• Forbearance Agreements: Preserving Legal Rights While Maintaining Customer Relationships
  • September 9, 2013 | Author: David Brown
  • Law Firm: Weltman, Weinberg & Reis Co., L.P.A. - Cleveland Office
  • Unfortunately, even the most careful and thorough lenders encounter default situations from time to time. The appropriate response is heavily dependent upon the factual background of the particular loan at issue. Loan modifications, repayment plans and legal action may all be appropriate responses. If the offending loan is secured by real estate or other collateral, though, a forbearance agreement should be considered. After all, forbearance agreements often allow lenders to solidify their position while also maintaining or even strengthening their relationship with the client.

    Forbearance agreements are typically used in situations where a borrower has committed a payment default. In these instances, lenders may find that it is more costly for them to foreclose on the collateral securing the loan, than to forego execution for a limited period of time. Under a forbearance agreement, the lender agrees to refrain from exercising its rights and remedies for a short period of time in exchange for an agreement from the borrower to undertake certain actions.1 The borrower may agree to list real estate or valuable equipment for sale, find alternative financing, or otherwise cure the default prior to the termination of the agreement. Whatever the agreement entails, the following provisions should always be included.

    Recitals
    The recitals offer the lender an opportunity to summarize each of the previous transactions between the lender and the borrower. The recitals should: (1) Identify all obligors (borrowers, guarantors, pledgers of collateral); (2) Identify loan documents and security documents; (3) Describe existing collateral; (4) List judgments and any material litigation; (5) List and describe defaults; and (6) Detail the amount of bank debt, including fees and professional fees.2 It is important that each of the recitals be described with as much detail and accuracy as possible. Names should include the full legal name of any obligors, as well as any known trade names, d/b/a’s, f/k/a’s, etc. Also, the collateral should be described as accurately as possible by using addresses, permanent parcel numbers, legal descriptions, VIN numbers and any other available means of identification.

    Affirmation/Reaffirmation
    After the recitals, it is a good idea to affirm the accuracy of the recitals, and to reaffirm each of the borrowers’ obligations under the original loan documents. Additionally, the lender should seek acknowledgments that the borrower does not have any claims or defenses as to the original loan documents or the current default event.

    Forbearance Period
    Obviously, any forbearance agreement needs to accurately and clearly describe the forbearance or “standstill” period.3 This provision can also be thought of as the forbearance agreement’s termination date. The forbearance period usually lasts one year, or less. This provision may provide for an automatic extension upon the occurrence of a particular event, such as an executed commitment letter or asset purchase agreement.4

    Fix Deficiencies
    If a deficiency exists in the original loan or collateral, provisions should be included for new or additional documents to be executed or collateral to be pledged. When a “collateral fix” is included, the termination date should be at least 90 days out to protect the lender from preference claims.5

    Interest Rates
    Forbearance agreements provide a good opportunity to increase interest rates. Most notes authorize the implementation of default interest rates. Forbearance agreements give the lender the opportunity to accommodate the borrower by increasing the interest rate, but to a rate lower than the default rate under the original note.6 The agreement should make clear that a breach of the forbearance agreement will result in the application of the original default rate.

    Waiver of Defenses, Release
    Understandably, a lender does not want to be in a position where it forbears from exercising and enforcing its rights only to be sued at a later date by the borrower. With this in mind, lenders should push for as broad of a release as they can get. The release should cover any and all claims that could be made by the borrower against the lender whether arising out of the loan relationship or otherwise.7 The lender will also want the borrower to state clearly that it has no defenses and waives and releases every defense it may have against the lender as well as an agreement not to sue the lender.8

    Indemnity
    The purpose of an indemnification provision is to protect the lender from incurring any additional expense in connection with the obligations for which the borrower is liable but could otherwise argue are not “indebtedness” as they are outside the definition of indebtedness under the loan documents.9 The indemnity should include language stating that it survives repayment of the indebtedness.

    Forum Selection/Choice of Law
    Forum selection and choice of law clauses are especially important when the lender and the borrower are in different jurisdictions. These clauses allow the parties to dictate the location of any resulting lawsuits, as well as the body of law that will apply to resolve all disputes. Typically, the lender will want to select the forum and law where it resides.

    Jury Trial Waiver
    Forbearance agreements should reaffirm jury trial waivers that are in existing loan documents or restate the waiver entirely.

    Events of Default
    The agreement should specify what events will be defaults under the forbearance agreement. The effect of a forbearance default will be a termination of the lender’s obligation to forbear, and the renewed right to enforce its rights and remedies immediately. Some defaults result in automatic termination without notice. These may include bankruptcy, a suit by any obligor against the lender, an indictment and death.10

    Liquidation Remedies
    The agreement can specify that the borrower consents to the appointment of a receiver or agrees to surrender collateral or hold a voluntary auction of assets by specified dates, and most certainly in the instance of a forbearance default.11

    Bankruptcy Considerations
    Some lenders have had success using forbearance agreements to combat preference actions in bankruptcy and to waive the automatic stay. Using a forbearance agreement to add security interests or to properly perfect previously granted security interests can permit the ninety-day preference period to run prior to a potential bankruptcy by giving the borrower options during the forbearance period other than an immediate bankruptcy filing.12 Even if the borrower seeks bankruptcy protection during the ninety-day preference window, the lender’s forbearance from exercising its rights immediately may be a concurrent exchange for new value that prevents the bankruptcy trustee from avoiding the preferential security interest or late perfection.13 Additionally, courts have enforced waivers of the automatic stay to permit lenders to foreclose on collateral.14

    In the current economic environment, forbearance agreements can often be beneficial to both borrowers and lenders. The borrower is given additional time to restructure its business, refinance or undertake an alternative exit strategy that will allow it to satisfy its obligations to the lender. The lender, on the other hand, can avoid the time and expense of a foreclosure, while obtaining additional fee and interest income, curing deficiencies and preserving its rights upon default.

    1 Jordan S. Solomon, Negotiating Forbearance Agreements, April 7, 2009, http://www.gibbonslaw.com/news-publications/articles.php?action=display-publication&publication-id=2733
    2 Beverly Weiss Manne and Michael A. Shiner, Restructuring Options: The Forbearance Agreement, August 26, 2008, http://www.turnaround.org/Publications/Articles.aspx?objectId=9651
    3 Id.
    4 Id.
    5 Id.
    6 Id.
    7 See Negotiating Forbearance Agreements, supra.
    8 Id.
    9 See Restructuring Options, supra.
    10 Id.
    11 Id.
    12 Penny R. Heaberlin, Forbearance Agreements can Improve Outcomes for Problem Real Estate Loans, Real Estate Finance, Vol. 25, No. 5, Feb. 2009, http://www.maslon.com/CM/FirmPubs/REF-0209-Heaberlin.pdf
    13 Id.
    14 Id.