Voluntary defaults and alternatives

That's right, we're starting to see an interesting strategy being put into play: borrowers are intentionally allowing properties to go into default in order to renegotiate a deal with the lender.

In the case cited here, "Millennium Partners this week acknowledged purposely defaulting on its two-year-old, $90-million CMBS loan for the 277-room Four Seasons San Francisco with hope of renegotiating the debt with the special servicer, LNR Property Corp., because the hotel, once valued at $135 million, is now worth less than is owed. The strategic move appears to be working for Millennium and others in California, which has industry experts expecting a lot more of it."

Why? Because on these CMBS loans the master servicers are mute, and typically powerless to really do anything outside a very narrow box. The special servicer has to get involved in order to get any attention on a possible workout. So the borrower purposely throws the deal into default by not paying or by otherwise defaulting on some covenant.

This strategy, of course, has risks, especially depending on what state you are in and the foreclosure laws there. I think Maura O'Connor of Seyfarth Shaw (where, in the interest of full disclosure, I worked for a couple of years in the 1990s) takes a better approach:

So, in order to trigger a file transfer from the master to the special servicer, a borrower or its counsel should request such a transfer in writing (to the master servicer), and should spell out that a default is “reasonably foreseeable” and imminent, and explain why. (However, I do not think it is a good idea to default in order to trigger a servicing transfer!)

This quote is taken from the comments, and I think this and other concepts in Maura's series on workouts are the best approach. Intentionally defaulting should be a last resort.