Demystifying Agreements to Consolidate, Extend or Modify

What are Agreements to Consolidate, Extend or Modify

Consolidation, Extension and Modification Agreement refers to an agreement made between a debtor and a creditor or pool of creditors to eliminate the obligations of the debtor to repay their respective obligations to a creditor in exchange for the issuance of new debt obligations (generally in the form of bonds) by the debtor. Such agreements are often employed by governmental units and municipal corporations to manage its outstanding debt obligations by creating a single consolidated debt obligation while avoiding a default . The new consolidated debt obligation usually has a lower overall interest rate then the debt obligations surrendered by the creditor to be refunded.
An Extension Agreement is similar to the consolidation agreement but does not require a surrender of outstanding debt obligations. A modification agreement is one that restructures can any or all of the existing debt obligations of a debtor without the issuance of new debt obligations. Generally, the purpose behind a modification agreement is to provide some type of modification to the debt when it is no longer feasible to restructure the debt.

Benefits of Agreements to Consolidate, Extend or Modify

The key benefits of these agreements are threefold. First, they can provide significant financial relief for a borrower whose loan is in default or is in imminent danger of default. Second, they can restructure an existing loan to make it more manageable for the borrower. Third, and perhaps most importantly, they can be structured to allow a borrower to survive for a second chance at recovery after the economy has begun to rebound no longer leaving the borrower underwater with their lender. In other words, a borrower is put on new terms to allow them to ride out the storm.

Situations that Commonly Require Agreements to Consolidate, Extend or Modify

The need for a Consolidation, Extension and Modification Agreement (CEMA) has become more evident in the very recent times, as property values have diminished, and it’s harder to keep a home. People are owed money on their home who have second mortgages or home equity loans, or judgments against them. Any of these outstanding debts can become problematic when the time to sell arises. In fact, many lenders will not release a mortgage lien when there is a home equity loan attached to it, because they have a right to net mensurae, "to know what may be levied." Other lenders do not have this right, but will still not release their mortgages when the time to sell comes. The idea being that they will lose their money when they take back the property through foreclosure proceedings. It is important that the times in which these agreements are used are understood because the when is as important as the how.
The most common use of a CEMA is when a borrower needs to refinance an existing loan with a new lender but at a lower interest rate. Due to market conditions, closing costs such as mortgage recording fees, bank or attorney fees and mortgage tax can be higher than if that particular transaction had been under a first mortgage loan. Therefore the basic idea is to avoid paying these fees by transferring existing mortgages into new loans.
A CEMA is also used where a borrower needs to refinance existing loans, but that borrower does not have sufficient income in order to qualify for the new loan, or pay the fixed debt. In these scenarios, consolidation is typically done by the creditors and the debtor. Their goal is to arrive at a long-term solution to solve the problem of the debtor’s insolvency. A business may execute a CEMA so new capital can be put to use and old capital can be refinanced at a lower rate.
Another time to utilize a CEMA is when a borrower sells his/her property, but has one or more liens against the property, other than the mortgage loan, such as a home equity loan, or judgment. Generally in most sales of property where a mortgage is held, unless the balance to the first mortgage is extremely low, the first mortgage lender typically requires a payoff of any subordinate liens or judgments before approving a payoff letter. The lender may give a borrower or seller a "window" to refinance the property and add said judgments or loans to the refinance transaction.

Risks and Legal Consequences

Consolidation, extension and modification agreements can be an effective means of resolving title problems but there are legal considerations that cannot be ignored. There are risks associated with entering into such agreements and legal advice is essential. If a deal seems good on its face, it is important to step back and seek out the legal ramifications of any proposed deal. There may be hidden pitfalls, or commercial reasons, that make the deal less appealing. Considerations of adverse claims need to be addressed. Other title problems may remain despite an apparent resolution and in either case the deal may collapse. There are risks to Title Insurers that may leave the insured with no protection.
For example, the advantages and disadvantages of severing or merging mineral interests requires careful consideration. How can title to the underlying land be addressed? Does the deal include implied rights of access? Does it raise potential adverse possession claims? Where there is one overriding interest, can other owners protect their rights? Is there a way for the parties to address potential claims not outlined in the agreement?
Another example includes concessions. Are concessions related to a specific well? Do they then exclude the parties from opportunities in future pools? Do they require the parties to pool a depth interval or formation? Does the party otherwise lose its fee mineral rights?
An additional example might include subordinations of surface rights. Does this imply a right to recreate new wells on existing permits and therefore expose the parties to greater costs or risk? Does it prevent re-entry or on-going operations on old wells and thereby create additional risk for the operator?

Negotiating Agreements to Consolidate, Extend or Modify

Negotiation of any amendment of loan documents, whether it be a consolidation agreement, an extension agreement or a modification agreement, will require, as a general matter, a larger commitment from the borrower than the lender is prepared to give. The fundamental negotiating position of a lender is to get added security and payment priority on the ultimate determination date. The borrower, on the other hand, wants as little short-term change as possible, commensurate with creating value and reducing risk on the secured collateral. Reflected in the borrower’s position in a restructured lending arrangement, in all likelihood, is the borrower’s own discomfort with respect to the security of its position under the loan capital structure as a whole.
The lender will likely want to protect itself in the near term with increased security, a longer maturity, or both, and the borrower will not want to provide either. As with all negotiations , the solution is to divide the pie into smaller pieces and get the lender to agree to a series of incremental steps down the road that will take the borrower "up the golden path" to a final destination that the borrower may not want to commit to just yet. Lenders have their own insiders at various levels who are capable of meeting with the borrower and studying its financial condition and business projections as it progresses down the refinancing path. Lenders are particularly experienced and sophisticated in the area of loan documentation, and the borrower should spend a good deal of time with its lawyer in coming to understand the dynamics and the personality of the lender, having all of the relevant lender players participate in the process of structuring the new arrangement by way of conference calls and meetings.
The safest approach is to try to over prepare the lender and assume that the lender is going to be as concerned as the borrower about the absence of both market activity and trading volume with respect to each party’s investment in the capital structure of the borrower, as well as the prospects of improvement in such trading volume and volume of market activity in the future. Failure to over prepare the lender could very well lead to a last minute rush to the negotiating table.

Case Studies and Examples

Consolidation, Extension and Modification Agreements are private agreements between a borrower and a lender whereby the borrower is given additional time to satisfy the obligations under the loan. These agreements may also increase and decrease the interest rate payable or waive or decrease the prepayment penalties.
For example, Loan #1 is a loan between Lender A and Borrower A. Both loans are supported by a deed of trust securing apartments in the same complex. However, these loans are cross-secured; meaning, Lender A has the right to exercise its remedies against both apartments if either apartment is in default. In this example, the seller sells both apartments and repay Lender A 25% of the proceeds of the sale as partial prepayment of the loans. Lender A may agree to consolidate the two loans under one new loan whereby Lender A waives or reduces the prepayment penalties by roughly 5%. Due to market conditions, the rate on the new loan may be reduced from 8% to 5%. Case Study: You are developing a property using a construction loan. However, during the construction process, your costs go over the original budget. The lender may agree to modify the existing loan and increase the loan amount to accommodate the additional funds needed. In this case, for example, the lender may modify the loan so that the loan proceeds may be used to pay off the existing loan and fund a portion of the cost overrun. The loan may have a higher loan to value due to the lower valuation of the property given the challenges faced during construction. Case Study: A multifamily owner is facing a downturn in the economy. Owners of multifamily properties with existing CMBS loans may have an especially difficult time satisfying their loans. A multifamily owner might consider a modification of the existing CMBS loan, which may include a reduced interest rate, extended term, defeasance of the loan, and possibly some increase in the loan proceeds. CMBS loans are non-recourse and prepayment penalties are high. Accordingly, the owner may need to weigh the prepayment penalties against the potential benefit under the proposed loan modification plan.

The Future of Agreements to Consolidate, Extend or Modify

As the market evolves, future trends in debt restructuring agreements are likely to be heavily influenced by the economic environment in which they operate. While consolidation, extension, and modification agreements have traditionally served as a means for borrowers to manage their financial obligations in times of trouble, the economic landscape has rapidly become more complex, and with it, the agreements themselves. The increasingly common use of syndicate lending and securitized debt means that borrowers may have to navigate a thicket of agreements with multiple creditors if restructuring is needed. We may also start to see more formalized structures for how these agreements work together and how creditors can coordinate on debt restructuring.
Technologically driven changes will also likely have an impact, both in the short and long term. With the rise of blockchain and smart contracts, borrowers may have more options for how their debts are restructured, and agreements may be documented and executed in new ways, making them easier to access and enforce and potentially minimizing the role of traditional legal intermediaries. However, these technologies are still some years away from having a widespread impact on the debt restructuring agreement space, especially if they are not adopted by the creditors.
More explosive changes could still be coming down the line. The rise of non-traditional lenders , including online lending platforms and hedge funds, means that the nature of creditors will be changing. This change could have significant impacts on how consolidation, extension, and modification agreements are drafted, by introducing different standards for the agreements and different expectations regarding the restructured debt from creditor to creditor.
The regulatory landscape is also likely to play a significant role in how debt restructuring agreements evolve. Over the past decade, there has been a growing consensus across jurisdictions on the need for a more robust debt restructuring framework, well grounded in human rights, to better balance the interests of borrowers and creditors during debt restructurings. Many different international institutions and organizations have put forth these principles, leading to the emergence of an extensive regulatory framework of international and national guidelines setting minimum standards for debt restructuring agreements. Much more could to come in this area, but as the economic landscape continues to change, the regulatory framework may have to change with it.
The future of debt restructuring agreements remains uncertain, but under current economic and regulatory trends, the future looks bright for restructuring and reorganization.