Termination due to LTV breach: do negotiations pay off?

Why should I read this?

The situation in the real estate finance market has noticeably intensified in recent years: Although there are some signs of hope, the volume of distressed real estate loans (including explicit non-performing loans) in Germany has increased by over 40% since 2022. At the same time, commercial real estate loans worth more than €300 billion are set to mature across Europe by 2026. In addition, many properties have been devalued, not only due to a lack of ESG compliance but primarily because of increased capital costs. The consequences are significant: borrowers are increasingly unable to comply with the agreed Loan-to-Value ratios (LTVs), i.e., the ratio of the outstanding loan amount to the value of the financed property or properties. In such cases, are lenders entitled to terminate the loan agreement? 

A possible termination by the lender requires a legal basis, which may arise either from statutory law or from the contractual agreements.

What else do I need to know?

1. Statutory Grounds for Termination

According to statutory law (Sec. 490 German Civil Code), a loan agreement may only be extraordinarily terminated by the lender if the financial situation of the borrower or the value of collateral has deteriorated significantly, or such deterioration is imminent, and as a result, repayment of the loan is at risk. The statutory requirements are intentionally set high and require a comprehensive assessment of the individual case. A deterioration is deemed to exist if the economic parameters relating to the borrower or the financed property have objectively and significantly worsened compared to the time of contract conclusion. A one-off breach of a single financial covenant (such as the LTV) would generally not be sufficient to establish a statutory right of termination.

2. Contractual Grounds for Termination: Events of Default

However, loan agreements typically contain a catalogue of events of default that go beyond statutory law. These include breaches of financial covenants such as the LTV. According to the LMA standard, a breach of a financial covenant expressly constitutes an event of default and thus a ground for termination. An LTV breach — unless a cure right, such as an “equity cure,” has been agreed — is not remediable and may entitle the lender to immediate termination. The borrower is therefore in a weak position if the lender wishes to enforce the security over the charged property.

Some may still hope that the right of termination for a one-off LTV breach (as provided for in the LMA standard) could be challenged under the German rules of general terms and conditions (AGB) as an unreasonable disadvantage and thus be invalid. However, it must be assumed that the agreement of financial covenants and the associated termination right do not constitute general terms and conditions. Financial covenants are typically discussed and negotiated extensively prior to contract conclusion. As a result, they generally do not qualify as general terms and condition, and the question of unreasonable disadvantage to the borrower does not arise.

3. Limitations on the Right of Termination in Individual Cases

Only in exceptional cases is the lender restricted in exercising its right of termination. This is the case if termination would violate the principle of good faith (Treu und Glauben), for example in the following situations:

• Inconsistent conduct: If the lender has expressly permitted or tacitly tolerated previous covenant breaches, a subsequent termination may be deemed to be in bad faith.
• Disproportionality: Termination may be inadmissible if it would severely harm the borrower without causing any disadvantage to the lender — for example, if the collateral remains valuable. However, the fact that termination of a highly leveraged acquisition loan regularly results in the borrower’s financial collapse does not, as such, render termination unlawful.
• Awareness of circumstances: Grounds for termination that were already known to the lender at the time of contract conclusion may not be subsequently invoked as a basis for termination.

4. Negotiation Pays Off

Especially in the current market environment, borrowers should pay particular attention to the contractual provisions governing the lender’s right of termination. It is advisable to agree on clearly defined limitations during contract negotiations such as equity cure rights or so-called “Mulligan clauses.”

The latter grant the borrower a kind of “second chance”: an initial breach of a specific financial covenant - such as the LTV — does not immediately trigger a right of termination but is “ignored” for a limited period or under certain conditions. Such a clause can help cushion short-term fluctuations without immediately jeopardizing the lending relationship.

We are happy to support you in negotiating and drafting your loan agreements.