Suggested Provisions for Forbearance Agreements

Introduction

When a commercial loan goes bad, the lender generally has two choices: (i) do everything it can to collect the loan, including a collection suit versus all obligors and/or liquidation of collateral or, (ii) work with the borrower by providing some time for it to right the ship and regain its financial footing. The latter option typically involves the parties entering into a forbearance agreement whereby the lender does not exercise any of its rights or remedies under the loan documents in exchange for certain terms, conditions and concessions from the obligors. The subject of this article is a non-exhaustive list of some provisions to consider including in a well drafted forbearance agreement. 

Introductory Sections

I start all of my forbearance agreements with detailed Recitals. There I want to list (i) all of the existing loan and security documents, (ii) all defaults under such documents that the lender is aware of and, (iii) all communications sent by the lender prior to my engagement as well as any communications sent by me relevant to those defaults, i.e.  any notice of default, demand, opportunity to cure, etc. I then conclude with a brief status of the relationship as of the date of the Agreement along the lines of, “Payments were not made as required for the prior two months, the maturity of the loan was accelerated, demand for payment was made by letter dated (include actual date) requiring payment in full by a certain date, but despite such demand, full payment has not been made as of the date of this Agreement.”   I then provide a complete and detailed statement of what the lender believes is outstanding, together with the reminder that there is a “default rate of interest” (if applicable) and that the obligors are liable for the lender’s collection costs and attorneys’ fees.  With that background in place, I then have the obligors ask the lender for forbearance, which the lender is agreeing to in exchange for the terms of the agreement.

My first section of the agreement after the Recitals requires the obligors to confirm everything stated in the Recitals, affirm the validity and binding effect of the loan and security documents, and confirm the accuracy of the representations and warranties in such documents other than any which may be causing the default. I should also mention at this point that the agreement very likely will be for a relatively short period of time, but if the borrower shows signs of turning the corner during the “forbearance period” it is likely to be extended through one or more amendments. Thus, it is important to set out as much detail as possible in the agreement because it may become the basis of the relationship for a long period of time.

Specific Forbearance Terms

I next address the specific terms and conditions of the forbearance. These are wide ranging and very fact specific depending on the type of business, type of and reason for the default(s) and how the lender wants to both protect and enhance its position but also give the borrower the ability to recover from the default. First and foremost, after an in-depth review of borrower provided financial information, the parties must agree on payments which make sense to both. These may be interest only for a time, at least enough to maintain the status quo.  Next, the agreement needs to address how the borrower will begin to regain its financial strength and cure the existing default(s). For example, in addition to non-payment, perhaps the debtor has violated a required financial covenant. Curing this default may involve a voluntary sale of some property to generate a curtailment of the debt or it may require the obligors to contribute additional collateral to the lender.  Regardless of the specifics, this section needs to be very detailed and if applicable provide certain progress benchmarks which can be monitored.

My next sections are designed to enhance certain provisions of the existing loan documents. This generally includes greater and/or more frequent financial reporting, greater and/or more frequent collateral inspection rights and a detailed list of items which the obligors are required to inform the lender about, i.e. any new defaults which arise, existing or future defaults to other creditors including trades, any existing claims or litigation and any changes in structure, key personnel or operations. I also include provisions to the effect that all prior discussions are memorialized in the agreement, any obligor who does not sign is subject to collection action and no provision can be amended except by written agreement.

Bankruptcy Provisions

I also include in the main section a somewhat controversial provision, known generally as a waiver of the automatic stay which is provided by the Bankruptcy Code in the event things do not go as planned and the borrower has to file for relief.  I say controversial because not all bankruptcy courts will accept them.  The courts have generally taken one of two approaches to such provisions.  Some courts, including the United States Bankruptcy Court for the Western District of North Carolina, have taken the position that such provisions are not enforceable as a matter of public policy, essentially rendering the automatic stay meaningless.  “Upholding pre-petition waivers of this sort deprives debtors of the "breathing spell" contemplated by the Bankruptcy Code and thwarts the congressional intent underlying imposition of the automatic stay.”   In re Jeff Benfield Nursery, Inc., 565 B.R. 603, 609 (Bankr.  W.D.N.C. 2017). 

Other courts such as the Northern District of Georgia Bankruptcy Court in In re Orchard Hill Baptist Church Inc., 608 B.R. 309 (Bankr. N.D.Ga. 2019), have upheld such provisions. Even those courts which have upheld them, however, generally note that such provisions are not automatic or self-executing and analyze the facts and circumstances of each case to determine whether the waiver should be upheld. For example, in the Orchard Hill case, the court considered four factors. First, the court found that the debtor, being a sophisticated borrower, agreed to the waiver language contained within the forbearance agreement and was ultimately bound by it. Second, the court found that the waiver was adequately bargained for at the time the parties entered into the forbearance agreement. Third, the court found that no other parties would be harmed by the enforcement of the waiver, as the debtor had few other creditors, all of whom had been silent in the case. Finally, the court found that the debtor’s proposed plan was not financially feasible, as the debtor still had made no payments on its debt and failed to show how it would be able to fund its plan. Based on these factors, the Orchard Hill Court concluded that the waiver of stay provision was enforceable.

Importantly, the Orchard Hill Court noted that the existence of such language does not automatically entitle a secured creditor to relief from the automatic stay. Instead, it only entitles the secured creditor to the right to seek relief from the automatic stay free of any opposition by the debtor. The debtor does not waive the stay but does agree not to oppose any motion for relief filed by the lender. Finally, it should be noted that the existence of the waiver does not constitute cause for relief in and of itself; it is a factor, but others must be considered as well.  Although I advise my clients that it may not be enforceable, I generally include it in my forbearance agreement.

One final note regarding Bankruptcy: I also include language in my forbearance agreement that nothing in such agreement or otherwise shall be construed as consent to the use of “cash collateral” without the express written agreement of the lender and/or an order of the bankruptcy court.  This forces the parties to the negotiating table quickly in the event of a Bankruptcy filing.

Concluding Sections

The concluding sections of my agreement generally fall into two categories. In addition to the document enhancements I noted above, I also include a number of extra covenants regarding record and collateral maintenance, as well as prohibitions on incurring further debt, fraudulent, voluntary and insider transfers and conveyances, related party loans, and increases in salary and other distributions.  My final section contains a number of waiver and release provisions. This section of the agreement also contains provisions which make clear that while certain forbearance terms are being imposed, they are for the benefit of the lender, not any obligor or other third party, and do not constitute interference in or management of the borrower or its business. Lenders must walk a fine line so that they are not accused of being the cause of the ultimate downfall of the business.

As noted above, this is a brief and non-exhaustive list of some key provisions. Every loan relationship and the reason for its troubled status is unique, so care must be taken in drafting every agreement to best serve the client’s desire to rehabilitate the borrower without being the final nail in the coffin.

Richard Biemiller is Pender & Coward shareholder focusing his practice in the areas of creditors’ rights, banking and financial institutions, commercial transactions and real estate.