With inflation, supply chain blockages, inflation, low crop prices, drought, expensive regulations and increased interest rates, many Central Valley farms, ranches and businesses are feeling stressed.  We are seeing an uptick in lenders moving loans to special assets departments and we perceive there is soon to be a wave of restructurings.

A farm or business faces many challenges when a restructuring is necessary. Even in the absence of payment or other loan defaults, a lender may increase scrutiny of a loan if it sees negative trends for an industry, a downturn in earnings, an increase in expenses, or other negative financial events, the so-called “covenants.”

In such instances, a lender and borrower often negotiate and execute a forbearance agreement. This article addresses these types of agreements from a borrower’s perspective. We believe that being educated as to what the agreement provides is very important and it helps borrowers better understand what is, and is not, typical.

A forbearance agreement, also known as a “standstill agreement,” is a separate contract that obligates a lender to refrain or forbear from enforcing existing or anticipated defaults for a period of time in exchange for new agreements by a borrower. Typically, a borrower gets more time by giving up rights. During a forbearance period, the borrower cures defaults, improves performance, or exits its borrowing relationship with the lender. The lender does not waive defaults during the forbearance and may enforce them and its rights and remedies at the conclusion of the forbearance term, or sooner if there is a default.

As a borrower, what are things you should look for in the forbearance agreement?

Defaults. The severity and type of default will be recited. If the defaults are not too severe and if the lender has confidence in the borrower a simpler extension and default waiver might be used. Borrowers will wish to carefully review the listing of the defaults as the borrower will be expected to acknowledge the defaults. Covenant breaches likely to precipitate a forbearance agreement include loan to value ratio violations, tax liens, skipped payments, diversion of collateral and collateral coverage issues.

Lender Confidence. Even where there is not a monetary default, the pending maturity of a loan may be the impetus for a forbearance agreement that requires a borrower to seek financing elsewhere. A lender that lacks confidence in the borrower is often interested in exiting the credit but not in liquidating assets to achieve repayment and will view a forbearance agreement as the cleanest path to exit.

A forbearance agreement is often a more attractive option for a lender than pursuing a judgment and forcing liquidation because:

• Collateral securing the indebtedness is often illiquid and enforcement of the loan through liquidation of the collateral would create a loss or a lesser recovery. Collateral usually brings less if sold under stress or duress.
• Deficiencies in loan documentation or collateral coverage can be corrected while giving the borrower time to effectuate a turnaround or obtain alternative financing. Borrowers must “flyspeck” the existing agreements to determine if there are defects. There is a lot of borrower leverage from identifying documentation defects. Lenders want to cure these defects. They also want borrowers to agree there are no claims against the lender.
• A lender can preserve defaults if a borrower continues on a downward trend and cannot exit in a timely manner and can use the defaults to the detriment of the borrower.
• A lender can obtain extra fee income. Lenders like these fees and interest bumps, especially when interest rates are low.

A Forbearance Agreement is not always better for a lender than a simple loan extension document. Some reasons include:

• No event of default has yet occurred.
• A lender may want to retain the relationship but needs for the borrower to reverse negative trends. Some borrowers have to be jolted into reality and a forbearance demand is a hard wakeup call to force the borrower to get real.
• A borrower needs continued advances, often for amounts in excess of the existing borrowing base formulas.
• Lenders often have regulatory pressures that just mandate certain paper being in the loan file.
• The timeframe for repayment or exit may require a long-term strategy (more than one year).
• Borrowers may also benefit from a forbearance because it gives them time and borrowers always want more time. (However, their desperate need for more time makes them very bad negotiators when it comes to what they are willing to give up.)

Negotiating the Agreement

Once it is determined that a forbearance agreement is needed, the parties can proceed in many different ways. First, they simply may negotiate terms, document the deal, and sign the agreement. If the parties cannot reach an agreement, they may proceed to litigation and liquidation or bankruptcy.

In many instances a lender will want written acknowledgement before drafting begins that until a written agreement is reached, it is under no obligation to forbear and the mere entry into forbearance negotiations is not a waiver of rights, remedies, or defaults. Sometimes lender’s propose a “pre-negotiation” agreement setting out:

• The parties’ identities.
• The nature of the default.
• An agreement to negotiate in good faith.
• A good faith fee to be paid in advance of execution of the forbearance agreement.
• Terms to be included in the agreement.
• Maintenance of the status quo pending conclusion of negotiations.
• Acknowledgement that all loan documents are unchanged and no defaults are waived, and the parties mutually reserve all rights (i.e., defaults and defenses).
• A reminder that the pre-negotiation letter is not an agreement to forbear and that notwithstanding any discussions or the reaching of any unwritten or preliminary understandings, the lender may determine not to undertake further discussions or may terminate discussions at any time and for any reason whatsoever without prior notice to any obligor and without liability.

Once it is decided to proceed the forbearance agreement must be documented to reflect the specifics of the transaction.  The following is a non-exhaustive list of terms usually included. This also provides a good place to summarize the existing transactions between a lender and borrower and:

• Detail all of the all obligors (borrowers, guarantors, pledgors of collateral).
• Identify existing loan documents and security documents.
• Describe existing collateral.
• List judgments and any material litigation.
• List all defaults.
• Detail the amount of bank debt, including fees and professional fees.
• State that borrower has requested forbearance.

Forbearance Period, Termination Date. The forbearance period and a termination or expiration date, until which the lender will forbear from enforcing the defaults, will be specified. The termination date provision can provide for an automatic extension upon the occurrence of a particular event, such as an executed commitment letter, agreed upon sales, or asset purchase agreement.

The forbearance period typically is less than a year, sometimes it is much shorter. Borrowers always want more time, while lenders want to keep borrowers on a short leash.

Forbearance Fee. A forbearance fee is charged. The amount varies from lender to lender. This may seem counterintuitive when a borrower is already facing cash shortages, but it constitutes consideration for the lender not to enforce its rights and remedies immediately. The fee should be reasonable relative to the transaction so that it is not be viewed as a penalty or as “unconscionable.” The fee, even if paid in installments or on the termination date, will be “fully earned” as of the execution of the agreement. Some lenders simply deduct the fee from the borrower’s account others will add to the loan balance.

If a borrower performs at certain levels or repays the obligations early or prepays at specified times and levels, a lender may waive all or any part of the fee, which can be a powerful incentive for a borrower to get its refinancing finalized and/or to perform as promised.

Confirm Collateralization, Fix Deficiencies. Borrowers and guarantors will be required to ratify their obligations under the various loan and collateral documents and confirm the validity and extent of their obligations to lender. If a deficiency exists in the documents or collateral, provisions will be included for new or additional documents to be executed or collateral to be pledged. A borrower may not realize the documentation or collateral deficiencies exist. When a “collateral fix” is included, the termination date will be at least 90 days out — the time required to “preference-proof the “fixed” liens for benefit of the lender. Borrowers need to recognize this and get their financial house in order or prepare for a Chapter 11 during this preference period.

Language may be included to reaffirm, re-grant, or grant new liens, security interests and deeds of trust, as well as an authorization for the lender to file financing statements and amendments. If it is not already included in the loan documents, a power of attorney may be added to authorize the lender to take actions as agent and attorney in fact for the borrower to effectuate the purposes of the forbearance and loan agreements if the borrower fails to do so.

Scope of Forbearance by the Lender. Exactly what the lender will not do during the standstill period should be specified: accelerate, record forbearance notices, discontinue lending, notify account debtors to pay, enter judgment, or execute on any judgment. Similarly, what a lender may do also should be detailed: perfect liens, protect collateral, defend against actions by third parties, pursue non-party obligors, seek exit financing, list and sell assets, etc.

Interest Rates. A forbearance agreement is often used by lenders to increase the interest rate. Again, the issue of the borrower’s ability to afford additional interest when it is facing a cash crunch may arise. However, if the goal is to push the borrower to exit the relationship, it benefits the lender not to make it too comfortable or inexpensive for the borrower to encourage the borrower to obtain leave the bank and obtain financing elsewhere. Lenders intend for the forbearance period to be uncomfortable and costly.

Tying the interest rate to financial covenant performance levels is a fairly common practice. Because most notes authorize the charging of default interest, a lender may agree to increase the interest rate to a level below the default rate as an accommodation to the borrower. The agreement will specify that upon the occurrence of a standstill or forbearance default, the default rate will apply immediately.

Payments During Standstill Period. Depending on the borrower’s circumstances, there may be a need for deferral of scheduled principal payments. Installment payments that will be due during the forbearance period should be stated with specificity by amount and date. Rarely will a lender agree to a deferral or forgiveness of interest payments unless a fairly dire situation.

If the purpose of the forbearance is to push the borrower to exit the credit, it should specify that payment in full is due upon the termination date. If the borrower owes on a line of credit and term debt, the borrower will be required to commit that both obligations will be paid in full on the termination date.

Discount Payoff. A good way to incentivize a borrower to exit is to provide a discount that decreases with time — the sooner the borrower exits, the higher the discount it receives. If the agreement contains a discount, it is important to tie the discount to payment by a date or dates certain. It will be stressed that a condition precedent to the discount is full payment; and that there is no dispute about the amounts due. Lenders will specify that strict compliance is essential and that time is of the essence.

The agreement will provide that a precondition to the right to the discount is that there has been no event of default in the interim.

Refinancing or Equity Infusion. The agreement may require that a borrower use its best efforts to obtain refinancing or an equity infusion. The agreement may set a schedule for the borrower to obtain and accept a commitment letter and for a closing of the new loan. An automatic extension of the termination date if a commitment is accepted prior to the termination date may be included. The agreement will likely require monthly reporting on refinancing efforts and obligate the borrower to provide a copy of any refinance offer and commitment from the replacement lender. Note that “waffling” commitment letters will not satisfy the lender.

Payment of Professional Fees, Other Expenses. The agreement will re-obligate the obligors to pay the lender’s professionals’ fees and expenses. These fees can be quite high and borrowers should insist on reasonableness language and a cap on amount.

Retention of Professionals. Lack of confidence in management or its ability to effectuate a turnaround may be a basis for including a provision requiring the borrower to hire professionals. The agreement will specify that such consultants (attorneys, accountants, consultants) shall cooperate and share information (including financial information) with the lender and are expressly authorized to do so.

Waiver of Defenses, Release. These are critical provisions for a lender and usually non-negotiable. If a lender is going to forbear from enforcing its rights, it wants a clean slate. If the obligors can preserve every defense to fight another day, the lender may choose to undertake the battle immediately rather than delay.

The release should be explicit, and a lender will want it to be very broad. It will be stated that obligors have no defenses and that they waive and release every defense and also covenant to not sue. It will cover things the borrower may not even know to exist. The release will run up to the date of the agreement.

Indemnity. The purpose of an indemnification provision is to protect the lender from incurring any additional expenses in connection with the obligations for which the borrower is liable but could otherwise argue are not “indebtedness.” The indemnity will include language stating that it survives repayment of the indebtedness.

Forum Selection. Especially important when the borrower and lender are in different jurisdictions, the lender will want the forum dictated in the agreement. Additionally, loan documents may provide for the specific jurisdiction for suits.

Jury Trial Waiver. The agreement will almost certainly require jury trial waivers. For lenders, the jury trial waiver is a standard “non-negotiable” term.

Events of Default. The agreement will require that obligors will continue to perform all of their obligations under existing loan documents. However, the agreement should specify what future events will be defaults under the forbearance agreement. The effect of a forbearance default will be a termination of the lender’s obligation to forbear, and the right to proceed to enforce its rights and remedies immediately, sometimes without notice or a grace period.

Some defaults result in automatic termination without notice. These include a bankruptcy or insolvency proceeding of the borrower (or a key obligor), a suit by any obligor against the lender, and indictment, death, or incompetency of one or more key persons. Other types of defaults may authorize, but not require, the lender to notify the borrower of the default before terminating the lender’s obligations under the agreement.

Bankruptcy/Receiver Provisions. A covenant that the borrower will not file bankruptcy will not be enforced but may be in the agreement anyway. Another alternative is a provision waiving the automatic stay if a bankruptcy is filed. Another is a stipulation to not oppose appointment of a receiver or even require consent to such appointment.

Liquidation Remedies. The agreement can specify that the borrower consents to the appointment of a receiver or agrees to surrender collateral or hold a voluntary auction of assets by specified dates or a forbearance default.

Representation by Counsel. The agreement may require the borrower to consult with counsel. This is to protect the lender from claims the borrower did not understand the agreement.

Parol Evidence. The agreement will almost certainly provide for the borrower to acknowledge that every single agreement of the parties is reflected in the agreement and there are no side deals or unwritten promises or representations.

Conclusion. Borrowers must recognize that a forbearance agreement is a lender’s tool. In exchange for more time the borrower will be called upon to waive rights and grant other rights. Borrowers should educate themselves before entering into forbearance agreements. Be sure that you can perform the requirements of the forbearance agreement during the period of the forbearance. A good dose of realism is needed during this process.

April 2023

Riley C. Walter is a certified business bankruptcy attorney certified by the American Board of Bankruptcy Certification and a member of Class 13 of the American College of Bankruptcy.  He practices in the Central Valley of California with an emphasis on farm and agribusiness cases.   Danielle J. Bethel is an associate attorney at Wanger Jones Helsley where she practices bankruptcy and insolvency law.