Tough Times for Lenders : Financial Services Lawyer & Attorney : Winstead Law Firm : Finance, Banking, Bankruptcy

One trend in the market at this moment: borrowers that want to utilize a mezzanine loan (as part of the debt structure) are having difficulty in obtaining the approval of their first lien (mortgage) lender to the mezzanine loan.

What is a mezzanine loan?

Here is a definition used by Standard and Poors:  a mezzanine loan is a loan "to equity holders of the borrower (including situations where the equity is pledged to secure reimbursement obligations under letters of credit or other contingent obligations). Frequently these loans are secured by a pledge of equity interests in the senior mortgage debt borrower."

Let’s explore an example of how it can play out when the project is in distress, the borrower fails to make a payment on the first lien loan, and a mezzanine loan is in place.

Let’s assume that the following:

• borrower fails to make a monthly payment on the first lien loan (this loan encumbers improved commercial real estate)
• the loan documents do NOT require the first lien lender to give borrower notice of the failure
• the loan documents state that such failure shall constitute a default (or an event of default) under the first lien loan
• a mezzanine loan is in place, secured NOT by the improved commercial real estate but by a pledge of ownership interests in the borrower 

Step One: review the first lien loan documents for the basis for a default, and the notices required to be given to the borrower.

Step Two: review any agreements between the first lien lender and the mezzanine lender, looking for any notice and cure rights on the part of the mezzanine lender relating to a borrower default under the first lien loan.  (This agreement typically is called an "intercreditor agreement.")

In the absence of a mezzanine loan, the first lien lender would take step #1 and go forward with exercising its rights under the loan documents.

However, the existence of the mezzanine loan requires the first lien lender to take step #2, which means that:

• prior to giving any notice or taking any action under the first lien loan, the first lien lender (or the servicer) should review the intercreditor agreement between the first lien lender and the mezzanine lender
• the intercreditor agreement typically will give notice and cure rights to the mezzanine lender for certain events, and on the exercise of certain rights and remedies of the first lien lender

A close reading of the intercreditor agreement might show the following (the following is fairly typical – but you’ll need to closely read your documents):

• before the first lien lender can take an “Enforcement Action” against the borrower, the first lien lender must give the mezzanine lender notice and opportunity to cure any default by borrower under the first lien loan
• the intercreditor agreement gives this definition: “’Enforcement Action’ shall mean . . . . acceleration of, or demand or action taken in order to collect, all or any indebtedness secured by the Premises (other than giving of notices of default and statements of overdue amounts) . . . . ”

So, based upon all of this information, what notices must be given by the first lien lender (or loan servicer)?

PICK THE CORRECT STATEMENT(S)

1: First lien lender must give borrower notice of borrower’s failure to make the monthly payment

2: First lien lender must give the mezzanine lender notice of borrower’s failure to make the monthly payment in order for a default to exist

3: First lien lender does NOT need to give default notice to borrower nor to mezzanine lender in order for a default to exist        

4: If or when first lien lender makes demand to the borrower for payment, then it must give mezzanine lender notice and opportunity to cure

#3 and #4 are correct (although the first lien lender might decide to give the notice of the default [under #3] merely as a business practice - if for no other reason that it would like to be paid - and to be able to show a court that it did give parties an opportunity to pay).

The lesson is read, read and read the documents; and then follow them.

Finally, don’t forget to give any notices required by local law or statutes.

Any questions or comments on this topic?

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This is the second of a two-part series (PART ONE) covering initial due diligence topics for workouts involving co-lender structures, with a focus solely on the participated or syndicated co-lender structure. The series is not a comprehensive listing of possible issues on this topic, but merely a basis template to assist you as you review the co-lender and other relevant loan documents.

Typical Servicing issues:

• how are on all decisions made within the co-lender group on these subjects?
  • waivers and consents
  • default\enforcement (special servicing issues)
  • after enforcement (expenses to protect\preserve, to sell, to complete; title of the property [name of servicer; tenant in common; nominee entity jointly owned]
  • advances, expenses and losses
  • excess recovery
  • is there a buy\sell provision if co-lenders are not able to resolve disagreement?
• what decisions may servicer make without input from co-lenders
• duties of servicer: what must it do (reporting, inspections, etc.)?
• standard of care of servicer
• what if servicer has an equity position?
• rights of co-lenders to examine and copy
• notification rights (when must servicer notify a co-lender)
• fees (primary servicing; special servicing; asset management and disposition)
• future property inspections and reporting (review reports only; or more active role, such as accompany servicer during on-site inspections)

Does the loan seller or originator have any liability?

• contractual duties and warranties
• fiduciary duties

Transfers

• buy\sell for disagreements
• transfers to affiliates
• transfers to third parties (right of first offer?)
• is sub participations\syndication prohibited?

Sharing of payments: on sums paid by the borrower, are payments applied -

• proportionately to all co-lender?
• non-proportionately to co-lenders?

If you have any comments, suggestions or additions to the foregoing, please post a comment.

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1st in a series of 2 postings

Much of the focus in the media on troubled real estate debt focuses on sophisticated debt structures, or on investors holding bonds in pools of loans. This focus, however, misses an important, intermediate player between these two ends of the barbell: the real estate lender.

In several real estate workouts that I’m handling now, the most difficult discussions are not with the borrower or its lawyer. Instead, the difficulty is within the mortgage lender group itself. Indeed, one distinctive in the current workout environment from the late 80’s is the large number of real estate loans involving multiple lenders holding a portion of the same mortgage loan or lien position.

Now, I’m not describing the situation where one lender has the mortgage lien, a second lender has a lien on the ownership interests in the borrower, and perhaps a third lender has an unsecured loan with the entity owning an interest in the entity owning the borrower.

Instead, I’m describing a single mortgage loan or facility that has been syndicated or participated among multiple real estate lenders. While the multiple or “co-lender” mortgage structure is not new to life insurance company lenders (nor to balance sheet lenders), in the last 15+ years the co-lender mortgage structure became widely used by the broader creditor market; and banks, Wall Street (the investment banks) and mortgage funds joined life companies in “structuring” the first-lien position.

This posting is Part One of a two-part series covering initial due diligence topics for workouts involving co-lender structures, with a focus solely on the participated or syndicated co-lender structure. The series is not a comprehensive listing of possible issues on this topic, but merely a basic template for your use as you read the co-lender agreements and related loan documents.

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