Identify Specific Problems and the Bank’s Goals for any Workout Scenario Of course, a bank’s primary goal in dealing with any problem loan is to realize full and timely repayment of the debt. However, when changes in the interest rate environment, collateral values and the borrower’s and guarantors’ overall financial condition make that unlikely, the bank should be realistic about best- and worstcase scenarios for resolving the loan and what it hopes to achieve in a workout. For example, is the bank interested in preserving a lending relationship with the borrower, avoiding foreclosure due to possible environmental concerns related to the property, or preserving jobs or the going-concern value of the collateral? Also, the bank must determine if the borrower wants to continue to operate the property or if they are resolved to hand over the keys. Moreover, what are the primary causes of the underlying loan default – poor management of the property, downsizing of a major tenant, construction cost overruns and time delays, or something else? All of these considerations, among numerous others, will factor into the bank’s strategy for addressing the nonperforming loan. Start with a Pre-Negotiation Agreement A pre-negotiation agreement (PNA) is a critical step before sitting down to negotiate with a borrower and should be thoughtfully drafted. A PNA may take the form of a letter agreement or a more formal document, but the main purpose is to maintain the status quo so that the bank and the borrower may freely engage in discussions and not be bound until a formal agreement is executed. The PNA also ensures that the borrower cannot use the negotiations themselves to oppose the lender’s efforts to enforce the loan documents or assert claims against the lender on the basis that the lender agreed during the course of the negotiations to a forbearance, or that the parties’ communications themselves constituted a modification agreement. Failure to obtain a PNA before starting negotiations can be prejudicial to a lender; a borrower whose back is against the wall is more likely to claim that the bank made promises on which the borrower relied to its detriment. Loan Workout and Forbearance Agreements If a borrower’s ability to repay a defaulted loan may improve over time (e.g., if the borrower is given more time to refinance), or if the loan is restructured (e.g., to require interest-only payments until cash flow improves), then a forbearance or loan workout agreement may be a good option. Technically speaking, a forbearance agreement and a workout agreement are different, although they share many of the same characteristics and goals and may be combined in a single form of agreement. A forbearance agreement temporarily defers the bank’s rights to pursue legal remedies such as foreclosure while giving the borrower a finite and short period to bring the loan current or refinance it altogether. By contrast, a workout agreement is typically intended to be a longer-term solution for dealing with a problem loan, which may involve restructuring payment terms and financial covenants, extending the maturity date of the loan, or reducing the loan commitment over time. Key Provisions to Include in Loan Workout and Forbearance Agreements Loan workout and forbearance agreements should always incorporate several key terms and conditions, including: • Identifying the existing loan documents, including promissory notes, guaranties, security agreements and pledge agreements, and any amendments or modifications; • The borrower and any guarantors should acknowledge the amount due on the debt and the existing defaults under the loan documents, including any payment defaults, breaches of financial covenants, or past-due taxes; • The borrower and guarantors should reaffirm the continuing validity of the loan documents and their obligation to repay the debt; and • Events that will constitute defaults under the loan workout agreement or terminate the bank’s obligation to forbear, including the expiration date for the forbearance, should be clearly identified. It is also prudent to include waivers, releases of claims and covenants not to sue the bank, especially based on claims of lender liability, negligence in the administration of the loan or other claims that may be advanced for the primary purpose of hindering or delaying the loan enforcement process. Beyond these basic considerations, forbearance and loan workout agreements must include provisions that are specific to the circumstances surrounding the defaulted loan. For example, in exchange for the bank’s agreement to forbear for a period of time or to modify the loan, the bank may require: • The pledge of additional collateral and/or partial paydown of the loan; • Additional guarantors; • Additional remedies that were not included in the original loan documents, such as the automatic right to the appointment of a receiver in the event of a further default under the loan documents; or • Confession or stipulation of judgment, which can save significant time and expense associated with obtaining a judgment against a borrower and/or guarantors. Ultimately, if the borrower is not able to get the loan back on track, a carefully negotiated and well-drafted forbearance or loan workout The Show-Me Banker Magazine | 13
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