We are often called upon to review commercial loan documents for clients. This usually occurs a few days before the scheduled closing. At that point, there is no time to change lenders if the loan documents contain onerous terms; all we can do is inform our client of the changes we would like to see and then request that the lender change them. We essentially have no bargaining leverage because the lender knows it is too late to shop for another lender.
This article discusses suggested changes to typical lender documents and to encourage clients to negotiate these issues before they commit to the loan. If a lender knows a borrower is not committed and can easily shop for another lender, the borrower is much more likely to negotiate loan terms.
Most borrowers are focused on the interest rate, required down payment and the amortization term. Those are important issues which have to be negotiated, but other issues can be just as important and rarely are addressed until the actual loan documents are prepared. Here are a few.
Notice of Default and Opportunity to Cure
Most residential loans have notice of default and opportunity to cure provisions; commercial loans often do not. However, if you ask, most lenders will be glad to insert these provisions. Typically, a borrower will want at least ten days’ notice of a monetary default and the opportunity to cure the default before any collection activity can begin and thirty days’ notice of non-monetary default and the right to cure it. Without a provision such as this, a lender can usually accelerate payment of the loan and begin foreclosure with no notice to the borrower.
Right to Re-construct with Insurance Proceeds
The deed of trust (mortgage) may give the lender the right to decide whether the borrower can use insurance proceeds to re-build after a casualty loss or whether the proceeds must be applied to the loan balance. If there is a complete loss, this may not be a problem. However, if, for instance, a ten-unit office building or apartment suffers a casualty loss which destroys three units, if the borrower cannot use insurance proceeds to repair and/or rebuild, the entire project may be compromised.
A lender will want to control insurance proceeds to ensure they are used to re-build but should commit to allowing the borrower to re-build.
Limitation of Guaranty Obligations
If the borrower is an entity such as a limited liability company or corporation, lenders will almost always require the principal owner to guarantee payment of the loan. Lenders will routinely include a “dragnet provision” or a “mother Hubbard provision” in the guaranty which extends the guaranty from just the current loan to any indebtedness of the borrower to the lender now or in the future. A borrower will want to limit the guaranty to the actual note being guaranteed.
You may also attempt to limit the guaranty to the top 20% or top 25% or top ___% of the loan so the guarantor is only obligated for a percentage of the loan. If your spouse has separate assets you may want to limit the property the lender can take if the guarantor if required to honor the guaranty.
There are several ways to negotiate or limit the guaranty, but these negotiations must take place before the borrower commits to the loan.
Representations and Warranties
Lenders often require borrowers to make all kinds or representations and warranties. For instance, they will require that you represent and warrant that all financial information given to them is true and correct. They will require detailed representations about environmental issues, property condition, etc. It is in a borrower’s interest to negotiate to eliminate as many representations as possible. For those which the lender insists upon, the borrower should attempt to limit all representations to the borrower’s “current actual knowledge”. Without this limitation a borrower could be liable for making a false misrepresentation even if the borrower had no actual knowledge that the misrepresentation was false.
Any representation that financial statements are “true and correct” should be modified to represent that they are “substantially true and correct in all material respects to the borrower’s current actual knowledge” or similar language. The lender should be concerned only that the borrower has not materially misrepresented the borrower’s financial condition; not that every amount listed is true to the penny.
If a borrower’s spouse must sign the note or a guaranty agreement, it is prudent to limit representation to the party who actually knows about the property. If a spouse does not know anything about the property, he or she should not be required to make representations because of a lack of knowledge about the property.
Waiver of Deficiency Statutes
Texas law allows a creditor to seek a deficiency judgment against a borrower if the note is not paid in full from foreclosure proceeds. For instance, if a creditor has a loan balance of $500,000 and the property is sold at a foreclosure auction for $400,000 the borrower could be sued for $100,000.
Texas has anti-deficiency statutes to keep creditors from abusing the foreclosure procedure by bidding in or purchasing the property at foreclosure at an artificially low price.
Section 51.003 of the Texas Property Code limits a creditor’s ability to low bid foreclosed properties and still seek a deficiency. But unlike some other consumer-protection laws, section 51.003 is waivable. Lenders routinely require borrowers to waive the deficiency statutes. Many lenders will agree not to include a waiver of the deficiency statutes if this is negotiated before you commit to the loan. Trying to get this waived a couple of days before the closing is usually fruitless.
Waiver of Jury Trial
Since juries tend to favor the little guy, a waiver of the right to a jury trial is often included in the loan documents. It is usually in a borrower’s interest to insist on a right to a jury trial if litigation is required.
Any terms you negotiate must be included in the loan commitment. If you need assistance in negotiating, we will be glad to help. It is much more efficient and fruitful to incur legal fees prior to signing the loan commitment than hiring a lawyer to negotiate right before closing.