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Can Churches Restructure Debts?

By Scott Carpenter on the 20th of July 2010

Churches have not been immune to the economic downturn. All charitable giving is down and the credit markets have made borrowing money or refinancing existing debt difficult. If a church is struggling to meet its debt obligations (such as a building project loan), what are the church’s legal options? (This e-newsletter is intended to provide an overview of legal options and does not provide an opinion on the moral or ethical issues involved in debt obligations.)

“Talk to your lender”. In a recent article published in the Wall Street Journal, the behavior of commercial property lenders was discussed. The behavior of these lenders has been described cynically as “extend and pretend.” Although for commercial property lenders “hope” is not a well recognized banking strategy, many lenders (for reasons that have to do with the lenders’ balance sheets and other considerations) are extending loan terms and hoping the situation will improve. This option can be a challenge for churches whose loans were bundled or sold or are being serviced by other entities. But behind every promissory note or deed of trust is a person or entity that wants to be paid. Discussion needs to occur between those people and the church leadership. Lenders appreciate borrowers that come to the table early with concerns about debt repayment, rather than simply missing payments and waiting for the lender to react.

“Propose Different Terms”. If discussing the debt challenge to the lender does not provide relief, perhaps the lender will extend the amortization schedule of the loan to lower the payments. Or some lenders will take “interest only” payments for a period of time in a debt restructuring to enable the church to keep current. “Different terms” can be net neutral to the bank over time, but significantly better for the borrower in the short term.

“Propose a Leaseback”. If a church has missed multiple payments and the lender will not restructure the debt or change the payment terms, the challenge for the lender is that if it initiates a foreclosure, the lender will likely end up the owner of the property (the foreclosure process involves an auction and it is possible that a bidder unrelated to the lender or the church would purchase the property at the auction). In the event that the lender ends up owning the property, the lender must do something with it. The lender could:

  • Own the property for a time and then sell it on the open market.
  • Own the property and rent it until the value goes up (hopefully) and then sell it.

Both of these scenarios have drawbacks for the lender. The market for existing church buildings is soft. Although there are always property purchasers who welcome a bargain, the lender wants to get as much money as possible for the property. If a church is working with its lender, the lender may agree to a consensual foreclosure called a “Deed In Lieu of Foreclosure” where the church voluntarily conveys ownership of the property to the lender. Ideally, the lender would agree, in advance, to rent the property back to the church for an agreed upon rent payment. Favorable terms for a church would include a rent payment that is based on a percentage of monthly income, for example. In the best scenario, the lender would agree to provide the church with a first option to purchase the property back in the event the lender no longer wants to be a landlord or on a particular date in the future that the church expects to be able to purchase the property back.

If you have any questions regarding this issue, or other questions related to church law in Arizona, please feel free to contact the author, Scott B. Carpenter, at scott@azchurchlaw.com or 480-991-6949.


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