Leveraging legal rights under real estate finance loan documentation

The issue

The borrower (a subsidiary of a UK-based real estate investment trust) had entered into a commercial real estate loan agreement arranged by CLAM. The loan is secured against a portfolio of real estate assets, diversified in terms of the number of assets, geographic location, and sector.

As this was a portfolio loan, the loan agreement contemplated that the borrower may want, over time, to release some properties from security or add properties to the security net, with the consent of the secured parties.

This allows the borrower to execute its strategy to trade properties when required and to maintain compliance with the financial covenants over time. The financial covenants aim to protect the secured parties by monitoring that an agreed level of cash is generated by the assets to service the interest payments on the loan and/or the value of the assets is sufficient to give the secured parties comfort that the loan can be repaid in due course.

The borrower wished to carry out a substitution of a number of assets to restructure their portfolio. The consent of the secured parties was required under the loan agreement and security documentation to release the existing properties from security and to take new security over the new properties.

Secured parties are sensitive to taking new security because, (i) when new security is taken, there is a period of time when the new security can be challenged upon the insolvency of the borrower and, therefore, the lender must actively accept this risk, and (ii) due diligence is needed to verify the quality and value of the property being offered as security for the loan.

We seek to ensure at the outset of each loan that we set the terms of the loan clearly and prudently so at material points in the life cycle of the loan, such as this, the borrower must seek a consent, waiver or amendment from the finance parties so that we can maintain value for our clients and stakeholders.

Activity

The borrower made a proposal to release certain properties from the security and add new properties to the security pool. We carefully considered the financial and potentially financially material sustainability implications of the borrower’s proposal.

From a financial perspective, the new assets were more valuable and were, in the view of our experts and the valuer, likely to retain their value better over the duration of the loan. The proposed substitute properties offered larger, more modern and institutionally acceptable assets subject to long-term leases.

From a sustainability perspective, the properties were also more energy efficient than those they were replacing (see the Table below), which gives us a view of their potential attractiveness to occupiers and likely capital expenditure needs in order to meet future anticipated regulatory requirements.

EPC	Existing properties to be substituted	New properties substituted
A	1	5
B	4	5
C	10	6
D	6	1
E	4	0

 

Table showing allocation of secured properties across EPC bands before and after the proposed substitution

The proposed assets were assessed against our usual due diligence criteria covering title reviews undertaken by our lawyers, building surveys, and Phase 1 environmental assessments (including flood risk) provided by specialist contractors from our panel as well as independent valuations. Once the due diligence requirements were satisfied and we were satisfied that the financial and material sustainability risks had been assessed, the transaction proceeded.

Outcome

Since the property substitution, the portfolio has continued to provide a stable and diversified income profile benefiting from strong net income cover. By agreeing to the release of security and bringing new assets into the security net, we consider that the loan is more resilient from a financial and sustainability point of view, preserving value for our clients and stakeholders.