What should a business watch out for before signing a loan forbearance agreement?

Your bank calls you after you fail to make a payment on your business loan. They offer a “forbearance agreement” meant to give you more time to resolve your issues. But can you afford to wait? Will this agreement jeopardize the future of your business? Now is not the time to make rash decisions. While these agreements can sometimes offer breathing room for borrowers to refinance or to improve their position, in my view they are mostly designed to protect lenders at the borrower’s expense.

Forbearance agreements only come into play when you are in default. At that point your lender has the right to seize your collateral immediately and sue you for any deficiency. Depending on your loan and your state’s laws, your lender can agree not to take action against you for a certain period of time if you agree to certain things.

Every forbearance deal requires borrowers or guarantors to give up certain rights or property in exchange for more time or other consideration. In my opinion, it is critically important to fully understand what you are getting into before you sign.

While there are many factors to take into account, in my opinion there are three that stand out.

Release and Waiver

First, you need to understand precisely what you’re giving up.

Forbearance agreements generally include a “release and waiver” of claims from borrowers against lenders. If you have any right to take action against the lender for breaching the loan documents or otherwise holding it liable, then you will need to release those claims.

What that means is that if you sign the waiver you cannot raise your lender’s prior improper or illegal conduct as a defense to their actions against you. In a nutshell, if the deal falls apart, you are out of luck.

It should be emphasized that the only claims that survive a waiver are the ones that come up after you sign. With that in mind, a bank that knows it acted improperly might offer a forbearance deal to reduce their exposure to their wrongdoing, which you otherwise could use to defend against some or all of the debt. You should carefully weigh the likelihood of success against the rights you are giving up as part of the deal. In my opinion, you should know precisely which rights, defenses, or set-offs you are waiving as part of the deal.

Banks Frequently Demand More Collateral

A second problem is the collateral. Banks frequently demand more collateral and/or cash to back up their debts. In my opinion it is extremely important to understand exactly what you are giving up, since a bank may obtain collateral through a forbearance agreement that it otherwise could not.

One example is a business owner who personally guaranteed the loan, and is asked to pledge the family home as part of the deal. Under Missouri law, assets held jointly by married couples cannot be reached to cover the debts of only one spouse. If the only spouse with personal exposure to the loan - as owner and guarantor - is required to give the lender access to the jointly held family home through a workout deal, the bank gets access to a property it otherwise could not reach to collect its money.

Think carefully before giving up protected security to get more time. In my opinion it may make more sense to let the business fail and to keep the family home.

Vague Clauses

A third issue to consider is whether the forbearance agreement actually requires your lender to forbear. Be careful, because vague clauses can frequently allow a lender to declare you in default before the forbearance period ends.

An example is a default clause that kicks in upon a “material adverse change” in the borrower’s financial condition. In my view, you should negotiate these and other similar terms out, or at least make sure they are carefully and clearly defined.

It should also be noted that the underlying loan documents usually remain in force. Many provide that the borrower is in default if the lender “feels insecure”. Watch out for these, because your lender might declare you in default just after you sign the deal. If you are not careful, you can waive rights, and pledge collateral, only to learn that the lender has declared you in default. In my opinion, that is the worst possible result.

Remember, however, that I am not saying forbearance agreements are never the right move. It is possible that under certain circumstances a forbearance deal is the best choice. It can only work, however, if you understand and negotiate its terms. No matter what your loan officer says, in my opinion your bank is acting in its own interest. It is important for you to act in yours.