COVID-19: Pre-negotiation letters as a critical tool for real estate workouts

The coronavirus disease 2019 (COVID-19) pandemic presents unparalleled challenges to all aspects of the global economy. In New York’s real estate sector, commercial lenders are facing challenges as borrowers involved in initiating or completing development projects face new capital market realities and government restrictions on construction, such as Governor Andrew M. Cuomo’s New York State on PAUSE order and implementing guidelines. 

Now more than ever, commercial lenders are encouraged to place negotiating and executing a pre-negotiation letter (“PNL”) at the very top of their loan workout checklists.   

I. What is a pre-negotiation letter and what should be included?

As we have previously noted, a PNL is generally a letter agreement from the lender to the borrower, and, preferably, any guarantors, that stipulates the lender is not waiving any of its rights in entering into discussions with the borrower about potential loan modifications, and that the discussions taking place are non-binding and may be terminated by either party. In practice, a PNL helps borrowers negotiate loan modifications confidentially and avoid a potential default, while protecting lenders from future lender liability claims arising from the borrower’s misplaced reliance on the possible modification of existing loans. There is no standard PNL; a well-drafted agreement will address the specific circumstances of the parties and the project. In all events, the lender is urged to insist that the borrower and any guarantors actually execute the letter and return the letter to the lender. 

In addition to the criteria noted above, parties may consider the following in preparing a PNL:

The PNL’s recognition of the borrower’s outstanding debt and the enforceability of the applicable loan documents. A PNL is not a forbearance agreement, however, since any agreement to forbear will be the outcome of any negotiations.

• The borrower’s confirmation that any pledged collateral remains intact and is not encumbered by any liens.
• The borrower’s right to refinance, and not having to forego refinancing opportunities by entering into the PNL.
• The parties’ expressly waive any potential claim arising out of any loan modification discussions.
• The lender’s requirement that any guarantors join the letter as signatories in addition to the borrower.
• The parties’ consideration as to whether and to what extent the negotiations should remain confidential, and whether the discussions are subject to any evidentiary privilege if litigation occurs.
• The PNL’s possible inclusion of provisions relevant to potential dispute resolution, including document retention requirements, jury waiver, forum selection, choice of law, and judicial interpretation guidance.

Negotiations over a PNL also present an opportunity to formalize discussions between the parties that may have taken place over time, as well as the opportunity to involve counsel in the discussions if counsel has not already been involved. 

II. New York courts’ treatment of pre-negotiation letters

If litigation over a loan default occurs, state and federal courts in New York routinely honor PNLs.¹ Typically, courts have considered a bargained-for agreement to negotiate (when there is no pre-existing legal obligation to do) so fair consideration for the contract.²

Judicial intervention in New York, and elsewhere, can be a time-consuming process even before the current COVID-19 health emergency and attendant court closings. In this context, a PNL can provide a critical tool for a lender to rebut a borrower’s and guarantor’s challenges to a lender’s foreclosure action that may delay judgment and, in turn, increase litigation costs. For example, a borrower recently argued that workout negotiations required the lender to restructure the loan, and that failing to do so constituted a breach of the implied covenant of good faith and fair dealing contained in every New York contract. The trial court rejected this argument, and a New York appellate court affirmed, because the parties’ loan and pre-negotiation agreements expressly countered this argument.³

In addition, a PNL may serve as “documentary evidence” admissible at the pleading or motion to dismiss stage of a New York state litigation under NYCPLR § 3211(a)(1). As a result, a PNL may offer a potential defense to lender liability claims brought by a borrower or guarantor against a lender early in litigation and before costly discovery begins.

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If you have any questions regarding pre-negotiation letters and their implications, please contact your DLA Piper relationship attorney, the authors, or any member of the DLA Piper Litigation group.

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This information does not, and is not intended to, constitute legal advice. All information, content, and materials are for general informational purposes only. No reader should act, or refrain from acting, with respect to any particular legal matter on the basis of this information without first seeking legal advice from counsel in the relevant jurisdiction.