Friday, December 19, 2008

WORKOUTS 101 – Where Will the Money Come From? Where Will It Go? Down the Legal Black Hole?

When an income property loan gets into trouble, you need to take a few minutes and realistically assess the sources of funds for the deal and how they should be used.

Potential Sources of Funds

  • Income from the property (NOI)
  • The property itself, i.e., you foreclose upon or take a deed in lieu of foreclosure on your collateral
  • The sponsor's outside resources (any cash or property the sponsor might contribute which is not your collateral)

Potential Uses for Funds

  • Your debt (principal, interest)
  • The property itself (operations, capital requirements)
  • Your attorneys and third party foreclosure costs
  • The sponsor's attorneys
  • The sponsor's outside obligations (other properties, living expenses, etc.)

Eventually I will discuss each source and use in more detail, but for now here are the two most common mistakes lenders make:

Starving the Collateral. If the sponsor is asking for a workout, the property has probably been on the slippery slope to default for some time. If you end up taking back the collateral, your recovery is going to be even worse if the property continues spiraling down. Spending pennies on the property during the workout period will save dollars in the end.

Over Reliance on Attorneys. Lenders tend to forget that money spent on attorneys does not get spent paying their debt and/or stabilizing their collateral. To the extent you minimize legal involvement, there is more money available for you. This is not to say attorneys shouldn’t have a role – they do. You need the attentive participation of an experienced attorney when:

  • You are an inexperienced workout person and you do not have full access to someone who is (e.g., a supervisor). In my opinion if you have not been directly involved in 50+ workouts you are not experienced. Pick your own number, but be aware people are generally overconfident of their own abilities.
  • You are absolutely certain you will recover every nickel of what you're owed plus costs. In this circumstance, it doesn't matter how much you spend, so litigate away. If you think this guideline fits your case you are almost certainly not experienced and should be hiring an attorney anyway.
  • You are too busy to focus on the deal; go ahead and outsource at $200 an hour if your organization is too stupid to staff its workout group adequately.
  • You work for an organization where you need to cover your ass. Even successful workouts tend to disappoint, and losses if a foreclosure or bankruptcy ensue almost always grow over time. No matter how experienced you are or how well you handle a situation, in some organizations it will not be good enough. If you work in such a place, you need an attorney participating in the deal to function as a lightening rod.
  • You have a realistic chance of extracting more outside resources from the sponsor if you litigate. Like certainty of collection, inexperienced people tend to think this is true more often than experienced workout people do.
  • Without litigation (a receiver, etc.) your sponsor is going to divert property income, waste the collateral, etc. Most lenders assume this will happen and are too quick to pull the trigger. If your sponsor believes he or she is the best person to run the property and that the deal can be saved, a receivership action is a direct route to a bankruptcy filing. That might be inevitable – in fact, if you think the sponsor is unfit to run the property you might as well get it over with. But, if you have time to monitor your deal and a cooperative, competent sponsor you are better off holding off on the receiver.
  • It’s time to document the agreement you've worked out. No matter how good you are, it's never a good idea to enter into an agreement without review by experienced counsel.