Crain’s Cleveland Business – Review that mortgage loan commitment if you are a guarantor

Perhaps you are an individual member, or your personal trust is a member, in a limited liability company that owns a performing commercial real estate asset.

Let’s say the LLC has made an application with a lender for a loan to acquire or refinance an existing loan on the real estate.

Unless you are the manager or managing member of the LLC, you may have little or no input into the terms of the guarantee of the prospective loan that you will be required to give.

Even if you assume the role of manager or managing member, your focus may be more on interest rate, term, amortization and required financial covenants.

However, in the event of a loan default, the loan approval will generally require full recourse to key principals of the LLC (that’s you!).

So what do you need to focus on in the loan commitment or proposed term sheet?

If the prospective lender will be originating the loan to hold in its portfolio as an asset, most likely you (or your personal trust if you have transferred significant assets to it) or both will be required to give an unconditional guaranty of payment.

If the LLC does not satisfy its obligations under the loan documents to repay the loan, the lender will want the ability to recover all sums from you and, if there are other guarantors, from them on a joint and several basis.

That means that even if you are only a part owner of the LLC, you may have to pay the entire debt.

To protect against this you should request that the lender cap your exposure either as a maximum amount of or a percentage of principal due as of the event of default triggering your payment obligation.

If the lender will not provide a loan on that basis, you should require a contribution agreement from your fellow LLC members. If you have to pay the lender more than your percentage interest, the other members of the LLC will be required to reimburse you for the overage. Of course if the other members are not as creditworthy as you are, you have a problem.

If the prospective lender originating the loan intends to sell the loan into the securitized market — i.e. the LLC’s loan will be put placed in a pool and sold to investors — your guaranty will be significantly different. 

The lender will require significant control over the cash flow as well as the condition of the commercial real estate itself.

Your guarantee will have two separate components. You will be typically responsible for losses suffered by the lender arising out of:

• Fraud, intentional or material misrepresentation
• Gross negligence or willful misconduct
• The removal or disposal of any personal property or fixtures after an event of default, unless any personal property that is removed or disposed of is replaced with personal property of the same utility and the same or greater value
• The misappropriation, misapplication or conversion of any insurance proceeds paid by reason of any casualty or any awards received in connection with a condemnation
• The failure to deliver to the lender upon foreclosure any security deposits, advance deposits or any other deposits collected
• The LLC’s failure to obtain and maintain in full force and effect required insurance or to pay any taxes or assessments affecting the property
• waste

All of the foregoing are commonly referred to as the “bad boy” covenants.

So far, you as the guarantor are quite comfortable that the manager of the LLC would never do any of those things and it is only the actual loss suffered by the lender that you have to worry about.

However, you as the guarantor may be liable for ALL of the debt to the lender if

• The LLC fails to maintain its status as a single purpose entity as required by the loan documents
• The LLC fails to obtain lender’s prior consent to incurring any additional debt
• The LLC fails to obtain lender’s prior consent to any transfer of the real estate or any membership interest in the LLC
• The LLC files a voluntary bankruptcy petition or consents to an involuntary bankruptcy

Also, if you have signed an indemnity agreement relating to the environmental conditions of the real estate, you may have liability beyond the amount of the loan.

You need to also review the requirements regarding guarantor financial covenants and reporting.

Most lenders will require a guarantor net worth covenant and a liquidity covenant.

Determine at the loan commitment, term sheet or application stage how those financial covenants are calculated.

Can you include joint assets with a spouse? Can you count retirement assets? Determine what financial reporting will be required. Will you be required to provide a global real estate holding report? What is the format for personal financial statement reporting? What are the deadlines for providing these reports and copies of your tax return?

Whether you are the manager of the LLC or merely a member of the LLC, it is extremely important to understand at the loan commitment, term sheet or application stage what your obligations as a guarantor will entail.

In the discussions surrounding the structure of the loan, none of the loan parties ever believe that the guarantors will be called upon to make the lender whole.  It is extremely difficult after the loan is approved or the terms are agreed upon to change the guaranteed obligations.