After a borrower default, lenders have multiple options to consider. While foreclosure may be inevitable, with the right facts and strategy, lenders can minimize their risk and maximize their potential recovery. Part 1 of this series provided a general overview of the series and initial considerations for lenders dealing with hotel and restaurant mortgage defaults. This article seeks to explore pre-foreclosure loss mitigation options as an alternative to commercial foreclosures. Some of these options include loan workouts/restructuring and deeds-in-lieu of foreclosure.
In many cases, a loan workout/restructuring is usually a better long-term option for lenders than a commercial foreclosure. However, this depends on numerous factors such as the value of the assets, the type of business, the location of the business, the management structure, etc. If the long-term business prospects are good and the borrower’s management team is competent and trustworthy, a loan workout/restructuring can allow the lender to mitigate its losses and ensure future profitability.
There are various loan workout options available to lenders. Typical workout options include deferments or forbearances, loan modifications or a combination of deferments, forbearances, modifications and other components.
For example, a deferment or forbearance allows a borrower to temporarily suspend payments on a loan. The difference is that interest typically continues to accrue during a period of forbearance, but not during a period of deferment. These options typically give the borrower much-needed financial flexibility during a cash crunch.
Alternatively, a loan modification or restructuring typically involves rewriting the terms of the loan. Some of the terms that are typically modified include: (1) changing from an adjustable-rate mortgage to a fixed-rate mortgage, or vice versa; (2) changing the nominal interest rate, (3) extending the term; (4) changing the property that secures the loan; (5) adding past-due amounts to the unpaid balance; or (6) adding additional guarantors or providing additional security or collateral.
Loan modifications also typically include a reaffirmation of personal guaranties. It is a generally accepted rule that a guarantor will be released from a guaranty by a “material alteration” of the obligation where the alteration is made without the guarantor’s consent. Equity Title, Inc. v. First Nat’l Bank & Trust, 564 So. 2d 1182, 1184 (Fla. 1st DCA 1990).
Examples of material alternations include an increase in the interest rate or an extension of time for payment. See Equity Title, Inc., 564 So. 2d at 1184 (providing that the increase in the interest rate on the principal obligation was a material alteration of the principal obligation); Bromlow v. Pyne Corp., 490 So. 2d 1027, 1028-29 (Fla. 1st DCA 1986) (releasing a guarantor from a guaranty after the terms for payment of the debt were changed without the guarantor’s consent). For these reasons, lenders should strongly consider including a reaffirmation of guaranties.
Further, in evaluating modifications, the lender should consider the hotel/restaurant’s assets and consider leveraging additional assets as security on the modified loan. Hotels and restaurants generally have both secured and unsecured assets. These can be broadly categorized as follows:
- Cash and cash equivalents
- Stocks and bonds
- Accounts receivable
- Land/real estate
- FF&E (furniture, fixtures and equipment)
- Tax assets
- Licenses, permits and other intangible assets
Ultimately, the lender will have to determine if a loan workout is a better alternative to foreclosure. This will involve an in-depth analysis of the loan file and the underlying viability of the asset.
Deeds-in-Lieu of Foreclosure
If a loan workout is not a viable option, foreclosure may be inevitable. However, the cost and risk of foreclosure is sometimes avoidable using a deed-in-lieu of foreclosure. A deed-in-lieu of foreclosure is an agreement whereby the borrower conveys the property to the lender in exchange for the lender releasing the borrower of the debt. See, e.g., Morris v. Osteen, 948 So. 2d 821, 823 (Fla. 5th DCA 2007).
This arrangement is faster and cheaper than foreclosure or bankruptcy and lenders can often obtain valuable concessions from the borrower. For example, the lender may be able to obtain unsecured assets or the release of lender liability claims. The lender might also be able to skirt the effect of any defective loan documentation.
Additionally, for strategy purposes, lenders may want to work on parallel tracks by filing a foreclosure action while at the same time negotiating a deed-in-lieu of foreclosure. The dark cloud of foreclosure hanging over the borrower’s head may lead to a more favorable agreement. Further, if the parties never come to an agreement, the lender could be months ahead of where it otherwise would have been if it had first tried to negotiate the deed-in-lieu of foreclosure without also initiating the foreclosure action.
After borrowers default, lenders need to consider their available options. Loan workouts are oftentimes appealing options and may be in the best interest of all parties. However, when loan workouts are not viable, lenders should consider other options such as deeds-in-lieu of foreclosure, pursuing personal guarantors or filing foreclosure actions.
Part 3 of this series will discuss accelerating the loan and enforcement of personal guarantees.
- Austin T. Hamilton, Esquire
- Pierce Schultz, JD Candidate
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