In certain cases, loan documents include a one-time right of transfer or other provision allowing the purchaser of encumbered commercial real estate to assume the subject loan from a borrower that desires to sell the property. One-time right of transfer or permitted assumption provisions always include certain conditions that must be satisfied in order for the lender to consider, and possibly approve, the assumption request. For example, conditions may include (among other things) requirements that: (i) the proposed borrower be experienced in the ownership and management of properties similar to the subject property, (ii) certain loan to value requirements for the subject property are satisfied and (iii) the lender’s standard underwriting requirements be satisfied. There are certain issues related to the loan assumption process that sellers and purchasers should be aware of before negotiating a purchase and sale contract that contemplates a loan assumption.
Timing: The lender’s underwriting process for a new borrower and guarantor may take a long period of time compared to a typical due diligence time period. If a subject loan is securitized the process will likely be even more protracted. In a recent transaction the firm worked on, the standard underwriting time period for a major lender was twelve weeks.
Cost: Typically, a lender will require certain deposits be posted at the onset of the assumption application process. In the event the lender does not ultimately approve the proposed new borrower or guarantor, the deposit may often be non-refundable (or will be non-refundable to the extent costs have been incurred by the lender). If a purchase and sale contract provides that a purchaser must incur the burden of such deposits and fees, a purchaser who is ultimately not approved to assume a loan may have no recourse to receive such deposits back.
Due Diligence Considerations: Given that the loan assumption application process may last for an extended period of time (as discussed above), parties may wish to commence the assumption process simultaneously with the commencement of due diligence. However, if a purchaser is ultimately dissatisfied with title, survey, diligence or the loan documents being assumed and wishes to terminate the contract prior to the expiration of a diligence period, a purchaser who commenced both processes simultaneously and posted non-refundable deposits may have no recourse to receive such deposits back.
Termination Right: Contracts will typically contain a termination right in favor of the purchaser to the extent the loan assumption is not approved. However, it may be worthwhile to also contemplate whether a purchaser has a similar termination right if a conditional approval is granted by a lender. It may be unclear under applicable law whether a conditional approval is tantamount to disapproval and the best approach would be to clarify this point in the purchase and sale contract.
There are various ways to resolve the issues outlined above in a purchase and sale contract. Alternatively, a seller or purchaser may view the risks as part of the cost of chasing a deal. Either way, it is best practice to review and understand these issues at the outset of structuring a transaction to make sure the purchase and sale contract reflects the negotiated deal.