Best Practices in Commercial Real Estate: Commitment Letter
Posted on 11/12/2018 at 01:00 PM by Benjamin Bruner
Commercial Real Estate Loan Documentation Best Practices
PART 1: Commitment Letter
Following credit approval, the formal real estate lending process typically starts with a commitment letter which seeks to establish the primary specific terms and conditions of the proposed financing. It is an opportunity for the parties to ensure that they are in basic agreement with the loan amount, repayment terms, interest rate, collateral, guaranty requirements, and fundamental representations and covenants. The commitment letter fleshes out any issues or misunderstandings between the parties prior to the preparation of the ultimate loan documents, but it is important to be aware of some potential pitfalls and issues that it can present.
The commitment letter creates certain binding obligations, and thus it should be carefully drafted to ensure that it doesn’t commit the lender to certain obligations that it intended to be contingent on certain actions, information or performance. For example, certain terms and conditions may require subsequent approval from loan or credit committees, and thus those conditions should be clearly spelled out in the commitment. The commitment letter should allow the lender flexibility and to that end, it should allow for the lender to terminate its commitment during the due diligence phase if certain issues or concerns present themselves or if certain conditions are not met (i.e. title, valuation or environmental concerns). Be aware though that even if a commitment gives the bank certain “discretion” in deciding certain issues later on, the lender must still use “good faith” and act in a “commercially reasonable” manner in resolving such outstanding items and issues.
In order to combat some of the dangers noted above, there are certain fundamental terms that a commitment letter should include for the protection of the bank.
- A clear description of the conditions precedent to closing (i.e. receipt and approval of appraisals and other due diligence receivables);
- A condition that there has been no material adverse change in the borrower or guarantors’ corporate structure or financial condition between the commitment letter date and the loan closing;
- A condition that the borrower may not shop competing financing or disclose the terms of the commitment letter to other lenders; and
- An acceptance and termination date after which the commitment expires.
We highly recommend that when using a commitment letter, you ensure the form has been sufficiently reviewed and approved by legal counsel to avoid the potential dangers noted above do not cost your bank time, resources and money. We can work with your bank to develop a standard form commitment letter or can review your current forms to ensure they reconcile with your desire and intent. The review, preparation and/or approval by legal counsel on the front end documentation of a loan can avoid costly issues in the administration or collection of the loan on the back end.
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