Early Warning Signs
Prior to a missed mortgage payment, there are often signs that a loan may be headed for trouble. These include:
- Compliance certificates, financial reports and the like are not provided when required under the loan documents.
- Financial covenants (for example,maintenance of a minimum fixed charge coverage ratio) are not satisfied.
- Taxes (for example, property, sales and payroll) are not paid when due.
- Insurance coverages are reduced or cancelled.
- Payments under key franchise agreements (for example, royalties and advertising contributions) are not paid in full or on time.
- Marketing expenditures are reduced.
- Ordinary maintenance and capital expenditures are deferred.
- Vendors and suppliers complain about late payments.
- There is a significant increase in employee turnover and/or a noticeable decline in employee morale.
- The borrower experiences a decline in its competitive position.
- Changes occur in the relevant market (e.g., there is an increase in vacancy rates).
- The borrower becomes more difficult to reach and is not as communicative.
- Suits are filed against the borrower by vendors, suppliers or other creditors.
It is also critical to watch for changes that the borrower might not reveal, for example, transfers of assets to related entities, changes in the name of the ownership entity, undisclosed sales of all or a portion of the business, stock transfers and other “below the radar” changes in management and ownership. In addition, the acquisition of additional subordinate debt, jurisdictional moves of the corporate office, new leases of property or equipment, and changes in existing contracts or leases should be carefully scrutinized.
Assuming an initial investigation has raised serious concerns – or perhaps uncovered defaults under the loan documents – one of the earliest steps for the diligent lender is to review the loan documents for completeness and available remedies and options. In addition, the lender needs to make sure that insurance is in place with appropriate coverage amounts. If not, the lender should determine whether, based on the loan documents, forced-placement of insurance is permitted and in what amounts. For example, the lender needs to ascertain whether the loan documents allow forced placement of insurance for all aspects of the borrower’s business, or merely casualty coverage for the lender’s collateral.
Lenders and servicers should remain proactive in this phase, increasing communication and closely monitoring the borrower’s operations, while remaining sensitive to lender liability issues and staying abreast of current valuation and appraisal.
In the case of franchised operations, non-payment of royalty fees, like non-payment of a debt service, is usually the last step for a property in trouble. All franchises have standards of operation, reporting requirements and capital improvement mandates, which are likely to be neglected prior to any monetary default.
Lenders need to determine when to bring in the experts and who they will be-legal counsel, management, receivers, note sale advisors and/or brokerage firms. Lenders should also carefully review the loan documents, checking the security documents first. In the case of a mezzanine loan, this includes the intercreditor agreement and the mortgage securing the senior loan.
New UCC financing statements should be filed as necessary (note that the borrower’s signature is no longer required). It is important to obtain the borrower’s cooperation to record any mortgages, leasehold mortgages, memoranda of lease or other real property security documents that were misfiled or not filed and to keep notes regarding deficiencies in loan documents for use in any subsequent restructuring (e.g., collateral “step backs” in pre-2001 loan documents, omission of suretyship waivers in non-borrower security agreements, perfection issues, and ineffective jury trial waivers).
The High Cost of Delay
Lenders must realize that time is of the essence – staying proactive and in control of the situation will help minimize losses. A turnaround is unlikely to happen by itself – delays mean that cash will continue to dissipate or, in many cases, be retained for the purpose of building up a “war chest” for a possible bankruptcy filing. Lengthy delays also mean that unpaid trade and other obligations will continue to mount, and assets may be sold at unfavorable prices to generate cash. Also, other creditors may declare defaults or begin enforcement actions.
Lenders have five basic actions that do not require a court action:
- Workout – restructuring the borrower’s obligations
- Deed in lieu of foreclosure (real property) and acceptance (personal property)
- Enforcement (collection or foreclosure – in those states which permit non-judicial foreclosure)
- Sale of rights (for example, a note sale or a sale of a judgment or bid)
In choosing the most effective path, a lender must carefully evaluate the prospects of recovery. In so doing, it is important to keep in mind that some facts may be distorted by the borrower. For instance, accounts payable may be significantly greater than represented by the borrower, and accounts receivable may be only partially collectible.
A lender should start with a full review of the loan documents, paying particular attention to the following:
- Security and security-related documents like mortgages, security agreements, control agreements, pledge agreements, UCC filings, security certificates and the borrower’s or any guarantor’s organizational documents.
- Guaranties, whether full recourse guaranties or “bad boy” or “carve out” guaranties.
- Cross-default and cross-collateralization provisions.
- Intercreditor agreements between the various lenders.
- Documents critical to the borrower’s business, considering whether the lender may need estoppels, comfort letters and the like. These include leases, management, franchise and supply agreements, and liquor/gaming licenses.
Before negotiating with the borrower, it is generally advisable to obtain a prenegotiation agreement, which addresses potential lender liability issues.
When determining the best recovery strategy, the lender generally should consider four critical objectives:
- Control of the cash
- Control of the business operation
- Maintaining or enhancing value
- Positioning for sale or refinancing
In its simplest terms, a forbearance is an agreement in which the lender agrees that it will refrain from exercising its default remedies in return for certain specified performances by the borrower and any guarantors. The terms of the agreement (including the required performances) are limited only by the imagination of the lender and the borrower.
This article is reprinted with the publisher’s permission from the COMMERCIAL LENDING REVIEW, a bi-monthly journal published by CCH, a Wolters Kluwer business. Copying or distribution without the publisher’s permission is prohibited. To subscribe to the COMMERCIAL LENDING REVIEW or other CCH Journals please call 800-449-8114 or visit www.CCHGroup.com. All views expressed in the articles and columns are those of the author and not necessarily those of CCH or any other person. All rights reserved.
Continuing its stellar track record of selling properties in receivership, Trigild successfully facilitated the sale of 11 casual dining restaurants in Illinois, Texas, New Jersey, New Mexico, Georgia and Indiana — recuperating 122% of the default loan amount for the lender. The sale was authorized by the federal court and facilitated through auctions and qualified brokers.
Trigild took immediate action after being appointed receiver of a Class A apartment complex in Buckhead, GA.– replacing the management company, resolving immediate health and safety issues and increasing occupancy.
In a separate action, Trigild was appointed receiver of a 63,000-square-foot retail center in Las Vegas, NV. While the property is currently 50% vacant, Trigild acted quickly – listing the available units at market price on key websites to dramatically increase occupancy.
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