Post-Loan Commitment Due Diligence

• Author: Gregory M Stein - Michael D Goodwin - Morton P Fisher Jr
• Pages: 247-267

247

CHAPTER 5

Post-Loan Commitment

Due Diligence

§ 5.01 Due Diligence and the Loan Commitment

When the lender extends the loan, it makes available a significant

amount of money in reliance on the skill and expertise of the borrower

and the value of the mortgaged property. The lender assumes that

the borrower will be a capable property manager that can develop

and operate the property successfully and produce cash flow that is

adequate to repay its debt. If the borrower is not sufficiently skilled

(or lucky), and thus is unable to meet its obligations to the lender,

the lender needs to be confident that the property can be sold for

enough money to satisfy the debt. The lender knows from the outset

that it needs to be comfortable with the ability and experience of

the borrower; with the physical, legal, and financial attributes of

the property; and with the quality of the legal documents and the

remedies they contain. The loan commitment should have already

addressed all these issues.

After the parties have executed the commitment, the lender

will obtain additional information during the due diligence period.

This information helps the lender decide whether all conditions

precedent have been satisfied, thereby requiring the lender to pro-

vide the funds to the borrower at the closing. The due diligence

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248 CHAPTER 5

responsibilities that the lender faces parallel, to a great extent, those

that the buyer confronts between the date of the purchase agree-

ment and the date of the closing. In each case, the party that is

spending money or extending credit in exchange for an interest in

property must learn all that it can about the property so that it does

not face unpleasant surprises later. Once the buyer or the lender

parts with its own funds, its options become far more limited. These

parties can no longer threaten not to close and instead must rely on

their contractual remedies, which may not lead to complete satisfac-

tion. Before the closing, the lender, like the buyer, must maximize

its knowledge of the property and of the party with which it has

contracted so that it can decide whether to proceed.

Comment: The lender’s due diligence standards may exceed those of the

buyer in many respects. Buyers are not as risk averse as lenders: a buyer

may be willing to take certain risks when acquiring property that a lender

will refuse to take when making a loan. Lenders such as banks, insurance

companies, and pension funds are also subject to regulatory limits on

their lending and the amount of risk they are permitted to assume. Thus,

the lender’s level of caution in scrutinizing tenant leases, for example,

may be greater than that of the borrower.

The review of the loan application and the negotiation of the

loan commitment constitute the first steps in the lender’s due dili-

gence. The lender will usually require that the borrower complete

a loan application and furnish the lender with extensive materi-

als regarding the borrower and the property. Then the lender will

include a wide variety of representations, warranties, covenants,

indemnities, and closing conditions in the loan commitment. By

executing a commitment that includes these provisions, the bor-

rower discloses information about itself and the property. If this

information turns out to be inaccurate, the commitment will place

the lender in a position to pursue the remedies set forth in the com-

mitment and to refuse to close.

A prudent lender will not rely solely on these disclosures from

the borrower and will use the post-commitment period to under-

take an independent due diligence review of the borrower and the

property. During this period, the lender will confirm the informa-

tion that the borrower has provided to it, will gather new informa-

tion on its own, and will decide after evaluating this information

whether to proceed to close the loan.

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