When restructuring a loan or working with a borrower on the verge of default, Loan Modifications are a widely used solution. The terms of a Modification can include virtually any change to the terms of the loan, from simply extending the maturity date of a loan to adding collateral, etc. Despite their overall flexibility and simplicity, a Modification still must be documented correctly to be enforceable and to maintain the lender’s original lien priority.
Put It in Writing!
When assessing the enforceability of any contract, the Statute of Frauds is a critical factor to consider, and loan modifications are no exception. Often distilled to the principle of "put the agreement in writing," the Statute of Frauds mandates that certain categories of contracts must be reduced to writing in order to be enforceable. It comes as no surprise that any contract involving land falls within the Statute of Frauds’ writing requirement. Despite modifying a pre-existing agreement, the Modification still concerns land, so the Modification must be in writing. Lenders often look to extension provisions of the original loan agreement to avoid preparing extra documents. Extension provisions generally provide the prerequisites for granting an extension or restrictions on the number of extensions. An extension provision alone is not likely to meet the Statute of Frauds requirements and should not be relied upon as a written Modification without first consulting an attorney.
Rather than viewing the Statute of Frauds as an obstacle, lenders should find some reassurance in its requirements. Holding a borrower to a written agreement is far more straightforward than relying on anything communicated verbally. The Statute of Frauds is an easy rule to comply with and an important consideration when determining how to document your Modification. Remember, even with the simplest Modification, when in doubt, write it out.
Borrower Financial Difficulties
A borrower experiencing financial hardship can present a persuasive case in court, and that case grows even stronger when the lender’s position rests solely on oral agreements. Discussions about Modifications frequently occur over a series of phone calls, at times involving several representatives from both the lender and borrower. Often, it is these phone calls that become the focal point of court battles and create the classic “he said, she said” dilemma. Memorializing phone conversations over email and requesting confirmation emails avoids unnecessary dilemmas.
Maintaining Lien Priority
For any loan secured by real estate, lien priority is a paramount concern for the lender. A first position lien has a variety of advantages in foreclosure over a second position lien, so maintaining the first position is vital for a lender looking to modify their loan. Preparing a modification of the security instrument and recording the document provides security for the lender’s lien position; additionally, it is recommended that lenders obtain the proper ALTA endorsements for the lender’s title policy.
To maintain lien position, a subordination agreement may also need to be prepared in connection with a Modification. While a simple extension may not require a subordination agreement, nearly any other type of Modification will when a junior lien exists on the property — particularly Modifications in which additional funds are disbursed. While the position of the original funds is generally safe, the position of the additional funds is generally not secure unless a subordination agreement is prepared. If a lender is uncertain about whether a subordination agreement is necessary, the lender should consult an attorney.
Which Documents Should You Prepare?
Modified versions of the note and security instrument should always be prepared; if a separate loan security agreement exists, a modified version of that document should be prepared as well. However, not all loan agreements are created equal, many documents can serve the same purpose, but have different titles. To avoid any question of whether a modified document should be prepared, consult with an attorney.
Any guaranties found in the original loan documents should be renewed through a reaffirmation of guaranty. A reaffirmation of guaranty requires the original guarantor to renew the guaranty of the original loan along with the terms in the Modification. Since guaranties provide recourse for lenders when the borrower is in default, a reaffirmation of guaranty is a major tool for lenders advancing more funds to a borrower or even extending a maturity date, ensuring that the guarantor cannot deny knowledge of the Modification.
Concluding Thoughts
Modifications offer lenders an effective means of preserving the borrower relationship while avoiding costly alternatives. Throughout the negotiation of a Modification, lenders should remain fully aware of what they are agreeing to and document that agreement in writing. Even the shortest phone calls can be forgotten several months after the fact, but written agreements eliminate the need to recollect every communication. Lenders should feel comfortable following this simple rule: “when in doubt, write it out.”
Do you still have questions about loan modifications? The team at Geraci can help. Contact us today.
