Main Street Lending Programs – Are they Compatible with Traditional Real Estate Lending?

In addition to several existing lending programs created to relieve the economic distress caused by the COVID-19 pandemic, the Federal Reserve announced that it will purchase up to $600 billion in loans through the Main Street Lending Program to ensure that credit flows to companies with up to 10,000 workers or up to $2.5 billion in revenue.

Arent Fox LLP’s Business Loan Task Force recently published an alert that provided an in-depth look at the two loan facilities (the Facilities) that comprise the Main Street Lending Program: a Main Street New Loan Facility (the MSNL), which allows eligible lenders to originate new loans to qualifying businesses, and a Main Street Expanded Loan Facility (the MSEL), which allows eligible lenders to increase the size of existing loans to qualifying businesses. In this alert, we explore how real estate borrowers and clients may benefit from the Facilities.

Pursuant to the term sheets for the Facilities that the Federal Reserve released on April 9, loans from the Facilities are available to “Eligible Borrowers” which are businesses that have a majority of their employees based in the United States and who are able to certify to making reasonable efforts to maintain payroll and retain employees during the Facility term. Commercial real estate is typically owned by a special purpose entity (SPE) that exists solely to own a single piece of real estate. The SPE itself does not have employees but contracts with affiliated or unaffiliated management companies to manage the real estate using employees of the management company.

Because the SPE does not have employees, it may not squarely fit the definition of “Eligible Borrower” and, without additional guidance from the Federal Reserve, it is unclear whether the employees of a real estate management company would be counted as employees of the SPE for purposes of qualifying as an “Eligible Borrower” under the Facilities. However, since the eligibility test for a borrower appears to be an alternative one (i.e. up to 10,000 employees or $2.5 billion in annual revenue), and because, unlike the PPP program, the funding level is determined based on EBITDA rather than payroll costs, these may be positive indications that the specific employee count of the entity may not matter for purposes of determining such eligibility, but might matter in the application of the covenants about restoring employment.

While it is unclear whether the Facilities will be of direct benefit to an SPE real estate owner, an SPE’s parent company may qualify as an “Eligible Borrower” and obtain loans from the Facilities. If the parent company of an SPE obtains a loan from one of the Facilities and the SPE needs cash flow to pay debt service on an existing loan, the parent company could contribute a portion of the loan proceeds as an additional equity contribution to the SPE or, alternatively, the parent company might be able to use the proceeds of such loan to extend an intercompany loan to the SPE. In either case, the parent company and the SPE will each need to be mindful to avoid violating any covenants in the loan documents to which it is a party, particularly a negative covenant that the entity not incur, create or assume any additional indebtedness or liabilities.

If the SPE’s loan documents contain such a negative covenant, then the lender will likely need to consent to the intercompany loan, and you should expect that the lender will require subordination of the intercompany loan to the mortgage loan. In any event, we recommend reviewing existing loan documents to which the parent company or the SPE is a party to identify whether there are any covenants that prohibit the desired course of action and to identify any potential guarantor liability under the guarantees that could be triggered by taking the desired action.

The MSNL may also be an attractive option for property management companies that need additional cash flow to sustain operations because the MSNL is unsecured and property management companies typically have few assets to offer as collateral for loans. This may be especially helpful for property management companies that are paid a property management fee that is based on a percentage of rents received by the SPE, which rents will likely be declining in the coming months. In the current environment, if rents are deferred or even forgiven, this may mean a delay or a reduction of a significant portion of a property management company’s revenue for an uncertain period of time. Taking advantage of the MSNL program could mitigate these current cash flow challenges.

We will continue to update this article with any relevant new developments.