The Indiana Bankers Association publishes the Hoosier Banker magazine, which features my article about forbearance agreements in the current issue. Click here for the online version of the piece. The full article follows. I’d like to thank the folks at the IBA for allowing me to contribute to the March/April publication.
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When facing a loan default, the fundamental question for lenders is whether to exercise their remedies against the borrower and/or guarantors (collectively, “obligors”) or to pursue a settlement (workout). A forbearance agreement is a workout tool—a temporary settlement agreement.
What is a forbearance? Black’s Law Dictionary defines “forbearance” as the “act of abstaining from proceeding against a delinquent debtor; delay in exacting the enforcement of a right; indulgence granted to a debtor.” The idea is that the foreclosing lender agrees to a timeout.
Why would obligors want time? They:
• face a judgment or a foreclosure (loss of their property) and need to restructure their affairs
• desire to sell the loan collateral (such as commercial real estate) to pay off/pay down the loan
• intend to work with another lender to refinance
• want to settle internal partner disputes affecting the loan’s performance
• need to resolve a temporary hardship (i.e. COVID or other impact on revenue)
• seek to cure covenant defaults such as mechanic’s liens or code enforcement violations
Why would lenders consent to a timeout?
• Foreclosure litigation is a last resort
• The loan’s performance stems from a temporary problem that can be solved with time
• There is a positive relationship with the borrower group (trust)
• The obligors are preserving and protecting the loan collateral (i.e. the assets are not in jeopardy of being lost or impaired)
• The collateral position is weak (i.e. there is relatively little value in the property)
• The collateral is defective (i.e. environmental contamination)
• The guarantors are judgment proof
• The loan documents have defects that can be fixed in the forbearance agreement
• Forbearance saves attorney’s fees and litigation expenses
• Temporary settlements avoid the commitment of bank personnel necessary to litigate
Contract.
Under Indiana law, forbearance agreements are contracts. The agreement reduces the situation into a single document that is relatively easy for judges to understand. (An added bonus is that judges tend to look favorably on lenders who resort to court after first affording obligors the opportunity to avoid suit in the first place.) Make sure to clarify in writing all of the essential terms of the deal.
Signatories.
All obligors to the loan should sign the forbearance agreement, or lenders risk releasing the omitted obligors from liability. This is because a forbearance agreement arguably constitutes a “material alteration” of the original obligation. Under Indiana law, a guarantor can be released from liability if the underlying obligation is “material altered” without the guarantor’s knowledge and consent. The simple solution is to have all the obligors sign the agreement. If a guarantor is unwilling to execute, then the lender should proceed to litigation or explore a different workout approach.
Settlement
As with any compromise, everything is negotiable. Also bear in mind that the parties can enter into forbearance agreements virtually at any point—before or during a lawsuit, even after the entry of judgment.
Release. All forbearance agreements should require the obligors to waive any and all rights, claims and defenses. This will help lenders and their counsel to streamline any future litigation necessary to enforce the loan if the forbearance agreement is breached. Indiana law is settled that forbearance releases are effective to protect against future lender liability claims. If an obligor is not willing to grant a release, then the lender might as well get on with the fight.
Deal terms. Here is a list of some key contract terms to be considered:
• Obligors’ admission of:
o existing loan documents and the ratification of same
o lien perfection
o default(s)
o debt amounts
• Payment terms:
o payment of principal and/or interest during the forbearance period versus deferral
o rate of interest
o payment of escrow items versus deferral
o treatment of any past due interest
o treatment of any past due principal payments
o payment of attorney’s fees
o payment of a forbearance fee
o payment of other out-of-pocket expenses such as appraisal fees
• Extension of maturity date
• Stipulated payoff amount upon maturity (end of the forbearance period)
• Agreed judgment, either filed or escrowed (aka “pocket” judgment)
• Addition of collateral
• Addition of guarantors
• Cure of prior loan document defects
• Requirement to resolve other liens or junior lien foreclosure suits
• Waiver of jury trial and covenant not to sue
• Consent to jurisdiction and venue
• Release of claims and defenses (see above)
Depending on your particular situation, the benefits of granting obligors more time through a thoughtful and well-written forbearance agreement can exceed the costs of deferring the enforcement of the loan.
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My practice includes representing parties involved in disputes arising out of loans in default. If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@dinsmore.com. Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.