Guaranty Insurance in Real Estate Finance Transactions

Description

Because it imposes personal liability, a guaranty is of particular importance to the guarantor and is often the most heavily negotiated document in a lending transaction. Terms may vary depending on the size and scope of the deal, the credit record and financial statement of the sponsor, and whether the loan is a construction or permanent loan. The inability of a sponsor to provide a guaranty, or a lender's determination that the sponsor's guaranty offers inadequate protection may derail the transaction.

Guaranty insurance can be used by the parties to transfer/mitigate against the risk of loan default without the need for a personal guaranty. If the borrower defaults, the lender acquires title through foreclosure, and if the proceeds from the sale are less than the outstanding loan balance, the lender can file a claim under the policy (up to the policy limit) instead of pursuing the borrower in court for the deficiency.

There are deal points to address in the related transaction. What if the claim is denied or the insurance company loses its investment grade rating (required by most banks) during the term of the loan? How is the policy read together with nonrecourse carveouts relating to bad acts of the borrower? What if the borrower causes a delay in the foreclosure? There will still be events for which the lender might require personal recourse to the borrower or guarantor.

The insurance company will want to underwrite the feasibility of the project and experience of the sponsor/borrower (similarly to the lender, but lenders focus is more on borrower) before agreeing to place insurance and the resulting policy limit may not cover all of the loss. Counsel must have a thorough understanding of the policy terms and limits to craft the loan documents accordingly.

Listen as our authoritative panel discusses this new guaranty insurance option and the issues which borrowers and lenders will encounter in incorporating it into a commercial real estate financing.