When lenders find themselves with problem loans but are not ready to start the collection process, they often turn to workouts — modifying loan terms to address existing defaults and hopefully prevent new defaults. Entered and prepared right, forbearance agreements can be a useful tool in the workout toolbox. Even the best-written forbearance agreements cannot undo past defaults or improve a borrower’s “five Cs of credit” outlook. Forbearance agreements make sense when the lender reasonably believes that specified actions over a specified period will yield better results than loan collection over the same period. Forbearance agreements necessarily involve lender concessions — at a minimum, forbearing from collections and enforcement — and lenders should expect borrower concessions in return. This often involves difficult borrower decisions, like selling assets and pledging more collateral. Lenders should start by determining the forbearance agreement’s goals. Goals may include collateral liquidation, permanently restructuring the relationship, or ending the relationship. Forbearance agreements are short-term contracts, so the lender should decide what they want the relationship to look like when the forbearance period ends. Forbearance agreements provide an opportunity to remedy errors or oversights in the loan documents. So the process should include a thorough loan file review, compiling and reviewing all notes, loan agreements, security agreements, deeds of trust, guaranties and other contracts. The review should include updating title work on real estate collateral, a UCC search on personal property collateral and checking for delinquent taxes. The lender should arrive at a precise calculation of all amounts due on the loan, including fees and reimbursable costs. While terms vary with the type of loan, borrower and defaults, the following are common forbearance agreement terms: • The borrower should acknowledge the amounts due on the loan and reaffirm the debt and loan documentation. • The borrower should acknowledge an existing default on loan obligations. • Most lenders require the borrower to release the lender from any claims or liabilities arising before the forbearance agreement. • The agreement must include a forbearance term — the lender should not agree to indefinitely forbear from exercising its rights. • The agreement must identify all payments required during the forbearance period. • The agreement must identify all covenants required during the forbearance period, including asset sales, borrower reporting and restrictions on the borrower’s conduct. • The agreement must identify all lender remedies in the event the borrower defaults on any forbearance agreement obligations. • The agreement should precisely specify any modifications to the lender’s rights — like reduced interest rates or modified payment terms. • A forbearance agreement is a contract, so it should include standard contract clauses, like choice of law, authority and notice provisions. • Preparing a forbearance agreement can entail considerable time and expense and lenders often include a forbearance fee term — a fee paid by the borrower or added to the loan balance — as part of the forbearance agreement. Finally, the complexity and sensitivity surrounding forbearance agreements almost always warrants involving an attorney. FORBEARANCE AGREEMENTS: BEST PRACTICES By Scott C. Sandberg, Partner Spencer Fane LLP, ICBC Associate Member INDEPENDENT REPORT | 23
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