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Revisiting Forbearance Agreements in a Pandemic

By: Laura Day DelCotto

The last five or more years have been ‘happy days are here again’ for cheap money and rising asset values. Piling on more and more debt has been encouraged and easy, including multiple tranches, secured positions and waterfalls. Repaying the debt, as opposed to selling the going concern at something above par or a series of never-ending renewals, seems to often be absent in all the business analysis. 

As we are prone to repeat time and time again, little thought is given by the ‘deal-makers’ on the front end to what happens on the back end when valuations diminish and liquidity is nonexistent. We are about to find out (again).

Shoring Up Collateral and Documentation Weaknesses

From a lender’s perspective, when a borrower needs an extension and additional borrowing, the forbearance agreement is the perfect vehicle to undertake a back-end review of the lender’s weaknesses, and get them fixed. This might include among others:

  • Full review by counsel of all loan documents
  • Running title and lien searches
  • Perfection of liens if deficiencies
  • Releases and waivers of all potential borrower claims
  • Analysis of other litigation or past due accounts
  • Mandated retention of borrower legal and financial consultants

Borrower has Little or No Leverage to Negotiate

From the borrower’s perspective, being in default means the lender has the full right to refuse to extend any additional borrowings or to renew. Period.  We routinely see borrowers without any liquidity approaching lenders at the very last minute with the news that payroll cannot be made. No lender appreciates receiving this emergency news. It creates the often-cited “lack of confidence” in management. Either they didn’t know they were so low on cash, or they have their heads in the sand, or all other sources of capital are tapped out. 

Forbearance Terms Strongly Favor Lenders

No one should be surprised to see onerous forbearance agreements. “Covenant-light” loans will become covenant-heavy. The real difficult question is whether the borrower wants to sign one. The deal-breaker is often the full release and waiver of all claims, in situations where a borrower thinks they have potential lender liability claims. There are also often bankruptcy related waivers and give-ups, like automatic stay waivers or advance stay relief stipulations. Sometimes even prohibitions on filing for bankruptcy altogether. While most of the “bankruptcy-limiting” provisions might later be deemed unenforceable in a bankruptcy court, the releases are generally enforced. Further, if a lender finds a hole in its perfection, then it will be fixing this and hoping to let a 90-day preference period run. This could be deemed a breach of duty, as it would have major detrimental impact on other creditors.

What is an Owner to Do?

There is no right or wrong answer. However, please go ahead now and work on removing the emotions of being angry at the lender for cutting off the cash. If the company can’t cash flow, then something needs to happen. It shouldn’t be riding on the backs of your trade by extending everyone into past due status. The answer also shouldn’t be raiding your own retirement accounts for money. If you come to grips early you will have more viable options. You don’t want to be sitting at a table with payroll due and a forbearance agreement you hate lying on the table with a pen. Don’t put yourself in this position. 

About DelCotto Law Group

DelCotto Law Group is Kentucky’s asset protection law firm known for its commitment to the lifetime success of its clients. With offices located in Lexington, Louisville and Danville, DLG serves Kentuckians with complicated financial matters, especially in the areas of bankruptcy and complex litigation. For more information please call (859) 231-5800, email info@dlgfirm.com or reach us on our contact page.

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