The loan payoff letter is a critical legal document for any lender making a secured loan to a borrower where the proceeds of the loan will be used to pay off an existing secured loan made by a different lender.
Essentially, a loan payoff letter is a representation by the existing lender regarding the outstanding amounts owed on the loan, including principal, interest, fees and other charges required to pay the loan in full and release any collateral. The new lender will rely on the information provided in the payoff letter in making the new loan, and in confirming that the new lender’s liens on the borrower’s assets will have first priority at closing. While payoff letters are a very common part of every closing, there is unfortunately no one standardized form of payoff letter that all lenders use. This lack of uniformity can lead to last minute negotiations and delays due to the need to revise payoff letters to satisfy everyone involved in a closing.
In an attempt to create a more uniform approach to payoff letters, here are the basic, essential elements that a payoff letter should include:
- The letter should be addressed to the borrower and actually signed by an authorized person for the existing lender. Problems occur when we just receive payoff statements which are not signed by anyone. In the case of a commercial loan, it is difficult for closing counsel for the new lender to rely on a payoff statement which has not been signed by a specific loan officer for the existing lender.
- The letter should include a clear statement of the payoff amount (i.e., the specific dollar amount representing all principal, interest, fees and other charges due and owing from the borrower to the existing lender) as of a specific payoff date. Open ended terms, such as “plus legal fees” or “additional costs TBD” are never acceptable. The letter should also contain an expiration date after which a new payoff letter must be requested if the refinance has not occurred by such date.
- The letter should include per diem accrual amounts for interest in the event that the payoff is delayed by one or more days thereafter. A per diem accrual will allow the borrower and new lender to re-calculate the interest component of the payoff amount as of the exact date when the new loan closes.
- The letter should spell out the payment method by which the existing loan can be paid off. In the commercial loan context, this typically means wire instructions to which the new lender can wire loan proceeds to pay off the existing loan, but it could also be an address to where a check can be mailed. (Note that in the event a check is mailed the payoff amount should be calculated to account for overnight mail or other delivery times.)
- The letter should contain clear language regarding the discharge or release of any liens granted by the borrower in favor of the existing lender to secure the old loan. Specifically, the letter should indicate that, upon receipt of the payoff amount, all liens and security interests in favor of the existing lender which encumber borrower’s assets are released and the existing lender will prepare and file UCC-3 termination statements, mortgage discharges or any other documents necessary to terminate existing liens. We actually prefer it when the existing lender authorizes the borrower or closing counsel for the new lender to file UCC-3 termination statements and record mortgage discharges once received from the prior lender.
- If the loan being paid off is a revolving loan facility, the payoff letter should clearly state that the revolving loan facility has been terminated and that the borrower may not request any additional advances. This is important since the new lender’s counsel needs to be certain that the payoff amount will not change before the closing.
Ordinarily, the borrower and new lender should wait to request the payoff letter until a closing date for the new loan is reasonably certain and imminent. If the payoff letter is requested too early, and the closing of the new loan slips beyond the outside date, the borrower and new lender may end up needing a second payoff letter from the outgoing lender. If the payoff letter is requested too late, especially when the payoff is complicated due to multiple loans and possible swap breakage calculations, this can disrupt or delay the scheduled closing. As a rule of thumb, it is a good idea to review drafts of all payoff letters at least three to five business days before the scheduled closing date.
Here are some of the potential issues and traps for the unwary that can occur with payoff letters:
- Complicated payoffs where there are many loans from the outgoing lender to the borrower secured by different forms of collateral. We recently encountered a situation like this when representing a new lender making a refinance loan, in which we received multiple one page payoff letters, for different types of loans, some of which were revolving in nature, others of which were specific real estate loans, not signed by any person on behalf of the outgoing lender and containing inadequate lien release language. Rather than rely on the multiple payoff letters, we required the borrower to work with its existing lender to issue one “global” payoff letter, signed by a specific bank contact at the existing lender.
- No clear statement as to the release of the existing lender’s liens. Does the payoff letter provide that the existing lender must “confirm in writing” receipt of the payoff amount before liens can be released? Or does the payoff letter indicate that its liens are “automatically” released once the existing lender “receives” the payoff amount? If the former, then the new lender and borrower would be wise to get an email from the person who signed the payoff letter confirming receipt of the payoff amount before terminating any liens in favor of the existing lender (another good reason for the parties to require that a live human being actually execute the payoff letter). If the latter, then the borrower and new lender may terminate liens in favor of the existing lender once they have confirmed that the wire to the existing lender was received, by issuance of a federal reference number for the wire transfer. It is still good practice, however, to confirm with the outgoing lender that the payoff amount was received and there are no issues.
- Release of all collateral. The payoff letter should clearly state that the existing lender is releasing all liens securing the existing loans. This can become an issue if the existing lender has issued a standby letter of credit (typically in favor of a landlord) which is not being exchanged for a new letter of credit from the new lender at the closing. If the existing lender intends to retain any kind of lien on some or all of the borrower’s assets, it should be specifically negotiated and addressed in the payoff letter or even an intercreditor agreement.
Revolving lines of credit, letter of credit facilities and/or SWAP terminations present their own tricky situations that are too involved for this particular article. If the existing loan being paid off is a revolving line of credit or other fluctuating obligation, the payoff letter will need to address how these are handled. The existing lender will often seek to be indemnified by the borrower or even the new lender for any checks or other items deposited into the borrower’s account with the existing lender and returned unpaid, whether for insufficient funds or for any other reason. Payoff letters in troubled loan situations will often include release language which requires the agreement and acceptance by the borrower as well.
The payoff letter is often one of the last documents to be delivered and reviewed prior to closing a loan transaction, but it is a key closing document. In our experience representing lenders, it is often the case that the first draft of the payoff letter is inadequate in one or more respects. We recommend that lenders be diligent in requiring their borrowers to obtain draft payoff letters well in advance of closing so that their counsel will have sufficient time to carefully review and, if necessary, negotiate them, in order to avoid delays in closings.
This communication is for informational purposes only and should not be construed as legal advice on any specific facts or circumstances.