By the time most owners call us, the default has already happened. Maybe the company is in default, but it needs the credit to stay afloat. Maybe the owners have a personal guarantee and can’t imagine the loss of the business if the bank cuts it off. In any event, the borrower needs the lender to agree to forbear from exercising remedies against the borrower — a “forbearance agreement.”
The lender’s first concern is repayment of the loan. It wants to put itself in as good a position as it can be in against the borrower, its guarantors and any other collateral they may have. However, the borrower has negotiating power; it has possession and control of the assets most likely to satisfy the debt: the business itself. The borrower may decide to attempt a workout, to defend against a lawsuit, or to sue the lender, or to file Chapter 11. To stop the lender from exercising remedies, the borrower will agree to give up something. The forbearance agreement is for a limited period of time, and the lender will want additional security or controls on the borrower’s operations. The amount of sacrifice has to be proportionate to the commitment of the lender. At a minimum, the deal has to give the borrower a reasonable chance to turn around its business.
Often a lender’s lawyer will tell you that the forbearance agreement is the bank’s form and the terms are not negotiable. Almost always, that is untrue. If a forbearance agreement does not give the borrower a reasonable chance to turn around the business, walk away. Be sure to select an attorney that specializes in commercial insolvency issues and represents borrowers.
The Period of Forbearance
What you need first is the period of forbearance — the agreed-upon pause on enforcement activities so the borrower can get its business back on track. But the number of days must be carefully calculated based upon the concessions the borrower and its guarantors are willing to make, the financial and other support it is receiving from the lender, and the time needed to achieve the next milestone in the debtor’s recovery. Regarding defaults, the lender will typically demand that the borrower identify all of its current monetary and non-monetary defaults and any other default under the loan documents or forbearance agreement that will terminate the forbearance. The old events of default and reps and warranties weren’t an issue when business was good – now they can be a minefield. Do a complete review to make sure you’re aware of all the defaults, or potential defaults, and disclose them. The forbearance agreement should provide that only a new and material default would allow the lender to terminate forbearance. Avoid calling an “insolvency” or a “material adverse change” an event of default – the lender already knows your financial condition is impaired.
The borrower’s most critical request would be a commitment to fund. The lender may demand that any commitment be “at its sole discretion” — in other words, not a commitment at all. Work with the lender to set clearly defined conditions that, if met, require the lender to fund. This takes a lot of trust between the parties. If the lender won’t commit in writing, at least have an open discussion about the borrower’s funding requirements and expectations before conceding what the lender wants.
Regarding payments, rates and fees, start by preparing a financial projection that will at a minimum cover essential operating costs for the immediate future, and eventually bring the business back to positive cash flow. You should hand the projection to the lender and ask for changes to the payment terms. Every aspect of the agreement is up for review: lower or suspend payments, renegotiate the interest rate, waive or defer fees. A lender may try to impose new fees — don’t agree to it. If the borrower has plans to refinance, sell assets, the business or take some other major action, you may be able to convince the lender to make more significant modifications, such as a discount on the principal, in order to encourage you to complete the transaction.
Expect to Pay a Price
Whether you intend to turn to the lender to help restructure a loan, or the lender is pushing you in that direction, expect to pay a price to get the relief you want. First, the bank will ask you and your guarantors to acknowledge that you owe it a sum certain of money, namely, the amount of your debt, plus any accrued interest, attorneys’ fees and other amounts due. You and they will need to confirm the enforceability of the loan documents, the validity and priority of the lender’s lien and security interest in any collateral, the existence of the defaults, and certain representations and warranties made in the loan documents. The lender will also require an acknowledgment that it is not waiving any of its rights, and that there are no defenses, offsets or counterclaims. In addition, the borrower and all guarantors will be asked to provide a general release of any claims against the lender. All this will normally be acceptable if the lender has treated you fairly and has properly secured and documented its loan. However, if the lender has overstepped in any way (e.g., by taking unjustified positions on the loan terms, or by interfering with your business) then you’ll have to carefully weigh what you are being asked to concede against what you will get in return.
The next thing a lender will probably ask for is an “unqualified reaffirmation” of the representations and warranties that you already made in your loan documents. Keep in mind that circumstances may have changed since you made them, so you should go through each one to disclose any changes and carve out anything that you don’t comply with anymore. The lender will also have various other conditions that you will have to meet, including strict compliance with all your obligations other than those that you identify as existing defaults, the curing of those defaults by certain deadlines, modified financial covenants, and so on. Make sure that you can realistically meet these conditions before you agree to sign anything.
Often, a lender may ask for additional collateral or a guarantee from an additional guarantor. It may require a mortgage on a piece of real estate owned by a related party (e.g., your personal residence). The lender may require new guarantors or ask to turn your limited guaranty into an unlimited guaranty. The lender may require a lock box on your receivables or an account-control arrangement, or a pledge of equity interests, tax refunds or litigation proceeds.
The lender may also ask you to agree, in advance, to tougher remedies if things go wrong again. That could mean giving up things that were off the table at the original closing. You could be agreeing to prejudgment remedies, without notice or a hearing, confession of judgment, appointment of a receiver, surrender of possession, a waiver of Article 9 sale notices under the Uniform Commercial Code, and even the lender’s relief from the automatic stay if you file bankruptcy. Review each with your lawyer so you understand the risk.
The last request is usually a chief restructuring officer or financial advisor. This is something you might actually want; sometimes a request for this comes from the borrower’s own lawyer. But the lender wants to keep a more direct line to the CRO and suggest someone who has a long history of doing business with the lender. The lender may want the CRO to disclose “all aspects of the financial operations” to the lender and respond to the lender’s questions. Politely decline the lender’s suggestions. Instead, have your insolvency lawyer recommend a turnaround professional that the lender will approve, who can disclose the information required under the agreement while still adhering to the fiduciary duty of loyalty to the borrower.
The Full Benefit of the Bargain
Clearly, the parties are hoping the agreement can lead to the borrower’s recovery, and the lender ultimately receiving the full benefit of the bargain that was struck when it made the loan. But what the borrower gives up must be proportionate to the forbearance, continued funding and other things the lender is providing, and aligned with the borrower’s actual prospects of success. Otherwise, the agreement itself can work against the turnaround.
