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Weekly UpdatesOnce the credit decision has been made, the transaction should be fully and carefully documented with prevention in mind. Use the checklist approach to be sure nothing is overlooked. Be sure all desired title and liability insurance is in place, with endorsements to cover the lender's interests. Particularly with construction loans, negotiate all necessary controls for the project -- to cover both the ordinary course of building and the possibility of default. A lender will never have a better opportunity to protect its interests than the period before it has disbursed the loan proceeds.
2. Monitoring and Early Warning. Information control is paramount. A lender must carefully monitor its loans until they are paid off. Early warning systems should be established to alert the lender to problems with the borrower, the collateral, or the project's feasibility. Is the construction or marketing of the project being delayed? Is the property being wasted? Are materials disappearing from the job site? Have the demographics and economics of the market changed adversely? If signs of trouble appear, the troubled asset group should be consulted at an early stage, even if the project stays in the hands of the loan servicing department.
3. Use a Special Assets Group for Troubled Assets. Whatever the name and acronym, (1) a specialized group should be used for handling troubled assets. A specialized division for working on troubled assets (for convenience we will refer to this group as a special asset group or "SAG") brings greater objectivity in dealing with troubled loan issues, thereby minimizing the peril of an approach drawn from past dealings with the borrower that may be either too sympathetic or too harsh and raise lender liability issues.
The SAG should also bring or will develop specialized expertise in handling the unique problems of troubled assets. It should be provided with expedited access to senior management for policy decisions and allocation of resources. It should also have authority to implement crucial procedures and policies such as settling customer complaints, bringing in special counsel, hiring consultants, executing pre-workout documents and documenting negotiations to avoid liability for unsuccessful workouts. Bringing the SAG into the situation also provides notice to the borrower that the lender is serious about collecting the debt and that this is not business as usual.
4. Information Update. The SAG, with its experienced, detached personnel, should gather, analyze and summarize all relevant information on the loan, the borrower, the collateral, and relevant documentation and history. Update the borrower's financial statements, tax returns, litigation history, and credit rating. In addition to gathering all loan documents, promissory notes, guaranties, and evidences of advances, notices, a complete written history of the loan should be prepared. When the history is compiled, care should be given to protect as much as possible from discovery if you choose litigation so that any candid descriptions of problems and proposed solutions to such problems will not be a part of the evidence at trial. This can be done by engaging outside counsel or involving the bank's in-house legal department. Loan service personnel should be interviewed, and waiver and estoppel issues must be evaluated. Consider interviewing witnesses with counsel present, to protect sensitive information obtained from disclosure later on if litigation is filed. The impact of conversations, correspondence, and course of conduct must be given careful consideration. Appraisals, projections, and feasibility studies should be updated as necessary.
Two final cautions on information updates. First, the update of collateral information should include a physical inspection of the premises. Walk the project! Don't settle for "drive-by" or borrower's guided tour. The physical inspection may suggest problems to be dealt with or new approaches to the project.
Second, the information, documents and summaries gathered by the SAG should be reviewed by counsel experienced in troubled loan matters and lender liability. This review should analyze the validity of the notes security interests, guaranties, and other important documents with an eye toward identifying defects that might be cured or curable. From this review, lenders should also be able to determine the potential of any borrower defenses or counter claims. Counsel should find out from the lender if there are any potential tort or strict liability claims that may go along with any transfers of ownership in real property, such as an apartment owner's duty to pay for tenant injuries or a landowner's duty to pay the costs of cleaning up contaminated property.
5. Evaluate the Information and Alternatives. All the gathered information needs to be evaluated by appropriate business and legal personnel. Fully armed with this information and evaluation, the lender can then assess whether to do nothing, commence a work-out or restructure of the loan, seek a receiver, initiate foreclosure or initiate involuntary bankruptcy proceedings.
6. Develop a "Game Plan" and Stick to it! Once an alternative course of action has been selected, the lender should develop a game plan or blue print for executing its course of action. There may be valid reasons to wait until specified events have occurred or time periods have elapsed. However, in general, once the course of action has been decided, delay is ill-advised. The most successful lenders are those who stick with their game plan, except as changed circumstances may warrant.
7. Pre-Workout Agreement. Before commencing workout negotiations, a pre-workout agreement should be executed. Such an agreement offers the advantage of protecting the lender from liability for claims arising from the workout process itself.
Many institutions have been "bitten" by their good faith efforts in a workout situation. They report that desperate debtors or their unscrupulous representatives have either misunderstood statements made in workout negotiations, or intentionally misrepresented positions taken. Whatever the motivation or cause of the problems, these institutions find themselves the victim of claims that oral agreements, representations, or waivers made in the course of a workout entitle the borrower to rights or damages never contemplated by the lender upon entering workout negotiations. The pre-workout agreement is designed to minimize these risks.
The pre-workout agreement typically recites that the parties are about to commence workout negotiations and that the agreement is a material inducement for the lender to participate. Loan documents can be attached as exhibits and acknowledged to be legally binding on the parties. It is usually agreed that the loan documents continue in full force, unless modified in the specific manner permitted by the pre-workout agreement. Sometimes, egregious problems that exist in the lender's loan documentation can be corrected in a pre-workout agreement, when the borrower is usually in a very cooperative mood. The confirmation of loan document's binding effect, recital of loan history, and acknowledgment of defaults may greatly simplify collection efforts later if the negotiations fail or the workout falls apart. Consider inserting a confidentiality provision in the pre-workout agreement, to try to prevent the borrower from using the media to increase its negotiating leverage, especially if the borrower is in a business that may attract media attention.
The key provision of the pre-workout agreement recites that discussions and negotiations between the parties may be lengthy and complex, however, no discussions or oral agreement have any effect whatsoever unless all parties execute a written agreement. This critical provision helps prevent a party from claiming a binding agreement was reached on certain issues in the absence of satisfactory resolution of all disputes in the workout process.
The agreement should: 1). provide that only amendments in writing have any effect; 2). should state that the pre-workout agreement is the entire agreement of the parties on the subject matter; 3). specify the governing law; and 4). provide for attorneys' fees to the prevailing party in the event of any dispute. The agreement should also provide that no negotiations or other acts taken in the workout process constitute any waivers by the lender of its rights except to the extent specifically identified in writing. The pre-workout agreement should also confirm that the attorney's fees to be incurred by the lender in the workout would be reimbursed by the borrower.
The most controversial issues on pre-workout agreements usually involve whether to include a mandatory arbitration provision for any disputes concerning the credit (with corresponding waiver of jury trial and court process) and any release provisions. Some lenders say they would rather proceed with the "main event" if they cannot obtain an arbitration provision and release for any action up to that date. Others would rather engage in the workout process to cure defects in the loan documentation in exchange for concessions to the borrower and are less concerned with the benefits of arbitration or waivers.
8. Document the Transaction Completely. It goes without saying that once negotiations have resulted in a restructuring or workout, all aspects of the agreement should be thoroughly and fully documented promptly.
(1.) Specialized groups working on troubled loan assets have often had interesting names and acronyms, such as the Managed Asset Division or "MAD," the Specialized Asset Division or "SAD," and the Specialized Assets Group or "SAG."
ABOUT THE AUTHORS
James R. Butler, Jr., Neil C. Erickson, Robert B. Kaplan, and Richard A.Rogan are partners with Jeffer, Mangels, Butler & Marmaro LLP, a full-service business law firm. All of the authors have extensive experience with troubled loans involving both traditional real estate loans and those involving the special assets described in the article.
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