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An Overview of Possible
Responses to Commercial and Multifamily Loan Defaults
By Eric Dean Esq.
The Wolf Firm - USFN Member (CA)
INTRODUCTION
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.
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