In real estate finance, most loan documents restrict a borrower’s right to modify the secured real estate. The alteration provisions in the loan documents relate to any alteration, improvement or demolition of any improvement made to the property. Since most real estate financing is non-recourse in nature, the lender is rightly concerned that changes to the secured property may affect the lender’s sole asset in the event of borrower default. Even when a financing is not without recourse, a lender is also rightly concerned by the modifications made to the real estate guarantee since he seeks, in whole or in part, this guarantee as security for his loan.
In a typical transaction, changes to the property that are above a threshold or that are “material” or “structural” in nature will require the prior written consent of the lender. The threshold below which the borrower can alter the property without the lender’s consent is defined in the loan agreement either as a dollar amount or as a certain percentage of the sum of the total original loan principal amount. In addition, many loan agreements provide that the prior written consent of the lender is not required for modifications that cannot reasonably be expected to have a material adverse effect, often defined as any event or condition having a material adverse effect on the use of the property, the business of the borrower, the enforceability, validity, perfection or priority of the lien of the mortgage or other loan documents, or the Borrower’s ability to perform any of its material obligations under the Loan Documents. Notwithstanding this threshold, many loan documents list specific types of modifications that do not require the lender’s consent, some of which may include the following:
- repairs based on life safety or emergency conditions or which are necessary to comply with applicable legal requirements;
- pre-approved changes;
- non-structural or decorative works carried out in the ordinary course of the Borrower’s business;
- changes made in accordance with an approved annual budget;
- changes to any existing lease at the closing date; and
- modifications and repairs resulting from a claim or condemnation.
Although this list is not exhaustive, the details of a transaction will dictate the list of modifications that do not require the consent of the lender.
If the changes requested by the borrower exceed the threshold amount, in addition to requiring the consent of the lender, the borrower is required to post security as security for the completion of the work without lien. This may take the form of cash, acceptable government securities, a letter of credit or a guarantee signed by a guarantor in favor of the lender. The borrower’s requirement to post security is to ensure that the parties making the alterations are paid for their work and to avoid any liens on the property. Once the alterations are complete, the security is returned to the borrower after the lender has received lien waivers and a clean title report of the property.
Change provisions in loan documents are necessary to ensure that the lender is aware of and consents to any major change plans. Constraints to modifications in favor of the lender include consent, as well as requiring the borrower to post collateral once a threshold amount is exceeded. In non-recourse loans, amendment provisions in the loan documents are essential to the lender’s protection of the secured assets.