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When one envisions the negotiation of a bilateral mortgage loan, they usually picture a borrower and lender working closely together to resolve issues pertaining to the ownership and financial performance of the property, along with general conditions to the loan itself. On a syndicated mortgage lending transaction, however, there is a group of lenders led by an administrative agent, leading to a myriad of additional issues to be considered.
Each lender in a syndicated loan holds a separate component note from the borrower evidencing its interest in the whole loan. A participation is similar in many cases to a syndication, but a participant's interest is in a percentage of a given lender's note, and the participant has a legal relationship merely with the holder of the note rather than with the borrower directly. The relationship between the lenders and agent is documented in a co-lender agreement while the relationship between a participant and lender is governed by a participation agreement.
The administrative agent, usually also a lender, serves the lenders in an administrative role with lenders agreeing on how much discretion the agent actually has. Given the limited level of discretion, the lenders and agent will expressly agree that the agent is not a fiduciary on behalf of the lenders. Even in situations where the agent is itself a lender, the lenders are not able to legally rely on the agent with respect to advice and information being provided by the agent. The agent's responsibilities include providing the borrower and lenders each with a single point of contact; acting on behalf of the lenders within the confines of a co-lender agreement; requesting and tallying lender votes, as a secured party under the loan documents, enforcing the rights of lenders when directed by the lenders; and handling administrative functions, such as accepting and disbursing funds and maintaining all documentation pertinent to the transaction.
The issues to be discussed apply both to co-lender agreements in a syndication and participation agreements in a participation. In each case, the key questions broadly fall under four umbrellas: assignment and liquidity rights, consent rights, defaulting lender rights, and post-default matters. The importance of any given issue or its resolution will be impacted by the size of the loan or lending pool, the type of asset being financed, the experience of the agent, or a myriad of other factors relating to the transaction.
Without supporting a particular position, this article provides some perspectives of agents and lenders with respect to critical co-lender issues as the parties negotiate documentation.
Assignment & Liquidity Rights
Lenders and agents have competing interests with respect to the assignment of a lender's interest in a loan. Lenders would like the ability to freely assign all or part of their interest in a loan for various reasons, including reduction of exposure to a single loan, borrower, or geography, or because the loan is in default. An agent will have its own concerns with lenders selling their interests.
First, the agent will want to maintain some control over the pool of lenders to ensure the syndicate is reliable. This is particularly the case in a construction loan or other loan with future funding obligations, where the agent, lenders, and borrower are concerned with all lenders' willingness and ability to make funds available to complete the contemplated work or pay an earn-out. An agent will also want to avoid working with a particularly hostile or litigious lender, or a lender whose interests may not coincide with the rest of the lender pool. Further, a borrower may not want to work with a potential lender in cases where there may be funding concerns, relationship issues, or concerns with a potential lender that is a competitor in other areas.
These concerns can be addressed in a few different ways. Some agents or borrowers may require consent over prospective assignees. Alternatively, an "eligible assignee" concept narrows the universe of possible lenders to generally institutional investors such as banks, insurance companies, pension funds, REITS, or investment funds. Financial parameters may be built into "eligible assignee" definitions to ensure a given lender's capacity to fund. Parties may also choose to agree on a list of unacceptable assignees if there are specific parties with whom a borrower or agent would prefer not to work. Lastly, parties will usually agree that the borrower or its affiliates cannot also be a lender to avoid conflicts of interest.
Another liquidity concern is commitment size. An agent will often request that each lender hold a minimum amount or certain percentage of the overall loan commitment. The reasons here are twofold. Working with many lenders may be overly burdensome relative to the particular loan. Also, a size requirement prevents a lender with a relatively small interest in the loan from holding up the loan by withholding its consent in instances where unanimous lender consent is needed to approve an action.
Lenders will typically understand these concerns. However, the ability to sell smaller pieces of their commitment may lead to greater marketability of shares of the loan. Therefore, a lender may want to retain the ability to sell down its portion of the loan without having to sell their entire interest. To address these concerns, the agent and lenders may negotiate either a minimum hold or maximum number of lenders that is reasonably acceptable to everyone. Allowing a lender to participate its interest, while the initial lender maintains sole authority, responsibility, and legal relationship with the agent, may also provide relief.
Predictably, the lenders or borrower may insist on a minimum hold for the agent or certain key lenders. Borrowers like to know that the parties they initially agreed to work with remain in place to ensure consistency in their course of dealing. Lenders generally want an agent to maintain an interest in the loan, especially where the agent's team has underwritten and sold the loan to the various lenders, and those lenders have informally relied on the agent's expertise. Maintaining this relationship helps assure that the agent will act in the lenders' best interests. Some agents may push back on this requirement as it can restrict their liquidity.
Consent Rights
As stakeholders in the loan, lenders require some consent rights relating to the direction of the facility. There are two levels of consent typically seen in syndicated facilities: "required lenders" and unanimous consent. Required lenders typically means two-thirds of the non-defaulting lenders, but is, in some cases, as low as 50 or 60%, and if there are only two lenders, will typically require the consent of both in any case.
Required lender consent is typically required for the waiver of some or all events of default, credit-bidding at an auction, acceleration of the debt, consenting to a bankruptcy filing by the borrower or by the agent against the borrower, waiving prepayment premiums, or waiving insurance requirements. Other items that may be added include:
- Approval of material alterations to the property
- Approval of changes to a cash management structure
- Approval of major agreements affecting the property, such as a new property management agreement, major lease, or easement
- Appointment of a receiver
- Approval to changes in zoning or use of the property
- Waiving default interest
- Agreeing to financing following the acquisition of title
- Settling a material title, casualty, or condemnation claim
Unanimous lender consent is typically required for the most critical decisions, and will typically include credit items such as modifying the maturity date, changing the principal amount or interest rate of the loan, agreeing to defer the payment of the debt, cross-defaulting the loan with another loan, changes in the post-default waterfall, releasing a guarantor, or terminating or cancelling loan documents. Other items that may be included are the modification or waiver of financial covenants, entering into forbearance agreements, consenting to other debt secured by the property, and some items described in the prior paragraph as required lender decisions.
Determining which decisions require the consent of lenders and at what level is often influenced by a couple of factors. Borrowers and agents want quick action without having to wait for other parties to weigh in while lenders seek to protect their investment in the loan and its collateral by voting on material issues affecting the loan. Another concern, particularly in the case of unanimous consent decisions, is that any one lender can hold up an action that the rest of the lenders may want. This is particularly the case where a lender's interests are not aligned with the rest of the syndicate, such as a lender whose goal is to "loan to own" rather than to get repaid at maturity.
Sometimes the decision to foreclose or accept a deed in lieu of foreclosure is also treated as a unanimous lender decision, but that raises the risk that one lender will be improperly able to hinder or prevent a foreclosure. One alternative is for the co-lender agreement to contemplate that the agent will automatically be instructed to foreclose unless some threshold of Lenders instructs the agent not to proceed. Both lenders and agents need to be thoughtful about which issues require what levels of consent.
Most parties to a syndicate, and usually the borrower, generally prefer to resolve issues quickly. Loan documents will provide a set number of days for lenders to vote before their failure to respond is deemed to be a consent. Lenders will frequently request and receive a second notice period before a lender who failed to respond to a consent request is deemed to have given its consent. Typical response periods are between one and two weeks, with an occasional extra week given for a second notice period. There may also be cases where a non-responding lender is deemed to have withheld its consent, although this is less frequent. This variation helps ensure that a lender who does not affirmatively approve a consent request is not bound to a risk it did not intend to take.
Lenders can come to an agreement on most loan administration and servicing decisions, but in some scenarios, a deadlock may occur. Some co-lender agreements contemplate that if the borrower requests consent and a lender blocks the consent, then the borrower or agent has the right to require a non-consenting lender to sell out of the facility at par value to a replacement lender, a concept colloquially referred to as "yank a bank." It may be advantageous in many cases for a lender group and borrower to be able to move forward, but a notable drawback to a "yank a bank" provision is that it rewards a recalcitrant lender who wants to exit the facility. Further, this result may be hard to reconcile with the typical pari-passu treatment of lenders in a loan facility. In other co-lender agreements, an agent is permitted to use its judgment in the event of a deadlock, which again may allow the transaction to move forward; at the same time, however, this agent right effectively disenfranchises the lenders. Along the same lines, some co-lender agreements provide that a deadlock amongst the lenders during an event of default will be resolved by accelerating the loan.
Lastly, loan documents will typically provide for circumstances where an agent can be removed. As with other points, there is a balancing of interests, as removing an agent also affects the borrower. Lenders want to ensure that the agent is in the best position to represent their interests. The agent needs the ability to operate relatively freely. The borrower, meanwhile, who generally selected the agent, has an expectation of consistency unless there is a reason for the change.
Borrowers and agents will want a high threshold for the removal of an agent, perhaps including the borrower's approval of both the removal and the replacement agent in most cases where no event of default is continuing. The most typical cause for removal would be a non-appealable court judgment that the agent was grossly negligent or committed willful misconduct in administering the loan. Other common causes for agent removal include the failure to maintain a minimum hold or the failure to remain a lender, being a defaulting lender, or the agent no longer being in the business of originating, investing in, or servicing commercial mortgage loans.
Defaulting Lender Rights
Defaulting lenders are typically lenders that breach their duties to the borrower or other lenders under a loan agreement or co–lender agreement. Most frequently, the breach results from the failure to advance funds in a facility where there are future funding obligations or where the lender fails to make a protective advance. Typically, when there is a defaulting lender, the other lenders or the borrower will be permitted to fund the defaulting lender's share of the loan – provided, however, that the borrower can't be considered a lender if it funds the defaulting lender's share, and the defaulting lender will owe the funding party interest on the funded amount.
On a longer-term basis, loan documents typically provide disincentives for lenders to default since such defaults would have adverse effects on the borrower, the agent, and the other lenders. Those disincentives can come in three forms: forced removal, suspension of voting rights, and/or subordination of payments.
Co-lender agreements take a few different approaches to the forced removal of a lender, with some being preferable to others. Some co-lender agreements give the other lenders in a facility the opportunity to purchase the defaulting lender's share at a discount, which not only disincentivizes a lender from defaulting, but also incentivizes existing lenders to take over the defaulting lender's obligations and keep the loan moving forward.
In other cases, the defaulting lender is required to sell its future funding commitment—but not its already-funded commitment—to a replacement lender identified by the borrower or the agent. In this case, the defaulting lender will not receive repayment of the funds it has already put into the loan until the non-defaulting lenders have been repaid in full. This formulation is less helpful in a facility where there are fewer future funding obligations.
Another less-favorable option is to require the defaulting lender to sell its entire share of the loan. While this removes the defaulting lender entirely, it can also create an incentive to default for a lender who wants to get out of a loan by allowing it to be repaid in full prior to the other lenders.
Defaulting lenders can also be penalized by having their rights to repayment of the loan or payment of debt service subordinated. In other words, amounts funded by other parties in lieu of a defaulting lender will be repaid from funds that would have otherwise gone to the defaulting lender until those amounts funded have been repaid with interest. In some more draconian co-lender agreements, a defaulting lender will not be repaid at all until each non-defaulting lender has been repaid in full. Further, a defaulting lender will generally have its voting rights limited, and in some cases, suspended entirely. In any case, loan documents should provide that a defaulting lender will not be disproportionately affected by any waiver, amendment, or consent. This includes having the defaulting lender's commitment increased, maturity date extended, outstanding principal forgiven, or interest rate reduced.
Post-Default Matters
Agents and lenders need to agree on what happens if the loan goes into default. Therefore, the co-lender agreement should contemplate protective advances, a post-foreclosure plan, and the allocation of funds received.
Protective advances occur when the borrower stops funding money to maintain and operate the property, so the lenders advance their own funds to preserve their collateral. There should be some discussion about when an agent can require lenders to advance funds. Restrictions typically come in two forms: (1) a dollar threshold before which protective advances must be approved by required lenders and (2) limitations on the uses of funds that lenders are not required to fund. Some agreements may provide that advances not required for critical purposes are optional. Critical purposes may include the payment of taxes and insurance premiums, mitigating life or safety emergencies at the property, and preservation of the agent's lien on the property.
If the lenders take ownership of the property following a foreclosure, a single-purpose entity owned by the lenders according to their pro-rata shares of the loan and managed by the agent would typically hold title. Co-lender agreements will typically dictate the course of action to follow, including the rights and responsibilities of the lenders and agent. A co-lender agreement may provide direction regarding agent-reporting, the hiring of professionals to operate the property, additional contributions of funds, and matters requiring lender approval, which will typically be analogous to those items requiring lender approval under the loan documents. Further, the co-lender agreement should also provide an exit strategy with respect to marketing the property to enable lenders to recover some or all of their investment.
Finally, the co-lender agreement should contain a post-foreclosure waterfall showing the order of priority for payments received by the agent from the property as ongoing income or from the ultimate disposition. The agent should always be disbursing payments on a pro-rata basis, with defaulting lenders being subordinate to non-defaulting lenders. While waterfalls may vary slightly, the agent is typically reimbursed first for its out-of-pocket expenses incurred in administering, servicing, and enforcing the loan or managing the collateral, and then the agent and lenders are reimbursed for protective advances. After the agent disburses these amounts, it will pay interest, fees, and principal to the lenders.
Conclusion
As noted earlier, this article is not advocating for a particular position on the issues discussed herein, as their resolution will be dictated by the specifics of the loan and syndicate. The consideration of each of these issues by the parties to a loan transaction will enable them to negotiate and understand all aspects of a co-lender agreement thoroughly and successfully.
Originally published in Bloomberg Law
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