Pub. 8 2020 Issue 2

ISSUE 2. 2020 13 LEASES For CRE Loans involving retail, office, or industrial buildings, the lender or its counsel should review all leases of the real property. Since the lender depends on the income generated from leases to pay debt service on the loan, the lender should review the leases for landlord pay- ment obligations as well as any rights of the tenant to offset or abate rent that may adversely affect the future rent payments. In addition, the specific terms of the leas- es and the creditworthiness of the tenants thereunder greatly affect the value of the real property collateral. As a result, the lender should review all leases for, among other things, provisions subordinating the lease to the lender’s deed of trust lien, mortgagee protection provisions, purchase rights, co-tenancy provisions, termination rights, landlord construction obligations, tenant improvement allow- ances or other provisions that may affect the overall market value of the lease. ZONING Since a city can shut down operations at a property that violate zoning restric- tions, the lender must confirm that the property’s use conforms to local zoning ordinances prior to loan closing (or if the property is non-conforming, that is has been granted an exemption or is grandfa- thered). Zoning should also be reviewed to confirm that the property complies with all relevant setbacks, building area, open space, height restrictions, and parking. Cities will generally provide a zoning certification letter confirming a property’s compliance with local zoning ordinances; however, these letters are not created equal and, as a result, the lender needs to review these letters with an eye on what is actual- ly covered by the letter and what must be determined through additional zoning due diligence. The lender may want to hire a zoning review consultant to prepare a zon- ing report to address all relevant zoning ordinances and issues. CHECKLISTS Tracking all of the various due diligence items for a CRE Loan can be a cum- bersome task. As a result, at the very beginning of the due diligence process, the lender and its counsel should prepare a due diligence checklist and circulate the same to the borrower and its counsel. In preparing the checklist, the lender should keep in mind that each transaction is unique and, consequently, the checklist should not be prepared in a perfunctory manner. Rather, the checklist should be thoughtfully prepared and tailored to the details of the specific property and for applicable law. In addition, to ensure that all due diligence matters are addressed and resolved in a time and cost-efficient manner, it is also wise to hold regular status calls with the borrower to run through the various open items on the checklist. By so doing, the lender can ensure that it has addressed all possible issues and, thus, taken the necessary steps to mitigate or avoid any and all risks asso- ciated with extending the CRE Loan. n Landon A. Hardcastle, an attorney with the law firm of Jones Waldo Holbrook and Mc- Donough, and concentrates his practice in real estate and commercial finance. Landon may be reached at lhardcastle@joneswaldo.com or 801-534-7288. Due diligence for a CRE Loan will vary depending on the specific facts and circumstances of each transaction. • Any recorded liens or other claims to the property that will need to be paid off or otherwise resolved prior to closing. SURVEY The lender should also obtain a survey of the real property prepared in accordance with the latest 2016 national standards promulgated by the American Land Title Association and National Society of Professional Surveyors (i.e., a 2016 ALTA/NSPS Land Title Survey). Be- cause this type of survey can take a while to complete, it should be ordered at the beginning of the due diligence process. At the very minimum, this survey should (a) confirm that the legal description of the real property matches the legal descrip- tion in the title commitment obtained by the lender, (b) reference the title commit- ment obtained by the lender and show the effect on the property of all exception items, including showing the location of all easements and detailing any existing encroachments, and (c) identify legal ac- cess to the property. Any issues identified by the lender or its counsel in the survey review will have to be resolved prior to closing. For example, encroachment agreements may be necessary if any en- croachments are identified on the survey or, in the event the legal description in the title commitment does not match the legal description in the survey, the borrower and the title company will need to work together to determine the correct legal description for the property. HAZARDOUS MATERIALS Environmental contamination can con- siderably affect the value of the real prop- erty. Moreover, a lender opens itself up to liability if it makes a loan secured by real property that requires environmental remediation. Thus, to eliminate the risk of liability in the event of environmental contamination, the lender should obtain a Phase One Environmental Assessment (a “Phase One”). A Phase One is used to meet the US Environmental Protection Agency’s standard of “all appropriate inquiry” to be eligible for certain protec- tions under the Comprehensive Envi- ronmental Response, Compensation, and Liability Act (i.e., CERCLA). If the Phase One raises any environmental concerns, the lender will most likely want to involve an environmental expert to perform additional site investigation, which is often referred to as the “Phase Two” assessment.