How COVID-19 Will Transform Real Estate Loan Docs: Part 2

By Frederick Klein and Skyler Anderson
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Law360 (June 16, 2020, 6:00 PM EDT) --
Frederick Klein
Frederick Klein
Skyler Anderson
Skyler Anderson
In this two-part series, we will explore several provisions in loan documents that may be affected by the COVID-19 pandemic and provide observations on how borrowers and lenders may address them.

In part one, we considered how the COVID-19 pandemic affects financial tests in loan documents, leasing covenants and prohibitions against additional debt. In part two, we will focus on the COVID-19 pandemic's impact on disbursement requirements in construction and other loans with a future funding component and on recourse carveouts.

Conditions to Disbursements

In construction loans or other loans with a future funding component, there will be certain conditions precedent that borrowers need to satisfy before the lender must disburse additional funds.

Force Majeure

One typical condition is for construction to be on schedule, but subject to delays for force majeure. As quickly as COVID-19 and coronavirus entered our consciousness, so did the concept of force majeure. The lesson for loan document negotiations is to account for COVID-19 pandemic-related issues when negotiating force majeure language — we encourage the inclusion of concepts such as pandemics, epidemics, government-imposed shutdowns and limitations on the conduct of construction activities.

Remaking Representations

Borrowers generally must remake representations and warranties at the time of each future disbursement. Borrowers often resist the idea that representations and warranties are living — i.e., representations are not covenants — or that they need to be remade at specified times in the future.

Borrowers are usually unsuccessful in convincing lenders to forego this requirement altogether, however, many lenders agree to a shorter list of representations that are only made at the time of closing, and not in the future in order to qualify for an advance.

For example, a typical representation might be:

There is no material fact currently known to borrower that has not been disclosed to lender that materially and adversely affects, nor as far as borrower can reasonably foresee, would be reasonably likely to materially and adversely affect, the property (or any portion thereof) or the business, operations or condition (financial or otherwise) of borrower or guarantor.

Because of the COVID-19 pandemic, such a representation may be difficult for a borrower to make. In the pre-COVID-19 pandemic world, many lenders have been willing to require that this representation only be made as of the closing date.

When the disbursement conditions are drafted appropriately — e.g., the representations that need to be remade exclude any representations that specifically are limited to a date or time — the borrower will not need to worry about changed circumstances that might disqualify the borrower from obtaining an advance, and even worse, making a misrepresentation that could constitute a default.

Accordingly, in representing a borrower, we encourage the borrower to spend sufficient time on each representation to ensure that the loan documents include only fundamental representations and representations that are tied directly to the construction.

To the extent a borrower is required to remake representations and warranties in the future, the borrower is encouraged to ask for the right to notify the lender of facts and circumstances unknown to the borrower as of the date of making the loan, so long as such updates do not, by themselves, cause other representations to be untrue or result in a material adverse effect on the borrower's ability to perform its obligations under the loan documents. This is a lesson that the COVID-19 pandemic has brought to many borrowers' and lenders' attention.

Other Issues

The COVID-19 pandemic has made it difficult for borrowers to satisfy other disbursement conditions. For example, due to the closure of, or limitations on access to, public record offices, some title companies have been delayed in searching public records and issuing updated title commitments or date down endorsements — both of which are routinely conditions to lender's future disbursement obligations.

Periodic inspections of the property are also generally required, but these inspections might not be possible account of travel restrictions and shelter-in-place orders.

A borrower might propose a caveat that if any disbursement condition is not satisfied due to force majeure, a lender will not refuse to make the disbursement so long as such failure of the condition would not lead to a material adverse effect on the property. While this is not a perfect solution for borrowers, it will at least force the parties to negotiate a reasonable accommodation, instead of enabling the lender to disapprove the advance without explanation.

Recourse Carveouts

Borrowers and lenders should consider how experiences during the COVID-19 pandemic may affect certain aspects of nonrecourse, or bad-boy, carveouts. The present circumstances have forced both borrowers and lenders to revisit the carveouts in a variety of contexts that might not have been relevant in the past.

In part one of this series, we identified an area of the loan documents where this may arise — if a borrower incurs additional indebtedness that is not otherwise permitted under the loan documents.

In addition, most loan documents will contain a recourse carveout for borrowers or guarantors who voluntarily file for bankruptcy or make an assignment for the benefit of creditors. Some variant of "or borrower or guarantor admitting in writing its insolvency or inability to pay its debts as they become due" will often be buried in the same carveout.

It is easy to imagine a scenario during the COVID-19 pandemic that may violate this carveout and result in full recourse. For example, suppose a borrower sends an email to its lender including the following text:

Several of our tenants informed us that they won't be paying rent for the next three months, and in several cases, our tenants were entitled to withhold rent due to an emergency order issued by Governor Reagan. Because of this, we will be a little short on our next debt service payment but we are happy to make it up once our tenants resume paying full rent, and repay us for deferred rent. Times are tough for everyone, but we are sure you will understand. Let's set up a time to speak at your convenience.

A literal interpretation of those words (which is how the courts have generally interpreted recourse carveouts) sounds like an admission, in writing, of borrower's inability to pay its debts when they are due.

Wise borrowers try to modify the carveout, asserting that it is vague and can lead to unintended, and very negative, consequences, particularly because courts have given lenders a lot of latitude on this point. Borrowers will try to limit the text to statements made "in a legal proceeding," and expressly permit "any admissions or discussions with lender." These clarifications will enable borrowers to truthfully and accurately inform lenders of objective facts related to their collateral, as they are occurring, so that the parties have an opportunity to initiate an appropriate dialog.

A related situation may occur when the property is generating insufficient cash flow. This might arise in several different contexts, including in single-purpose entity covenants (such as "borrower shall remain, and intend to remain, solvent"), the failure to maintain the property (e.g., physical waste to the property) or the imposition of mechanic's liens.

Due to several court decisions that strictly interpreted recourse carveouts, borrowers try to make exceptions in certain carveouts to address the possibility that, if the property generates insufficient cash flow, the borrower may be unable to pay certain expenses, such as, for example, real estate taxes. So long as the borrower promptly advises the lender of its inability to satisfy certain financial obligations, due a lag in rental revenue, the borrower should not suffer any adverse consequences.

Because of the COVID-19 pandemic, situations like this have occurred far more in the past two months than at any other time in recent memory. The borrower has done nothing wrong, and thus should not be subject to a material expansion of its liability for repayment of a loan that was always intended to be nonrecourse.


While both borrowers and lenders are coping with unique issues that the COVID-19 pandemic has presented, everyone is encouraged to apply the lessons we are learning to seemingly routine language in loan documents.

Correction: A previous version of this article misspelled author Frederick Klein's first name in the byline. The error has been corrected.

Frederick Klein is a partner and Skyler Anderson is an attorney at DLA Piper.

The opinions expressed above are those of the authors only and do not necessarily reflect the views of the firm or any of partners or other lawyers. This article is for general information purposes and is not intended to be and should not be taken as any form of legal advice.

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