Over the last few weeks, I’ve commented on the new version of the OCC’s Commercial Real Estate Lending Handbook (I give it a gentlemen’s C); and I listed a few legal topics that deserve some guidance from the OCC. “Guidance” could even merely be a list of important topics (ending with a warning that the list is NOT an all-inclusive list). I expect legal issues to be identified and put on the “check the box” list by the OCC  – with the banks expect to check the box. The "Blank" List   Unfortunately, instead of leading the class by at least listing legal issues associated with risks in commercial real estate lending, the OCC implicitly affirms those banks that under value and under utilize legal counsel.  (Let’s resist the temptation to comment on “why” this takes place.) Fortunately, some banks are very good at identifying and monitoring legal issues. Several of them do this by a simple two step process:

  1. List key legal provisions in loan documents
  2. Instruct legal counsel to report, in writing AND PRIOR to closing, if these provisions are altered

Here is a sample list (it is NOT an exhaustive or all-inclusive list):  legal counsel must report (in writing) any changes, from the bank’s standard form, in loan document provisions that cover the following –

  • grace period, late charges and default interest
  • prepayment, lockout and yield maintenance
  • transfer restrictions (due on sale) provisions
  • subordinate financing (due on encumbrance provisions)
  • material deviations in, or deletions of, the remedies provisions (unless required under the governing law of the state in which the collateral is located)
  • recourse provisions
  • environmental provisions
  • taxes and insurance premiums escrows
  • any reserves or other escrows
  • granting clauses or form description of collateral contained in such granting clauses (unless required under the governing law of the state in which the collateral is located)
  • casualty or condemnation provisions
  • addition of a provision allowing a release of collateral (unless expressly provided for in the credit approval)
  • lender approval process relating to amendments, renewals or termination of major leases (or new leases)
  • cooperation provisions, including use of any future technology required by lender (such as on-line reporting and delivery of required materials and information)
  • WARNING: __________ [this list is not “all-inclusive” and you should revise it as needed]

My suggestion is that every bank (or other lender) take this approach.  Surely at some point, the OCC will view this simple approach as a key to safe and sound banking practices. Please share you comments below.                

In an earlier posting, I reviewed the OCC’s new Commercial Real Estate Lending handbook .  The purpose of the handbook is to give parenting – I mean guidance – on risks inherent in commercial real estate lending.  On legal topics, the handbook takes a mind-boggling approach: it swings from legal light, to “I know it when I see it,” to neglect.   Even with this inconsistency, my main complaint with the handbook is that, with a few exceptions, it misses the opportunity to give bank examiners and lenders guidance on important legal topics.  Based on this, I give the handbook a gentleman’s C.  (One reader followed up with me, and gave it a D.)  As we all know, guidance often comes in a list (starting with your first “star chart” on the kitchen refrigerator). The OCC lending handbook needs a “star chart” on important legal topics.   In this posting, I’ll identify and list some of the legal topics that create risks in commercial real estate lending.  Of course, this is “not an exhaustive listing” – and you ou can add to the list (or chart) by commenting below. Topics in the list are not described in detail.  The value in the list is the indentification of some (but not all) of the more prominent legal issues, when little or no guidance is offered in the OCC Commerial Real Estate Lending Handbook.  The goal is NOT perfection – it simply is about being better. Fortunately, legal lists do not need to be created.  They are everywhere.  One place to start is by looking at topics covered by key legal education providers or by legal organizations at their annual meetings.  I’ll start with two of my favorites. At the annual meeting of the American College of Mortgage Attorneys, members (actually, “Fellows”) present papers and discuss legal issues of immediate importance to lawyers working on real estate finance transactions.  This is a top-notch group.  If they identify the following legal topics as important, then . . . this list is a good list.  Here are a few of the topics from the recent annual meeting (no priority order and with my comments in parentheicals):

  • credit enhancement tools: letters of credit (currently in disfavor); earnout provisions (stay away from subjective triggers); guaranty agreements (choice of law and service of process provisions are important); and master leases (you’re better off with a guaranty)
  • intercreditor agreements (never, ever use the “standard” form – craft it to the deal)
  • ground leases (approval of any changes to the ground lease by the mortgage lender)
  • golf course loans (a trap for the inexperienced; and be sure to include websites and other technology rights in the collateral package)
  • Islamic Shiriah loans (a trap for the inexperienced)

Recently, I’ve been speaking on legal technology at the University of Texas Law School’s Mortgage Lending Institute.  This annual seminar draws accomplished speakers on a wide variety of important real estate lending topics.  Again, here are a few of the topics presented at the seminar (no priority order and with my comments in parentheicals):

  • construction lending (lien waivers; payment and performance bonds; and full-funding conditions)
  • tenant subordination agreements (might not be needed if already addressed in the lease; lender will NEVER accept liability for anything arsising prior to lender acquiring full legal title to the project)
  • impact of oil, gas and other mineral interests (merely relying upon local drilling ordinances could be risky)

Every list, of course, should end with a statement that “this list is not an exhaustive listing.” In future postings, I’ll list other topics.  Right now you can locate other topics by using  the “search” function (near the top of the page) to look for information and my perspective on other issues. If you want to dig even deeper, “click” on the “Resources” tab (near the top of the page) for instructions on accessing Winstead’s on-line training and presentation materials. Again, use the comment field below to list some of our favorite topics.

Last month, the Office of the Comptroller of the Currency published the Commercial Real Estate Lending handbook (August 2013).  The 128 page handbook gives guidance to bank examiners and bankers on risks inherent in commercial real estate (“CRE”) lending.  It replaces a 95 page version published in 1995 (and revised in 1998). For this new school year and since commerical real estae lending is increasing in the “recovering” economy, I expected the OCC’s CRE lending handbook to grade-out with an “A+.” Instead, it is a solid, gentleman’s “C.” Make that a fraternity “C.”

Your Company is in this picture, too!
And probably make that a “C” for your company, too.   Like the OCC’s handbook, in many companies there is a disconnect or chasm between the business platform and legal issues undergirding the platform.  The “C” grade is NOT limited to the OCC and the banking sector. The OCC’s Commercial Real Estate Lending handbook takes an inconsistent approach in the role or importance of basic legal issues as a subset of risk management.  The approach swings from:

  • “legal light”: a few topics list legal issues and mention lawyers, but the topics are limited in number –
    • in the context of environmental risks,  handbook lists specific legal issues (p. 71)
    • the term “counsel” appears 5 times:
      • in the review of (ground) lease documents  (p. 53)
      • in assessing environmental risks (p. 70)
      • in the review of loan docs and other agreements “to determine if the improvement” comply with applicable laws and restriction (p. 104)
      • in the review of takeout agreements (p.107)
      • in the review of completion insurance bonds (p. 108)
  • “I know it when I see it – but you have to guess what I see”: some topics include the use of the phrases “legally bound” and “legally enforceable,” but with no guidance on “how” an examiner or banker is to verify or arrive at these legal conclusion (assuming the examiner or banker is not an experienced commercial real estate lawyer) –
    • what do these phrases mean or require?  They are not defined in the Glossary (Appendix C). Are legal opinions required? Does this require hiring a lawyer? If “yes,” this sidesteps the reality that most Companies are seeking ways to spend LESS money on lawyers.
    • similarly, the handbook contains references to “appropriate” loan documentation and “loan documentation policies.”  Again, what do these phrases mean or require?  Broad generalizations give no guidance on loan document provisions, and are not helpful in addressing or mitigating risk.
  • neglect: most topics simply do not include any reference to anything legal –
    • maybe for purposes of the OCC handbook, legal issues simply are outside the scope of the OCC handbook.  If this is the OCC’s approach, then legal issues should be disclaimed, with no mention of legal issues.
    • one of my problems with this “neglect” approach is that it denies reality.  Legal issues are part of the DNA of safe and sound lending, and risk management.  Banks and the OCC acknowledtge this by spending millions of dollars on legal services.  Indeed, guidance might even help to control legal fees.

My expectation was that the handbook would give lists of “no” change provisions, or a list of legal topics that need to be addressed (with the ability of a bank to explain any deviation from the provisions or list). Clearly, either I misunderstand the uses of the handbook, or the OCC missed an opportunity to give more meaningful guidance. Perhaps the gentleman’s “C” is too gentle. In future posts, I’ll describe a few of my favorite “no-no change” provision, and give an overview on current legal topics covered at several recent seminars. Please post your comments and perspectives below.

In many cities, urban growth now fills the farmland that once surrounded Navy and Air Force airfields.  Real estate development and finance near Navy and Air Force runways, however, requires special attention to a special set of restrictions called “AICUZ.”  These Department of Defense regulations severely restrict land located near military runways.  It is easy to overlook (or overfly) them in your review of real estate title, because they sometimes are implemented as zoning restrictions – and typically not expressly listed in the real estate title commitment or report. Think of AICUZ as “stealth” or hidden restrictions on the development and use of real property. As an Air Force brat, I literally lived under the sights and sounds of the F-86 Sabre, the F-101 Vodoo, the F-4 Phantom and the B-52 Stratofortress, with an occasional U-2. They were LOUD, but as Air Force brats, we barely noticed them.  (Ok, you always stopped to watch the U-2s).  (And yes, since Dad worked in base ops, I did sit in the cockpit of a U-2.) However, we did stop one day when the sound of an approaching F-101 didn’t have the usual rhythmic pulse.  The sound stopped us as the bird wobbled overhead, and then over the ridge line toward the runway. Almost immediately after the plane disappeared (on what Dad called “final approach” to the runway), the pilot popped up over the ridgeline (sitting in his seat), his parachute deployed, he lifted off the seat, next came a muffled explosion, and then a black cloud.     In a few minutes, a helicopter raced toward the spot where the parachute disappeared. We jumped up and down – we were part of the action!  Of course, no one believed any of this the next day at school. Today, reviewing title as part of financing a project will never has us jumping up and down – unless you fail to discover the AICUZ restrictions associated with the neighboring military airbase. Here’s how the City of Virginia Beach describes AICUZ: “The purpose of the AICUZ (Air Installation Compatible Use Zone) Program is to protect the health, safety and welfare from noise and hazards through compatible development in the airport environment. The program was instituted by the Department of Defense to address the problem of land development surrounding military air installations. It provides for the development and implementation of a plan to determine those land areas for which development should be significantly influenced by the operation of the airfield. These land areas are then designated as the AICUZ for that installation.” This depiction of the AICUZ south of the runway (at the Joint Reserve Base) in Fort Worth will help you understand the impact of an AICUZ: Fort Worth AICUZ at Joint Reserve Base (Thanks to Elizabeth Solender for bringing the Fort Worth AICUZ to my attention.) Next time you’re dealing with real property located near a military airfield, don’t overlook AICUZ restrictions. Missing AICUZ restrictions could be a “hard landing” for the profitability of your project. It could even turn the investment into a ball of smoke. If you have experience in dealing with AICUZ restriction, please comment below.

In some parts of the country, a recovering local economy means the special asset (or problem loan) groups are reducing staff, as loan production groups come back to life.  Leaving the special asset group under-staffed could be a mistake if the staff is not able to properly complete basic foreclosure tasks.  One basic task is inspecting the property prior to taking title to the property (whether through foreclosure or a deed in lieu of foreclosure [FAQ series for information on deeds in lieu]).  Here’s a decision tree that might help you in deciding if an inspection “really” is needed, and a recent example that should energize you to look before you leap (into ownership of the collateral).   Decision tree: verify that your mortgage loan documents give you the right to enter the property, then

  • Current Inspection Report: ask yourself this question: “when was the last time that someone looked at every part of the property?” If the answer is “more than a few months” then a current inspection should be a priority
  • Court Ordered Entry: if the borrower does not allow you to inspect the property, then investigate (with your lawyer) the available court orders that could give you access to the property (in order to inspect it)
  • Extraordinary Situations:  of course, there are situations where inspecting the property just is not possible, with the result that –
    • Foreclosure is the only option (for example, the lien itself is about to lapse or expire) (I’m having a tough time thinking of other justifications to not inspect)
    • Receivership is the better option (for example, you already know of problems and your presence on the property [during an inspection] could cause you problems)

Still not convinced that an inspection should be a top-shelf priority item? Once Upon a Time . . . The phone rings and you’re called to meet with City officials at the police precinct office near your “new” apartment project (shortly after you foreclosed on what seemed like just another project). At the meeting, you’re introduced to the Chief of Police and representatives from the Mayor’s office, the zoning department, the City health department and a lawyer from the local District Attorney’s office.   They vaporize you with a list of alarming health and safety issues at the apartments. The bottom-line message was simple: you have 30 days to show some “progress” on the issues or the City would take enforcement actions. Their list included the following:

  • an active farm growing illegal plants
  • sewage flowing into one of the units
  • on unit has a 50 foot hole in it, with dirt piled up to the window
  • organized dog fighting

As always, it is the basic stuff that jumps up to bite you.  (And gets the immediate attention of your insurance group.) Please share your comments below.  

Provisions in commercial mortgage loan documents,  where a particular state law is “selected” as the governing law, can drive a deal into a ditch, and take a good (or growing) lending relationship into the emergency room.  In many situations, this topic is a good example of over-thinking, and perhaps over-lawyering.

  • Simply stated, which of these two thinkers gets it right on using (or not using) choice of law provisions in a typical commercial mortgage loan?

  The choice of law topic is a very intellectually rich subject for lawyers.  Much is written about it.  Entire books.  It is a class topic for an entire semester in law schools.  It is a wonderful topic for lawyers.  It “invites” debate and discussion.  And confusion. However, lawyers who go to war over the “choice of law” provision (in commercial mortgage loan documents) are the poster child for those who argue for simplicity in contracts, and who view lawyers as deal inhibitors, and as creators of all things complicated. My perspective is that in the typical mortgage loan, there is no legitimate reason for this provision to be the subject of discussion.  There is no “choice” in choice of law.  The approach should be simple –

  • the mortgage loan documents should be governed by the law of the state where the project (the loan collateral) is located

Here are a few reasons supporting the two perspectives on this: Choice of Law Should NOT be the Law of the State Where the Project is Located

  • Quality Control: Mortgage lenders need to know that their loan portfolio has consistent terms (subject to the exception below).  Thus, all of the loans should apply the laws of a single state.
  • Easier to Manage: Using the laws of a single state makes it easier for loan servicing to make decisions.
  • Exceptions (creation & enforcement):  Of course, local state law must govern the creation of liens and the enforcement of remedies.  So, the choice of law must always have this exception.
  • He (She) Who Has the Gold Makes the Rules:  The loan is the lender’s money, and if a borrower wants to use it, then the borrower simply needs to do as told – accept this approach and close the loan.  The lender must be obeyed (if the borrower wants the money).
Choice of Law SHOULD be the Law of the State where the Project is Located
  • Quality Control:  In our age of technology, surely “quality” can be controlled by smarter uses of technology (for collaboration, reporting, etc).  Keep a list.  Share it.  Also, legal opinions on choice of law provisions (that select the law of another state) can be very expensive.  Let’s not lose track of this important point: the lender needs to lend money; and if the choice of law provision inhibits the deal, or increases legal fees or mucks up the closing process and experience, then the result could negatively impact the Lender’s ability to handle future loans from the borrower, or from others in the local market.
  • Easier to Manage:  Again, we’re well into the information age.  Access to laws of the 50 states is not difficult.  Collecting and sharing information about state law should not be a problem.  Again, let’s not get side tracked . . . the lender needs to lend money.
  • Exceptions: if and when the loan goes bad, taking the “exceptions” approach (where one state’s law governs some topics and another state’s law govern other topics) injects a level of complexity into an “already” bad situation.  Dealing with a troubled loan is difficult, and now it becomes even more challenging because the lender, the borrower and then the courts must become experts at implementing the choice of law provision.  Indeed, how is injecting this complexity a “good” thing?   Will a court handling the case correctly apply the law (as selected under the loan documents)?
  • He (She) Might Have the Gold But . . . No One Wants It:  Again . . . the lender needs to lend money.  Also the market understands that our system of governance allows States to have differing laws.  So, “why” should a lender try to “unify” them in a lending platform?  Does the market actually reward a lender for doing so?
Selecting the laws of the state (for all topics) where the project is located just makes sense.  And cents.
A simple thought.
Please share your thoughts below.

       

Lenders are refreshing their mortgage loan documents with provisions based on the “lessons learned” during the recent (continuing?) economic experience.  One change is to add a service of process provision. The change is based on this basic lesson learned: when the tough times hit, borrowers and guarantors sometimes are hard to find. A few simply disappear behind gated communities, on yachts, or regularly move from one remote estates to another – maybe intending to make it difficult for the lender to give them required legal notices of litigation or foreclosure (referred to as “service of process“).

Hide and Seek – in style
Or maybe this simply is a desire to get away from the stress of it all – leave the train wreck (1913 State Fair Trains Collide) for the lawyers.  Or perhaps just a final surrender to the wanderlust whisper. In response, many lenders now bake into their loan documents a provision where the borrower (and the guarantor) agree that legal notices (or service of process) will be given to a designated person (or company), who will accept those notices. So far, I haven’t had a borrower object to the provision. If you’re tired of spending money and wasting time in an adult version of hide and seek (or simply not wanting someone to do what you can’t do), then consider adding a service of process provision in your standard forms of documents for:

For other “lessons learned,” click this link (or use another search term). If you have comments, or your own suggestions, please comment below – then board your yacht or follow your wanderlust.

Email is killing us all. At our desks. Following us. 24/7. To survive, I try to manage myself and my e-mail with this approach:

  • watch the clock
  • use folders
  • automatically keep copies of sent e-mail in correct folder
  • when typing is talking . . . talk

Each of us needs to improve our use of the software on our desktops.  Better uses of it will improve our process – returning to us some time to actually think and effectively work. The main culprit or point of pain for many of us is email.  Email is killing us:

  • too much of it
  • wrong uses of it (example: people use it in “conversational” style, forcing us to waste time simply trying to understand it)
  • it is distracting (example: pulling us away from important tasks, and chopping up our time into inefficient pieces)
  • thought leaders sum it up: email is dead
  • it is our shared experience

Each of us learns to cope with email.  Email shapes our process, and often our attitude about our work. With our companies spending more and more on technology, and less and less on training us to use it, the “help desk” on using e-mail now is  a community effort: it takes place in our work groups and with others around our work stations – guerrilla style warfare.

  • we need email survival training
  • we need to share our favorite tips with each other

[Training & Sharing: In the mid-’60s, my Father went through a jungle training course in the Philippines on his way to what he still calls “Southeast Asia.”  (One survival school trick not offered up by the instructor: when the local kid finds you in the field [and they did], give the kid a battery from your flash light, and the kid won’t tell the instructor that he found you.)  He never refers to the Vietnam War, probably because  his helicopter unit abruptly left its in-country base when it “fell off the map” (it was over run).   The balance of his “tour” was based in Thailand – but after his unit officially  “disbanded” – giving him the opportunity to “covertly” visit neighboring countries (and the other one up “up north”), with added off-the-record benefits of wearing whatever clothes he wanted (but never a dog tag) for an extra $1,000 a month.  Sometimes is was “hot.”  Although he was trained going in, the most valuable lessons came from within the unit and from their very experienced passengers.]

  • is email changing you? slowing you down?
  • would your day improve if you improved your use of email?
  • what would you trade to become better at using email?  (30 minutes next Saturday, as you look for more tips on the internet?)

Here are a few email tips:

  • Watch the clock (not the email folder): only look at your e-mail for 5 minutes at the beginning of each hour
  • Email options: set up your email to automatically “save” a copy of each sent email in the folder from which the email is generated
  • Use folders
    • Create a folder system
    • After you read an email, then:
      • delete it, or
      • move it to your “Action needed” folder (if appropriate), or
      • move it to the deal or other folder
    • IMPORTANT: if you need to “reply” to an email, FIRST move the e-mail to the appropriate folder; and then send the “reply” e-mail (from that folder).  If you use my “email options” tips (above), then a copy of your reply email will automatically be saved in this folder.  No more lost time in dragging your email replies from your inbox (or from sent folder) into the appropriate folder.
  • Talk, Don’t Type:  if your use of email starts to look like a conversation, STOP the email exchange and call the person.
  • Other tips: search the internet for other e-mail tips.  BE AGGRESSIVE in becoming better at improving your use of e-mail.
Confession: I need to be better at all of this.
This fall, I’ll be speaking on technology topics at three different legal conferences (ACMA annual meeting; UT Law Mortgage Lending Institute; Texas State Bar Advanced Real Estate Strategies Course)  Portions of each presentation will focus on tips like these.  I’ll be sharing some of the tips here, too.
(If you’ll attend any of these conferences, let’s get together at the conference.)
If you have other email tips to share, please do so below.

Credit seems to be more available for commercial real estate.  For example, I know of one commercial real estate lender working on a construction to permanent loan program.  This type of lending blends two types of loans: a construction loan to build the project and a term loan to finance it once the project hits certain targets. If implemented correctly, a lender literally will capture market share.  And a borrower can save time and money by closing two loans at one time.  However, it has unique due diligence and documentation provisions, which are different from a construction to perm loan covering a home. In this post and in future posts, we’ll look at a few of these elements and provisions.  Understanding these should help you as you jump into offering or accepting a construction to permanent loan.  And, don’t forget to address or include the “lessons learned” over the past 4 years into the equation!     Some of the unique elements of a construction to perm loan:

  • Survey requirements
    • initial survey
    • foundation survey during construction
    • as-built survey as a conversion (and/or as a final advance condition)
  • Title insurance requirements, such as:
    • mechanics and material mans coverage
    • pending disbursement or down dates on draws
  • Casualty and liability insurance requirements
    • builders risk coverage
    • evidence of coverage by contractor(s)
  • Credit enhancement covering construction risk, such as:
    • Full liability of borrower until rental, loan to value andor debt service coverage thresholds
    • Guaranty of sponsor: full paymentperformance v. completion; and then merely bad-boy events; (one issue: does completion guaranty include merely shell or also tenant improvements?) (another issue: what are the requirements or conditions to migrating the guaranty from a 100% of the loan and project to merely covering bad-boy events?)
    • Letter of credit until rental, loan to value andor debt service coverage thresholds (another issue: how to handle letters of credit from tenants?)

I’ll cover more in future posts. If you have any comments on any of this, please do so below.

David Johnson and Joe Regan are sharing their knowledge and experience in the Financial Appellate Voice, a new blog focusing on litigation involving the financial services industry in Texas.

They start strong with a webcast and posts on these topics (these are just a few that jumped out at me):

David and Joe give first-hand accounts and comment on “real life” cases.  (But remember: each case or situation will differ; so, reach out to your lawyer for advice covering your situation.)

Take a look and add it to your Google Reader, or subscribe using your e-mail.