Basic Documents Related to Financing Commercial Property Acquisitions

by James C. Neeld/http://about.me/james.neeld

Who am I?

I am an attorney with The Katz Law Firm practicing real estate and finance law. I began my legal career chasing bad guys for the U.S. Army and prosecuted over 50 cases in both Federal and U.S. Army courts. Sonnenschein Nath & Rosenthal (now Dentons) made the decision that I was a better finance attorney than a litigator (bless them) and I spent seven years with SNR, making partner. Currently and less dramatically, I handle acquisitions, dispositions and financing in multiple jurisdictions for all sorts of clients, many of whom actually pay me regularly. You can read more about me at http://about.me/james.neeld.

What are we discussing?

We are discussing loan documents related to the acquisition of commercial real estate. We are not discussing residential acquisitions and I am not qualified to handle questions regarding residential real estate matters. Oddly enough, I find commercial transactions easier than consumer transactions.

The type of property typically dictates the type of financing available or desired for the acquisition. For example, a single-tenant warehouse can be financed with many different options of financing including credit tenant lease bond financing. On the other hand, a mixed-use development that is only 20% leased will probably need to have structured financing which will include a mezzanine piece and typically an A and B loan.

If you have no clue what the preceding paragraph discussed, don’t worry! This paper will discuss standard loan documents assuming a qualified borrower on qualified terms on a commercial transaction. The “standard loan documents” will comprise documents I would typically find in a rather straight forward acquisition. Obviously, your experience may differ from mine and each real estate transaction will have its own nuances which we must navigate.

Why do we care?

Because what I do is very important and you should listen to me carefully and not update your social status on Facebook. In all seriousness, most if not all real estate attorneys need to have a basic understanding of the loan documents related to an acquisition of real property. In my experience, they all have much more than a working knowledge. A bit like peanut butter and jelly, real estate attorneys go with financing.

How are we going to do this today?

First and foremost, you can read this article on your hand-held device, your laptop or at home anytime you want at this link: https://medium.com/p/4b7f09570df2. This article will remain available in my personal documents for as long as I find it relevant and useful.

I hope in my presentation today that I give a few useful tips to my seasoned peers and provide a decent base of information for those new in this business. I recommend you read areas where that I have labeled “ProTip!” Those sections are small nugget of wisdom that I have gained mostly from hard lessons or from my mentors in this wonderful business of ours.

A. Standard Loan Documents

A lender’s list of typical loan documents is attached to this article as Exhibit A. There are, of course, many more loan documents than we will cover in this article and they are all dependent on the type of property at issue.

1. Promissory Note

A promissory note is either a negotiable promissory note that qualifies as a negotiable instrument or a non-negotiable promissory note. For purposes of this article, we will only discuss a negotiable promissory note as that will be the promissory note used by financial institutions. Most of us attribute the term “promissory note” with a negotiable instrument.

A negotiable promissory note is defined under the Uniform Commercial Code§3–104(a):

Except as provided in subsections (c) and (d), “negotiable instrument” means an unconditional promise or order to pay a fixed amount of money, with or without interest or other charges described in the promise or order, if it:
(1) is payable to bearer or to order at the time it is issued or first comes into possession of a holder;
(2) is payable on demand or at a definite time; and
(3) does not state any other undertaking or instruction by the person promising or ordering payment to do any act in addition to the payment of money, but the promise or order may contain (i) an undertaking or power to give, maintain, or protect collateral to secure payment, (ii) an authorization or power to the holder to confess judgment or realize on or dispose of collateral, or (iii) a waiver of the benefit of any law intended for the advantage or protection of an obligor.

The Uniform Commercial Code (“UCC”) for Missouri and Kansas are exactly the same. Kansas is found at Chapter 84, Article 3 “Negotiable Instruments” and Missouri is found at Section 400.3–104. As a general rule, and especially concerning Article 3 of the UCC, Kansas and Missouri match the model UCC.

When someone signs a promissory note as its maker (“issuer”), he/she automatically incurs the obligation in UCC §3–412 that the instrument will be paid to a “person entitled to enforce” the note. “Person entitled to enforce” (“PETE”) is in turn defined in §3–301:

Person entitled to enforce” an instrument means (i) the holder of the instrument, (ii) a nonholder in possession of the instrument who has the rights of a holder, or (iii) a person not in possession of the instrument who is entitled to enforce the instrument pursuant to Section 3–309 or 3–418(d) . . . .

Three primary entities are involved in this definition that have to do with missing promissory notes: (1) a “holder” of the note, (2) a “non-holder in possession who has the rights of a holder, and (3) someone who recreates a lost note under UCC §3–309.

For purposes of our discussion, we care about the “holder”. Essentially a “holder” is someone who possesses a negotiable instrument payable to his/her order or properly negotiated to the later taker by a proper chain of endorsements. This result is reached by the definition of “holder” in UCC §1–201(b)(21):

“Holder” means: (A) the person in possession of a negotiable instrument that is payable either to bearer or to an identified person that is the person in possession; or (B) the person in possession of a document of title if the goods are deliverable either to bearer or to the order of the person in possession.

The holder of a negotiable instrument can enforce the instrument against the borrower or issuer. So, it is important to know who holds your promissory note and therefore, who can enforce the promissory note against the issuer.

ProTip: All financial institutions request that the promissory note be freely assignable without the permission of the borrower. I have had success requiring borrower’s consent to future assignments of the promissory note even with larger institutions.

From a practical standpoint, the promissory note contains the economic terms of the business deal negotiated between the lender and the borrower. A form promissory note is attached as Exhibit B. All promissory notes will contain:

  1. The unconditional promise to repay.
  2. A specific amount, typically called the “principal amount”.
  3. The date certain of repayment or other repayment terms and the specific dates for such repayment.
  4. The lender (person to repay) and the place of repayment.
  5. The interest rate applicable to the outstanding principal or not.

ProTip: There is no such thing as an interest free loan. If you fail to include an interest rate, then the Applicable Federal Rate will apply for federal tax purposes.

2. Security Instrument — Loan Agreement

The security instrument is the recorded document that secures the indebtedness stated in the promissory note with a lien on real property. There are two types of security instruments: a deed of trust and a mortgage.

For both a deed of trust and a mortgage, the borrower (or trustor in the case of a deed of trust) transfers legal title to either the lender or a trustee (in the case of a deed of trust) and retains equitable ownership of the fee interest. A deed of trust has three parties, the trustor (borrower), a trustee and the beneficiary (the lender) and a mortgage simply has the borrower and lender.

The key legal difference is a deed of trust contains a statutory power of sale so that the trustee may liquidate or foreclose on the collateral to satisfy the indebtedness owed by the borrower/trustor. As I am sure you are aware, Kansas is a mortgage state and Missouri is a deed of trust state.

For the remainder of this section, we will discuss both the mortgage and the deed of trust in the context of a security instrument.

A security instrument’s purpose is fairly straight forward and simple, that being an immediate grant of collateral to secure an indebtedness created by a promissory note (or other obligation). However, security instruments have grown to encompass many more covenants and promises between a lender and a borrower. In the absence of a loan agreement, the security instrument is typically where you will find positive and negative covenants of the borrower, conditions to funding and events of default, along with legal waivers.

a. Conditions to Funding

Conditions to funding are typically found in a construction loan. As you might suspect, a construction lender will want the borrower to have all legal permits in place to build, all governmental approvals, maybe even pre-leasing conditions to funding. Even after the initial funding, a construction lender will want lien releases and a review of the construction budget prior to making additional advances during a construction project.

Some conditions are applicable to all loans, such as the issuance of a lender’s policy of title insurance with the removal of the mechanic lien exception or that the real property is properly insured or that an “as-built” survey exists, certified to lender prior to funding.

The conditions to funding should be clearly stated and understood by the parties and contained in one section of the security instrument or the loan agreement.

b. Positive Covenants

Positive covenants are promises the borrower must keep during the term of a loan. Some more common examples are:

  1. Maintain insurance on the collateral in the amount of the full replacement value of the collateral.
  2. Pay all taxes as they become due and owing, or pay on a monthly basis the estimated amount of taxes on a monthly basis so that lender can pay on behalf of borrower.
  3. Keep the collateral in good repair and working order.
  4. Make financial disclosures to lender.
  5. Maintain certain financial measures in place for an income producing property, such as a debt service coverage ratio (e.g. the amount of income vs. expenses related to a property expressed as a ratio).
  6. Special purpose entity requirements.

Negative Covenants

Negative covenants are promises by the borrower to refrain from doing certain things. Negative covenants are typically the more troublesome of the covenants in a loan agreement or security instrument. Some of the more common negative covenants are:

  1. No distributions to members/owners of borrower as long as loan is outstanding.
  2. No change of control of borrower.
  3. No transfer of ownership greater than 20% of borrower.
  4. No sale of the underlying collateral or further encumbrance of the underlying collateral.
  5. Cash control covenants which include hard and soft lockbox agreements.
  6. Interest rate swap or protection purchases based on market events.
  7. No new leases without approval of lender or new leases only made on lender approved lease form.

ProTip: Include the ability of borrower to bond around or insure over liens or encumbrances filed against the collateral by third parties.

ProTip: Most lenders will accept re-organizational carve-outs in order for borrower to merge or otherwise organize with affiliates or other entities controlled by the principals of borrower. Having this exclusion (carve-out) is useful I have found.

c. Events of Default

Events of default are the conditions under which the lender can start exercising remedies. Some are obvious such as the failure of borrower to make payments as required under the promissory note. Some are less obvious such as:

  1. The infamous Material Adverse Effect clause such as:
Material Adverse Effect” shall mean a material adverse effect on (i) the Property, (ii) the business, profits, prospects, management, operations or condition (financial or otherwise) of Borrower, Guarantor, Sponsor or the Property, (iii) the enforceability, validity, perfection or priority of the lien of the Security Instrument or the other Loan Documents, or (iv) the ability of Borrower and/or Guarantor to timely perform its obligations under the Security Instrument or the other Loan Documents.

2. The absence of a “Material Action” such as:

Material Action” shall mean with respect to any Person, any action to consolidate or merge such Person with or into any Person, or sell all or substantially all of the assets of such Person, or to institute proceedings to have such Person be adjudicated bankrupt or insolvent, or consent to the institution of bankruptcy or insolvency proceedings against such Person or file a petition seeking, or consent to, reorganization or relief with respect to such Person under any applicable federal or state law relating to bankruptcy, or consent to the appointment of a receiver, liquidator, assignee, trustee, sequestrator (or other similar official) of such Person or a substantial part of its property, or make any assignment for the benefit of creditors of such Person, or admit in writing such Person’s inability to pay its debts generally as they become due, or take action in furtherance of any such action, or, to the fullest extent permitted by law, dissolve or liquidate such Person.

3. Death of a guarantor.

ProTip: I have found more success negotiating grace periods, cure periods or other solutions to prevent an “Event of Default” than arguing against the lender’s “form” Event of Default language.

3. Legal Opinion

It may not seem obvious, but the legal opinion issued by borrower’s counsel is a “standard loan document” in my opinion and is a document that some counsel are uncomfortable giving. The best resource on legal opinions is found at The Legal Opinion Resource Center found at http://apps.americanbar.org/buslaw/tribar/. It is absolutely critical that you use this resource in your legal opinion practice.

For purposes of this article, I have used (and use in my practice) the Inclusive Real Estate Secured Transaction Opinion issued by the ABA/ACREL Committee. This form legal opinion can be found here at http://apps.americanbar.org/dch/committee.cfm?com=RP213000. You will find both PDF and Word versions at that website.

As you might conclude, whole seminars are dedicated to the secured transaction legal opinion. My goal is to focus you on certain portions that I typically find troublesome in these situations.

The first and foremost comment must be taken directly from the ABA report itself:

“No attorney will or should give or receive an opinion that incorporates the Accord or the ABA/ACREL Report without being sufficiently comfortable that he or she understands those documents and how they are likely to be interpreted in the future. Few have achieved this level of comfort.”

Yeah, so what does that mean? It means:

a. Unless you limit the scope of your inquiry, the scope will be determined by the reasonable standard. Use language such as:

Scope of Review. In connection with the opinions hereinafter set forth, we have limited the scope of our review of the documents related to the Transaction to [originals/photocopies of] the Transaction Documents and the Financing Statements. In addition, in connection with the opinions hereinafter set forth, we have reviewed such other documents and certificates of public officials and certificates of representatives of the Client, and have given consideration to such matters of law and fact, as we have deemed appropriate, in our professional judgment, to render such opinions.

b. The “duly executed”, delivered and for due consideration opinion means that you are giving a legal opinion that a valid contract exists between borrower and lender.

ProTip: You need to be very careful with the consideration portion of this opinion. Beware of situations where a third party is giving collateral for a loan for “belts and suspenders” or “extra consideration” without getting anything in return. Beware of situations where an affiliate entity is giving collateral for a sister company without getting anything in return.

c. A usury opinion is implied in your remedy opinion unless you disclaim the usury opinion.

ProTip: In light of the “recession” I have declined giving usury opinions for almost all the states in which I am licensed to practice. The reason is that terms such as Exit Fees, Closing Fee Advances, Point Paydown Schedules and other similarly creative methods of “juicing” a deal have simply not been tested since the S&L Bailout in Texas in the 1980's. Reading some of those cases will make you not want to ever give a legal opinion again.

The form legal opinion is attached as Exhibit C for your convenience.

B. Security Agreements

A security agreement is the written document that creates a security interest in property that is not real estate. A security interest in real estate is created with a security instrument (deed of trust or mortgage). A “security interest” is a right by a creditor to have a specific item or items of property sold to satisfy the debt owed to the secured party. In order to enforce a security interest against other creditors and in bankruptcy, the security interest must be properly created and perfected.

A lender wants the ability to enforce its security interest and it wants priority over other lenders. As a result, a lender (the UCC uses the term creditor) needs to meet the requirements of enforcement against the debtor and must perfect its security interest so as to preserve it against third parties.

1. Enforcement.

Section 9–203(b) of the UCC sets forth the requirements for the enforceable security interest against a debtor:

(b) [Enforceability.]
Except as otherwise provided in subsections (c) through (i), a security interest is enforceable against the debtor and third parties with respect to the collateral only if :
(1) value has been given;
(2) the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party; and
(3) one of the following conditions is met:
(A) the debtor has authenticated a security agreement that provides a description of the collateral and, if the security interest covers timber to be cut, a description of the land concerned;
(B) the collateral is not a certificated security and is in the possession of the secured party under Section 9–313 pursuant to the debtor’s security agreement;
(C) the collateral is a certificated security in registered form and the security certificate has been delivered to the secured party under Section 8–301 pursuant to the debtor’s security agreement; or
(D) the collateral is deposit accounts, electronic chattel paper, investment property, or letter-of-credit rights, and the secured party has control under Section 9–104, 9–105, 9–106, or 9–107 pursuant to the debtor’s security agreement.

In most commercial cases, creation of the security interest is a fairly easy requirement to meet. The creditor must obtain a signed security agreement which describes the debt and states that debt is secured by the collateral.

A security interest becomes enforceable when it “attaches” to the personal property as set forth in UCC §9–203(a):

(a) [Attachment.]
A security interest attaches to collateral when it becomes enforceable against the debtor with respect to the collateral, unless an agreement expressly postpones the time of attachment.

2. Perfection.

There are four methods of perfecting security interests in assets under the UCC: (1) filing financing statements; (2) by possession; (3) by control; and (4) by other methods under state and federal law, which involves the filing of certificates of title or other legal compliance (e.g., motor vehicles, airplane and boats).

For most business assets, the filing of a financing statement (known as a UCC-1 form) in the appropriate location and containing the required information is the method of perfection. As a rule of thumb, if the creditor uses the description of the collateral set forth in the security agreement for collateral ordinarily taken for a commercial debtor (e.g., equipment, goods, inventory, fixtures, accounts, general intangibles, payment intangibles, instruments and goods, etc.), the description will suffice. In addition, the financing statement can recite that it covers “all assets" UCC §9- 504(2)

ProTip: If you want to use “all assets” make sure you get specific authorization to file against “all assets” in the Security Agreement. You may not use the term “all assets” in the Security Agreement. See discussion below.

Financing statements are typically filed in the State of organization in the case of a business and in the State of residence in the case of an individual. Financing statements must be renewed every five years.

3. Types of Collateral

The UCC permits financing statements to contain the words “all assets” or “all personal property.” UCC 9- 504(2). Although this may be true in the terms of the asset description in certain financing statements, it is not true with respect to the security agreement. THE STATUTE PROVIDES THAT “SUPERGENERIC” DESCRIPTIONS IN THE SECURITY AGREEMENT, SUCH AS “ALL ASSETS” OR “ALL DEBTOR’S PERSONAL PROPERTY” WILL FAIL TO CREATE A SECURITY INTEREST. UCC 9–108(c). The good news is that Article 9 permits the practice of listing defined categories of assets in both the security agreement and the financing statements. UCC 9–108(b)(3); UCC 9- 504(1).

The types of assets are very broad. For example:

a. “Goods.” Goods means all things movable including fixtures, crops, and manufactured homes. UCC 9–102 (44).
b. “Inventory.” Inventory is generally goods sold or leased whether under a sale or service contract or that are consumed in business. UCC 9–102 (48).
c. “Equipment.” Equipment is defined as goods other than inventory, farm products, or consumer goods. UCC 9–102 (33).
d. “Fixtures.” Fixtures means goods that have become fixtures under real property law. UCC 9–102(41).
c. Intangible Property such as (A) “Account.” The term “account” includes a right to payment for goods sold or services rendered, but could include assets as broad as credit card charges, lottery winnings, and might even include health care receivable if properly defined. However, it does not include chattel paper, commercial tort claims, deposit accounts, letters of credit, or rights arising out of other types of payment. UCC 9–102(2). (B) “Chattel Paper.” Chattel Paper means an obligation evidenced by monetary obligation and a security interest in specific goods. UCC 9–102(11).

A security interest in an asset also creates a security interest in the proceeds. Included within the definition of proceeds is the term “supporting obligation” which could include guaranties and letter of credits rights that support the collateral. UCC 9–102(a)(64); UCC 9–203(f); UCC 9–315.

Article 9 permits a description which grants to the secured party rights in all collateral “in which debtor now has or hereafter acquires an interest.” This is known as an “after-acquired property clause.” UCC 9–204.

It is common practice for lender’s to combine a security agreement with a mortgage or deed of trust among other things. Typically, a mortgage and/or deed of trust will be titled “Deed of Trust, Security Agreement, Assignment of Leases and Fixture Filing”.

C. Assignment of Leases and Rents

Which leads us to the discussion of the Assignment of Leases and Rents. For income producing properties, this document purports to create a present assignment of the income from the real property (the leases and rents) to the lender. Typically, the lender will then grant the borrower a license to use the leases and rents until or unless an event of default exists.

If the tenants paying rent are fairly sophisticated, they will require a Subordination and Non-Disturbance Agreement (“SNDA”) be executed by the lender requesting the assignment of leases and rents. An SNDA does exactly what the title states, it (i) subordinates the lease to the mortgage lien and (ii) binds the lender not to disturb the tenant (e.g. foreclose out the leasehold interest) as long as tenant performs under the existing lease.

The main issue with regard to an assignment of rents is whether (i) it creates a security interest in the income of the real property or (ii) it creates a present assignment of the income of the real property. States such as Texas and New Mexico have adopted the Uniform Assignment of Rents Act which states clearly that an assignment of rents creates a security instrument in the income of the real property.

Courts in Missouri have long held that an assignment of rents does not create an absolute conveyance of the rents to the lender. Instead, the borrower is entitled to receive the rents and profits until the lender “enters into actual possession, or takes some equivalent action” with respect to the property.

In more recent times, courts in Missouri have elaborated on the conditions that must be satisfied before a lender may collect rents under an assignment of rents clause, namely:

  1. Proper documentation of the assignment;
  2. Proper recording of the assignment in the form required for an interest in real estate;
  3. Default on the part of the borrower; and
  4. Possession of the property by the lender, or action equivalent to possession by the lender. Jewish Center for Aged v. BSPM Trustees, Inc., 295 S.W.3d 513, 523 (Mo. Ct. App. 2009)

In short, an assignment of rents is not automatic. Rather, it lies dormant until the lender takes certain steps to activate or perfect the assignment. Only after these steps have been taken may the lender collect rents directly from the tenants. Of the four conditions outlined above, it is the last that has caused the most controversy and confusion. Specifically, courts have differed over what action by the lender is equivalent to possession under Missouri law.

Kansas mirrors Missouri with regard to assignment of rents, although the courts are not as clear on the “extra step” required. In re Bryant Manor, LLC, 422 B.R. 278 (Bankr. D. Kan. 2010).

D. Additional Guarantees

A guaranty is an agreement made by a third party, to pay and/or perform the obligations of a debtor for the satisfaction of a debt owed to a creditor upon the occurrence of an event, typically a default by the debtor, under the original loan agreement. The Statute of Frauds requires that a guaranty be in writing, signed by the guarantor(s) and delivered to the creditor.

In the context of a loan transaction, a guaranty serves as a form of collateral to support the debt obligation between the debtor and the creditor. But, the guaranty and the loan agreement evidence separate obligations, and their independence is not affected by the fact that both agreements are written on the same instrument or are contemporaneously executed.

The guaranty cannot exist without a primary debt obligation. Thus, if the primary debt obligation has been fully satisfied, is void or is illegal, a guaranty of the debt obligation can also be deemed unenforceable.

There are varying types of guaranties.

  1. An absolute guaranty provides that the guarantor promises to pay or perform the obligations of the debtor upon the occurrence of an event of default (typically debtor’s default). If a guaranty does not contain words of limitation or conditions, it is typically construed as an absolute guaranty.
  2. A conditional guaranty requires the happening of some contingent event (other than the default of the debtor) or the performance of some act on the part of the creditor before the guarantor will be liable.
  3. A payment guaranty obligates the guarantor to pay the debt at maturity (which may arise due to an event of default). Upon the occurrence of a debtor’s default, the guarantor’s obligation becomes fixed and the creditor does not need to make a demand on the debtor.
  4. A collection guaranty is a guarantor’s promise that if the creditor cannot collect the claim with due diligence, usually after suit (and exhaustion of remedies) against the debtor, the guarantor will pay the creditor.
  5. A performance guaranty obligates the guarantor to perform some obligation on behalf of the debtor for the benefit of the creditor.
  6. A continuing guaranty is a guaranty that is not limited to a single transaction but contemplates a future course of dealing which may encompass a series of transactions, may be for an indefinite period and/or may be intended to secure payment or performance of an overall debt of the debtor. As such, a continuing guaranty may include subsequent indebtedness without new consideration.

For purposes of this article, we will discuss the full and conditional guaranty agreements. Conditional guarantees are typically related to non-recourse loans and a “triggered” by the happening of a “bad boy” event. The recourse carve-outs are typically things that are associated with “bad acts” such as fraud, theft or false statements. In today’s non-recourse environment, the term “bad boy carve-outs” have little meaning and the conditions related to recourse are much broader than in the past. For example:

  1. failure to pay Taxes, charges for labor or materials or other charges that can create liens on any portion of the Property;
  2. failure to pay Insurance Premiums, to maintain the Policies in full force and effect as expressly provided herein;
  3. any security deposits, advance deposits or any other deposits collected with respect to the Property which are not delivered to Lender upon a foreclosure of the Property or action in lieu thereof;
  4. the filing of a bankruptcy petition by Borrower.

ProTip: These provisions will typically be in the initial term sheet. The time to fight this battle is at the term sheet level when the lender is more inclined to negotiate these “legal terms”.

A party’s enforcement of a commercial guaranty, like any other contract, requires the analysis of basic contract principles. What sets a commercial guaranty apart from other contracts is that a commercial guaranty may lie dormant and unattended to by the parties until the occurrence of some subsequent, triggering event. At that time, which may be months or years after the commercial guaranty and the underlying debt documents were originally executed, the party seeking to enforce the guaranty then has to examine the terms of the guaranty, the status and condition of the guarantor and other facts and circumstances existing at the time of enforcement.

When two or more persons guarantee the debt of another, they simultaneously enter into an implied promise on the part of each to contribute his or her share if necessary to meet the common obligation between the co-guarantors. The discharge of one co-guarantor’s direct liability to the creditor does not relieve him or her from liability to contribute to the other co-guarantors. In addition, the fact that a creditor sues only some of the co-guarantors, or recovers a judgment against fewer than all of them, does not excuse those not sued or not included in the judgment from paying their part of the joint debt. Accordingly, as a general rule, one or more of the co-guarantors against whom the judgment is recovered may, upon paying the creditor, compel contribution from all other co-guarantors. A creditor’s release of one guarantor does not necessarily release the co-guarantors. Lestorti v. DeLeo, 4 A.3d 269 (Conn. Super. Ct. 2010).

E. Cross Collateralization

If two loans are secured by the same collateral, that collateral is cross collateralized between the two loans. If one loan is in default, then the lender may enforce its remedies against the entire collateral.

This seems pretty straight forward. However, as Dale Whitman discussed in his great 1998 article, the main issues in this area of lending involve dragnet clauses.

A dragnet clause is a mortgage provision stating that future, but currently unspecified, debts that the borrower owes to the lender will automatically be secured by the present mortgage. Courts tend to regard dragnet clauses with suspicion because they rarely are negotiated specifically and often are unnoticed entirely or misunderstood by borrowers. Hence, courts often construe dragnet clauses in ways that limit their effectiveness. GRANT S. NELSON & DALE A. WHITMAN, REAL ESTATE FINANCE LAW § 12.8 (3d ed. 1993).

An example is:

This mortgage shall also secure all future indebtedness which is incurred during the term of this loan that the mortgagor may owe to the mortgagee.

The cross-collateralization provision stated above secures all obligations, debts and liabilities plus interest owed by borrower to lender. Many borrowers do not realize the importance of this provision.

ProTip: Once again, your client will have more luck getting this removed than you will once the loan documents are delivered. The time to carve this out is when the term sheet is issued.

F. Resolutions and Authority

A resolution is the method by which entities officially act and grant authority to individuals to act on behalf of the entity. Lender’s require both the organizational documents for the borrower and evidence of the authority of the person signing the loan documents. In short, a lender wants to make sure that the entity has authorized the loan and that the person signing on behalf of the entity has the authorization to bind the borrower.

The lender’s checklist attached to this article as Exhibit A gives you an example of the authority documents required by a lender. For your convenience, I have attached a form Incumbency Certificate and Unanimous Consent of Members as Exhibit D which I hope you will find useful.