If you are in default or threatened with foreclosure on a commercial real estate loan, you are in a boat with many other business owners. When these loans go into default, lenders often seek some sort of “loan workout”, a negotiated deal of the parties’ choosing that stops short of foreclosure. The question is which of the many types of workouts might apply in your case.
Weighing Other Options
Don’t assume that negotiating a deal blocks other options. Keep in mind that while you are looking for a workout, your lender will usually be weighing other options. It can:
- Start paperwork to foreclose on your property or send a receiver in.
- Sell the loan to a third-party investor.
- Accept a discounted payoff (unlikely).
- Ask for a deed in lieu of foreclosure.
- Take no action (also unlikely).
- Work out a deal.
Which of these directions a lender may choose depends on a raft of factors, among others:
- How serious your default looks.
- How likely you look to perform as agreed.
- The value of the collateral.
- What it would cost to foreclose.
- How long foreclosure would take.
- How hard it is to manage the collateral until resale.
- Whether lender can reach the assets of any guarantors.
- The likelihood you or guarantors will go bankrupt.
- The lender’s own internal or regulatory worries.
Pre-negotiation Letter
Before seriously tackling workout talks, your lender may insist on a pre-negotiation letter, the business equivalent of a “letter of intent”. Most of the terms in these pre-negotiation letters are not binding until the parties seal a final workout. Such letters may bind you though to provide financial information, give access to the property, or not dispose of business assets outside the ordinary course of business. The most important item in a pre-negotiation letter, though, is its so-called “estoppel” representation. It says that the loan documents are still in effect, the loan is in default, and you have no defenses or counterclaims.
Three Typical Workout Agreements
Three typical workout agreements are the forbearance agreement, the reinstatement, and the loan modification. All of these options are likely to ask for a fee of some kind. Lender will also want you to pay its legal fees and expenses tied to the default and the negotiations.
A forbearance agreement gives you more time. It lets the lender refrain from enforcing its remedies for an agreed period or until you slip into a new default under your loan documents or the agreement. This is not a reset to square one. You remain in default - the agreement can’t help that. As with a pre-negotiation letter, these agreements will contain covenants - in plain English, promises - on your side and most of the same estoppel language. If the lender grants the forbearance to give itself time or let you show that compliance is possible, the deal may ask for a new appraisal or a cure of the facts that caused your default.
The “reinstatement” treats the defaults as if they have been resolved, putting the loan back to performing as if nothing had happened. This usually comes only if you first cure the facts underlying your default - e.g. pay missed payments, come up to speed on operational and financial covenants. Lender then withdraws its notices of default or admits they have lapsed.
A “loan modification” is just that. It makes clear, enforceable changes to the loan documents. Lender may ask to extend the term (“extend & pretend”). It may ask for amendments that loosen your leasing or occupancy covenants or lower your debt service coverage ratio. Other common changes include setting you on interest-only payment for a while or re-amortizing after the extension term. Beyond the fee, lenders often demand more. Lender may demand a partial principal paydown, more collateral (such as larger cash reserves held by the lender), or a new guarantor. It may set a date for you to refinance or sell the property before the original maturity.
Workout deals may involve a combination of forbearance, reinstatement and a loan modification. As in any business negotiation, the points you win depend on how much leverage you or the other side have. If lender holds all the cards, be ready for a take-it-or-leave-it result. If you are willing to consider bankruptcy or have the sense that lender lacks the time or stomach to foreclose, you may be able to bargain more favorable terms - better than the first offer. But to avoid last-minute surprises, before you sign anything, you should get a lawyer experienced in commercial loan workouts.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
