Loan Modifications are a popular solution when restructuring a loan or dealing with a borrower on the brink of default. 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.
Get it in Writing!
The Statute of Frauds is an important consideration when examining the enforceability of any contract, and loan modifications are no exception. Best summed up as “put the agreement in writing,” the Statute of Frauds requires that certain categories of contracts are always put in writing to be considered enforceable. Unsurprisingly, a contract involving land must be in writing under the Statute of Frauds. 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.
Despite appearing as a potential roadblock, the Statute of Frauds requirement should provide some peace of mind for lenders. It is much easier to bind a borrower to a written agreement than anything communicated orally. 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 Hardships
Borrowers falling on tough times can make a compelling argument in court; the borrower’s argument becomes more compelling when a lender only has oral agreements to back them up. Communication regarding Modifications often takes place through a series of phone calls, sometimes with multiple representatives of the lender and borrower participating in those calls. 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.
Securing Lien Priority
A lender’s lien priority is a major consideration for all loans secured by real estate. 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.
A subordination agreement may also need to be prepared for a Modification to ensure that the lien position is maintained. A simple extension may not require a subordination agreement, but nearly any other Modification will need a subordination agreement when there is a junior lien on the property; especially Modifications where 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.
What Documents Should You Prepare?
The note and security instrument should always have a modified version prepared; if a separate loan security agreement is prepared, it should also have a modified version prepared. 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 in the original loan documents should be reaffirmed with 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.
Conclusion
Modifications are a great way to save the relationship with the borrower and stay away from costly alternatives. When negotiating a Modification, lenders should always be aware of what they are agreeing to and memorialize 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.”
Still have questions about loan modifications? The team at Geraci can help. Contact us today.
