During real estate downturns, commercial mortgage loans may be difficult to refinance, and some borrowers might suffer from insufficient cash flow to service their mortgage debt. In some cases, lenders might prefer to modify delinquent or nonperforming loans rather than foreclose. If, by granting concessions – temporary or permanent – the lender can end up with a borrower that can continue servicing the debt, the lender then can avoid taking on the headaches of owning property that cannot be quickly disposed of. Whatever the reason, though, modification of a mortgage loan requires careful thought and attention to prudent processes.
While by no means comprehensive, following is a list of some factors that should be considered when modifying a commercial mortgage loan:
- Seek the consent of any junior lienholders where appropriate, in order to preserve priority of the lien. Even if the recorded mortgage expressly reserves the lender’s right to modify in the future, the prudent lender will carefully evaluate the potential claims of any junior lienholders of the collateral. Any modification that could impair a subordinate lienholder’s ability to collect on its lien could result in a loss of priority unless the junior lienholder consents. This is particularly relevant if the proposed modification will increase the interest rate or the amount of the debt, or will shorten the time for repayment. If, on the other hand, the modification extends the time for repayment or reduces the monetary obligations (e.g., interest rate or principal amount), then the junior lienholders could be seen to benefit. Nevertheless, the prudent lender will carefully review title to the real property that secures the loan, and seek consent from any junior lienors if and where appropriate.
- Protect the lender’s title insurance coverage. Lender title policies expressly exclude coverage for any post-issuance modifications to the insured deed of trust. Most jurisdictions, however, provide for the issuance of an endorsement to the lender’s policy to assure the lender that its title insurance coverage will not be impaired by the execution and delivery of the modification. Under appropriate circumstances, Texas title companies can issue the T-38 endorsement, which insures that “the company will not claim that the policy coverage has terminated or that policy coverage has been reduced solely by reason of the execution of” the modification agreement described in the endorsement. As a condition to issuing this endorsement, though, the title company will want to review the proposed agreement to confirm that it falls within the parameters of the types of modifications that can be insured by means of this endorsement.
- Obtain the consent of any guarantors of the loan. In general, a guarantor will be released from liability under its guaranty if the principal obligation is modified without the guarantor’s consent, often regardless of whether the guarantor waived notice of modification in his or her guaranty. Best practice is to have the guarantor(s) sign the modification, acknowledging and consenting to the modifications of the loan and reaffirming the obligations under the guaranty for the loan as modified.
- Record the executed modification promptly in the real property records of the county where the real estate is located. This will put the public (and thus future lien claimants) on notice of the loan’s modified terms. Again, the goal is to preserve the priority of the modified mortgage lien over subsequent liens.
- Consider bankruptcy implications. If the lender requires additional collateral for the loan as part of the modification, for example, the receipt of that additional collateral might be deemed a preferential transfer under the bankruptcy code. The modification agreement should include a borrower representation and warranty that no bankruptcy proceedings are pending or contemplated, and the lender should evaluate the borrower’s financial condition to satisfy itself as to the risk of a bankruptcy filing soon after the modification is filed.
Questions? Feel free to call.
Laura McClellan
www.tklaw.com
