Using Real Estate Financing Commitment Letters to the Borrower's Advantage
A real estate financing loan commitment letter is an important document in the loan negotiation process because it is a binding contractual commitment by the lender to lend money on the terms stated. In the commitment letter the lender will outline the terms upon which it is willing to make the loan and upon signing the commitment letter, the borrower is agreeing to borrow the funds subject to the stated terms.
The commitment letter should contain all of the business terms and some of legal the terms for the loan.
Use the Commitment Letter Process to the Borrower's Advantage
- Before the commitment letter is finalized is the borrower’s best time to negotiate.
- Unfortunately, borrowers often do not involve attorneys until after the commitment letter is executed, which can be too late because many of the loan terms are already locked in by the commitment letter.
- Lenders are also less willing to negotiate terms of loan documents that were not included in a commitment letter.
- Examples of items to negotiate at the commitment letter phase:
- In a multifamily apartment loan agreement, there is often a requirement that all leases be at least 6 months—no month-to-month leases are allowed. However, the borrower can negotiate a deviation from this standard language by asking for it in the commitment letter. This type of deviation would be much harder to get later.
- Many loan documents preclude transfers of ownership interest in the borrower; but a borrower may want to have the right to transfer ownership for estate planning purposes in the future—most lenders have language that can be inserted into their forms, permitting such transfers without the application of transfer/assumption fees or prepayment “premiums”—but this alternative language needs to be negotiated for up front when the borrower has leverage.
- The commitment letter negotiation phase is also a good time to try to get a reasonable cap on lender’s legal fees, other post-closing charges (such as escrow account fees) that are charged to the borrower.
- The following standard terms appear in most commitment letters:
- loan term;
- interest rate (and if not locked, how and when to lock it);
- amortization of payments;
- whether a guaranty will be required;
- prepayment premiums (if any);
- commitment and loan fees; and
- payment of lender’s expenses.
- The borrower should consider negotiating to have the following added to the terms outlined in the commitment letter:
- How will it be calculated (actual days elapsed or 30-day months)?
- What is the mechanism to lock in an interest rate, if it is not already locked?
- Secondary Financing:
- Does the borrower need or envision a second position deed of trust or mezzanine financing? If so, get it addressed in the commitment letter so it is excepted from the “due on sale” clause in the note or deed of trust (also make sure the financing will be attractive—will the second position lender have the ability to realize on its collateral?).
- Tax And Insurance Escrows: ask if they can be abated until there is an uncured monetary default.
- Insurance Requirements:
- The borrower may want to get insurance requirements established and be able to satisfy them before executing the commitment and before paying the commitment fee
- Is there is a form lease in place (or is it a single tenant property), and if so, can the lender agree that the lease’s insurance section’s description of coverage is sufficient?
- How much and what types of insurance are required?
- Can the lender change and increase the insurance requirements later?
- Can the borrower self insure, or include the property as part of larger (blanket) policy?
- Recourse vs. Non-Recourse Liability: spell out carve outs in detail, rather than just state “standard carve outs”—watch for carve outs which create “full recourse” rather than just paying the lender for its damages caused by a particular breach.
- Is the death of a guarantor is an event of default?
- Is there a restriction on transfer of guarantor’s assets?
- Is there a limit on the guarantor’s liability?
- Extension: Is there a provision to extend commitment date if needed?
- Can you cap lender’s legal fees?
- Can you cap charges for post closing escrow accounts?
- Can you use existing surveys?
- Can there be at least one assumption by an acceptable borrower for a one-percent fee?
- Will the assuming borrower assume based on the same interest rate?
- Will the original borrower and/or lender be released upon assignment?
- Partial Releases and Partial Prepayments:
- Are there multiple parcels of collateral being pledged? Does the borrower want some of them released as the loan balance gets paid down? If so, this should be spelled out in the commitment letter.
- Will the loan payment be reamortized upon partial pre-payments (including application of insurance or condemnation proceeds)?
- Late Charges, Default Interest, Cure Period:
- Consider asking for small late charges (flat dollar amount) and specific predetermined default interest rates; ask for 5–10 days to cure (after notice if possible) for monetary defaults and 30 days for nonmonetary (but with extended time if the default cannot be cured within 30 days).
- Title Insurance:
- Are their oddities regarding title you need waived or endorsed around now? If so, the borrower should bring these up before paying nonrefundable commitment fees.
- Ask for surveyor’s certification early on as it is another long lead time item and the process should be started before the commitment letter is signed.
- Opinion Letter:
- Can you get the lender to agree that any opinion letter required will be limited to borrower’s authority and due organization?
- If a Delaware borrower entity, are you required to employ Delaware-licensed counsel, or will the lender let the attorney assume the laws of the jurisdiction where the property is located are the same as Delaware for opinion purposes (some lawyers may be willing to give Delaware authority opinions without being licensed in Delaware; this is risky, and lenders may not be willing to accept it regardless).
- For large loans ($20 million or more) the borrower may be required to obtain a bankruptcy remote opinion.
- Request confidentiality of financial information for both the borrower and guarantors.
- Try to have most confidential information contained in the loan documents and other unrecorded documents instead of in the deed of trust (e.g., release prices for parcels).
- Other Lender Due Diligence: Be sure the commitment letter spells out what the lender will be looking at and spending borrower’s money to get, including:
- environmental assessments;
- review of entity documents, consents;
- financial statements of borrower and guarantor; and
- UCC searches.
- Timing: The limited time between finalizing the commitment letter and closing of the loan makes negotiating before the commitment letter is signed important. For instance, with a Fannie Mae loan the time between execution of the commitment letter and actual closing on the loan is very short.
This outline is excerpted from the General Practice Solo and Small Firm Division’s Real Estate Committee’s CLE conducted on August 9, 2008 in New York entitled “Advising the Small Business in the Big Real Estate Deal.” Ms. Milano’s program was entitled: “Commercial Real Estate Financing: The Borrower’s Perspective.”
Maria Milano is a principal at the Seattle law firm Riddell Williams, P.S; her practice includes business advising, transactions, bankruptcy, and litigation. She can be reached at Riddell Williams P.S., 1001 4th Avenue Plaza, Suite 4500, Seattle, Washington, 98154, Phone: 206-389-1752, firstname.lastname@example.org.
© Copyright 2008, American Bar Association.