Often when a business has fallen on hard times and is struggling to comply with its obligations under a business loan, a borrower might think that the lender is out there just waiting for an excuse to declare a default on the loan and to start collecting its collateral. Well this is often not the case.
In fact, on most occasions in these instances, the lender wants the borrower to succeed on its loan just as much as the borrower does and the last thing it wants to do is to start exercising its collections remedies on the loan based on the borrower’s default.
So in these instances, it’s good for the borrower and the lender to get together to figure out a way for the borrower to get through some temporary difficult times through the aid of some concessions by the lender and commitments by the borrower. When the borrower and lender are agreeable to doing this, they typically enter into what’s called a “Forbearance Agreement.”
In today’s edition of Three Things, I’m going to discuss what a Forbearance Agreement is, the terms that they typically include, and a few important things that should be considered by a borrower and a lender when negotiating a Forbearance Agreement.
1. First, what is a “Forbearance Agreement”?
A ‘forbearance agreement’ is generally an agreement in which a lender agrees to not to take any action or to “forbear” from exercising its rights under loan agreement based on a borrower’s default for a specified period of time, provided the borrower makes certain commitments and agrees to take certain actions to address the concerns of the lender about the business loan.
Note that a Forbearance Agreement can also be done in settings other than a borrower/lender relationship. For example, lessors and tenants can also enter into a Forbearance Agreement to address the same issue i.e. the tenants need for some temporary relief from the obligations of its lease agreement.
2. What clauses do “Forbearance Agreements” typically include?
- An affirmation of the loan debt and security;
- A waiver by the borrower of all claims the borrower may have against the lender and a waiver of defenses it may have to any claims of the lender;
- Acknowledgment of an existing default by the borrower;
- Pledging or surrender of additional collateral by the borrower;
- The suspension or reduction of payments required under the loan for a set period of time;
- Clear statements as to what the lender is going to “forbear” from doing;
- The term during which the obligations of the Forbearance Agreement apply;
- Clear statements identifying the events of a default; and
- A statement as to the lender’s remedies in the event of a default.
3. Important subjects to consider in negotiating a Forbearance Agreement:
FOR A BORROWER:
A. Is it worth it? One of the things borrower should consider when entering into
a Forbearance Agreement is whether the lender is getting more value from the borrower under the Forbearance Agreement than what the borrower is giving up.
For example,
* If a lender says it will suspend payments for a month or two, but in exchange for this, it wants the borrower to pledge substantial amounts of additional collateral to the lender, the borrower may not be getting much value in exchange for what it is giving up.
or
* If lender is asking the borrower to waive a claim that it may have against the lender and the borrower believes it is a good and substantial claim, then the borrower may want to consider whether the value it is getting from the proposed Forbearance Agreement is really worth waiving this claim against the lender.
B. What will the lender “forbear” from doing. The borrower should make sure
that the Forbearance Agreement is clear as to what the lender agrees to “forbear” from doing in exchange for the borrower’s commitments under the Forbearance Agreement.
For example, is the lender just agreeing to “forbear” charging default interest or late fees on certain past due payments? Or is it agreeing to “forbear” recording a Notice of Default on a Deed of Trust or otherwise foreclosing on the borrower’s assets for a certain period of time?)
If a borrower does not want the lender to commence any foreclosure action during the term referenced in the Forbearance Agreement, then it should insist that the Forbearance Agreement is clear on this point.
FOR LENDERS:
A. Thorough acknowledgment of debt status. If you’re a lender, one of the most important things you’ll want to do is to make sure the borrower stipulates in the Forbearance Agreement as to the validity of the loans, the loan terms, the loan amounts and the lender’s security interests in the borrower’s property. A lender is not going to want to allow the borrower to suspend or reduce loan payments or to take advantage of some other concessions made by the lender, if the borrower can later dispute the validity of the loan or the lender’s security interests.
B. Don’t forget the guarantors. It’s also a good practice for Lender’s to have all guarantors of the loan obligations sign off on the Forbearance Agreement, especially if the lender wants the guarantors to waive or release any claims the guarantors may have against the lender.
Understand the Bankruptcy case law in the applicable jurisdiction. I would also caution lenders to make sure they understand the bankruptcy laws in the state where the borrower may file for bankruptcy after entering into the Forbearance Agreement. Bankruptcy Courts in different jurisdictions have different rules as to the applicability of the terms in a Forbearance Agreement in bankruptcy. For example, some Forbearance Agreements provide that the borrower waives any protections of the automatic stay in the event it later files for bankruptcy. In some jurisdictions under some circumstances, these waivers have been held to be enforceable in the borrower’s subsequent bankruptcy case. In other jurisdictions, they are not.
Standard terms. The Forbearance Agreement should also include the standard terms that are often used in loan agreements. Some of these standard terms are especially important in the context of a Forbearance Agreement. I will address these in a later publication.
Like any agreements, Forbearance Agreements can be beneficial to both parties to the Agreement. However, if either party is not careful in negotiating the agreement, it may suffer some pretty significant adverse consequences.
We provide legal services with regard to Forbearance Agreements here at Patino King, so if you have any questions, please contact us.