COMMERCIAL FINANCE PART 6: LOAN WORKOUTS
With residential realty on the rebound, many people think real estate problems are over. But it’s not necessarily so for owners of commercial property. Today’s Article will focus on strategies for dealing with defaulting commercial loans. This is Part 6 in our Commercial Finance Series.
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By Keith Dunnagan, BPE Law President & Managing Attorney
Commercial loans are different from the average residential loan in that the commercial loans tend to be written with much shorter terms and many have interest-only payments with some sort of a balloon payment at the end of the term. The short loan terms and high balloon payments make it much more difficult to navigate a bad situation at the wrong time. Plus most, if not all, commercial loans carry some sort of guaranty to keep a principal on the hook for the balance of the loan even if a bad scenario rears its ugly head. The question that rises is how do we handle those lending problems when they arise.
There are multiple to ways to handle a commercial loan in default or nearing default and each loan presents its own unique challenges. The common choices include foreclosure, bankruptcy or loan workouts. Foreclosure and bankruptcy are always a last resort although sometimes unavoidable. After a foreclosure, it is likely that the lender will pursue the principal guarantying the commercial loan for the difference between the amount received for the property (which is typically at a steep discount from fair market value) and the balance on the loan. Filing for bankruptcy protection will significantly impede access to future borrowing which is necessary to continue a commercial property owner’s business. However, with good timing and a willingness to work with a lender the commercial loan workout provides significant advantages and ultimately reduces the costs to the borrower.
Loan workouts can take many forms, sometimes they are discounted payoffs or discounted refinances completed through a new lender. Sometimes the loan workout is a forbearance or a loan extension. Sometimes the workout is a short sale to a third party. However, the method in which a loan is resolved is determined by which path the borrower and lender are willing to navigate. We find that most lenders are open to discussing loan workouts in the commercial setting and generally are unlikely to simply ignore the borrower and there is a simple reason for this attitude. Unlike residential loans which are commonly bundled and sold on the secondary market, most lenders keep commercial loans in their own investment portfolio. What that means is that if the loan takes a loss, the originating lender is taking that loss as well, there are no clawbacks or repurchase contracts that allow the lender to seek payment from another money source. The primary source of payment for the lender is the borrower. Consequently, lenders tend to approach the commercial loan problems differently.
The most common mistake that borrowers make in these types of matters are two fold (1) the borrower simply refuses to communicate with the lender thereby forcing the lender to take alternative action; or (2) the borrower communicates with lender but does not provide accurate information. Either of these tactics will likely lead to a disastrous and avoidable result. When working with lenders on a commercial loan workout it is necessary to provide accurate information. The lender makes decisions based upon the financial information related to the property and the borrower. Here is where it is important to understand what and why a lender is looking at certain information. The lender is assessing the viability of the loan and the ability to obtain cash rather than the property. Gaining the ownership of a property is rarely the goal of the lender. They are not property managers or investors, they are financial institutions with the desire to monetize the investment. As a result, it is imperative to be able to distill the factual circumstances of a loan in financial terms. Show the lender the accurate depiction while at the same time providing the economic solution to the loan problem.
As a recent example of this style of negotiating, the commercial attorneys at BPE Law Group assisted a California property owner in negotiating a discounted payoff with its lender. The project was time intensive and took nearly a year to complete. But it was worth it as the borrower was able to reduce its loan liability by more than $1,000,000. Too often, borrowers and attorneys alike look for the bad in the loan and try to threaten a lender with litigation as a means working out a solution. More often than not, that strategy fails when the simple strategy of facing the economic realities head on would solve the problem. The lender has a vested interest in reaching a viable business solution for the portfolio loan that may not be performing. Remember, the lender has money riding on the outcome too.
For over 20 years, the attorneys of BPE Law Group, P.C. have been assisting our clients with their real estate, business, and other legal needs. We’re currently assisting a number of parties that are pursuing or developing cannabis operations in California. If you have questions concerning real estate, business, or any other legal matter, give us a call at (916) 966-2260 to schedule a consultation with one of our experienced attorneys or email Keith at firstname.lastname@example.org.
This article is not intended to be legal advice, lending advice, or a specific recommendation of any particular lender or company, and should not be taken as such advice.