As lender liability law firms go, we are one of one of the few that only represent borrowers. Never banks, special servicers or lenders. Our mission is to protect property owners from predatory lenders. Today many borrowers are at risk. The COVID-19 pandemic has everyone in the hospitality industry concerned. After you read what some banks are planning, you will also be angry.
Earlier today we received a copy of a document circulated by a law firm that represents banks. It lays out a road map for how banks and loan servicers should deal with struggling buyers. While many banks are publicly promising to help, their actions say otherwise.
It’s obvious that many business owners are struggling. What may not be obvious is that some in the financial industry are gearing up to take your hard earned money. All of it. In the paragraphs below we will share what we have learned.
The direction to bankers starts out fairly benign. Lenders are facing a cascade of bad loans, especially from borrowers in the hospitality and foodservice industry. (We certainly don’t disagree.)
Lenders are being told to gather detailed financials from the borrower and carefully listen to how the borrower plans to get back on its feet after the pandemic ends.
So far so good (although some of the information sought by lenders could set you up for a future default. Be careful.)
Lenders are strongly urged to issue default notices. In the typical commercial loan (including CMBS loans), the formal declaration of a default triggers default interest, fees and penalties. It can also trigger a cash sweep, allow the creditor to seize loan reserves and force a lock box arrangement if one is not already in place. As you will read below, the FDIC has issued guidance telling banks they can extent loan payments without declaring the loans in default or "troubled."
At a time when struggling borrowers most need help, banks are being urged by their lawyers to place borrowers in formal default. Even if the bank doesn’t foreclose or exercise its other remedies, some loan agreements allow all those default charges and interest to silently accrue. That means next summer when you are finally back on your feet and caught up your lender can swoop in and demand hundreds of thousands of dollars in accrued fees.
There is more.
The guidance suggests that lenders utilize carefully worded pre-negotiation agreements. (See our post, Pre-Negotiation Agreements – Beware the Lurking Danger.) As originally intended, PNAs allow both parties to negotiate confidentially without having anything that said later be used in court.
Some lenders misuse a PNA by promising to negotiate in good faith but instead use the document to clean up problems in the loan documents and strengthen their position. That is exactly what banks are being told to do with respect to the pandemic.
Specifically, banks are being told to include language in the PNA that requires the borrower to acknowledge the default. It one thing for a bank to declare a default but quite another to require the borrower to admit to default before the bank will even negotiate. That doesn’t sound like good faith to us.
This same roadmap written for banks also suggests PNA language that allows the bank – not the borrower – to waive confidentiality. That means you and your loan servicer can speak frankly but later if the bank wants to use something you said in confidence, it can. But you can’t use anything the bank says against it.
Assuming the parties are able to work out an extension, lenders are being told to do so in a written forbearance agreement that can be rescinded at any time. It is also suggested that they secure up as much extra collateral and personal guarantees as possible.
If that isn’t enough, where the practice is legal, creditors are told to take assignments of collateral and deeds and hold them in escrow.
Lenders are also being told to have language in all agreements where the borrower waives all claims it has against the lender. Even if the lender acts in bad faith, lenders are using forbearance agreements to protect themselves from all liability.
Banks are also being told to insert language that requires borrowers and guarantors to waive their bankruptcy rights and allow the lender to seek immediate relief from the automatic bankruptcy stay. Thankfully that practice is not legal in all jurisdictions.
We think that the actions of many lenders and loan special servicers is reprehensible.
At the beginning of the pandemic, Treasury Secretary Mnuchin discussed help for those businesses most affected the most by the pandemic, the hospitality industry. Mnuchin said, “There may be specific industries that are highly impacted by travel that have issues with lending . . . . hotels and cruise lines….[W]e are focused on helping those businesses that need liquidity.”
The CEO of the one of the largest CMBS special servicers had similarly reassuring words. Barry Sternlicht, the CEO Starwood Property Trust and Starwood Capital Group, was interviewed on CNBC recently and stated that “we need lenders to forbear” during this time and that we need a three-month “economic timeout” during this severe crisis caused by COVID-19. Starwood is the parent of the largest CMBS special servicers, LNR Partners.
Unfortunately, we are seeing many cases where lenders and special servicers are talking the talk but not delivering. (For a true coronavirus related horror story, read how LNR mistreated a mall owner who hadn’t even missed a payment.)
We are especially baffled by the response of some banks. The Fed has cut the lending rate to banks to near zero. Banks have plenty of liquidity.
More importantly, the FDIC has instructed “financial institutions to provide borrowers affected in a variety of ways by the COVID-19 outbreak with payment accommodations that facilitate their ability to work through the immediate impact of the virus… Financial institutions may want to consider addressing any deferred or skipped payments by either extending the original maturity date or by making those payments due in a balloon payment at the maturity date of the loan.”
The FDIC has formally stated that banks do not have treat most loan modifications or forbearances as a formal default. Typically, when a bank enters into a forbearance agreement, bank accounting rules require the bank to show the loan as a troubled asset. That can trigger higher reserve requirements.
In light of the pandemic, the FDIC is essentially turning a blind eye to loans that might be as much as 6 months delinquent if related to the pandemic. There is NO reason for banks to force most hotel and other business owners into defaults, forbearance agreements or modification agreements with crippling terms.
Fighting Back Against Bad Lenders and Special Servicers
Some financial institutions pray on desperate borrowers during and immediately after a disaster. When business owners are panicked, they tend to sign anything placed in front of them. As long as they can keep the doors open for another month, some will sign almost anything. If not handled properly, the short extension you negotiate today could cause huge problems in the future.
Now is the time to take a deep breath before negotiating with your bank or loan servicer. Consult with a lawyer that handles commercial lending and CMBS disputes but be careful.
In the last few weeks there have been thousands of lawyers who are declaring themselves as experts in dealing with lenders. We have been quietly representing hotels and small businesses for years. (Large businesses too!)
For more coronavirus business information, visit our special coronavirus resource page. This is the one place for any questions you may have. If you need our help, reach out to attorney Chris Katers at [hidden email] or the author of this post, attorney Brian Mahany at [hidden email]. We can also be reached at 888.249.6944. All inquiries are kept strictly confidential.