A forbearance agreement is a contract between the borrower and the lender, and it can be a valuable tool for lenders dealing with defaulted loan situations. Typically, if a loan is in default, a borrower will be eager to be granted time by the lender to correct or cure whatever problems have led to such default.
Depending on the situation, a lender, too, may prefer to offer the borrower time to cure a default instead of exercising other rights or remedies it may have under the loan documents. A forbearance may, among other things, provide an opportunity for the lender to improve its collateral position, clarify the terms of the loan documents, and better protect and reserve the lender’s rights in the event the borrower is unable to cure the existing default or payoff the loan by the end of the forbearance period.
A forbearance agreement can provide the following benefits to lenders, and this list is by no means exhaustive of all the potential benefits available under forbearance agreements:
- it will contain an acknowledgment by the borrower of the outstanding loan balance and an acknowledgement that the amount owed by the borrower is not subject to any defense, setoff or counterclaim. It will also require that a borrower (and any guarantors) reaffirm their obligations to the lender under the loan documents, and it will affirm the validity of the loan documents. These acknowledgements and affirmations will avoid any future dispute as to the computation of what is due and owing by the borrower to the lender.
- it will contain an acknowledgment by the borrower that a default has occurred, or that multiple defaults have occurred, and it will contain an acknowledgement of the lender’s right to accelerate and demand immediate repayment of all amounts owed. (Defaults are not ordinarily waived in a forbearance agreement; the defaults are simply not acted on by the lender during the forbearance period.)
- it will affirm that the borrower is in default and has requested the forbearance.
- it will set a timeline for the resolution of the borrower’s difficulties and/or exit from the loan, and it will set forth a firm date by which the lender can and/or will exercise its rights and remedies to recoup that which it is owed by the borrower.
- it will permit lender’s counsel to review the loan documents; to the extent the documents need to be corrected, clarified or enhanced, a forbearance agreement presents a vehicle for doing so.
- it may provide the opportunity for a lender to adjust interest rates and require additional financial reporting of the borrower or any guarantors or require the borrower or any guarantors to uphold additional covenants.
- it will always contain a full release by the borrower and any guarantors of claims against the lender and its officers, obviating the likelihood of the borrower asserting counterclaims against the lender in the event the borrower defaults on the forbearance agreement or in the event the forbearance period expires and the lender is compelled to exercise its rights and remedies against the borrower.
- it can be conditioned on a myriad of other terms, such as the retention of a turnaround consultant, the pledge of additional collateral, the payment of a forbearance fee, the support of additional guarantors, the recapitalization of the business, or the sale of unneeded assets to reduce the indebtedness, etc.
Absent a material default or the occurrence of fraud, a short-term forbearance agreement with a borrower is oftentimes the best initial step to addressing a troubled loan. Particularly as economic difficulties arising from COVID-19 pervade the market, a forbearance agreement is often the first step that a lender can take in dealing with a borrower having difficulties. At Hackett Feinberg, many of our lawyers have extensive experience helping lenders negotiate and structure the right forbearance agreements for their borrower’s particular circumstances.
This communication is for informational purposes only and should not be construed as legal advice on any specific facts or circumstances.