Lately, borrowers and lenders involved with troubled commercial real estate properties seem to be getting a bit more realistic about trying to resolve distressed deals with a consensual workout agreement. We are seeing an uptick in the interest of both sides, and the special servicers who often drive resolutions, in actually addressing what’s going on with the property, and agreeing on a plan to get it back into the black. This is a big leap forward from mindlessly extending and pretending – and hoping something will magically change. It could be that lenders, having made back some of the money lost in the crash, can “amortize their losses”. It could be that a lot of the industry has now adjusted to the post-boom era, and has decided that the current rather muddled market is the “new normal”. Or maybe folks just have got tired of kicking the proverbial can down the road. Alternatively, maybe both lenders and borrowers have realized that many defaulted loans ultimately provide a better return if they are restructured and worked out with the assistance of the borrower than if they are foreclosed upon and sold, or held in an expensive receivership for a long time. In any event, more workouts – with a higher expectation for long term success -- seem to be happening.

Practically no workout starts without the lender or special servicer seeking a “prenegotiation letter” or “agreement” (a “PNA”), as the opening step in the parley. Borrowers frequently seem confused about the purpose of such letters, and whether they should sign them. Of course, what each PNA does, and whether it should be signed, depends on what it says. But we can make a few general useful observations about PNAs, which have legitimate uses … and illegitimate ones. The PNA form initially presented by the lender to the borrower may be fair, or overreaching – but a borrower can always ask to have it revised. Since most lenders and special servicers won’t even discuss a workout until the PNA is signed, it’s important to understand what a PNA does – and should do.

Simply put, the prenegotiation letter is a letter agreement between the borrower, guarantor, and lender or special servicer in which the parties agree that they can discuss a potential workout without either party taking the position that they have reached an oral agreement as a result of such discussions, and to avoid any waiver of rights that could be alleged as a result of such discussions. Like “settlement discussions” in litigation, it creates an opportunity to chat candidly about positions and possible resolutions, without a risk that tentative positions will be misrepresented as commitments. This is the legitimate, beneficial use of a PNA.

Prenegotiation letters should be simple, understandable and non-controversial. They should not require either side (lender/special servicer or borrower/guarantor) to stipulate to any disputed facts or to waive any rights. The point is to create a “safe space” -- safe from litigation – within which the parties can discuss a possible settlement. If – and it’s a big “if” -- the language in the PNA does not expansively add other waivers of a borrower’s or guarantor’s rights, it should be something borrowers and guarantors should be willing to sign if they want to discuss a workout.

Lenders and special servicers also need to understand what they are getting, and giving up, by signing a PNA. It’s their responsibility to make sure that any PNA is not overreaching, as a PNA that is too clever, or contains overly subtle waivers on the part of a borrower or guarantor, may not be enforced by a court applying 20/20 hindsight should the workout discussions fail, especially if the borrower or guarantor was not represented by counsel when he or she signed it.

Some lenders and some special servicers seek to get more by asking their borrowers to admit alleged facts or to make statements that could keep them from asserting legitimate claims later. For example, it is not uncommon for a PNA form to have a borrower state that the borrower has “no claims” against the lender. That’s going to be tough for a borrower who fears that they may have legitimate claims or defenses -- or simply does not know. Alert borrowers’ counsel may spot and seek to negotiate changes to that sort of clause. Of course, it is within a lender’s rights to hold the line, and say, “we will only talk to you if you first agree that you can’t sue us for anything at all.” That’s going to reduce the number of possible negotiated solutions, though.

PNA’s are often submitted (like many other legal documents) as if they were holy writ, carved into stone tablets by an almighty hand. However, they are simply documents written by people (usually lawyers -- not deities -- seeking advantages for their clients), and can be altered if needed to reflect the parties’ agreement. To get the parties to the table to negotiate a possible deal, PNA forms should be reasonably fair, simple, and clear, and should be limited to their legitimate purpose of making sure neither party waives any rights, nor acquires any new rights to sue simply as a result of engaging in settlement/workout negotiations.

In workouts, as in any other legal agreement, it’s important to know exactly what the words on the paper mean, so it is important to parse a PNA with precision, and preferably with the aid of your lawyer, before signing it. That way, borrowers and lenders both can make sure they understand what they are agreeing to, and what they are being asked to risk, or give up, before even getting to the bargaining table.

Instant Insights /

Prenegotiation Agreements: Tools or Terrors?

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