As owners and operators of commercial real estate consider the financial impact of COVID-19, it is important to keep in mind certain common provisions of loan documents and other contracts pertaining to insolvency, and avoid any missteps regarding the same when communicating with your lender or other contract parties.
A party’s “bankruptcy” is often a contract default. For example, bankruptcy is almost universally an event of default for a borrower under typical commercial loan documents. The bankruptcy of a party to a contract such as a management agreement, leasing agreement or development agreement is often a default for which such agreement may be terminated. Bankruptcy is also often a “removal event” for the manager or general partner under a joint venture agreement. Unlike the common use of the term bankruptcy (the actual filing for bankruptcy in a formal court proceeding), the term “bankruptcy” as defined in the aforestated loan agreements and other contracts is typically more broadly defined to cover an assignment for the benefit of creditors, receivership and insolvency of a party, as well as the admission in writing that the party is unable to pay its debts as they become due.
If you are considering asking a contract party for some concession under a contract or joint venture agreement, or asking a lender for relief for an upcoming loan payment on a non-recourse loan or a loan for which there is a non-recourse carveout guarantor, such communication should not be drafted in a manner that could constitute or be construed as an admission that the requesting party is unable to pay debts as they come due for any reason, including due to COVID-19. Such an admission may enable a contract counterparty to terminate the agreement or remove a manager or general partner from their managerial and oversight positions (with potential loss of economic rights, such as a Promoted Interest, incident to such removal). Perhaps even more problematic, almost all non-recourse carveout provisions under typical commercial real estate loan documents provide that the borrower and/or non-recourse carveout guarantor(s) can be liable for 100% of the principal and interest on the loan for “admitting in writing the inability of Borrower to pay its debts as they become due.” Lawyers may try to limit this carveout to an admission in a court pleading, but where such limitation is not accepted by a lender, the mere written admission of a borrower may trigger full recourse against a borrower or its guarantor(s). Accordingly, borrowers must avoid any communication with a lender that could be construed as an inability to pay debts as they become due.
Note that under Section 4023 of the CARES Act (effective 3/27/20), a multifamily property owner with a federally backed mortgage loan has the right to request up to 90 days loan forbearance in the event such borrower is experiencing financial hardship due to COVID-19. While Section 4023 requires a borrower to affirm financial hardship when requesting forbearance, it does not expressly state that such request will not constitute a breach of non-recourse carveout provisions (e.g., an admission of inability to pay debts as they become due). This may have been a legislative oversight, as it seems to contradict the intent of Section 4023 to provide relief to borrowers. Nonetheless, borrowers should be cautious in their communication with lenders and counterparties when discussing borrower’s financial hardship. For further discussion of Section 4023 of the CARES Act, see here.