Workouts 101, Part 4: Lenders' Leverage

Having discussed previously what leverage a borrower has in a workout, here's  a brief overview of some of the lender's points of leverage, and what the lender needs to know before starting a workout.  While some of these points should be obvious, it's always a good idea in a workout to return to the basics to check each of the usual elements of a possible resolution for holes and issues.The lender has the right to enforce the loan and take the property back.  At the risk of stating the obvious, if the borrower does not repay the loan it borrowed, the lender has the right to take back the real property collateral for the loan.  This may be done in different ways depending on the state where the property is located, but ultimately this is the lender's big stick. Often the lender and borrower cannot agree whether there would be any real value (equity) left in the property after repayment of the loan.  If the lender and borrower both know there will be no equity left after repayment, neither side has much incentive to instead do a workout unless the borrower is willing or able to put in more money in hopes of realizing a long term gain on the property.  (Or unless the lender does not want to take the property back, for some reason, like a property that is severely environmentally contaminated.) However, if the lender and borrower do not agree whether there's equity remaining in the property, then one side or the other will be motivated to work out the deal if possible -- and the other, less motivated.The lender may have the right to go after the borrower's other assets, or those of a guarantor.  This is the lender's second biggest stick.  Or maybe this is the biggest, if the borrower has significant other assets or the guarantor is an attractive collection target.  While most lenders don't want to wipe out a reputable borrower or guarantor who has been a good customer in the past, and is facing difficulties now, they want to get repaid.  (One lender told me that, while he did not want to wipe borrowers out, he had no qualms about repayment of a loan that would require a borrower to scale back his standard of living.  In my experience primarily working as lender's counsel, that's pretty typical.)In fact, a lender's representatives owe a duty to its investors and shareholders to collect as much as possible on the loan and any guaranties.  While most if not all lenders can be reasonable if the borrower plays fair and is doing its best, some borrower tactics are not welcome.  If the borrower or guarantor starts playing games, such as hiding information or lying, or taking money generated by the property to pay other debts, or opposes foreclosure where there's no or little equity in the property, the lender will be more likely to aggressively press forward with enforcing the loan against all available assets of the borrower and any guarantors. Obviously, there's a cost to enforcing a loan;  depending on the difficulty under the applicable state law of collecting on a particular asset, a lender may elect not to bother going after that asset.   For example, in California, a lender may not pursue any other judicial cause of action, such as suing the borrower directly, without foreclosing on the real property collateral.  But such a lender usually may start either or both of a nonjudicial foreclosure sale (a/k/a a trustee's sale) which takes less time and is cheaper, and cuts off the borrower's redemption rights . . .  or a more formal judicial foreclosure proceeding, which takes a lot longer, is a lot more expensive, and allows the lender to seek a "deficiency" - the amount still owed in excess of the purchase price for the property paid at the nonjudicial foreclosure sale - against the borrower, but gives the borrower redemption rights for up to a year.   To decide which way it wants to enforce the California loan, a lender and its counsel must figure out:

•  what the real estate collateral (and any other collateral) is worth,
• whether the loan is of a type where getting a deficiency is allowed,  
• if the borrower has other assets available to satisfy a deficiency,
• if a guarantor has assets available to repay the loan or a deficiency,  and several other issues. 

• Review all loan documents without reading any summaries first (so you see what's actually written on the controlling documents);
• Note any changes from the lender's standard provisions (such as extended cure or notice periods);
• Ask whether any changes have been allowed but have not been documented, or whether the lender has entered into any other agreements with borrower parties, which might give rise to lender liability;
• Check for common defects/deficiencies, such as incorrectly identified parties, lack of or incomplete suretyship waivers, incorrect collateral descriptions and UCC financing statements, defective cash management agreements, missing or unattached allonges if the note has been modified, undated or not fully executed documents, missing exhibits, unfinished post-closing items, missing title insurance policy, missing original note;
• Confirm the real estate collateral is correctly described and matches the survey;
• Check to see if any Subordination, Nondisturbance and Attornment Agreements have been signed by major tenants, or should be;
• Confirm that all needed consents for personal property collateral were obtained,  that all descriptions of that collateral are complete and correct, and that all steps necessary to perfect and preserve the lender's security interest have been taken;
• Review status and priority of advances over mechanics' liens;
• Review evidence of environmental condition of property;
• Investigate any changed circumstances of the borrower, guarantor or property or ownership of the collateral;
• Analyze the applicability of any changes in the law;
• Confirm that the lender actually has in its possession all needed original documents;
• Check to determine whether all post-loan closing items have been finished;
• Review updated title information to determine if any new title issues or claims have arisen since the loan funded;
• Conduct and review updated searches of UCC, tax and judgment liens concerning borrower and any guarantor;
• Check to see if any circumstances have changed (such as the borrower's name or jurisdiction of organization) and investigate any other issues relevant to the particular borrower, loan or property.