Highlights Of HUD’s New Section 232 LEAN Closing Documents, April 9, 2013

by Pepper Hamilton LLP

On September 7, 2012, the Federal Housing Administration (FHA) published in the Federal Register new regulations for the Section 232 Healthcare Facility Insurance Program, which became effective as of October 9, 2012. In order to institute the new regulations, FHA drafted new loan closing documents. The first drafts of the new closing documents were released on May 3, 2012. After providing an opportunity for discussion and industry comment, revised loan document drafts were circulated on November 21, 2012. Following another round of comments and review from both the industry and U.S. Department of Housing and Urban Development (HUD) staff, on March 14, 2013, HUD released final new loan documents to match the final regulations (the Closing Documents).

HUD has publicly stated that the new LEAN documents must be used if a facility receives its commitment on or after April 9, 2013. Much like when the new MAP documents were released, we anticipate many waivers will be requested for at least those deals currently in an application queue. Our sources at HUD have told us that while headquarters has not told the field counsel how such waivers will be handled, HUD will be paying particular attention to ensure that if a request to use the previous form of documents effects a new regulation, that a formal regulatory waiver will be required.

In addition to the new Closing Documents, there are also new Lender Narratives, production certifications, construction documents and asset management documents (Additional New Documents) that must be used for all applications submitted on or after July 12, 2013. HUD encourages these new documents now; however, HUD is requiring that applications submitted between now and July 12 must include either the complete use of new documents or the complete use of the old documents – a lender cannot mix the new documents and old documents when submitting an application.

This Update discusses the substantive provisions in the new Closing Documents. Below we highlight provisions in some of the Closing Documents that we believe are of particular interest to Borrowers, Operators and Mortgagees. While this article covers only some of the new Closing Documents, all of the Closing Documents and the Additional New Documents can be found online. Those documents discussed below can also be found by clicking on the headings in this article for a direct link to the document.

Mortgage, Assignment of Leases, Rents and Revenue and Security Agreement

The first noticeable change from the current mortgage to the new form is that HUD has combined the security instrument and Owner security agreement. The new security instrument closely resembles the new MAP security instrument in style and substance, including the exculpation language concerning the key principal identified in the Mortgagor’s Regulatory Agreement. The most significant change in the new Security Instrument is the inclusion of the Operator’s license (whether the Operator is an affiliate or not) as collateral for the Security Instrument.


The Note is very similar to the new MAP note with one notable difference, the time for assessing late charges under the LEAN Note is 15 days, as opposed to 10 days for the MAP program.

Owner Regulatory Agreement

While the MAP regulatory agreement serves as the base for this new form, there are a number of items that only apply to healthcare facilities that we want to highlight. The first item is of importance for Borrowers who self-operate their facility; the entity will be required to execute both the Owner and Operator Regulatory Agreements as well as the Operator Security Agreement. While all Owners must submit an annual financial audit, if the Owner is also the Operator of the facility, it must submit quarterly financial reports per the terms of the Operator Regulatory Agreement.

Another interesting provision affects non-profit borrowers; namely, if a non-profit borrower is underwritten at the more conservative numbers required of a for-profit borrower, the non-profit borrower must adhere to special distribution constraints that do not apply to for-profit borrowers. HUD takes the stand that it has long required non-profit borrowers to maintain residual receipt accounts rather than allowing them to make distributions of surplus cash. Given that HUD was frequently willing to waive or modify that policy, HUD has stated that if it is a 223(a)(7) refinancing, and the non-profit borrower was previously treated as a for-profit borrower and permitted to distribute surplus cash, the non-profit can select to be treated as a for-profit entity for distribution purposes.

In regards to withdrawing surplus cash from the facility, if an Owner withdraws surplus cash during a reporting period (as is now permitted) and the financial statements at the end of the period show that there is negative surplus cash, the Owner must restore the amount of funds taken from the facility to return it to a positive balance.

Additional provisions include: (i) Owner must submit an annual financial audit within 90 days after the close of its fiscal year; (ii) Owners must obtain written cost estimates for work that costs more than 5 percent of the facility’s Gross Annual Revenue; (iii) Owners must notify HUD and their lender within two days of any notices they receive that are G-Level or higher; (iv) a key principal carve-out similar to the MAP regulatory agreement; and (v) HUD’s new requirements for any management agreement.

Operator Regulatory Agreement

As in accordance with the new regulations, 24 CFR 232.1003, the Operator must be a single-asset entity. While this is a change in the requirements, HUD makes clear through the regulations that they will be willing to grant waivers of this requirement. We anticipate in particular that deals being refinanced pursuant to 223(a)(7), and in states where obtaining a new license is incredibly difficult, that HUD will be open to waiver requests when one Operator operates multiple facilities. At the LEAN Training in March, HUD stated that directors are authorized to grant the single-asset entity Operator waivers.

Another significant new requirement is that all Operators must now create a Risk Management Program. HUD’s only indication of what must be included in the Risk Management Program came from a short blurb in the December 19, 2012 LEAN Blast and we await further direction from HUD as to the requirements. In addition to the Risk Management Program, if a facility is running an operating deficit, the Operator must hire a consultant to review the operations of the facility and, after discussing the recommendations with the Owner, Lender and HUD, it must determine which of the consultant recommendations to implement.

The Operator must provide quarterly financials and year-to-date certified financials; the financial statements do not have to be audited unless the facility is Owner-operated and then only the annual financial statement must be audited. While the Operator is permitted to pull surplus cash from the facility at any time, these quarterly financial reports are designed to ensure that the facility has a positive cash flow. If a facility is running a negative working capital balance, then the Operator is not permitted to take any distributions until a positive balance is restored.

Other items of note are that the Operator has two business days to deliver notices that are G-Level or higher, or any financial/operating reports as requested by HUD or the Lender; commercial leases can have terms up to five years; and the definition of Material Term has been revised to permit certain Account Receivable modifications that have already received HUD approval to change without further HUD approval.

Operator Security Agreement

There are a number of changes to the Operator Security Agreement; the most significant change is that the Operator, whether a related entity or not, must pledge its assets as collateral to the Owner’s loan. HUD has stated they now want the Operator’s collateral to be loan collateral because HUD has a strong interest in the operation of the facility and regards all funds derived from the operation of the facility as project funds. This pledge is not only in the Operator Security Agreement but now, as an exhibit, HUD is requiring the Operator to execute and record an Assignment of Leases and Rents. This new Assignment is an attachment to the form Operator Security Agreement and provides notice of the Lender’s security in the rents, leases, government receivables, provider agreements and residential leases.

Additionally, HUD now requires that all Operators provide and attach a Cash Flow Chart to the Operator Security Agreement even if there is no account receivable financing. Lastly, Exhibit C to the Operator Security Agreement requires the Operator to identify any other names it has used in the previous five years, any assets acquired in bulk transfer in the previous five years and the Operator’s rights in investment property, letters of credit, chattel paper, tort claims, deposit accounts and instruments (including promissory notes).

Addendum to Operating Lease

The Addendum to Operating Lease is similar to the current form document; however, there are a few interesting revisions. First, the Operator must be a Special Purpose Entity (as defined by Program Regulations). This requirement is in addition to the language from the new Regulations, 24 CFR 232.1003, which is silent about a requirement for the Operator to be a special purpose entity and instead focuses on the Operator as a single asset entity. Second, at the termination of the operating lease, the Borrower will have the opportunity to purchase the Operator’s personal property “at book value,” an arrangement that we believe will not be popular with third-party Operators. Third, the discussion of material Account Receivable terms has been removed from the Operating Lease Addendum.

Despite not being stated in the Operating Lease Addendum, HUD still requires that there be at least a 1.05 DSC in the rental payments to the Mortgagor.

Subordination, Non-Disturbance and Attornment Agreement – Operating Lease

There are now two different form SNDAs, one for the Operating Lease and a separate SNDA for the Master Lease. The only relatively interesting new requirement in the Operating Lease SNDA is that if the Operator gives a notice of default under the operating lease, it must also provide that notice to the Lender for the notice to be valid and effective.

Master Lease Subordination, Non-Disturbance and Attornment Agreement

The Master Lease SNDA includes Operator requirements that for an unknown reason, are not included in the Operating Lease SNDA. For example, the Master Lease SNDA includes the requirements for dealing with an operating deficiency, as also stated in the Operator’s Regulatory Agreement but not part of the SNDA for the Operating Lease. The Master Lease SNDA does permit the master tenant to cure an Operator default provided there is no material risk of termination, project operating deficiency or payment default under the loan documents. The Master Lease SNDA also sets forth the terms in which a facility may be released from the Master Lease.

Master Lease Addendum

An entirely new document is the form Master Lease Addendum, which is designed to be attached to a current Master Lease that will incorporate all of HUD’s required forms. Of course, as all have experienced, most of the time when HUD requires a Master Tenant, such a structure does not currently exist and therefore the Master Tenant and the Master Lease are strictly created to satisfy the HUD requirement. It is everyone’s hope that a simple Master Lease with the attached Master Lease Addendum will make the pain and time required to negotiate an entire Master Lease a thing of the past.

The new Master Lease Addendum includes many of the sections that we have been negotiating with HUD for the past few years. The difference between the new form and the proposed addendum that had been making the rounds for the past year is that the current draft removes all references to Account Receivables financing and those provisions concerning the ownership of a facility’s FFE. Additionally, the final promulgated version removes the requirements that the Master Tenant have a risk management plan, enter into the facility’s deposit account control agreement or be a special-purpose entity.

HUD clarified a number of items at the LEAN Training in March; it was confirmed that if there is currently a HUD-approved Master Lease in place, any facilities added to that Master Lease do not require the new addendum. In addition, the cross-default provisions are designed so that surplus cash from one facility will be used to support a poor performing facility on the Master Lease.

Intercreditor Agreement and Rider

After HUD received significant backlash from AR Lenders regarding the first draft of the new Intercreditor Agreement, HUD made substantial improvements to the promulgated Intercreditor Agreement. The final version of the Intercreditor Agreement requires that the FHA Lender provide notice at least 30 days prior to declaring a default that would cut-off the AR Lender’s priority (the first version required no advance notice). Additionally, if an AR Lender continues to advance funds to a facility, even after the FHA Lender has declared a default, for reasons the AR Lender deems necessary to preserve and protect its collateral (such as to keep the facility operating) the additional funds are protected as AR Lender collateral and the AR Lender can still collect repayment of those funds. The Intercreditor also permits the AR loan to be extended, and the interest rate revised within certain pre-approved parameters, without having to obtain HUD’s approval at the time of the modifications. It is also worth noting that HUD has removed the language from the Rider that allowed for FHA and non-FHA facilities to be on the same AR line of credit and HUD now requires a separate Intercreditor Agreement for each facility.

Please note that if the facility is being refinanced pursuant to 223(a)(7), and there is already an Intercreditor Agreement in place, that Intercreditor Agreement may remain and the new form is not required.

Management Certification

The Management Certification is very similar to the MAP Form 9839. This certification is not required unless the facility has a manager; if there is only a separate Operator, the form is not required. The certification sets forth requirements for the manager and must also be executed by ORCF, in which the management agreement and management fees are officially approved.

Master Tenant Security Agreement

Another new document that HUD is requiring be recorded is the Master Tenant Security Agreement; unlike the Operator Security Agreement, the entire document will be recorded. Much like the Operator Security Agreement, the Master Tenant agrees in this document to secure the obligations of the loan documents and the borrower’s mortgage.

Master Tenant Regulatory Agreement

The Master Tenant Regulatory Agreement is very similar to the Operator Regulatory Agreement – it also includes the Risk Management Program requirements.

A/R Financing Certification

The Accounts Receivable Financing Certification is the document in which the Account Receivable Borrower certifies: (i) it has provided HUD with copies of all of the documents evidencing the accounts receivable loan; (ii) it has not commingled government receivable funds with non-government receivable funds; (iii) that the account receivables collateral does not secure any obligations to projects that are not FHA insured; (iv) there is no identity of interest between the accounts receivable borrower and accounts receivable lender; and (v) there is not a conflict of interest with the accounts receivable lender.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Pepper Hamilton LLP | Attorney Advertising

Written by:

Pepper Hamilton LLP

Pepper Hamilton LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.