Drafting Forbearance Agreements: A Road Map to Resolving a Troubled Loan
When faced with a matured loan or a borrower that is otherwise in default and lacks the funds necessary to satisfy the loan in full, some lenders are quick to resort to traditional collection methods like foreclosure. In certain situations, foreclosure will not yield a recovery that will make the lender whole, but an alternative exists that is a win for both lender and borrower. If such a solution appears possible, the parties typically engage in “workout” negotiations with the goal of reaching a resolution in what is known as a “forbearance agreement.” This type of agreement takes many forms, but at its essence, it is a written document signed by all affected parties that establishes where the parties have been (the loan history), the problem that brought them to the table (a default), and where they plan to go from here (the terms of the forbearance).
When drafting a forbearance agreement, it is helpful to think of it as a road map of the underlying loan. The map starts with the beginning of the loan relationship, takes the parties on the journey from where the loan began through the point of the forbearance, and ends with the destination where the parties want to go after the agreement is signed. The opening section, usually titled “recitals,” covers the territory where the parties and the loan have already been. This section should provide a specific recitation of the loan history, including when the loan originated, any prior modifications, the outstanding principal, interest, and cost balances, and the currently-applicable payment terms, interest rate, and maturity date. It should conclude with the “why are we here” portion of the trip, which is where a borrower acknowledges default and a lender acknowledges its agreement to forbear from collection of the debt based on the terms of the agreement.
After these background portions of the loan map, the forbearance agreement should explain where the trip is going next or, in other words, what the parties want to do to resolve the event that caused them to need forbearance in the first place. This portion of the agreement should state the terms of the forbearance between borrower and lender in detail, leaving no portion of the deal in question. When drafting or reviewing the agreement, the following are among common terms to consider:
- Loan documents survive the forbearance agreement and all terms therein remain intact except as specifically modified in the agreement
- Guarantors under original loan documents remain obligated and/or new guarantors are now obligated
- Lender has no obligation under forbearance agreement to make any further compromise, extension, forbearance, or modification
- Lender in no way performed any business functions or exercised any management decisions for borrower
- If there are defects in mortgage or security interest perfection, borrower consents to actions necessary to rectify same
- Borrower and lender agree on specific terms for new payments, interest rate, and/or maturity
- New terms are included for any additional collateral or guarantees
- Specific “triggering events,” such as partial or full sale of collateral, are described
- Borrower waives potential claims against lender
- Events of default and remedies upon default are clearly explained
Of course, many more terms could be included to memorialize a given forbearance agreement and ensure that the specifics of the deal are covered. This is the real benefit of a forbearance agreement – it is flexible enough that it can be modified in any way necessary to fit the unique circumstances of any lender and any borrower.
Although the point of a trip is usually to reach the final destination, in the forbearance agreement road map, the borrower and lender must also address what will happen if they do not reach the intended target despite their best intentions. After describing where the parties want to go on their forbearance road trip, the agreement should include terms that will apply to the loan if the borrower is not able to satisfy all parts of the deal. Will the lender have rights to immediately declare the full balance of the loan due or will the borrower have time to cure? Is a payment default treated the same way as a violation of a non-payment covenant? Lenders and borrowers must discuss these questions as part of their negotiations and include specifics in their forbearance agreement.
The end of the forbearance agreement road map is the signature page where, just like on a treasure map, “X” marks the spot. It seems axiomatic that the borrower and the lender must sign the agreement by the “X” for it to be effective, but what about any other parties who could be affected by its terms? One often overlooked portion of a forbearance agreement is ensuring that it is signed by all affected parties, specifically including any guarantors, and not just the borrower and the lender. Modifying a lender’s rights to enforce a guarantee and, in turn, the terms of a guarantor’s liability, may not be enforceable without the guarantor’s signature even if the borrower signed the forbearance agreement. The borrower should also consider whether there are junior liens on the property securing the subject loan. If matured junior liens exist, the junior lienholder must be a signatory to the forbearance agreement. Otherwise, the agreement will provide little real benefit to the borrower because the junior lienholder could continue disruptive collection efforts if not bound by the agreement, even if a senior lienholder has agreed to forbear from its collection rights.
By using this “road map theory” of forbearance agreement drafting, the borrower and lender should end up with a clear understanding of where the loan has been, where the parties want it to go, and what happens if they do not make it their destination. Although the agreement cannot ensure success for the parties, its flexibility allows them to develop their own unique path to resolve an otherwise dead-end loan and develop a mutually beneficial solution.