- Deposit account control agreements (DACAs) minimize funding risks, but what exactly are they?
- These tri-party agreements give lenders more control, providing protection from borrower default.
- Here's a closer look at how DACAs work and why they might benefit you.
Deposit account control agreements: While this uncommon term may not ring a bell, it's useful to know — especially for those working in commercial real estate or alternative investments.
These agreements are established when a borrower secures a loan from a third party, and helps lenders keep a degree of control and minimize their risk in a transaction. Understanding the finer points of a deposit account control agreement (DACA) is important for both the lender and the borrower.
Here, we’ll detail the definition of DACAs, the situations in which they’re useful and the roles all parties play. We’ll also cover why the right banking partner is essential in establishing a strong DACA.
A DACA can be complicated, so it's important to first understand its definition in detail.
Deposit account control agreements are tri-party agreements among a lender, a borrower and a bank. These are often referred to in other, sometimes more familiar terms, such as '"lockbox agreements," "control agreements," "account control agreements" or "ACAs." (They are not, however, “escrow agreements.”)
In a DACA, a borrower grants a lender a security interest in their specific account with a bank. This enables a lender to have overarching control over the distribution of funds for their loan, and provides some protection for the lender, in case of borrower default. The lender has the ability to control the flow of funds from the account to the borrower, freeze them if necessary, and to give their own instructions.
Depending on the terms of the DACA, the borrower may or may not have direct access to the funds in the account. In "non-invoked" or “springing” DACAs, borrowers may access the funds; in "invoked" or “blocked” DACAs, borrowers may not. However, it's important to note that a lender may change these terms — by either "invoking" or "uninvoking" — at their discretion, as many times as they choose to. It's possible to include multiple accounts within one DACA, but they all must have the same status of invoked or non-invoked.
It's also important to note that DACAs don't have an inherent time limit and don't require renewal.
Because DACAs are highly specific, they’re not right for — or relevant to — every borrower and lender.
Most commonly, DACAs are established in commercial real estate transactions, alternative investments and energy development. Partners often include hedge funds, private equity firms, technology startups and venture capitalists. This list is, of course, non-exhaustive, but it should paint a strong picture of their utility.
A private equity firm (lender) lends $30 million to a commercial real estate developer (borrower), who will use the funds to develop a new, luxury hotel on a vacated lot. The lender establishes a DACA at the borrower’s business bank, then funds the loan. The borrower has the full $30 million loan, but the DACA grants the lender a degree of control over how and when the funds are distributed.
Initially, the lender provides access to $20 million to make the immediate purchase of the real estate. The borrower may use these funds as outlined in the loan agreement. The lender then holds the remaining $10 million for soft costs in the controlled account — but the borrower doesn’t have access to this money until the lender begins receiving mortgage payments. Once the mortgage begins flowing to the lender, the lender releases the $10 million on an approved schedule.
However, let’s say the borrower is not able to begin mortgage repayments. With the DACA, the lender decides not to release the last $5 million, and the money, instead, goes back to the lender. This helps provide the lender a degree of protection from borrower default.
Alternatively, the lender might release the loan funds to the borrower, but require as a condition of the loan that all hotel revenue flows through the controlled DACA account. The lender monitors income, and if the borrower is not able to begin mortgage repayments, the lender might redirect some or all of the revenue to the mortgage payments.
DACAs provide benefits to the lender who leverages them. Essentially, DACAs provide protection from borrower default, enabling them to help minimize their risk on a loan — if something goes wrong, lenders can invoke their right to start collecting.
Parties want to have that third-party involvement, so that they know that the agreement is being held to the agreed-upon terms.
DACAs are also surprisingly flexible. Working with a bank, lenders can establish distribution schedules that best suit them — for instance, allowing weekly borrower disbursements, or even disallowing any borrower withdrawals without authorization.
For transactions that require a DACA, a strong banking partner is essential.
First, working with a trustworthy bank is paramount. The right banking partner will be willing to work with parties to ensure that the agreement terms suit the situation. Once the specific terms of a DACA are established, a bank partner must adhere to all points set forth in the agreement. It’s critical to have a partner who will understand — and follow — all of the nuances of a specific DACA, especially since DACAs are designed for specific transactions.
Additionally, for time-sensitive transactions, the right banking partner is crucial. A strong banking partner can move fast to execute on the DACA among all parties. Service-level agreements (SLAs) from banks, which are needed to secure DACAs, can range from days to weeks. Working with a bank that understands time sensitivity and will strive to work within your constraints is key to making sure transactions run smoothly.