Best Practices for Funds, Fund Managers, and Lenders during the COVID-19 Crisis

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As the economic downturn caused by the COVID-19 outbreak started to look more and more like a recession, many lenders and fund managers were asking what they can do to prepare. Evaluating your current capital arrangements is an essential step in preparing for this possibility.

For Fund Managers:
Do your funds have the capabilities to withstand the stresses of a recession? Do you have the right tools and powers as the fund manager to preserve capital, work out loans, prevent a run on the fund, or acquire distressed assets?

For Lenders:
Are your capital partners, secondary market buyers, and bankers liquid enough to provide the capital flow you need? Perhaps it’s time to evaluate their commitments to you, and explore new options to control the capital.

You will learn:

  • How to protect yourself, your business, and your investors in the event of a recession.
  • Best practices and creative strategies regarding capital preservation, redemptions, and capital markets.
  • Practical solutions for fund operations, including insurance, supplemental disclosures, and investor relations tactics.

Kevin Kim, Esq.:

All right. Good morning everyone. Thank you for joining us today for this Geraci webinar on best practices for funds and fund managers during this Coronavirus Pandemic as we wait for the attendees to file in. Definitely want to thank everyone for joining us here today. My name is Kevin Kim. I'll be hosting this webinar alongside my associate Tae Kim. Say hi to everyone.

Tae Kim, Esq.:


Kevin Kim, Esq.:

So before we get started, some light housekeeping. For those of you who are new to Zoom webinars, we will be muting everyone's mics, but we encourage everyone to ask as many questions as you like. We'll try to get to all of 'em with time allotted. Please direct your questions to the question and the answer section. So if you move your cursor down below, your zoom toolbar should give you a Q&A section. Please type your questions there as opposed to the webinar chat because it's a lot easier to address questions in the Q&A section as opposed to the chat function. Of course, feel free to chat amongst yourselves and chat with us as we present today. It looks like we got a good amount of people coming in, so I think we'll get started. So once again, welcome everyone. My name is Kevin Kim.

We're here today to present on best practices for funds and fund managers during the COVID-19 crisis. This webinar is primarily focused on fund managers who are managing debt funds, mortgage funds for private lenders, as that is Geraci Law Firm's core area of expertise. So to introduce ourselves today, I'll introduce myself. My name is Kevin Kim. I'm the partner that manages the firm's corporate and securities division. I'm a national expert on mortgage fund formation for private lenders. I've been doing this for quite some time now. I'm also the lead instructor for the American Association of Private Lenders Certified Fund Manager course, which is now online. We've been teaching hundreds and hundreds of fund managers, many of you who are on the call today about fund formation in the private lending industry. With me today is Tae Kim, an associate on my team. Tae, please introduce yourself.

Tae Kim, Esq.:

Sure. Hi, my name is Tae Kim. I'm an associate here at Geraci Law Firm Corporate and Securities Division. I work alonGeracide with Kevin Kim and our other associates, Olivia Durnell and Dave Kelly. We help prepare structure the funds, specifically mortgage real estate and other related funds, and we're here to talk about our best practices. Thank you so much, Kevin.

Kevin Kim, Esq.:

Alright, so let's get started. So once again, we've got some people coming in a little bit late today. It's all good. Let's talk about housekeeping really quick. Once again, please direct your questions to the Q&A function in Zoom, not the chat, because we can't get to all the questions in the chat function because it scrolls up and we lose 'em all. We'll make sure to answer all your questions. We'll try to get to 'em during the webinar. If not, we'll get to 'em after the webinar. So let's get started.

The first slide here is the introduction. So we really wanted to have this webinar for fund managers because starting roughly about early March, we started to have more and more phone calls with our clients who are fund managers from across the country about how this pandemic is going to impact funds and how they should be operating. What are some best practices? And we're talking about an evolution. Of course, over time, this crisis has had such a devastating and catastrophic effect on the national economy and its impact here in our industry has been really, really fraught with uncertainty and volatility. But this webinar is meant to give a lot of the fund managers out there or aspiring fund managers out there, some best practices, some hope, and I guess some opportunity as well.

This webinar is catered to fund managers, the mortgage fund managers out there, and other sponsors that have discretionary capital and address the impact this is going to have on your business and also the investments you're going to be offering. We're going to evaluate some commonplace and key features that a fund should have to prepare for these kinds of crises and talk about how we can, if you don't have them, how we can address that. We're going to talk about some key decisions that fund managers are having to wrestle with during this crisis as it pertains to their investors and investor investment decisions. We're also going to talk about some key strategies and really important strategies when it comes to investor relations, one of the most important aspects of running a fund and it becomes ever more important in a crisis situation. And of course, we're also going to talk about additional disclosures and reports that we strongly recommend a fund manager should put in place when it comes to the impact of this type of economic downturn caused by a pandemic.

And then we're going to close and talk about some impacts for REITs because that's a very important topic. So first thing I want to give a big picture overview for those of you who are either a fund manager or an aspiring fund manager or a direct lender and you're not sure what to think or what to do about this COVID-19 pandemic has really caused one of the fastest economic crises in recent memory. We went from a boom cycle to really a cycle of unforeseen volatility. The choice you can use the words you like. I've heard unprecedented, uncharted waters, unforeseen all the words are the same. Ultimately it's bad and it's causing a lot of volatility. But the interesting thing though is that is kind of, I would say that it's media induced. I would say also it's induced by Wall Street's reaction, but it's not necessarily as catastrophic for clients of mine that have funds and for lenders that have discretionary capital.

And why is that? First things first, the Wall Street aggregators exit, while it has caused a mass, mass disruption to the space, really creates an interesting opportunity for lenders and for lenders who have discretionary capital and can make their own decisions and can fund their own deals. It hasn't eliminated business opportunity completely. We really think that a lot of it has to do with the rational panic caused by the media and also caused by Wall Street's exit from this sector. But I'm here to tell you that you as fund managers are the alternative to Wall Street. In fact, the investments that you offer are consider alternative investments and most of you have been adjusting your risk exposures and your credit guidelines and taking a conservative stance and still trying to operate and navigate this unforeseen situation that we're in. So these factors I feel are going to provide more stability and offer a path to success over the investment banks, much like our clients were able to succeed during the last economic downturn. But we're going to get into some now to some specific issues. So Tae, take it away. Let's talk about fund documents. So all the clients out there that have a fund, I'm sure you all have your offering documents, I'm sure you all have your ppms. So Tae let's talk about that. What should they be evaluating when it comes to a crisis like this when it comes to their offering documents?

Tae Kim, Esq.:

Sure. So I think one of the most important thing that the fund managers should look to and evaluate is really the offering documents itself. Offering documents, meaning the private placement memorandum at the operating agreement or an LPA, the subscription agreement, whatever that package is that you provide and disclose to the investors, that in and of itself is the ultimate guide as well as disclosures and protection that to the fund managers in the form of disclosure. So then tying to that will be the anti-fraud rules that is very prevalent throughout in the securities laws or specifically rule 10b-5. It's basically that it is unlawful for any person directly or indirectly by use of and means of instrumentality, of interstate commerce to employ any device scheme or artifice to defraud to make any untrue statement or omit a material fact necessary in order to make the statements made.

So in other words, the offering document, specifically the private placement memorandum provides that disclosure into making the statement within that document to be true. And anything that is omitted from that document that if it is a material fact is an important aspect to that. So from a practical purposes, when we're looking into business opportunities as well as other areas of businesses that you want to engage in, you have to make sure that the offering documents states so that you can do so. For example, you are right now in a conservative fund, right? It's a first lien position only. The LTV is say 50 to about 65% a RV, and it's a fund where it provides a stabilized or some type of a conservative return to the investors. However, yet there's a business opportunity that comes by, for example, an NPL or distressed asset or real estate acquisition that is very enticing and it can juice up the yield, but yet if the offering document does not state so that you cannot do so because otherwise you may be violating or being in non-compliance with that of the securities law, specifically rule 10b-5.

Kevin Kim, Esq.:

So I mean, guys, this is a very, very complex issue here, but let's try to bullet down, one of the things that I talk about with my clients is they ask us what can we do given the certain language we have? So you have a problem sometimes where the language is too broad, and in that situation I would ask, what have you been doing so far, right? What have your policy and procedures been until now? What investor expectations have you created based off of past actions, past policies, past processes in dealing with these issues? And in those scenarios, our recommendation is to stick to it. Don't deviate it because deviate from it. Because if you deviate from a certain expectation the investor has of how you're going to operate the business, for example, dealing with exits, right? If you've been operating in a certain fashion, you deviate from that. Even if you're offering documents are so broad, it kind of lets you do whatever you want. You don't want, even then you don't want to create a situation where you have materially misrepresented a key fact of the investment, a material fact of the investor. And that is grounds to start the conversation about 10b-5 liability, which is the term we use as lawyers, but to the layman out there ultimately boils down to securities fraud. So very important guys. Moving on, let's talk about


Some key things that we want to see in offering documents for fund managers to make sure that they're not hamstrung or they're not restricted or they're able to do what they need to do during a situation like this. Take it away.

Tae Kim, Esq.:

Sure. So now that we discussed the securities law in of itself, what does the contract say, right? Basically the offering documents including the PPM, the LPA or the oa, and how broad and how much of a discretion does the fund manager have? And these are the bullet points in the summary that we intend to dive deeper into as we continue to discuss. But basically, the powers associated with either suspending the business activities, redemptions or distributions, the rights and limits of the fund managers and the indemnification clauses that protects you and the standard that gets delineated when it comes down to the indemnification clauses, the protection of the fund manager's tenure. So in other words, does the operating agreement or the LPA state in there that you do have the right to continue on with the business unless or otherwise you get voted out by the investors?

Does the operating agreement does provide that type of protection and any other and other unwritten policies and procedures are written within that are practiced by the fund? And is that consistent with the rest of the fund documents that is important when it comes down to operating the fund. In addition to that, we're also going to be talking about from a summary perspective, the risk disclosures. Are your risk disclosures updated and has that been provided to the investors from an expectation perspective? Some of these more common risk factors that are associated now is the Global Pandemic Act of God and other governmental action risks involved is disclosed to these offering documents. And if so, and if not, what are some of your actions and some of your conduct that you want to take, especially when it comes down to the communication with that of the investors to be sure you do not need to have a consent from the investors in order for you to provide these risk disclosures. It's a matter of disclosing to them on an ongoing basis and updating them for management of the expectation of the investors.

Kevin Kim, Esq.:

Right? And guys, this is why it's so important to make sure that your fund documents, your offering documents, your PPM, your operating agreement or your limited partnership agreement, your social agreement, they're up to date, making sure that you've had counsel scrubbed them and update them on an annual basis. Now, obviously no one could have predicted this. No one's going to have added a COVID-19 disclosure to their PPM. Now, maybe though it is time to start thinking about do we need to put out a risk factor or risk disclosure to the investors stating not only what this will likely do to our industry, our portfolio, but also what we plan to do about it to mitigate risk. But one thing that Tae touched on, here's really, really important is this concept of unwritten, right? Unwritten policy and procedures. So knowing what tools and powers you have from a best practice perspective, you want to enter this battle any battle with an understanding of what powers you have, what capabilities you have, and what precedents you've set in the past.

And I know a lot of my clients, they operate and they're not up to date or they're not current on what their documents say or they need a refresher. And so this is why it's so important to make sure that you work closely with counsel. The most frequent phone call that I'm having today is what do my fund documents say about this particular fact pattern? And we'll go through the facts and we'll analyze it, and we'll also ask questions, what have you been doing until now based off of this legal language, right? And then we will craft a strategy going forward in whatever situation it may be. So moving on, let's talk about one big topic that's come across our desk when it comes to fund management during COVID-19 has to do with suspending redemptions, right? Suspending redemption requests, not allowing investors to exit the fund. So te, tell us the process we should go through and then I'll kind of jump in and give some points of my own.

Tae Kim, Esq.:

Sure, absolutely. So this is, as Kevin mentioned, one of the biggest aspects when it comes down to our current landscape. So there's three step process the fund manager should look into. First of all, should you, step two is can you, and number three, how should you execute these things? And so should you really is more of a business decision and not really a legal decision. When it comes down to the business decision, one of the biggest things that we recommend is evaluate the overall portfolio. And what do you mean by that is not just the loan portfolio in and of itself, but just really the overall financial health of the company. That's when you ask a lot of questions, discuss with the team, and here's some of the questions that I think should be discussed throughout the team. For example, look at the financial statements, the balance sheet and the income statements.

How much equity or liquidity do you have? What are your current and your long-term assets? Are there sufficient cashflow coming in from an income basis? What is your debt to equity ratio? Some of the other aspects that you want to look into is what are these pending redemptions that's coming in? Are investors freaking out? Are they doing a run on the fund and such that it's actually at the detriment of the fund overall? And as well the loss reserves. What are your current loss reserves right now? Can you increase your loss reserves? Is there a limitation to that? And that's when you can look into the PPM for that. We'll discuss that a little bit more. Do you also have a line of credit, any liquid assets such that you can weather through these difficult times? And also in one more aspect is just really the potential losses or the actual losses that are coming down the pipeline.

What are some of these percentages of the default rates that are coming in from the baseline of the total portfolio? Is it increasing? Is it stabilized? And if it is increasing, how quickly is it coming in and how quickly is it increasing? Do you have any clear and efficient tax exit plan to unwind these defaults? And also, are there any regulations currently right now that are preventing you from being able to efficiently exit out some of these defaults? And so based on that overall evaluation, if you believe that there is a need for a suspension of any redemption, the next step really is can you do this right? And that's when you look into the legal documents, the contractual terms that talks about the redemption and the withdrawal aspect of it. In other words, what does your offering documents say? That's when we go through the whole process of, again, in the withdrawal provision and the redemption that talks about how this, these capital for the investor capital can be to be distributed back out to them.

Some of these aspects that you really want to look into is how broad or how discretionary does this language have that allows you to suspend the redemption? Is it by ways of consent or is it by notice? And what are some of the rationales that are listed in the documents that discusses or that ultimately causes you to have the decision to suspend the redemption? And again, just reiterating or can you do so from a business perspective in the form of capital? Is there a sufficient liquid assets to be able to do this? And ultimately, if you are suspending it now that you believe that you can do so, how should you execute these things? And these are really, at the end of the day, the investor relations that you need, that you have with your clients and your investors, both the written and the unwritten policies.

The biggest key aspect of it is transparency, disclosure, operating with honesty to not cause panic when it comes down to the investor to avoid that type of run on the fund situation and really communicate with the investors as to the reason and the rationales why you're doing it. Some of the positive aspects of the reasons why you're doing it, say that, hey, there's a lot of opportunities out there right now. I believe that this is actually a good opportunity for us to deploy the capital. And so thereby we're suspending the redemption. That's one of the rationales that you can discuss with the investors. Email and written communications are important, but I found out personally that if you pick up the phone and talk to them, if there's any issues or any bad news that seems to really calm and quell the investors panic. And so some of these practices can really be, it can go very far when it comes out to protecting your fund.

Kevin Kim, Esq.:

Alright guys, so I do want to talk about some specific back patterns we're seeing today when it comes to redemptions. We have had significant discussions with various sizes and various geographic concentrations of funds on this issue. One thing that we've been finding is that the rationale to suspend redemptions is really forced by investors irrational panic or greed to go after some opportunistic investment on Wall Street, not necessarily because of fund issues. Most clients are being conservative because the rationale financially or economically has to do with the valuation of collateral. It's really uncertain, particularly if you're lending on a lot of commercial real estate and you've got a lot of say, retail or hospitality, which we know is going to be detrimented by this, it is being detriment by this virus. It may be worth your while to evaluate and project losses. And this is why it's so important to have data, to have the necessary reports.

So you can take that data, you can take the current concentration and performance of the portfolio and then apply certain key assumptions to see if x percent of the portfolio were to go into default and we were not able to foreclose right away, how would that impact the fund's performance in a worst case scenario, in a realistic scenario, in a best case scenario, so on and so forth. So it'll allow you to make good decisions. So what I'm finding lately is we ask clients, have you extracted your most recent reports from your servicers and from your administrators? And a lot of times like, oh wow, we didn't really think about that. We're just suspending withdrawals because investors are freaking out and they're banging down the door. And that's one big issue. But the other big issue is, should you even do this, maybe the performance of the fund is so conservative that it may not even be necessary.

And even if it isn't necessary and you want to be conservative and you want to do it, then it comes down to investor relations. And so the last thing you want to do is, and Tae hit the nail on the head, you want to pick up the phone, you want to be available. So let's get into the next section. Oh, one thing here I want to talk about here is the best efforts clauses. A lot of fun documents out there that we see not prepared by us, but ones we see just have a withdrawal clause that just says the manager will allow withdrawals and pay withdrawals on a best efforts basis. Maybe they'll install a lockup notice period. Best efforts basis. Clauses are really dangerous in these scenarios because it creates so much wiggle room, it creates so much discretion for the manager. And I always default to what have you been doing until now from a policy perspective and have you deviated from that?

And even if your documents don't have this and have more of kind of a fine tuned, stricter policy when it comes to redemptions and withdrawals, another issue that you run into with redemptions is the idea to go in a situation where you're creating a new policy, right? You're creating a temporary policy to give some of your investors some peace of mind on the redemption request. While that's feasible, it's not something you should just go do without counsel because what oftentimes is being proposed is if you deviate from the suspension of the redemption clauses in your offering documents, you may end up creating what we call a side letter, right? And without even thinking about it and side letters, you're giving a benefit to one investor to the exclusion of the other investors. Now we have a conversation, not only material misrepresentation of material fact, but we've also got breach of fiduciary duty because you treated one investor preferentially over another. So we have to make sure we're navigating those waters carefully and it's a area that can cause significant liability. So we really encourage folks, if you're thinking about doing this or you want to create some new programs around this, talk to your attorney to navigate these waters carefully. All right, so some of the issues associated with redemptions and also some best practices in the documents and the clauses tey give us some of the issues that we normally see on these redemption provisions.

Tae Kim, Esq.:

And I just wanted to add a little bit about the best efforts basis method that Kevin mentioned from a legal perspective, state laws, they're all over the place when it comes down to the best efforts in terms of the legal definition is contractual term used to obligate the parties to make their best attempt to accomplish such a goal. So what does that even really mean, right? So the jurisdictions, when it comes down to the state law as to what best efforts mean, it varies all over the place. Some of the states state that the best efforts really it does not require or to make every conceivable effort to do so. Some states believe that it's a good faith standard used as well as, or some other states think that it's more than good faith efforts or some other states that it's a reasonable standard. So it really depends on the governing law of the state where you're at.

But as Kevin mentioned, it creates a lot of confusion. It creates contentions. It can substantially hurt the fund when it comes down to creating a side letter and a preferential situation that is to one investor or opposed to the other. There's a breach of fiduciary duty issues that Kevin mentioned as well. And basically the priority of redemption can be higher than other areas of the operation of the fund, which is very important when it comes down to making sure that basically the best effort basis method can create certain type of contentions and it can be problematic. And as Kevin mentioned to speak with the securities council about that. And so what we do recommend when it comes down to the redemption clause there, redemption clauses, there are a couple of best practice pointers that we advise our clients to put into just to prevent any type of investor panic run the fund situation.

And there are various gap stops to protect the fund altogether. And so here's some of the withdrawal sample languages that we do put into. One of 'em is a lock of provision. Typically at minimum 12 months, we see an average between 12 to about 24 months or so with a 90 day notice provision. So after the lockup period has been finished, the investor provides a notice in which the effective day will be the 90 day from the date that you receive that notice to allow the trickle out of the withdrawal. When it comes down to trickling out, we typically advise our clients to be within four quarters such that it's evenly divided among within 20% of that member's capital redemption request. But at the same time, no more than 10% of the total outstanding capital of the fund or $500,000, whichever, is less such that it again protects the fund from any type of run on the fund situation or any redemption requests that may be at the detriment.

And also it's a first come first serve basis in that it's a fair, there is no breach of fiduciary duty situation where whoever comes first are going to be able to redeem that out. And also the managerial discretion whether to waive or modify such type of withdrawal requirements, which gives you the managerial discretion to a certain extent, subject to the terms of the provision in the offering documents as well as other types of corporate law to be able to have that type of discretion. And also there are suspension clauses in there which gives you very specific rational for suspending that redemption, for example, when it comes down to the covid situation or pandemic situation, that it is beyond the control or responsibility of the manager to be able to do so, or if there is a more redemption that's coming down the pipeline. But you have illiquid assets in there, basically you have to dispose some of these things. But the rationale is you do not want to do a fire sale off of and dispose these assets, which can devalue the fund overall. And some of these rationales are very important when it comes down to suspending that withdrawal. And also firm policies on pending requests prior and during suspension or some of these aspects that we do put in or we advise our clients to put into the offering documents to protect the fund.

Kevin Kim, Esq.:

And the purpose of all this, to be clear here, these are normal terms for normal times. So we recommend that the best practice when it comes to having a redemption policy in a fund is to have actually very, very clear guideposts and restrictions when it comes to normal exit requests. That way you can actually say, we've hit our cap for the year, for the fiscal year, we can't honor any more requests in accordance of the documents. That's part one. And part two is having a key, very, very clear reasoning or a very, very clear reason to suspend even if you haven't hit those numbers in these pandemic scenarios. One of the most common specific rationales we give is the inability to value the asset. And that's a very important and very relevant rationale today because a lot of the statement is that the ground is shifting beneath this, right?

We're not quite sure what the value of the collateral is going to be at the end of all this. That's one. And number two, we don't necessarily know the value of the loans today as well. They're not trading at book value as they were before all this hit. And so that rationale is in all of our documents and we recommend that they be in documents because then you have a specific thing to point to, and now you're not just going off on a limb that's not written in the documents. And then you have a defensible argument if a investor were to get aggressive and you say, look, we disclosed this to you, you signed it, and we're using this rationale and here are the reasonings to justify it, right? And so it's important to make sure that these are in there. One thing we see a lot is insufficient redemption clauses in a lot of documents, and it's one of the very big challenging things to overcome.

But the other issue that comes from this and is tied to this has to do with suspending operations and distributions. This is a more dramatic scenario. So the first issue that we come across is suspending withdrawals. And the second part of that is kind of tied to it is suspending operations and distributions, ongoing loan origination, capital raising, and also worst case scenarios are suspending distributions maybe should we do this right? So of course this is a very big decision, much more dramatic I feel than a redemption suspension. So it's very important that you consider all aspects of this and consult with counsel. But some things that you want to talk about in the should you portion of this evaluation really has to do with talking about the portfolio itself. Current credit guidelines, can you sustainably take on loans that are going to fit your new credit guidelines that are more conservative?

Most funds right now are asking the question of if we're suspending with redemption, shouldn't we also suspend operations and should we also suspend redemption? It's kind of a correlated line of questioning, and I don't necessarily believe that they're automatically correlated with one another. I think they're mutually exclusive when it comes to the idea of spending operations as a whole new originations. I don't disagree with the idea of tightening credit guideline. I think it's very smart. I think it's a thing to do right now because it's not necessarily a good idea to be doing high leverage loans right now. And because of the market's contraction rates are coming up, it's a natural reaction to the economy's contraction. And I totally understand that. But it doesn't necessarily mean that you have to stop new loan origination because there's two aspects to this. While you may have suspended withdrawals, new originations that are lining up with market terms may fill and support any potential impact that the older loans may have on the fund.

And so newer loans may also provide more conservative positions, right? If your LTVs are coming way down on assets that on real estate that are in locations that have not traditionally been impacted too much in economic crises may be worth taking on. So I would encourage folks to continue operations unless you have a reasoning to do so internally. And so that goes to portfolio performance. If you have significant default rates, significant potential losses, and there is a need to significantly up the loss reserves, preserve dry powder in preparation for workouts, mods, forbearances, and ultimately foreclosure, then it may make sense to cease operations temporarily to monitor these troubled assets. And really this goes back to the idea of data, right? If you have the necessary tools in place, and this is part of the best practices to have either some type of fund administration servicer out there or software internally to give you accurate and readily available data so you can make these projections on your portfolio and identify problem assets and start preparing for those potential, I guess losses or additional costs.

And this will dictate your decision to suspend operations. Now, this may impact your decision to suspend distributions as well. That will be really boil down to if the entire portfolio is really starting to contract and starting to get underwater and not producing income and the income that is being produced needs to be really considered to be used for workouts, mods for closures, what have you, then it may make sense to suspend distributions. But because this is such a dramatic decision, I would strongly recommend it not be made on a will. So the next question on this list is can when you are dealing with a can you scenario, of course you want to look at your documents, you want to look at your offering documents, evaluate your powers as the fund manager, but you also want to evaluate the types of securities you're offering because you may be offering debt instruments that don't permit you to suspend payments of debt service.

But on top of the can you on the legal restrictions, but also can you from a practical perspective, right? You should also evaluate, this is why investor relations is so important, evaluate your investor base, look at them and see how this will play out. I don't know your investors, but you know your investors and I hope you know your investors and I hope that you've been following best practices associated with best relations and knowing which ones of your investors may be a risk to you. And so as maybe they're legit, maybe they're just angry, maybe they're just a activist. And preparing your response and preparing your decision and how you roll it out is going to be as important as all the data and the analysis and the process of making that decision. And that goes to the last part, how do you execute? How do you execute?

So this is a big, big dramatic decision. If you were in the investor's shoes would be this would anger you significantly more than suspending a redemption because now not only are you able to not able to exit, but you're not able to get a coupon. And most of these funds don't have a clawback type clause because it's not economically feasible for this product base. But how should you execute? So it's important to think about the investor relations here, the phone calls, but the written statements and also getting investor buy-in. Investors are much more understanding to folks who are communicative, who are honest, who give a plan of action of how they're going to resolve this challenge. They do not respond well to blanket statements that we're going to make this decision, we're going to do this, and that's it, right? That doesn't work. I don't recommend that.

I think it's going to cause a lot of investor panic, investor anger. And then this is also the time to really a step up your game when it comes to transparency and reporting, reporting. Investors want to know what's going on. They want to have really strong reporting here. So really concentrate on that if you don't have the tools in place to create those reports to get a portfolio snapshot whenever you need to really think about looking at the marketplace when it comes to the software providers or third party solutions out there, if you're not sure of who to speak to, please contact us and we can make a ton of recommendations on that front. So moving on, we want to talk next about this section here is indemnification and arbitration. So we always talk about this whenever we do a fund, but especially when there's a crisis on our hands or an economic downturn.

We're especially proud of our indemnification arbitration clauses because they were crafted in the crucible of the great financial crisis. We really reworked them and we fought them and we defended them, and we've seen them work on the front lines. So indemnification, it's important that the fund documents have indemnification for the fund manager to recoup costs, including legal costs in defending lawsuits against the fund manager, whether that be an investor lawsuit or a third party lawsuit or regulatory lawsuit. The fund is obligated to pay or reimburse the fund manager for legal expenses up to a certain standard of liability. And that's standard in our documents. And we recommend this across the board, is gross negligence. That's the floor, right? That's what they have to prove for these costs to be born by the fund manager and not being paid by the fund. And why is that important? Gross negligence, for those of you who don't know, is a very high standard. Most situations in this world are tied around negligence.

You made a decision you shouldn't have made. A reasonable person would not have made that we're really oftentimes not dealing with true intentional malfeasance here. And so that's why we set it there. And also because of the mechanics that the fund is now obligated to reimburse the fund manager for legal expenses for this high standard of liability, it creates a chilling effect on investors. And we've seen this happen time and time again in lawsuits involving funds. And the story that I have is essentially this comes from the last cycle. During the great financial crisis, we had many funds we were representing and fund managers were being ganged up on by their investors. And we had activist investors trying to really initiated a coup against the fund manager and gather all the investors together, requesting information, contact information of all the other investors. And we use this clause to explain to fund investors, look, you are free to do this.

You have every right to do this, but understand that you are obligated to indemnify the fund manager for legal expenses up to a certain standard of liability, and this will directly impact the available cash that should be distributable to you after we resolve the issues in the fund. Well, once you start appealing to their pocketbook, investors start to realize maybe this isn't the wisest decision and maybe we should let the fund manager start to work things out. And that did definitely chill the potential coup that we had in our hands, and that happened multiple times. So it's very important you have this indemnification clause in your fund documents, and they're not in every PPM that we've seen out there. So definitely make sure that you have 'em in there. If you don't have 'em in there, give us a call. We can definitely try to put them in your documents for you.

Another thing that's important to have is arbitration. Some fund documents actually are missing arbitration clauses. Because we're in the Reg D exempt world, we're not publicly traded securities, we're not necessarily, our offerings are not approved by the SEC. We actually have the ability to have forced arbitration in venues of your choosing predetermined in accordance with either A or jams. And not only does arbitration itself significantly reduce litigation costs, but it allows the fund manager to have much more control over the situation they're going into. It can force arbitration to a venue of their choosing. It can also force, we have much more control over selecting who the arbitration is going to be run by. And so this is also an essential clause. And oftentimes we see a very narrow arbitration clause that oftentimes isn't enforceable and it allows the plaintiffs to get to the trial and eating up more costs there.

So we really strongly recommend that you evaluate your arbitration clauses when it comes to dealing with this crisis because we don't want investors to bring lawsuits. We definitely don't want that. We definitely don't want third parties suing the fund either, but we definitely, if it does happen, we do want to have these provisions available to us. So next section here has to do with investor relations strategies. And this is one of the biggest issues that come up when you're faced with an economic downturn and you have to make certain decisions that may not be in line with your offering documents or may cause a little bit of friction with your offering documents. So the very base standard when it comes to anything dealing with investors is the fact that you as the fund manager are a fiduciary, meaning you have fiduciary duty to your investors. This is imposed by both corporate law and by securities. And so te, can you please explain to us what the two core fiduciary duties are for fund managers?

Tae Kim, Esq.:

Sure. So the two biggest duties when it comes down to the fiduciary duty of the fund manager is duty of loyalty and duty of care. Some of these aspect of it is loyalty, right? So no self-dealing or acting at the detriment of the others in terms other investors when it comes down to the loyalty issues such that the fund manager is taking advantage of a situation including self-dealing. Another aspect is the duty of care that are you acting at the best interest of the investors and also in duty of care, are there any preferential treatment or any of the type of preferences that you are giving to any of these investors? And so why that is important is in the event that you fall below or you stay within the duty of loyalty and the duty of care situation, then there is a term of art in the corporate law called the business judgment rule that protects you, that you are protective from acting at the best interest of the investors and the fund as well as being loyal to these investors. And having that being as part of your practices of the fund management is very important as that protects you from any type of litigation.

Kevin Kim, Esq.:

And so guys, it's a very friendly standard when it comes to the business judgment rule, but it's important to think about, okay, so are you acting in the best interest of the fund, right? And so this is very nuanced when it comes to these requests, if you will, for preferential treatment. Some investors may say, Hey, well what about this type of arrangement to get me out of the fund? Or what about, Hey, I'll take on this additional risk in exchange for maybe a reduction in my fees or whatever. Have you have to be very careful here because if the documents don't address this, if you haven't addressed this in your documents and you just go ahead and do it now you have violated loyalty, your duty of loyalty to every other investor by giving that one investor what he wants. There are solutions to this.

There are huge solutions. They're easy and easy to manage and very big solutions to this. But you have to talk to council here because the last thing you want to do is to enter into these preferential scenarios without the adequate disclosure to the remaining investors or without adequate disclosure to the investor himself and properly documenting it. And now you've got an issue if it were to come out in discovery on top of that, making sure that it's something that you can meet, right? We've had a lot of side letter scenarios that came out of the last recession that were litigated until say, 2012, actually no, 2015 that these side letters were not possible to meet. Be very careful and analyze whether you can actually meet these arrangements if you going to do them. I don't recommend fund managers deviate from the terms of their offerings and their standard policy and procedures if they can avoid it, but I understand the need to in certain scenarios.

So please contact counsel if you're thinking about doing this. It is doable, but it is fraught with a ton of risk. On top of this is just the general concept of avoiding self-dealing, right? And this is a huge issue when it comes to funds in an economic downturn because what happens when a debt fund, a mortgage fund hits an economic downturn? We have an increase in foreclosure, we have an increase in REO and ways since way back, even during the last cycle. One of the biggest questions we get from fund managers is, well, can I take that REO off the funds books, right? Me, the fund manager or me myself as the principal of the fund manager? And you have to be very careful there because what you're doing is you're excluding an opportunity. You're taking away an opportunity from the fund to make money.

If you were to take away a risk from the fund, arguably maybe you're doing the fund to service, but if you were to take the opportunity away, if the REO were to sell a for a profit, that should belong to the fund, unless you've carved that out in the documents, right? So it's very important. It's a very multi-step analysis, not just something you can just go do because it's an opportunity for you. Now, let's talk about the investor relations strategies in general when it comes to managing this crisis. Number one, number one important thing. Communicate, communicate, communicate. And I know all of you are very communicative people. That's the way we operate in our world. The private lending and the mortgage industry is very much a relationship business. Be very communicative. Be available to your investors. Field their calls, field their emails, be responsive. Don't just rely on a written report, a written statement and put your head in the sand.

Because the number one reason why investors contact counsel is or contact a regulator is because I can't get a clear answer from the sponsor. And it may be bad news, but I'm not getting heads or tails and it makes me think he has something to hide. So very much, very important to be very, very communicative. And also that data we talked about earlier, so important, so important to have. If you don't have data, you are not making an informed decision. You're driving in a snowstorm with a blindfold on if you don't have that data available to you. And I hope to God that it's accurate. So if you're relying on a homemade spreadsheet, I don't know, I would recommend perhaps finding a provider that can help you with that. And also lastly, while you're doing all of this, making sure that you're consulting with counsel frequently have your attorneys on speed dial because here in this scenario, you may be making certain decisions that impact the entire fund that may be maybe unpopular or detrimental or may cause issues beyond just investors hurt feelings or causing fear, but actually can cause liability.

So really contact and consult with counsel frequently. If your attorney's not available to you, please contact us. So moving on to the next slide here, reporting and supplemental disclosures. So first thing, we talked about reporting earlier. I've got a laundry list of key data points, but the proper or formal way to do investor reports should include key parameters of the investment of terms of the investment. Should also include performance over the year when it comes to distributions as compared to the entire life of the fund. And it should also have a lot of data points on the portfolio. Weighted average coupon weighted average, LTV, geographic concentration, property type concentration, default rates, number foreclosures. There's so many more we can talk about, and I'm the laundry list here, but if you're not sure what data points to include in your investor reports, please, please contact us.

We can help you walk through those. We work with clients to build their investor reports with their administrators. On top of that though, don't just submit the report. Also be able to have a clear written statement and also have a clear verbal statement ready and be available to discuss these concerns and convey to the investors your confidence and how you're going to protect their capital. And also see the fund out of this, the investors are looking to you to not only be the white knight here, but also to give them confidence in this investment. Next thing here is supplementary disclosures. As Tae mentioned, we strongly advise that funds, if you haven't already done this, evaluate your risk factors to see if you have some type of act of God and government action disclosure or risk factor in your private placement memorandum or offering circular. If you do not have that, or if it's very thin, which a lot of them are contact us, we strongly recommend that actually that these ppms actually have a supplementary disclosure addressing these types of crises.

Why? Simply because this is not the first time we've seen this sars, H one N one mers, and now the coronavirus have been in recent memory, I was in Asia during the SARS and H one crisis. And I can tell you we are one step away from a thing like that happening again here. This is the first time it's really hit our shores. So making sure we disclose something like that, this type of lockdown is also unprecedented. So really think about upping your disclosure when it comes to these situations to address the potential impacts and what the fund manager will do to mitigate risk. And all in all, if you would like to see if your documents are up to date or may need to have some amendments here, and there are some issues associated with that, depending on the fund's operating agreement or limited partnership agreement, you may or not be able to amend your documents to address these changes or address these best practices.

You really have to look at the voting standards and the amendment standards in your documents. So really it's important to consult with council, consult with council that knows the space, that knows what's going to happen in this space, that knows the impact both on Wall Street and on Main Street when it comes to this industry specifically, because then you can craft the risk factors that you need. And I think that's all we have today. A little housekeeping, actually. A little housekeeping. Let's get through the questions real quick and then we're going to get into some housekeeping announcements. So first things first, Francisco Williams, thank you for your question. Can you send a link about the course? I'm assuming you mean the CFM course. I will give that out. It's on the A PL website, American Association Private Lenders website, but I'll give it to you directly as well.

It's also on my LinkedIn page. We just posted it, so please visit me there. Heather asked, what are some examples of actions to take or strategies to use to adequately disclose and document side letters if a fund manager decides to go that route, if they want to? So side letters are a tricky business because you have to make sure not only you've got a defensible position, a standard if you will, but also that you disclose it to investors. So one of the things that we recommend best practice here is to, once you've crafted the documentation to actually do the site letter, we recommend that it be disclosed to investors. And this is what I mean by of defensible position. If you are going to say, well, just without any specific rationale to give it to the investor, then the other investors will want it as well.

So having a defensible position, a standard, if you will, for example, in normal situations outside of this COVID-19 crisis, we oftentimes see situations where the investor wants a reduced fee and we say, okay, we will, but has to have a minimum investment of X dollars. That allows us to have a baseline standard going forward, and we're comfortable disclosing it to our investor community. So Heather, that I hope that answers your question. Happy to discuss it offline in more detail. Another question here, usual turnaround time for California or Texas for demand letter to sponsor. And what's the next steps after demand is not met, if that attendee will reach out to us directly? This is a very broad question, and it's also about our timelines to draft investor representation letters. Please contact us directly. Happy to discuss that offline. Last question here. Does the sponsor need to update the PPM and projections as addendum to covid disclosure and send to investors?

We recommend that a special report be sent out to investors, including projections and impacts using the data we recommended. Do you have, we recommend sponsors contact counsel to create this because you don't want to use overly inflammatory or panic causing language to do so. You also want to have a very clear, and you don't want have any kind of confusing language either. So it's very important you do so. But yes, I agree that you should and you should contact counsel to craft that alongside your administrator. So that's all we have today, guys. Thank you for attending. We've had a great group here. A little bit of housekeeping. Up next is we've got another webinar coming to you on forbearances. So if you are a lender and you're thinking about forbearances, very deep dive on that. My partner Nema Daghbandan and associate Senior Associate Melissa Martorella on Monday.

And also we want to promote our virtual conference - first ever in this sector, in our space in our industry. The virtual conference called Lender Connect will be on May 20th. Early bird tickets are ending tomorrow, so if you'd like to purchase early bird tickets tomorrow is the last day. It's going to be a very, very amazing event with lots of great content and a full virtual exhibit hall. So it's definitely going to be a very interesting opportunity to connect with our industry while we are sheltered in place. Once again, my name is Kevin Kim, and thank you take Kim on my team for joining us today. Thank you for all the attendees, and if you have any other questions, please contact us. Our contact information is here on this slide. We didn't get to everything we liked to today, but we got through most of it. So please feel free to give us a call if you've got any other questions about funds or fund management. Thank you and have a nice rest of your day.

Tae Kim, Esq.:

Thank you.

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