A Roadmap for CRE Loan Document Review in connection with Waiver, Forbearance and Modification Requests During the COVID-19 Pandemic

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As income streams are interrupted due to loss of rents in the midst of business closures during the continuing pandemic, many borrowers are reaching out to their lenders to discuss debt service and other relief under their commercial real estate loan documents. Although it may not always seem so, particularly at a time when lenders may be facing a balance sheet of defaulted loans and borrowers may be facing a portfolio of defaulted leases, lenders’ and borrowers’ interests are often aligned in avoiding worst-case scenarios. Once a pre-negotiation agreement is signed, the parties can begin to negotiate with transparency about a possible loan forbearance or modification. For the next step, if they haven’t already, the parties should review the existing loan documents to determine which provisions should be addressed in connection with any forbearance or loan modification request. This Legal Update sets forth some of the loan provisions upon which the parties may focus.

It should be noted that, given the nature of the current situation, both lenders and borrowers may have strong incentives to focus on streamlining issues to be addressed in a modification or forbearance, thus allowing the parties to get through the worst of the pandemic and buy additional time to develop a better understanding of where things will stand when the crisis subsides. Accordingly, while all of the following provisions may merit consideration, in the short term the parties may elect only to address the most time-sensitive and/or essential matters.

Payment Obligations

Borrowers, especially owners of hospitality and retail properties where operations have been disrupted or may have ceased entirely due to the pandemic, may request that their lenders reduce, delay or waive the obligation to make monthly debt service payments (or the principal portion thereof) for a period of time. In connection with the foregoing, borrowers may also request that any penalties or other fees for late or non-payment be waived.

Reserves

Borrowers may request flexibility in both the use of existing reserves and their obligations to maintain reserves for a period of time. For example, borrowers may request that funds previously deposited into a reserve account for a specified purpose (e.g., capital expenditure and/or rollover reserves) temporarily be made available to service their debt. Where applicable, borrowers may request that reserve funds earmarked for disbursement during underwritten shortfall periods (e.g., shortfall reserves, free rent reserves or seasonality reserves), as well as funds being held as additional collateral for the debt, be released and applied presently. In addition or in the alternative, borrowers may request their lenders temporarily suspend or otherwise delay or waive required monthly deposits and/or other replenishment of reserves for the relevant period. Lenders, on the other hand, may look to increase reserves and additional collateral being held for loans. Further, if material underlying loan issues existed prior to the pandemic, lenders may be less flexible in the scope of agreed upon modifications.

Financial Covenants

Property-level requirements

Many loans include ongoing financial covenants, such as maintaining maximum a Loan to Value (LTV) percentage and/or a minimum Debt Yield or Debt Service Coverage Ratio (DSCR). The failure to satisfy these covenants can result in a range of consequences, including (i) triggering cash management (more on that below), (ii) requiring a pay-down of the loan, the funding of a reserve or delivery of additional credit support to satisfy the covenant, or (iii) triggering an Event of Default. Possible forbearance options to address the financial covenants will likely vary depending on the severity of the failure, its prescribed consequence and the anticipated period of time such failure will continue. For properties expected to recover once stress is relieved, lenders may consider lowering thresholds or providing a holiday on testing of such covenants.

Guarantor requirements

Many loans also include a covenant requiring the guarantor to maintain a minimum net worth, which often includes minimum liquidity, for the term of the Loan, and the parties may decide to revisit these requirements in light of the possible impacts of the pandemic on markets and valuations. Among other options, the parties may wish to discuss guarantor substitution rights and/or consider substituting the existing guarantor or adding an additional guarantor to satisfy these requirements as is further addressed below.

Cash Management

Springing Cash Management

If the subject loan documents provide for cash management to “spring” following customary trigger events, the parties may discuss modifying or suspending for a specified period of time certain triggers which are more likely to occur during the pandemic, such as (i) falling below a minimum Debt Yield or DSCR, (ii) tenants under “Major” leases going dark or experiencing a credit downgrade, and (iii) Events of Default under the loan documents. On the other hand, for loans without any cash management provisions, lenders may want to consider implementing cash management on a going forward basis.

Excess Cash Trap

If the subject loan documents include an ongoing trap of “excess cash” to fund a cash collateral reserve, borrowers may request a suspension of that cash trap to give them additional control over their excess cash to facilitate dealing with contingencies during the crisis. Lenders, on the other hand, may prefer to build up as much cash collateral as possible and may look to broaden the cash trap provision on a going forward basis in return for the concessions given to borrowers.

Maturity Date

Refinancing a loan with impending maturity may be challenging in the current climate. Similarly, loans with extension rights may have financial or other hurdles (such as LTV, Debt Yield and/or DSCR tests, completion of required work and/or lease-up, etc.) as conditions to such extension which will be difficult or even impossible to satisfy in the time required. Similar to the 2007-2009 downturn, we anticipate requests to extend maturities for existing loans (without as-of-right extension options) and/or waive or delay certain conditions for extension (where extension rights are already provided under the loan documents).

Leasing Covenants

As we already know, the pandemic is disrupting many businesses from operating in their normal manner and tenants have begun requesting relief under their leases. As a further consequence, many borrowers are likely to request that the review and approval rights of lenders over leasing matters be loosened from those set forth in the loan documents. While the parameters triggering a review and the standards for granting consents vary considerably from deal to deal and among asset classes, many loan documents limit the borrower’s rights to enter into certain new leases and to amend, modify, terminate or accept the surrender of existing “Major” leases. The flexibility that borrowers will likely request to respond to their tenants as they, in turn, adapt to the crisis, will vary from property to property and may include (i) the right to offer rent relief while operations are impacted by the pandemic, (ii) the right to retain specified lease termination payments (as opposed to depositing those amounts to a lender-held account), (iii) the right to apply security deposits against rental payments, (iv) the right to offer incentives to tenants to remain in their space, (v) the right to temporarily cease tenant improvement work, and/or (vi) shortened lender review and/or deemed approval periods. Lenders, on the other hand, may wish to maintain existing review and approval rights or even to increase those rights to minimize the risk that lease modifications or other actions do not, in the aggregate, result in insufficient revenue to service the debt and pay operating expenses.

Property Manager Kick-Out Rights

Loan documents may give the lender the right to require that the borrower terminate its property manager following the occurrence of certain events, including (i) the Debt Yield or DSCR falling below a certain threshold, (ii) the bankruptcy of the property manager or (iii) the occurrence of an Event of Default under the loan documents. The parties may discuss waiving some or all of these rights for a specified period of time. Lenders may also consider requiring that property management, leasing, construction management and other fees payable to borrower-affiliated parties are either deferred or do not accrue during the forbearance period.

Special Considerations for Construction or Transitional Loans with Required Work

Provisions related to construction obligations will also require renewed consideration. Parties should review the definition of “Force Majeure” (or similar) to determine whether it includes pandemic, acts of god, supply chain disruptions, governmental orders to stop work, delays as a result of government closures and/or other factors, some or all of which may be impacting ongoing projects as a result of the pandemic. If work is continuing during the pandemic, certain conditions for loan advances, such as increasing the amount of title insurance (through a pending disbursements clause), updating title searches and/or endorsing or “dating down” title policies, may be difficult to satisfy and may make it difficult for lenders to agree to continue making advances even on an otherwise performing construction or transitional loan. Lastly, it is worthwhile to note that some jurisdictions, such as New York where certain building loan-related filings are required, closures of municipal offices may make it difficult to close, amend or service construction loans.

Restrictions Against incurring Additional Debt

Many borrowers may seek to take advantage of the various loan and/or grant programs available under the CARES Act or other federal, state or local government stimulus packages. Accepting such a loan or grant may be prohibited under the loan documents and borrowers may request that certain provisions, such as the definitions of “Permitted Indebtedness” and “Permitted Encumbrances” (and the like), be modified to permit such debt and related security interests. Lenders may consider adding specified Events of Default or carve-outs from exculpation provisions for a borrower’s failure to comply with the requirements of such program. In addition, borrowers may need additional flexibility to carry a higher percentage of or longer term for payment of trade payables. Separately, borrowers may look to bring in additional sources of equity, requiring a review of transfer provisions to confirm the same is permitted or whether any consent of their lenders is required.

Reporting Requirements

As an initial step, all parties (including guarantors) should review financial reporting requirements and address whether all requirements are currently satisfied. Lenders are likely to request additional financial information regarding the Property in connection with their review of modification, forbearance or waiver requests and borrowers should start to gather relevant data to ensure an expedient review process. Separately, lenders may require enhanced and/or more frequent reporting for the duration of any forbearance period.

Events of Default

To the extent the parties agree to modify or forbear with respect to any specific obligations or covenants of their loan documents and so long as the borrower and guarantor comply with the terms and conditions of the modification or forbearance documents entered into between the parties, the specified events of default related to those obligations and covenants, and their corresponding remedies, should be waived for the relevant period. As noted above, however, lenders may require additional events of default if, for example, additional indebtedness or encumbrances are permitted.

Recourse Carve-Outs

Similarly, to the extent the parties agree to modify or forbear, the carve-outs to the exculpation provisions related to the applicable obligations and covenants (if any) may be waived or modified for the relevant period. As noted above, however, to ensure compliance by borrowers, lenders may seek to include additional carve-outs if, for example, additional indebtedness or encumbrances are permitted.

Additional Collateral/Credit Enhancements

The parties should review rights and remedies available with respect to any existing collateral in addition to the mortgaged property which secures the subject loan. Further (although perhaps somewhat less likely given the unique constraints parties are facing during the pandemic), lenders may seek additional collateral or additional guaranties as consideration for granting forbearance or modifying loans.

Special Considerations for Loans with Multiple Lenders

Lenders will need to review any co-lender, intercreditor or similar agreements regarding any requirements to provide notices to any co-lenders and/or senior or junior lenders, as applicable, or to consult with and/or obtain consent from such other lenders, with respect to a borrower’s forbearance or modification request. In addition, the pooling and servicing agreements for loans which have been securitized will likely include specific review and approval rights for special servicers, controlling class holders, operating advisors and/or rating agencies.

Checklists

In addition to the summary above, we have prepared a checklist as a tool in your review of existing loan documents when beginning negotiations, as well as a “closing” checklist for the forbearance or loan modification which should be modified for each specific transaction. Please reach out to the authors of this article if you would like copies.

These materials have been prepared by Seyfarth Shaw LLP for informational purposes only and do not constitute legal advice.