Using Forbearance Agreements

In the process of resolving a troubled lending relationship, the parties will often use a “Forbearance Agreement” to establish the rules by which that lending relationship will operate during troubled times.

What is a Forbearance Agreement?

A “Forbearance Agreement” is any agreement by which the lender agrees not to take action against the borrower that it would otherwise have a legal right to take. The lender “forbears” from filing a foreclosure action, or suing on a note, or the like. This can be documented by a letter agreement, amendment to existing loan documents, or a document called a “Forbearance Agreement.”

When Do I Need a Forbearance Agreement?

If there is a default under the existing loan documents, but the lender is willing to defer action on that default, a Forbearance Agreement may be useful. The Forbearance Agreement can perform a number of functions: 

• Focus the lender and the borrower on the reasons for the default.
• Identify the default as either a resolvable issue, or an irresolvable impediment to a continued relationship.
• Give both parties some “breathing room” as they work to identify problems and solutions.
• Allow the lender to correct any deficiencies in existing documentation.
• Allow the lender to preserve any defaults.
• Allow the lender to obtain a release of any claims arising from actions previously taken on the credit.
• Allow the borrower time to determine a resolution and then implement it (sale of assets or the business as a whole, for example).
• Allow restructuring of financial terms to make them more manageable for the borrower, while still providing acceptable debt service and an acceptable rate of return to the lender.
• Allow any steps that might eventually have to be taken for liquidation to be taken with enhanced and agreed-upon cooperation by the borrower.
• Provide for orderly, going-concern sale of borrower’s business or portions of it.

What Kinds of Things Will a Forbearance Agreement Say?

As with original loan documentation, documentation of the workout should be clear, accurate and properly completed. There are no “required” provisions of a Forbearance Agreement. Provisions commonly included in a Forbearance Agreement include: 

• Confirmation of existing defaults, including the timing and amount of monetary defaults.
• Confirmation of the lender’s collateral position. If necessary, the lender should obtain subordinations or other documentation required to fill any gaps found in the original documentation of the loan.
• Agreement by the borrower that it has no lender liability or other claims against the lender.
• Admission by the borrower that it has no valid defenses to an enforcement action brought by the lender.
• If foreclosure has already commenced, agreement by the debtor that judgment can be entered and waiving redemption rights. If borrower is in bankruptcy, consider including a “drop dead” clause.
• Confirmation that the lender is not waiving any defaults, nor any of its rights or remedies by virtue of entering into the workout agreement.
• Appropriate representations and warranties from the borrower.
• Operating provisions, particularly affirmative and negative covenants.

For more information about resolving troubled lending relationships, please contact one of the authors of this alert or your attorney.