How do borrowers and lenders manage during an economic downturn?
COVID-19’s impacts on our lives now include massive intrusions into the arrangements between borrowers and lenders. Customers have disappeared. Revenues have disappeared. But financial obligations remain.
How can borrowers and lenders work together in these uncertain times to make the best of a bad situation?
Fortunately, there is an option called a forbearance agreement, an agreement that clarifies how a borrower and lender can best manage in circumstances like these. In some circumstances, a forbearance agreement can even salvage a business relationship that would otherwise crumble.
A well-crafted forbearance agreement benefits all parties – the borrower, lender and any guarantors.
Expectations are clarified, tension is reduced, disputes are clarified or eliminated, additional time is created for strategizing, costly litigation is avoided and otherwise positive relationships between borrower and lender can be reaffirmed.
More specifically, lenders benefit from:
- Perfecting existing collateral and confirming the lender’s priority position;
- Identifying opportunities for additional collateral and or guarantees;
- Indemnifications or releases;
- Additional covenants and restrictions on the borrower;
- Strengthening procedural position should the borrower be subject to bankruptcy or insolvency; and
- Avoiding the risks and costs associated with enforcement.
Borrowers benefit from:
- Additional time to address financial issues;
- Avoiding bankruptcy or insolvency proceedings;
- Continued finances; and
- Additional conditions to allow for flexibility or modification of credit terms.
Key Terms and Provisions
There are essential elements to a forbearance agreement.
The Loan Amount and Outstanding Principal: It is important that the parties confirm the loan amount. It is also an opportunity to make sure all parties are on the same page regarding the outstanding debt.
Security Documents and Existing Collateral: Similar to stating the loan amount and outstanding debt, it is helpful to confirm the existing security documents and collateral. This also allows parties to determine what documents should continue and if there is a need for additional security and or collateral.
Defaults (if any): If the borrower has defaulted, all events of defaults should be acknowledged in the agreement.
Acknowledgments: A lender should seek the borrower’s acknowledgement of the following:
- Defaults and receipt of notice of defaults (if any);
- Lack of defences or counterclaims;
- That the loan is due and payable (if applicable);
- The lender is not required to make more loans to the borrower;
- The lender is reserving all its rights under both the initial loan agreement and the forbearance agreement and is not waiving any existing or future rights under either agreement; and
- The lender has acted in good faith.
Forbearance Period: Like most agreements, a forbearance ordinarily runs for a prescribed period, or until there is an event of default. It is usually beneficial for the borrower to have a longer period and for the lender to prefer to be bound for a shorter timeline.
Scope: The scope sets out exactly which actions the lender is forgoing during the forbearance period, in addition to those that the lender may choose to take.
Waiver of Defences and Release of Claims: Usually in a forbearance agreement the borrower and guarantor will waive any claims or defenses they may have against the lender.
Payments and Interest: Here the parties can negotiate the best payment plan for the borrower. This could be any of the following or a combination:
- Reduced payments;
- Reduced interest;
- No principal payments but payment of interest; and/or
- Deferred interest payments.
Amendments to Loan Agreement: If parties agree, amendments could be made to the loan. This is also an opportunity for the parties to correct any deficiencies in the loan.
Reaffirmation of Guarantees: This is one of the main reasons why guarantors should be party to a forbearance agreement, so they can reaffirm their guarantee under the loan. Their acknowledgement helps to avoid any future argument as to the enforceability of their guarantee due to the forbearance agreement.
Bankruptcy Provisions: Where the forbearance period is long, a lender may want provisions related to bankruptcy or insolvency. These provisions would minimize risks and or ensure procedural advantage for the lender. For example a waiver of automatic stay, which allows the lender some relief should the borrower be subject to bankruptcy or insolvency.
The impact of COVID-19 is extensive, and reaches many borrowers and lenders. As a result of the uncertainly created by COVID-19, forbearance agreements may be more valuable than ever. They can bring certainty to parties at a time of tremendous change, and enable them to move forward together.
Our team is available if you would like to discuss the strategies available.