Before the economic downturn, when delinquencies were lessprevalent, junior and mezzanine lenders had less reason andoccasion to fear for their investments. A sense of complacencydescended on the lending community at a time when most loans simplywere repaid. Occasionally, junior lenders knew so little about thestate of some debt investments that one might hear from a seniorlender or a servicer only after a borrower had already missedseveral interest payments. But loan payments generally flowed backinto lenders' coffers without much fuss or maintenance, and manyjunior lenders let the default arrangement ride, allowing thespecial servicer already in place to lasso in the relatively rarestray borrower.

|

[IMGCAP(2)]In 2009, however, as the market softened andborrowers found loan payments increasingly difficult to make,defaults began a steep climb and special servicers found themselveswith a glut of business on their hands. With that spike in activitycame an increased awareness among junior lenders that they shouldpay heed to their own interests rather than riding the wave of thelarger lender pool.

|

Choosing and working with a special servicer with which a juniorlender is familiar or has a prior relationship can help a lenderstay ahead of the curve. Knowledgeable and informed legalrepresentation can help a junior lender obtain rights within anintercreditor or co-lender agreement to replace the loan'sappointed special servicer with a special servicer of its ownchoosing. Even if not acted upon, the option is one that lendersshould take care to have in place. A special servicer placed by amaster servicer is certainly not a negative option, but a specialservicer appointed by a junior lender provides the additionaladvantages of a familiar face and may facilitate a more direct lineof communication between the lender, the borrower and the specialservicer. It should be noted that the option to install a specialservicer on behalf of a junior lender is typically conditional onthe satisfaction of certain conditions, foremost being theservicer's credit rating.

|

A direct connection between a lender and a special servicer islikely to leave the lender more informed. Cole Schotz, for example,recently represented an opportunity fund client in its effort toreplace a loan's special servicer with one with which the clienthad a prior business relationship. The fund took these steps in aneffort to ensure a friendly face in the room if and when the loanwas to be defaulted and subsequently restructured or foreclosedupon.

|

Without these steps, Cole Schotz's client would likely face aneven greater uphill battle in the event that the loan goes intodefault and special servicing. The fund believes that theconnection between the lender and the special servicer is likely toresult in greater access to the borrower and information concerningboth the loan and the collateral.

|

The lending industry can no longer rely on interest income toflush into their accounts as easily as it once did. That does notmean debt investors should change their business model and foregothe extension and purchase of loans. Rather, it is time for alllenders to become more acutely aware of their rights, such as thatto appoint special servicers, and to use those rights to betterposition themselves to protect and preserve their investments atopa stable bottom line.

|

Leo Leyva is a partner in Cole Schotz's Bankruptcy andCorporate Restructuring practice, and Jordan Fisch is a partner inthe firm's Corporate, Finance and Business Transactions practice.The views expressed here are the authors' own.

Want to continue reading?
Become a Free ALM Digital Reader.

  • Unlimited access to GlobeSt and other free ALM publications
  • Access to 15 years of GlobeSt archives
  • Your choice of GlobeSt digital newsletters and over 70 others from popular sister publications
  • 1 free article* every 30 days across the ALM subscription network
  • Exclusive discounts on ALM events and publications
NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.