Hot Topics in Commercial Lending
As lenders’ counsel in loan transactions, we often see a number of negotiated provisions. This article highlights some of the provisions and offers practice tips to address them.
Change in Ownership of the Borrowing Entity
t is common for commercial loan agreements to contain a covenant or restriction that prohibits the borrower from assigning, selling, pledging or transferring any direct or indirect interest in the borrowing entity. Sometimes, the lender will include provisions in the loan documentation that allows transfer to other existing members within the borrowing entity provided, however, that notice is given to the lender concurrent with the transfer. Other commercial loans may allow a transfer of existing membership interest provided a majority interest is retained by the current owners of the borrowing entity or designated key principals. A change in ownership, especially a change in the majority interest or key principals, increases the likelihood of a change in the day-to-day business and operations of the borrower.
Practice Tip: At a minimum, lenders should require consent on a transfer of majority ownership interest or a change in key principals within the borrowing entity.
Highly Volatile Commercial Real Estate
One of the more notable changes that became effective January 1, 2015 is the new Basel III Capital Regime (Basel III), which increases capital requirements for the so called “high volatility commercial real estate” (HVCRE). A loan involving HVCRE requires a capital requirement that is 50% higher than the capital requirement for other commercial real estate loans. A HVCRE loan is defined as a credit facility that, prior to conversion to permanent financing, finances or has financed the acquisition, development or construction of real property, subject to certain exclusions.
This policy change requires that the borrower represent and provide evidence it has paid or otherwise contributed the required equity for a given project. Further, if the project is a construction project, prior to the loan being converted to a permanent loan, the lender can place certain restrictions on the borrower’s ability – either directly or indirectly – to make any distributions, loans or repayment for capital contributions, developer fees or management fees to its members, partners or affiliates. Therefore, Basel llI limits the type and amount of distributions chat a borrower and/or its members of affiliates will be able to obtain from a project prior to conversion to permanent financing.
Practice Tip: Include provisions in HVCRE loan documents restricting distributions, repayment of capital contributions, developer fees and management fees co borrowers and affiliates.
Guaranties
Guaranties are a common requirement of community banks making commercial loans. The guaranty should specify if it is a payment guaranty (primarily liable) or a collection guaranty (enforceable only after exhausting borrower assets and collateral.) If the guaranties are not for the full amount of the debt, it should be clearly specified in the guaranty if the dollar amount or percentage pertains only to the principal amount of the debt or if the percentage also limits any potential liability for interest, late fees, attorney fees and costs. When there are multiple guarantors, the guaranties should also specify whether the guaranties are joint and several or if each guarantor is responsible only for their pro rata share of the loan.
Instead of a default occurring under the loan, guarantors are more frequently asking for the ability to present a substitute or replacement guarantor if a guarantor dies or becomes incapacitated or insolvent during the loan term. Such a provision requires that the incapacitated, insolvent or decedent’s estate present a substitute guarantor to the lender, with the lender reviewing the substitute guarantor within a specified timeframe under the lender’s then current underwriting standards. If the substitute guarantor then passes the lender’s current underwriting standards, the substitute guarantor would need to sign a guaranty in similar format and content as the guaranty originally signed on the lender’s then current template.
Practice Tip: Clearly draft guaranties to specify the type of liability, the amount of liability and responsibility relative to other guarantors.
Mortgage Registry Tax
In Minnesota, any instrument creating or evidencing a lien of any kind in real property as security for a debt is required to pay mortgage registry tax to the Minnesota Department of Revenue1. The mortgage registry tax is paid by the borrower at the time of the filing of the mortgage or debt instrument. The tax rate is .0023 times the debt or portion of the debt secured by the recorded mortgage or, if in Hennepin and Ramsey counties, .0024 times the debt2.
Often a borrower will want to advance additional monies under a loan that is currently in place. If a loan is set up as a revolving line of credit and mortgage registry tax is imposed on the maximum amount of the line of credit, no additional mortgage registry tax is due as the line is paid down and re-advanced3. If a loan is originally set up as a term loan, the loan has been fully advanced, and the borrower wants to advance additional funds against the loan, the borrower is required to pay mortgage registry tax on the difference of the current outstanding balance of the loan and the new funds to be advanced. Likewise, if a borrower wants to convert a term loan to a revolving line of credit, the borrower will be obligated co pay mortgage registry tax on the maximum available amount on the line of credit at the time of conversion.
Practice Tip: Any additional advance of funds beyond the original loan amount or a conversion of a term loan to a line of credit mandates payment of the mortgage registry tax on the additional funds advanced or the maximum available amount of the funds converted to a revolving line of credit.
Environmental Issues
Borrowers often like to truncate or limit liability for any potential environmental issues or hazards with respect to a property serving as collateral for a loan, after the loan is in default or the borrower is no longer in possession. Lenders are typically not held as responsible parties under applicable environmental laws solely by virtue of holding the mortgage loan or taking title to the property without also operating the property. However, following a loan default or foreclosure, it may be necessary for the lender to appoint a receiver or have another party come in on behalf of the lender to operate the property. As a result, it is important for environmental indemnification clauses to specifically limit the lender being responsible for any environmental issues that already exist or have occurred when it takes possession or title to the property. Once the lender takes possession or forecloses, the borrower should continue to remain responsible for any environmental issue or release that occurred prior to lender taking possession.
Practice Tip: Lenders should continue to hold borrowers responsible for environmental issues that first occurred or existed prior to the lender taking possession on title of the property.
Michelle R. Jester is an attorney representing lenders in financing transactions such as origination of loans, participations, workouts and foreclosures. Lisa M. Ashley is an attorney practicing in banking and real estate law representing lenders, developers, landlords and investors in all aspects of loan origination. Jester and Ashley practice in the Banking & Finance Group of Messerli & Kramer, P.A. in Minneapolis.
1Minn. Stat.§ 287.01, et. seq.
2Minn. Stat.§ 287.035
3Minn. Stat. § 287 .05 Subd. 3