Can a Forbearance Agreement Actually Help a Lender Collect from Its Debtor?
While it may be instinctive for a lender to bring suit against a defaulting borrower, entering into a forbearance agreement instead may actually increase a lender's chances of successfully collecting a debtor's obligation. A forbearance agreement, sometimes called a standstill agreement, is a binding contract between a lender and a borrower that extends the time available for a borrower to perform under the operative loan documents.
While not every situation will lend itself to a forbearance agreement, this alternative can be beneficial to a lender if the facts and circumstances are appropriate. By entering into a forbearance agreement, a lender gives up certain rights, including the right to immediate payment of its borrower's obligations. In return, however, a lender will receive benefits. For example, a lender can require a borrower to make admissions in the agreement or waive certain rights. A lender may also have the opportunity to correct any collateral deficiencies. However, any increase or changes in collateral should be structured in a manner that avoids potential preference liability (e.g., by having the forbearance period extend for more than 90 days). Additionally, a lender can often charge a forbearance fee to the borrower for entering into the agreement. Lastly, the borrower may be able to locate another party to "take out" the existing lender. This will allow a lender to be paid, hopefully in full, without having to look to the collateral, if any, and bear the cost of liquidating that collateral. Similarly, a short extension of time may provide a borrower with the breathing room it needs to clear whatever hurdles it faces and repay its obligations.
In order to take full advantage of the potential benefits of a forbearance agreement, a lender must ensure that the document is properly drafted. The agreement should not only contain express language implementing the benefits outlined above, but also set forth the facts and circumstances of the borrower's financial situation and its relationship with the lender. Although each case is different, following are a few items that a lender may want to include in a forbearance agreement:
- A recital of all of the obligations and obligators (including guarantors);
- A recitation of the collateral securing the obligations of the borrower;
- A requirement that the forbearance agreement identify the specific defaults under the operative loan agreements;
- A reaffirmation of the borrower's financial and non-financial obligations (including representations, covenants and warranties);
- A waiver of defenses against the lender;
- A release for the benefit of the lender from the borrower;
- A termination date; and
- A list of events that would constitute events of default under the agreement.
Ultimately, a lender should consider all of its options, including entering into a forbearance agreement, before bringing suit against a borrower in default. While it may seem counterintuitive, a forbearance agreement, if properly drafted and used, can actually improve the chances that a lender will be paid.