Loan Modifications: A Few Considerations
by Laura McClellan
Modifying a mortgage loan requires careful thought and attention to prudent processes. During real estate downturns, commercial mortgage loans may be difficult to refinance, and borrowers often suffer from insufficient cash flow to service their debt. In some cases, lenders might prefer to modify delinquent or nonperforming loans rather than foreclose and take on the headaches of owning property that it cannot dispose of quickly. By granting temporary or permanent concessions, the lender sometimes can prevent a default and enable the borrower to continue servicing the debt. In return, sometimes the lender’s security can be enhanced, perhaps by obtaining additional collateral. While not comprehensive, following is a list of some factors that should be considered when modifying a commercial mortgage loan:
· Seek junior lienholders’ consent, where appropriate, in order to preserve lien priority. Even if the recorded mortgage or deed of trust expressly reserves the lender’s right to modify, the prudent lender will carefully evaluate the potential claims of any junior lienholders. A modification that could impair a subordinate lienholder’s ability to collect on its lien could result in the senior mortgagee’s loss of priority unless the junior lienholder consents. This is particularly relevant if the proposed modification will increase the interest rate or the principal amount of the debt, or will shorten the time for repayment. On the other hand, a modification that extends the time for repayment or reduces the monetary obligations (e.g., interest rate or principal amount) might actually benefit the junior lienholders. Nevertheless, the prudent lender will carefully review the title to the real property that secures the loan, and seek consent from any junior lienholders 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 a T-38 endorsement. This endorsement 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. 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. The best practice is to have the guarantor(s) sign the modification, acknowledging and consenting to the modified terms 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 modified mortgage lien’s priority over subsequent liens.
· Consider bankruptcy implications. For example, if the lender requires additional collateral in return for concessions, the receipt of that additional collateral might be deemed a preferential transfer under the bankruptcy code. The modification agreement should include a borrower 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.
· Clean up the record. Each modification is an opportunity to review the loan file and correct any oversights or errors in the original loan documentation. Review the file carefully to understand the current status of the loan documentation, including any prior modifications. Everything can be corrected in the modification agreement, including incorrect dates, recording data, omission of key waivers, warranties, or other provisions. If a party’s notice addresses have changed, the record can be updated to reflect current information. Check for the need for UCC continuations or amendments.
· Confirm the authorityof the borrower parties who are consenting to the modification, including the entities’ legal existence and good standing status. Check whether relevant organizational documents have been amended since loan origination.
Laura McClellan is a partner at Thompson & Knight LLP, focusing her practice on real estate transactions and real-estate-secured lending. She is a fellow in the American College of Mortgage Attorneys, and can be reached at firstname.lastname@example.org.