Finance, Professional Perspective – Important Co-Lender Issues In Syndicated Mortgage Loans – Charges, Mortgages, Indemnities
When one envisions the negotiation of a bilateral mortgage
loan, they usually picture a borrower and lender working closely
together to resolve issues pertaining to the ownership and
financial performance of the property, along with general
conditions to the loan itself. On a syndicated mortgage lending
transaction, however, there is a group of lenders led by an
administrative agent, leading to a myriad of additional issues to
be considered.
When one envisions the negotiation of a bilateral mortgage loan,
they usually picture a borrower and lender working closely together
to resolve issues pertaining to the ownership and financial
performance of the property, along with general conditions to the
loan itself. On a syndicated mortgage lending transaction, however,
there is a group of lenders led by an administrative agent, leading
to a myriad of additional issues to be considered.
Each lender in a syndicated loan holds a separate component note
from the borrower evidencing its interest in the whole loan. A
participation is similar in many cases to a syndication, but a
participant’s interest is in a percentage of a given
lender’s note, and the participant has a legal relationship
merely with the holder of the note rather than with the borrower
directly. The relationship between the lenders and agent is
documented in a co-lender agreement while the relationship between
a participant and lender is governed by a participation
agreement.
The administrative agent, usually also a lender, serves the
lenders in an administrative role with lenders agreeing on how much
discretion the agent actually has. Given the limited level of
discretion, the lenders and agent will expressly agree that the
agent is not a fiduciary on behalf of the lenders. Even in
situations where the agent is itself a lender, the lenders are not
able to legally rely on the agent with respect to advice and
information being provided by the agent. The agent’s
responsibilities include providing the borrower and lenders each
with a single point of contact; acting on behalf of the lenders
within the confines of a co-lender agreement; requesting and
tallying lender votes, as a secured party under the loan documents,
enforcing the rights of lenders when directed by the lenders; and
handling administrative functions, such as accepting and disbursing
funds and maintaining all documentation pertinent to the
transaction.
The issues to be discussed apply both to co-lender agreements in
a syndication and participation agreements in a participation. In
each case, the key questions broadly fall under four umbrellas:
assignment and liquidity rights, consent rights, defaulting lender
rights, and post-default matters. The importance of any given issue
or its resolution will be impacted by the size of the loan or
lending pool, the type of asset being financed, the experience of
the agent, or a myriad of other factors relating to the
transaction.
Without supporting a particular position, this article provides
some perspectives of agents and lenders with respect to critical
co-lender issues as the parties negotiate documentation.
Assignment & Liquidity Rights
Lenders and agents have competing interests with respect to the
assignment of a lender’s interest in a loan. Lenders would like
the ability to freely assign all or part of their interest in a
loan for various reasons, including reduction of exposure to a
single loan, borrower, or geography, or because the loan is in
default. An agent will have its own concerns with lenders selling
their interests.
First, the agent will want to maintain some control over the
pool of lenders to ensure the syndicate is reliable. This is
particularly the case in a construction loan or other loan with
future funding obligations, where the agent, lenders, and borrower
are concerned with all lenders’ willingness and ability to make
funds available to complete the contemplated work or pay an
earn-out. An agent will also want to avoid working with a
particularly hostile or litigious lender, or a lender whose
interests may not coincide with the rest of the lender pool.
Further, a borrower may not want to work with a potential lender in
cases where there may be funding concerns, relationship issues, or
concerns with a potential lender that is a competitor in other
areas.
These concerns can be addressed in a few different ways. Some
agents or borrowers may require consent over prospective assignees.
Alternatively, an “eligible assignee” concept narrows the
universe of possible lenders to generally institutional investors
such as banks, insurance companies, pension funds, REITS, or
investment funds. Financial parameters may be built into
“eligible assignee” definitions to ensure a given
lender’s capacity to fund. Parties may also choose to agree on
a list of unacceptable assignees if there are specific parties with
whom a borrower or agent would prefer not to work. Lastly, parties
will usually agree that the borrower or its affiliates cannot also
be a lender to avoid conflicts of interest.
Another liquidity concern is commitment size. An agent will
often request that each lender hold a minimum amount or certain
percentage of the overall loan commitment. The reasons here are
twofold. Working with many lenders may be overly burdensome
relative to the particular loan. Also, a size requirement prevents
a lender with a relatively small interest in the loan from holding
up the loan by withholding its consent in instances where unanimous
lender consent is needed to approve an action.
Lenders will typically understand these concerns. However, the
ability to sell smaller pieces of their commitment may lead to
greater marketability of shares of the loan. Therefore, a lender
may want to retain the ability to sell down its portion of the loan
without having to sell their entire interest. To address these
concerns, the agent and lenders may negotiate either a minimum hold
or maximum number of lenders that is reasonably acceptable to
everyone. Allowing a lender to participate its interest, while the
initial lender maintains sole authority, responsibility, and legal
relationship with the agent, may also provide relief.
Predictably, the lenders or borrower may insist on a minimum
hold for the agent or certain key lenders. Borrowers like to know
that the parties they initially agreed to work with remain in place
to ensure consistency in their course of dealing. Lenders generally
want an agent to maintain an interest in the loan, especially where
the agent’s team has underwritten and sold the loan to the
various lenders, and those lenders have informally relied on the
agent’s expertise. Maintaining this relationship helps assure
that the agent will act in the lenders’ best interests. Some
agents may push back on this requirement as it can restrict their
liquidity.
Consent Rights
As stakeholders in the loan, lenders require some consent rights
relating to the direction of the facility. There are two levels of
consent typically seen in syndicated facilities: “required
lenders” and unanimous consent. Required lenders typically
means two-thirds of the non-defaulting lenders, but is, in some
cases, as low as 50 or 60%, and if there are only two lenders, will
typically require the consent of both in any case.
Required lender consent is typically required for the waiver of
some or all events of default, credit-bidding at an auction,
acceleration of the debt, consenting to a bankruptcy filing by the
borrower or by the agent against the borrower, waiving prepayment
premiums, or waiving insurance requirements. Other items that may
be added include:
- Approval of material alterations to the property
- Approval of changes to a cash management structure
- Approval of major agreements affecting the property, such as a
new property management agreement, major lease, or easement - Appointment of a receiver
- Approval to changes in zoning or use of the property
- Waiving default interest
- Agreeing to financing following the acquisition of title
- Settling a material title, casualty, or condemnation claim
Unanimous lender consent is typically required for the most
critical decisions, and will typically include credit items such as
modifying the maturity date, changing the principal amount or
interest rate of the loan, agreeing to defer the payment of the
debt, cross-defaulting the loan with another loan, changes in the
post-default waterfall, releasing a guarantor, or terminating or
cancelling loan documents. Other items that may be included are the
modification or waiver of financial covenants, entering into
forbearance agreements, consenting to other debt secured by the
property, and some items described in the prior paragraph as
required lender decisions.
Determining which decisions require the consent of lenders and
at what level is often influenced by a couple of factors. Borrowers
and agents want quick action without having to wait for other
parties to weigh in while lenders seek to protect their investment
in the loan and its collateral by voting on material issues
affecting the loan. Another concern, particularly in the case of
unanimous consent decisions, is that any one lender can hold up an
action that the rest of the lenders may want. This is particularly
the case where a lender’s interests are not aligned with the
rest of the syndicate, such as a lender whose goal is to “loan
to own” rather than to get repaid at maturity.
Sometimes the decision to foreclose or accept a deed in lieu of
foreclosure is also treated as a unanimous lender decision, but
that raises the risk that one lender will be improperly able to
hinder or prevent a foreclosure. One alternative is for the
co-lender agreement to contemplate that the agent will
automatically be instructed to foreclose unless some threshold of
Lenders instructs the agent not to proceed. Both lenders and agents
need to be thoughtful about which issues require what levels of
consent.
Most parties to a syndicate, and usually the borrower, generally
prefer to resolve issues quickly. Loan documents will provide a set
number of days for lenders to vote before their failure to respond
is deemed to be a consent. Lenders will frequently request and
receive a second notice period before a lender who failed to
respond to a consent request is deemed to have given its consent.
Typical response periods are between one and two weeks, with an
occasional extra week given for a second notice period. There may
also be cases where a non-responding lender is deemed to have
withheld its consent, although this is less frequent. This
variation helps ensure that a lender who does not affirmatively
approve a consent request is not bound to a risk it did not intend
to take.
Lenders can come to an agreement on most loan administration and
servicing decisions, but in some scenarios, a deadlock may occur.
Some co-lender agreements contemplate that if the borrower requests
consent and a lender blocks the consent, then the borrower or agent
has the right to require a non-consenting lender to sell out of the
facility at par value to a replacement lender, a concept
colloquially referred to as “yank a bank.” It may be
advantageous in many cases for a lender group and borrower to be
able to move forward, but a notable drawback to a “yank a
bank” provision is that it rewards a recalcitrant lender who
wants to exit the facility. Further, this result may be hard to
reconcile with the typical pari-passu treatment of lenders in a
loan facility. In other co-lender agreements, an agent is permitted
to use its judgment in the event of a deadlock, which again may
allow the transaction to move forward; at the same time, however,
this agent right effectively disenfranchises the lenders. Along the
same lines, some co-lender agreements provide that a deadlock
amongst the lenders during an event of default will be resolved by
accelerating the loan.
Lastly, loan documents will typically provide for circumstances
where an agent can be removed. As with other points, there is a
balancing of interests, as removing an agent also affects the
borrower. Lenders want to ensure that the agent is in the best
position to represent their interests. The agent needs the ability
to operate relatively freely. The borrower, meanwhile, who
generally selected the agent, has an expectation of consistency
unless there is a reason for the change.
Borrowers and agents will want a high threshold for the removal
of an agent, perhaps including the borrower’s approval of both
the removal and the replacement agent in most cases where no event
of default is continuing. The most typical cause for removal would
be a non-appealable court judgment that the agent was grossly
negligent or committed willful misconduct in administering the
loan. Other common causes for agent removal include the failure to
maintain a minimum hold or the failure to remain a lender, being a
defaulting lender, or the agent no longer being in the business of
originating, investing in, or servicing commercial mortgage
loans.
Defaulting Lender Rights
Defaulting lenders are typically lenders that breach their
duties to the borrower or other lenders under a loan agreement or
co–lender agreement. Most frequently, the breach results from
the failure to advance funds in a facility where there are future
funding obligations or where the lender fails to make a protective
advance. Typically, when there is a defaulting lender, the other
lenders or the borrower will be permitted to fund the defaulting
lender’s share of the loan – provided, however, that the
borrower can’t be considered a lender if it funds the
defaulting lender’s share, and the defaulting lender will owe
the funding party interest on the funded amount.
On a longer-term basis, loan documents typically provide
disincentives for lenders to default since such defaults would have
adverse effects on the borrower, the agent, and the other lenders.
Those disincentives can come in three forms: forced removal,
suspension of voting rights, and/or subordination of payments.
Co-lender agreements take a few different approaches to the
forced removal of a lender, with some being preferable to others.
Some co-lender agreements give the other lenders in a facility the
opportunity to purchase the defaulting lender’s share at a
discount, which not only disincentivizes a lender from defaulting,
but also incentivizes existing lenders to take over the defaulting
lender’s obligations and keep the loan moving forward.
In other cases, the defaulting lender is required to sell its
future funding commitment—but not its already-funded
commitment—to a replacement lender identified by the borrower
or the agent. In this case, the defaulting lender will not receive
repayment of the funds it has already put into the loan until the
non-defaulting lenders have been repaid in full. This formulation
is less helpful in a facility where there are fewer future funding
obligations.
Another less-favorable option is to require the defaulting
lender to sell its entire share of the loan. While this removes the
defaulting lender entirely, it can also create an incentive to
default for a lender who wants to get out of a loan by allowing it
to be repaid in full prior to the other lenders.
Defaulting lenders can also be penalized by having their rights
to repayment of the loan or payment of debt service subordinated.
In other words, amounts funded by other parties in lieu of a
defaulting lender will be repaid from funds that would have
otherwise gone to the defaulting lender until those amounts funded
have been repaid with interest. In some more draconian co-lender
agreements, a defaulting lender will not be repaid at all until
each non-defaulting lender has been repaid in full. Further, a
defaulting lender will generally have its voting rights limited,
and in some cases, suspended entirely. In any case, loan documents
should provide that a defaulting lender will not be
disproportionately affected by any waiver, amendment, or consent.
This includes having the defaulting lender’s commitment
increased, maturity date extended, outstanding principal forgiven,
or interest rate reduced.
Post-Default Matters
Agents and lenders need to agree on what happens if the loan
goes into default. Therefore, the co-lender agreement should
contemplate protective advances, a post-foreclosure plan, and the
allocation of funds received.
Protective advances occur when the borrower stops funding money
to maintain and operate the property, so the lenders advance their
own funds to preserve their collateral. There should be some
discussion about when an agent can require lenders to advance
funds. Restrictions typically come in two forms: (1) a dollar
threshold before which protective advances must be approved by
required lenders and (2) limitations on the uses of funds that
lenders are not required to fund. Some agreements may provide that
advances not required for critical purposes are optional. Critical
purposes may include the payment of taxes and insurance premiums,
mitigating life or safety emergencies at the property, and
preservation of the agent’s lien on the property.
If the lenders take ownership of the property following a
foreclosure, a single-purpose entity owned by the lenders according
to their pro-rata shares of the loan and managed by the agent would
typically hold title. Co-lender agreements will typically dictate
the course of action to follow, including the rights and
responsibilities of the lenders and agent. A co-lender agreement
may provide direction regarding agent-reporting, the hiring of
professionals to operate the property, additional contributions of
funds, and matters requiring lender approval, which will typically
be analogous to those items requiring lender approval under the
loan documents. Further, the co-lender agreement should also
provide an exit strategy with respect to marketing the property to
enable lenders to recover some or all of their investment.
Finally, the co-lender agreement should contain a
post-foreclosure waterfall showing the order of priority for
payments received by the agent from the property as ongoing income
or from the ultimate disposition. The agent should always be
disbursing payments on a pro-rata basis, with defaulting lenders
being subordinate to non-defaulting lenders. While waterfalls may
vary slightly, the agent is typically reimbursed first for its
out-of-pocket expenses incurred in administering, servicing, and
enforcing the loan or managing the collateral, and then the agent
and lenders are reimbursed for protective advances. After the agent
disburses these amounts, it will pay interest, fees, and principal
to the lenders.
Conclusion
As noted earlier, this article is not advocating for a
particular position on the issues discussed herein, as their
resolution will be dictated by the specifics of the loan and
syndicate. The consideration of each of these issues by the parties
to a loan transaction will enable them to negotiate and understand
all aspects of a co-lender agreement thoroughly and
successfully.
Originally published in Bloomberg Law
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