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Impact of COVID-19 on Loan Documents

Lender responses to the pandemic have diverged based on the types of assets involved. While the long-term effects of COVID-19 on loan documents and requirements remain to be seen, there are some common accommodations and adjustments that many lenders and borrowers have agreed to in the short term.

Existing Loans

For existing loans, many lenders have agreed to brief deferrals of principal and interest payments, typically for three-month periods. Some lenders have also agreed to temporarily suspend debt yield/debt service coverage ratio tests. Under many existing loan documents, PPP loans and similar debt under government relief programs may be considered to be prohibited additional indebtedness. Borrowers should seek a modification of their loan documents, when necessary, to allow such loans and forgivable debt to be classified as permitted additional debt. Although typically a representations and warranties clause will include a statement that no material adverse change has occurred in the borrower’s financial condition or at the property, some borrowers have successfully negotiated clause changes so that any adverse impact specifically arising from the pandemic will not be deemed a breach of those representations or warranties.

New Loans

For new loans, some lenders are requiring borrowers to provide debt service reserves at closing. For multifamily mortgage loans, Fannie Mae and Freddie Mac are requiring many borrowers to escrow debt service reserves at closing, with reserves range from 6 to 18 months depending on the loan-to-value ratio and debt service coverage ratio.

COVID-19 has impacted force majeure clauses and covenants in new construction loans with regard to permitting and governmental approvals. Many borrowers are requesting that construction delays arising from COVID-19 be recognized specifically as permitted force majeure delays. In response to government office closures and delays in scheduling inspections, borrowers are also requesting more flexibility from lenders regarding the timing and form of required government approvals and certificates of occupancy. Borrowers should also take care when negotiating lease covenants, and anticipate potential areas of conflict between COVID-19 relief laws and the loan documents. State and local laws enacted during the pandemic may restrict landlord remedies against tenants, and frustrate a borrower’s ability to satisfy its covenants to enforce lease obligations.

Financial Covenants in Loan Documents

Financial covenants in both new and existing loans should be carefully evaluated for potential risks arising from the pandemic. In particular, borrowers should review how net operating income is defined in their loan documents, and any occupancy requirements for tenants and the impact of any rent deferral agreements. As a practical matter, consider how pandemic safety measures—additional sanitation procedures, HVAC improvements, and increased utilities costs for running HVAC systems longer—may increase operating expenses and necessitate negotiating lower debt yield/debt service coverage ratio requirements.

We are here to help answer specific questions and offer advice on your options. Feel free to contact any member of our Real Estate Group.

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