W Forbearance AGREEMENTS THE BENEFITS OF A TIMEOUT BY JOHN WALLER, DINSMORE & SHOHL LLP FINANCIAL MANAGEMENT When facing a loan default, the fundamental question for lenders is whether to exercise their remedies against the borrower and/or guarantors (collectively, “obligors”) or to pursue a settlement (workout). A forbearance agreement is a workout tool — a temporary settlement agreement. What is a Forbearance? Black’s Law Dictionary defines forbearance as the “act of abstaining from proceeding against a delinquent debtor; delay in exacting the enforcement of a right; indulgence granted to a debtor.” The idea is that the foreclosing lender agrees to a timeout. Why would obligors want time? They: ▶ face a judgment or a foreclosure (loss of their property) and need to restructure their affairs; ▶ desire to sell the loan collateral, such as commercial real estate, to pay off/pay down the loan; ▶ intend to work with another lender to refinance; ▶ want to settle internal partner disputes affecting the loan’s performance; ▶ need to resolve a temporary hardship (i.e., COVID or other impact on revenue); or ▶ seek to cure covenant defaults such as mechanic’s liens or code enforcement violations. Why would lenders consent to a timeout? ▶ Foreclosure litigation is a last resort. ▶ The loan’s performance stems from a temporary problem that can be solved with time. ▶ There is a positive relationship with the borrower group (trust). ▶ The obligors are preserving and protecting the loan collateral (i.e., the assets are not in jeopardy of being lost or impaired). ▶ The collateral position is weak (i.e., there is relatively little value in the property). ▶ The collateral is defective (i.e., environmental contamination). ▶ The guarantors are judgment-proof. ▶ The loan documents have defects that can be fixed in the forbearance agreement. ▶ Forbearance saves attorney’s fees and litigation expenses. ▶ Temporary settlements avoid the commitment of bank personnel necessary to litigate. Contract Under Indiana law, forbearance agreements are contracts. The agreement reduces the situation into a single document that is relatively easy for judges to understand. As a bonus, judges tend to look favorably on lenders who resort to court only after first affording obligors the opportunity to avoid suit in the first place. Make sure to clarify in writing all the essential terms of the deal. Signatories All obligors to the loan should sign the forbearance agreement, or lenders risk releasing the omitted obligors from liability. This is because a forbearance agreement arguably constitutes a “material alteration” of the original obligation. Under Indiana law, a guarantor can be released from liability if the underlying obligation is materially altered without the guarantor’s knowledge and consent. The simple solution is to have all the obligors sign the agreement. If a guarantor is unwilling to execute, then the lender should proceed to litigation or explore a different workout approach. Settlement As with any compromise, everything is negotiable. Also bear in mind that the parties can enter into forbearance agreements virtually at any point — before or during a lawsuit, even after the entry of judgment. Release All forbearance agreements should require the obligors to waive any and all rights, claims and defenses. This will help lenders and their counsel to 40 HOOSIERBANKER
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