circumstances continuation of curent management is essential to facilitate continuity or because of ongoing negotiations with governmental officials or prospective tenants. In others, where management is disengaged, dishonest or ineffective replacement of current management is of paramount concern.
6. Rents – The adoption of appropriate controls to ensure rents are properly accounted for and disbursed may be a primary goal. At the same time the lender does not want to be deemed a mortgagee in possession or accused on lender liability.
7. Cost Controls – Effective control of costs and expenses is essential in both the work out process and in the ultimate outcome of the response to loan defaults. Once the required analysis is made, the adoption of optimal strategies based on clearly defined objectives is essential. To optimize the position of the lender/servicer, it is essential that experienced, competent and cost effective attorneys, consultants and receivers (if a receiver is to be appointed) be utilized. The use of the wrong professional will create unnecessary costs, negatively impact the probability of a timely and effective resolution and diminish the likelihood that the position of the lender/servicer will be maximized.
FORMS OF NON-LITIGATION WORK OUT AGREEMENTS
There are various forms of non-litigation “Work-Out Agreements” which are in many instances not mutually exclusive and may be employed in combination. The forms and terms of the agreements can vary significantly depending on multiple factors. In broad terms, these agreements can be defined as follows:
The Forbearance Agreement – Under the typical Forbearance Agreement, the borrower and guarantors each acknowledge the defaults, reaffirm the loan documents, release any possible claims against the lender/servicer, acknowledge the loan balance and acknowledge the legality of any pending foreclosure. The borrower also agrees to a program to cure its defaults in accordance with the terms set forth in the Agreement and not commit further defaults and the lender agrees to a postpone further action if the borrower timely performs as agreed.
The Loan Modification Agreement – Under the typical Loan Modification Agreement, the borrower and guarantors acknowledge the defaults, reaffirm the loan documents, release any possible claims against the lender/servicer, acknowledge the loan balance and agrees to perform in accordance with the terms of the agreement. The agreement can take a wide variety of forms and may include modifying the loan balance, adopting new payment terms, requiring additional reserves, imposing a lock box, waiving existing defaults, extending the maturity date or may otherwise restructure the loan on a temporary or permanent basis.
The Lock Box Agreement – Under the Lock Box Agreement, the borrower agrees that all property income will be deposited in an agreed account and disbursed from the account in accordance with the terms of the Lock Box Agreement. It is common for lenders/servicers to require lock box in the context of a loan modification or forbearance. The Lock Box Agreement provides the lender/servicer with ready information as to property performance and also typically provides that funds not used in property operations be used as additional reserves.
The Deed in Lieu of Foreclosure – Where the borrower can no longer support the loan collateral and there are no viable guaranty claims, the lender/servicer may consider negotiating a deed in lieu of foreclosure to avoid the delays and costs associated with a foreclosure. If there are guarantors, the lender/servicer may consider negotiating a compromise of these guarantees as part of the deed in lieu process. Before accepting a deed in lieu, the lender/servicer must make a determination that there are no title defects or junior liens or encumbrances and inspect the property since by accepting the deed in lieu, the lender/servicer is accepting title and the real property collateral as is.
A Sale of the Loan Collateral – At times, the lender/servicer will be presented with a proposed buyer who is determined to have better management skills or deeper financial resources than the existing borrower. In such circumstance, subject to appropriate title protections and other conditions, the lender/servicer may agree to a loan assumption perhaps in conjunction with a loan modification. Alternatively, if the proposed buyer has alternative sources of capital available and the loan collateral does not support the loan balance, the lender/servicer may agree to a “short sale” arrangement under which the lender/servicer agrees to release its lien in conjunction with an agreed payoff. If there are guarantors, the lender/servicer may in conjunction with either such arrangement negotiate a resolution of the guaranty claims.
LITIGATION ALTERNATIVES
Circumstances may dictate that litigation be instituted to protect the interests of the lenders/servicer. The remedies sought in litigation and strategy adopted will vary depending on the loan analysis and objectives implemented and the jurisdiction in which lawsuit is to be filed. For example, in some jurisdictions the lender/servicer as plaintiff will have the opportunity to chose and nominate a receiver, while in other jurisdictions the judge selects his choice of a receiver. Similarly, in some jurisdictions, receivers are routinely appointed on an application made with 24 hours notice while in others the court will only appoint a receiver where extreme or urgent circumstances are demonstrated by the plaintiff.
The threat or commencement of litigation may also be an effective method of inducing the borrower to enter into a work-out agreement, tender a deed in lieu of foreclosure or agree to a receiver marketing and selling the loan collateral pre-foreclosure. Litigation may also be essential to protect the loan collateral including property rents. Litigation may also be mandated to protect the lender/servicer from liability. The use of appropriate court remedies allows the lender/servicer to gain appropriate controls over the collateral without becoming a mortgagee in possession or otherwise creating claims of lender liability or predatory lending practices.
The Preliminary Injunction: A Preliminary Injunction is a court order that requires the borrower and its agents to refrain from engaging in specified acts such as committing or permitting waste on the loan collateral, failing to maintain insurance, failing to account, failing to maintain the collateral or to make required repairs, failing to properly apply rents, etc. The Preliminary Injunction is, therefore, much like a work out agreement. The Preliminary Injunction allows the lender/servicer to obtain protection without the costs of a receiver. If the borrower or its agents violate the injunction they are subject to a contempt citation. Additionally, the Preliminary Injunction Order can provide that, at the option of the lender, a receiver designated in the order will be immediately appointed if the terms of the Preliminary Injunction are not complied with. This is particularly helpful in jurisdictions where obtaining an order appointing a receiver is difficult or costly.
The Appointment of a Receiver: A receiver is a court appointed officer who assumes the position of an owner of the property. The receiver typically appoints a property management company to operate the property. In certain circumstances, the receiver may be authorized to market and sell the property without conclusion of the foreclosure. The receiver is an appropriate remedy where the borrower is incapable of management, untrustworthy or where actions must be taken to protect the loan collateral or avoid or cure legal non-compliance. A Preliminary Injunction will also typically be entered in conjunction with the appointment of the receiver. The appointment of a receiver may also prove of benefit where the borrower later files bankruptcy. The appointment of a receiver may be extremely helpful in situations where the loan collateral is only partially completed or is in need of repair or the curing of defects. In such circumstances, the lender/servicer may not want to fund monies to the borrower to make repairs or improvements and does not want to foreclose and then make the repairs or improvements and be subject to latent defect claims.
Claim and Delivery: Where personal property collateral is being removed or threatened to be removed from the property, an order of claim and delivery requiring the turnover of the personal property to the marshal or sheriff may be appropriate. A preliminary injunction or the appointment of a receiver may also be an appropriate remedy under such circumstances.
Claims against Guarantors: The obligations of guarantors are independent and typically unsecured. Depending on the terms of the guaranty, a lawsuit may, therefore, be pursued against guarantors concurrent with the foreclosure of the loan collateral. In conjunction with such suit, a pre-judgment attachment of the guarantor’s assets may be sought allowing the assets to be seized and held pending judgment. Assertion of claims against the guarantor and obtaining an attachment can prove to be powerful methods of facilitating a work out.
Judicial Foreclosure: Where there is a substantial deficiency, depending on the laws of a particular state, the lender may file suit against the borrower seeking the award of a deficiency judgment I conjunction with the foreclosure of the loan collateral.
Rent Skimming, Fraud and Claims as To Environmentally Impaired Properties: Many states have specific statutes providing the note holder with broader remedies than might otherwise exist if the borrower or its agents have engaged in bad acts such as fraud or rent skimming or where the loan collateral is environmentally impaired. In such circumstances, depending on the laws of the state, in addition to or in lieu of foreclosure, the lender may have claims for both actual and punitive damages. A Preliminary Injunction may also be employed during the pendency of a lawsuit to stop rent skimming or other bad acts.
CONCLUSION
In summary, depending on the facts and issues presented and the desired objectives, lenders and servicers have multiple tools available to protect the lender’s interests and achieve defined objectives if events of default exist in the commercial and multi-family loan. Focusing on key factors, defining objectives and adopting appropriate strategies based on the circumstances presented at the early stages of the special servicing process will greatly enhance the likelihood of a viable and effective outcome.