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Course: Commercial Real Estate Final Exam1
School: unknown
Year: 2003
Professor: Berg
Course Outline provided by Legalnut.com
 

 

 

 

 

COMMERCIAL REAL ESTATE FINAL EXAM – TAKE HOME

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Professor Robert S. Berg, J.D.

  1. QUESTION #1 -- LENDER’S LOAN DOC’S

    1. Prepare a closing checklist containing what documents you need from the borrower to review prior to closing, what documents the lender will prepare and what documents you, as lender’s counsel, need to prepare.

      1. The number one rule taught in class is to always go to a closing with a checklist. It gives you as the attorney control over the discussions. In addition, it allows all parties at the closing to follow along with you and helps to keep the discussions and negotiations on track so that important terms are discussed and reconciled. A checklist is also a good tool to follow because it aids at preventing you as the attorney from negligently missing an important step in the transaction, thereby hedging against legal malpractice.

      2. Closing checklist: documents needed from the borrower. Borrower wants to get rich by using other people’s money (OPM). Listed below is a closing checklist which lists the documents that the lender will need from the borrower:

        1. Business Licenses.

        2. Articles or Organization and operating agreement.

        3. Certificate of good standing.

        4. Tax returns and financial statements for the previous three years.

        5. Financial Statements & interim reports.

        6. Schedule of payables & Receivables.

        7. Borrower’s budget projections.

        8. Business valuation opinion from borrowers accountant(s).

        9. Property/business valuation from a Certified Valuation Analyst.

        10. Property Profile with financial ratios (Ex. Profit margin & financial ratios).

        11. Property tax statements.

        12. Tax appeal status.

        13. Architectural plans.

        14. Copy of any long-term leases.

        15. Borrowers mission (vision) statement.

      3. Documents the lender will prepare:

        1. Loan questionnaire. P885.

          1. This provides general information about the borrower, the entity the borrower represents, the subject property, amount of financing needed.

        2. Phase 1 inquiry. This document is not prepared by the lender but is part of the lender’s due diligence inquiry that is paid out of borrower’s proceeds (soft costs). Phase 1 inquiry contains the following:

          1. Environmental questionnaire.

            1. This questionnaire should address whether the site is vacant or developed, the type or nature of the borrowers business, require discussion as to whether there are any pending environmental actions or civil suits pending on the property. And any other questions that may help the loan officer determine whether there are any potential liabilities associated to the property.

          2. Chain of title search.

            1. Title Search. This cost comes out of borrower’s proceeds. (Soft costs). The title search will indicate possession of the property by known polluters, such as oil, gas, or agricultural companies. Michigan is a title theory state.

          3. Governmental records search.

            1. Governmental agencies (EPA Environmental Protection Agency, DOT Department of Transportation) have information about contaminated properties; permit applications, health records, environmental compliance and other useful information.

          4. Physical inspection the property. Look for obvious contaminations, hazards, and problems with building structure.

          5. Survey. This cost comes out of borrower’s proceeds. Shows the boundry lines of a property (Soft costs)

          6. Interviews with various parties.

        3. Loan document commitment which mentions:

          1. Cure period in case of default.

          2. Risk of loss during executory period.

          3. Fire clause & condemnation clause.

        4. Mortgage or Deed of Trust. In Michigan you can put in future advance language. This language protects 1st lender’s position making the tax lien part of the first lien.

        5. Reserve Account for property Taxes.

        6. Business purpose affidavit is needed only if rate is greater than 7%. MCLA 438.31 is Michigan’s usury law. Exceptions for corporate loans over $100,000.00.

        7. Real estate transfer affidavit. If sales price is not disclosed on the deed. If buyer wants privacy. For property tax assessment.

        8. ALR; Annual Loan Rate. This requires that the lender disclose the finance charges and annual percentage rate be disclosed.

      4. Documents lender’s counsel will prepare:

        1. Promissory note. AKA mortgage note; Contains terms of payment and is a negotiable instrument. Promissory note is an instrument that contains an absolute promise to pay a specified person a definite sum of money at a specified time in a prescribed manner. The promissory note is very important because it acknowledges that a debt exists. A mortgage only allows a lender to foreclose on the property whereas the bank can sue the borrower for any deficiency resulting from the sale on the basis on the note.

        2. Financing statements.

          1. On Real Property: To be filled on real property at the register of deeds.

          2. On Personal Property:

        3. UCC-1. Chattel search done at secretary of state. To be done pre-closing & post-closing because there is no gap coverage.

        4. UCC-1A. Fixture search done at the register of deeds. To be done pre-closing & post-closing because there is no gap coverage.

 

 

 

 

    1. Add to the checklist any due diligence requirements to be prepared or ordered from outside companies at the borrower’s expense to protect the lender.

      1. Research the borrower: this is necessary in order to keep the lender from “Sfitzing” (sweating)

        1. Dun & Bradstreet report. This is a good way to see how the borrower rates compared to his peer group competitors.

        2. Better business bureau. To see is any complaints have been filed against the borrower.

        3. Licensing department in Lansing. To make sure that the borrower is properly licensed so that he may carry on and maintain the apartment building without any interruption.

        4. Phase 2 environmental. This is an extensive environmental audit conducted is the Phase 1 report shows evidence of a potential environmental problem.

        5. ALTA survey to protect against encroachments & easements.

        6. Check the Lender’s preferred list of clients.

 

    1. Describe the type of personal guaranty you would recommend and the general provisions you would negotiate in the document.

      1. Recourse loan. This type of loan makes the borrower personally liable on the loan in the event that the legal entity, which borrows the funds, is unable to repay the balance of the loan. This gives the lender additional protection against default on the loan.

      2. The lender may also want a personal guarantee from a third party. This “Guarantor” becomes secondarily liable for another’s debt. Because the borrowers’ are part of an LLC, and therefore have limited liability, it is important that as part of the lender’s agreement to loan that the borrower’s submit to being personally liable upon default of the loan for the LLC.

        1. Full unconditional Guarantee: the member manager is liable for the complete amount of the loan proceeds.

        2. Deficiency Guarantee: the member/manager is liable for only that portion of the loan that the LLC is deficient in payment.

 

    1. The closing will occur at the title company. What is the role of the title company at the closing? Prepare a list of instructions to the title company to protect lender’s first lien position.

      1. The role of the Title Company at the closing is to give the buyer a marked-up title commitment and send a buyer the permanent title policy after the closing. In addition, the title company assembles & executes the documents at the closing along with notarizing the documents, arranging copying and sets up escrow accounts.

      2. Instructions to the title company to protect lender’s first lien.

        1. Check for recorded interests, constructive notice of a superior recorded interest. Michigan is a race/notice state.

 

 

 

 

 

  1. QUESTION #2 -- BORROWER’S LOAN DOC’S

    1. As counsel for the borrower, what provisions in the loan documents would you try and negotiate with lenders counsel to protect the borrower? P658

      1. Interest rate (hedge against usurious loans).

      2. Permit junior financing. Allow for secondary financing.

      3. Remove any options to call. This eliminates the possibility of the loan being due upon the lenders option and creates a comfort feature for the borrower.

      4. Loan charges; mention to the borrower that these charges are sometimes negotiable, and see is you can save the client some money. If you can reduce the loan costs then maybe the client won’t complain as much when they get your bill or legal services.

      5. Borrower’s Right to prepay. It is an important right for the borrower to have the right to prepay his loan without penalty. The borrower may find that interest rates have dropped and a substantial saving could be gained if the borrower refinances to payoff the original loan with a lower rate loan. Prepayment penalty provisions should be eliminated if at all possible. .

      6. Late charge for overdue payments and length of grace period. This is an important provision to negotiate with the lender. Borrower wants minor penalties and interest charges upon delinquency of payments.

      7. What happens to insurance proceeds upon destruction of property?

 

    1. How would I as borrower’s counsel negotiate with lender’s counsel to allow for a second mortgage even though there is a prohibition against secondary financing?

      1. Junior mortgage, aka a second mortgage, ranks below the first lien in priority. Any mortgage, no matter how many, coming after the first mortgage is classified as a junior lien. As borrower’s counsel, I would recommend that the lender permit the secondary financing that is Subordinate to the original mortgage agreement. A subordination agreement is a written agreement between lien holders to change the priority of the first, senior, lien to a junior lien

 

    1. What data might the lender require to determine whether to permit a second mortgage?

      1. Appraisal value of the property before and after improvements. Whether the improvements will increase the value of the apartment building. The increase in value of the property creates security for the lender if he has to foreclose on the property.

      2. Language in the subordination agreement that states:

 

        1. That the “proceeds of the new loan may be used only for construction purposes and the mortgage is subordinate only to the extent that the proceeds of the new loan are use to construct…”

 

    1. What documents is needed to subordinate to the primary lender?

      1. Subordination agreement.

      2. Appraisals.

      3. Promissory note.

      4. Mortgage.

      5. Financing statement.

    2. What risk does the second mortgagee have and how might the second mortgagee minimize its risk in making this loan?

      1. Payment risk. That is that upon foreclosure of the disputed property, if the property is sold and the proceeds are insufficient to pay off the first of primary mortgage, the seconds mortgage and any junior mortgages will not get paid because they are subordinate to the primary mortgage.

 

  1. QUESTION #3 -- GROUND LEASE & CONSTRUCTION LOAN

    1. What are the most important provisions would you need to negotiate with the land owner to protect Rite Aid and to ensure that it can get financing for its construction loan. P755.

      1. A ground lease is a lease of the bare land for usually a term basis. The lessor (land owner) retains title to the land. Any leasehold improvements made to the land are the property if the lessee (tenant), unless stated otherwise in the lease.

      2. A construction loan is a high-risk loan because a large sum of money is borrowed and no building exists which can be pledged as security. The lender pays out loan proceeds in stages as the building is constructed. Due to the risk, the loan will be a short term financing arrangement with an interest rate that is usually above the prime rate.

      3. The most important provisions Buyer’s counsel would need to negotiate:

        1. Premises.

          1. It would be important to negotiate the lessee’s minimum square footage requirement. In addition it would be important to find out if the land owner has given an easement either implied, express or by prescription to the KKK Ku Klux Klan. If the KKK has an easement over part of the ground lease property it may appeal as if Rite Aid is endorsing the KKK and this could be bad “advertising” or Rite Aid therefore causing a boycott of Rite Aid and a reduction in value of the property if people are not willing to shop there.

        2. Improvements to the property.

          1. Does Rite Aid have the Rite to demolish any existing buildings that are on the property?

          2. Who has the Rite to any improvements at the expiration of the lease?

          3. Must Rite Aid reconstruct upon total damage to the building?

          4. Whether ground lessor has to approve financing for reconstruction.

        3. Term of the lease.

          1. When does the term begin? Is it at the date of initial construction or upon completion of the structure/possession?

          2. What situations would permit the lessee to terminate the lessee prior to the lease expiration?

          3. Is there a Rite to renew or extent the lease for another term?

        4. Use and Purposes.

          1. Is Rite Aid permitted to change the use of the property from its original use.

          2. Is the lease contingent on the lessee being able to use the property for a particular purpose? If the lessee’s desired use cannot be accomplished can the lessee terminate the lease without liability?

 

        1. Rents.

          1. Is the rent a net lease or a gross lease?

          2. Is the minimum rent based on market value or a cap rate?

          3. Are there any escalation provisions (such as having the rent tied to an index)

          4. What other charges are associated with the rent?

        2. Financing and Subordination.

          1. Has the leasor agreed to subordinate his land (and the lease) to the lien of a lender who will supply funds to construct or buy new improvements? If so then lessor may lose his land is lessee defaults and lender forecloses.

          2. If lessor agrees to subordinate his land, what security deposit is required to be posted by Rite Aid?

          3. If Rite Aid engages in additional construction in the future, must the lessor also subordinate his lease to future construction?

          4. Is lessor protected from personal liability?

        3. Chattel financing.

          1. Does Rite Aid have unrestricted Rites to finance the purchase of furniture and equipment?

          2. Does the lessor have to subordinate his lease to a chattel lender?

        4. Condemnation.

          1. If there is a partial condemnation of the land (but not of the building) cause a reduction in Rite Aids rent liability?

          2. What if the partial condemnation destroys or removes some of Rite Aids improvements?

        5. Brokers.

          1. Who is responsible for any broker commission?

        6. Assignment and Subletting.

          1. Does Rite Aid have permission to assign or sublet the premises?

          2. Which uses will the lessor permit upon assign or sublet the premises?

        7. Liability Insurance.

          1. Is additional liability insurance required is the premises are assign or sublet?

 

    1. What are the protections the ground lessor would look for in the event of a default on the construction loan and what protections would the lender who is seeking to assume the ground lease payments are made and how would the lender incorporate these protections in the mortgage?

      1. What are the protections the ground lessor would look for in the event of a default on the construction loan?

        1. If the lessor agrees to subordinate his lease to the construction loan the lessor will want to make sure that he is not personally liable for any deficiency on the construction loan upon Rite Aid’s default. If lessor refuses to subordinate his lease to the construction loan the lessor will want to make sure that his land is not encumbered as a result of Rite Aids default on the construction loan.

      2. What would the ground lessor request from Rite Aid if it were seeking permanent financing for the drug store after the construction period? P687.

        1. Copy of the mortgage

        2. Copy of the promissory note

        3. Copy of the financing statement

      3. What would the lender providing permanent financing require in its loan documentation to protect its lien position.

        1. It is the permanent lender’s money that is being used to finance the construction. Therefore, the permanent lender wants a mortgage on the building and the construction lender wants the building paid off. In addition, the permanent lender wants to insure proper construction of the project. Therefore, the lender wants to include language in the loan documents that gives him the right to examine the plans and specifications in advance and insist that the building be built in compliance with them. In addition the permanent lender will want the construction loan paid upon completion of the construction. The permanent lender will then hold the loan with the long-term security he contemplated when making the loan.

        2. In addition, the permanent lender’s commitment should include a buy-sell agreement prior to the start of the construction. This is an agreement between the permanent lender, construction lender, and the borrower whose purpose is to insure that the permanent lender will buy the loan from the construction lender and that the construction lender will sell the loan to no one else.

        3. The permanent lender will also want to approve:

          1. The survey, location of the premises in relation to roads and intersections. The permanent

          2. The leases and operating agreements if they exist at the time of the construction loan.

          3. Engineers report & any estoppel certificates & final title searches.

      4. If Rite Aid vacates the premises after 10 years what are the ground lessor’s remedies?

        1. What are the ground lessor’s remedies?

          1. Equitable relief; to take the property by foreclosure.

          2. Restitution damages: the court may make Rite Aid to pay the lender an amount equal to the benefit, which it has received from the lender, that is the loan amount that is unpaid. This type of remedy is available assuming that Rite Aid is solvent.

        2. What are the remedies for the permanent lender?

          1. Equitable relief; to take the property by foreclosure.

          2. Restitution damages: the court may make Rite Aid to pay the lender an amount equal to the benefit, which it has received from the lender, that is the loan amount that is unpaid. This type of remedy is available assuming that Rite Aid is solvent.

        3. What foreclosure problems might the lender have?

          1. During the equitable period of redemption Rite Aid may neglect the property and this could reduce the value of the building. If the ground lessor didn’t subordinate his lease, then the lender can only foreclose on the physical structure and not the land. This will reduce the resale value of the property.

 

  1. QUESTION #4 -- CONSTRUCTION LOAN

    1. What are Comerica’s remedies against Logan’s? Under what circumstances might Comerica proceed to complete construction and still insure its first lien position against Logan’s if construction is completed? P812

      1. What are Comerica’s remedies against Logan’s?

        1. Physical possession:

        2. Assignment of rents: this can be activated by a clause in the title awarding the mortgagee rents by serving notice on Logan’s tenants, if any, an assignment to pay their rents to Comerica.

        3. Appointment of a receiver: Comerica could also convince the court to appoint a receiver. Receivers are usually appointed to prevent impairment of the property. This may be difficult to prove depending on how the court defines “impairment”. It may require a showing of deterioration in value or a change in economic values. The problem with trying to get a receiver appointed is that it takes a lot of time, and during this time the property is idle and the interest on the loan is continuing to grow.

        4. Deed in Lieu of Foreclosure: Ideally Comerica would seek repayment of its loan by recovering and selling the underlying security. This is a voluntary conveyance by Logan’s, which eliminates the statutory period of redemption in exchange for Logan’s is let off the hook for the deficiency on the loan. Comerica’s advantages from receiving a deed in lieu of foreclosure are:

          1. Comerica becomes the owner of the property. And has control.

          2. This agreement can be consummated quickly and Comerica can record its deed.

          3. It avoids potentially bad publicity, waste of time and expenses of a foreclosure action.

          4. Avoids bankruptcy filing.

      2. Under what circumstances might Comerica proceed to complete construction and still insure its first lien position against Logan’s if construction is completed?

 

        1. Comerica would proceed to complete construction because without completed construction of the building there is little for Comerica to attach upon foreclosure. By completing construction, the risk of loss is reduced because Comerica now has real property to sell.

 

    1. Why would Comerica wish to continue funding construction if Logan’s is in default? If Comerica decided not to foreclose, what terms of a workout agreement would I procure as Logan’s counsel? P802.

      1. Why would Comerica wish to continue funding construction if Logan’s is in default?

        1. Comerica is in the financing business, not the restaurant business. Comerica wants to service the loan or sell the loan in the secondary market. Comerica does not want to foreclose or operate a restaurant. To do either would be a poor use of their resources and would require Comerica to enter a business arena that it is not competent to take on.

 

 

      1. If Comerica decided not to foreclose, what terms of a workout agreement would I procure as Logan’s counsel? P808.

        1. A workout agreement is a written agreement between the borrower and the lender that describes a payment plan designed in order to satisfy the borrower’s debt to the lender. The workout agreement should contain the following terms:

          1. That during the workout the lender will refrain or agree to a limited exercise of its legal remedies.

          2. The loan will be restructured to provide for lower interest rates, accruals of interest or extended maturity date.

          3. The borrower’s recourse liability is limited in case of business downside.

          4. No additional collateral is needed for the restructured loan

          5. That the borrower retains title to the property. That no deed in lieu of foreclosure be given.

          6. No involuntary bankruptcy proceeding would be instituted against Logan’s.

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