Navigating the Storm: What Secured Creditors Should Know About Distressed Commercial Real Estate

August 29, 2023

By: Daniel J. Garfield

Distressed commercial real estate presents a challenging landscape for secured creditors, demanding careful navigation to protect their investments. Understanding the key concerns in these situations is vital for safeguarding those interests.

In the face of default, secured creditors must be prepared to initiate legal actions to recover their funds or otherwise resolve the borrower’s distress. However, the declining value of the property may limit the ability to recoup the entire investment. In dire circumstances, foreclosure may become the only recourse, leading to a costly and time-consuming process. Careful secured creditors will have a plan in place before default occurs. Engaging legal and other counsel early in the process is important as well.

Forbearance Agreements
Forbearance agreements serve as a means to address short-term financial difficulties faced by borrowers. By suspending or modifying loan payment requirements or other obligations temporarily, these agreements provide breathing room for the borrower to stabilize its financial situation.

For secured creditors, forbearance agreements can offer several benefits. They provide an opportunity for the borrower to regain financial footing, increasing the chances of repayment. Further, they can allow secured creditors can preserve the value of their collateral and avoid the costly and time-consuming foreclosure process and other litigation.

When negotiating forbearance agreements, certain key elements must be addressed:
Payment Suspension or Modification: Forbearance agreements may suspend loan payments for a specific period or modify them to make them more manageable for the borrower. This temporary relief allows the borrower to focus on stabilizing their financial situation.

Duration: The duration of the forbearance period should be clearly defined in the agreement. It can range from a few months to a year or more, depending on the circumstances. The agreed-upon timeline provides clarity for both parties.

Conditions and Requirements: Forbearance agreements may include conditions that the borrower must meet to qualify for relief. This can include providing financial documentation, adhering to a repayment plan, or fulfilling other specific obligations.

Reporting and Monitoring: Secured creditors often require regular reporting and monitoring during the forbearance period. This ensures transparency and allows the creditor to assess the borrower's progress in meeting the agreed-upon conditions.

Lender Remedies
When faced with a default situation, secured creditors possess various remedies to protect their investments. These remedies empower them to take legal actions to recover the outstanding debt and mitigate potential losses. Here are a few common remedies:

Foreclosure: Foreclosure allows secured creditors to force a sale of the distressed property to satisfy the outstanding debt. It involves a legal process that may vary depending on jurisdiction, requiring compliance with specific timelines and notice requirements. Experienced attorneys can guide secured creditors through the foreclosure process, maximizing their recovery options.

Receivership: In some instances, secured creditors may seek the appointment of a receiver to manage the distressed property. A receiver acts as a neutral party, ensuring the property’s value is preserved and potential revenue is maximized during the resolution process.  Because the secured creditor gets to nominate the specific receiver, receivership allows a highly-tailored solution to a complex problem.

Deed in Lieu of Foreclosure: A deed in lieu of foreclosure is an alternative to the formal foreclosure process. In this scenario, the borrower willingly transfers the property's title to the secured creditor, effectively satisfying the debt. This remedy provides a streamlined resolution, avoiding the costs and time associated with foreclosure.

Loan Workout: Secured creditors can engage in negotiations with the borrower to develop a loan workout plan. This may involve modifying loan terms, restructuring repayment schedules, or exploring other mutually beneficial arrangements. Loan workouts aim to help the borrower overcome financial challenges and protect the secured creditor’s interests.

Bankruptcy, in particular, poses significant challenges to secured creditors, reshaping the landscape and affecting the rights and positions of secured creditors. When a borrower and secured lender cannot resolve a default, bankruptcy (or the threat of bankruptcy) can be a powerful tool for the borrower.  However, it can also be expensive and potentially risky and will subject the parties to making their claims and arguments public.

Bankruptcy’s automatic stay provision emerges as a formidable obstacle, freezing all collection efforts, including foreclosure proceedings and cash sweeps. The existing owners and management team typically stays in control of the collateral, but must continue to ensure that all expenses during the bankruptcy are paid timely. The building can be sold free and clear of all liens, giving buyers comfort that they are buying a property with a relatively clean title.