Navigating Troubled Waters: Tips and Strategies for Addressing Distressed Assets and Underperforming Loans (Sponsored Content from Selzer Gurvitch Rabin Wertheimer & Polott, P.C.)

Alonso Cisneros, an attorney with Selzer Gurvitch Rabin Wertheimer & Polott, P.C., shares ideas that lenders and borrowers can use to navigate the loan workout process in a challenging commercial real estate market.

Over the past few months, we have heard the alarm bells about a looming commercial real estate crisis due, in part, to any number of factors: decreasing occupancy rates, crushing interest rate cap costs, high interest rates, exorbitant insurance premiums, and a tsunami of maturities occurring over this and the coming few years. Now, let’s say that, on top of this bout of worrisome financial news, you are a lender with a loan (or two, or three) that is underperforming, but you think you can help the borrower. Or, you are a borrower with an asset in distress who could use a little breathing room. The reality of the situation is palpable for both parties. You both realize that you are past the point of “extend and pretend,” and any further extending and pretending will accelerate a potentially undesirable ending.

Preparing Yourself and the Vessel

The foundation for a successful workout process (from a simple forbearance to a complicated prepackaged bankruptcy) begins with the lender. As the lender, if you have not operated under the strict terms of the loan documents up to this point, it is extremely important that you do so going forward. Any notices and correspondence (with some exceptions) will be used as evidence in legal proceedings; therefore, you want to refer to your loan documents when it comes to the manner of notices, addresses, timing, method of delivery, etc. Be specific in the type of default, reference specific sections from the loan documents, and include specific amounts and dates. Demand cure in accordance with the loan documents and reserve your rights and remedies as a creditor.

Another key part of the process is to include a pre-negotiation agreement, which will provide you, the lender, with the option to dual-track the process by asserting your rights and remedies per the terms of the loan documents while negotiating with the borrower, without prejudicing those rights and remedies. With the correct pre-negotiation agreement, your discussions with the borrower will be treated as settlement negotiations. The discussions are not binding until the parties enter into a written agreement executed by all parties.

As a borrower, you should not expect or rely on a loan modification, and you should pursue other alternatives during the workout process.

Both lender and borrower must involve all key stakeholders in the workout process, which begins with understanding the consent requirements established under the various loan documents, any intercreditor or subordination agreements, and any secondary mortgage market documents, such as a pooling and servicing agreement. Both parties need to determine their objectives, evaluate the project and loan situation, assess their strengths and weaknesses, evaluate potential courses of action, and develop a strategy.

The loan workout process has a higher likelihood of success when the parties are proactive, honest, and act in good faith. Do not bluff. Be realistic, but be creative. Do not spend time and energy on the impossible or the unrealistic. Put principles and egos aside.

The Lender’s Considerations

As the lender, your ultimate objective is to get repaid in full in accordance with the terms of the loan documents. In addition, you want to preserve the value of the property (or increase it if necessary), minimize disruption in payments, and minimize lender liability claims. 

To evaluate the situation, you must assess the availability of additional collateral (cash reserves, letters of credit, or payment or performance bonds); obtain an updated appraisal from a third party; perform a physical inspection of the property; examine the borrower’s and guarantor’s financials; obtain an updated title search; and review the loan documents for ongoing lender obligations. You should also evaluate potential lender liability claims.

You must also weigh your strengths and weaknesses. In the strengths column: your borrower and its equity partners have deep pockets; the principals are subject to considerable personal liability under the loan documents; or there is a third-party that is willing and able to perform any necessary capital improvements, or has a better management structure that will take the property out of distress. In the weaknesses column: there are some potential lender liability claims that have some legs; there are large unpaid mechanics’ liens (or tax liens) that will prime the priority of your mortgage; the project is particularly complex making it difficult to transition once you foreclose; or a loss exposes you to considerable reputational or headline risk.

Based on the state of the asset and the status of the loan, and taking into account your strengths and weaknesses, you will have any number of options: ignoring the problem, entering into foreclosure or deed in lieu of foreclosure, a prepackaged bankruptcy. Each of which has its own set of advantages and disadvantages.

The Borrower’s Considerations

As the borrower and owner of the asset, you want to minimize the principals’ personal exposure and you want to minimize losses and capital outlays. This may include retaining the asset and your equity in the asset, maintaining or regaining control of the project’s cash flow, and possibly avoiding a domino effect if the project is cross-collateralized or cross-defaulted with other assets in your portfolio.

You must evaluate the asset and loan situation and should undertake similar actions as the lender.

On the strength side of the ledger: you are able to cut costs at the property without jeopardizing the state of the project; you have access to dry powder to address deferred maintenance or to add equity to the project; or the project itself is complex or unique and not easily operated by someone else (much less the lender). On the weakness side of the ledger: the project is still under construction; your investors are not willing or able to contribute additional equity; you and other principals have a high level of personal exposure under the loan documents; or your third-party manager mismanaged the project and absconded with funds leaving the property in disrepair and not cash-flowing. You must first come to terms with your strengths and weaknesses.

Like the lender, your options will depend on the state of the project, the status of the loan, and your strengths and weaknesses. You may opt to contribute additional equity, give the property back to the lender, sell the property, litigate lender liability claims, or file bankruptcy. You will have to weigh the advantages and disadvantages of each course of action.

Navigating the Workout Process

Successful workouts are predicated on transparency and pragmatism. Both the borrower and lender must approach negotiations with a spirit of cooperation, seeking common ground while acknowledging each party’s respective objectives and constraints.

The parties must be open to creative solutions. For the lender, this may involve restructuring the debt in an unusual manner or pursuing third-party investors. Similarly, for the borrower, this may involve new equity partnerships to reposition the asset.

In the face of mounting challenges, communication and collaboration emerge as the linchpins of success in navigating the workout process. By fostering open dialogue, conducting thorough assessments, and exploring creative solutions, borrowers and lenders can navigate these challenges with confidence and chart a course toward resolution.

(Sponsored content includes material submitted independently of the Mortgage Bankers Association and MBA NewsLink and does not connote an MBA endorsement of a specific company, product or service. For more information about sponsored content opportunities, contact Bill Farmakis at or 203/834-8832.)