Converting Debt to Equity: An Alternative to Modification or Extension of Loans

The Playbook, and the Case for Ripping It Up

When a borrower cannot repay a loan at maturity, lenders have customarily chosen between two options: modification and extension of the loan; or the exercise of the lender's remedies under the loan documents. Modification and extension agreements typically afford the borrower additional time to repay the loan, in the hope that market conditions will improve before the new maturity date. They also frequently afford the borrower additional relief, such as the right to accrue interest during the extension period, and even a promise of additional loan advances to fund tenant improvement and other costs required to reposition the asset. The exercise of remedies under the loan documents entails either judicial foreclosure or the delivery of a deed in lieu of foreclosure.

It may be time to rip up the playbook and turn to a third option. Historically, lenders have been unwilling to go into business with their borrowers, preferring to observe a rigid separation between debtor and creditor. This approach made sense in past downturns, when lenders could be confident that the market would rebound and their collateral would recover its value.