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LEAN Update

Summary of HUD’s New LEAN 232 Regulations, September 7, 2012

Friday, September 07, 2012

On September 7, 2012, the Federal Housing Administration (FHA) published new regulations for the Section 232 Healthcare Facility Insurance Program in the Federal Register. FHA had previously proposed new regulations and loan documents on May 3, 2012, solicited comments from the industry, and even hosted a town hall discussion of the proposed regulations on May 31, 2012 at HUD Headquarters. It was apparent to all who participated that further deliberations would be required prior to release. The revised regulations illustrate how seriously HUD took those deliberations. Many of the most objectionable provisions have been removed, and HUD made many wise modifications. HUD went to considerable length discussing the comments and explaining their rationale in the Federal Register. Below are highlights of the new regulations, summarizing how some of the changes will affect borrowers, operators and mortgagees.

Six Months Before Some of the New Regulations Become Effective

Section 232.1(b) states that many of the new requirements will come into effect only for facilities that receive firm commitments issued on or after April 9, 2013. This summary notes if a new regulation becomes applicable immediately.

Operators Must Now Submit Quarterly Certified Financial Statements (Applicable Immediately)

HUD amended 24 CFR 5.801 to include operators of nursing homes as entities that must submit financial reports. While owners are still required to submit annual audited financial statements, HUD does not believe that it has a strong enough grasp of the financial strength of the facilities in the 232 portfolio; therefore, operators are now required to submit quarterly and annual operator-certified financial statements. For owner-operated facilities, the annual statement must still be an audited financial report.

This requirement is applicable immediately and applies to all 232 facilities, not just those receiving new commitments but those that are also currently FHA-insured.

The regulations do not address managers and therefore it is unclear for facilities with managers whether the manager must submit a manager-certified quarterly statement or whether the owner must submit quarterly statements or whether only annual audited financial statements must be submitted. We anticipate that HUD will release additional information on this topic when the long-awaited LEAN Handbook is released.

Facilities Subject to Routine Inspections Need Not Also Endure REAC Inspections (Applicable Immediately)

HUD has determined that facilities that undergo “reliable and adequate” physical inspections pursuant to state or local government licensing requirements may be exempted from REAC inspections so long as the results are readily and timely available to HUD. It is not clear now if HUD will release a list of states/localities whose physical inspections are deemed “reliable and adequate,” but it is believed some sort of determination must be made soon for this new regulation to be helpful to health care facilities.

New Timing for Defaults on 232 Mortgages

The date of default is no longer based on the initial date of a borrower’s regulatory or monetary default. The default date is now tied to the date the borrower fails to make a payment after the lender has accelerated the debt due to a regulatory or monetary default. For example, if a borrower has a regulatory default on August 1, but the lender does not accelerate the debt until November 1, and the borrower fails to make the payment required on November 1, the date of default is November 1 and does not track back to the August 1 regulatory default.

Additionally, when a lender becomes eligible to receive mortgage insurance benefits because of a borrower default, the lender must, within calendar 45 days, notify HUD of its intention to file an insurance claim. HUD within 90 calendar days shall acknowledge and accept, or reject for cause, or extend for an additional 90-day period its review of the insurance claim. HUD has extended the time period involved in the claim process to provide itself more time to review and potentially work out claims.

Please remember that HUD also proposed new regulations on July 9, 2012, to permit partial prepayment claims for 232 LEAN deals, as is permitted for MAP deals. This proposal has garnered wide support from the industry and we anticipate the proposed regulation will become final this fall.

Revised Definition of Eligible Borrower

An Eligible Borrower is now defined as a single-asset entity that possesses the powers necessary to own the project. HUD has permitted some leeway by allowing the commissioner to approve a non-single-asset entity under such terms and conditions HUD deems acceptable. The Federal Register provided no hints as to what “terms and conditions” non-single-asset entities may be accepted, but we anticipate it will only be permitted in those rare instances when a portfolio of FHA-insured facilities are owned by a single entity and all of the facilities that entity owns will be FHA-insured.

Long-Term Debt Service Reserve Only Required When Deemed Necessary

The proposed regulations required a long-term debt service reserve for all insured mortgages. The industry’s uproar over the requirement was heard, and in the final version HUD changed the regulation. The final regulation appropriately grants HUD the ability to require a reserve when there is an atypical long-term risk, such as an unusually high mortgage amount or if a master lease, typically used in a portfolio transaction, is unavailable. Reassuringly, HUD wrote in the comment section that “HUD anticipates that requiring a long-term debt service reserve will be the exception and not the norm.”

If required, the long-term debt reserve may be financed as part of the initial mortgage amount.

Project Funds May Be Removed Only So Long as There Is Positive Surplus Cash

HUD removed the proposed requirement that operators maintain positive working capital at all times. The final rule requires that in order for the borrower, operator and/or manager to take a distribution, there must be surplus cash.

The final regulations removed the unworkable blanket prohibition on principals receiving project funds without HUD approval. Principals who work at an insured facility are now still allowed to receive a salary without HUD approval.

New Operator Requirements and Definitions

The old regulations included no requirements for operators. HUD has now created an entire subsection to address the reality that many 232 facilities are run by operators some of whom are not related to the owner.

Eligible Operators

An operator must now be a single-asset entity, which possess the powers necessary to operate the facility. After hearing the industry’s concerns regarding this requirement, HUD left the door open for the commissioner to approve non-single-asset entities, and made it clear that a master tenant under a master lease is not deemed to be an operator. We do not anticipate it will be difficult to convince HUD to approve non-single-asset operators, as HUD clearly wants experienced operators and many of those entities operate multiple facilities.

Treatment of Project Operating Accounts

The proposed regulations required the operator to segregate its accounts, in order to isolate the funds from one facility from those of another facility. Thankfully, HUD realized that in today’s age of computerized accounting software, it is very easy for an operator to be able to identify funds that belong to a particular facility while those funds are “comingled” with funds from other facilities. The final regulation permits funds to be comingled so long as they can be identified as belonging to a particular facility, and requires the funds from an FHA-insured facility to be deposited in a federally insured institution.

Operating Expenses (Applicable Immediately)

The regulatory agreements have long required goods and services to be purchased at reasonable prices and to be necessary for the operation and maintenance of the project. The requirements are now incorporated not only in the regulatory agreements but in the final regulations themselves.

Management Agents

HUD must approve in writing all management agreements, management agents and any material changes to the management agreement. While this is in line with current practice, the initial proposed regulation required HUD’s approval for any changes to the management agreement, HUD compromised by only requiring approval of material changes in the final regulations.

Prompt Notification to HUD and Mortgagee of Circumstances Placing Collateral at Risk

The regulations require that the operator (or owner of owner-operated facilities) notify HUD and the mortgagee of failure to comply with governmental requirements or other events that might put the license at risk. Examples of such events are provided in the regulations. Notification of the risks must be provided to HUD within two business days of receipt by the owner and/or operator.

This new regulation is applicable to all operators, effective as of October 9, 2012.

New Loan Documents

The new LEAN loan documents were not released with the final regulations. Our sources have told us that HUD is targeting release of the loan documents for comment in October. Let’s all hope we avoid the debacle of the constantly shifting MAP loan documents.

Christine Waldmann Carmody and Blair L. Schiff

Written by

Christine Waldmann Carmody
Phone: 202.220.1231
Fax: 202.220.1665
waldmannc@pepperlaw.com

Blair L. Schiff
Phone: 202.220.1223
Fax: 202.220.1665
schiffb@pepperlaw.com


The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.

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