Representing Borrowers in Commercial Loan Transactions: Diving Into the Loan Documents

Loan documents – those bastions of arcane and archaic legal language which memorialize and govern the lender-borrower relationship – play an outsize role in any commercial loan transaction. And customarily they are overtly lender-friendly, regularly tipping the balance in lenders’ favor and placing even sophisticated borrowers at significant operational disadvantages. Lenders’ counsel are accustomed to receiving pro forma loan document comments from borrowers’ counsel – those standard qualifiers like “reasonable,” “to the best of borrower’s knowledge,” “other than in the ordinary course of business,” and so on. But borrowers’ counsel would be wise to consider, in appropriate circumstances, more substantive negotiations.

This note provides several drafting suggestions for counsel representing borrowers in commercial loan transactions. Whether a lender or its counsel will accept particular changes depends on a number of factors, but lenders are often agreeable to certain edits that can shift, in a small but meaningful way, the lender-borrower relationship in borrower’s favor.

Application of Insurance Proceeds

Following a casualty event to a mortgaged property, a lender and a borrower may have differing motivations in how insurance proceeds are to, or should, be applied. Standard loan documents typically give lenders the right, at their discretion, to apply insurance proceeds to the repair of damaged mortgaged property, or to the repayment of the loan. Lenders’ counsel are generally unamenable to requests that give borrowers automatic rights to apply insurance proceeds to repairs. Borrowers’ counsel should instead attempt to negotiate monetary thresholds, below which amount borrower is allowed to receive directly, and apply, all insurance proceeds towards repair. For disbursement of insurance proceeds in excess of the threshold, language should be requested prohibiting the lender from applying proceeds to repayment of the loan so long as certain conditions are met; namely, that no event of default has occurred prior, or during, disbursement of the proceeds, that there will be sufficient proceeds to complete the repairs, that the repairs will be completed within some agreed upon timeframe, and that borrower will provide lender with evidence of all insurance required to be maintained under the loan documents.

Environmental Matters

Real estate borrowers of all sizes are well aware of the ramifications of adverse environmental matters at their properties. In instances where a borrower is requested to represent or covenant as to the presence or status of hazardous substances, care should be taken to except from those matters “de minimis” hazardous substances – those hazardous substances which are used or present in the ordinary course of a borrower’s business in compliance with all environmental laws and which have not been released into the environment in such a manner as to constitute contamination. Counsel should further request that a borrower’s indemnification obligations as to environmental matters will not apply to any matters pertaining to hazardous substances first arising or affecting a borrower’s property after the transfer or sale of the property to any unaffiliated third party. In addition, language which provides for a borrower to make representations or covenants as the status of environmental matters on any property not owned by borrower (“any property adjacent to or within the immediate vicinity of” a borrower’s property) should be stricken.

Events of Default

Borrowers’ counsel should always contemplate edits to events of default sections, and particularly to “catchall” defaults. Any provision which provides that a borrower will be in default if there is “any other default under any of the other loan documents” should be removed. Similarly, provisions listing as an event of default (i) a borrower’s failure to provide more collateral or repay part of a loan where a lender believes the collateral securing repayment is “insufficient” or (ii) any adverse change in the borrower’s position or circumstances should at the very least be tailored.

Other Areas to Negotiate

Other loan document provisions ripe for borrower negotiation include: prepayment penalties (requesting exemptions from prepayment penalties for any prepayments made as a result casualty or condemnation events or arms’ length sales of premises to third parties, or those made in the last 30 (or 60 or 90 or 180) days prior to maturity), late charges (providing that they will only apply to regular, monthly payments, and will not apply to any amounts owed as of maturity), financial reporting requirements (replacing the more-exacting standards of generally accepted accounting principles with the standard accounting principles of borrower, or requiring that audited financial statements only be provided upon the happening of certain triggering events), and guarantor defaults (providing borrowers with the right, upon the death, incapacity, or default of a guarantor, to provide another guarantor in lieu of a default being declared).

Effective representation of borrowers in commercial loan transactions requires thoughtful contemplation, and negotiation, of loan documents – with a focus on leveling the playing field, considering the future, and reducing the risk of the unknown for your client borrower.

This article is intended for general informational purposes only and should not be considered legal advice or counsel, nor does it create an attorney-client relationship.