Of Strictures & Structures

Just as there's no free lunch, there are no free loans. That's the essence of the effort that borrowers and lenders have been making for several years now to cope with troubled commercial real estate loans. As attorneys who have been on the front line of distressed debt tell DAI, restructurings-no matter how creative or inventive they may be-always come at a price. In the words of Gordon Gerson of Gerson Law Firm in San Diego, the best and simplest way to restructure a distressed loan permanently is with new capital, either from the borrower or from another source. Otherwise, the restructuring is almost always a temporary measure like the extend and- pretend approach that has become an industry clich é. As Dennis Russo of New York City based law firm Herrick, Feinstein LLP sees it, "there's no one-size-fits all solution for borrowers who are struggling with debt. A solution that works for one borrower may not work for another, and many solutions come at a price. In that sense, there's rarely a silver bullet or magic wand." Nonetheless, "if you're analytical and reasonable, there may be maneuvers worth trying," says Russo, who is co-chair of the commercial real estate department at Herrick, Feinstein. As an owner-developer, Russo gained real-world perspective on borrowing in the late '80s and early '90s. He cites a number of approaches that may or may not work, depending on the borrower, the specific loan documents and the property itself. These include forgiveness of debt, lowering the interest rate, having the lender take a back-end piece of the deal, finding another lender to take out the original lender, putting the project into bankruptcy or finding a third party to take pay down the debt in exchange for equity.

On forgiveness of debt, Russo advises: "Be careful of the tax implications if part of your debt is forgiven. If the forgiveness isn't structured properly, you'll have to recognize the forgiveness as income and incur a tax liability that you can ill afford."

A lower interest rate will lower payments now, but such an approach may involve the unpaid interest accruing on the back end of the loan when, the lender and borrower both hope, the borrower will be in a better position to repay the loan.

Asking the lender to take a backend piece of the deal won't work with a traditional bank, Russo says. "But if your lender is something other than a traditional bank-a fund, for instance-they may be interested in an equity piece in exchange for giving you a more favorable loan in the interim."

Finding another lender to take the original one out of the deal may not come with terms as favorable as the borrower would like, "and the original lender probably has to be willing to be taken out at a discount," Russo says. "Because the rate may be higher, it has a flavor of the borrower's doubling down on his bet, but it may act as a float or bridge to get a borrower through a rough patch on an otherwise viable project." Bankruptcy for the project, or more precisely for its special-purpose entity, is likely to trigger a personal guarantee because "most loans come with springing guarantees," Russo says. The benefit of a bankruptcy is that a borrower can possibly force the lender to take the court's terms, which may mirror or at least approximate the borrower's desired terms. "But a bad-boy guarantee would tend to put the borrower personally on the hook for the loan, and that's something to be avoided," Russo points out.

Finding a third party to pay down the debt in exchange for equity also has its pitfalls. As Gerson points out, although new equity coming into a project is "what lenders want to see most," a capital infusion usually means new money coming in from new investors. "Based upon the way loan documents are written, you sometimes can't have new money coming in that becomes a controlling interest in the property because this might trigger a default under the loan documents," Gerson explains.

When it comes to new capital coming into the project, Gerson points out, whether the loan is with a CMBS source or other types of lenders is crucial. "Other lenders might be more receptive to restructuring in ways that are just not possible with CMBS," he says.

For example, "special servicers in most cases won't allow another source of debt," says Gerson. That's because of restrictions in the loan documents and terms of the pooling and servicing agreements that limit what the special servicers can do when the loan is in default. "That's why, clearly, it's a lot easier for a life insurance company, a bank or a credit union to modify a loan than it is for a servicer of a CMBS loan," he says.

Russo points out another obstacle to restructuring CMBS loans. "Special servicers are so overwhelmed by the number of troubled loans they're servicing that they simply can't give each loan prompt or in-depth attention," he says.

One solution is to mine longstanding relationships. "It helps if you know someone who can get your asset to the top of the pile. It's worth a try to see if you can go through channels, especially back-channels, to get the servicer at least to look at the debt and see if anything can be done to restructure it."

According to Gerson, all of these approaches generally fall into one of three categories. One is a restructure in which a loan becomes interest only, the interest rate is reduced for a period of time or the lender grants other temporary concessions. "Seldom, however, will the lender simply agree to waive rights to receive principal, and particularly in the CMBS world that's somewhere between virtually impossible and not possible," Gerson says.

Another category, as Gerson and Russo both explain, is an infusion of new capital either from the borrower or another source.

The third category is cases in which a lender will grant concessions if the borrower agrees to make improvements to the property. "The lender may give some debt relief or be induced to do a loan restructure if the borrower will do things to increase the value of the property," Gerson explains. "As bad as it is for the lender not to receive full payments on the loan, even worse is for the asset to be depreciating in value-not because of market conditions, but because of deferred maintenance."

Both Gerson and Russo indicate that borrowers stand a better chance of winning concessions from lenders if they can show that the distress is temporary and can be corrected. Says Russo: "The best way to convince lenders that a project is viable, and therefore worthy of being considered for debt restructuring, is to show that some temporary condition is causing the inability to meet the payment schedule." As examples he cites the loss of a major tenant, the likely renewal of leases in any rental setting, litigation that will be resolved over time and markets that have softened but appear poised for an eventual rebound. Ultimately, Gerson says, "Borrowers need to show that they will have either new capital or new sources of revenue, which means tenants."

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