Source: JD Supra —
When a borrower is seeking real estate financing, there is invariably timing pressure to solidify a mortgage loan term sheet (on occasion, in the form of a loan commitment or loan application), so that the next steps in the loan process (lender’s due diligence and loan document preparation) can be commenced quickly; with the ultimate goal being a prompt loan closing. The timing pressure is most often due to pending deadlines, such as a pending due diligence termination right or closing date under a contract of sale, or a loan maturity date under existing financing documents, or market or cost pressures, or concerns about rising interest rates or carrying costs of a project that needs funds for construction or other repositioning costs. Accordingly, many borrowers desire to avoid allowing the negotiation of the loan term sheet to get too protracted, and prefer to iron out the details (especially the legalese) in the definitive loan documents after the term sheet has been approved.
As experienced owners of commercial real estate, as well as their mortgage brokers and consultants (collectively, “CRE Professionals”), are well aware, the loan term sheet stage is when the borrower has the most leverage to negotiate acceptable loan terms. Once the term sheet is executed, and loan application fees are paid and good faith and expense deposits are made, the lender knows that the borrower is far less likely to walk on closing the loan because of unsatisfactory terms set forth in the definitive loan documents. Accordingly, when negotiating the loan term sheet, which will serve as the “blueprint” of the material terms of the proposed loan, there is a balancing act in determining which terms need to be negotiated upfront in the term sheet, in order to avoid the risk of being unable to satisfactorily negotiate them within the loan documents, and which terms the borrower can be reasonably comfortable leaving to negotiate in the loan documents in order to avoid unnecessary delays in completing the loan term sheet.
However, determining the “material terms of the loan” for a borrower to negotiate into the loan term sheet is an art, not a science. In particular, CRE Professionals are aware that they cannot attempt to cover every aspect (not even every material aspect) of a loan within the term sheet, as such an attempt would clearly derail the loan procurement process. Accordingly, the determination of what a borrower should negotiate into the term sheet involves an assessment and balancing of the risk of (i) failing to be able to negotiate material terms into the loan documents during the loan document review process, because such terms were not previously set forth in the term sheet, versus (ii) overly negotiating the term sheet and failing to move the transaction to closing in a timely fashion. In addition, in many cases, a strategic judgment will be made to purposely exclude a material term from the term sheet, with the intent to first raise the term during the loan document negotiation process. Another consideration is that certain modifications to the business terms may require lender’s underwriting approval, which could require significant lead-time to meet the closing date goal.
In almost every instance, certain terms will be included in the loan term sheet as they represent the threshold, central terms of the loan, such as identification of the lender, the borrowing entity, the loan amount, the interest rate, the repayment terms and maturity date, and the property serving as security for the loan. And many terms of the loan, subject to unusual deal specific issues, are generally recognized as not material enough to affect the overall business deal, and are typically excluded from the term sheet, such as events of default and remedies, and casualty and condemnation rights.
Over the years, in our real estate practice, we have found that there are several specific material terms of a commercial mortgage loan which are often excluded from the lender’s initial draft of the loan term sheet, and which borrowers regularly contemplate negotiating into the loan term sheet, as part of the “art” of negotiating the term sheet. These material terms include: (i) delineation of the matters guaranteed under a recourse carve-out guaranty; (ii) leasing rights, and (iii) rights to make indirect transfers of ownership interest in the borrower. A discussion of each of these material clauses is set forth below (note that, for the purposes of this discussion, we have not taken into account specific considerations applicable to construction or bridge-type financings).
