The Loan Commitment

AuthorGregory M Stein - Michael D Goodwin - Morton P Fisher Jr
The Loan Commitment
§ 4.01 The Need for a Loan Commitment
Part II of this book examined sales transactions, discussing the issues
that are likely to arise when an owner wishes to sell its property
to a buyer. In most instances, that buyer will be borrowing some
of the funds it needs to acquire the property. Most buyers do not
have enough money to buy real property without borrowing funds,
and even if they do, the use of borrowed funds offers attractive tax
benefits and leveraging opportunities. Part III turns to a discussion
of loan transactions.
Keep in mind that a sales transaction need not be accompa-
nied by a loan transaction. An individual investor, for example,
can purchase real estate entirely with his own funds. Similarly, a
loan transaction need not be accompanied by a sales transaction,
as when a property owner refinances property it already owns at
a lower interest rate. The discussion in Part III, however, assumes
that the loan transaction is taking place at the same time as an
acquisition of property, as a means of addressing those issues
unique to acquisition loans. Thus, while the text that follows usu-
ally refers to the parties to the loan as “the lender” and “the bor-
rower,” it should be evident that the same party is filling the roles
of both borrower and buyer.
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If you are representing a borrower that is refinancing property
that it already owns or a lender that is providing money to a party
that already owns the property it will mortgage, this discussion will
still be valuable to you, but some of the issues discussed here may
not be pertinent to your transaction. It also is worth remembering
that the seller sometimes furnishes the buyer with some or all of the
needed financing by accepting a note and mortgage at the closing as
part of the consideration for the property. In these cases, the seller
and the lender are the same entity.
The buyer needs to make sure that the seller is obligated to sell
the property and that the lender is obligated to lend the acquisition
funds. If the buyer contracts to buy the property but cannot obtain
a loan, then it may have to breach the purchase agreement and pay
damages to the seller, perhaps by forfeiting its earnest money down
payment. If the buyer receives a loan commitment but cannot close on
the property, it may lose its loan commitment fee even though it does
not acquire the property. From the buyer’s perspective, the acquisition
and lending transactions are contingent upon each other, which means
that the buyer must enter into two different agreements that provide it
with some flexibility in the event that something goes wrong.
The most common way for the buyer to protect itself against
these overlapping uncertainties is by signing a purchase agreement
that contains a financing condition. This closing condition in the
purchase agreement should state precisely what type of loan com-
mitment the buyer must receive before it is obligated to close so
that the parties understand exactly what types of nonperformance
will be legally excused.1 The buyer then should make sure that it
attempts to meet this financing condition during the due diligence
period.2 If the buyer meets this condition, it must close. If it is unable
to satisfy the financing condition, however, it can exercise its con-
tractual right to terminate the purchase agreement without penalty
and without forfeiting its earnest money deposit. Less commonly,
the buyer may be able to secure a commitment for a line of credit in
advance and then contract to acquire the property. In a case such as
this, the parties will execute the loan commitment first, and the com-
mitment will contain numerous conditions addressing the property
that the buyer may acquire with these funds.
Neither the buyer nor its lender will want to rely on a verbal prom-
ise to make a loan. The buyer will want to be sure that if it decides
to close, the lender must make the acquisition funds available at the
closing. In fact, the buyer is likely to face a preclosing termination
deadline under the purchase agreement, after which it will be unable
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The Loan Commitment 215
to withdraw from the agreement without penalty. The lender wants
to know that it will be compensated if it sets aside funds for the buy-
er’s use. The lender may have passed up other lending opportunities
or may itself be borrowing the funds from another source, and it does
not wish to lose money as a result of the seller’s unexpected with-
drawal from the transaction. Each party, then, wants to execute a loan
commitment in advance that places obligations on the other party if
certain enumerated conditions are met.
Comment: Many purchase agreements condition the buyer’s obligation to
close on the receipt of a loan commitment and not on the actual receipt
of the funds. Sellers are reluctant to agree to condition the closing on the
actual receipt of the funds, because they wish to know in advance whether
the closing is going to occur. A buyer in this situation needs to be confident
that it can satisfy all conditions contained in the loan commitment.
In a growing number of transactions, the borrower and lender
do not execute a loan commitment in advance but rather execute
a nonbinding term sheet, loan application, or similar preliminary
document spelling out the basic terms of the loan. In these cases,
the parties plan to execute a much more detailed loan agreement
concurrently with the note, mortgage, and other operative loan doc-
uments. In these settings, neither party has undertaken any binding
obligations in advance of the closing. Thus there is little need for the
loan agreement to contain closing conditions, since it will be exe-
cuted at the same time as the operative loan documents and at the
same time as the loan is funded.
In cases such as this, if the borrower or the property do not meet
the lender’s requirements, the lender will simply decide not to close
and not to execute the loan agreement and other loan documents.
The lender still must verify that the borrower and the property meet
the lender’s standards, but it has not yet undertaken any contrac-
tual obligations to the borrower. Such an arrangement places the
borrower at greater risk, of course, because the borrower has no
enforceable commitment to the funds before the closing.
Comment: In many cases, the term sheet or loan application is effec-
tively binding on the borrower but not the lender. The document may
expressly provide that the lender has not yet approved the loan or made
a commitment to lend, or it may provide that the lender’s obligation to
fund is conditioned on the lender’s approval of a wide range of matters
related to the property, the borrower, and the market generally.
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