PERSON OF THE WEEK: Helene Jaron On Workouts And Lender Liability

MortgageOrb checked in with Helene Jaron, a member of the business law department at Cozen O'Connor, where she focuses her practices on real estate finance and securitization. She offers some timely advice on avoiding lender liability claims and navigating tricky workouts involving securitization and/or mezzanine pieces.

You have mentioned that commercial mortgage lenders often risk liability claims if they take ‘too active a role’ in working with borrowers. What typically constitutes a too-active role? How can lenders guard against these claims?

Helene Jaron: Once a loan goes into default, if a lender takes no action and accepts payments from the borrower, or if the lender actively engages in workout negotiations, the lender runs the risk that if negotiations break down, a borrower will claim a de facto forbearance or loan modification. Borrowers also have been more aggressive with lender liability counterclaims.

Once a loan goes into default, the lender should send a default notice that identifies the default and unequivocally states that no oral communication between the lender and the borrower shall constitute an agreement of the lender with respect to the loan, and that any agreement between the borrower and the lender must be in writing.

Lenders also should obtain a pre-negotiation letter from the borrower prior to entering into any type of settlement or workout discussion. The pre-negotiation letter should provide that, while the parties may engage in ongoing discussions and negotiations, no agreement reached with respect to any matter shall have any effect unless such agreement is reduced to writing.

If the borrower is unwilling to sign a pre-negotiation letter, the lender should, nonetheless, send the letter to the borrower prior to commencing any discussions with the borrower.

Q: You have also noted the problems associated with mezzanine loans and discussed opting for preferred equity instead. What are the specific advantages of preferred equity? What are the risks?

Jaron: A mezzanine loan is secured by the equity interests in an entity. If there is a default, a mezzanine lender must conduct a commercially reasonable sale under the Uniform Commercial Code in order to gain control of the entity and, ultimately, the real estate.

Typically, there is an intercreditor agreement between the senior mortgage lender and the mezzanine lender that may allow the mezzanine lender to cure mortgage borrower defaults for up to three months before the senior lender commences a foreclosure action.

One advantage of preferred equity is that the investor has an existing ownership interest in the entity. If there is a default under the preferred-equity agreement, the preferred-equity investor has the right to become the managing partner/member of the entity, without the need for judicial action.

Moreover, there is no limitation on how many defaults can be cured by the preferred-equity investor, as it is in the ownership structure, and depending on the circumstances, the preferred-equity investment can be characterized as either debt or equity.

The disadvantage, however, is that the defaulting partner/member still retains a non-controlling interest in the entity.

Q: In your work with commercial mortgage workouts, what complications have you found are most common – particularly with securitized loans?

Jaron: The most common complaint we hear from borrowers under securitized loans is that they cannot get the attention of the master servicer. The master servicer will not transfer the loan to special servicing unless the loan is in default or a default is imminent, and the master servicer may be unwilling to speak to a borrower until an actual default has occurred.

For those securitized loans that have been transferred to special servicing, there is no readily available exit strategy. In many cases, the loans far exceed the current value of the property. If refinancing is even available, it will be at a very low leverage, which means a borrower will have to come up with a substantial equity investment in order to retain the asset.

For many borrowers, this simply is not an option, and they elect to give back the keys.

Q: How much do you think the Term Asset-Backed Securities Loan Facility (TALF) will help revive commercial real estate lending? Is the recent extension meaningful?

Jaron: Investors sought $669 million of legacy CMBS TALF loans for the July subscription and $2.3 billion of legacy CMBS TALF loans for the August subscription. The increased demand for TALF-eligible bonds has had some success in bringing spreads on AAA CMBS to reasonable levels, but it has yet to stimulate securitized lending.

While several single borrower deals are in the pipeline, the real challenge is reviving conduit origination. Many banks have either eliminated or significantly decreased their underwriting and origination staff. Banks will need to staff back up, which they may be unwilling to do until they know they are able to hedge interest-rate risk while they aggregate loans for securitization.

Their willingness to come back into the market also may depend, in large part, on whether they anticipate a market for bonds rated below AAA.


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