A “Workout” Agreement can generally be defined as an agreement between a lender and borrower (and often third parties) which modifies original loan obligations when the borrower is either about to default or already has defaulted on the loan. While there’s a lot you should know about Workout Agreements if you are a lender or borrower that is dealing with a distressed loan, the following are three things you should know about Workout Agreements.
“Workout Agreement” v. “Forbearance Agreement”
You may have heard of the terms “Workout Agreement” and “Forbearance Agreement”, and you may have wondered what the difference is.
Well, they’re kind of the same in that they both concern an agreement between a lender and a borrower to modify the application of certain loan terms to avoid a foreclosure by the lender due to the borrower’s default on a loan.
The main difference between the two terms is that a Workout Agreement modifies the terms of the loan permanently, while a Forbearance Agreement modifies the application of certain loan terms for a specific and relatively brief period of time.
A “Forbearance Agreement” is best suited for a situation in which the borrower is going to experience difficulties in complying with terms of a loan (most often payment terms) due to unforeseen problems which are expected to be temporary.
A “Workout Agreement”, on the other hand is designed for situations in which the borrower’s problems in complying with the terms of a loan are not based on circumstances which are expected to change soon, but rather are based on an assessment of the borrower’s ability to comply with the loan terms over the loan term or an extended period of time.
Pre-Workout Agreements
It used to be that if a Borrower’s loan was very substantial and complicated, then a Lender would require the Borrower to sign a “Pre-Workout” or “Pre-Negotiation” agreement before engaging in any discussions about how the orginal loan could be modified and related issue. Generally, the purpose of a Pre-Workout Agreement is to eliminate the possibility that workout discussions could be used against either party in subsequent litigation.
These days, Pre-Workout Agreements are becoming more common even for smaller loans as they allow the Lender and Borrower to communicate more freely, and both parties benefit from the protection provided by these agreements.
Most Pre-Workout Agreements include the following provisions:
- A reservation of rights by the Lender and the Borrower;
- An agreement that nothing is binding on the parties until a final Workout Agreement is prepared and signed by the parties, and
- That any party may terminate the discussions at any time without liability to the others.
Some Lenders may require the Borrower to confirm the debt amount, the loan documents and that the Borrower has no claims or defenses against the Lender.
As a general matter, Pre-Workout Agreements are very helpful in that they facilitate meaningful discussions between the parties about how to resolve loan problems. Both parties should be sure, however, that this benefit is not outweighed by other commitments which a party is being asked to make in the agreement.
Be Prepared!
The old Boy Scout motto to “be prepared” is very important for the parties to successfully complete a Workout Agreement. Typically, there is a limited amount of time for the parties to complete a Workout Agreement because the Borrower is facing difficult financial circumstances and is about to default on a loan or already has defaulted. So there is very little time to waste in trying to put together the terms of a Workout Agreement.
Both Lenders and Borrowers both need to closely review the loan documents to understand their rights and obligations with respect to the loan at issue.
To the extent not already provided, the Borrower should be prepared to provide the Lender any financial records the Lender may require to obtain a comprehensive understanding of the Borrower’s financial circumstances. If errors have been made in previous financial reports provided to the Lender, they should be corrected.
The Lender should immediately review the collateral which secures the loan and assess the value of the collateral and any potential problems with the collateral which may impact its value.
Both parties also need to assess what may be needed from third parties including guarantors or other lien-holders in order to successfully complete a Workout Agreement.
These are just examples of information that is needed for Borrowers and Lenders to intelligently negotiate a Workout Agreement to insure that their interests will be protected as much as possible. If the Borrower and Lender have obtained this and all other necessary information, they will “be prepared” to negotiate a Workout Agreement efficiently and effectively.
Hope you found this helpful. If you have any questions about Workout Agreements, please feel free to contact me at Patino King, L.L.C.