In my last article, I discussed how owners of commercial, industrial, retail and multi-family properties, hurt by falling property values and tightened lending standards, are seeking loan modifications as a possible alternative to bankruptcy in an effort to avoid foreclosure and survive until cash flow improves or loans can be refinanced on acceptable terms. I considered possible outcomes of negotiations with a lender, alternatives to loan modification, information an owner needs to gather before negotiating, and some factors that can affect an owner’s bargaining position with respect to its lender. Now I will examine how a thorough review of the loan documents can improve an owner’s leverage in negotiations.
As we know, loan documents are lengthy, detailed and to most readers, sleep-inducing. Yet the devil is in the details when it comes to loan documents, as with all legal matters. Nonetheless, during the boom years, lenders did not always invest the time and resources to carefully prepare loan documents or review them for errors before closing. This may have been due to the fact that lenders thought little about collection problems at that time, since property values were going up, not down, and deficiencies after foreclosure were non-existent. As a result, it may not have seemed so important to lenders to proofread their work in a careful manner.
Given that, it is not surprising that a large percentage of loan documents prepared during the boom years contain serious errors. Among other things, I have seen mistakes as to parties, legal descriptions, Assessor’s Parcel Numbers and forms of acknowledgement, as well as undated or not fully executed documents, missing exhibits and incorrect or non-existent UCC filings. Mistakes as to the form of trust guaranties are extremely common, in my experience.
The lender is usually unaware of errors in the loan documents until the owner points them out while attempting to negotiate a modification. Typically, the lender has not looked at the documents since closing and has been dealing with the owner on the basis of summaries of the loan terms attached to the file.
Since the laws relating to foreclosure and the enforcement of creditor’s rights are highly technical, errors in loan documents can have serious consequences for a lender and will get its attention. A court can be tough on a lender who tries to enforce defective loan documents. Among other things, a court can enjoin a lender from taking action under the loan documents until it makes a final decision as to whether or not they are enforceable. Therefore, when errors in the documents are pointed out, the lender will have its own counsel review the loan documents and advise it what the legal ramifications might be.
It is not always certain whether a particular error will make the loan documents unenforceable. Frequently, there is no Nevada statute or case law that addresses the exact issue, so the owner and lender will each make its best guess as to how a court might rule if the issue were litigated.
Even if the legal effect of a particular error is unclear, the existence of the error can give the owner a valuable bargaining chip, at the very least. The lender knows that legal action is expensive and time consuming and the result can be hard to predict. Therefore, if the owner can persuade the lender that there is a significant risk that the error makes the documents unenforceable and that the owner is prepared to take legal action to get a court ruling to that effect, the lender will become concerned about its ability to enforce its rights.
Faced with a credible threat of legal action that might prevent enforcement of its loan documents, the lender may become motivated to negotiate a loan modification, or to negotiate better terms than it initially offered the owner when it was unaware of the error in the loan documents. If the parties reach agreement to modify the loan, the lender will be sure to get corrected loan documents signed in connection with the modification. Then, if a default occurs or foreclosure ever becomes imminent, the original erroneous documents will not be put to the test in court.
Knowing what the loan documents actually say is crucial for any owner who wants to negotiate the best possible modification with its lender. Information is power. A savvy owner will take the opportunity to uncover all of the defects in the loan documents and use them to maximize its leverage in negotiations.