Negotiating Commercial Real Estate Loan Documents
Commercial real estate loan documents tend to be lengthy, complex, and very pro-lender. It is easy to be distracted by the many issues these documents address, and lenders are not receptive to major rewrites of their loan documents, which, in their view, serve only to ensure that they will be paid back on time. Nevertheless, often commercial real estate loan documents go too far, and there are a number of issues borrowers should be sure to address.
The savvy borrower will save time and money by keeping in mind the most important issues that the lender may be willing to negotiate. Here is a short list of the most common issues that fall into this category:
1. Late Charges: Late charge provisions should provide for a reasonable amount for the late charge (typically not more than 5-6% of any delinquent payment) and should not be imposed prior to a grace period (typically not less than five business days).
2. Default: Most lenders will allow a grace period for monetary defaults, and many will agree to a notice and cure period, at least as to payments other than scheduled monthly payments. Nearly all lenders will agree to a notice and cure period for non-monetary defaults (typically not less than 15 days’ written notice, with an extension of up to at least 60 days if the borrower is diligently working to cure the default). Many lenders are willing to limit or eliminate “material adverse change” clauses that make a default out of changes in the borrower’s, guarantor’s, or property’s condition or circumstances. Default conditions relating to the death or incapacity of the guarantor may also be negotiated.
3. Representations and Warranties: Any inaccurate representations should, of course, be corrected, and the borrower should only make representations of which the borrower cannot be really certain to the best of the borrower’s knowledge.
4. Accounting Method: Many loan documents stipulate that GAAP be used as the borrower’s accounting standard. Unless the borrower’s financial records are already being prepared in accordance with GAAP, this provision should be changed to reflect the borrower’s actual accounting method, in order to avoid an inadvertent default.
5. Reimbursements: Borrowers should consider limiting provisions requiring the borrower to reimburse the lender’s costs to appropriate categories of reimbursements (and, in the case of certain costs such as appraisals and environmental reports, limited in frequency during the loan term). These provisions should also limit the reimbursement to reasonable costs.
6. Insurance: The borrower should have its insurance broker review the insurance requirements, to ensure that these requirements are feasible and will not substantially increase the borrower’s current insurance costs. If earthquake insurance is required, the borrower may wish to negotiate to eliminate this requirement.
7. Due on Sale/Due on Encumbrance: Restrictions on sale, transfer, or encumbrance of the property and of equity interests in the borrowing entity are common, and there is generally only limited room to negotiate them. For most borrowers, the key point is that entity transfer restrictions should permit transfers to family members and into and out of trusts for estate planning purposes. Most lenders are willing to agree to permit such transfers.
8. Leasing Restrictions: Commercial real estate loan documents tend to contain restrictions on any leasing activity without the lender’s consent. In a loan secured by a property leased to a single tenant there may not be much room to negotiate these provisions, but in multi-tenant situations it is generally possible to negotiate some flexibility for leasing of smaller leases at market rents without the lender’s consent, especially if a pre-approved lease form is used.
9. Damage/Destruction: Loan documents generally give the lender the right to apply insurance proceeds from damage to or destruction of property to pay down the loan, in lieu of allowing the borrower to use the proceeds for rebuilding. California law is ambiguous as to whether the lender’s right to do this is enforceable. It is a good idea to negotiate a right to have the lender provide the funds for rebuilding, subject to reasonable funding controls.
10. Attorneys’ Fees: Lenders are generally willing to have their ability to charge for their attorneys’ fees limited to reasonable fees and costs, except for fees and costs they incur in enforcing the loan documents.
All of the foregoing issues are worth negotiating on behalf of the borrower, and lenders generally recognize that these are legitimate concerns and are willing to discuss them. The specific changes will, of course, depend on the actual loan document provisions involved. Each set of loan documents may, of course, also raise additional issues that are worth negotiating. Borrowers should therefore be sure to review any set of loan documents with their attorneys.
To fully understand the legal implications of your commercial real estate loan documents and your unique situation, please contact Ross Adler, shareholder and member of the real estate group at Hopkins & Carley, one of the most competent and prestigious law firms in the Bay Area. His practice encompasses a broad range of transactional real estate matters, particularly on behalf of financial institutions, developers, and property owners. To contact Ross to discuss your specific needs, please email him directly at radler@hopkinscarley.com.