Loan Documents

AuthorGregory M Stein - Michael D Goodwin - Morton P Fisher Jr
Pages269-314
269
CHAPTER 6
Loan Documents
§ 6.01 Document Preparation
In addition to the due diligence responsibilities discussed in
Chapter 5, the parties also have to agree on the language of the
operative loan documents. Recall that the loan commitment itself is
nothing more than an executory contract in which the lender agrees
to lend the funds on specified terms, and recall as well that some
parties do not even execute a loan commitment. The lender does
not actually fund the loan until the closing and will not do so unless
the borrower executes and delivers acceptable loan documents. The
parties must negotiate these loan documents after they sign the loan
commitment—assuming they even use one—so that the documents
will be ready for execution when the closing date arrives.
If the parties are unusually concerned about the terms of these
documents, they may accelerate this schedule and attempt to agree
on the exact wording of the documents, or certain key provisions
of the documents, before they even execute the loan commitment. If
they are able to do so, they can then attach the agreed documents to
the commitment, undated and unsigned, and reference them in the
body of the commitment itself. Instead of saying that “the borrower
will execute a note that is reasonably acceptable to the lender,” the
commitment will state that “the borrower will execute a note that
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270 CHAPTER 6
is substantially identical to the form note attached to this loan com-
mitment as Exhibit A.” This approach takes more time and energy
at the outset but also means that the parties’ closing preparation
will be relatively easy: they simply prepare copies of these agreed
documents and sign and date them at the closing.1
The advantage to executing a loan commitment of this type is
that the parties eliminate the possibility that they will be unable
to agree on the critical terms of the loan documents after they sign
the commitment. The primary disadvantage is that the parties may
negotiate a long list of documents before they execute the commit-
ment itself and before each is fully confident that the other is firmly
committed to the loan. In other words, the parties might negotiate a
lengthy list of documents only to have the deal come apart. For this
reason, the parties are more likely to sign a loan commitment that
does not establish the precise language of the operative loan docu-
ments, deferring those negotiations until later.
That “later” arrives after the parties execute the commitment,
when, in addition to all their other responsibilities, they must also
agree on the language of the loan documents they will sign at the
closing. In most cases, the lender will prepare these documents and
will use its standard forms, tailored to the specific business terms to
which the parties have agreed. These forms, not surprisingly, tend
to be pro-lender documents, and the borrower will spend much of
its time trying to persuade the lender to make changes to accommo-
date the borrower’s chief concerns. The borrower should not expect
the lender to agree to all changes that the borrower wants and may
have little negotiating leverage. At the same time, to the extent that
the lender has already made concessions in the loan commitment,
the borrower must be sure that the loan documents reflect those
concessions.
Comment: Even if the loan documents are not attached to the loan com-
mitment, key provisions often will be spelled out or summarized in the
commitment or in exhibits to the commitment. The parties may agree
to nonrecourse language at this early stage, for example. The borrower’s
greatest leverage in a loan transaction is typically at the time the parties
negotiate the commitment, when the lender is still competing for the
borrower’s business. Consequently, the borrower may seek to use this
leverage to accelerate the negotiation of those provisions of the loan
documents about which the borrower cares the most.
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Loan Documents 271
Comment: Although the loan commitment will not usually specify all
the terms of the loan and the precise language of the loan documents,
the doctrine of good faith and fair dealing applies to the negotiation
of the loan documents in some jurisdictions if a loan commitment has
been executed. Therefore, it is incumbent upon each of the parties to
include in the loan commitment those loan document provisions that
are most essential to it—particularly if these provisions are unusual—in
order to avoid a claim that its failure to close on the loan was a violation
of this doctrine.2
The remainder of this chapter examines the most important
loan documents and the terms they ordinarily contain. This chap-
ter assumes that the lender prepares the initial drafts and that the
borrower then must negotiate these documents from a position of
relative weakness.
§ 6.02 Note
The promissory note is the document that evidences the debt. It is
the borrower’s IOU to the lender. Many nonexperts in real estate
law believe that the mortgage or deed of trust document,3 in which
the borrower grants a security interest in the property to the lender,
is the central element of a real estate loan transaction. This belief is
incorrect. In most jurisdictions, a note without a mortgage creates
a valid—if unsecured—debt, while a mortgage without a note is
meaningless.4
Comment: In states such as Maryland, a mortgage (but not a deed of trust)
serves as evidence of the debt. In these states, a note may be unneces-
sary, and if the mortgage is inconsistent with the note, the terms of the
mortgage will usually govern.
The note must state the name of the borrower, the principal
amount that the borrower has borrowed, the maturity date by which
the note must be paid in full, and the frequency of payment. If the loan
is to be repaid at a fixed interest rate, the note should set forth that rate.
If the loan is to be repaid at an adjustable interest rate, the note should
state the manner in which the rate will be calculated, the frequency
with which it will be adjusted, and any caps on these changes.
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