Editor: It is interesting that you are both in a "Workouts and Restructuring Practice." I understand that you have different backgrounds.
Barrow : Technically, I am in the Trial Practice Group and Glenn is in the Real Estate and Banking Practice Group, but we have a multi-disciplinary practice group that focuses on workouts, restructuring and lender liability avoidance and claims.
Editor: Is this a new practice group since the economy has taken a turn?
Reitman: We have recently set up our Workout and Restructuring Group. However, our firm has expertise in Real Estate and Banking, Tax, Litigation and Bankruptcy, with attorneys who have practiced in the cyclical downturns of the 1970s, '80s, '90s and our present downturn. We have been seeing a lot more workouts in the past six months, and we have been able to draw upon our firm's collective experience to help our clients in these workouts.
Editor: So you have been seeing the impact of this downturn on your clients?
Reitman: We have. We represent many banks that have been dealing with troubled loans.
Editor: What types of loans have been in "trouble"?
Reitman: They are primarily loans to home builders that are in trouble.
Editor: How do the home builders get in trouble?
Reitman: If a home builder cannot sell houses, then it will have problems repaying its loan. Home builder loans have an inventory component. The inventory component consists of loans for the acquisition of the lots which mature within a short period of time - six to nine months, generally. The idea is that once the builder starts to build a house on a lot it has more value, so within that six-to-nine-month period of time a builder can move a lot out of its inventory by starting the construction of a house. Once the construction of a house starts, there is a different maturity as this is now a construction loan for that house. The construction loan is repaid when the house is purchased. The problems really start when the home builder cannot sell its houses. When the home builder cannot sell the houses, its lots remain as inventory over the six to nine months and the home builder is than required to pay a "curtailment" payment or an extension fee. A curtailment payment is an amount that will reduce the overall principal of the line. It is a mandatory principal payment. So now that the home builder owes curtailment payments, it has to pay interest on the construction loans on the houses that have not sold AND the contractors and subcontractors are not getting paid. Essentially, when the home builder cannot sell its houses, the machine stops.
Editor: The machine stops when the home builder cannot pay its loan.
Reitman: Yes, but it may be a different scenario depending upon the loan. For example, a retail shopping center that has issues with its tenant's ability to pay rent would have different problems. As would an office building with non-paying tenants.
Editor: I see, there are different problems for different types of loans.
Reitman: Yes, and different approaches to resolve issues with other types of loans.
Editor: Generally, how will the banks deal with a borrower who cannot repay its loans?
Reitman: Each bank is different and each loan is different as well. Generally, the banks will try to resolve the issues with the borrowers before an attorney is involved, but we do not recommend this as Hunter can explain.
Barrow: Glenn's right. Generally, when you know that your borrower is going to have difficulties that may be beyond his control, as we have seen in the sub-prime market fallout and the current housing market, it is a good idea to get your priorities in order.
Editor: How can a bank get its priorities in order? Isn't a bank's priority to its customers?
Barrow: In a troubled loan situation, the bank's priority is getting its loan repaid whether by the payments from the borrower or a sale of its collateral. Another priority, which goes hand-in-hand with the first priority that I mentioned, is to ensure that the borrower does not have a cause of action against the bank.
Editor: How can a bank make sure that it is effectively handling a troubled loan situation and has its priorities in order?
Reitman: For the most part, banks already have procedures in place to deal with troubled loans, which include getting an attorney involved as quickly as possible. Generally, we advise our clients that if they are dealing with a troubled loan, whether it is a home builder, real estate, commercial or otherwise, the first thing they do is make sure they have a complete and accurate loan file. We also recommend that if it is bad enough, they use counsel for negotiations.
Barrow: Yes. This is important. Direct negotiations between a bank and a borrower working out a troubled loan is not wise. Words are misinterpreted and can be used against the bank in litigation. To protect itself, the bank needs to start anticipating litigation as a potential scenario. Unfortunately, a bank and its lending team must become vigilant in their approach with the borrower. The lending team may have experienced many years of good productive work with the borrower, but once everything starts to turn, the lending team has to understand that their words, acts and deeds can be used against them. It is then time to "circle the wagons," so to speak.
Editor: I imagine that this can be an issue for your clients?
Barrow: It is difficult, but very important.
Editor: So a loan officer calls you and tells you they have a troubled loan, what is next?
Reitman: We ask for the loan file to be sent to us and then we start a loan documentation review. This is a detailed analysis of the loan file - what is missing, errors or omissions, title search, review of insurance binders, etc.
Editor: Do you figure out what is wrong with the documents and go from there?
Reitman: Sometimes. The goal of the loan and documentation review is to understand what our clients' rights are and what we need to fix, if anything. Most of the time the title search can tell us what is going on with the borrower.
Editor: How is that?
Reitman: An updated title search will tell us whether any mechanic's liens have been filed, whether taxes have been paid, whether any judgments have been entered against the property, voluntary liens, etc.
Editor: After you have a better picture of the situation, what do you do?
Reitman: The next step is to form a strategic plan with the bank of how it plans to deal with the workout. Plans vary depending upon the issues and may change during negotiations. However, they always start with getting as much information from the borrower as possible and sending a detailed default notice to the borrower which preserves the bank's rights and remedies.
Editor: I can't imagine the borrower takes too kindly to default letters when they are already in a bad situation. How do they react?
Reitman: For the most part, they are expecting them. We have had quite a few threaten litigation fairly quickly.
Barrow: When the borrowers threaten litigation, a trial lawyer will get involved in the negotiations. For the most part, banks do not, for obvious reasons, respond well to threats of litigation. Most of our clients will then move the account from the loan officer to the bank's Special Assets Group. Essentially, it moves the account away from the person the borrower had been dealing with for the years it has had the account with the bank. This usually changes the tenor of the negotiations and the dynamic of the lending relationship.
Editor: How cautious should a bank be when exercising its rights and remedies?
Barrow: Most of the time, the rights and the remedies the bank can and will take against a borrower in a troubled loan are comprehensive, bargained-for rights and remedies that are in the loan documents. Everything from mandatory principal payments, as Glenn had mentioned, to sweeps of proceeds from the sales of houses are usually expressly provided for in the loan documents. As long as the bank enforces its rights and remedies, it can usually do so without worrying that its actions will be judged harshly by a judge or jury. Don't get me wrong, I am not saying that the borrower cannot bring a claim, because it can. However, for the most part, the claims can be defended successfully as long as the bank's behavior is in accordance with its rights.
Editor: What type of behavior is likely to increase the risk of liability for a bank?
Barrow: Typically, a borrower will try to claim that the bank is controlling the borrower's business and day-to-day operations. When the element of "control" is present, banks subject themselves to more viable and significant claims. Also, borrowers will usually rely on oral or written communications that are outside of the "four corners" of the lending documents. That is why it is critical that banks be sure to properly and professionally communicate with their borrowers in accordance with the lending documents.
Editor: What is the next step after the default notice?
Reitman: Usually a meeting with the borrower, bank and counsel for both will be in order so that they can sit down and determine the plan of action for the workout. It may be that we enter into a forbearance agreement where the bank will forbear exercising its rights and remedies under the loan documents as long as certain conditions are met. We recommend trying to enter into a forbearance agreement, but it doesn't always happen.
Editor: What do you do when that does not work?
Reitman: It depends. If the borrower and/or guarantors are adversarial, we will take measures to foreclose on the collateral and sue for a deficiency. As I said, it really depends. We sometimes help our clients sell the loans to other banks or other investors.
Barrow: Sometimes litigation or bankruptcy is inevitable, and our trial lawyers and/or bankruptcy attorneys will get involved.