When borrowers seek financing for real estate ventures, whether the borrowed funds are to be used for the acquisition of property, the construction of a project or to refinance existing debt for a longer term hold, in many cases the lender will require security for the debt to include guarantees from companies related to the landowner/developer and/or from one or more individuals with a material interest in the borrower entity(ies).
While my colleague Peter Roberts, QC has written previously on considerations for a guarantor when a loan goes into default and the lender seeks to exercise its rights in connection with a guarantee that has already been granted, this post will provide a guarantor with some points to consider before signing any documents requested by the lender.
For a guarantor involved in real estate loan transactions, its obligations will seldom be limited to one agreement with the lender.
Often, the commitment letter pursuant to which the lender offers the loan to the borrower will include covenants, representations and warranties from the guarantor(s). These should be carefully reviewed and considered to ensure: 1) that the representations and warranties are true and accurate; and 2) that the covenants will not unduly restrict the guarantor’s ongoing or future business plans (for instance, prohibitions on providing guarantees in respect of other loans, restrictions on a change of shareholder control or restrictions on dividends or repayment of shareholder loans).
The package of agreements required by the lender from a guarantor will be set out in the commitment letter and should also be carefully reviewed and considered. In addition to guarantees, whereby the guarantor promises to pay the outstanding debt to the lender in certain circumstances, the package will likely include an environmental indemnity, whereby the guarantor(s) and the borrower agree with the lender to reimburse the lender for all costs incurred by the lender in connection with any environmental contamination related to the subject property. Lastly, in the case of a construction loan, the lender will likely require the guarantor(s) to provide a debt servicing and cost overrun agreement pursuant to which the guarantor(s) agree to service the ongoing loan payments owing to the lender if the borrower fails to do so and to cover any cost overruns if the cost to complete the project exceeds the project budget approved by the lender.
Following are a few considerations for a guarantor looking to limit the extent and duration of its liability to the lender:
- Request that the guarantee be limited. The guarantee may be limited to a fixed amount that is lesser than the amount of the loan or to a percentage of the indebtedness from time to time. It could also be limited to a fluid amount (for instance, the lesser of the maximum loan amount and the amount of indebtedness of the Borrower to the lender from time to time).
- Where multiple guarantees are required, request that the guarantors provide several, as opposed to joint and several, guarantees (i.e. instead of one joint and several guarantee for $1,000,000 from two guarantors where either could be liable for up to $1,000,000, the two guarantors each provide a several guarantee for $500,000).
Where a guarantor's liability under the guarantee has been capped at a specific amount, a guarantor should be alive to the fact that the inclusion of the environmental indemnity and debt service and cost overrun agreements in the guarantee package has the potential to materially increase their liability to the lender over and above the liability limit stipulated in the guarantee. This risk can be mitigated by:
- Requesting that a limit be placed on the term of the environmental indemnity (as these agreements usually contain provisions extending their enforceability in perpetuity, even after the debt has been fully repaid).
- Requesting that the liability under the debt service and cost overrun agreement be limited to the corresponding liability under the guarantee (this one will admittedly be an uphill climb with most lenders).
No matter how small the amount of bargaining leverage a borrower may have on a specific loan negotiation, there will be far less once the commitment letter is signed by the parties. Therefore, it is advisable for borrower parties to raise any of the above-mentioned points as early as possible in the negotiations with the lender and certainly before the commitment letter is signed and returned to the lender in order to ensure that any concessions are included in the commitment letter or, at a minimum, to ensure that the commitment letter does not include language expressly requiring a form of agreement a guarantor wishes to avoid.
Lastly, if a guarantor has been unsuccessful in convincing the lender to permit them to sever their liability from the other guarantors (in other words, if the lender has insisted on one joint and several guarantee from all the guarantors for a cumulative amount), then a guarantor may consider dealing separately with the other guarantors to enter into a side agreement whereby the respective guarantors each agree to contribute a pro-rata share to the liability incurred by any one guarantor under the lender agreements.
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