When the Boom Fades: A Primer on Commercial Real Estate Workouts

Certain sectors of the Portland commercial real estate and construction markets are in the early stages of decline. The possibility is very real that an overall market malaise is on the horizon. This brief article deals with a real estate lender's goals in a workout, one significant aspect of a down market that also sees foreclosures, lender liability litigation and bankruptcies. Of those alternatives, workouts, like taking time at lunch to go for a jog, can be the most rewarding.

If a distressed real estate project leads to a nonperforming real estate loan, the lender and borrower must each assess the problem, determine the courses of action available, and implement a plan to resolve the loan default. The workout process should lead to a written agreement between the parties that provides a solution to the default. The lender should identify its goals prior to entering into negotiations with the borrower. The lender's goals typically include:

1. Giving the borrower some grace period or other concessions to correct the default;
2. Strengthening the lender's position through third-party guarantees and/or grants of additional collateral;
3. Fixing any loan documentation or lien perfection problems the lender has discovered;
4. Taking steps to ensure that during the workout period the value of the project subject to a secured lender's lien position does not deteriorate further;
5. Getting information from the borrower that can help the lender collect more later if the workout is unsuccessful and the parties wind up in state court or bankruptcy court;
6. Obtaining a signed workout agreement that contains at least the following important concessions from the borrower;
1. Acknowledgment of the debt that is due;
2. Acknowledgment of the lender's collateral position;
3. Ratification or reaffirmation of the loan documentation;
4. A statement acknowledging that the borrower is in default;
5. A statement that the borrower has no defenses, claims or offsets;
6. A release of any claims the borrower may have against the lender up until that time;
7. Representations and warranties from the borrower that may be helpful to the lender down the line if the workout does not succeed, such as representations regarding the borrower's solvency or the extent of collateral; these representations could form the basis for a fraud/nondischargeability action later if the representations turn out to be materially false.

As lender, you should always consider the workout option. Indeed, problems with your loan documentation or your prior acceptance of late payments may dictate that you enter a workout agreement that can fix these problems. The best workouts leave the borrower believing that the borrower is getting something substantial, such as additional time and the ability to continue in business, when in fact the primary advantages of the workout have flowed to the lender. I have noted only some of the concessions or advantages that creditors should seek in a workout agreement. There are many more advantages that can be taken depending on the particular case, and the workout situation is the time to take them. You should always do a complete review of your loan documentation and prior management of the credit before agreeing to any workout terms. And it is a good idea to involve your lawyer in commercial workout planning, negotiations, and the documentation of workout agreements.

This article is intended to inform the reader of general legal principles applicable to the subject area. It is not intended to provide legal advice regarding specific problems or circumstances. Readers should consult with competent counsel with regard to specific situations.

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