Page 26 - December 6-19, 2023 Law & Accounting Our Real Estate Group Serving the Commercial Real Estate Community • Leasing • Real Estate Development • Real Estate Acquisition • Environmental • Private Equity • Commercial Lending, Workouts and Foreclosure • Real Estate and Commercial Litigation • Construction Contracts and Litigation • Corporate Our clients rely on our experienced team of lawyers to guide them through all of their legal needs, from signi cant business decisions to the most complex global deals and litigation. Our breadth and depth of practice enable us to handle the most complex matters and solve our clients’ problems seamlessly. 1700 Lincoln Street, Suite 2100 Denver, Colorado 80203 303-298-1122 I n commercial real estate mortgage loan transactions, potential lenders will only make a loan to a borrower for a frac- tion of the value of the mortgaged property securing the loan, often around 60%, and will require the borrower to contribute or retain the remaining amount with required equity. With higher inter- est rates and constrained capital, real estate developers and own- ers are looking at requirements to solicit greater equity investments in their projects prior to approach- ing lenders. Often, the developer and an unrelated money partner (“investor member”) will form a joint venture to own and control, directly or indirectly, the property. Customarily, the developer will be the “managingmember” and con- trol the day-to-day operations and management of the JV (and thus the property), while the investor member will participate in major decisions and otherwise passively expect a favorable return on its investment. These two members enter into a “JV agreement” that outlines the rights and obligations of the members. Importantly, since the inves- tor member’s return will be paid from property revenues and/or proceeds fromthe sale of the prop- erty, the JV agreement outlines remedies if the property is under- performing. Each member’s rem- edies gener- ally include the right to buy out the other mem- ber, and gain exclusive con- trol and own- ership of the JV. Since the exercise of this remedy can f undame n - tally change the ownership structure of the borrower that was underwritten by the lender, lend- ers may closely analyze the JV agreement and impose require- ments for the JV agreement based upon issues that conflict with the lender’s loan document require- ments. n JV agreement guidelines. Lenders’ primary concerns are the distribution of profits from the property, and each member’s right to exercise remedies, par- ticularly when property revenue is sufficient to cover debt service and property expenses (i.e., taxes, insurance and operating costs), but not preferred returns under the JV agreement. Some lenders expressly require that investor members’ return be payable only from excess cash flow follow- ing payment of debt service and property costs in order to ensure amounts payable under the loan documents are payable prior to any amounts payable under the JV agreement. Relatedly, lenders typically require that preferred returns not be payable on set dates or intervals, as this requires “on-demand” performance of the property and increases the likeli- hood of a default under the JV agreement. Similarly, lenders will often prohibit a provision in the JV agreement that allows investor member to require the managing member to buy its interest in the JV prior to the maturity date of the loan, as this likely requires a balloon payment from themanag- ing member that may result in a default under the JV agreement or weaken the financial strength of the JV. That said, lenders appreciate that inadequate returns will give rise to investor member remedies under the JV agreement. The rem- edy about which lenders gener- ally have the most concern is the right of the investor member to take control of the JV, thus, indi- rectly, controlling the borrower and the property, particularly if such a remedy is available while there is no default under the loan. Since most loan documents pro- hibit transfers of control in the bor- rower and the property (without lender’s consent), such takeover may trigger a default under the loan documents without a negoti- ated takeover right pursuant to the loan documents. If the loan documents permit a takeover of the JV, lenders will generally require the investor member to designate a guaran- tor that will replace the existing guarantor upon such takeover, and will underwrite the investor member and replacement guar- antor to the same extent as the managing member and existing guarantor. By effectively under- writing each as a potential loan party, the lender hedges against a change in control of the borrower and property beyond the lend- er’s control. Importantly, the loan documents may condition such a takeover on advance notice to the lender and the payment of a fee, new or supplemental opinions, and the borrower’s reaffirmation of special purpose entity and other standard “know-your-customer” representations contained in the loan documents. Beyond the takeover rights, provisions in the JV agreement regarding a forced sale of the property or replacement of the property manager should, gener- ally or specifically, account for any applicable conditions in the loan documents.Aforced salemay trig- ger prepayment fees under the loan documents or be subject to a lockout period. A new property manager may require the lender’s review and approval, including of the new management agreement and manager’s credit and experi- ence, and themanager’s execution of relevant loan documents (such as a subordination agreement). If known in advance of loan clos- ing, it can be helpful to request that the lender preapprove the replacement property manager in the loan documents and for this preapproved manager to review and comment on any applicable loan documents. Certain JV agreement “defaults” may be red flags for lenders. For example, lenders will not want the investor member to be permit- ted to exercise remedies in the JV agreement based on the perfor- mance (even bad acts) of another entity or property unrelated to lender’s loan. Lenders disfavor, and some prohibit, the right of the investor member to exercise remedies simply for the property’s failure to meet specific, quantifi- able metrics like debt yield or net operating income tests. Note that some agency lenders have strict guidelines and will not make a loan if JV agreements have any unacceptable attributes, many of which are similar to those outlined above. n Conclusion. The members Consider lender concerns in your joint venture agreement Peter A. Hamberger Associate, Ballard Spahr Please see Hamberger, Page 43