By Thom Avery
In situations where commercial borrowers (developers, businesses, etc.) are in default on a promissory note, the lender may offer to enter into a “forbearance agreement” or some other form of deferment agreement with the borrower. These are often presented by the lender as a generous concession on their part in order to give the borrower additional time to try to work its way out of the problem. Although, forbearance agreements may provide the breathing space a borrower needs, more often than not, they are a means by which the lender improves its position to the detriment of the borrower.
Forbearance agreements are used when the borrower is already in default on the loan and the lender could immediately begin to collect against collateral and file a lawsuit for any deficiency. In a forbearance agreement, the bank or other lender offers to forbear from collection efforts for a period of time in exchange for certain things from the borrower. All forbearance agreements involve borrowers and/or guarantors giving up certain rights or property in exchange for additional time or other considerations. It is of utmost importance that a borrower, or guarantor, understand the deal they are making before signing a forbearance agreement.
First and foremost, the borrower has to understand what he or she is giving up in exchange for the time offered by the lender. Over the course of my career, I have reviewed countless forbearance agreements presented by banks or other lenders to my clients. Often, the client visited a bankruptcy attorney to see if they were a candidate for bankruptcy and was then referred to me. Every forbearance agreement I have reviewed includes a waiver by the borrower of all claims, defenses, and set-offs to the debt. If the borrower signs such a waiver or any agreement which includes such a waiver, anything that the bank may have done which was improper or illegal up to that point can no longer be the basis of a claim or defense by the borrower. Signing such a forbearance agreement means that if the borrower is not able to successfully work through its problems under the terms of the forbearance agreement and the bank subsequently takes actions to collect on the debt, the borrower will have no defenses to the bank’s claims and no effective means to resist the bank. The only exception would be claims that arose after the execution of the forbearance agreement. A lender that knows it did something wrong, which could constitute a defense to all or some portion of the debt, may use a forbearance agreement as a way to remove or minimize its risk going forward. Any borrower or guarantor who is asked to sign a forbearance agreement with a waiver needs to understand exactly what rights, defenses or set-offs it may be waiving by signing. The chances of successfully working through your problems during the forbearance period must be weighed against the rights that are surrendered.
Second, lenders often require borrowers or guarantors to surrender additional collateral and/or cash as part of the forbearance agreement. It is extremely important that the borrower and guarantors understand exactly what it is that they may be giving up for more time. Sometimes banks include collateral in a forbearance agreement that they would not otherwise be able to obtain in collection efforts. For example, if one spouse has a business which is the borrower under the loan, and personally guaranteed the loan, the bank may request a security interest in that spouse’s home in exchange for the forbearance agreement. Under Missouri law, assets held jointly by a married couple are not subject to the debts of only one or the other. So, in this situation, if the business owner is married, his or her personal residence, assuming it is titled jointly, would be immune from collection efforts by the bank on the business loan. A borrower should think long and hard before giving that type of security to the bank in exchange for some additional time to work through its problems. It may be better to let the business go and keep the family home.
Finally, borrowers and guarantors need to make sure that forbearance agreements offered by lenders actually require it to forbear. Banks or other lenders write in numerous, vague clauses which allow them to declare the borrower in default of the forbearance agreement prior to the time specified for forbearance. For example, the forbearance agreement may require the borrower to “cooperate” with the bank without defining what that means. If possible, borrowers and guarantors need to negotiate these types of clauses out of the agreement or at least make sure they are clearly defined. In addition, and very importantly, forbearance agreements typically leave the underlying loan documents in place. Many loan documents include a provision that states that the borrower is in default of the loan if the lender “feels insecure.” This is extremely vague language and there is no clear law as to what would justify a bank “feeling insecure.” Unwary borrowers could sign a forbearance agreement, waive their rights, give up additional collateral and then, very shortly after signing the document, find that the bank is declaring them in default because it “feels insecure.” This would be the worst of all results.
Under certain circumstances, forbearance agreement may be the right way to go for a borrower who is struggling to meet its obligations to a bank. However, it is extremely important that the particulars of the forbearance agreement be understood and the terms be negotiated with the lender. Regardless of what the loan officer may tell you, the bank or other lender is looking out for its best interest in entering into any forbearance agreement with you. It is up to you to make sure your interests, and those of your business, are protected.
Thom Avery is a recognized leader in Missouri on the subject of lender liability. He has extensive experience representing businesses and developers in disputes and litigation with banks and other financial institutions. On behalf of his clients, Thom has obtained large settlements from banks for lender liability, judgments voiding guarantees and negotiated favorable work-outs.