Once you’re in default, can you negotiate with the lender? Generally, yes. But you should know that under most loan agreements the lender can accelerate the loan, enforce rights against collateral, and charge default interest. And if the loan is a revolving credit facility, the lender can cut off further credit unless it agrees to allow additional lending. The lender is under no obligation to grant you waivers of the default or a restructuring. However, because lenders are interested in recovering as much as possible from a borrower, and because a lender often achieves this result by allowing the borrower to continue operations, it’s not uncommon to negotiate a “workout” in which the lender waives the default and provides a restructuring of terms and covenants. Lenders look at everything in their interests. That would certainly include not unnecessarily driving the borrower out of business.
Wait Too Long to Discuss Financial Difficulties
Talk to your lender before you default, not after. Most business owners wait too long to discuss financial difficulties because they are embarrassed or because they expect the problem to go away. This is exactly the time when a lender needs to be able to trust management. Honest and clear financial statements are often the key to helping the lender understand the problem. If management is not trusted, a lender may choose remedies far worse than the desired workout.
Read all of your loan documents after default. If a default exists under one loan agreement, that may also be a default under all of your other loan agreements (so-called “cross-default provisions“). Many things that you are accustomed to doing in the ordinary course of business (such as selling assets, making investments or even paying distributions) may be prohibited while the company is in default, and if you do them anyway it will greatly impact the confidence your lender has in you. Your lender will want to see that you are taking the default very seriously and not creating more default events on your loans.
Once you default on a loan, the lender’s old loan officer might no longer be the one making decisions. In many cases, the bank will assign the problem loan to a special assets group which looks at the situation from a different perspective than your old relationship manager.
Workout Agreement
When working out the terms of a workout agreement, there’s no one-size-fits-all and there’s not even a market standard. One borrower may only have to agree to loosen financial covenants and pay a higher interest rate to work out the situation. Another might have to bring in fresh capital (i.e., either equity or subordinated debt) to the business, or sell a division or subsidiary and use the proceeds to repay some outstanding debt. This is all negotiable. In any event, the borrower needs to make sure it obtains a waiver for all existing defaults, has enough working capital or revolver access to fund operating expenses (including debt service), and gets its financial covenants reset to levels it can live with.
And watch out for taxes: if the lender reduces or cancels any debt, you’ll have taxable income equal to the amount of the reduction or cancellation, as a general rule. This can create an unexpected tax liability. (Check with your tax adviser.)
Sometimes the lender will write to you with notice of default to establish a record, even though usually the borrower is the one who has to send notice of default. Many lenders will also send you a reservation of rights letter to say, “Hey, we do know you’ve defaulted, we’re still evaluating the situation, and the fact we haven’t acted yet doesn’t mean we waive our rights.” All this jargon is to assure the bank will not inadvertently lose its ability to demand immediate repayment of the loan, even if it is negotiating with you to do some kind of a workout. A “negotiation protocol agreement,” which some lenders prefer, acknowledges the default, states that the parties are negotiating, and that either party can terminate the discussions at any time.
Under a forbearance agreement, a lender agrees not to take certain actions, such as accelerating a loan, foreclosing on collateral, or charging default interest, until a specified date or until there is a new default by the borrower. It is not a waiver of the existing default. A new default by the borrower automatically ends the forbearance agreement. A borrower should check the documents to make sure it can perform any action it wants during the forbearance period (e.g., a revolver draw or the sale of assets). A forbearance agreement can be used as a bridge to negotiate a waiver or amendment of the documents.
A waiver means a default listed in the waiver no longer exists, so the lender can’t take action for that default. But a waiver only applies to the default(s) specifically described in it. In contrast, an amendment changes the actual terms of the loan. If there are a number of lenders involved, certain changes — like waiving payment defaults or reducing amortization or cash interest payments — will require all of the lenders affected. Any time you get a concession from a lender in writing you’ll likely need to give them a release: basically, you’ll give up all claims against the lender for any matter prior to signing.
In short, yes, it is possible to negotiate with lenders and get changes to the loan agreement when you have defaulted. But just as with any other type of settlement, there will be certain concessions you have to make in order to achieve a resolution. My advice is be proactive.
