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Virtually every investor in commercial real estate will from time to time enter into a lending relationship as part of a real estate transaction. A loan is generally for the purpose of financing the acquisition of the real estate or to refinance an existing loan. A refinance may be for the purpose of obtaining a lower interest rate, taking a portion of the borrower’s equity out in cash, or to replace a loan which has matured. In a typical commercial real estate loan transaction, the real estate will serve as the primary collateral for the loan.
Attorneys representing the lender or the borrower may be involved in many aspects of the commercial real estate loan process. The attorney’s role may include drafting and negotiating loan documents, participating in the due diligence process, advising the client with respect to various legal issues, or providing an opinion letter. Some lenders may have in-house counsel who will draft and negotiate the loan documents on behalf of the lender, but on larger or more complex transactions, lenders will generally engage outside counsel. Some smaller transactions may be documented on a lender’s standard documentation without attorney involvement on behalf of the lender or borrower. However, many of the larger transactions often require the involvement of attorneys representing both the lender and borrower.
At the outset of the secured lending process a borrower and lender will discuss the terms of the potential loan. These discussions will generally culminate in a term sheet that outlines the general agreement of the parties in relation to the loan in question. The term sheet is not intended to be a binding agreement, and should expressly state that it is not a commitment by the lender to lend money to the borrower. Instead, it is only intended to be a document in which the key business terms of the loan transaction are to be set forth in writing so that all parties clearly understand what the finalized transaction will look like.
After a term sheet has been drafted and the lender has completed its underwriting of the loan, it may issue the borrower a loan commitment letter. This is a binding agreement which actually obligates the lender to lend money to the borrower in accordance with its terms. It is often conditioned on the satisfaction of various conditions that are set forth in the commitment letter. Commitment letters are most likely to be issued in connection with very large loans, for certain programmatic loans where revision to the loan documentation is often very limited, or sometimes, if requested by a borrower. In many circumstances, lenders may not issue a commitment letter at all, preferring to negotiate a term sheet and to proceed directly with the preparation of definitive loan documents. Borrowers often view the commitment letter in a more favorable light than the term sheet, feeling that it provides a modicum of security and some assurance that the lender will make the loan if the borrower can satisfy the lender’s conditions.
Both the commitment letter and term sheet serve as the basis for drafting the loan documents for the transaction. As such, both contain all of the material business terms of the loan transaction, and the loan commitment may also contain many of the covenants, representations and warranties and other essential terms of the loan transaction. Any conditions that the borrower must satisfy prior to the lender’s funding of the loan are also clearly specified within the loan commitment and the term sheet, with the commitment letter being the more specific of the two.
In almost all cases, lenders making commercial real estate loans require the borrower to furnish a title insurance policy to the lender in connection with the closing of the loan transaction. The title insurance policy is issued by a title insurance company upon the recording of the deed of trust, and insures the lender against various risks, including insuring that the lender has a valid and enforceable lien and the lender has the lien priority as set forth in the title policy.
The Texas Department of Insurance regulates the issuance of title policies in Texas. The Texas commercial title insurance commitment (issued on form T-7) is the title company’s promise to issue the title insurance policy (issued on form T-2 for a commercial loan policy and on form T-1 for a commercial owner policy) subject to the terms and requirements set forth in the title commitment.
The risks (i.e., the exceptions) listed in schedule B of the title commitment, in most cases, will not be insured by the title company. Certain of these exceptions are general in nature, may not be modified and appear in all title policies. Since the loan and owner’s title commitment are issued on the same form, these general exceptions in the title commitment include notes as to whether the exception applies to the owner’s or loan policy.
Once a lender has approved the commercial real estate loan transaction, many lenders (or their counsel) will send out a package of general information to the borrower, which is customarily referred to as the “hello package.” The hello package will typically contain information relating to the longer lead-time items needed for loan underwriting and closing. The hello package consists of a cover letter with several attachments including: the closing checklist; a form of tenant estoppels certificate; a form of subordination, non-disturbance and attornment agreement (“SNDA”); a list of the lender’s survey requirements; and, if required, a list of the lender’s special purpose entity requirements. It is important for borrower’s counsel to quickly and closely review the hello package for the requirements as well as applicability to the property.
After a lender has approved a commercial real estate loan and the terms of the loan transactions have been generally agreed upon whether pursuant to a commitment letter or term sheet, the preparation of loan documents will commence. A typical commercial real estate loan transaction will include, at a minimum, a promissory note and deed of trust. In many transactions, a loan agreement (sometimes referred to as a credit agreement) or a loan and security agreement, will also be executed by the parties. In addition to the aforementioned documents, a typical commercial real estate loan transaction may include, depending on the structure of the transaction and other lender requirements, various other agreements, including, but not limited to the following documents: guaranties; an assignment of leases and rents; one or more security agreements; an environmental indemnity agreement; UCC-1 financing statements; subordination non-disturbance and attornment agreements; and tenant estoppel certificates.
Except in cases where the lender uses a note/deed of trust structure, the loan agreement is the primary agreement between the lender and the borrower, and it will set forth most of the terms and conditions of the loan, although some of the specific loan terms such as the interest rate, payment schedules and maturity date may be set forth in the promissory note.
Among other things, the terms and conditions typically contained in the loan agreement include: (i) closing conditions; (ii) restrictions or conditions to the disbursement and use of loan proceeds; (iii) borrower representations and warranties; (iv) affirmative and negative covenants; and (v) events of default. If the loan also serves as a security agreement, the loan will contain provisions (i) describing the collateral, (ii) granting a security interest in the collateral, (iii) providing covenants relating to the use and operation of the collateral and (iv) providing remedies relating to the foreclosure on the collateral.
A promissory note is an instrument which evidences the borrower’s indebtedness to the lender. It is the borrower’s promise to repay the lender and it is usually set up as an absolute and unconditional promise to repay based upon the occurrence of certain specified events. A promissory note generally contains the primary economic terms of the loan, such as the principal amount of the loan, the interest rate, the maturity date, and the terms of repayment. Depending on the terms and complexity of the loan, as well as a lender’s customary practice, the promissory note may be a very short document containing only a few of the key economic terms, or an extensive document detailing complex interest rate or payment terms. The typical real estate promissory note can be a negotiable instrument, but it does not have to be. In cases where a loan agreement is provided, often a short form promissory note is utilized and it will refer to the loan agreement for additional detail regarding the terms not fully stated in the note itself (which will make such note non-negotiable).
Deed of Trust
The deed of trust is the most widely used real property security device in Texas. Under a deed of trust, the borrower (grantor) conveys title to real property to a trustee as security for the debt owed to the lender (beneficiary). The trustee named in the deed of trust is most often an individual (often counsel for the lender or an individual at the title company). The trustee does not need to be a Texas resident. A deed of trust includes a power of sale permitting the trustee following an event of default to sell the property at a non-judicial foreclosure sale after complying with the statutory requirements governing such foreclosure sales.
The deed of trust must meet certain basic requirements. The deed of trust must be in writing, in English, and it must be signed by the grantor. It must describe the obligation that is being secured by the deed of trust. Typically, the deed of trust will include a reference to the obligations evidenced by the promissory note which are intended to be secured by the deed of trust, as well as a reference to the principal amount of the loan. Another critical element of the deed of trust is the description of the property that is to be encumbered by the deed of trust. The property must be identifiable, with common practice being to attach the full legal description of the property to the deed of trust. Most often, the legal description used will be that provided in the title commitment. The deed of trust must contain a power of sale clause. At a minimum the remedies should also allow the trustee to sell the mortgaged property at a public sale in accordance with applicable Texas law. The deed of trust must also be acknowledged by the grantor.
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