Tips to Dodge a Loan Default and Gain Control of Default Provisions

Kim Alexander, Counsel

Your position as a borrower is at times like a dodgeball player. You sometimes struggle to avoid getting knocked out by the flying ball (aka the “default notice”) and there can be many close calls. In order to avoid getting hit with the ball, you should carefully negotiate your loan’s default provisions to make it difficult for a lender to strike you down by declaring an event of default (“EOD”).

1. Press for Grace Periods
Insist that a failure to make any payment (including payment in full at maturity) only rises to the level of an EOD after the expiration of a minimal grace period. Five days is fair. If not acceptable to your lender, then, at a minimum, there should be a grace period for all payment defaults other than for principal and interest payments. And, failure to make any payment should not be considered an EOD if funds are set aside by your lender in a reserve to make those payments.

As to nonmonetary defaults, you should require that notice is given and that grace periods are provided. While lenders may only give you short grace periods for certain types of breaches such as the failure to deliver insurance certificates, do not be afraid to ask for up to 30 days for other nonmonetary breaches (or even 60 days if you commenced the cure within the initial 30 day period).

2. Nix Cross-Default Provisions Linking the Subject Loan to Other Loans
Do not allow cross-default provisions in your loan documents. It is not customary to permit a lender to call an event of default under one loan on account of a default under another loan.

3. Must have Materiality Thresholds
Breach of representations, warranties and covenants in general should not rise to the level of an EOD unless they are material breaches. Try the same approach with other specified defaults such as “waste.” You should seek to limit a default resulting from waste to that which materially diminishes the value of the property. Such limitations make it more difficult for the lender to declare an EOD. In addition, as mentioned above, breaches should not be considered an EOD unless you fail to cure them after the expiration of a reasonable time period following your receipt of notice.

4. Disagree with Death Being an Event of Default
Death or incompetency of a member or guarantor are outside of your control and should never be considered an EOD. At a minimum, some reasonable time period should be required to provide a substitute guarantor and, if there is more than one guarantor, then urge your lender to consider the remaining guarantor acceptable without the substitution of an additional guarantor. In addition, any transfers due to the death of a member should likewise not trigger an EOD.

5. Limit Liens
EOD’s as a result of liens filed against your property should be limited to those liens caused by your non-payment (as opposed to a tenant’s non-payment) and should not be regarded as an EOD unless you fail to discharge same after notice. Sixty days is a fair period of time to discharge or bond a lien.

6. Push Back if Events of Defaults are Outside of Your Control
Any default triggered as a result of an involuntary bankruptcy, insolvency or other related action should not be treated as an event of default unless the action results in the entry of an order for bankruptcy relief and such order is not dismissed or discharged within a reasonable time period. Consider requesting 90 days. Also, remember to also carve out any action instituted by your lender as you want to avoid an EOD caused by your lender’s actions.

7. Tighten Up Material Agreement Provisions
Your defaults under critical reciprocal easement agreements, condominium documents and other material property documents may sometimes give rise to an EOD under your loan. So, be careful to tighten up that default language. Your defaults under key property documents should only trigger an EOD under your loan if such defaults were in your control to prevent and give the other party a right to terminate the material agreement.

8. Beware of the Catch-All Default Provision
Just when you thought you had dodged the dodgeball, then you are hit with the catch-all default provision included in most loan agreements. The catch-all default provision triggers an EOD if there is any other default under any of the other loan documents. This is problematic because the other loan documents may not require notice or provide for a cure period. Be wary of these provisions and insist that the catch-all provision include a notice requirement and a cure with respect to defaults that are not specifically itemized elsewhere in the loan agreement’s default provision. It is reasonable to request 10 days for the payment of a sum of money that may be due under the other loan documents and 30 days for all other defaults (with such additional time of up to 60 days if you have commenced the cure within the initial 30 day period and are diligently proceeding to cure same).

If you carefully negotiate and limit the scope of the default provisions, you may give yourself a better chance of avoiding your lender’s dodgeball (the default notice).

Contact one of our real estate attorneys at A.Y. Strauss in New Jersey at 973-287-3561 or New York at 646-374-3061 if you have questions about the intricacies of real estate acquisition and sales, real estate finance, leasing or joint ventures.

The opinions expressed in this blog do not create an attorney-client relationship and do not constitute legal advice. Neither the transmission of the information contained within this blog nor the use of the information or communication with A.Y. Strauss LLC creates an attorney-client relationship with A.Y. Strauss LLC.

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