Crisis Averted? Close Calls and Lessons for CRE Lenders After Recent Bank Shutdowns

Part II - Breaking up is hard to do…

…or so they say. And with a bank in receivership, it's even harder.

In the immediate wake of the Signature Bank takeover, commercial real estate lenders undertook swift inventory of their loan files to identify where they may have had exposure due to funds on deposit with Signature Bank. This meant identifying each deposit account control agreement (commonly called a lockbox agreement, or clearing account agreement, or deposit account agreement, and referred to in this article as a "DACA") and each cash management agreement with Signature Bank as a counterparty.

Further, most lenders have been evaluating whether there should be changes to their lockbox and cash management arrangements, and many borrowers have been contacting their lenders and insisting that their funds be transferred to accounts at banks other than Signature Bank.

How does a lender break up with a DACA or cash management bank in financial distress? This article will walk through some relevant considerations, whether for this breakup or a future one.

Let's start with what the relevant documents say:

Loan Agreement -

• The loan agreement will usually contain eligibility requirements that must be satisfied in order for a bank to be used for cash management accounts and lockbox accounts (also sometimes called clearing accounts or deposit accounts). Often, the concept of an "Eligible Institution" is specifically detailed, with eligibility tied to a bank's ratings.
  
• The loan agreement often provides for the right of a lender to select the cash management account bank (including the unilateral ability to replace such bank from time to time).
  
• However, loan agreements often are silent on the ability of a lender to select, or to cause the borrower to replace, a lockbox bank, unless such bank no longer meets the Eligible Institution criteria.
  
• Even if the loan agreement provides for Eligible Institution criteria, and allows for the replacement of a bank, it generally is not so granular as to detail the specific replacement process should a bank no longer satisfy the relevant criteria (such as borrower cooperation, costs and expenses, etc.).

DACA -

• Typically, DACAs provide for unilateral termination by a lender upon 30 days' notice to the lockbox bank and borrower.
  
• Most DACAs do not address, either expressly or implicitly, what happens if the lockbox bank is taken into receivership or shut down (or downgraded or placed on any sort of watch list, for that matter).
  
• However, simply because a DACA may require 30 days' notice for termination to be effective, that does not mean that funds must continue to be deposited with the lockbox bank during the interim period. Although it will require the cooperation of both borrower and lender, tenants and other relevant parties can be directed to make their payments into a different account while the notice period for termination is running.

Cash Management Agreement -

• A cash management agreement is similar to a DACA, in that it provides for lender control over a specific bank account. Like with a DACA, generally a lender will have the unilateral right to terminate a cash management agreement upon notice to both borrower and cash management bank, usually 30 days.
  
• As with the interim period after sending a termination notice on a DACA, a lender can prevent funds from going into the cash management account by sending a redirection notice to the lockbox bank, instructing it to send daily sweeps to a different account.

Practically then, what is a lender to do? The documents described above provide a number of provisions that - even when taken as a whole - do not fully contemplate a sudden distress event, such as the shutting down of a lockbox bank or cash management bank, or the transfer of accounts to a successor bridge bank as part of receivership.

What we are seeing right now, in light of current banking concerns, is a combination of the following:

• Many lenders and/or their servicers preemptively moved funds out of Signature Bank, with or without following the technical provisions of relevant loan documents.
  
• Some lenders have delivered redirection letters to their lockbox banks, instructing them to cease daily sweeps into cash management accounts at Signature Bank/Signature Bridge Bank.
  
• Some lenders are working with their borrowers to divert funds from going into Signature Bank/Signature Bridge Bank lockbox accounts.
  
• Many lenders are setting forth action plans with their borrowers to implement new lockbox and/or cash management regimes at banks other than Signature Bank/Signature Bridge Bank.

All of the above actions rely, to a certain degree, on borrower cooperation and/or after the fact loan modifications.
What could make this process easier, or at least more clear, for a lender should there be a next time?

1) Consider using a definition for "Eligible Institution" in the loan agreement and any other relevant document, such as the servicing agreement, that specifically details as additional criteria that a bank taken under control of the FDIC or other relevant authority is no longer an Eligible Institution.

2) In each of the loan agreement and DACA, consider whether a lender should have an express unilateral right to direct borrower to terminate and/or replace a lockbox bank relationship upon such bank no longer being an Eligible Institution. Note here that any such termination should not be automatic - rather at lender's option so that cushion time (e.g., 30 days) can be utilized to identify and implement a replacement DACA. To have a DACA automatically terminate may not be enforceable (and/or raise ipso facto issues) and, from a practical perspective, could leave cash management matters in an even more abrupt state of limbo where funds could be rejected.

3) In connection with any termination or replacement of a lockbox bank or a cash management bank, thought should be given to including a covenant (most practically in the loan agreement) requiring borrower to cooperate with the process and detailing related action steps.

4) In each of the DACA and the cash management agreement, a lender may want to eliminate provisions that require the bank being terminated to affirmatively acknowledge receipt of the termination notice as a condition to the effectiveness in the case of a termination triggered by bank distress. A shut down bank or a bank in distress may not have the administrative processes in place to handle such acknowledgement.

5) Similarly, lockbox banks often require written notice, then written acknowledgement back from the bank, and then the passing of a few business days before implementing any change in its daily or weekly sweep protocol to a new cash management bank. Given the importance of expediency in a shut down or receivership situation, lenders may seek an exception to that process allowing for a shorter timeframe and electronic delivery methods if the bank to which the funds are being swept is under FDIC control.

Breaking up may be hard to do, but at least with a clearer path, it might be just a little bit easier.

For thoughts about opportunities for new lockbox banks to ease the transition for rollover DACAs from Signature Bank, be on the lookout for our upcoming Crunched Credit blog post next week.

Stay tuned for more thoughts and suggestions for commercial real estate lenders navigating their documents post-Signature Bank.

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