Month: November 2019

Mixed Economic News from the Construction Industry

Navigating mixed signals in the construction industry; the AIA’s Architecture Billings Index through September 2019 indicates generally flat but encouraging business conditions. Dated – No. Important – Yes. Why?

The Architecture Billings Index (ABI) is a composite index derived from monthly report surveys from member firms located throughout the country reporting on activity of “work-on-the-boards.” The data is compiled by the American Institute of Architects Economics & Research Group. Using a first-hand survey index from architectural firms, the ABI serves as a leading economic indicator of nonresidential construction activity and provides a glimpse of nonresidential construction activity approximately 9-12 months into the future or the typical time frame for a project to mature from design development through to construction. The ABI has a reputation as being an even-handed barometer of expected construction and economic activity within that forward-looking time frame.

ABI scores are centered near 50, with scores above 50 indicating an aggregate increase in billings and scores below 50 indicating a decline in billings. While the September ABI score remained below 50 at 47.9, that score is 2.5 points higher than the prior month indicating that fewer firms saw declining billings in September. In September, the Design Contract Index robustly increased up to 54.4, an increase from 47.9 the prior month indicating that firms experienced an increase in the number of clients signing contracts for new projects.

The ABI also evaluates the  impact of stalled and cancelled projects at architectural, engineering, and contracting firms as a predictive element of economic downturn. The ABI found that since the beginning of the year 52% of firms had seen projects significantly delayed, placed on hold, significantly scaled back or cancelled while 46% reported no such impact.

Overall, data from the ABI combined with recent data reported by the U.S. Dept. of Commerce announcing that construction spending rose by 0.5% in September 2019, in part, because of a combination of new governmental and private residential projects, indicates positive, but tempered, growth.

Guarantor Provisions to Negotiate in Non-Recourse Financing

Many commercial real estate loans are “non-recourse,” which means in general terms that foreclosing on the real estate securing the loan is the lender’s sole remedy for a borrower’s failure to repay the loan.  The lender is generally prohibited from suing the borrower entity or any individual guarantors to recover the unpaid debt or any deficiency remaining after foreclosure. 

However, there certain types of defaults and circumstances for which the borrower and, in most cases, individual guarantors could be liable, despite the non-recourse nature of the loan.  In the interest of facilitating the deal and closing of the loan, guarantors too often undertake unreasonable obligations, which can be substantially mitigated by incorporating measured, but effective, qualifications and limitations into the guaranty of recourse obligations (the “Guaranty”) and environmental indemnity.  The main objective of the guarantor’s counsel in negotiating the Guaranty and environmental indemnity is to limit the guaranteed obligations and deliverables of guarantors. Limiting the guarantors’ responsibilities should begin with the representations and warranties made by guarantors. There should be minimal overlap thereof with representations and warranties made by the borrower, since a breach would be recoverable against the borrower and the lender already has a means of recovery. Any property-related representations should be limited to the actual knowledge of the guarantor, without independent duty to verify or inspect. The guarantor’s obligation to deliver financial statements should be limited as much as possible, so as to avoid the risk of any administrative default for failure to deliver. With respect to delivery of financial statements, guarantors should insist that the lender accept a personal certification, rather than audited financial statements. Depending on the size of the loan, guarantors may be able to negotiate that such deliverables only be required during ongoing events of default. If the lender is unwilling to agree, then counsel should ensure that the guarantors are not required to deliver financial statements more than once annually, and upon lender’s reasonable demand during the continuance of an event of default. A guarantor should also try to reduce the amount of any penalty for failure to timely deliver financial reports.

While the desire of guarantors to help “close the deal” may obscure the importance of such concerns, guarantors should (i) be wary of being too accommodating and (ii) engage independent counsel to best protect their interests, while striking the proper balance with the commercial realities of the transaction.

Preemptive Wordsmithing: Considering Future Alterations of Commercial Property at the Outset

Borrowers often envision future alterations to enhance the economic value of the commercial real estate asset, when closing the initial loan. Such alterations can be in the form of capital improvements, tenant improvements, renovations, and/or expansions of the facility. At term sheet negotiation, the borrower should consider the long-term and short-term plans for the property, so that the loan contains appropriate flexibility to deal with future alterations. Obtaining the lender’s consent after the loan documents have been signed is typically more difficult and expensive than obtaining such consent up front. In addition to any finance professionals working on the loan, legal, leasing, development, and property management teams need to be involved in such discussions, so that appropriate feedback is obtained for strategic planning. 

Under most loans, future construction or significant alterations are not permitted, unless the lender’s prior, written consent is obtained. The easiest and most convenient way to deal with construction plans is to address it directly in the loan and to obtain lender’s advance approval over the terms of such construction and development. If not addressed in the loan documents, the lender will likely have broader discretion as to whether it will be permitted, and the borrower will have limited leverage in negotiating favorable requirements after the initial loan closing.

It is important, prior to signing the loan documents, to provide the lender with as much information as to the proposed plans as possible. The lender will want to become comfortable with the planned construction and consent in advance.  It is critical that (i) the project is clearly defined as to scope, cost, schedule, and (ii) detailed present plans are presented to the lender in advance. It is important to build into the loan a specific approval process for details, as they become more specific. In the loan documents, the lender would typically require deliveries of (i) detailed plans and specifications, (ii) an officer’s certificate confirming no default, (iv) copies of permits and variances, (v) security documents or funds, (vi) proof of insurance, and (vii) any tenant or third-party consents required in connection with the proposed development. It is possible that for minor or limited construction or redevelopment the lender’s consent may not be required, if it falls below certain thresholds, which can also be negotiated as part of the loan. Such factors may include whether the alterations would (i) have a material effect, (ii) exceed a dollar amount or percentage of the loan amount, or (iii) be structural in nature. The issues referenced above are non-exhaustive, and the host of lender concerns with releasing a portion of the real estate collateral underscore the need to clearly document such parameters clearly and preemptively, so as to minimize unbudgeted time and expense in obtaining the lender’s consent down the road It is important that an attorney be engaged to properly memorialize and capture such nuances.

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