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Property Finance Jargon and Legal Documentation

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Title: An Introduction to Property Finance Author: OBRIENLJ Last modified by: JZL Created Date: 8/5/2008 4:56:13 PM Document presentation format: On-screen Show – PowerPoint PPT presentation

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Title: Property Finance Jargon and Legal Documentation


1
Property Finance Jargon and Legal Documentation
  • Thursday 11 September 2008
  • Jonathan Lawrence, Partner, KL Gates LLP
  • jonathan.lawrence_at_klgates.com
  • 020 7360 8242

2
Overview
  • Pack documentation introduction
  • Property finance glossary
  • Investment loan term sheet
  • Development loan term sheet
  • Loan and security documentation
  • Parties
  • Provisions

3
Borrower(s)
  • Borrower
  • Trading entity or
  • Special Purpose Vehicle (SPV) company?
  • Single/Multiple
  • Multiple borrowers for multiple properties
  • Cross-collateralisation

4
Obligors or Borrower Group
  • Obligors
  • Guarantees may be required from shareholders in B
    / other entities in Bs group
  • Especially relevant where B is an SPV
  • Sponsor
  • Individual or entity behind the real estate
    acquisition, B and management of real estate
  • Not usually a party to loan documentation

5
The Finance Parties
  • Lender
  • Lends / Advances the funds
  • Identity of original lender may change during the
    term of the loan
  • Lender may reduce exposure to loan through
    syndication, securitisation or sub-participation

6
The Finance Parties
  • Facility Agent
  • Day to day administration of loan
  • Security Trustee
  • Holds security on trust for all Secured Parties
  • Controls enforcement process
  • Hedge Counterparty
  • B enters into a hedge with respect to all or part
    of its interest rate exposure under the loan with
    the hedging counterparty
  • e.g. fixed-to-floating interest rate hedge

7
Documentation
  • Term sheet
  • Loan agreement
  • Security documentation
  • Hedging documentation
  • Fee letters

8
The Loan Agreement
  • No standard format
  • Long form / short form

9
Purpose of the loan
  • Should always be set out in loan agreement
  • L not obliged to monitor the loan to make sure it
    is used for the purpose advanced
  • Quistclose Trust established

10
Tranching
  • Facility may be made up of a variety of loans /
    tranches
  • Together they are the facility
  • Each may be used for a different purpose
  • Greater flexibility different terms

11
Interest
  • Usually based on aggregate of
  • 1. Floating rate of aggregate of LIBOR/EURIBOR
  • 2. Margin agreed between L and B (fixed or
    variable) and
  • 3. Any Mandatory Cost
  • Paid on each interest payment date (end of
    interest period)
  • Interest period generally 1, 3, 6 or 12 months
  • Interest may be capitalised

12
Representations and warranties
  • Statements of fact made by B or Obligors about
    certain matters of fact relating to themselves,
    their status and the underlying real estate
  • If untrue, L may call an Event of Default
  • Standard reps e.g. that it is solvent, that
    security has not been granted in favour of
    another party
  • Specific reps e.g. property specific concerns re
    environmental issues

13
Covenants
  • General
  • General obligations imposed on Obligors
  • Additional covenants for SPV
  • Negative pledge

14
Covenants
  • Property
  • Ensure that property will not fundamentally
    change during the term
  • Restrict development, granting of leases etc.
  • Insurance covenant
  • Application of insurance proceeds
  • Damage
  • Loss of rent

15
Covenants
  • Information
  • Delivery of information
  • Financial statements, annual accounts
  • Proceedings
  • Property reporting requirements (rental income,
    tenant details etc.)

16
Covenants
  • Financial Loan to Value (LTV)
  • Day 1 L obtains credit sanction to lend up to a
    maximum percentage of the value of a property
  • Ongoing Measures the ratio of current market
    value of a property against the then principal
    amount of the loan outstanding
  • If max is exceeded due to fall in property
    prices, B will have to bring the loan into
    compliance by prepaying proportion of
    loan/disposing of property

17
Covenants
  • Financial Interest Cover
  • Ratio of net rental income (gross rental income
    less certain deductions e.g. insurance premiums,
    tax) to Bs interest payment obligations
  • Test measures the ability of B to comply with its
    interest payment obligations
  • Bs interest payment obligations usually serviced
    from rental income
  • Can be look back or look forward

18
Covenants
  • Financial Debt Service Cover (DSC)
  • Used when loan is amortising
  • Ratio of net rental income received versus Bs
    interest and principal payment obligations
  • Can be look back or look forward
  • Must be more than 1 to ensure B meets interest
    and principal obligations under the loan

19
Covenants
  • Financial
  • Remedy a breach of financial covenants by B
    paying additional funds into blocked reserve
    accounts
  • Funds will be deemed to reduce outstanding
    balance of the loans (LTV) or to supplement net
    rental income (Interest Cover and DSC)
  • May be released if B complies with financial
    covenants or applied to prepay loan if financial
    covenants not complied with
  • Restriction on number of times can remedy a
    breach in this way

20
Events of Default
  • Trigger events which may mean L cancels
    commitments and declares all amounts owing and
    immediately payable - Acceleration
  • L under no obligation to accelerate loan
    following event of default may
    waive/renegotiate
  • B often allowed grace period
  • e.g. insolvency of obligor, non-payment of sums,
    misrepresentation, breach of covenant, material
    adverse change

21
Term and Prepayment
  • Term length of lifespan of loan
  • L cannot prevent B repaying the loan prior to end
    of term
  • Prepayment not favourable for L as misses out on
    interest, therefore L imposes prepayment fees
  • L may require mandatory prepayment e.g. proceeds
    of sale

22
Principal
  • Loans are interest only or amortising
  • Interest only B pays interest on each payment
    date and principal paid as bullet repayment on
    maturity date
  • Amortising B repays specific amounts of
    principal on regular basis during term of loan

23
Payment mechanics
  • Property Managing Agent
  • Rental income paid into segregated trust
    account/held on trust by Managing Agent
  • Managing Agent responsible for paying net rental
    income into Rent Account
  • Duty of care agreement Managing Agent owes L
    direct contractual duty of care
  • On interest payment date funds are applied in
    order waterfall

24
Default interest
  • Additional interest which accrues on overdue
    amount in event that B or Obligor fails to make a
    payment under the loan
  • Usually around 2-3 above the interest rate
    usually payable on the loan
  • Rate must not be set too high as it may be
    considered a penalty and non-recoverable

25
Security
  • Legal mortgage
  • Fixed charge
  • Assignment of rental income
  • Floating charge
  • Guarantees
  • Negative pledge

26
Legal mortgage
  • Over specified real estate
  • Transfer of legal ownership from mortgagor to
    mortgagee
  • Mortgagor has right to return of property and
    payment of any balance after satisfaction of
    mortgage (right of redemption)

27
Fixed charge
  • All other freehold and leasehold property
  • All buildings, fixture, plant and machinery on
    the property
  • All future interests in land
  • Benefit of all agreements relating to land
  • Right and interest in proceeds of sale of charged
    property
  • Amount standing to credit of all bank accounts
  • Book debts and other receivables
  • Goodwill and uncalled capital
  • Right to recover VAT on any supplies relating to
    charged property

28
Assignment by way of security
  • Rental income
  • Right to payment under all present and future
    insurance policies over any charged property
  • Rights against any tenants of property
  • Benefit of any hedging documentation
  • Rights under any development and acquisition
    documentation
  • Benefit of all contracts relating to property

29
Other security
  • Floating charge
  • Over all other assets of B not covered by the
    other security
  • Crystallisation
  • Share charge over shares in B
  • L has opportunity to take control of B
  • Choice to sell B rather than the property
  • Negative pledge

30
Practicalities
  • Security documentation must be correctly
    registered (perfected)
  • English company Companies House
  • Non-English company Slavenburg register
  • Land Registry
  • Deed of priority required?
  • Governing law location of assets?

31
Guarantees
  • Especially relevant when dealing with SPV B with
    no trading history where real estate is sole
    asset
  • L should ensure the guarantor enters guarantee as
    a primary obligor and therefore has to
    immediately comply with any demand made on the
    guarantee without L having to first make demand
    of B
  • Guarantor likely to seek grace period

32
Why is the security package so important?
  • Security Trustee has certain control over all
    assets of B
  • Ideally only security over property itself is
    needed to recover the principal amount of the
    loan
  • Remaining security satisfies Ls underwriting in
    case the LTV covenant is breached

33
Conditions Precedent (CPs)
  • Prior to advancing funds, L will insist on
    receiving certain documents and/or B satisfying
    other requirements
  • Corporate documentation and authorisations
  • Financial information
  • Property documentation and due diligence
  • Legal opinions
  • Miscellaneous

34
Corporate documentation and authorisations
  • B and any Obligors must have taken necessary
    corporate action and obtained necessary approvals
    inc shareholder approval where necessary
  • Includes board minutes and directors
    certificates attaching constitutional documents

35
Financial Information
  • L likely to insist on seeing full details of any
    equity, shareholder loans and other finance are
    received before any loan is made
  • L will require copy of pro forma balance sheet of
    B (in the case of an SPV) together with a sources
    and uses statement detailing how the loan
    advance, any shareholder loans, other finance and
    any equity is to be utilised
  • Evidence that bank accounts have been opened

36
Property documentation and diligence
  • Report on title/certificate of title
  • Details of any leases and tenants
  • Copies of title documents
  • Insurance details
  • Physical inspection of property
  • Valuation/structural survey/environmental report
    (addressed to the Finance Parties)

37
Legal opinions
  • Provided by law firms from all relevant
    jurisdictions
  • Jurisdiction of incorporation of each Obligor and
    governing law of any Finance Document
  • Addressed to Finance Parties
  • Confirm e.g. that Obligor exists and has legal
    capacity to enter into Finance Documents
  • Opinion provider will often attempt to limit
    reliance

38
Miscellaneous
  • Evidence that Ls fees, costs and expenses in
    connection with transaction are paid upfront -
    usually deducted from gross advance
  • Deal specific CPs may be required e.g.
    documentation re any development or capital
    expenditure works
  • Sweeper CP any other documentation or evidence
    required by L
  • If multiple drawdown is permitted certain CPs may
    be required for each drawdown

39
Utilisation / Drawdown
  • Specific procedure for drawdown
  • Notice to lender required
  • Likely that initial drawdown must be made during
    an agreed availability period
  • Overall number of drawdowns likely to be limited
  • CPs must be satisfied prior to drawdown

40
Assignment, transfer and Qualifying Lenders
  • L usually reserves right to freely transfer its
    interest in the loan provided that B does not
    incur any tax liability on its interest/other
    payments due to change in status of transferee
    Qualifying Lender concept
  • Crucial that L can assign interest freely if it
    intends to syndicate/securitise the loan
  • Often prohibited for B and Obligors to assign
    rights and obligations without written consent of
    Ls

41
Tax
  • Gross-up obligation on B
  • Where L is a Qualifying Lender, if any amounts
    paid by B are reduced because withholding tax is
    imposed, B will have to gross-up so L receives
    amount it would have done notwithstanding the
    deduction of tax

42
Amendments and waivers
  • Amendment usually allowed with written consent of
    Majority Lenders and Obligors
  • Some amendments e.g. a decrease in margin will
    require consent of all Ls as they fundamentally
    affect the loan terms

43
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