FORBEARANCE AGREEMENTS--BEWARE
The Dangers of Forbearance Agreements with Lenders
By Thom Avery
Blitz, Bardgett & Deutsch, LC
In situations where commercial borrowers are in default on a
promissory note, the lender may offer to enter into what is typically called a “forbearance
agreement.” 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. 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, 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. 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 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 they 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 the time and opportunity to
work through their 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 them 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. If possible, borrowers and guarantors need to
negotiate these types of clauses out of the agreement. 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 and you must do the same.
