Real estate developers may be wondering what to expect for upcoming draws of construction loans or credit lines to fund real estate development if the FDIC places their lender into receivership. In the 2008/2009 financial crisis, borrowers were left waiting for funding from FDIC-insured lenders in receivership, like CORUS Bank, even after the FDIC stepped in to take over. While the projects stalled, materials moldered, carrying costs rose, and liens stacked up. The FDIC’s formal guidance on loan takeovers has not changed significantly since that time.1
This time around, though, the FDIC is signaling that it may take a different approach. The agency-operated successor to one bank recently put into receivership posted on its website a statement that it has assumed all the prior bank’s loan positions and will honor all commitments to advance under existing credit agreements. This sounds promising, as there may be room to hope that construction borrowers and borrowers with unfunded credit lines will in fact have the terms of their loans honored. After all, this time around, real estate loans are not at the heart of the reason for the banks’ receivership.
However, the lessons of the 2008 era would temper any optimism. After all, it would be in the interest of an FDIC receivership not to continue to fund loans that won’t be paid back until long after the receiver’s assets have been sold to a third party. So the FDIC may consider a request to fund, or may request appraisals, reports, tax returns (most likely from a special purpose entity borrower with no income to report), etc. But in the end, the conclusion may still be that it is not in the interest of the receivership to fund additional amounts. Note that the best interest of the borrower is not an express consideration in the FDIC’s written guidance; only the best interest of the receivership is.
Construction borrowers for in-progress projects should be aware their general contractors as well as subcontractors of every tier will likely have unpaid retention amounts and that many may also have amounts owed for work performed since the prior construction draw. In order to protect themselves, the contractors, subcontractors, and suppliers will all have to file mechanics’ liens within the requisite statutory period. This means that if the receivership drags on, even with cooperating contractors and subcontractors, those mechanic’s liens will have to turn into lawsuits, as each claimant is required to file suit within the statutory period to preserve its lien.
On the other hand, it is important to note that a bank receivership does not relieve a borrower from having to comply with its loan covenants and obligations, which undoubtedly require bonding against or paying off all mechanic’s liens within 15-30 days. Unfortunately, for many borrowers, that is hard to do without construction loan funds. In addition, once lawsuits to enforce liens are filed, the borrower will need lawyers to answer complaints and litigate the cases to prevent foreclosure of the mechanic’s liens. Those lawsuits are likely additional violations of loan covenants.
The FDIC’s policy is to seek a purchaser for the assets of a bank in receivership. Its mandate is to get the best return for the government. Thus it may take a while for a sale to occur. Once the sale occurs, borrowers will have a new lender and may be able to negotiate a restructure of existing loans. However, those borrowers will be borrowers with a loan in default, whose construction has likely ground to a halt, and perhaps who are in a dispute with the general contractor over construction contract defaults. That makes negotiations more challenging. After all, from a lender’s point of view, the borrower should have (perhaps was required by its loan covenants to have) filled the gap with equity. So sympathy is usually in short supply.
If we look again at the lessons of the 2008 banks in receivership, many assets were sold to funds expressly set up to buy banks’ outstanding loans in order to foreclose on the underlying assets. Some purchasers of loans simply refused to negotiate with borrowers. The impact on borrowers depends on factors such as the prospects for an overall sale, the appetite of the purchaser for specific types of borrowers and loans, and the nature and status of the credit. Borrowers with loans that are classified negatively or are in default may want to consider moving the credit elsewhere to the extent possible.
Where does that leave a borrower from a lender in receivership? If your construction lender is in receivership, you may need to immediately seek new equity and replacement financing. You should certainly try to get the FDIC (or any successor bridge bank) to provide funding. But you should also concurrently have a contingency plan in place so that you can retain the benefit of your construction pricing and avoid the need to engage lawyers to fight mechanic’s lien claims. Once those claims have been filed, every single one of them must be resolved at the time you record a new loan, in order to provide clean title to the new lender. That requires extraordinary coordination and complicated escrow provisions. Having guided clients through that process in the post-2008 period, we know how challenging it can be to get everyone on the same page at the same time and hold them in place while you deal with recalcitrant lienholders. Much better to avoid the problem if at all possible.
1 The FDIC’s guide “A Borrower’s Guide to an FDIC Insured Bank Failure” says the following about situations where the FDIC is appointed receiver of a lender:
“The role of receiver generally precludes continuing the lending operations of a failed bank; however, the FDIC will consider advancing funds if it determines an advance is in the best interest of the receivership, such as to protect or enhance collateral, or to ensure maximum recovery to the receivership.
In very limited circumstances, the FDIC will consider emergency funding needs required to ensure the short term viability of a borrower, to protect or enhance collateral value, or for public safety.
If you submit a request for additional funding, the FDIC will conduct a thorough analysis to determine the best course of action for the receivership. The FDIC uses information contained in the failed bank’s loan files to the extent it is available and considered reliable.
Because the files of failed banks are often incomplete or poorly documented, the FDIC may require additional information to perform its analysis and make a fact-based decision. Such information can include current financial statements and recent tax returns from borrowers and guarantors, and third party reports such as market studies and appraisals.”