What Every Lender Must Know About Forbearance Agreements
There are more uncertainties than certainties regarding the economic outlook in response to COVID-19. One certainty is that loan defaults will rise. Those of us that lived through the great recession learned many valuable (if not painful) lessons in loan workouts and restructurings. A common tool for lenders dealing with troubled loans is the forbearance agreement. Forbearance agreements can take many forms and accomplish many things. Forbearance agreements can maintain the status quo, give the borrower time to “right the ship,” give more protection or collateral for lender to recover from, or simply give all parties time to figure out what to do next in the middle of stormy weather. Any forbearance arrangement or loan modification in response to a borrower default must take into account certain considerations.
All Workouts Should Start with a File Review
All loan workouts, whatever form they may take, just like any foreclosure or other legal proceeding, should begin with a thorough review of the loan file. The forbearance agreement is, first and foremost, an opportunity to fix or remedy any errors or oversights in the loan documents.
Order Title Work and a UCC Search
If there is real estate collateral, it is critically important that one of the first things the lender accomplishes is to have a foreclosure commitment or letter report prepared by a title company. Having title work prepared is the only way to fully and accurately determine whether there any title issues. For example, does the legal description on the foreclosure commitment match the legal on the mortgage? Has the legal description changed? Is the owner the same as the mortgagor? Has any property been released from the mortgage? Additionally, the lender must determine whether there are junior liens or other encumbrances that have attached to the property. Likewise, as to personal property collateral you must conduct a UCC lien search to determine that security interests are properly perfected, to determine lien priority, and determine if there are any IRS issues with the borrower.
Check the Status of Outstanding Taxes
The title work should tell you if there are delinquent real estate property taxes, or you can obviously run a search online to determine this. It is critical that you know the status of the real estate taxes to require the borrower to pay the taxes in the forbearance period.
Understand What you Hope to Gain from Giving the Borrower Time
The lender should always determine the goals of the forbearance. What are the expectations and best case scenarios that the parties hope to achieve? Is the lender interested in continuing a lending relationship with this borrower? Is liquidation of the collateral the goal, or is the collateral only valuable as a going concern? Is there additional collateral that the borrower/guarantor could encumber? Are there environmental concerns that prevent immediate foreclosure/sale? Are there jobs that need to be saved, are there political reasons that come into play or is the workout newsworthy? The borrower must decide if they want to continue to operate their business, or if they are ready to hand over the keys.
What Terms/Provisions Should You Make Sure to Include in Your Forbearance Agreement
Every lender should maintain a checklist of terms/conditions that should be set forth in each forbearance agreement. These terms include:
- Identify all of the existing loan documents including notes/obligations, all security agreements including mortgages and personal property security agreements, and all guaranties.
- Identify the amount due on the obligations.
- Identify any past due taxes.
- The borrower should acknowledge an existing default under the loan documents.
- The borrower should reaffirm the debt and loan documentation.
- The forbearance agreement must provide a forbearance term. This is up to the parties. Lenders are often reluctant to go out farther than 6 months. On occasion, the parties may agree to an automatic renewal whereby if certain milestones are met, the forbearance term automatically renews for an additional period.
- If payments are required during the forbearance term, the agreement must provide the amount and timing of payments, any changes in interest rate, acknowledge that fees and costs are accruing and have accrued, and identify whether other payments (such as taxes) need to be paid.
- The agreement must clearly identify the events of default including failure to pay, failure to perform, and the imposition of any proceeding against the borrower by other creditors that could impact the lender or its collateral.
- The agreement must identify the remedies upon default. If the agreement provides for a deed in lieu (discussed below) then upon default the bank may be entitled to record the deed. The agreement should at a minimum provide that the bank would have all of its available remedies at law (foreclosure, collection, Chapter 128 receivership).
- A forbearance agreement is a contract, so you should include standard contract terms such as: (1) time is of the essence clause; (2) choice of law provision; (3) no delay or omission by bank shall constitute a waiver; (4) no oral modification clause; (5) parol evidence clause; (6) notice provisions and addresses of all parties and counsel for notice purposes; and (7) agreement may be executed in counterparts.
- Will the agreement contain a right to cure? The borrower should request one, the bank will likely argue against any cure provision.
- The bank should consider inserting a provision into the agreement that it is not providing tax advice as part of the forbearance negotiation and process. As borrower’s counsel, you need to be prepared to advise your clients on potential tax consequences arising from the forbearance process.
- The lender will want a release from any and all liability relating to the loan documents from the borrower and guarantor. Additionally, the lender should include a jury waiver so that any litigation going forward will not be subject to a demand for a jury by the borrower or guarantors.
What Remedies Should be Available if There is a Default Under the Forbearance Agreement
By extending the borrower an opportunity to “right the ship” or find replacement financing the lender should not then be further delayed in the event of additional default by the borrower. Here are some common remedies every lender should consider as part of a comprehensive forbearance agreement:
- Deed in lieu of foreclosure: The lender may require the borrower to execute a deed in lieu of foreclosure to be held in trust during the forbearance period. This would give the lender the right (but not the obligation) to take back real property collateral without the necessity of commencing a foreclosure action. A word of warning – any lender should involve a title company when it comes time to record a deed in lieu to make sure that title is clear and free from liens or claims that would then become the lender’s problem. A further word of warning – the deed should also include what is referred to as an “anti merger provision” providing that may afford some protection to the lender if a lien is present after recording the deed in lieu.
- Voluntary surrender: As to personal property collateral, the lender may ask the debtor/grantor of security interest to execute a voluntary surrender of the personal property. As with a deed in lieu, the forbearance agreement may provide that the voluntary surrender will be held in escrow during the forbearance term.
- Shortened Redemption Period: Because the lender is agreeing to grant additional time to the borrower/guarantor, the bank will likely ask that the borrower agree to a shortened redemption period in the event that the lender needs to commence a foreclosure proceeding. Additionally, if a deed in lieu is granted there may be any number of reasons why the lender cannot actually record a deed in lieu, or after obtaining a deed in lieu, why the lender may choose not to record the deed. Therefore, the bank will want the forbearance agreement to provide that the lender may foreclose on the property, at its option, that the borrower consents to the entry of a judgment of foreclosure, and that there will be a shortened redemption period or no redemption period in some circumstances.
- Chapter 128 Voluntary Assignment: It may be in the parties’ best interest that the borrower agree to a Chapter 128 receivership, which is a Wisconsin receivership statute which provides that the debtor/borrower assign its assets to a court-appointed receiver for the benefit of the debtor’s creditors. In Wisconsin, the secured creditor must consent to any such assignment. A Chapter 128 proceeding may be voluntarily agreed to by the debtor, or may be involuntarily commenced by a creditor. The bank may consider asking the debtor to consent in a forbearance agreement to a voluntary assignment for the benefit of creditors in the event of default under the agreement. The bank may consider requesting that the borrower execute a voluntary assignment form to be held in escrow.