Commercial real estate and hospitality loans start – and usually end with – paperwork. Loan documents create a blueprint for safeguarding the rights and obligations of a credit union. However, credit unions often fall into the “let the attorney handle it” trap instead of mastering loan documents. They believe the legal counsel will catch every nuance by acting as an infallible guardian. And this can prove very costly, in case a loan becomes troubled. Credit union leaders like you must ensure that no critical point slips through the cracks by taking ownership of the loan files. A clear understanding of every clause, default trigger, and covenant will help you gain psychological and legal leverage. In this blog, we help you master loan documents based on the insights shared by Steven Ellsworth, SVP of Portfolio Management at AVANA Companies.
Why You Must Understand Loan Documents?
When you approach an attorney, he/she knows you will not contact him/her after the problem is resolved. Hence, your professional relationship with the legal counsel remains transactional and reactive. You can make the legal review stronger only when you know the loan document in and out. The clear understanding will help you spot issues early, protect your portfolio effectively, and enforce terms confidently by answering these key questions.
- What was agreed to?
- What obligations do you have?
- What constitutes a default?
- And where are those items stated exactly?
Key Areas to Focus On
When understanding and reviewing loan documents, you must focus on specific areas. These focused areas will help you appear clear, prepared, and confident during communication with the lender and attorney.
Events of Default
This section is paramount in the loan document as your primary trigger for actions. This clause describes when you are considered in breach. An event of default may be failure to make payments, failure to provide financial information, or breach of covenants or representations. When you map the section chronologically, it will be clear which default has been breached and when you breached it.
Cite Clauses Precisely for Legal Impact
Your communication with the lender or attorney will become clearer when you cite specific clauses and sections in the loan document instead of giving vague references. For instance, you can reinforce your rights effectively by citing “Section 6, Paragraph 1A”. The precision will streamline your discussion while making you earn the respect of borrowers and their legal counsel.
Documentation as a Powerful Tool
When sending a default letter, lenders do not mention that you are in default. The default letter describes the exact reason by referring to particular clauses and sections. Hence, no room is left for the borrower’s excuses. There are instances when specific default clauses prompted stalled owners to resume payments almost immediately. You can use a well-referenced document as a robust communication tool and a powerful legal aid.
Working with Attorneys – Don’t Abdicate Responsibility
We advise you to address the legal issue by hiring a great attorney. But you must not treat the attorney as the sole safety net. You need to ensure that the attorney does not overlook critical points by following these best practices.
- Share with them the loan documents with key clauses highlighted.
- Provide a summary of defaults.
- Suggest the actions you believe are necessary, and ask for their legal review or validation.
In addition to strengthening the case, these best practices will help you save time and keep legal fees in check.
The Psychological & Legal Leverage
Hospitality loan resolution is part strategy and part psychology. The borrower will negotiate with you in good faith when he or she realizes that you have documented defaults and are ready to take necessary action. For instance, identifying that the cash-out proceeds were purportedly used for gambling, based on an insight gained during loan document review, may substantiate a claim that the non-payment resulted from willful misconduct rather than genuine financial difficulty. The informed and precise communication will help you resolve the case and prompt the borrower for compliance.
Lessons from the Field
Based on our experience in managing problem assets over three decades, we have seen that credit unions often rely on attorneys entirely to piece together missing facts. In addition to increasing legal costs and losing leverage, this results in delays that prevents credit unions from taking the required actions early and confidently. When you master the loan document, it becomes easier to press defaults, structure workouts, or initiate foreclosure without delays.
Conclusion
Loan documents drive troubled asset management by acting as your primary defense and offense. It becomes easier for you to protect capital and maintain an upper hand in borrower negotiations when you understand every clause in the loan document. Despite working with an attorney, you must strengthen the legal process by leveraging the insights gained through an elaborate loan document review. Need support in navigating complex CRE loan documents and managing special assets situations? Our portfolio experts can help you get ahead of potential defaults.
About AVANA CUSO
Established in 1998, AVANA CUSO is one of the most seasoned credit union service organizations (CUSO) with a focus on commercial real estate lending. Driving excellence through end-to-end customer service and our investments in technology, AVANA CUSO supports credit unions, including connecting them with commercial real estate entrepreneurs, brokers, and small business owners through participation lending. Our mission is to help credit unions diversify their lending portfolios by expanding their lending programs beyond local communities, mitigating concentration risk while enhancing loan to share ratios. Part of the AVANA Family of Companies, AVANA CUSO strives to improve communities by funding socially responsible projects that boost economic growth and foster job creation. AVANA CUSO is headquartered in Glendale, Arizona.