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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.

©2022 MICHAEL BEST & FRIEDRICH LLPNational Law Review, Volume , Number 365

About this Author

Ann Ustad Smith, Michael Best Law Firm, Finance and Banking Attorney
Partner, Practice Chair

Ann works with business owners, investors, and lenders, establishing and navigating their financial relationships and resolving matters relating to financial distress. Her practice is focused on commercial transactions, commercial litigation, bankruptcy, and other insolvency situations, and she is known for:

  • Structuring and closing complex financial transactions

  • Practical, effective solutions to distressed financial situations

  • Resolving (including through...