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We are going to go out on a limb and guess that almost all borrowers will have occasion, in the coming weeks and months, to speak to their mortgage lenders about impacts of the COVID-19 pandemic on their operations, their loans and their properties. Borrowers would be well advised to give thought to how best to approach their lenders so as to maximize their prospects for successful communications and minimize any unforeseen adverse consequences. Because we are commercial mortgage lawyers, our article was written with commercial mortgage borrowers in mind. However, we expect the general principles we advocate will be applicable to other asset classes and to debtor/creditor relationships generally.
Here are some thoughts:
Review your documents before you reach out to your lender.
- If you have a nonrecourse or limited recourse loan, make sure you understand any exceptions to nonrecourse that may be inadvertently triggered by your communication. Unfortunately, there are often many. For example, many loans have some variant of a provision that triggers recourse if a borrower “admits, in writing or in any legal proceeding, its insolvency or inability to pay its debts as they become due.” If yours has such a provision and you haven’t negotiated an agreement permitting candid conversations with your lender, consider doing that in advance so that the specter of full recourse is not hanging over your head.
- Think about what you want the lender to do, and make sure you understand how your desired outcome plays out under your documents. For example, if you anticipate tenant defaults, you might want to offer some sort of structured rent deferral for tenants in need, and you want the lender to agree to some sort of corresponding debt service deferral. For instance, you may be required to get lender approval for any lease modification which defers or relieves rent. And your request may well trigger any cash traps under the loan documents, or as a quid pro quo for debt service relief.
Know who your lender is now.
- This seems simple enough, but if your loan has been securitized, you are facing an entirely different dynamic (and cast of characters) from the one you would be facing if your lender retained your loan on its balance sheet. If your loan has been securitized, the lender that made your loan has transferred it to a securitization trust and will likely be out of the picture. Instead you will be dealing with servicers who are acting on behalf of bondholders, who are investors in the securitization trust and who may in fact be bondholder/investors themselves. If you want to ask for material modifications or longer-term forbearance, you’ll need to deal with the “special servicer” for your loan. But finding out who that is can be a challenge. Once you have figured that out, you (or more likely your advisor) would be well advised to secure the applicable pooling and servicing agreement and get a sense of what the various servicing roles and their respective authorities are. Suffice it to say that dealing with special servicers in negotiating loan modifications and forbearance is challenging: Their flexibility is constrained by arcane Real Estate Mortgage Investment Conduit (REMIC) rules, and their motivations are often quite different from those of your friendly neighborhood bank. You should secure the services of advisors who understand that world.
At the outset, perform your loan obligations if and to the extent you can.
- For example, if you have the ability to make April’s payment, do it. It is much better to begin the conversation as a performing borrower seeking to work collaboratively with its lender through a difficult situation outside your control than as a borrower in default. Many consequences flow unavoidably once a loan is in default, and few of them are good. In the case of nonrecourse financing, if property revenues would permit you to make a partial payment, consider offering to do so. Failing to do so may trigger recourse under your loan, and in any event is a breach of the social contract which underlies nonrecourse financing. Making it clear to the lender that you’re going to do everything you reasonably can to address the issue establishes the good faith that is a prerequisite to any negotiated accommodation.
In your communications, be honest, transparent and factual.
- While you should be careful to understand the risk of and take steps to protect yourself from legal jeopardy, nothing is gained by adopting an adversarial posture at the outset. Similarly, be candid when describing the nature of your challenges, including, for example, your projections regarding impacts of the current situation on tenants and your property cash flows and the issues you need to confront and overcome in order to work your way through these challenges. Document each carefully as appropriate (e.g., with rent rolls, operating statements, etc.) to help the lender understand your challenges. Do not miss the opportunity to use this communication to establish yourself as a competent borrower with a clear understanding of the situation and a well-conceived plan for the property. Try to avoid unpleasant future surprises to the extent you can (i.e., don’t undersell the problem in your initial communication, only to have facts overtake you later). Your job will be much harder if you fail to gain and then maintain the confidence of your lender from the outset.
We wish we could provide you with a clear understanding of what you can expect from your lender if you follow our advice and remain true to the things that made you a desired borrower in the first place. At the moment, there is no general consensus on the part of lenders and/or servicers as to what to do when confronted with requests for loan modifications under these unprecedented circumstances. While it is true that federal and state regulators have issued an interagency statement on loan modifications that aims to encourage financial institutions to accommodate borrowers affected by COVID-19, this statement is an encouragement to act rather than a mandate. Moreover, many lenders are not subject to such regulation and many may not be as understanding as they should be. Further, we think there is a substantial incentive on the part of lenders to not be the first mover, even if the required course of action is clear.
So, gazing into our crystal ball (hah!), we think that borrowers can anticipate great difficulty getting their lenders’ attention in the first place (after ten good years, their shrunken distressed assets teams will be overwhelmed), and lenders may well adopt short-term and incremental solutions (60-day forbearance, anyone?), one after another, as they work to get their arms around the situation and anticipate the impact of COVID-19 on longer-term real estate fundamentals, as applied to their portfolios. Nevertheless, like good handwashing skills, these simple guidelines should stand you in good stead as you proactively seek solutions while the world stays home.