Commercial Real Estate Investing From A-Z Loan Documents: Top Things To Keep in Mind
What is a cognovit clause? What are some of the main things that a borrower should be aware of in a loan document for a commercial property? Adam Lustig, head of the Real Estate Group at Bilzin Sumberg shares his knowledge.
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What is a cognovit clause? How can that affect an investor if it is in a loan document?
A cognovit clause is a clause in an agreement that authorizes the entry of a judgment against the defaulting party in the event of a default. It's commonly referred to as a confession of judgment. If the loan documents contain a cognovit clause, it allows for the lender to file suit against the borrower in the event of a default, and to immediately obtain a judgment without any prior notice to the borrower. Obviously, that's potentially a major problem for a borrower because they don't receive notice of default, they don't receive an opportunity to cure, and they don't have the right to raise any defenses or effectively to have their day in court.
What are some of the main things that a borrower for a commercial property should be aware of with regards to loan documents?
Most commercial real estate loans are non-recourse loans, which means that in the event that the borrower defaults, the lender’s recourse is to foreclose on the property. If the value of the property isn't the amount of the judgment, the lender does not have the right to go after the borrower personally, for the deficiency. However, lenders under non-recourse loans typically require what are referred to as bad boy guarantees, or non-recourse carve out guarantees. Principals who are signing those guarantees need to be aware of the circumstances under which they could have personal liability. Early in my career, bad boy guarantees were limited to truly bad acts like fraud and material misrepresentation, misappropriating funds, bankruptcy and similar bad acts. Today, bad boy guarantees have grown in length but many of those things do not necessarily result from a bad act of the borrower, they could be change in economic circumstances or more macro-economic things that could trigger liability. You have to be careful in negotiating the bad boy guarantee and those bad acts, because they trigger personal liability to the principals who are signing them.
Top things to watch out for in loan documents:
Lenders requiring not just a mortgage on the property as their collateral, but also a pledge of all of the ownership interest in the borrower. Clients have agreed to that, they signed it before engaging counsel, once they've agreed to it, it's really hard when you get to the loan documents to try to undo it but that is one of those traps for the unwary. With a foreclosure you have to go through the courts, that process can take six to 12 months. With a pledge of equity, the lender can do a UCC Article 9 foreclosure, which only requires 10 days’ notice to the borrower before a public or private sale of the property is held.
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