Real Property Lender Security, Lease, and Other Downside Concerns

Langdon Owen
June 5, 2008 — 2,289 views  
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1. Types of Transactions.  The major concerns of a secured lender in real estate loan transactions, particularly those involving leases, is the topic of this outline.  This outline will serve as a checklist of matters deserving consideration by a lender as part of a transaction.
 
There are different sorts of “lenders” providing financing for real estate transactions, and there are different loan situations.  A financing where the property is subject to one or more leases may involve such situations as: a fee owner trust deed to secure a tenant improvement loan, a fee owner loan against the leased land for the owner’s own purposes, or a leasehold secured loan to the tenant.  The tenant as sublessor is in a position similar to a fee owner leasing a property.  A seller in a seller financed transaction will be in a situation analogous to a fee lender.  In each situation, the lender’s key concern will be ensuring the ability to have the loan repaid out of the collateral.
 
2. Deal Structure.  The lender may lend to a fee owner who leases to tenants or may lend to a tenant under a long-term lease.  The structure of the lease deal itself will be of great interest to the lender.  Where the lender lends to the landlord, if rents are below market, or if the property cannot be leased to an adequate extent, the property value will decrease and the cash flow may not cover the loan servicing payments.  Where the lender lends to the tenant, the lease needs to have commercially-reasonable terms to be financable, and special lender protections will be required.
 
The lender’s loan agreement or trust deed will cover many lender concerns, but some matters will need to be handled, as well, in the lease itself to provide lender with rights as to the party to the lease which is not the lender’s borrower.  Agreements with borrower’s insiders and with unrelated third persons likely will be needed to some extent, as well.
 
3. Loan Agreements.  Lender loan agreements (or seller financing agreements) will cover conditions prior to lending, the amount of the loan, its disbursement and its repayment terms, loan fees, interest rate, general events of default, security interests, guaranties, credit worthiness, and financial covenants, etc. Depending on the type of transaction, in order to protect a lender, they may cover such matters as:
 
a. Construction Matters - e.g., of substantial improvements by borrower.
 
i. Protection of title generally and against mechanics or material liens, etc.:

- escrows for staged advances within agreed budget, plans, and time schedules
- certifications of percent of completion by independent engineer or architect  
- conditioning advances on lien releases from workers, contractors, and material and equipment suppliers, and on other matters (engineer report, etc.)  
- requiring direct payment of approved costs by lender  
- title insurance update endorsements as advances made  
- covenants as to extent of services and who will perform services, and not allowing any others; job site and job log inspections  
- establishing the extent of any staking or other engineering or other services which may have occurred prior to the loan  
- survey; title reports; zoning and land use approvals  
- require lender consent to substantial plan changes or additions  
- no other work to be done  and no other funds to be  used.
 
ii. Protection in case of need to take over project :

- assignments of contracts with contractors, subcontractors, engineers, architects, etc.  
-  assignment of and right to use plans and specifications from the architects and engineers; right to make changes after default  
- assignment of all utility, rail, and similar connections
- rights to use equipment and tools of third persons
- water rights
- proper maintenance and condition of premises
- requiring in agreements exculpation by third parties of lender on take over for prior borrower actions and nonpayment defaults
- perfection of assignments and fixtures by UCC filings
- consents to assignments and use provisions by the third parties affected. 
 

iii. Liability and loss protection (also applies to other types of loans):
 
- liability insurance, workers compensation coverage, from parties, contractors, etc.
- environmental assessments and reports
- environmental exculpation and indemnification
- business interruption insurance
- casualty insurance (to lender first, not to landlord)
- waivers of subrogation
- dispute resolution provisions
- indemnities, certifications
- waiver of lender obligations and exculpations by debtor (to extent allowable)
- title insurance
- special forms of insurance (e.g., flood)
- bonds for bids, completion, etc., and assignment of rights under bonds
- payee designation on all insurance and bonds
- permanent loan takeout commitment
- waiver of lender obligations for debtor defaults, etc. (as to third-party agreements)
- provisions that insurance not voided as to lender by debtor’s wrongful acts
- other insurance quality provisions (insurer strength, no cancel, limits on deductibles, etc.).

b. Cash flow protection in all forms of loans:
 
i. Right to require lender lease consents on major leases, both on initial lease or any modification or assignment
 
ii. Subordination and attornment and no prepayment provisions with tenants
 
iii. Estoppel certificates from tenants
 
iv. Management contract assignments (no liability of lender for borrower’s acts)
 
v. Lock box rent arrangements and restricted or controlled deposit accounts
 
vi. Right to endorse rent checks and other payments
 
vii. Assignment of rents and leases or subleases and related books and records, including machine readable information with software and equipment required to access it
 
viii. Regular copies of rent rolls, management reports, financial information
 
ix. Mortgage and UCC perfection
 
x. Insider subordinations of claims (“doormat” no-pay provisions, or on default no pay).
 
c. Default protection matters generally as to all types of loans:

ii. Rights to obtain control of all operating aspects - trust deeds, security interests in furniture fixtures and equipment, security interests in needed service or supply contracts; perfection of security interests
 
iii. Ability to access personal property of tenant debtor
 
- consent from landlord to enter premises
- ability to sell on premises
- ability to store on premises for period of time for reasonable amount

iv. Guaranties, letters of credit, key person life insurance, outside collateral, other credit enhancements, cross-collateral, offset rights
 
v. Access to proceeds of insurance, condemnation, etc., and right to designate use to pay loan or reconstruct
 
vi. Nonrecourse loans - express limitations on scope (i.e., describing partial liability circumstances)
 
vii. Appraisals, surveys, accountings, reports
 
viii. Assignment of equity interests in borrower company
 
ix. Special bankruptcy provisions
 
x. Assignment of payment rights of principals from borrower company.
 
d. Loan transferability.
 
i. Ability to participate loan with other lenders or to assign without further obligation.
 
ii. Negotiable note (for holder in due course treatment).
 
iii. Use of borrower special purpose and bankruptcy remote entities for securitization transactions (such as REMICs):
 
- bond rating requirements
- ability to obtain entity control
- eliminate fiduciary duties by single asset, single obligation entity
- restrict authority to file bankruptcy
- investor reviews collateral, not the borrower.
 
iv. Trust indentures and bonds (specialized transactions):

- tax-exempt financings (see IRC §§ 103, 141 through 150 special tax rules)
- real estate mortgage investment conduits (REMICs) (see IRC §§ 860A through 860G special tax rules)
- early payoff requires defeasance with government bonds
- stringent, lacking in flexibility
- securities law issues.
 
v. Standardized instruments for some secondary markets, governmental guarantors, loan servicing arrangements, etc.
 
e. Typical loan-related terms.
 
i. Typical loan events of default:
 
- failure to pay interest, principal, or fees when due
- failure to pay other amounts
- failure to observe covenants in loan documents on a variety of matters (possible grace periods)
- default by debtor or guarantor under other transactions with lender (cross-default)
- default with third persons
- submitting false or incomplete information or making false statements
- insolvency events as to debtor, guarantor, pledgor of collateral
- due on transfer violation or change in control
- default by guarantor, pledgor of collateral
- lender deems self insecure (good faith required).
         
ii. Some consequences of default: 
 
- alternative remedies not exclusive
- acceleration of obligations
- default interest
- late fees or penalties
- prepayment premium triggered
- foreclosure of collateral (trust deed, UCC security)
- suit on guarantees
- suit on deficiency
- adverse credit reporting
- appointment of receiver
- attorney’s fees and costs; other professional fees
- cash control.
 
iii. Typical loan covenants:
 
- maintenance and repair
- insurance (casualty, liability, etc.)
- lease provisions or modifications
- tax and assessment payment
- no liens or other security interests
- adequate records
- financial tests or lease-ups
- provide regular financial information on debtor and guarantors
- restrictions on insider and related company deals
- rent lock box, cash control
- maintain letter of credit
- maintain franchises, license, etc.
- reporting of litigation or threats of claims
- reporting of environmental problems
- no changes in location of debtor or collateral
- access for inspection
- audit rights
- legal compliance by debtor (tax, licenses, Americans with Disabilities Act “ADA,” environmental and natural resources, health, land use, building codes, etc.)
- no changes to debtor organization
- regular no default certification by officers of debtor
- sinking funds and defeasance provisions
- prepayment restrictions and premiums.
 
iv. Typical guarantee provisions:
 
- continuing or terminable
- existing obligations, future obligated advances, or any future obligations created at discretion
- joint and several or proportionate liability
- unlimited or limited (amount, time, etc.)
- no consent for lender to modify deal
- no consent for lender to release collateral, other guarantor
- waivers of notice and suretyship defenses
- waivers of contract, statute of limitations, other defenses on underlying obligations
- guaranty performance not collectibility
- surety and enforceable without recourse to debtor, collateral, other guarantors, etc.
- waivers or subordination of claim of guarantor against debtor
- payable whether debt due on acceleration or otherwise
- expenses guaranteed (enforcement, protect collateral, etc.)
- costs of bankruptcy proceedings of debtor, guarantor, other guarantors, pledgor of collateral
- callable on death, insolvency events of guarantor
- no information on debtor required from lender
- no changes to guarantor organization
- acknowledgment of benefit, consideration
- financial covenants and limits on other guarantees
- security for guaranty.
 
v. Types of collateral which may be included in the transaction:
 
- fee interest in land (from debtor, subordination of others, from landlord)
- lease interest in land
- water, mineral rights
- easements, appurtenant rights
- equipment and supplies used with property
- contracts with management, contractors, railroads; maintenance contracts and warranties; marketing agreements and franchise rights; utility and other supply agreements
- leases and rents
- rights to proceeds of insurance or condemnation
- prepaid amounts, rebates, refunds
- fixtures, crops, timber, severed minerals
- plans and specifications
- key agreements with local government (annexation, development, tax benefits)
- equity interests in debtor organization or related organizations
- outside collateral of any type available
- trademarks used with property
- phone numbers, e-mail, websites associated with property
- advertising and literature.
 
4. Matters for Lease Coverage.  Lender’s rights as to some other (nonborrowing) lease party will need to be defined and protected in the lease itself or in an amendment to the lease or in a separate instrument relating to the lease.

a. Consents to possession by lender.
 
b. Attornment, nondisturbance, subordination agreements with tenants or subtenants; no prepayment of rents or lease modifications.
 
c. Access to tangible collateral, including:
 
- landlord lien subordination
- repair damage from removal of fixtures.
 
d. Estoppel certificates (from tenants on loans to landlord, from landlord on loans secured by leasehold).
 
e. Access to insurance and condemnation proceeds; waiver of subrogation.
 
f. Subordinations of tenants to fee trust deed, of subtenants to leasehold trust deed.
 
g. Assignment and sublease restrictions and changes in tenant form or control.
 
h. Notice and right to participate in proceedings; copies of all notices.
 
i. Rights to exercise lease powers or options (purchase, renewals, etc.).
 
j. Maintenance and repair obligations; use of third-party contractors; restrictions on tenant improvements and mechanic’s liens, etc.
 
k. Waivers as to lender obligations on environment, Americans with Disabilities Act (ADA), prior conduct of borrower, etc.
 
l. Dispute resolution provisions.
   
m. Waiver of lender obligations to perform borrower duties under lease (e.g., lender will not make landlord’s payment of tenant allowances).
 
n. Extra time to cure and right to cure borrower’s lease defaults, no need to cure certain matters.
 
o. Lender consents needed to make lease changes, assignments, subleases, etc.
 
p. Right to require direct lease if can’t cure old lease, including:
 
- cure prior matters of financial nature with subrogation against tenant
- time limits to request 
- priority to request where more than one creditor may request new lease
- transactional cost; obtaining actual possession.
 
q. Foreclosure and right to assign or sublease by lender of tenant interest, including:
 
- financial responsibility standard acceptable to landlord
- time within which to object
- operational ability and reputation standards
- business suitable to building or project
- competition for landlord’s potential tenants (not an existing tenant or in negotiation)
- rental not lower than rate landlord quoting for similar space or discount or advertising limited
- possibly exclude governmental agencies or certain kinds of tenants
 
r. Ability to finance buyer at foreclosure sale with buyer granting trust deed in the foreclosed interest.
 
5. Typical Documents.  Some of the typical documents needed in real estate lending include:  

a. Loan agreement.
 
b. Promissory note (negotiable, or nonnegotiable).
 
c. Trust Deed and Assignment of Rents (fee, leasehold).
 
d. Security Agreement on tangible and intangible personal property (debtor, guarantors).
 
e. UCC financing statement - central filing.
 
f. UCC financing statement - fixture filing.
 
g. Prior loan and security releases; subordinations
 
h. Tenant estoppel certificates; subordinations, attornment, nondisturbance agreements.
 
i. Landlord consent and agreement for access, insurance proceeds, condemnation proceeds, cure rights, direct lease rights, etc.
 
j. Lien waivers; escrow agreement in some cases.
 
k. Agreements with, or assignment of rights as to, third parties (services, supplies, etc.).
 
l. Guarantees of principals, related organizations.
 
m. Title policy and endorsements.
 
n. Insurance certificates; payee designation.
 
o. Environmental reports, soil tests.
 
p. Survey.
 
q. Appraisal.
 
r. Rent lock box agreement, account control agreement.
 
s. Company resolutions or approvals.
 
t. Legal opinions.
            
u. Escrow agreement.
 
v. Principal’s certifications of financials, factual matters.
 
w. Credit reports.
 
x. Funding instructions.

Langdon Owen