COMMUNITY BANKING INSIGHTS A Legal Resource for the Community Banking Industry Mon, 22 May 2017 21:59:15 +0000 en-US hourly 1 COMMUNITY BANKING INSIGHTS 32 32 A “Pro-Creditor” Supreme Court Decision That Does No Favor for Banks Tue, 16 May 2017 21:28:36 +0000 Earlier this week, the U.S. Supreme Court held that a creditor who deliberately files a bankruptcy proof of claim for a time-barred claim does not violate the Fair Debt Collection Practices Act (FDCPA). Midland Funding v. Johnson, No. 16-348, 581 U.S. __ (May 15, 2017) (slip op.). The 5-3 decision authored by Justice Stephen Breyer was met with a blistering dissent by Justice Sonia Sotomayor.  While the decision will help unscrupulous debt collectors, it will likely hurt legitimate creditors such as banks.

The FDCPA imposes penalties for “unfair and unconscionable means to collect a debt.” 15 U.S.C. § 1692f. All states have statutes of limitation setting a time limit on bringing certain types of lawsuits.  Once the limitations period has passed, a creditor may not sue to collect the debt.  The debt does, however, in some sense continue to exist.  If the debtor chooses to repay a time-barred debt, the creditor can keep the money.  As a banker, please be sure to send a thank-you note when this happens; you’ll be in no danger of writers’ cramp given the infrequency of the occurrence.

Courts have held that filing a civil lawsuit to collect a debt known to be time-barred violates the FDCPA. See e.g., Phillips v. Asset Acceptance, LLC, 736 F.3d 1076, 1079 (7th Cir. 2013).  This is so even though rules of pleading do not require the creditor’s complaint to state that the lawsuit is timely.  Rather, the statute of limitation creates an affirmative defense, meaning that the defendant has the burden to plead and to prove that the claim is time-barred.  Courts reason, however, that knowing the borrower has an ironclad defense is just the same as knowing that the debt isn’t valid for any other reason.  To sue on a claim known to be invalid constitutes “misleading” and “unfair” conduct in violation of the FDCPA.

In Midland the Supreme Court created a different rule for bankruptcy proofs of claim:  Even if the claim is subject to an ironclad defense, filing a proof of claim does not violate the FDCPA.  The Court reasoned that since the debtor initiates the bankruptcy proceeding (in Midland, under chapter 13 of the Bankruptcy Code), “the consumer is not likely to pay a stale claim just to avoid going to court.” Midland, slip op., at 6.  Further differentiating a bankruptcy proceeding from non-bankruptcy litigation, the Court cited the involvement of a knowledgeable trustee and the streamlined claims resolution procedure. Id. “These features of a chapter 13 bankruptcy proceeding,” concluded the Court, “make it considerably more likely that an effort to collect upon a stale claim in bankruptcy will be met with resistance, objection, and disallowance.” Id. at 7.

The Court was also troubled that “a change in the simple affirmative defense approach, carving out an exception, itself would require defining the boundaries of the exception.” Id. at 8.  What if it’s an affirmative defense other than statute of limitations?  What if the affirmative defense is not obvious from the face of the proof of claim?  Better to have a bright-line rule, consisting of “the simple affirmative defense approach” – which apparently is that there will never be a penalty under the FDCPA for filing a claim that is valid but for the possible, or even definite, existence of an affirmative defense. Id.

In the real world, banks may pay a price for the Midland decision.

This is great news for debt collectors who have made a business model out of buying up stale debt for pennies on the dollar, filing thousands of proofs of claim, and hoping that a few of them will slip by without objection. But how does this affect banks?  Shouldn’t bankers rejoice at any limitation courts impose on the broad reach of the FDCPA?

Certainly that’s one way to look at it. But in the real world, banks may pay a price for the Midland decision.  If Midland truly means that it’s okay to file a claim even when there’s an ironclad affirmative defense, then it opens the doors for the filing of invalid claims that in the past would not have been filed.  Bankruptcy trustees will need to respond.  Instead of allowing without further inquiry a claim that appears legitimate on its face, trustees can be expected to ask the creditor:  Is the claim time-barred?  Have you released the claim (release is another affirmative defense)?  Have you already been paid (yes, that’s right, payment is an affirmative defense)?  A reputable bank would never deliberately file a claim for a loan that was repaid, released or otherwise legally uncollectable.  Yet banks may increasingly be called upon to respond to due-diligence inquiries from trustees.  Not only would they bear their own expenses in responding, but in chapter 7 cases would suffer reduced recoveries on account of the increased legal fees of the trustee.  And banks’ recoveries will be diluted by distributions on account of time-barred claims since some, inevitably, will slip through.

Midland might in a technical sense be a pro-creditor decision, but it could prove costly to banks and other legitimate creditors.


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So What Does a Bankruptcy Carve-Out Clause Really Mean? Delaware Bankruptcy Court Concludes It is Not a Cap on Fees After All Fri, 03 Feb 2017 18:15:05 +0000 In chapter 11 bankruptcy cases, it is not uncommon for secured parties/lenders to provide a “carve-out” for various professional fees.  Frequently there may be a “carve-out” for “all chapter 11 professionals” or the “carve-out” may be broken out in different amounts for the debtor’s professionals as opposed to, for example, Creditors’ Committee professionals.  These “carve-outs” can often be in a Cash Collateral Order (assuming the debtor is using the secured party’s collateral) or in a DIP Order (debtor-in-possession financing). So what does a carve-out mean?

In a recent Delaware bankruptcy case, In re Molycorp, Inc., 2017 WL 56703 (Bankr. Del. Jan. 5, 2017), the DIP Lender agreed to a $250,000 “carve-out” for the fees and expenses of the professionals retained by the Creditors’ Committee.  The Committee professionals filed a fee application far in excess of the “carve-out” amount, and as a result the DIP Lender objected to the fee application.

In overruling the objection, the Bankruptcy Judge concluded that the language in the DIP Order was not a “cap” on allowed fees.  Moreover, the Judge distinguished the current case, which was a successful reorganization, from a failed reorganization.  Had the case been a failed chapter 11, then the Judge agreed that the “carve-out” presented a limitation on how much money the Committee professionals would be entitled to out of the Lender’s collateral or money, but not so, at least not as written, in a successful reorganization.


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Transfer Act for Lenders Thu, 26 Jan 2017 15:44:47 +0000 A previous blog post addressed lender liability for environmental conditions on property a lender might acquire as a result of foreclosure.  Another issue lenders in Connecticut must consider prior to foreclosing on a property is the Connecticut Transfer Act.  The Transfer Act requires transferors of “establishments” to make specific disclosures to transferees regarding the environmental condition of the property being transferred and also requires one party (usually either the transferor or transferee) to be a certifying party, i.e., the party responsible for all investigation and remediation of the property in accordance with Connecticut’s Remediation Standard Regulations (or “RSRs”).

An establishment includes properties where certain enumerated operations have occurred at any time since May 1, 1967:  dry cleaners, auto body repair, and furniture stripping; as well as any property where greater than 100 kg of hazardous waste was generated in any one month, on or after November 1, 1980; and/or where any hazardous waste, generated at a different location, was recycled, reclaimed, reused, stored, handled, treated, transported or disposed of.

When a transfer of an establishment occurs, certain form filings must be made with the Connecticut Department of Energy and Environmental Protection (“DEEP”) unless the transfer is excluded by statute.  Two such exclusions are:  the conveyance of an establishment through foreclosure and the conveyance of a deed in lieu of foreclosure to a lender (as defined in the previous blog post on this issue).  However, this exemption does not include a lender’s subsequent transfer of the property to a third-party buyer (e.g., via a quitclaim deed).  Accordingly, any transfer of an establishment from a lender to a third-party buyer is considered a “transfer of establishment” and, for this reason, appropriate Transfer Act forms must be filed and one party must agree to be the certifying party responsible for the investigation and any required remediation of the property.  If a transferor (in this case, the lender) fails to file the appropriate forms with DEEP, the transferor, by statute, is liable for the full cost of investigating and remediating the property.

When a transfer of an establishment occurs, certain form filings must be made with the Connecticut Department of Energy and Environmental Protection…

In a limited number of circumstances, the efforts necessary to show that the property complies with the RSRs may be minimal, but will still require the retaining of a Licensed Environmental Professional (“LEP”) to confirm that the site meets all requirements.  At a minimum, the LEP will need to conduct environmental investigations to certify that the property does not require remediation.  More commonly, the efforts needed to demonstrate compliance with the RSRs can be costly—requiring significant investigation, some degree of remediation, and potentially filing an Environmental Land Use Restriction on the land records.  For these reasons, prior to selling a property to a third-party (or better yet, prior to foreclosing or accepting a deed in lieu of foreclosure), lenders should confirm that the property is not an establishment.  And if it is an establishment, lenders should take all steps necessary to comply with the Transfer Act.

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Ninth Circuit Holds Debtor Must Pay Default Interest Rate in Order to Cure Under Bankruptcy Plan Thu, 12 Jan 2017 19:54:09 +0000 In a win for secured creditors, the Ninth Circuit Court of Appeals recently held that a debtor who sought to cure a pre-petition default of its loan through its Chapter 11 plan must pay the default rate of interest set forth in the note. In Pacifica L 51 LLC v. New Investments Inc., the debtor proposed to pay the outstanding amount due under the note at the pre-default interest rate.  This proposal was in accordance with law in the Ninth Circuit, which held that even if a loan agreement provided for a higher post-default interest rate, a debtor who cured a default was entitled to repay at the lower, pre-default rate.

In overruling its prior case, the Court held that while a debtor is permitted to cure a default through a bankruptcy plan and return to pre-default conditions, the debtor is not allowed to avoid a post-default interest rate if that rate was provided for in the loan documents.  The Court explained that under the Bankruptcy Code, the amount necessary to cure a default is determined in accordance with the underlying agreement and applicable nonbankruptcy law.  Thus, because the note provided for a higher default rate of interest and such a rate was permitted under state law, the debtor could not avoid this obligation.

The Ninth Circuit’s holding is consistent with the majority of other circuits, including the Second Circuit (which covers, among other states, Connecticut and New York), which allows creditors to receive the default rate of interest from debtors attempting to cure defaults through their bankruptcy plans.

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The Bond Bandwagon Mon, 19 Dec 2016 15:38:51 +0000 Are you ready to jump on the tax-exempt bond bandwagon? Over the last eight years, the landscape of tax-exempt bond financing has changed and more and more bonds are being sold directly to banks across the nation.

Do you have customers or potential customers that are: hospitals, health centers, visiting nurses associations, nursing homes, assisted living facilities, continuing care retirement communities, child care organizations, colleges, universities, private independent schools, museums, theaters, zoos, adult day care facilities, boys & girls clubs, community action agencies, and social service agencies?

Are you ready to jump on the tax-exempt bond bandwagon?

If so, you may be able to offer them a competitive financing option through the purchase of tax-exempt bonds. In Connecticut, the State of Connecticut Health and Educational Facilities Authority (“CHEFA”) lends to the types of organizations listed above through the proceeds of the bonds issued under their authority. Other state agencies and towns across Connecticut can also issue bonds for various projects and various borrowers.

The bank, as purchaser of the bonds, is able to set what the requirements will be for the collateral and covenants in the transaction, and will be responsible for conducting all of the due diligence.

Under the Securities Act of 1933, in order for a bank to purchase the bonds directly, it must be considered either an “accredited investor” under Regulation D or a “qualified institutional buyer” under Rule 144A. The definitions of “accredited investor” and “qualified institutional buyer” contain many different types of entities, but do include any national bank, or banking institution organized under the laws of any state, territory or the District of Columbia, the business of which is substantially confined to banking and is supervised by the banking commission in the state or territory in which it is organized. The bank must own and invest at least $100 million in securities of unaffiliated issuers and has an audited net worth of at least $25 million.

If your bank meets these qualifications to purchase bonds, you may want to make that leap onto the bond bandwagon.

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New Forms May Alleviate Some Concerns About Massachusetts Notarizations Tue, 13 Dec 2016 13:00:37 +0000 Massachusetts is notorious for having hyper-technical rules about notarization.  The trouble started in 2009 with the bankruptcy case of Matthew H. Giroux.  Mr. Giroux signed a mortgage in front of a notary public.  He acknowledged to the notary public that he signed the mortgage voluntarily for its stated purpose.  The notary public signed where he was supposed to, affixed his notarial seal, and inserted the expiration of his commission.  The mortgage was then recorded in the appropriate registry of deeds.  The notary public, however, forgot to insert Mr. Giroux’s name in the certificate of acknowledgement (the notary block on the mortgage); so it said: “[B]efore me personally appeared _____________ to me known to be the person (or persons) described in and who executed the foregoing instrument . . . .”  The bankruptcy court didn’t like that and invalidated the mortgage.

Ok, lesson learned.  Notaries—don’t forget to fill in the name of the person who signed the mortgage.

Then, in 2013, an appellate bankruptcy court muddied the waters even further in the case of Shawn and Annemarie Kelley.  The court invalidated the Kelleys’ mortgage that was signed under a power of attorney because the certificate of acknowledgement indicated that the individual who signed the mortgage on behalf of Mr. and Mrs. Kelley acknowledged that she did so as her own free act (i.e., the free act of the person who physically put pen to paper).  The court found that the acknowledgement should have said that she signed it as the free act and deed of the persons on whose behalf she was signing (i.e., the Kelleys).  Not only that, but the certificate of acknowledgement on the offending mortgage mirrored (more or less) the form certificate of acknowledgement contained in an Executive Order issued by the Governor of Massachusetts (which effectively served as the Massachusetts manual for notaries public).  The court didn’t care, and essentially found that the form used (i.e., the form that the Governor ordered that all notaries should use) was incorrect.

The court invalidated the Kelleys’ mortgage that was signed under a power of attorney…

Well, I can only guess that the Massachusetts legislature thought this state of affairs was a little silly (as do I, if you couldn’t tell from the tone of the preceding paragraph).  On October 6, 2016, a new statute was passed in Massachusetts called “An Act Regulating Notaries Public to Protect Consumers and the Validity and Effectiveness of Recorded Instruments.”  The statute seeks to accomplish a few very important things.  First of all, it essentially replaces the old notary law with the Executive Order referenced above (the one that the court said had incorrect notarial forms).  In other words, the legislature deleted the old statute and (more or less) copied and pasted the Executive Order in its place.  Now there can be almost no argument (but you know us lawyers and our wacky arguments) that the forms promulgated by the Governor are not sufficient—the Executive Order and the statutory forms are almost identical.  Second, the Act is explicit that notaries public may use the new statutory forms, but that the existence of those forms “shall not preclude the use of any other forms lawfully used as required or authorized by any general or special law or any regulation or executive order regulating notaries public.”  Third, the new law explicitly states that the certificate of acknowledgement is not invalid if it acknowledges “the voluntary act of an individual executing a document in a representative capacity [presumably including persons acting under power of attorney as well as officers/members/managers signing on behalf of a corporation or limited liability company] but fail[s] to acknowledge the deed or instrument as the voluntary or free act of the principal or grantor,” directly overruling the holding in the Kelley case.

The new statute comes into effect on or about January 4, 2017.

So, the moral of this story is (a) the Massachusetts legislature just gave us some wiggle room when it comes to notarizing mortgages and deeds (but just a little wiggle room; note, for example, the new statute does not necessarily solve the problem noted in the introductory paragraph above) and (b), Massachusetts has new statutory forms for acknowledgements, oaths (jurats), etc.  These new statutory forms may or may not be consistent with many banks’ current forms, depending whether they use the old forms from the Executive Order (which are mostly, but not entirely, identical), whether they use the old statutory forms (which remain acceptable for use), or whether they use some hybrid (which some banks may have adopted in the wake of Kelley and related cases).

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DOL’s New Overtime Regulation Will NOT Go in to Effect on December 1 Wed, 30 Nov 2016 17:29:10 +0000 Last week, a Texas federal judge temporarily blocked the federal Department of Labor’s proposed overtime regulation that would have increased the number of employees eligible for overtime pay by increasing the salary level for the “white collar” exemptions to $47,476 per year.

Under the FLSA, employees must be paid time and a half of the employee’s regular hourly rate for each hour worked over 40 hours a week, unless the employee falls within an exemption from overtime by meeting the criteria for salary and duties.  As it stands, to qualify for a white collar exemption, the employee must meet the minimum salary level of $455 per week or $23,660 per year.  The proposed regulation would have doubled that minimum salary level, allowing fewer employees to be exempt. The regulation would have also raised the salary used for “Highly Compensated Employees” from the current threshold of $100,000 to the 90th percentile of average weekly salaried earnings – about $122,000.

Under the FLSA, employees must be paid time and a half of the employee’s regular hourly rate for each hour worked over 40 hours a week

In blocking the regulation until trial, a Texas court reasoned that the DOL exceeded its authority by imposing an increased salary level that would supersede consideration of the employee’s actual duties when determining whether employees fell within the overtime exemption.  In light of the Court’s concerns, the Court ordered a preliminary injunction to stop the rule from going in to effect on December 1, 2016, as planned.

Going forward, it remains to be seen how the DOL will respond to the injunction.  Though the DOL may take steps to challenge the Court’s decision before President Obama’s term expires on January 20, 2017, given such a short time span, it is not likely that the rule will go in to effect this year.

For now, employers should continue to abide by the current overtime rules and await further developments.  Employers who were planning to implement changes based on the projected impact of the proposed regulation may choose to reconsider their plans.

We are closely tracking the status of the rule and will circulate updates on any changes as they develop.  If you have questions, please contact a member of our team.  For more details, see our previous write-up here.



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Protecting Lenders from Environmental Liability for Foreclosed Properties Tue, 01 Nov 2016 14:21:48 +0000 Readers may recall an earlier blog post regarding a bank’s potential liability for damage to private property caused by a tree falling onto a neighbor’s property.  In addition to property damage from obvious unsafe conditions, banks should also consider the potential liability associated with potential, unseen environmental conditions on property it has foreclosed upon.  Under Connecticut and federal law, landowners are typically responsible for the remediation of environmental contamination that exists on their property, regardless of who caused the contamination in the first instance.  However, there are exemptions that protect lenders from liability for environmental conditions so long as certain requirements are met.

…there are exemptions that protect lenders from liability for environmental conditions so long as certain requirements are met.

First, the entity that acquires the property via foreclosure must be a lender.  Although “lender” is broadly defined, there are some entities, affiliated with banks, which may not be considered a “lender” who is exempt from liability.  “Lender” specifically includes insured depository institutions, insured credit unions, banks or associations chartered under the Farm Credit Act, and a leasing or trust company affiliated with an insured depository institution as well as “any person (including a successor or assignee of any such person) that makes a bona fide extension of credit to or takes or acquires a security interest from a nonaffiliated person.”

By comparison, some banks have created separate entities that have the role of holding a bank’s Other Real Estate Owned.  These entities may or may not be considered lenders, depending on how the entity is structured and how it obtains the relevant property. For this reason, careful consideration should be given to the process by which lenders foreclose upon properties which may have environmental contamination.

Second, lenders also must not participate in management of operations at the foreclosed upon property prior to foreclosure.  The term “participate in management” is defined by the statute and requires actual participation not just the mere ability to participate.  Participation in management includes managing the business operations, reviewing and/or approving day-to-day operations, and/or influencing a business’s processes or waste disposal.  Lenders, however, may take certain actions to wind-up business operations or sell the property, may respond to (or remediate) a release of hazardous substances that presents a danger to the environment or human health, or may take other actions that preserve, protect, or prepare the property for sale or other disposition.  Lenders should be aware, however, of the risk of liability if any of a lender’s actions specifically cause a release of hazardous substances.  Accordingly, all actions should be done with an appropriate standard of care.

Finally, after foreclosing on a property, lenders must seek to sell the property at the “earliest practicable, commercially reasonable time, on commercially reasonable terms, taking into account market conditions and legal and regulatory requirements.” Lenders have wide latitude in determining what is reasonable—and the requirement is not that the property actually sells, but is listed for sale within a reasonable time period.  Often 6-12 months, depending on the state of the property and the efforts needed to prepare it for sale or other disposition has been determined to be a reasonable time period within which to list a property for sale.

Properties that may have environmental contamination can include a variety of commercial or industrial businesses, including gasoline stations, auto body repair, dry cleaners, greenhouses or nurseries, printing operations, and manufacturing facilities.  Before foreclosing on a property with a business that requires the use of hazardous materials or which may otherwise have environmental contamination on-site, a lender should pay careful attention to its foreclosure process to ensure it remains exempt from liability.  If a lender’s actions take it out of the safe harbor from liability, a lender could find itself liable for all environmental contamination on a property.

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Title Insurance: What is its Value? Thu, 13 Oct 2016 15:34:12 +0000 As I type this blog post, I am sitting at my desk with a four-inch-thick binder filled with title insurance forms—form policies, form endorsements, premium rate tables, survey requirements, etc.—and it occurs to me that many people who deal with real estate loans and title insurance on a daily basis may have never read a title insurance policy.

It’s probably not necessary for a loan officer involved in a real estate transaction to read the whole title insurance policy, but it may be helpful to have a basic understanding of the benefits and limitations of a lender’s title policy as well as some of the optional endorsements.  To provide a basic understanding of title insurance, this post is the first in what will be a series of articles on title insurance from a lender’s perspective.

Almost all commercial loan title insurance policies issued in the United States are on a standard form known as the 2006 ALTA (American Land Title Association) Loan Policy, with some minimal variations depending on the jurisdiction.  At its most basic level, a lender’s title insurance policy is intended to insure that the lender has a valid and enforceable mortgage on the real estate.  The “Covered Risks” in the ALTA policy include (subject to certain exceptions and exclusions) insuring the lender against loss or damage resulting from things like: forgery of the mortgage (or the deed to the borrower), improper notarization, liens not disclosed in the policy, the borrower not owning the property, no right of access to the property, avoidance of the lien of the insured mortgage in a bankruptcy proceeding, improper recording, etc.

Some may wonder: What is the value of title insurance?  The answer is: Hopefully you’ll never find out.  If your borrower pays its loan in full without incident, you never have to look at, or think about, the title insurance policy; you never know or care if there is a problem with title.  However, the same can be said of the mortgage itself.  If your borrower pays the loan in full, then you never needed the mortgage in the first place.

…if you need to begin foreclosure proceedings or your borrower files a bankruptcy petition, the title insurance policy can be invaluable.

On the other hand, if you need to begin foreclosure proceedings or your borrower files a bankruptcy petition, the title insurance policy can be invaluable.  I can describe several times over the last few years that I’ve been involved when a title insurance claim was filed or threatened (for the record, my involvement was limited to addressing preexisting title problems).  These have included a situation in which an executor transferring real estate never had the probate court’s authority to sign the deed, instances where a mortgage was avoided (invalidated) because it was not properly notarized, an incorrect legal description, a mortgage being recorded in the wrong office, an improperly conducted foreclosure in the chain of title, and a situation in which a prior mortgage was paid off but the release was never recorded and the lender (or a successor) no longer exists.  In each of these cases, the title problem was resolved by the title insurance company (or an attorney paid by the title insurance company).

All of these situations are rare (some more than others), but if they come up on one of your loans, you’ll be glad you have title insurance.  The title insurance company generally will pay to correct any title defects and, in most cases, will hire and pay an attorney to handle the entire situation.  In addition, title insurance itself may be partially responsible for the rarity of title problems.  Simply obtaining the title search and going through the underwriting process forces borrowers (and sellers of land) to address potential concerns before they become a problem.  For example, it is not uncommon for the title insurance company to tell a borrower that it needs to get an additional document from a seller, or that the parking lot needs two more spaces in order to comply with zoning requirements.

All in all, title insurance forces you (or more realistically, your lawyer and the borrower’s lawyer) to think about potential title problems before the closing, and it protects the lender if the loan ever goes bad or if title to the real estate is ever challenged.

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Unitranche Financing – is it for you? Tue, 27 Sep 2016 12:00:42 +0000 The use of unitranche financing creates opportunities for lenders and value for borrowers.  There are some risks that lenders must understand in these structures.

With the volume and competition of middle market financings growing, many loan officers and lenders are asking, “What can we do better in order to get more business?”

In an acquisition financing scenario, unitranche may be a good path for you and your borrower.  You may able to offer your borrower good terms, close quickly and keep admin and legal costs down.

Recently, middle market lenders have been enjoying higher yields than large cap lenders and have been able to control, even in club deals or smaller syndicates, documentation, underwriting and decision making.  Middle market lenders can access a variety of financing structures and provide borrowers with custom terms and conditions with less adherence to what is “market.”

In an acquisition scenario many lenders commonly face the following structures of senior and subordinate debt.

First and Second lien financing. In a First and Second lien financing, there are two separate groups of lenders who are separately granted liens on the same collateral. Pursuant to an intercreditor agreement, the two lender groups agree that the first lien lenders have a senior priority lien and therefore recover first on the value of the collateral following the exercise of remedies by the lenders against the borrower.

Recently, middle market lenders have been enjoying higher yields than large cap lenders and have been able to control, even in club deals or smaller syndicates, documentation, underwriting and decision making.

While other arrangements do exist, this is common and many acquisition deals will also involve some form of seller financing.  This is true for the smaller deals where the borrower may have limited capital, other than sweat equity, to invest.

In First and Second lien scenarios there are two sets of loan documents, perhaps with different covenants, and two lenders to administer the loan terms.  You and the other lender will be represented by separate counsel to document the loan and those attorneys will also negotiate an intercreditor or subordination agreement.

In any structure involving subordinated debt, the lenders need to understand both the return on investment and the default risks.  Senior lenders live by a tried and true rule — the liquidation value of the borrower’s assets must be sufficient to cover the senior debt.  The senior lender is taking on less risk than and sub debt lender or second lien lender.  Therefore, the rates are usually lower than the sub debt lender rates.  The sub debt lender is taking on more risk and therefore the reward, and rates, are usually higher.

In a untrianche scenario, there is a single layer of senior secured debt.  The borrower needs only one set of loan documents.  All lenders and the borrower are party to the agreements.  Same covenants, same default scenarios, same remedy provisions.  This benefits the borrower, the senior lender and the sub debt lender.  The borrower may be getting a better “blended” rate.  The senior lender may be getting a higher rate of return and the sub debt lender has less risk exposure.

The lenders will enter into an agreement between themselves – an Agreement Among Lenders.  The sophisticated lenders can negotiate to create certain scenarios of first out and last out “tranches.”  These terms and conditions are typically negotiated on a case by case basis and will be dictated by the interest and involvement of each lender in the deal.

Unitranche deals can incorporate all of the typical facilities that lenders typically offer borrowers. In an acquisition scenario there can be multiple term loans, equipment loans and revolvers. Lenders can structure these with first out tranche facilities and last out tranche facilities.   Similarly, separate pricing can be used for different facilities.  The structure, pricing and arrangements among the lenders would be dealt with in the AAL.

In the middle market sectors, the benefits of unitranche lending are reduced closing, legal and admin costs; quicker closing since there are one set of documents for the borrower’s team to review and negotiate; less risk since the risk and pricing is spread between the lenders; some borrowers may be able to leverage more senior debt; decreased debt service for borrowers; streamlined compliance and admin.

As a senior secured lender you could make your borrower happy by providing more credit, quicker and cheaper.  While at the same time, as a senior secured lender you debt would be fully collateralized, your pricing could increase and you can still manage and administer the loan.  Obtaining higher ROI without more risk exposure, since the liquidation value of the collateral is sufficient to cover the debt, will make you a hero with your credit department.  Being able to develop a reputation as a lender who gets the borrower more money, faster and cheaper could go a long way for your reputation and should help get you more business.

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