By Leor Margulies
Robins Appleby LLP
A recent case that our firm was involved in known as 660 Sunningdale GP Inc. v. First Source Mortgage Corp. (Sunningdale v. First Source) relating to recovery of a commitment fee on an aborted loan, brought to mind the importance of the wording of commitment letters to both lenders and borrowers. This case is to be contrasted to the earlier case of MarshallZehr Group Inc. v. Ideal (BD) Developments Inc. (MarshallZehr) which also involved the interpretation of the various provisions relating to the payment of commitment fees. Commitment fees can be significant amounts and determining when they are earned and payable is critical to both the lender and borrower.
Sunningdale case
In the Sunningdale case, the borrower had paid a $100,000 deposit against a total fee of $426,000. The borrower was not able to satisfy various discretionary conditions precedent to the funding. The borrower decided that it was going to seek alternative financing from MarshallZehr, and terminated the commitment. First Source registered a caution on the property to secure payment of the outstanding $326,000. Sunningdale paid $326,000 to its lawyers in escrow pending a court decision, to remove the caution.
The key in that case was the wording of the clause that entitled First Source to full payment of the fee whether or not the advance was completed. The wording in question provided, “In the event the loan is not advanced and the commitment is terminated, through no fault of the lender, the deposit shall not be refundable to the borrower and may be retained by the lender as liquidated damages. Notwithstanding the foregoing, the borrower shall be responsible for and pay the deficiency between the lender fee and the deposit forthwith on demand, unless if caused by the default of the lender.”
Although at trial the judge dismissed the claim of First Source for the additional $326,000 on the basis that the amount payable was a penalty, the Court of Appeal reversed that decision and correctly confirmed that this was not a penalty but part of the contract and the consideration for First Source committing to fund on the terms set forth in the commitment, and that First Source was entitled to the $326,000.
MarshallZehr case
This decision is to be contrasted against the MarshallZehr decision, where various conditions precedent were not met and MarshallZehr exercised its right to terminate the Commitment. A small deposit of $26,000 had been paid but a significant amount of the mortgage commitment fee of $396,000 remained outstanding. In this case, however, the clause relating to the payment of the commitment fee was very different. It provided that the remainder of the lender fee (after payment of the deposit) would be “deducted from the initial advance.” No where else in the commitment letter did it provide that the commitment fee would be payable, whether or not the lender funded. Accordingly, the court held that as the commitment stipulated payment of the balance of the lender fee only when the loan was advanced, and because MarshallZehr had terminated the commitment and not completed the advance, the remainder of the fee was not payable.
When developers are signing commitments, they need to be cognizant of the fact that there are many conditions that are required to be satisfied to obtain funding. These conditions are known as conditions precedent. For land financing, they may include satisfaction with the fair market value of the land by an appraisal, the potential for pre-sales, the status of zoning, environmental conditions, and a review of financial abilities of the guarantors. If any of these conditions are not satisfied, and quite often they are subject to the lender’s discretion, the lender may be able to legitimately terminate the agreement and claim the balance of the commitment fee.
In a development project, there may be additional conditions such as budget approval, equity injection, status of pre-sales, terms of purchase agreements and condominium documents applicable. Again, failure of meet any of these conditions could entitle the lender to terminate the loan transaction and retain any fee paid and claim the balance. This, of course, would depend on the wording of the agreement. There is clearly a fairness for the lender to be able to claim some or all of the fee, depending on the basis on which a loan does not fund. The lender is committing to fund based on representations from the borrower as to its ability to satisfy the conditions precedent. However, if the conditions are not satisfied or the borrower decides to go elsewhere, the borrower would be hard pressed to claim that it is entitled to be relieved of its obligation to pay the commitment fee.
However, there are many conditions that are subject to the approval of the lender or issues that come up that are unknown to the borrower which may result in the lender not funding. These could be conditions that are more discretionary, as opposed to factual and in those circumstances, the borrower should try to negotiate a reduction in the commitment fee to perhaps only the good faith deposit or a lesser amount, depending on how much it is, if the commitment is terminated because of an unsatisfied condition.
Most lenders who enter a loan commitment intend to complete the funding and will be reasonable in exercising a discretion on the satisfaction of the conditions. They are generally not intending to use their discretion unreasonably to terminate the commitment, retain the good faith deposit and even claim the balance.
On the other hand, there may be conditions precedent that are not satisfied as a result of the borrower having agreed to conditions it hoped it could satisfy or simply missed them when signing the commitment. In those circumstances, the borrower is taking the chance of losing its good faith deposit and exposing itself to a claim for the full commitment fee.
There are a number of key lessons here for developers entering into commitments:
- Review the conditions precedent carefully. Ensure that you can satisfy the conditions or to the extent that they are not satisfied yet, try and negotiate some reduction in the commitment fee or good faith deposit where the conditions are not satisfied through no fault of the developer, notwithstanding its efforts;
- The commitment fee and the good faith deposit should not be payable in the event that the lender fails to fund through no fault of the borrower;
- Even where the borrower has erred in its projection that it could satisfy certain conditions precedent, if it has acted in good faith and still cannot satisfy the conditions, the borrower should seek some reduction of the good faith deposit and/or total commitment fee, taking into account that any third party expenses would have to be covered plus reasonable administration fees for the lender. This, of course, is something to be negotiated;
- Developers with longstanding relationships with lenders will often find the lenders reasonable in reducing fees payable and not seeking payment of the balance of the fee where the borrower has acted in good faith and used its best efforts to satisfy conditions precedent, but where the borrower is entering into a new relationship with a lender and does not have the history and loyalty of the lender, they may not be so generous in deviating from the terms of the commitment. Therefore, it is important to review the terms carefully and ensure that the conditions precedent can either be satisfied or that there is an escape hatch for those that cannot be satisfied.
Leor Margulies is Real Estate Group Co-Head, Robins Appleby LLP. robinsappleby.com.
