Forbearance Agreements: A Useful Tool for Lenders After Default

Objective of the Forbearance Agreement

In preparing a forbearance arrangement, the agreement itself should state the reason for the forbearance as well as what must be accomplished during the forbearance period. The agreement may include various representations and warranties associated with the purpose of the forbearance, as well as include specific interim steps that must occur if the goal of the forbearance is to be achieved. The agreement should also clearly state exactly what actions the lender is refraining from during the forbearance period, the length of which should be set forth in the agreement.

Admission of the Default, and Waivers and Releases

In most situations, it is imperative for the borrower to acknowledge the enforceability of the loan documents and lender's right to declare a default and accelerate under them, as well as reaffirm the debt and the outstanding balance. Acknowledgment by the borrower of the outstanding debt will avoid or reconcile any dispute to the balance. The borrower must also acknowledge that it has requested the forbearance in order to establish consideration for the benefits it has received due to the forbearance as well as recognize the validity of the loan documents and the lender's lien on the collateral. Equally as important, a borrower, especially one that stated that it has claims against the lender, must waive all claims and defenses against the lender. Securing a waiver of defenses and a release at this point is crucial if the lender perceives litigation as a probable outcome in the near future.

Conditions to Forbearance and Early Termination

In addition to providing a 'drop dead' or expiration date in the agreement, forbearance agreements can also include events or conditions that would cause the early termination of the forbearance. Typically, termination of the forbearance arrangement will occur as a result of a breach of the forbearance agreement, additional defaults under the other loan or transactions with the borrower, a material adverse change in the borrower's business or financial condition or destruction or damage to the value of collateral, the pledge of any of the collateral to another creditor, the institution of litigation by another creditor or the filing of a bankruptcy petition.

The forbearance agreement may also include provisions terminating the forbearance if certain anticipated events do not occur. These types of provisions are commonly tied to the overall objective of the forbearance and should list events that are necessary if the borrower is going to accomplish the goal of the forbearance. For instance, a lender can require the borrower to obtain a workout consultant who will provide regular updates to the lender or require the borrower to sell the business, a division of the business, or company assets with the goal of paying off the lender with the proceeds. A lender can also use the forbearance to secure additional guarantees or collateral, or collect additional fees and interest. Finally, a lender can impose requirements on the borrower's use of its own funds to repay the loan.

Reporting and Disclosure

Nowadays, frequent and detailed financial disclosure is commonplace. The forbearance arrangement should require periodic reports regarding any interim steps and the borrower's progress toward accomplishing the overall purpose, and provide copies of any related third-party correspondence and documentation. The agreement may also provide for the examination of the borrower's books and records by the lender's own auditors or consultants.

'Pre-Workout' Provisions

If the forbearance's objective is to explore a possible restructuring or long-term arrangement, the lender can use the forbearance to set the rules that will govern those discussions and negotiations. For instance, the borrower and lender can agree that the lender is not obligated to enter into or continue negotiations, that the negotiations constitute settlement discussions and are inadmissible in any later proceedings, and that the discussions will not be binding until final documents are executed and delivered.

Sale of Assets

The forbearance agreement can permit the borrower to sell business assets, including all or part of the collateral. However, such provisions must require the borrower to procure and maintain adequate insurance on the equipment prior to sale and can mandate how the sale must be conducted and how the proceeds will be applied to the debt.

Permissible Actions By the Lender

A lender may be permitted to take specified enforcement actions not-withstanding the forbearance. Many times, litigation may already be pending at the time the arrangement is entered into. In these situations, the lender should secure the borrower's consent to taking actions necessary to preserve the status quo, prevent dismissal or default, and extend deadlines. Conversely, the borrower itself may be required to take or refrain from certain actions in the litigation.

Expiration and 'Meltdown' Provisions

Eventually, the forbearance expires or is terminated due to a breach or the borrower's successful completion of the forbearance goals. On the one hand, if the objective of the forbearance was to allow the borrower time to cure the existing defaults or otherwise improve its business or financial condition and the borrower meets the goals set forth in the agreement, the defaults may be waived and the loan returned to its original terms, or an agreed-upon long-term modification may take effect. However, if the agreement terminates as a result of a breach, the agreement itself should specify that the lender can immediately proceed to enforce or continue to enforce all of its rights and remedies to collect the obligation.

Even if the lender has not instituted litigation, the forbearance agreement should have a provision whereby the lender is entitled immediately to proceed toward judgment, especially due to the borrower's acknowledgment in the forbearance agreement of its default and the amount of the debt, in addition the borrower's waiver of its defenses and claims against the lender. Obtaining such acknowledgments in the agreement will obviate the need to prove default, liability, and damages in litigation. If any action has been filed, the lender should take steps to obtain the court's approval of the agreement, rendering the forbearance a settlement, enforceable in the event of default.

Although a borrower's waiver of its right to file a bankruptcy petition is against public policy, the lender should insist upon provisions in a forbearance agreement to secure its rights in the event of a bankruptcy proceeding. Lenders have some ability to protect themselves. The lender can require provisions in the forbearance agreement regarding indemnity against funds disgorged in connection with avoidance actions and the use of cash collateral. Another important provision may be to obtain the borrower's consent to relief from the automatic stay so that the lender can proceed outside the bankruptcy court to obtain its remedies. Alternatively, a lender can seek to dismiss the bankruptcy case of a borrower if the borrower represented that it did not intend on filing a bankruptcy petition, if the lender acts to its detriment in agreeing to the forbearance, and the borrower commences the bankruptcy proceeding shortly thereafter.

Finally, the lender should include a forum selection clause or 'consent to jurisdiction' provision in the agreement, in the event of disputes, thus avoiding unfriendly jurisdictions. To appear fair to both parties, the chosen forum does not need to be the home state of either the lender or borrower. However, the forum selection clause must be mandatory or some courts may not enforce the provision. The lender should also retain the right to bring an action to secure its collateral in any jurisdiction where the collateral may be located. In addition to a forum selection clause, a lender should include a jury trial waiver provision. Although the underlying loan documents may contain a jury trial waiver clause, the forbearance agreement should contain such waiver as well to ensure that if any dispute arises between the parties and a lawsuit is filed, the lender can enforce the contractual jury trial waiver.

Conclusion

A lender should evaluate a potential for-bearance agreement with the goal of increasing the likelihood of repayment while improving its ultimate ability to recover. By including such provisions in any forbearance arrangement, a lender secures itself a better position in the event of a subsequent default by the borrower. At the same time, both the lender and the borrower must ensure that the forbearance arrangement provides sufficient time and flexibility to allow the borrower to accomplish the goals of the forbearance.

Joseph M. Grant is an attorney at The Hodkin Kopelowitz Ostrow Firm, P.A., in Fort Lauderdale, FL. Grant concentrates his practice in commercial litigation, representing financial institutions in areas such as equipment leasing and secured transactions. He may be reached at 954-525-4100 or [email protected].

With a borrower in default and facing the threat of imminent litigation or bankruptcy, both lenders and borrower are increasingly looking to the appealing alternative of forbearance agreements. These are arrangements whereby lenders refrain from exercising their available default remedies in exchange for certain concessions from the borrower. Depending on the circumstances, forbearance agreements give lenders an alternative to the expenses and delays associated with litigation or bankruptcy. Forbearance agreements can also be used to take the place of a more long-term modification of the parties' arrangement. Accordingly, a forbearance usually gives up little on the part of the lender, but allows the lender to secure a number of benefits that will be very helpful in the event of a subsequent default by the borrower.

Parties consider forbearance agreements for a variety of reasons. Lenders seldom immediately shut down a transaction after an initial default and typically give the borrower time to solve its financial problems. If the default is minor or is only temporary, a forbearance agreement may be entered into to give the borrower time to cure the default. In situations where the borrower and the lender are negotiating a broader restructuring, the parties may agree to enter into a forbearance agreement to give the lender time to analyze the default situation and determine if it is willing to consider a longer arrangement, as well as give the parties time to negotiate the terms of a possible restructuring and ultimately document the new arrangement. A lender may also consider a forbearance in situations where the borrower may be refinancing its debt or selling the company or its assets. Under these circumstances, a lender may agree to a forbearance simply to allow the 90-day preference period to expire with respect to any new collateral. Finally, lenders can use a forbearance agreement to correct certain deficiencies in the loan documents or with lender's interest in the collateral.

The reason for entering into a forbearance agreement obviously de-pends on the specific transaction. The forbearance agreement can also take on many forms, such as a letter agreement, additional loan documents, or the preparation of a formal 'Forbearance Agreement.' However, here are a few issues to consider when agreeing to a forbearance and eventually preparing a forbearance agreement.

Objective of the Forbearance Agreement

In preparing a forbearance arrangement, the agreement itself should state the reason for the forbearance as well as what must be accomplished during the forbearance period. The agreement may include various representations and warranties associated with the purpose of the forbearance, as well as include specific interim steps that must occur if the goal of the forbearance is to be achieved. The agreement should also clearly state exactly what actions the lender is refraining from during the forbearance period, the length of which should be set forth in the agreement.

Admission of the Default, and Waivers and Releases

In most situations, it is imperative for the borrower to acknowledge the enforceability of the loan documents and lender's right to declare a default and accelerate under them, as well as reaffirm the debt and the outstanding balance. Acknowledgment by the borrower of the outstanding debt will avoid or reconcile any dispute to the balance. The borrower must also acknowledge that it has requested the forbearance in order to establish consideration for the benefits it has received due to the forbearance as well as recognize the validity of the loan documents and the lender's lien on the collateral. Equally as important, a borrower, especially one that stated that it has claims against the lender, must waive all claims and defenses against the lender. Securing a waiver of defenses and a release at this point is crucial if the lender perceives litigation as a probable outcome in the near future.

Conditions to Forbearance and Early Termination

In addition to providing a 'drop dead' or expiration date in the agreement, forbearance agreements can also include events or conditions that would cause the early termination of the forbearance. Typically, termination of the forbearance arrangement will occur as a result of a breach of the forbearance agreement, additional defaults under the other loan or transactions with the borrower, a material adverse change in the borrower's business or financial condition or destruction or damage to the value of collateral, the pledge of any of the collateral to another creditor, the institution of litigation by another creditor or the filing of a bankruptcy petition.

The forbearance agreement may also include provisions terminating the forbearance if certain anticipated events do not occur. These types of provisions are commonly tied to the overall objective of the forbearance and should list events that are necessary if the borrower is going to accomplish the goal of the forbearance. For instance, a lender can require the borrower to obtain a workout consultant who will provide regular updates to the lender or require the borrower to sell the business, a division of the business, or company assets with the goal of paying off the lender with the proceeds. A lender can also use the forbearance to secure additional guarantees or collateral, or collect additional fees and interest. Finally, a lender can impose requirements on the borrower's use of its own funds to repay the loan.

Reporting and Disclosure

Nowadays, frequent and detailed financial disclosure is commonplace. The forbearance arrangement should require periodic reports regarding any interim steps and the borrower's progress toward accomplishing the overall purpose, and provide copies of any related third-party correspondence and documentation. The agreement may also provide for the examination of the borrower's books and records by the lender's own auditors or consultants.

'Pre-Workout' Provisions

If the forbearance's objective is to explore a possible restructuring or long-term arrangement, the lender can use the forbearance to set the rules that will govern those discussions and negotiations. For instance, the borrower and lender can agree that the lender is not obligated to enter into or continue negotiations, that the negotiations constitute settlement discussions and are inadmissible in any later proceedings, and that the discussions will not be binding until final documents are executed and delivered.

Sale of Assets

The forbearance agreement can permit the borrower to sell business assets, including all or part of the collateral. However, such provisions must require the borrower to procure and maintain adequate insurance on the equipment prior to sale and can mandate how the sale must be conducted and how the proceeds will be applied to the debt.

Permissible Actions By the Lender

A lender may be permitted to take specified enforcement actions not-withstanding the forbearance. Many times, litigation may already be pending at the time the arrangement is entered into. In these situations, the lender should secure the borrower's consent to taking actions necessary to preserve the status quo, prevent dismissal or default, and extend deadlines. Conversely, the borrower itself may be required to take or refrain from certain actions in the litigation.

Expiration and 'Meltdown' Provisions

Eventually, the forbearance expires or is terminated due to a breach or the borrower's successful completion of the forbearance goals. On the one hand, if the objective of the forbearance was to allow the borrower time to cure the existing defaults or otherwise improve its business or financial condition and the borrower meets the goals set forth in the agreement, the defaults may be waived and the loan returned to its original terms, or an agreed-upon long-term modification may take effect. However, if the agreement terminates as a result of a breach, the agreement itself should specify that the lender can immediately proceed to enforce or continue to enforce all of its rights and remedies to collect the obligation.

Even if the lender has not instituted litigation, the forbearance agreement should have a provision whereby the lender is entitled immediately to proceed toward judgment, especially due to the borrower's acknowledgment in the forbearance agreement of its default and the amount of the debt, in addition the borrower's waiver of its defenses and claims against the lender. Obtaining such acknowledgments in the agreement will obviate the need to prove default, liability, and damages in litigation. If any action has been filed, the lender should take steps to obtain the court's approval of the agreement, rendering the forbearance a settlement, enforceable in the event of default.

Although a borrower's waiver of its right to file a bankruptcy petition is against public policy, the lender should insist upon provisions in a forbearance agreement to secure its rights in the event of a bankruptcy proceeding. Lenders have some ability to protect themselves. The lender can require provisions in the forbearance agreement regarding indemnity against funds disgorged in connection with avoidance actions and the use of cash collateral. Another important provision may be to obtain the borrower's consent to relief from the automatic stay so that the lender can proceed outside the bankruptcy court to obtain its remedies. Alternatively, a lender can seek to dismiss the bankruptcy case of a borrower if the borrower represented that it did not intend on filing a bankruptcy petition, if the lender acts to its detriment in agreeing to the forbearance, and the borrower commences the bankruptcy proceeding shortly thereafter.

Finally, the lender should include a forum selection clause or 'consent to jurisdiction' provision in the agreement, in the event of disputes, thus avoiding unfriendly jurisdictions. To appear fair to both parties, the chosen forum does not need to be the home state of either the lender or borrower. However, the forum selection clause must be mandatory or some courts may not enforce the provision. The lender should also retain the right to bring an action to secure its collateral in any jurisdiction where the collateral may be located. In addition to a forum selection clause, a lender should include a jury trial waiver provision. Although the underlying loan documents may contain a jury trial waiver clause, the forbearance agreement should contain such waiver as well to ensure that if any dispute arises between the parties and a lawsuit is filed, the lender can enforce the contractual jury trial waiver.

Conclusion

A lender should evaluate a potential for-bearance agreement with the goal of increasing the likelihood of repayment while improving its ultimate ability to recover. By including such provisions in any forbearance arrangement, a lender secures itself a better position in the event of a subsequent default by the borrower. At the same time, both the lender and the borrower must ensure that the forbearance arrangement provides sufficient time and flexibility to allow the borrower to accomplish the goals of the forbearance.

Joseph M. Grant is an attorney at The Hodkin Kopelowitz Ostrow Firm, P.A., in Fort Lauderdale, FL. Grant concentrates his practice in commercial litigation, representing financial institutions in areas such as equipment leasing and secured transactions. He may be reached at 954-525-4100 or [email protected].