Decision tree: verify that your mortgage loan documents give you the right to enter the property, then

• Current Inspection Report: ask yourself this question: “when was the last time that someone looked at every part of the property?” If the answer is “more than a few months” then a current inspection should be a priority
• Court Ordered Entry: if the borrower does not allow you to inspect the property, then investigate (with your lawyer) the available court orders that could give you access to the property (in order to inspect it)
• Extraordinary Situations:  of course, there are situations where inspecting the property just is not possible, with the result that -
  • Foreclosure is the only option (for example, the lien itself is about to lapse or expire) (I’m having a tough time thinking of other justifications to not inspect)
  • Receivership is the better option (for example, you already know of problems and your presence on the property [during an inspection] could cause you problems)

Still not convinced that an inspection should be a top-shelf priority item?

Once Upon a Time . . .

The phone rings and you’re called to meet with City officials at the police precinct office near your “new” apartment project (shortly after you foreclosed on what seemed like just another project).

At the meeting, you’re introduced to the Chief of Police and representatives from the Mayor’s office, the zoning department, the City health department and a lawyer from the local District Attorney’s office.   They vaporize you with a list of alarming health and safety issues at the apartments.

The bottom-line message was simple: you have 30 days to show some “progress” on the issues or the City would take enforcement actions.

Their list included the following:

• an active farm growing illegal plants
• sewage flowing into one of the units
• on unit has a 50 foot hole in it, with dirt piled up to the window
• organized dog fighting

As always, it is the basic stuff that jumps up to bite you.  (And gets the immediate attention of your insurance group.)

Please share your comments below.

Take another look at your mortgage loan forms with these questions in mind, and ask yourself if the forms are “as old as dirt.”

My bet is that you won’t like the answers to the question.  (Yes, it’s even embarrassing.)

Do your mortgage loan documents cover:

• third party (or “cloud”) documents storage?
• require lender consent to any use of electronic (eSign) documents with tenants and vendors?
• address use or surrender of internet or social media tools (such as websites, Facebook, etc.) upon a loan default?
• turnover of hardware and data used in the operation of the property?
• due diligence (check list items) on technology contracts used in the operations, marketing or leasing of the property?
• continuation of these contracts following foreclosure (or deed in lieu)?
• what kind of new defaults and remedies are needed?
• annual listing of technology contracts and third-party services?
• using e-mail as a permitted method of giving “notice?”
• require a borrower to cooperate if and when lender implements new technology tools (such as online reporting)?

Of course, this is not an exhaustive list.  My list seems to grow every few weeks.

I recently spoke on this topic at the Texas Bar Advanced Real Estate Drafting Course, and later this summer, I plan to do a webinar series on this topic.

If you have questions to “add,” please comment on them below.

It’s a party.

My perspective is that lawyers soon will be invited to participate in the party.

But right now – despite all of the hype of lawyers as being “important business partner and advisers” –  lawyers are sitting out the dance.

Left behind at the curb.

Think about all of the investment and energy on this topic, yet so little of it is directed at using (what seems to now be a fundamental tool) to achieve greater connection and more information from company lawyers (whether in-house counsel or outside law firms).

In the last month, I”ve talked with two significant companies about ways to include lawyers in this fundamental topic.

Here is a screen shot of my “mindmap” overview.

Questions for you:

• are you seeing this, too?
• where is this going?

My perspective is that lawyers soon will be joining the party, and will no longer be left behind at the curb.

Please give share your comments below.

Here are my observations on distressed commercial real estate in 2012:

Lessons from 2012:

• Realistic Expectations:  Borrowers no longer dreamed of a magical workout leading to a better day – a day when the white knight (i.e. the dream tenant or the long-forgotten millionaire Aunt) would show up and instantly transform the project from pauperville to profit city.   Investors no longer expected lenders to increase the pace of resolving distressed commercial loans.
• Regulators in No Big Hurry:  From life insurance companies to banks, regulators continued the course traveled the year before (and the years before) – pushing lenders to resolve loans with an eye toward avoiding pushing the lender into failure.  Prudence won over pushy.  Interestingly, I didn’t hear a lot of complaining about this approach.
• Loan Originators Paying Attention:  For the loan originators who returned to the “positive” side of the ledger (and now are origination commercial real estate loans), they are much more knowledgable and attentive to issues that are problematic when a deal goes bad.  Issues are spotted, evaluated and handled.    Sure, this point is difficult to quantify.  (Who would ever admit it?)  And the conversations are handled discretely.  It is refreshing.

Predictions for 2013:

•  Better in Job Growth Markets:  generally, 2013 will look a lot like 2012 with this exception – job growth markets will allow the “marginally” distressed deal to escape the death spiral.
• The Same . . Just Less of It:  for all other markets, the slow-mo approach will continue.  It is progress in that the bad-deal inventory is being moved off the books of lenders. So, in 2013 we’ll see . . .
• The New Jobless:  New loan production will not be healthy enough to employ all of the talented professionals who no longer are needed to handle distressed commercial real estate loans.  This one really hurts.

Please post your comments below.

Next up: lessons on technology from 2012 and predictions for 2013.

New commercial real estate lending started to come back in 2012.  Finally.

Here are my observations on the distinctive attributes of this come back, and my prediction of what it will look like in 2013:

Lessons from 2012:

• Tough Love: Loan documents are longer, and tougher.  Lessons learned from the tough times now are included in many base commercial real estate forms.  (I’ll comment on these in the future.)
• Rose Colored Glasses: Unfortunately, the “return” of lenders (and liquidity) to the market and the expectation of borrowers looks like this – a train wreck.  Parked in the workout group during the tough times, loan originators return to loan production with fresh memories of tough loans characterized by inadequate underwriting, bad documents and inadequate personal liability.  On the other hand, the strongest borrowers are flush with cash and are willing to place it into the project, with the expectation that the lender will reward the wise decision with reasonable terms and limited personal liability.  These different perspectives collide during negotiations of the loan documents.  It is not pretty.
• Fewer and Newer:  In comparison to 2007, there are fewer lenders in the market.  However, many “new” lenders are entering into new commercial real estate finance markets.
• Something for Almost Everybody:  Yes, some real estate products remain tough to finance (office, retail); but over the last half of 2012 I worked on a broad range of commercial real estate -

- unsecured (registered) notes to a regional grocery chain
- forms for a new (production) single family builder program (multiple states)
- construction loans for senior living projects (multiple states)
- permanent loans (multiple states) (office and retail)

Prediction for 2013

• More of the same.  Not flood waters more; but a steady, gradual improvement.

Over the next week, I’ll comment on my 2012 experience with distressed commercial real estate, and then the growing (and latent) impact of technology on investing in (and working with) commercial real estate.

I hope that 2012 found you improved over 2011.

Happy New Year.

Bad loans go to the penalty box

MEAF takes a mind-bending approach in determining the amount of capital that must be set aside (as a loan loss reserve) for a bad commercial real estate loan.  Under MEAF, loss reserves are based on a formula that “includes a moving eight month moving ratio of company to industry experience with minimum to maximum limits.”  (Instructions for Life Risk Based Capital Formula (MEAF) risk based capital).  This comparison of company losses to the industry means that a few of bad loans could generate (via the formula) a total loss reserve well in excess of the actual losses from those few bad loans.

This plays out as follows (and has been the story for life company holdings of commercial mortgages over the past few years):

• they avoid recognizing defaulted commercial real estate loans
• they hyper monitor loans in tough markets and over the last couple of years prior to maturity
• for loans that could go into default, or be tough to refinance at maturity, life companies will sell the loan PRIOR to either event – even if the sale is at a loss (i.e., not at par)
• recognizing that the MEAF approach has a draconian effect, the NAIC set floors and ceilings on the MEAF formula during 2009-2012

Why the incredible low number of defaulted loans on the part of life insurance companies in recent years?  MEAF is part of the answer.

The suggested approach will be similar to the process used to assign capital charges to corporate bonds.

With cost of funds for banks at an all-time low (i.e., zero and almost zero), it will be interesting to see  whether this change (if it is passed by the NAIC and adopted by the states) will at least partially level the playing field for life insurance companies, as they compete with banks for the best commercial loans.  At the very least, it could level the playing field at the investment committee in a life insurance company (as mortgage lending competes with corporate bonds for investment allocations).  And it could mean more liquidity for the commercial real estate market.

It also will mean the “end” of the “deals” for those who have been buying these loans from life insurance companies.

Please share your comments and perspective below.

Here are some observations on how I foster collaboration by the layout of my new office and the hardware on my desktop.  The goal, of course, is to be better, smarter and faster.

For those who follow me here at L360, you’re probably asking: “what’s going on this month? Why so few posts?

The answer is two-fold: in the last 3 weeks -

• I’ve given two presentations on (i) “how” lawyers should better use technology and (ii) the technology trends that will impact lawyers.  Each presentation was for a different audience (the annual meeting of the American College of Mortgage Attorneys and at the University of Texas Law School’s Mortgage Lending Institute [MLI]).  This Friday, I’ll give the MLI presentation a second time, but in Austin.  These presentations are a great opportunity for me to sharpen my vision on the ways technology will allow lawyers to work more efficiently, to bring more value to their clients and to collaborate with clients and each other.
• My law firm (the Dallas office) moved out of one building and into another one.  This is my first move into another building since 1989.  Of course, “how” we work has changed immensely in the 23 years since 1989.  This is an opportunity for me to change the physical attributes and layout of my office and my desktop, in order to be better, smarter and faster.

Today is the third day after the move.   A walk around the floors, and peeks into the other offices,  clearly shows that my brain works . . . differently . . .  than . . . anyone.  (Or at least my office looks very different from the other offices.)

My new office focuses on collaboration as the path to better, smarter & faster. (read Tom Mighell and Dennis Kennedy’s book).  Some of this might work for you:

• No desk.  Instead, I have a small, round table with chairs (4 chairs – once we “find” the wayward fourth chair).  The table will be kept clean and used for team meetings.  It gives us a place to meet, independent of other meeting rooms.  I use an elevated (electric) computer table as my “stand up desk.”   I still can sit on a stool at the elevated computer table, or use the small table.  However, I never write down information; instead, I’m typing notes, e-mails, document changes, etc.  It is 100% electronic.
• Stand up work “desk.”  The elevated work “desk” allows 2 or 3 of us to look at documents, maps, plats, and other resource materials (online).  This results in “real time” discussions, decisions and work product.
• Two large (19″) computer monitors on the stand up work space.  Now we can have multiple items in front of us.  For example, when I review work, no one hands me a piece of paper.  Instead, we pull it up and black line it to show the suggested changes.  On the 2nd screen we make any modifications to the document.  No passing documents with hand written markups.  This is ”real time learning” followed by quick execution.
• Separate notebook computer.  The “stand up” work space is large enough to allow me to also use my MacBook Air, which now gives us yet another tool to access documents, maps, plats and other resource materials.
• Small projector & larger meetings.  If needed (larger groups or simply needing a larger screen or viewing area), I have a small (2oo lumens) Acer K-11 projector, which allows us to all look at the same content (documents, maps, plats and other materials).  I’ll connect my small projector to my MacBook Air, which will throw the desktop onto the wall.

This layout should achieve my goal: an office where the team, as a whole, will be more efficient and with better collaboration, our work product will be enriched.

If you have any suggestions, please comment below.

Three Defining Points.

The first defining point burdens all lawyers.  The second continues to divide them from their clients or customers.  And the third is simmering and heading to a boil.

Let’s see if you can identify them.

1.  Who said this?  “First thing we’ll do, we’ll kill all of the lawyers.”

With this line, the Bard captured the hostility of the underclasses toward those who understand, and perhaps manipulated, the law; and in turn enriched themselves. It is spoken from the perspective of those powerless to effectuate change.  The next defining point triggered a change that transformed this perspective to almost all buyers of legal services.

2.  Name the Gang of 9 who doomed the legal profession to the billable hour?

They know it when they see it, and they didn’t like what they saw.  This ruling in 1975 began the slippery slope of the hourly rate, alternative fee arrangements and most importantly, increasing friction between the legal profession and clients. In time, Shakespeare’s line returned, but now with a new focal point by a broad cross section of buyers: legal fees, legal fees, legal fees.

3.  Rock, Paper, Scissors: which one has 2 of these?

Rock (1):  The August 5, 2012 soft landing of Curiosity on Mars joined technology with hard rock – foreshadowing a significant decision by the American Bar Ass’n on the next day.  This decision will impact commercial real estate finance lawyers.

Scissors, Paper (2):  On August 6, 2012, the ABA added technology as a topic expressly included in the competency requirement of Model Rule 1.1 (and other ethical rules).  Scissors cutting apart the sole reliance on paper by lawyers.

These three promise to change “how” commercial real estate finance lawyers go about their work.

Please join me at the MLI later this week for more on this, or please comment below.

• Simply stated, which of these two thinkers gets it right on using (or not using) choice of law provisions in a typical commercial mortgage loan?

The choice of law topic is a very intellectually rich subject for lawyers.  Much is written about it.  Entire books.  It is a class topic for an entire semester in law schools.  It is a wonderful topic for lawyers.  It “invites” debate and discussion.  And confusion.

However, lawyers who go to war over the “choice of law” provision (in commercial mortgage loan documents) are the poster child for those who argue for simplicity in contracts, and who view lawyers as deal inhibitors, and as creators of all things complicated.

My perspective is that in the typical mortgage loan, there is no legitimate reason for this provision to be the subject of discussion.  There is no “choice” in choice of law.  The approach should be simple -

• the mortgage loan documents should be governed by the law of the state where the project (the loan collateral) is located

Here are a few reasons supporting the two perspectives on this:

Choice of Law Should NOT be the Law of the State Where the Project is Located

• Quality Control: Mortgage lenders need to know that their loan portfolio has consistent terms (subject to the exception below).  Thus, all of the loans should apply the laws of a single state.
• Easier to Manage: Using the laws of a single state makes it easier for loan servicing to make decisions.
• Exceptions (creation & enforcement):  Of course, local state law must govern the creation of liens and the enforcement of remedies.  So, the choice of law must always have this exception.
• He (She) Who Has the Gold Makes the Rules:  The loan is the lender’s money, and if a borrower wants to use it, then the borrower simply needs to do as told – accept this approach and close the loan.  The lender must be obeyed (if the borrower wants the money).

Background.  In a struggling economy, with liquidity issues, loan covenant failures, and no up-tick in company performance in sight, many companies turn to the ultimate solution: sell the company.  Restructuring the company simply is not an option because new capital is not available (to pay-down company debt and fund operations), and existing lenders will not increase credit availability.  The only “option” for the company maybe to sell, which means the company needs both time to find buyers, and cooperation from the first lien lender(s).

Time and cooperation.

If these two intersect or balance, then an understanding the perspectives (of the company and the first lien lender) becomes a key in crafting the forbearance agreement – so the tight rope walk can begin.

Here are some of the tips presented at a recent seminar by Houlihan and Lokey (Adam Dunayer, Brett Lowry and Michael Boone) and by Winstead (Eli Columbus, Phil Lamberson and Frasher Murphy):

The Company Perspective:

• how much will the lender charge for the forbearance? (and “who” funds it?)
• what are the third party costs in putting the forbearance in place, and then in keeping it in place (legal, accounting and others)? (and “who” funds these?)
• what time line milestones (of sales) will the lender require; and are they realistic (in the current market)?
• once the sales milestones are achieved, what will be the extensions of the forbearance period (and on what terms)?
• what will be the deferral of principal payments on first lien debt?
• what about an increase in the advance rate on first lien debt (creating liquidity)?

The First Lien Lender Perspective:

• pro forma budget of short term cash flow: is it realistic?
• what new or additional covenants are needed; and what current covenants should be put on the shelf?
• what time line milestones should be imposed for sales?
• what sales information should be provided; how will sales be sourced; and what are the costs associated with the sales?
• is a delay penalty or fee realistic; and what amount?  (and “how” should it be structured?)
• how should any “credit enhanced” components of the existing debt be handled?

If you have suggestions or comments, please share them below.