Financing Focus

Beware of Loan Provisions

The language in preprinted lending documents could cause you plenty of trouble.

When buyers purchase a property with financing or are refinancing an existing loan, they often see loan documents that are either preprinted or generated by a document assembly program. In either case, making changes to preset terms can be a challenge.

The whole purpose of these documents is to allow someone to quickly generate a serviceable set of loan documents. Nevertheless, prospective borrowers who want to ensure that the loan documents reflect their understanding of the loan terms must adhere to the provisions of these documents. Here are three examples of language that that should be modified and why. 

Unwarranted Fees

Mechanically produced prepayment provisions can be worded in a way that are surprising to commercial real estate professionals - and are unfair to the borrower. Typically, in form promissory notes, a prepayment provision appears like this one.

Prepayment Fee: Upon prepayment of this Note, the Lender is entitled to the following prepayment fee: The Promissory Note (the “Note”) may be prepaid in whole or in part at any time upon payment of a premium (the “Prepayment Fee”) … If Borrower prepays this Note in whole or in part. Borrower shall pay a prepayment penalty of ____ percent of the original principal balance of this Note.

The note permits the borrower to make a partial prepayment, but the prepayment fee is a percentage of the original principal balance of the note, instead of the amount actually prepaid.  To show what damage this may cause, imagine the borrower has a single loan secured by multiple rental houses, and the borrower sells one of the houses.

When the borrower approaches the bank to apply the proceeds to a partial prepayment of the loan, would the borrower expect the bank to charge them a prepayment fee based on the entire amount of the loan? No. But technically, the remaining balance of the loan is still outstanding, earning interest at the contracted-for rate. 

Ambiguous Provisions

One popular provider of loan document production software includes the following provision in its forms.

Subsidiaries and Affiliates of Borrower. To the extent the context of any provisions [sic] of this Agreement makes it appropriate, including without limitation any representation, warranty, or covenant, the word “Borrower” as used in this Agreement shall include all of Borrower's subsidiaries and affiliates. 

When the title to real estate is held by a single-asset entity that is owned and controlled by an umbrella investment entity, such a provision spells danger. 

If commercial real estate professionals want to avoid having disputes over whether the “context” of a provision in the loan agreement is relevant, they need to change the language. 

Commercial real estate professionals should insist that the lender at least strike the references to affiliates. Failure to do so leaves commercial real estate professionals open to the risk that an action that has no effect on the loan or the lender's security nevertheless puts the loan into default.

One-sided Provisions

Designed for the lending institutions that buy them, form loan documents tend to be one-sided and can hide some nasty surprises in what appear at first glance to be boilerplate provisions. The “Miscellaneous Provisions” of one loan document for one of my clients recently contained this provision:  

Notice of Lender's Breach. Borrower must notify Lender in writing of any breach of this Agreement or the Related Documents by Lender and any other claim, cause of action or offset against Lender within thirty (30) days after the occurrence of such breach or after the accrual of such claim, cause of action or offset. Borrower waives any claim, cause of action, or offset for which notice is not given in accordance with this paragraph. Lender is entitled to rely on any failure to give such notice.

The borrower has only 30 days after the lender commits a bad act to place the lender on notice, and failure to deliver that notice means the claim is lost. Absent that provision, you would have four years to bring a claim based on the lender's breach of contract. I have yet to see a loan document that similarly limits the lender's right to bring action of its own.

These are just a few of the issues to be wary when dealing with form documents. 

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