THE LENDER’S PERSPECTIVE ON FORBEARANCE AGREEMENTS
BY MICHAEL D. FIELDING
MICHAEL D. FIELDING
Partner, Husch Blackwell LLP
MICHAEL D. FIELDING IS A PARTNER IN THE KANSAS CITY OFFICE OF HUSCH BLACKWELL LLP. HE REPRESENTS LENDERS IN CONNECTION WITH TROUBLED LOANS.
Troubled loans are stressful for all parties involved, but a properly implemented forbearance agreement is a powerful tool for enabling lenders to make a successful exit with minimal loss. Michael Fielding examines how these agreements can create a win-win result for both parties.
No one — not even a lender — enjoys dealing with a troubled loan. It is stressful for the borrower, it leaves the lender wondering how much of the loan will be recovered, and it is almost always difficult to resolve. When faced with these situations, lenders frequently turn to forbearance agreements as a means of resolving the problem. Why do these agreements appeal to lenders? Can these agreements achieve a satisfactory outcome for both parties? This article explores the lender’s perspective in approaching forbearance agreements and provides some insight as to how these agreements can help both parties.
WHAT INDUCES A LENDER TO ENTER INTO A FORBEARANCE AGREEMENT?
A lender’s ultimate motive is no different from any other business — to maximize profit. This reality reveals a clear “North Star” that can be used to guide our thinking about troubled debt and the role forbearance agreements can play. To be certain, there are numerous — and often interrelated reasons — why lenders seek forbearance agreements, and these reasons are very much in accord with enhancing profitability. After all, certain kinds of forbearance — such as giving the borrower time to refinance its existing loan, sell itself as a going concern, restructure operations to become profitable or sell certain assets in an orderly liquidation — will almost always be less costly for a lender than pursuing judicial enforcement remedies for breaches of loan documents.
Nonperforming loans look bad on a lender’s books. By entering into a forbearance agreement which calls for some payments, lenders can avoid having to reclassify loans in their internal and regulatory reports. When the underlying loan documents contain errors, the forbearance agreement becomes an easy way to clean up and erase certain potential problems. Lenders also desire forbearance agreements because they clearly lay out what will happen in the future. Forbearance agreements offer lenders the opportunity to obtain additional collateral as security for their loans. Finally, forbearance agreements oftentimes can become a bridge over troubled waters for both parties. Specifically, lenders value long-standing business relationships. When borrowers encounter financial distress, a forbearance agreement can enable the borrower to buy time and get to higher ground such that the business relationship may continue.
WHAT IS COMMONLY INCLUDED IN A FORBEARANCE AGREEMENT?
Forbearance agreements generally have several common provisions. To begin, there are typically recitals explaining “how the parties got here,” including identification of the loan documents, the defaults that have occurred and the outstanding indebtedness owed. It is very common for lenders to require borrowers to concede or admit these basic points. Lenders also desire to get an acknowledgement of the enforceability of the loan documents.
The forbearance period will be clearly spelled out. The specific type of forbearance (including type and duration) will vary based upon the circumstances of each individual case. Typically, forbearance agreements will cover a number of months, but very rarely more than a year.
Forbearance agreements frequently require the borrower to take certain actions, such as making payments by certain dates, pledging additional property as new collateral, liquidating certain collateral, voluntarily surrendering collateral to be foreclosed upon, entering a non-opposition to foreclosure of certain pieces of collateral and restructuring the borrower’s operations (such as altering reporting requirements or appointing a chief-restructuring officer).
Well-drafted loan documents will be very clear with bright-line benchmarks. These will include clear default provisions and unambiguous remedies in the event of an uncured default. Remedies may include initiation of a lawsuit, a previously executed consent to judgment, the filing of a deed-in-lieu of foreclosure, or the set-off of any monies held in an account, among others.
Almost universally, forbearance agreements will contain a waiver of any claims that the borrower may have against the lender. Additionally, the borrower must agree to waive any defenses it could assert to the enforceability of the loan documents. Forbearance agreements will also contain a waiver of any jury trial right in the event of a default, and they will spell out where any disputes under the agreement must be litigated and what law will be deemed controlling.
Some borrowers may ask: “Why would I agree to provisions like these?” The answer, as one special assets officer once quipped, is “the price of a parachute goes up once you fall out of an airplane.” It is true that a forbearance agreement may feel a bit one-sided, but it gives the borrower a window of very precious time to right the ship, fix the problem and successfully exit the situation.
WHAT CHALLENGES EXIST FOR DOING A FORBEARANCE AGREEMENT?
While certain provisions in forbearance agreements are very common, each situation is always unique, and there is never a “one-size-fits-all” remedy. Is the loan syndicated? Is there a lead lender that must get approval from other lenders who have purchased the credit to enter into a forbearance agreement? Even when dealing with a single lender, it is not a foregone conclusion that it will agree to a forbearance agreement. Again, a lender’s ultimate objective is to maximize the profitability of its business. When forbearance agreements are consonant with the profit motive, then a lender will likely agree to it, but if traditional default remedies appear more profitable, the odds of entering into a forbearance agreement are significantly reduced.
Such calculations — even within the context of maximizing profits — are not just about numbers or short-term profit-making. Lenders want to see their borrowers thrive and continue to utilize a variety of banking services in the process. The key issue in play is one of trust. Every banking relationship depends on it, and while it rarely gets quantified on a spreadsheet, trust can be the determining factor when all other considerations are more or less equal.
Handshakes and holiday fruit baskets notwithstanding, what does trust look like in a banking relationship? First and foremost, trust is established and maintained by regular and accurate communication regarding the underlying business and financial performance, including timely submission of all required reports and other documentation. When borrowers go dark, it is only natural for lenders to think the worst. Human nature is to downplay mistakes or bad luck, and lenders know this all too well with respect to their borrowers. Nothing builds trust like clarity and transparency.
Given a borrower’s penchant for seeing the sunny side of every situation, the benefit of transparency within the lending relationship is that it is always helpful to have another set of eyes on the business — in this case, the objective gaze of a lender. While lenders are not business advisors, their unbiased and discerning perspective can help borrowers spot issues at an early stage. Just as a doctor’s chance of saving a patient is significantly greater for minor matters, a forbearance agreement will likely be successful for all parties if implemented when the debt challenge is small; however, left unattended, the troubled debt can eventually grow so burdensome that a forbearance agreement, no matter how skillfully drafted, will be of little use.
Properly implemented, a forbearance agreement is a powerful tool for enabling lenders to successfully exit a troubled loan with minimal loss. By knowing and understanding the dynamics that lenders face, a borrower can proactively work with its lender to ensure mutual cooperation and a win-win result for both parties.