Cooperative Solutions for Distressed Projects
June 8, 2009
The current economy has resulted in many real estate projects that do not generate sufficient income to pay the operating cost of and the debt service on the project. Borrowers, unable to refinance and generate sufficient income, are looking for a way out. Lenders, trying to avoid keeping non-performing projects in their portfolios, are looking for ways to turn these distressed projects around. Borrowers and lenders need creative, cost effective solutions. In many situations, if the borrower and lender can work together, they can maximize the benefits for each. Transactions like deeds in lieu of foreclosure or “cooperative” foreclosures are becoming more common as they offer benefits to both a borrower and a lender.
"Cooperative” Foreclosures: A Cost Effective Alternative
For borrowers and lenders the word “foreclosure” sounds ominous. A “cooperative” foreclosure, however, can be a very cost effective solution for both the borrower and lender of a distressed real estate project. A “cooperative” foreclosure can be especially beneficial for a project which has a value equal to or less than the outstanding balance on lender’s first mortgage loan.
The borrower benefits from a “cooperative” foreclosure because it is relieved of the distressed project and its guarantors may be able to reduce their financial exposure. In addition, the time, administrative costs, and legal costs can be significantly less than traditional foreclosure proceedings or non-judicial workout alternatives. The lender also benefits from the reduced costs and shorter resolution time, but the most significant benefit to the lender may be the continued operation of the improvements on the real estate and a smooth transition which, for certain projects, is critical to maximizing the value of the project collateral.
The “cooperative” foreclosure is beneficial over other work-out solutions as the judicial process may create a greater protection against claims from subordinate creditors. This is a distinct advantage over a deed in lieu of foreclosure, in which subordinate liens remain [see discussion of Deeds in Lieu of Foreclosure]. A disadvantage is that it is a more public process, so it may not provide the confidentiality available with other solutions.
A basic “cooperative” foreclosure transaction may look like this:
More complex “cooperative” foreclosure transactions that deal with more than real estate will present additional issues not discussed above, such as those relating to subordinate creditors, employee compensation and benefits, tax matters, preferences and other bankruptcy considerations.
"Cooperative” Foreclosures: A Cost Effective Alternative
For borrowers and lenders the word “foreclosure” sounds ominous. A “cooperative” foreclosure, however, can be a very cost effective solution for both the borrower and lender of a distressed real estate project. A “cooperative” foreclosure can be especially beneficial for a project which has a value equal to or less than the outstanding balance on lender’s first mortgage loan.
The borrower benefits from a “cooperative” foreclosure because it is relieved of the distressed project and its guarantors may be able to reduce their financial exposure. In addition, the time, administrative costs, and legal costs can be significantly less than traditional foreclosure proceedings or non-judicial workout alternatives. The lender also benefits from the reduced costs and shorter resolution time, but the most significant benefit to the lender may be the continued operation of the improvements on the real estate and a smooth transition which, for certain projects, is critical to maximizing the value of the project collateral.
The “cooperative” foreclosure is beneficial over other work-out solutions as the judicial process may create a greater protection against claims from subordinate creditors. This is a distinct advantage over a deed in lieu of foreclosure, in which subordinate liens remain [see discussion of Deeds in Lieu of Foreclosure]. A disadvantage is that it is a more public process, so it may not provide the confidentiality available with other solutions.
A basic “cooperative” foreclosure transaction may look like this:
- Lender may require a pre-workout agreement setting forth the parameters and terms of the workout negotiations, the status of the loan and loan documents and any information lender will require from borrower to aid in its workout discussions.
- Certain due diligence is performed, including a title search to identify any subordinate lien holders that should be included in the transaction.
- Borrower and lender will negotiate the terms of the basic transaction agreement (i.e. the workout agreement), which may include: settlement of any personal guarantees; operation of the project; appointment of a receiver; allocation of liability; payment of debts for which there may be personal liability; transfer of property; settlement of deficiency or payment of surplus; and content and filing of court documents.
- Receiver, if applicable, is selected.
- The court documents are filed, including the Appointment of Receiver, if applicable, Foreclosure Complaint and Agreed Decree in Foreclosure.
- Transfer documents are executed, delivered and recorded.
More complex “cooperative” foreclosure transactions that deal with more than real estate will present additional issues not discussed above, such as those relating to subordinate creditors, employee compensation and benefits, tax matters, preferences and other bankruptcy considerations.
