I. INTRODUCTION
The following information is intended to provide an overview of various types of financing, a summary of the documents involved, and a description of selected, significant issues that arise with each type of financing. This article should is not intended to be, nor should it be considered as the advice of counsel.
II. TYPES OF FINANCING
The following summarizes selected types of financing often used for real estate projects. The following types of financing are used in both commercial and residential projects (including master-planned communities, but such methods of financing are not typically used for the financing of individual homes).
A. Conventional Financing
1. Summary
Conventional financing typically refers to a structure where a third-party lender advances money to a borrower to enable the borrower to acquire property or to refinance property. Conventional financing often is coupled with other types of financing to acquire or develop real estate.
2. Documents
The complexity of the loan documents used in conventional financing typically depends on the size of the transaction and the lender involved. Many smaller community banks use “LaserPro” documents, which are difficult to negotiate because of the software programs the lenders use. Other lenders will use longer and more detailed documents. The loan documents can vary significantly, depending on the type of asset financed (for example, the loan documents used for the financing of a hotel or other income property may differ from the loan documents used for the financing of vacant land).
Typically, there is a promissory note that provides for repayment of the loan amount, a loan agreement that describes the overall relationship among the parties (and may include some parameters on the debtor’s other business operations; i.e., debt ratios and covenants relating to the financial condition of the borrower), a deed of trust (to secure the promissory note), an assignment of rents (often included in the deed of trust), an environmental indemnity agreement, a guarantee agreement, and other miscellaneous documents. Not all of the above documents are used in every transaction, and in some transactions, additional documents are used.
In addition to the above documents, some lenders require that the borrower’s attorney provide an opinion, attesting to the enforceability of the loan documents and other issues that a lender may find important. Opinion letters are required on a less frequent basis for transactions with lenders doing a significant number of loans in Arizona for properties located in Arizona. Out-of-state lenders (particularly those without much lending experience in the state or lenders engaging in significant sized loan transactions) often require opinion letters. Opinion letters often are expensive as law firms view them as “insurance policies” on the lender’s loan. The State Bar of Arizona has adopted a model form of legal opinion, which is frequently accepted by lenders (with minor modifications) as the standard.
3. Special Issues
a. Negotiation of Purchase Agreements.
In negotiating purchase agreements, a buyer must ensure it has adequate time to obtain satisfactory financing. Typically, purchase agreements provide a specific “due diligence” or “feasibility” period. Within that period, a buyer should secure a commitment letter or some other acknowledgment from a lender on which the buyer can rely in proceeding past the feasibility period. One problem the buyer typically has is the number of conditions that are prerequisites to funding the loan and that are stated in a commitment letter. Occasionally, a buyer can build in a separate financing contingency that runs for a longer time period than the due diligence or feasibility period. Once the due diligence and/or feasibility period has expired, the earnest money typically is nonrefundable and a buyer will have no claim to a return of its earnest money based on a buyer’s failure to obtain satisfactory financing. It is imperative that a buyer provide itself sufficient time between obtaining the lender’s commitment and closing to satisfy the lender’s contingencies described in the commitment letter. While a borrower may not be able to satisfy every loan condition during the feasibility period, it should ensure that those conditions that are outside the buyer’s control (i.e., the appraisal) are satisfied prior to the expiration of the feasibility period.
b. Lender Due Diligence.
A buyer should carefully consider the lender’s requirements for funding the loan. Most lenders will require a structural evaluation (in the case of an existing building), a Phase 1 environmental site assessment, a survey, and other items. Often, lenders have a list of consultants approved to perform due diligence studies, and a borrower or borrower’s counsel should ensure that the appropriate consultants perform such tasks to ensure compliance with the conditions in the commitment and to avoid delaying final approval or funding. A borrower should ensure that each of the reports and studies can be completed during the appropriate time frame provided in the contract and the loan commitment. An example of a type of problem that could arise if the borrower fails to timely obtain such reports (or timely deliver them to the lender) follows: if the results of a structural evaluation show a building to be in need of significant repair in the short term, the lender may require a holdback to ensure completion of such repairs. Essentially, this can materialize into a requirement that the buyer invest additional funds into the project, and may impact the financial feasibility of the transaction for the buyer.
c. Tenant Estoppels and SNDAs.
Lenders often will require tenant estoppel certificates and subordination agreements (also known as subordination, non-disturbance and attornment agreements (“SNDAs”)). The estoppel certificates assure the buyer and lender that there are no defaults under existing leases (or identify the defaults that exist), and the SNDAs make clear that the lender’s lien is superior in title to the leases. Typically, it is prudent for the buyer to include in the contract a right to obtain these items (or an obligation of the seller to obtain these items) as a condition of buyer’s obligation to close and as a condition to the nonrefundability of the buyer’s earnest money deposit. Some lenders prefer a particular form of tenant estoppel or SNDA. Accordingly, a buyer should try to provide in the purchase contract that the seller will provide (or cause to be provided) tenant estoppels and SNDAs to buyer and lender in the form required by the lender. In the alternative, the tenant estoppels should authorize the buyer’s assigns and the lender to rely on such documents. Lenders often will require as a condition to funding that a borrower obtain a minimum percentage of tenant estoppels before the lender is committed to fund the loan. Before beginning to negotiate the purchase contract, a buyer may want to identify the demands of the lender and obtain information from the real estate agent or from the seller as to whether the tenants typically cooperate. One way to draft around the issue in the purchase contract is to require that, in the event the seller cannot obtain the required estoppels from the appropriate percentage of tenants, the seller provide an estoppel, which includes an indemnification of the lender and of the borrower in the event the seller’s estoppel is incorrect. Some lenders refuse to rely on a seller’s estoppel. Again, these are important items to discuss and to understand from a commitment letter prior to, or early in the feasibility period.
d. The Proper Borrower Entity.
Lenders can be selective about the type of entity to which they want to lend. Virtually all commercial lenders will accept a single-purpose entity as the borrower. Depending on whether the loan is recourse or non-recourse, lenders may or may not require a separate guarantee. Some lenders, and particularly lenders providing large loans, will require specialized single-purpose entities. For example, some lenders may require the entity to be a Delaware entity. Others require the board of directors or board of managers to include at least one “outside” director or manager. Some require special covenants in the operating agreement or shareholder agreement. What is critical is that a borrower understand the requirements and confirm with the lender that the entities formed or to be formed conform to the requirements well in advance of closing.
e. A Special Note on SBA Financing.
With lower interest rates, there has been a dramatic increase in businesses purchasing the buildings they occupy (instead of continuing to rent). SBA financing is attractive to many businesses. SBA lenders allow the owners of a business to form a new entity to own the property and act as the borrower; however, generally the ownership of the entity that owns the real property must have the same ownership as the business entity. This requirement can pose problems to those businesses seeking to have outside investors as partners in the entity owning the property. There are a number of other topics and requirements related to SBA lending, which are beyond the scope of this program.
f. Conveyance to or from Trusts. A.R.S. § 33-404 requires a disclosure of names and addresses of trust beneficiaries when a conveyance involves a trust. There is some dispute among industry practitioners as to whether equitable conveyances (such as a transfer to a trustee under a deed of trust) trigger the statute and require a disclosure of names and addresses of trust beneficiaries. The conservative lawyer should err on the side of making the disclosure.
B. Seller Financing.
In contrast to conventional financing, where a third-party lender finances the property for the borrower, a property is seller financed, where the seller of the property finances the property for the benefit of the buyer. Seller financing can take the form of seller carryback financing, options and subdivision trusts.
1. Seller Carryback Financing
a. Summary
Seller carryback financing is common in vacant, undeveloped or partially developed land transactions where the seller is familiar with the property. For example, seller carryback financing is often used in the purchase of property from farmers, who sell their farms for the development of subdivisions or master-planned communities. Seller carryback financing also is an option to consider when there is an issue with the property that makes the property undesirable to a third-party lender. For example, if the property has an environmental issue and is in the process of remediation, the seller of the property is in no worse position as, prior to the seller carryback financing, the seller may have had responsibility for the environmental condition as an owner, and the buyer has agreed to take the property subject to the environmental condition. Typically, third-party lenders are uninterested in contaminated property and the only form of financing to accomplish the transaction is seller carryback financing.
b. Documents
The loan documents used in seller carryback financing are similar to those used for conventional financing.
c. Special Issues
Many of the issues that arise in seller carryback financing are similar to those that arise in conventional financing if the property is improved, income-producing property. One issue that typically does not frequently arise in third-party financing of improved, income-producing property, but frequently arises in seller carryback financing of vacant land, is the right to have portions of the property released from the lien of the deed of trust, often called “partial releases.” One reason partial release rights are included in such deeds of trust is to enable developers to develop the property in phases. For example, the developer may develop a portion of the property, but before the developer can sell the property to a third party free and clear of the lien of the deed of trust, the developer must release the portion of the property from the lien of the deed of trust. The partial release provisions often provide that upon payment of a certain amount, usually determined as some percentage of “par” (i.e., 125% of price per acre for which the property was purchased), a portion of the property would be released from the lien of the deed of trust. Prior to the original sale, the parties typically agree on a “release pattern” or a path the releases must follow. Alternatively, the parties could agree on parameters of the releases. For example, a developer may be permitted to obtain releases of property provided that the release parcels are a minimum of 40 acres and contiguous to a prior release parcel. If a developer is planning to develop any community, but particularly a large community, the developer should ensure that the partial release provisions or other portions of the deed of trust provide for release of school sites, wastewater treatment plant sites, fire station sites, easement areas and other similar areas, without following the release pattern or otherwise observing the parameters for release. Often, the lender/seller may require that the developer pay a release price, in connection with a release of such types of sites. There are a number of related issues as well, which must be negotiated in the deed of trust.
2. Options
a. Summary
An option is where a property owner grants the exclusive right to a potential buyer to purchase property, usually at a fixed price, for a stated period of time. The potential buyer can exercise its option to purchase the property for the price specified in the option agreement. For the right to have the option, the buyer usually pays a fee, which is forfeited to the seller in the event the buyer does not exercise its option. Often, a buyer and seller will structure a transaction to be a sale of portions of property over time (also known as a “rolling option”) as a means of financing the property for the prospective buyer. If the property seller who grants the option or options is a third-party, non-original land owner, then the structure appears more like a “landbanker” structure described below. This section deals with the situation where the existing owner is the seller, and thus, this type of option is another form of seller financing.
b. Documents With an option, the parties typically execute an option agreement, a memorandum of option, a termination of memorandum of option (which is usually deposited with the escrow agent and held in the event of a buyer default), and sometimes a performance deed of trust (which protects the status of the seller’s title to the property, and the buyer’s option interest, through the option term). After the buyer’s exercise of the option, the transaction resembles a typical real estate transaction.
c. Special Issues
(i) Options as Personal Property; Foreclosure.
Some sellers often favor the use of options as a means of financing. When financing property through the use of options, the sellers retain fee title to the property, subject to a recorded memorandum of option, rather than conveying title to the property to the buyer, and using the property as collateral for a seller carryback. Although there are no Arizona cases directly on point, most practitioners treat option rights as personal property, which can be terminated as provided in the option agreement. For example, the buyer and seller could agree that if the buyer didn’t exercise its option or make a required payment within a limited time after the date it should have made such payment (or exercised its option), the option terminates and the buyer would have no further rights. In the absence of an agreement by the parties, most practitioners believe the Arizona Uniform Commercial Code would govern the parties’ rights.
(ii) Title Concerns as a Buyer.
One concern a buyer typically has when financing is structured as an option is the status of title. Because the seller continues to hold title to the property, the property becomes subject to any judgments against the seller or any other items to which seller may subject the property. A prudent person seeking a voluntary interest in the real property (i.e., an easement) should check the public record, recognize that buyer has an option (because the third party would see the memorandum of option in the title report) and obtain the buyer’s consent before recording its interest. It is not clear the rights the buyer would have if the third party fails to obtain buyer’s consent, but the real property likely would be free and clear of the interest of the third party if conveyed to buyer pursuant to the terms of the option agreement (and recorded memorandum of option). A buyer, if it wants to have stronger rights, will obtain a “performance deed of trust” against the property. If the seller allows a new item to impact the property, it would be a default under the performance deed of trust, and would allow the buyer to foreclose on the property. A buyer can also purchase an optionee’s title insurance policy; however, the optionee’s title insurance policy only protects the buyer for the period prior to the effective date of the title insurance policy.
(iii) “Booking” the Acquisition.
An important issue that impacts public homebuilders, public developers or other public companies that acquire property pursuant to an option agreement is whether the buyer must “book” the sale. In other words, the company would show the agreement as a purchase and seller carryback (showing the asset and the liability on the balance sheet) rather than an option, which may or may not be exercised, and where the only risk is the forfeiture of the option deposit. A complete discussion of this issue is beyond the scope of these materials. Where such issues arise, the borrower should speak with an accountant or other tax professional. A seller should simply recognize that if it is selling property by way of an option (or rolling option) to a public homebuilder or other public entity, these issues may arise and may impact the way the transaction is structured.
3. Subdivision Trusts
a. Summary
A dual beneficiary subdivision trust (“Subdivision Trust”) is another type of seller financing. To create the Subdivision Trust, a seller conveys fee title to property to a trustee (usually a title company) pursuant to the terms of a trust agreement. The trust agreement names the seller as the “first beneficiary” and the buyer as the “second beneficiary.” The buyer typically makes payments at certain times and takes certain actions, such as acquiring title from the trustee to a certain number of lots or a certain portion of the property. As long as the second beneficiary is performing the obligations (i.e., making the required payments or acquiring the required property), then at certain intervals, the trustee conveys fee title to all or part of the property to the second beneficiary or its designee. When all of the obligations are satisfied and the entire purchase price has been paid, together with any additional amounts which may or may not be specified as interest, the trustee is directed to release the balance of the property to the second beneficiary. If there is a default during the term of the trust, which is not cured within any required cure period, the trust agreement typically provides that the trustee convey the remaining property to the first beneficiary, with the second beneficiary forfeiting any remaining interest. This expedited remedy is similar to the remedy under an option. Dual beneficiary trusts are not exclusively seller financing vehicles, and are often used as a financing vehicle for golf courses or other situations where improvements are conveyed with conditions.
b. Documents
To evidence the Subdivision Trust, the parties include virtually all of the terms of the transaction in a trust agreement, which is not a recorded document. The only other documents are the conveyance documents to transfer the property from the seller to the trustee. Because a conveyance to a trustee, on behalf of a trust, triggers the need to comply with A.R.S. § 33-404, the parties should ensure that the disclosure required has been satisfied in the deed conveying the property.
c. Special Issues.
The special issues relating to Subdivision Trusts are similar to special issues on option agreements.
(i) Preservation of Status of Title.
One benefit of the Subdivision Trust over the option is that title to the property is better insulated by a Subdivision Trust rather than an option. In a Subdivision Trust, title is held by a third party, and it is not subject to judgment against the first beneficiary or other title issues created by the first beneficiary.
(ii) Foreclosure.
One of the perceived benefits to the first beneficiary is the quicker, less cumbersome means of extinguishing the rights of the second beneficiary. A beneficial interest in a Subdivision Trust can be treated as personal property. Cf. Lane Title & Trust Co. v. Brannan, 103 Ariz. 272, 440 P.2d 105 (1968). This concept is similar to the seller’s ability to terminate an option, rather than having to follow the statutory procedures of conducting a trustee’s sale or judicial foreclosure. The documents typically provide that if the second beneficiary fails to make a payment as required by the trust (or acquire property as required by the trust) after a cure period, the trustee is instructed to convey the property to the first beneficiary. No forfeiture or trustee’s sale process is required.
C. Landbanking
1. Summary
Landbanking is a method of financing used often by homebuilders to finance the acquisition of the property and infrastructure (both onsite and offsite) necessary to develop the property into a subdivision. The landbanker (acting as the lender) holds fee title to the property and grants the borrower an option to repurchase the property at a fixed price. The option price typically is the original cost of the land (on a per-lot basis), plus the cost of the infrastructure, plus an additional amount representing interest. The landbanker typically accepts an assignment of the land purchase agreement, and advances funds for the closing of the acquisition of the property. Concurrently, the landbanker retains the homebuilder, by way of a construction agreement, to construct the infrastructure improvements on the property (and any related off-site improvements). The landbanker advances additional sums to the homebuilder by its payments under the construction agreement. The landbanking relationship essentially is a combination of a rolling option with a third party other than the seller and a multiple advance construction loan.
2. Documents
To evidence the landbank transaction, the parties execute an assignment of the purchase agreement for the property to be financed, an option agreement (granting the homebuilder the right to repurchase the property at a fixed price), a construction agreement (engaging the homebuilder to construct the improvements), the standard conveyancing documents and other miscellaneous agreements to indemnify or otherwise guarantee the homebuilder’s repayment (though such guarantees and indemnities are becoming less frequent as they often require the homebuilder to “book” the asset and the liability).
3. Special Issues.
Borrowers have similar concerns as buyers in option relationships.
a. Title to Property.
Borrowers often have concerns regarding the status of title to the property because a third party holds title to property that the borrower ultimately wants to purchase and develop. As with options, the property will be subject to any judgments or other title defects caused or created by the landbanker. The borrower can obtain limited protection through an optionee’s title policy.
b. Non-Disturbance Agreement.
The title issue is more significant with landbankers, as landbankers often use other sources to finance their business operations, and encumber the property that is the subject of the landbank transaction as collateral. By creating a lien in favor of a third-party lender on property owned by the landbanker and optioned to the borrower. The borrower undertakes a greater risk – the risk of the success of the landbanker’s other business operations. Borrowers can and should protect against liens created in favor of third-party lenders to the landbankers by obtaining a non-disturbance agreement between the third-party lender and the borrower, where the third-party lender agrees to honor the option agreement (and preferably the entire landbanking structure) in the event of a default by the landbanker and foreclosure by the third-party lender. The non-disturbance agreement also should provide that the third-party lender give the borrower notice of any default by the landbanker and an opportunity to cure it, and should provide that the borrower receive credit for any option deposit paid to the landbanker. For the borrower to obtain meaningful protection, it is critical that the borrower obtain a credit against the fixed option price for unadvanced amounts under the construction agreement. If no credit is given, the borrower has the right to purchase the property at the fixed price, the calculation of which includes the infrastructure construction costs, but at the time, the construction may not have been completed and the buyer’s option would be for an artificially high price.
c. Track Record of Borrower.
Prior to advancing funds in a landbank transaction, the landbanker may want to examine the track record of the borrower. Landbanking typically involves more risk than other forms of lending as the collateral is totally undeveloped land (or vacant land, subdivided into lots, but otherwise unimproved) with the intent that the property be improved by the borrower pursuant to the terms of the construction agreement. If the borrower defaults (or does not exercise its option) and fails to perform, the property is retained by the landbanker, but is rendered less valuable. Thus, landbankers typically like a well established builder who has a track record of success.
d. Special Property Attributes.
A landbanker should also consider any special obligations or contingent obligations that it may incur as a landowner. For example, community facilities districts are becoming popular in some areas, but, as discussed later, landowners owning property in such districts (including landbankers) are exposed to increased risks that, as a property owner, they may need to participate to a more significant degree in development financing activities.
D. 1031 Exchanges
1. Summary
A 1031 or “like-kind” exchange is a means of financing property with proceeds from the sale of another property. If an owner of investment property sells the property, and wishes to defer the capital gains tax that otherwise would be due on the sale of the property, the property owner can take the proceeds from the sale and reinvest in a similar investment property, provided that the property owner satisfies all requirements of I.R.C. § 1031 and accompanying regulations. 1031 exchanges often are combined with other types of financing to complete the purchase of property.
2. Documents
A 1031 exchange is always part of two purchase and sale transactions. The documents to evidence the purchase and sale transaction, in a transaction involving a 1031 exchange, are no different from documents in a typical purchase and sale transaction. In addition to the typical conveyance documents, the taxpayer and the “qualified intermediary” (see below) enter an exchange agreement, and an assignment of the purchase agreement from the taxpayer to the qualified intermediary; the assignment is executed in both the sale transaction and the purchase transaction. The assignment can provide that the taxpayer may “direct deed” the property to the buyer in the sale or accept a direct deed from the seller in the purchase (rather than having the property first conveyed to the qualified intermediary).
3. Special Issues
a. Release of Proceeds.
It is critical upon the sale that the taxpayer not accept the proceeds directly, and instead, direct the escrow agent to deliver all proceeds to the qualified intermediary, to be held until the acquisition of the replacement property. The qualified intermediary should be shown as the recipient of the proceeds on the settlement statement. If for any reason the proceeds are distributed to the taxpayer, rather than directly to a qualified intermediary, the taxpayer may no longer take advantage of the benefits of I.R.C. § 1031.
b. Holding Period.
Taxpayers must hold property for two years before qualifying to perform a 1031 exchange. If the taxpayer holds the property for less than the two-year period, the IRS presumes that the person must be in the business of buying and selling property and that the property is not “investment property,” a prerequisite to a 1031 exchange. There are certain exceptions to the rule, and those exceptions and the associated risks are beyond the scope of these materials.
c. Investment Property.
The property that is the subject of a 1031 exchange must be held as investment property and cannot typically be used by parties who have improved or developed such real estate for sale. Typically, this requirement disqualifies developers who actively improve property (zoning, platting, constructing improvements) before selling.
d. Time Frames.
After the sale of the first property, the taxpayer has 45 days to elect one or more properties to purchase with the proceeds, and 180 days from the original sale to close escrow on the acquisition of the replacement property or properties.
There are number of other special issues, and the above is a basic summary of a complicated area of law having a great number of exceptions and issues. Any party completing a 1031 exchange should have the proposed structure reviewed by an accountant.
E. Equity Financing
1. Joint Ventures
a. Summary
Joint ventures take the form of limited liability companies, partnerships and other types of entities. Joint ventures can take many different forms, but often arise when a small group of individuals or entities come together, each having different expertise, to acquire, develop, manage or otherwise operate a project. One party to the joint venture may have development expertise and may be the party charged with developing the property and handling all construction-related and development-related issues. Another party to the joint venture may be the monetary partner with access to the capital or other financing resources necessary to acquire and develop the project. Often joint venturers are combined with other types of financing.
b. Documents
Depending on the type of entity that the parties ultimately decide to form, the documents typically consist of an operating agreement or partnership agreement. If one party contributes property to the joint venture (rather than forming the joint venture to enable the acquisition of property), then the parties should execute a contribution agreement (similar to a purchase agreement) between the contributing owner and the joint venture entity. Either joint venture scenario will require preparation and execution of standard conveyancing documents.
c. Special Issues
(i) Securities Issues.
In typical loan transactions, a borrower usually does not face securities issues. In equity financing, and particularly if there is a developer that is not the monetary partner, that developer may be subject to federal and state securities risks that would not be present when using conventional financing with a traditional lender. The United States Supreme Court case of SEC v. W.J. Howey Co., 328 U.S. 293 (1946) held that a security is “an investment of money in a common enterprise with profits to come solely from the efforts of others.” Subsequent cases have broadened the definition of a security. Thus, a lawyer must be cognizant of securities issues when documenting a joint venture. A complete description of securities laws’ impact on equity financing is beyond the scope of these materials.
(ii) Other Items.
One other significant concern is the degree to which each party can control the joint venture entity and the decision-making authority of each of the parties to the joint venture. Other issues include the priority of return and the preferred return (if any) on each party’s investment. These and other issues should be analyzed on a case-by-case basis, depending on the client’s position in the transaction.
2. Syndications
Essentially, syndications are joint ventures with a larger number of partners. Syndications were popular in the 1980s, and with the real estate market gains of the past few years, are becoming increasingly popular again. Syndications typically include a securities offering as a way of raising money from investors for real estate acquisitions. Syndications are documented in a similar manner and raise some of the same special issues as joint ventures.
F. Community Facilities Districts
Community facilities districts (“CFDs”) are special taxing districts formed by municipalities, usually at the request of developers. CFDs are used to finance public infrastructure within larger projects and masterplanned communities. The CFD, once formed, can issue bonds and use the proceeds to pay for certain “public infrastructure” (as defined in A.R.S. § 48-701(12)). Public infrastructure typically includes street, sewer, water and other similar infrastructure improvements. The bonds typically are repaid over a number of years by the property owner, which initially is the developer, but which, over time, will be homeowners and commercial property owners. CFDs are popular in newer communities and municipalities. CFDs are a very complicated area with regard to their formation and financing.
Practitioners will confront CFD issues on a more frequent basis when representing clients who purchase property within a CFD. Other than the obligation to pay certain additional taxes and/or additional assessments, persons buying within an existing community facilities district are typically not subject to the same risks as the original developer. The documents and special issues are beyond the scope of these materials, but are available in more detail in an article by the author, available at the law firm’s website at www.tbb-law.com.
III. NEGOTIATING FINANCING DOCUMENTS
A. The Purpose of the Loan Documents.
Many practitioners will disagree as to the purpose of the loan documents (or other documents to evidence a financing). Some practitioners believe that the purpose of loan documents is to find any way possible to restrict the borrower and create a default if the borrower’s business plan does not perform as expected. Other practitioners believe that loan documents contain extensive restrictions and default provisions primarily to ensure that if there is a change in circumstances that jeopardizes the lender’s ability to be repaid, that the borrower cooperate to work out the financing and protect the lender’s interest. It is the author’s belief that practitioners should not review loan documents with an eye toward converting the loan documents from lender-friendly documents into borrower-friendly documents. Most lenders simply refuse to agree to many requested changes.
Instead, the author believes the borrower’s attorney should review the loan documents, and the lender’s attorney should prepare such loan documents, with the goal of achieving three critical items: (a) making sure that the loan documents accurately describe the agreement of the parties; (b) making sure that, in most situations, the lender acts reasonably; and (c) making sure that the loan documents do not have unintended consequences. The first critical element is unambiguous. Second, although in certain situations, the lender should have the right to act in its sole discretion, the lender generally should be reasonable. If the borrower knows that the lender must be reasonable, the borrower’s counsel is more likely to recommend that the client not aggressively negotiate other issues and other protections to the same degree that borrower’s counsel otherwise would if the lender had complete discretion throughout the loan transaction. Finally, and probably most importantly, neither the borrower nor the lender desires unintended consequences. It is the lawyer’s role (both lender’s and borrower’s) to make sure the loan documents do not cause unintended consequences. For example, if all parties contemplate a transfer of the property to an affiliate of the borrower after closing, then the due-on-sale clause should contain an exception for such transfer. If not, the borrower could inadvertently be in default immediately after the transfer.
B. Helping the Financing Transaction Move Smoothly.
The best way to facilitate the financing transaction as a borrower or borrower’s counsel is to anticipate lender needs and to satisfy such needs or be prepared to satisfy such needs prior to their request. The borrower’s counsel should be in frequent contact with the lender (or lender’s counsel) to identify any special requirements, special needs or closing checklists that may be used by the lender.
IV. CONCLUSION
It is impossible to cover all financing issues that may arise in a transaction. The purpose of this article and the scope of these materials is simply to provide the reader with an overview of different types of financing to enable a lawyer to counsel a client on what type of financing to consider and/or to provide insightful comments (or an appropriate referral) when reviewing or analyzing loan documents on behalf of the client. Each of the above topics probably could be the subject of a separate seminar. Any questions about the foregoing topics, including any specific questions or issues related to real estate financing should be directed to Titus Brueckner & Levine PLC at (480) 483-9600.