Forbearance Agreements Provide Breathing Space

Current economic and credit market conditions have created for both lenders and borrowers a difficult environment in which to work out the many loan agreements that are or soon will be in material default. Few options are available to borrowers to refinance their troubled loans, while lenders often find that foreclosure on collateral generates recoveries far below the amount of the outstanding secured debt. One tool that can be useful to both sides under these circumstances is a forbearance agreement. Today, we discuss some central concerns the parties should address in their forbearance arrangements.

Background

In the usual forbearance arrangement, a lender conditionally agrees to refrain for a limited time (the forbearance period) from exercising its rights and remedies under a defaulted credit agreement while the borrower seeks to refinance, restructure or otherwise repay its debt or cure its defaults. Forbearance agreements are sometimes referred to as “standstill agreements.” That label is incorrect, however, because rarely do both parties simply “stand still.” Rather, forbearance agreements often require borrowers to make certain concessions and undertake new actions; adopt significant substantive amendments to the loan documents that go into effect immediately; and guide how the credit facility will operate during the forbearance period. Forbearance arrangements are distinct from both “pre-workout agreements” and comprehensive restructurings, which are at opposite extremes of the workout negotiation continuum. Pre-workout agreements are the opening gambit in workouts. Their primary function is to facilitate negotiations by establishing that the parties may consider and discuss revising the loan terms, or renewing or extending the loan, without prejudicing their respective rights, claims and defenses should they fail to reach a definitive restructuring agreement.¹ Since pre-workout agreements maintain the status quo of the lender and the borrower during the workout discussions, they, much more than forbearance arrangements, provide a standstill. Comprehensive restructuring arrangements, of course, result in both a cure or waiver of the borrower’s defaults and a permanent revision of the terms of the credit facility. Forbearances fall between pre-workout arrangements and comprehensive restructurings. Reduced to their essence, forbearance agreements merely suspend the exercise of creditor remedies temporarily while neither curing or waiving the borrower’s defaults nor impairing the lender’s right to exercise remedies ultimately.