On Monday 29 June, Partha Pal and Ian Jack, shareholders at Greenberg Traurig, hosted ULI UK’s first virtual Masterclass. The event was fully subscribed and attended by 30 ULI UK Young Leader members.
As an introduction, Partha and Ian discussed a central principle of real estate financing: security. Whilst in most cases the lender will have security over the assets being financed, enforcing this security does not come without cost and consequence. Firstly, a lender enforcing security must be capable of taking control of the assets and avoid making matters worse. Secondly, selling the assets at a bad price could adversely affect the value of similar assets that they hold security over, and thirdly, unless the situation can be directly attributed to the borrower, enforcement may affect the lender’s reputation in the market.
Enforcing security in a distressed situation, therefore, is often not the first or best resolution for either the lender or borrower. So, what other resolutions are available? To cure the distress, Partha and Ian first sought to understand its causes and symptoms:
Partha and Ian categorise distress into three categories:
Idiosyncratic – specific to individual assets (e.g. a tenant vacating a single-asset asset)
Sectoral – distress that impacts upon particular sectors or geographies (e.g. traditional retail due to the emergence of e-commerce)
Systemic – distress that impacts upon all sectors and geographies (e.g. Covid-19 or the Global Financial Crisis), albeit to different degrees.
Distress can manifest itself in several ways. However, often the most effective way to recognise the symptoms is through the obligations of a borrower. These can include:
Revenue Payment Failure – failing to make payment of interest or fees when due
Capital Payment Failure – failing to make repayment of principal when due
Service Cover Failure – failing to meet interest or debt service cover covenants
Loan to Value Failure – failing to meet loan to value covenants
Structural Failure – a structural failure that impacts upon its solvency, such as a tax liability that remains undischarged
By recognising the symptoms and assessing the causes, solutions can be found. Consensual cures to the above could be as follows:
Revenue Payment Failure / Service Cover Failure – where the failure is caused by systemic distress, a logical step could be to temporarily waive the loan covenants; a step that Partha and Ian describe as “waive and wait”. However, where it is the result of sectoral or idiosyncratic distress, solutions may be more radical, such as reducing the debt burden or injecting new capital to facilitate asset management initiatives.
Capital Payment Failure / Loan to Value Failure – where the failure is caused by systemic distress, a logical step would be to defer capital payment obligations for a time; a step that Partha and Ian described as “extend and pretend”. However, where it is the result of longer term sectoral or idiosyncratic distress, solutions may be more radical, such as reducing the debt burden or injecting new capital to facilitate asset management initiatives.
Structural Failure: as this failure is caused by idiosyncratic distress, the solution requires a more bespoke approach.
For any such consensual cure to be found, there must be a level of alignment between borrower and lender. Finding this alignment can be harder still where more parties are involved (e.g. contractors, forward-funders, mezzanine providers). Otherwise, non-consensual approaches can be considered. Non-consensual approaches commonly include: cash trapping, replacing asset managers, appointing receivers, appointing administrators and schemes of arrangement.
Overall, it was an enlightening discussion with Young Leaders able to ask questions of the experts, Partha and Ian, as well as network with each other.