Best Ways to Extend Business Loan Repayment Terms

The ongoing pandemic means tough economic times are continuing for many commercial borrowers, and lenders know they’re a long way from back to normal. Plenty of borrowers already have been on the phone with their bank over payments they can’t make or may not be able to make in coming months. Some ask for time to make smaller payments or put off principal amounts for a while, some for interest-only periods during which they could try to get back on firmer footing, some to modify lending formulas and covenants, and some simply to have defaults waived.

Today’s lenders usually meet these issues with two kinds of agreements, which they call loan modification or loan forbearance contracts. Knowing how these are set up and written - and understanding the fine print - is vital to either side when looking for the right kind of arrangement.

In the Typical Loan Modification

A loan modification permanently changes one or more of the terms of an existing loan at risk of default so it performs again. It can also give short-term relief like deferring payments, altering the amortization term, or temporarily changing financial covenants. If agreed to, it treats any earlier defaults as if they never happened, and undoes any acceleration if the lender already accelerated. Most borrowers will much prefer a loan modification to a forbearance.

In the typical loan modification, borrowers usually ask for one or more of the following:

• Borrowers may ask to defer some or all of the interest and principal payments, or to reduce them.
• Borrowers may ask to extend the terms of their loans, take smaller amortization payments, or pay interest only for a time. An interest-only period means that all of the borrower’s monthly payments go to interest, not to principal.
• Borrowers sometimes ask the lender to lower the interest rates.
• Waiving whatever prepayment penalty or make-whole penalty the lender includes if they refinance the loan.
• A typical modification contract changes one or more of the covenants.
• On construction loans, borrowers may request a bigger reserve funded from loan proceeds, and more time to finish the project. They may also want a force majeure clause: the loan agreement excuses the borrower from some of the loan’s obligations if pandemics, shutdown orders or similar government actions caused its economic nonperformance.
• Lender allows additional equity investors or permits the borrower to get additional financing.
• More favorable guaranty terms.

New Terms or Conditions

The lender also may want new terms or conditions in exchange for modifying the loan. The lender will negotiate hard for these, treating the modification as a chance to go back over the whole loan file and improve its position in the transaction. They will see the borrower’s financial trouble as a chance to mitigate their own risks and to fix issues they’re unhappy with in the original loan documents.

Typical examples of one or more provisions the bank may require are:

• The lender may ask the borrower to provide additional collateral.
• Tying the loan’s performance to the borrower’s other credit arrangements, or to the borrower’s other loans with the same bank.
• If the loan is unsecured, the lender may ask for a promissory note secured by an asset.
• The bank also may ask for a guaranty from one or more principal players it has no guaranties on, and it may convert limited, or springing guaranties to unlimited ones, or may convert a non-recourse loan into a recourse one.
• Cash from tenants goes into a bank lockbox controlled by the lender to insure it gets paid before it goes to the property owner.
• More reporting requirements and new financial covenants.
• The borrowers and guarantors waive and release the lender from any claims, defenses, and setoff rights related to this loan.
• The modification contract may require a modification fee payable to cover the lender’s costs of preparing and processing the contract.
• Monitoring fees help offset the lender’s increasing administrative costs as it works to see that the loan performs.

In Forbearance

Whether a lender offers a forbearance or modification contract may depend on what it sees in the borrower’s future. In forbearance, the lender temporarily holds off its legal rights and remedies, but only as long as the borrower complies with the agreement’s terms. Unlike a modification, the bank doesn’t cure any current defaults - if there are any, they’re still in place.

The loan stays non-performing, which may matter to a regulated lender. Even so, the borrower gets some space to breathe, with payments deferred or reduced for a time. Borrowers may obtain forbearance to reach settlements with taxing authorities and with vendors or find other ways to repay the loan. The contract may give them a period in which it’s allowed to offer the lender some new source of repayment - refinancing or paying off the loan with proceeds from the sale of certain assets, for instance - or by bringing in new capital through a subordinated lender.

If the lender thinks a turnaround is possible, and wants to support the borrower, it may prefer forbearance, waiving or changing some terms for a while so the loan can be reinstated. Forbearance would let the borrower restructure without the costs and loss of control over its assets in a bankruptcy.

It can also cut a lender’s immediate collection and processing costs and delays, and the defaults are preserved, leaving an option to go ahead with the foreclosure when convenient, later. A friendly foreclosure, a kind of forbearance, is also possible, where the borrower voluntarily gives up the collateral to the bank. The bank then quickly takes a judgment, sets a date to sell the collateral without opposition. During this time, the borrower can continue to market the collateral on a more open schedule for a better price.

As with modification, the lender will use forbearance as a chance to go back through the loan documents and fix flaws that worry them. It may also try to improve its collateral, but a new collateral position in an unsecured or undersecured loan may bring up the specter of bankruptcy clawback if the borrower later files, as a preferential transfer under section 547 of the Bankruptcy Code. A lender in forbearance also may be better positioned to minimize loss through a going-concern sale of the business or an orderly liquidation of the borrower’s assets.

In a forbearance, borrowers often ask for one or more of the following:

• Deferred payments. The agreement suspends or reduces the borrower’s payments for an agreed period.
• A forbearance lasting a year or longer.
• The agreement may provide that default is wiped out when the borrower completes its duties under the agreement.
• Terms under which the borrower can take over marketing any sale of a business or its collateral, free of lender oversight.
• The Lender promises not to enforce its acceleration rights.
• If the loan was already accelerated, early repayment penalties, whether because of default or a prepayment due to a sale of collateral or refinancing, are waived.
• The bank may agree to a deadline farther out for an already-past due loan.

Lenders will look to fortify their position in a forbearance agreement, or structure a way to speed an exit out of the loan. There are a few typical tools they’ll look to.

• The bank imposes requirements for fixing the defects in the business and improving its financial position: better collection procedures, inventory turns, credit terms from vendors, expense cuts.
• Borrower acknowledges the existence of the Events of Default and that such events have not been waived by Lender, that it has no valid defenses, and that Lender has reserved all rights and remedies under Loan Documents with respect to such defaults except as specifically agreed in the agreement.
• Borrower reaffirms the lender’s lien on collateral.
• A forbearance of a very limited length in the range of three to six months. That forbearance period ends early if the borrower doesn’t follow the agreement.
• Borrower still makes periodic payments on a current basis.
• At the end of the forbearance period, any balance due, together with accrued interest, the lender’s costs and charges, must be repaid in full.
• More collateral for the loan and new or greater guaranties from the individuals or other entities involved