CASE, a commercial real estate investment and advisory firm specializing in distressed and structured-finance situations, today released “The Game Theory of Loan Workouts,” a white paper by Managing Partner Shlomo Chopp. Chopp illustrates, with real world examples, that a successful out-of-court restructuring turns on the lender’s decision to modify or enforce, and that the borrower influences that decision long before the parties negotiate the economics of a modification.
In Chopp’s day-to-day experience, a commercial real estate workout is a sequence of interdependent decisions, in which each party acts on what it expects the other side to do. A lender compares a borrower’s proposal with foreclosure, liquidation, or another enforcement outcome, and an abstract notion of fairness is not part of that comparison. Asking for better terms doesn’t answer it. The borrower must show why a negotiated resolution gives the lender a better risk-adjusted outcome than exercising its remedies, and why leaving the borrower in control remains credible.
Chopp applies concepts from game theory, including asymmetric bargaining, outside options, incomplete information, repeated games, credible commitments, backward induction, and wars of attrition, to the workout of a distressed commercial real estate loan. His central conclusion is that a borrower’s leverage in a workout often comes from preparation and information rather than posture. A borrower’s knowledge of the property, its tenants, its market, its operating needs, and its upside can give it an edge, and that edge erodes as the lender completes its own diligence and forms its own conclusions.
“A workout isn’t won when the lender finally agrees to a term sheet. By that point, much of the outcome is already decided,” said Chopp. “The lender has spent many months forming a view of the asset, the borrower, and what it can recover through enforcement. If you want a different outcome, you must learn early how the lender is making that decision and give it a credible reason to conclude that your proposal is its least-worst alternative. That takes much more than negotiating the number.”
Chopp takes on two common assumptions about loan workouts. The first is that a lender relationship or an aggressive negotiating posture creates enough leverage, and the second is that a financially attractive proposal should succeed on its economics alone. In Chopp’s view, neither accounts for how lenders make decisions. A lender must compare its recovery under a modification with its recovery through foreclosure. It must also judge whether the borrower can execute the proposed business plan, and whether its own asset manager can credibly support that recommendation through the lender’s approval process.
The lender judges the borrower’s ability to execute from conduct the borrower may consider routine. Diligence responses, consent requests, the handling of vendor payments and operating shortfalls, and even the timing and tone of communications can become evidence of whether the borrower can be trusted to perform under a modified loan. A borrower may see a missed deadline or an operating problem as only that, while to the lender it can reinforce the concern that leaving the borrower in control creates additional risk.
Out-of-court workouts can be more complex than they appear. Without the established legal process of a court-supervised restructuring, the borrower must influence a series of discretionary decisions by a lender that generally holds the stronger contractual position and a viable alternative in foreclosure. In the paper, Chopp describes how CASE works backward from the lender’s eventual decision to modify, foreclose, or sell the note, and determines what information, commitments, and economics each earlier stage will require.
CASE runs its workout advisory engagements from the same sequence. Rather than treat a workout primarily as a transaction to broker, the firm examines the property, the loan documents, the valuation assumptions, the operating issues, and the borrower’s exposures, coordinates with legal counsel, and helps the borrower build a plan that can withstand the lender’s scrutiny. Reaching an agreement is only part of the objective. The firm helps the borrower determine whether an agreement is economically sustainable in the first place, and in some situations walking away may be the better outcome.
In the paper, Chopp recommends that borrowers begin 60 to 90 days before default, while they still hold the information advantage and have more strategic options. This leaves time to assess the property and the loan, anticipate the lender’s concerns, and develop a documented plan before the lender’s assumptions become difficult to change.
“The Game Theory of Loan Workouts” is written for commercial real estate owners, lenders, investors, and advisers working through stressed and distressed loans who want to understand the incentives and decisions that determine whether an out-of-court restructuring succeeds.
The full paper is available at https://www.caseinv.com/media/game-theory-loan-workouts
About CASE
CASE is a commercial real estate advisory and investment firm focused on distressed situations. It restructures debt and limits downside risk for family offices, syndicates, private owners foreign institutions, and sovereign wealth funds. CASE has worked across banks, institutional and private lenders, investment funds, and CMBS special servicers, and it works at both the property level and the capital-stack level to negotiate and resolve distressed loans. The firm represents borrowers in situations they cannot handle alone, helping capable operators deal with loan terms and lender processes that are new to them. For more information, visit www.caseinv.com.
View source version on businesswire.com: https://www.businesswire.com/news/home/20261105390373/en/
Media gallery
