Summary Of Proposed Changes To HUD's LEAN 232 Loan Documents

April 25, 2018, Pepper Hamilton LLP - In an effort to summarize the highlights of the LEAN Email Blasts that we receive, we at Pepper Hamilton are providing this quick synopsis of the latest LEAN update.   Our aim is to provide pertinent information succinctly as a roadmap to the LEAN Email Blasts, not to replace the LEAN Email Blasts.  We hope you find    these summaries helpful.

The Office of Residential Care Facilities (ORCF) has circulated, for public comment by May 10, 2018, updated versions of the 232 LEAN Loan Documents in the April 10, 2018 LEAN Email Blast (for your convenience, the revised Loan Documents are here).  The MBA Closing Working Group is assembling comments for submission to HUD by May 1, 2018.

Proposed Changes to 232 LEAN Loan Documents

The new loan documents generally reflect an effort by HUD to bring the documents in line with the LEAN Handbook issued last year. By way of example, the definition of “Principal” in the Security Instrument and Regulatory Agreements has been revised to reference the LEAN Handbook, as opposed to the Code of Federal Regulations. 

The revised Borrower’s Regulatory Agreement incorporates a Section 38 Addendum listing and executed by the key principals (this revision mirrors the MAP Regulatory Agreement).  As part of this revision, the specific references to the key principals in the Note and Mortgage are replaced with a general reference to this Section 38 Addendum. 

Also, the Borrower Regulatory Agreement (Section 29) and the Operator Regulatory Agreement (Section 13) are revised to reference the HUD-required Management Agreement Addendum and delete the specific management agreement requirements.

Additionally, the documents have been revised to be a bit more prospective.  The definitions of “Master Lease” and “Operator Lease” have been expanded to include not just any lease in place at the time of closing, but any lease impacting the project that may be entered into after closing.  Similar changes have been made to the definitions of “Master Tenant” and “Operator” to include entities involved in post-closing leases.

Multifamily Note:  A new carve-out to Section 9 (pre-payment restrictions) is included, allowing the Lender to require the Borrower to comply with any HUD-imposed conditions before a pre-payment is accepted.

Borrower Regulatory Agreement:  A new Section 36(c)(vii) requires that non-IOI Borrowers or Master Tenants use all “commercially reasonable” methods to cure a breach of the Master Lease or the Operator Lease to avoid a mortgage insurance claim.

Operator’s Lease Addendum:  Section 4 has been revised to reflect that the right to purchase the Operator’s equipment, upon the termination of the Lease, flows to the Borrower (as opposed to the Master Tenant).

Operator Regulatory Agreement:  Two changes have been made to this document that may have a minor impact on the operation of a project. First, Section 3(c) of this document has been revised to require, in accordance with HIPAA regulations, that Operators redact patient information when submitting reports to the Lender or HUD. Second, Section 15 is revised to prohibit the Operator from charging a fee for service animals.

Operator Security Agreement:  Recital F is revised to incorporate healthcare insurance receivables into the definition of “Healthcare Assets.”  Additionally, HUD has promulgated a separate form of the Operator’s Assignment of Leases and Rents and removed that document as an attachment to the Operator’s Security Agreement.  The new form is identical to the old attachment.

Operator SNDA:  The revised document incorporates a new Section 8 for non-IOI Borrowers and Operators that expands the cure period for Operators in the event of a default under the operating lease, provided that there is no risk that any permit or license required to operate the project will be terminated.

Master Tenant Regulatory Agreement:  A new Section 5(d) is incorporated into this document that mirrors the default/cure provisions of new Section 36(c)(vii) of the Borrower Regulatory Agreement.  As in the Operator Regulatory Agreement, Section 9 prohibits the Master Tenant from charging a fee for service animals.

Master Tenant Security Agreement:  HUD has revised this document to remove the assignment of leases and rents provisions and promulgated a separate Master Tenant Assignment of Leases and Rents.  This new Assignment of Leases and Rents is similar to the Operator Assignment of Leases and Rents.  With the removal of these assignment provisions, we assume HUD will no longer require the Master Tenant Security Agreement to be recorded.

Additionally, Section 3(i) is revised to not require a DACA for payroll accounts when the funds have already passed through a DACA-controlled account.  Finally, Section 9(e) is revised to require the Master Tenant to cooperate with the Lender in the event of a default under the Master Lease.

Master Tenant SNDA:  A customized Master Tenant SNDA will now be required for each project, instead of having one SNDA cover all the projects under a Master Lease.

NC Escrow Agreement:  A number of changes have been made to this document to bring it in line with the LEAN Handbook and ORCF practices: (1) Recital C is revised to specifically incorporate borrower elective repairs into the definition of “Non-Critical Repairs”; (2) Section 1 and Section 2 are revised to allow both the Repair Estimate Amount and the Additional Deposit Amount to be in the form of cash or a letter of credit; (3) Section 3 has been revised to state the Borrower is responsible for costs over and above the Repair Estimate and that any such overage may not be paid out of the Reserve for Replacement; (4) Section 4 requires a Latent Defects Escrow only when the actual cost of repairs exceeds $1,000,000, and the escrow of 2.5 percent of the total actual cost of the repairs must be held for a period of 15 months; and (5) Section 5 is revised to allow previously approved Lenders to administer the NC Repair Escrow.

Request for Endorsement:  New Section A(15)(b) is included to allow for approved Lenders to administer the Non-Critical Escrow.  New Sections C(1)(g) and (h) are incorporated for the Lender to disclose the short-term and long-term debt service reserve.  Finally, revised Section D(12) requires the Lender to certify that it has conducted litigation searches of the Borrower, MT, Operator and related Principals and to disclose the results of that search on an exhibit to the Request for Endorsement.

Construction Contract:  Article 1(A) is revised to require HUD’s written approval of any side agreements, as opposed to just disclosure.  Other revisions to the Construction Contract eliminate the potential for incentive payments for “lump sum” contracts and incorporate an exhibit to calculate incentive payments for “cost plus” contracts.  Additionally, the Construction Contract has been revised to eliminate the potential for a pre-commitment early start, but leaves the potential for a post-commitment early start.

Lender’s Certificate:  A new Section 27(g) is included, requiring HUD approval for any off-site storage of construction materials.

Intercreditor Agreement:  There are a number of changes proposed for the Intercreditor Agreement: (1) Section 2.7(b) has been revised to provide an extra day for FHA Lenders to review over-line advances (the Lender now has two business days to submit a request for approval to HUD), and each request must include a collateral analysis, provide by the AR Lender, that such an advance is supportable; (2) a new Section 2.7(h) provides three options to describe how the AR Loan is cross-collateralized across the HUD projects (joint and several liability, another arrangement approved by HUD, or not applicable); (3) new Sections 2.7(i), (j) and (k) restrict the availability of income derived from HUD-insured projects to pay any “Non-HUD Affiliated Obligations”; and (4) Section 3.3 has been revised to specifically permit AR Loan funds to be used to repay unaffiliated manager/consultant fees as a second priority.