By Thomas Furst, partner, Adam Leitman Bailey PC
In the midst of the current economic deep distress, there are, and will continue to be, countless communications from tenants to real estate owners requesting forbearance from the payment of rent.
This will in turn no doubt trigger requests from owners to their lenders, requesting forbearance with respect to mortgage payments. The following discusses some of the relevant considerations, as well as existing moratoriums, as they apply to residential and commercial loans. The discussion concludes with a brief overview of the Federal Paycheck Protection Program, which offers forgivable loans that may be used to pay, among other things, mortgage interest.
Admitting Inability to Pay Debts – Commercial Loans: While it is likely that most lenders will act reasonably and not take unfair advantage of the current situation, it makes sense for real estate owners to take appropriate caution in their communications with lenders. In this regard, we note that many non-recourse carve-outs in loan documents provide, as an exception, a borrower’s admission of inability to pay its debts.
Although Courts have held that such admission, in order to trigger a non-recourse carve-out, must be very explicit and direct to the lender (excluding, for example, an admission of financial distress in a government filing), it would be prudent to couch the communication to the lender in as tentative a manner as possible. For example, a real estate owner should avoid telling a lender that its tenants will not be paying rent and that this would make it impossible to make mortgage payments [thus, perhaps, admitting insolvency]. Instead, a real estate owner should say to its lender something like the following:
Our tenants are requesting rent forbearance and we would like to consider granting such forbearance under current conditions but would need to know your [the lender’s] position with respect to our mortgage payments in the event such forbearance is granted.
Lease Modifications and Commercial Lenders: Similarly, when Tenants request a lease modification, even when a real estate owner will remain fully solvent following such Lease modification, it is important to note that non-recourse carve-outs could be lost, or limited guaranties could become full guaranties, in certain instances, if real estate owners make material changes to a lease without the lender’s prior consent. Whereas the foregoing likely does not apply to termination of an inconsequential lease in the ordinary course of business, a real estate owner should consult with its lender, in writing, before making any significant lease concessions or modifications to material leases.
Fundamental Items to Cover in a Workout Discussion with a Lender: There are a number of items which should be made clear, preferably in writing, in any discussions with the Lender
- Real estate taxes: If real estate taxes are being escrowed as part of the monthly mortgage payment, there should be a discussion as to how real estate taxes will be paid in the event that payment of same is due during the forbearance period. One option is to pay, even during the forbearance period, the portion of the mortgage payment which represents the real estate tax escrow, assuming the lender agrees to this arrangement.
- Make-up of missed interest payments: The borrower should clarify whether the missed interest payments will be due at the end of the forbearance period or within a specific time period thereafter.
- Make-up of missed principal payments: The borrower should determine if the portion of the missed mortgage payments consisting of principal will be due at the end of the mortgage term and whether the mortgage term will be extended accordingly. If the term is extended, inquiry should be made as to how yield maintenance/prepayment penalty schedules are affected by extension of the mortgage term.
- Late charges and legal fees: Will these charges be waived.
- Reports to credit bureaus: Will there be any negative reporting?
- Guarantees: Will Guarantors receive the same forbearance as the Borrower?
Foreclosure moratorium in NY, residential and commercial mortgages: There is a 90-day moratorium on foreclosures in NY State, and this applies to both residential and commercial mortgages. The moratorium begins on approximately March 20, 2020.
Moratorium on certain mortgage enforcement remedies — residential mortgages: On March 24, 2020, the NYS Department of Financial Services (DFS) issued an emergency regulation requiring that New York State regulated financial institutions provide residential mortgage forbearance on property located in New York for a period of 90 days to any individual residing in New York who demonstrates financial hardship as a result of the COVID-19 pandemic, subject to the safety and soundness requirements of the regulated institutions. Forbearance includes, but is not limited to, the following:
- Waiving mortgage payments based on financial hardship
- Grace period for loan modification
- No late payment fees or online payment fees
- No negative reporting to credit bureaus.
NY Gov. Andrew Cuomo clarified that the above will not exempt residents from mortgage payments but will expect lenders to adjust the mortgage to include those payments on the back-end. Furthermore, after the 90-day period is over, NYS will “reassess as the situation goes on if that should be extended or not.”
Federal Paycheck Protection Program Loans: This new federal program provides cash-flow assistance through 100% federally guaranteed loans to employers who maintain their payroll during this emergency.
Eligible entities must have been in operation on February 15, 2020 and include small business concerns and 501(c)(3) nonprofit organizations, individuals who operate a sole proprietorship or as an independent contractor and eligible self-employed individuals, as well as certain business concerns that employ not more than 500 employees per physical location.
Permitted uses of the loan include payment of interest (but not principal) on a mortgage obligation, lease obligations and utilities. Application for forgiveness of the loan is made through the applicable lender.
Conclusion: A very significant number of real estate owners are under severe financial stress on account of tenants’ inability to meet some or all of their financial obligations. Consequently, it is more important than ever for these owners to carefully strategize their approach with tenants, lenders and government entities in a manner which will enable the owners to survive this unprecedented crisis and emerge on the other side in as strong a position as possible.