As the global impact of the novel coronavirus pandemic (COVID-19) rages, there is an expectation that there will be a growing number of non-performing commercial real estate loans. The loan market is likely to become an opportunity for well-prepared sellers and buyers. Rather than suing non-performing borrowers, lenders sometimes prefer to sell loans in order to offload risk, reduce the number of real estate assets held on their books, and better leverage their balance sheets, especially in an environment where buyers may become unable to make scheduled payments. For investors, this environment offers a way to invest in real estate at a price lower than face value, but with the associated risks. In addition, the acquisition of distressed debts can serve as a vehicle for acquiring real estate. Once an investor acquires distressed debt from a lender as part of a loan buy and sell transaction, the investor puts himself in the lender’s shoes and can therefore exercise the remedies available to them. previously the lender, such as foreclosure of collateral, breach of security claims on personal guarantor, and other related legal remedies.
Before entering into a mortgage buy and sell transaction, a buyer should consider the nature of the loan and the underlying collateral and assess their ability to administer the loan and, in the event of foreclosure, manage the collateral. Since troubled real estate debt can often lead to foreclosure, buying and selling loans ultimately includes buying a lawsuit. It is therefore essential that buyers understand the myriad of challenges that come with buying a lawsuit and foreclosure, which include inherent delays in the court system, and can include unforeseen and costly expenses, such as court payments. escrow, overdue property taxes and water bills relating to the underlying collateral property, building code violations and streets and sanitation, as well as legal fees and court costs.
In addition to the considerations set out in this article, buyers and sellers should engage professionals who are experienced with the type of debt under consideration and familiar with the local court system, as it is essential at every step that the parties consider and understand the issue. way forward for an exit strategy and tailor the transaction accordingly.
1. Conditions sheet. The condition sheet will establish the basic conditions for the loan buy and sell transaction. The buying and selling of loans often works like an acquisition of property, with a purchase contract under which a deposit is made and a due diligence period takes place before a formal closing. Some of the essential points covered by the terms sheet include price, scope, key due diligence items, whether the loan is transferred on a released service basis or whether the existing seller or manager will continue to manage the loan, the rights termination and recourse and allocation of transaction costs.
2. Due diligence. The scope of due diligence in a loan purchase should generally include a review of the loan documents, the borrower, any guarantor, the underlying collateral, and the procedural position of the pending litigation.
a. Review of loan documents. Buyers should receive the original signed loan documents from the seller in order to verify the proper signatures, registration and legalization, as well as to check for any other defect of proof. It may be helpful to have a litigator review the documents to assess potential evidentiary issues that may arise at the trial or summary judgment stage. It is important for a buyer to fully understand each of the following: (i) the terms of payment under the loan, (ii) any other financial commitments relating to the loan; (iii) all provisions and remedies in the event of default detailed in the loan documents; (iv) the exemption and remedy provisions; (vi) guarantees or other credit support; and (vii) the borrower’s commitments or even the lender’s obligations. In addition to reviewing all loan documents, buyers should have a full understanding of the borrower’s payment history and property tax status with respect to the collateral. It is also essential to determine whether the loan documents permit the use of receivership, the standards for appointing a receiver, the notice to be given and the requirement of a surety. A clear provision for the appointment of a receiver in loan documents gives the lender a strong case for appointing a receiver (in Illinois this then becomes virtually automatic by law with an allegation of default), since the borrower has already accepted this recourse by signing the loan documents. Even though the loan documents are silent on receivership, Illinois allows the appointment of a receiver with a valid rationale under the Illinois Mortgage Foreclosure Act (735 ILCS 5 / 15-1704) , but this will likely be the subject of a contested motion practice. . Receivership is an important due diligence consideration as it is a valuable tool for collecting debt and protecting the underlying collateral, especially when foreclosure will not provide immediate protection.
b. Property review. An updated preliminary title, including a foreclosure notice, should be ordered to assess the current condition of the property, any liens that may have arisen, and to identify the parties needed in the event of a foreclosure. A rider can also be obtained to substitute the purchaser as the named insured on the lender’s existing policy. Since a troubled real estate debt buyer could potentially become the owner of the underlying secured property, the buyer should: (i) assess the risks to which he may be exposed as a lender (c.) And (ii) ) identify and assess the risks a homeowner may face (i.e. regulatory compliance, building code violations, receivership, and neighboring property issues). Pro tip – many jurisdictions will allow a buyer to issue an access to information request (often referred to as a “FOIA request”) to local building code agencies to determine if there have been violations. This information can prove useful in a buyer’s diligence and review of a property.
vs. Borrower / Guarantor Review. The due diligence review should also include the borrower himself, as well as any guarantors of the loan. It is important that a buyer understands the organizational structure of the borrower / guarantor, but this investigation should focus on the financial capabilities of that party and on verifying their creditworthiness and adequate capitalization to timely fulfill their obligations. loan obligations. . It often happens that in the event of default, the buyer’s remedy (if any) exceeding the warranty is against the guarantor under any applicable warranty. Researching liens, UCCs, judgments, bankruptcies and litigation on the borrower and any guarantor is recommended.
D. Review of disputes. It is essential during the due diligence review to determine whether a foreclosure action has been filed or if there are other pending litigation, the procedural status of that litigation and whether the court has appointed a receiver. Care should be taken to ensure that the appropriate parties are identified, that appropriate service has been obtained for unknown owners and unregistered applicants, and that the lender’s reinstatement and redemption rights are followed. As discussed in the Review of Loan Documents section above, a qualified litigator can assess evidentiary issues and can also provide practical advice on the judge handling the case and the court system and can review the court file for defenses raised and obstacles that may need to be overcome.
3. Transaction documents. The main transaction document is the Loan Purchase and Sale Agreement (“LPA”). Additional documents, such as the extension, recordable assignments of recorded documents, mortgage and note, will be required to complete the transfer at closing. Pro tip – In the LPA, buyers must ask the seller to provide an affidavit of amounts owed, which meets the requirements of the Illinois mortgage foreclosure law, so that it is possible to prove the loan history for the period during which the buyer did not own the debt. In addition, representations and warranties are a key part of the LPA that buyer and seller typically receive from other usual representations of the business. Most other representations will come from the seller regarding the loan, the borrower, and the underlying asset. The seller’s current representations and warranties include: generally, buyer and seller will indemnify each other for losses resulting from circumstances or events caused by the indemnifying party during their respective period of ownership of the loan, with seller being responsible for any future intentional or grossly negligent fault. , which does not occur during its period of ownership. The APL will also discuss closing logistics. Reserves and other accounts may need to be transferred or credited. The original loan file must also be given to the buyer.
- Identification of all loan documents, including true and correct copies thereof;
- Specification of outstanding principal balance, unfunded loan amount and reserve amounts and an affidavit from the vendor thereon;
- If a default on the part of the lender has occurred and the borrower / guarantor has a defense, counterclaim or right of set-off;
- Whether any claims, waivers or discharges have occurred under the loan documents;
- If the seller is the owner of the loan, free of any charge;
- Whether the due diligence documents provided are true, correct and complete copies;
- If the seller is aware of any defaults by the borrower or the guarantor;
- If the seller becomes aware of the borrower disputing the debt amount, raising defenses or arguing for lender defaults or other challenges; and
- Declaration that the seller does not withhold any information intentionally.
As a general rule, buyer and seller will indemnify each other for losses resulting from circumstances or events caused by the indemnifying party during their respective period of holding the loan, with seller liable for any future willful misconduct or by gross negligence, which would not occur during its period of ownership. The APL will also discuss closing logistics. Reserves and other accounts may need to be transferred or credited. The original loan file must also be given to the buyer.
The issues and challenges of disposing and acquiring distressed real estate debt can vary in complexity. Understanding the fundamentals of the types of bad debt to acquire and the various remedies available once acquired is essential for those considering a mortgage buy and sell transaction. Appropriate legal advice and careful assessment of the underlying circumstances, as well as using the right structure to acquire distressed assets, will be paramount in the new COVID-19 environment. However, although difficult, it can be very attractive to acquire distressed debt that can generate substantial returns.