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Can You Rely on Your Loan Commitment Letter?

The loan commitment letter is an indispensable part of every construction project and of every acquisition of real property purchased with borrowed money. The commitment is, in essence, a contract in which the lender promises (in return for a non-refundable fee) to make a loan if certain conditions are met. If, for some reason, the lender does not fund the loan, the result is usually a financial disaster for the borrower, sometimes leading to bankruptcy, litigation, or both. Obviously, the borrower needs an enforceable commitment letter he can rely on.

Consequently, the wording of the loan commitment letter is every bit as important as the wording of the purchase contract. It is, therefore, important to read the commitment carefully and to negotiate the modifications necessary to protect your position.

As a borrower, there are three areas of particular concern:
(l) Is the commitment enforceable?
(2) Can you satisfy the conditions for funding?
(3) Are you giving away your ability to negotiate fair loan documentation?

Enforceability
Your commitment is worthless if it is not enforceable. The lender could refuse to fund if it changes its mind about the feasibility of the project, finds that interest rates have increased, or decides that it just does not want to fund for any other reason. Unfortunately, this does happen.

In order to be enforceable, the commitment must contain all the material terms of the loan. For example, it must contain the name of the borrower, the exact amount of the loan, the interest rate, and the terms of repayment. One recent case held that a commitment letter tying the interest rate to the lender's "standard interest rate quoted from time to time" was not specific enough and the commitment was unenforceable. In order to avoid this problem, it is best to specify exact terms whenever possible rather than "standard rates," or "usual or customary terms," and so on.

Conditions
Every commitment letter sets forth an exhaustive list of conditions that must be satisfied before the lender has a duty to fund the loan. Sometimes these conditions are so comprehensive and numerous that is seems impossible to satisfy them all. As a borrower, however, it is critical that you review each and every one of these conditions to assure yourself that you will be able to satisfy them and, more importantly, that you will be able to document that they have been satisfied. You should try, whenever possible, to eliminate conditions that must be satisfied "to the lender's satisfaction," or which give the lender the right to refuse to fund if it "deems itself insecure," or which are based on other discretionary determinations by the lender. These kinds of provisions can give the lender an opening to refuse to fund.

Documentation
Commitment letters will often provide that the loan documentation--such as the note, the deed of trust, and the loan agreement--will utilize the lender's standard forms, or that the documentation will be prepared to the satisfaction of lender's counsel. These provisions should be qualified to allow reasonable input from your own counsel. Otherwise, you may be agreeing in advance to dangerous and unreasonable provisions that your own counsel may be powerless to protect you from.

Conclusion
The commitment letter is an important part of nearly every major development of acquisition. It should be reviewed carefully, preferably by your own legal counsel, and its terms negotiated so that you have a fair and enforceable commitment with terms you know you can satisfy.

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