Due Diligence Pays Off for Borrowers, their Projects, and Investors

Even with stringent procedures in place, private lenders can sometimes run into unforeseen challenges when funding projects. Unlike how banks often seem, Enact Partners actually wants to fund borrower projects. Borrower success is how we grow, which means we work hard and creatively to support borrower needs. When borrowers win, Enact Partners wins, and our investors win.

Due Diligence Pays Off for Borrowers, their Projects, and Investors

That said, not all projects or borrowers are created equal. To protect against “bad loans,” Enact Partners uses a thorough checklist of qualities we look for in borrowers, their projects, and the overall situation. This includes items such as appraisals, property inspections, background checks, credit reports, and anything else thought necessary to mitigate risk. Through meticulous due diligence, our goal is to ensure loan repayment, which typically depends on projects being successful and/or borrowers putting up enough collateral to mitigate risk.

But what happens if a borrower does not fully disclose all pertinent facts while securing a loan?

Let’s explore a cautionary tale that underscores the importance of private lenders dedicating the time necessary to properly evaluate borrowers—even those known to them or other parties involved in the deal.

The Temptation of Trust

Several years ago, Enact Partners encountered a seemingly straightforward lending opportunity: a $4 million first-position note on a property with a 20% loan-to-value ratio. The note came from a trusted private lender with a history of successful dealings with other private lenders. In addition, the borrower had a concrete exit strategy backed by a signed purchase and sale agreement with a third-party buyer. On paper, at first glance, it looked like a sure thing.

Deviating from Protocol

Given so much positive history with the borrower and involved parties, we deviated from our standard protocol “just this once” by relying on a stale credit check provided by the note seller in lieu of doing our own background work. This would prove to be a move we would come to regret later, as it allowed fraudulent past legal entanglements to slip through.

Unraveling the Deception

Initially, the project proceeded smoothly and as expected. However, as the maturity date approached, startling revelations surfaced. The borrower, in need of more time to sell the property, presented a preliminary title report disclosing a substantial senior lien on it—something that was conveniently omitted during our note purchase.

Fraudulent Tactics Unveiled

What followed were a series of fraudulent maneuvers by the borrower:

  • Selling the Property—The borrower planned to sell the property to pay off the senior lien, leaving nothing to settle our loan. Legal action was taken to prevent this.
  • Self-Foreclosure—Our discovery that the borrower was “involved” (from a business sense) with the senior lending entity seeking to foreclose on the property added new layers of complexity. A temporary restraining order was secured to halt this highly irregular (to say the least) “self-foreclosure” attempt.
  • Mediation Threats—Faced with roadblocks to selling and foreclosing on the property, the borrower proposed mediation, demanding a $150,000 reduction in our loan payoff. This prompted a strategic settlement negotiation with the title company.

Settlement and Lessons Learned

Ultimately, a three-way settlement was reached. The title company paid the borrower; the borrower released all claims; and we received full repayment of the loan.

From this ordeal, valuable lessons emerged:

  • Know Your Borrower—Relying solely on a note seller’s endorsement can be a pitfall. No matter what, even if you think you know the borrower, conduct thorough background checks and seek references from past lenders. A lot can change in a short period of time.
  • Proforma Title Policy Scrutiny—Scrutinize proforma title policies, redline exceptions, and ensure alignment with escrow instructions. Review the final policy for discrepancies.
  • Timely Receipt of Final Title Policy—Confirm receipt of the final policy and promptly review it to ensure consistency with preliminary reports and escrow instructions.
  • Engage Legal Counsel—If title issues arise, engage legal counsel early on. Insurance companies may be vital allies, but don’t shy away from seeking independent legal support.

A Cautionary Tale

The world of lending is fraught with hidden risks, and due diligence is a lender’s greatest shield against them. While private lenders welcome the opportunity to operate in an environment with a lot less red tape than banks, this cautionary tale underscores the importance of thorough evaluation, adherence to due diligence procedures, and unwavering vigilance. In the face of temptation, lenders can never deviate from established protocols and best practices—their success and borrower success depends on it.

Despite funding complicated projects that other lenders consider too risky, such as land, development, construction, and commercial ventures, our track record speaks volumes:

  • Enact Partners has only foreclosed one property since its founding more than 10 years ago, reflecting thorough due diligence and careful risk assessment when making lending decisions.
  • Investor return goals have been met consistently, year-after-year, since our inception.
  • No investor has ever lost money with Enact Partners.

Contact Us About Your Borrowing or Investing Needs

(760) 516-7776 | [email protected] | www.enactpartners.com

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