November 25, 2013
by Charles L. Hahn & Steven A. Jacobs
Trott & Trott, P.C. – USFN Member (Michigan)
The foreclosure-related challenges of property management, maintenance, and security are significant for commercial mortgage lenders: from managing rental income and tenancy rates, to preventing vandalism, navigating potentially contentious landowner disputes, and maintaining property value through regular maintenance. It takes little time for even a thriving property to become a costly liability.
As a result, it is essential to work closely with a legal expert who has demonstrated expertise in dealing with these challenging circumstances, and knows how to protect lender investments. What follows is a review of the most effective mechanisms available to lenders looking to preserve their properties.
Promptly assembling the correct loan documentation is critical to protecting both collateral and continued cash flow. Commercial loan documentation provides the legal tools needed to safeguard the collateral, whereas important addenda and clauses provide the lender the power to act decisively through the assignment of rents and appointment of receivers. Efficiently preparing and enforcing loan documents depends on the preparedness of the lender/servicer, as well as its property management and legal teams.
Rental Income Control
An agreement for assignment of rents can be an important tool in re-directing cash flow from the tenants’ lease agreements to the lender, allowing that income to be applied to the loan balance after payment of expenses. In some cases, this rental income can be collected concurrently with a foreclosure action and continue through the redemption period, making the assignment of rents a mechanism that allows cash flow to be obtained while bypassing the defaulted borrower.
The drawback of acting upon an assignment of rents is that it can potentially decrease motivation for borrowers to continue maintaining the premises, as operating expenses will not be reimbursed through the rental receipts. Lenders/servicers should be prepared to take over responsibility for the premises in its entirety, and have a detailed maintenance plan in place to maintain asset value.
With cooperative borrowers/mortgagors, a negotiated property management transfer may be possible after executing the assignment of rents. It is essential to hire a property management company with a professional skill set that is well suited to the property in question — it makes little sense to hire a property management company specializing in multi-family operations to manage a mixed-use commercial property. If a management resolution cannot be reached, a judicial action may be filed to insert a receiver to manage the collateral.
Most commercial loan documentation includes powers for lenders to take control of the property through a receivership. Even when loan agreements lack such powers, existing laws frequently fill in the gaps. Lenders/servicers should have compelling reasons to request a receiver appointment. Items such as unpaid taxes or insurance, current property use and condition, management capabilities of the mortgagor, or difficulties collecting rent are all important considerations for a court when deciding whether to displace a mortgagor of its interest. Receivership can be a temporary damage control tool or part of a comprehensive foreclosure procedure when a complete takeover and liquidation are needed. In either situation, swift acquisition of asset control is important, as property conditions can deteriorate rapidly. The primary drawback to a receivership is the overall expense, and a cost-benefit analysis is warranted before proceeding.
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