Reducing Risk for the Commercial Lender in Loan Modifications
Loan modification agreements can result in a “win-win” situation for both borrowers and lenders, provided that both parties perform the necessary due diligence. Most loan modifications are fairly simple transactions that involve extending the maturity date, amending or waiving covenants, or changing the interest rate of the loan. Plus, they often require less time and expense than originating a new loan. However, as loan modifications become more complicated, the parties involved must understand the role and importance of title insurance and proper loan documentation.
Insuring the Loan Modification
Virtually all lenders require that every commercial real estate loan includes a lender’s title insurance policy. When modifying the terms of a commercial real estate loan, lenders often only require a title search of the property to determine whether changes to the ownership of the property have occurred, or if any unacceptable liens or title matters of record have been recorded since the date the mortgage or deed of trust was initially recorded.
Lenders should remember that their title insurance policies will insure their mortgage or deed of trust lien on the property only as of the date set forth in Schedule A of the policy. It does not insure the state of title at the time of a later modification unless the lender obtains a bring-to-date endorsement.
As a general rule, the lender should insure material loan modifications, especially those requiring a modification to the mortgage or deed of trust, so it does not lose its lien priority and unwittingly excuse its title insurer from honoring the title policy. In such instances, the lender should obtain an endorsement of the title insurance policy to bring the date of the policy and any endorsements forward to the date of the modification. Then, the lender should carefully review the endorsement to determine, among other things, whether any additional title exceptions are being added to the title insurance policy as a result of the endorsement.
Documenting the Loan Modification
It is also essential to properly document loan modifications. From a priority and guaranty standpoint, a lender’s greatest fear is that a loan modification will be deemed a novation. A novation occurs when the original debt is discharged and replaced by a new debt. Accordingly, the loan modification documentation should clearly state that the modification is not intended as a novation and that the existing security interests created under the original loan documents continue in full force and effect. Loan modification documents should also include the following terms:
- Reaffirmation of liability and waiver of all defenses by all borrowers and guarantors.
- Consent to modification from junior lienholders and other third parties, if applicable.
- A specific description of the modification being granted.
- Borrower’s agreement to pay the costs and expenses for the modification.
Removing Remaining Obstacles
To the extent possible, lenders also should use the loan modification as an opportunity to ensure that (i) any problems or gaps in the lender’s file were resolved or reconciled, (ii) all original loan documents were properly recorded and filed, (iii) the title insurance policy was issued in the proper form with the requested endorsements, and (iv) any required post-closing items have been received.
In today’s commercial lending market, it is common for lenders and borrowers to agree to modify the original terms of their loans. Lenders, however, must take appropriate precautions to reduce inherent risks by considering the issues and recommendations addressed above.
Michael Smith is an attorney with Lerch, Early & Brewer focusing on the structuring, negotiation, documentation, due diligence, and closing of commercial lending transactions. For more information on reducing risk for commercial lenders in loan modifications, contact Michael at (301) 657-0166 or firstname.lastname@example.org.