Summary of HUD’s LEAN 232 Program E-Mail Blast: Office of Residential Care Facilities (ORCF), July 2014

by Pepper Hamilton LLP
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In an effort to summarize the highlights of the U.S. Department of Housing and Urban Development (HUD) LEAN E-mail Blasts that we receive, and rarely have time to review in a timely fashion, we at Pepper are providing this quick synopsis of the latest LEAN update. Our aim is to provide pertinent information succinctly as a roadmap to the LEAN E-mail Blasts, not to replace the LEAN E-mail Blasts. We hope you find these summaries helpful. Here is a link to the complete July 23, 2014 LEAN Blast.

The hyperlink HUD provided for this E-Mail Blast (http://intraportal.hud.gov/hudportal/documents/huddoc?id=JulEmailBlast072314.docx) is not working; to make the document available, we have imported it to our Web site, via the hyperlink above.

ORCF Released Revised 232 Documents

In response to HUD’s February request for comments on the new loan documents, HUD has posted revised Section 232 documents. The changes to the documents include a few substantive revisions, as well as edits resolving scrivener’s errors and updated OMB form information. The new documents are posted on HUDClips for immediate use and redlines are provided on the ORCF Web site – note that the quick links on the Lean 232 documents Web page, where the redlines are located, have not been updated with clean versions of the new loan documents. The documents must be used for any legal packages submitted after August 31, 2014.

We have found that the vast majority of the edits are designed to make the 232 program more palatable for third-party operators. This is a welcomed approached as an increasing number of third-party operators were having difficulty getting comfortable with HUD’s requirements. The longer the LEAN programs excellent track record continues and the faster the processing times shrink, more and more interested owners and operators will become interested. We believe the LEAN program will continue evolve and become more friendly to owners and third-party operators as the 232(a)(7) queue runs its course and the lending industry brings new, strong borrowers and operators into the FHA-insured realm.

A summary of Section 232 documents substantive changes:

1. Master Lease Subordination, Non-Disturbance and Attornment Agreement (Master Lease SNDA) (HUD-92333-ORCF)

The following changes were made:

  • In Section 3, “Project Operating Deficiencies,” ORCF revised the definition of a “Project Operating Deficiency,” which gives rise to the need to retain a consultant, by substituting debt service coverage ratio for several other financial indicators. ORCF also added language explicitly limiting the circumstances in which a denial of payments or a proposed termination of Permits and Approvals would constitute a Project Operating Deficiency. ORCF’s intention was to clarify that an operator diligently and adequately addressing such matters would have some reasonable time to resolve them. In addition, ORCF clarified that a Project Operating Deficiency will not be considered an Event of Default unless such circumstance meets the requirements for an Event of Default pursuant to the relevant Loan Document.
  • In Section 4, “Master Tenant and/or Operator Rights to Cure,” ORCF clarified that the defaults being referenced are those of the borrower. ORCF also revised the section to allow an operator or master tenant to cure a borrower default even if a Project Operating Deficiency exists.
  • In Section 10, “Miscellaneous,” ORCF revised the definition of “Material Risk of Termination” to make it consistent with the definition used in the Regulatory Agreements.

2. Operator Security Agreement and Rider (HUD-92323-ORCF)

  • In Section 2, “Representations; General Covenants,” ORCF revised subsection (c) to recognize that Books and Records might be located off-site.
  • In Section 8, ORCF revised subsection (g) to clarify that “Permitted Liens” would not be a circumstance constituting an Event of Default.
  • In Section 23, “Miscellaneous,” ORCF revised subsection (b) to recognize that certain sections of the document impose a reasonableness standard on the decisions of a Lender.
  • ORCF added Section 25, which will be used to indicate whether the Security Agreement includes a Third Party Rider.
  • Finally, ORCF added a final paragraph to the Third Party Rider, so as to include a definition of Material Risk of Termination consistent with the definition used in the other Section 232 documents.

3. Master Tenant Security Agreement (HUD-92340-ORCF)

  • ORCF revised the Master Tenant Security Agreement to include the same changes set forth in the Operator Security Agreement and also added a Third Party Rider to the Master Tenant Security Agreement for use when the Master Tenant is not related to the Borrower.
  • In Section 3, “Representations; General Covenants,” ORCF edited subsection (j) explaining how a Master Tenant might receive Government Payments due the Operator.
  • In Section 16, “Operations Transfer/Cooperation in Event of Sublease Termination,” ORCF added language clarifying that the required cooperation encompasses addressing Provider Agreement issues.

4. Healthcare Regulatory Agreement – Operator (HUD 92466A-ORCF)

  • In Section 6, “Consultants,” ORCF edited the definition of “Project Operating Deficiency” consistent with the edits discussed above with respect to the Master Lease SNDA.
  • In Section 8, “Notice of Violation and Event of Default,” ORCF revised subsection (a) clarifying that in the case of a non-Identity-of-Interest Operator, the payment obligations being referenced therein are those of the Operator.
  • In Section 20, “Books, Accounts, Financial Reports, Financial Covenants,” ORCF edited subsection (h) elaborating that if ORCF directs that a report be sent to the Lender and/or another third party, it is so that the party can review such reports at ORCF’s direction.

5. Healthcare Regulatory Agreement – Master Tenant (HUD-92337-ORCF)

  • Made conforming changes that were discussed above with respect to the Master Lease SNDA and the Operator Regulatory Agreement.
  • In Section 2, “Approved Use; Permits and Approvals,” ORCF edited subsection (c) to clarify that the civil money penalties referenced are those of the Healthcare Facility.

6. Healthcare Regulatory Agreement – Borrower (HUD-92466-ORCF)

  • In Section 13, “Reserve for Replacement,” ORCF revised subsection (e) so that upon Borrower’s satisfaction of all of its obligations under the Loan Documents, the account balance may be distributed either to the Borrower or the Borrower’s designee.
  • ORCF edited Section 23 to clarify that goods and services referenced therein are those, if any, that the borrower purchase or acquires in connection with the Project.
  • In Section 26, “Operator; Cooperation in Change of Operator,” ORCF amended subsection (e) permitting that arms-length negotiated purchase options in a lease are not categorically impermissible.

7. Security Instrument/Mortgage/Deed of Trust (HUD-94000-ORCF)

  • In Section 1, “Definitions,” ORCF clarified the definitions of “Event of Default,” and “Mortgaged Property” as it applies to security deposits.
  • In Section 4, “Assignment of Leases; Leases Affecting Mortgaged Property,” ORCF modified subsection (b) to clarify that a Borrower’s right to collect rent, which ceases upon an Event of Default, will be reinstated should the Event of Default be subsequently cured.
  • Various sections were edited (e.g., Section 7(a)) so that instead of directing the Borrower itself to take action, the document directs the Borrower to take “or cause the Operator to take” the action.
  • In Section 19, “Property and Liability Insurance,” ORCF modified subsection (c) to explicitly set forth a “reasonableness” standard in the language allowing a lender to impose various requirements for the maintenance of insurance.
  • In Section 22, ORCF revised subsection (b)(3) to more clearly address extensions of Borrower’s cure period.

8. Intercreditor Agreement (HUD-92322-ORCF)

Based on further collaboration with the industry, ORCF has further edited Section 2.3(a) (the “standstill provision”). ORCF, at the industry’s behest, added language to make it clear that the FHA Lender could not contact account debtors or seek to change the remittance instructions as to where proceeds of accounts receivable should be paid prior to the AR Lender’s loan being paid in full. ORCF also added language to provide comfort to the FHA Lender and ORCF that the standstill provision would not in any way hamper the FHA Lender’s abilities to exercise remedies to which it may be entitled or to transition the operation of the facility to a new operator or to seek all related licenses, permits and provider agreements.

ORCF is also now requiring that an Intercreditor Agreement be executed for each facility in an account receivable portfolio rather than permitting multiple facilities to be referenced in one Intercreditor Agreement.

9. Guide for Opinion of Operator’s Counsel, and Certification (HUD-92325-ORCF)

After considering comments to the Operator Opinion, ORCF revised three sections that were problematic for opining attorneys:

First, the Opinion permits the opining attorney to limit the opinion to the corporate/partnership/limited liability company law of the Operator’s organizational jurisdiction. Previously, the operator’s attorney was not permitted to limit the scope of the organizational jurisdiction opinion.

Second, the revised Operator opinion allows the opining attorney to limit the opinion to the laws of (i) the property jurisdiction; (ii) the organizational jurisdiction (if different than the property jurisdiction); (iii) the UCC of the state where the operator is located; and, the new addition, (iv) sections 9-314 and 9-304 of the UCC in the state law which controls the terms of the DACA and DAISA. ORCF and OGC hope that the addition of limitation (iv) will give more comfort to the opining attorney that they are not forced to comply with the entire UCC of the state law for the controlling collateral state.

Third, the definition of “Transaction Documents” inappropriately included the accounts receivable documents, and that reference to the accounts receivable documents has now been removed.

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