As interest rates for commercial loans remain low, many property owners will pursue financing for their businesses or seek to refinance their current loans. The first document that a borrower is asked to sign in connection with a commercial loan is the loan commitment letter. The main goal of the loan commitment letter is to set forth the basic terms of the loan (how much, for how long, at what rate) as well as outline some other critical provisions (e.g., prepayment rights, transfer rights and required escrows).
Here are some points to keep in mind when negotiating a loan commitment letter:
Prepayment Rights: When lenders make loans, they expect a certain profit from the interest paid by the borrower over the course of the full term of the loan. When a loan is paid off before the intended maturity date, the lender loses the benefit of its bargain. In New York State, borrowers do not have a right to prepay loans except as may be set forth in the loan documents. Therefore, borrowers should insist on an express right to prepay. Negotiation will arise in the context of when the borrower may be allowed to prepay (at any time or only after a certain number of years into the term) and/or the amount of any prepayment (in whole or just in part). Borrowers should also make sure that any prepayment penalty would not apply to the application of insurance proceeds as a result of a casualty or condemnation event.
Due on Sale: With a loan that is secured by one property, it would difficult to challenge a provision allowing a lender to call a default if the borrower sells the property without the lender’s permission. However, if the loan is secured by more than one property, the borrower will want more flexibility in this regard. One way to make this provision more palatable is to ask that the lender’s consent to a sale not be unreasonably withheld, conditioned or delayed. Another possibility is for the lender to allow one or more of the properties to be sold provided the proceeds are used to pay down the loan proportionately. It is important to make sure these scenarios fall outside the general prepayment provision and will not be subject to prepayment penalties, if any.
Transfer Rights: The provisions concerning the transfer of interests in the borrower are often difficult and highly negotiated. A lender’s primary concern regarding transfers of interest in the borrower is really one of change of control. The lender makes a loan to a company based on many factors, one of which is its comfort level with the principals of that company. However, a borrower should always campaign for a bit of wiggle room. Specifically, a borrower should be allowed to make transfers that do not violate the lender’s primary concern. For example, transfers that do not result in a change of control or transfers to affiliates or to family members in connection with bona fide estate planning should be permitted.
Guarantors: A principal of a borrower that is asked to give a personal guaranty of the loan should tread cautiously. Lenders will always prefer broad liability, but these individuals should strenuously resist. Ways to reduce liability include setting a maximum amount of exposure or limiting the guaranty to interest only. Another way is to provide for a release if the borrower meets certain conditions (e.g., operating income or debt-to-equity ratios).
Escrows: Many loans will call for certain funds to be held in escrow. Typically, these are for real estate taxes and insurance payments. Obviously, a borrower should try and eliminate these accounts entirely, but if the lender insists, a borrower could try and have the accounts set up only if there is an event of default. A borrower should also oppose the Lender’s preference to hold the funds in non-interest bearing accounts.
Closing Costs: Although the borrower generally does not have much leverage to negotiate many of the bank fees and expenses, it is important that the commitment letter detail all the costs and fees that the borrower is going to be expected to pay and their due dates. Typically, these include any origination fees, the cost for the environmental site assessment, the appraisal, flood zone certificate, lender’s counsel’s fees and other miscellaneous bank service fees. If the borrower is expected to pay for the bank’s legal fees, perhaps a cap can be negotiated so that the borrower’s exposure is limited.
As mentioned above, a loan commitment letter merely provides a general outline of the understandings between the parties that will be developed in greater detail in the loan documents themselves. However, much time and effort (and legal fees) can be saved if those understandings are sufficiently laid out in the commitment letter, ensuring that there are no surprises as the parties move further into the process.