"standard Carveouts" Commercial Lending

Comments(2)

• 
  CharlieTango4th June, 2004

  There's basically 5 general types of standard carveouts. Here's a description of them that I found on the web:
  
  1.Erosion of collateral. Some nonrecourse carveouts protect a lender against borrower actions that over time erode the value and benefits that the lender reasonably expected to receive from the collateral. By making the borrower personally liable for actions or omissions like improper application of property cash flow or failure to apply rental income to debt service, the lender protects itself from gradual loss of the collateral and preserves the loan-to-value ratio under which it agreed to make the loan.
  
  
  2.Destruction of collateral. Other carveouts protect a lender against sudden loss or substantial impairment of the lender's collateral -- one-time borrower actions that permanently diminish or destroy the expected value of the lender's collateral. Some examples: "waste," bad-faith cancellation of a desirable lease, loss of insurance followed by a fire, or surrender of an underlying ground lease. Again, the fact that the borrower is personally liable for these events helps the lender preserve its collateral and its loan-to-value assumptions.
  
  
  3.Allocation of external risks. A few carveouts merely shift major external risks away from the lender. For example, if a previously unknown environmental problem destroys the value of the lender's collateral, a nonrecourse carveout shifts this problem to the borrower (or its principals), protecting the lender from unexpected loss of value and deterioration of the loan-to-value ratio. Given the number of lenders that want to identify and shift to someone else all risks except nonpayment and market decline in value of collateral, one should expect to see a lengthening list of carveouts of this type. Indeed, every time a grand new legislative scheme creates a new external risk to real estate collateral, some lenders expand their nonrecourse carveouts to shift that risk from the collateral to the borrower personally. As one recent example, some lenders have added to their litany of carveouts any risk arising from asset forfeiture because of illegal activities at the property, whether or not the borrower's fault. Before that, there was the Americans with Disabilities Act.
  
  
  4.Avoiding the need for additional investment. When a lender makes a loan, the lender has typically already advanced the maximum amount it wants to lend against the collateral. The lender does not want to invest additional money merely to preserve and enforce its position. Any additional investment undercuts the lender's fundamental "loan to value" assumptions. Hence the lender will seek to make the borrower personally liable for any funds the lender must advance to protect its position. Some examples: payments for taxes or for insurance premiums; other costs incurred to protect the collateral; or attorneys' fees in enforcement.
  
  
  5.Behavior control. The final major category of nonrecourse carveouts reflects the desires of lenders to simplify, streamline, and speed up enforcement after a loan default. Borrowers can drag out this process through vigorous defenses and aggressive use of bankruptcy. During that time, the collateral usually deteriorates and declines in value, and unpaid interest accrues. A lender can mitigate that result by insisting that the borrower (or its principals) assume personal liability for the lender's enforcement costs, and potentially even for the entire loan, if the borrower does not surrender quickly to the enforcement process.
  
  Hope this helps.

• 
  cjmazur4th June, 2004

  Thanks, I was never able to google and answer!