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If the current economic downturn continues, the number of borrowers that default under debt agreements will increase significantly. A previously prized borrower that once could dictate terms to its lender likely will find itself with fewer options when facing a default and will be forced to work with its existing lender to obtain either a waiver or a forbearance agreement.
Waiver and forbearance agreements contain many similar provisions, and they both provide a certain amount of relief for the borrower. One significant legal difference: A forbearance agreement will not eliminate the default. To the contrary, a forbearance agreement expressly preserves the default, and the lender only agrees to refrain from exercising its remedies during the forbearance period. A waiver agreement, on the other hand, waives the default and restores the parties to their pre-default positions.
Advising clients facing a default requires an understanding of the following: the different legal issues parties should consider in determining if a waiver or a forbearance agreement is appropriate, actions a lender should consider to bolster its position on a post-default basis, and provisions parties may consider in drafting and negotiating a waiver or a forbearance agreement.
If a default has occurred, the borrower will want the lender to grant a waiver to eliminate the default. A waiver will generally indicate the lender's desire to maintain its relationship with the borrower. If the lender does not want to continue the relationship and wants the borrower to repay or refinance the loan on an accelerated basis but is willing to give the borrower a period of time to pay off the loan, then the lender may prefer a forbearance agreement. The lender may also desire a forbearance agreement if it believes it does not have sufficient information to determine whether a waiver is appropriate.
Hard Look
Waiver and forbearance agreements provide the lender with an opportunity — possibly the last one — to correct any perceived deficiencies in existing terms, documentation or collateral. Therefore, the lender thoroughly should review the loan documents and conduct due diligence on its collateral to make sure the documentation and collateral reflect the lender's understanding of the deal.
Lenders also can require: reductions in the borrower'sfacility size ( e.g. , the loan amount or commitment); increase in interest rates and fees; provision of additional credit support ( e.g. , additional collateral, personal guarantors, etc.); further restrictions on the borrower's actions ( e.g. , permitted indebtedness, dividends, management fees, affiliate payments, etc.); imposition of additional financial reporting, collateral audits, or appraisals; and engagement by the borrower or the lender (at the borrower's expense) of financial or other consultants.
1. Documentation: There are certain common documentation concepts lawyers should consider when drafting a waiver or forbearance agreement. The borrower will need to disclose to the lender all outstanding defaults prior to the execution of the waiver or forbearance agreement. If there are undisclosed defaults, then the waiver or forbearance agreement will not prevent the lender from exercising its rights and remedies with respect to such defaults.
It will be important for the lender to limit the agreement to the disclosed defaults so the lender does not inadvertently waive an unknown default. The agreement, therefore, should expressly state that its scope is limited to the specific defaults listed. The agreement also should contain language preserving the lender's right to continue to require strict compliance with the loan documents notwithstanding the waiver or forbearance.
Both a waiver and a forbearance agreement should contain conditions to effectiveness and customary representations. A forbearance agreement will also need to set forth the expiration date of the forbearance period and contain a specific list of items that will result in an early termination of the forbearance period. The lender and the borrower also should consider the necessity of amending the loan documents in the waiver or forbearance agreement. The lender will also want to document any fees it is charging in connection with the waiver or forbearance agreement. Note that Texas courts have generally held that a fee on a loan, other than a bona fide commitment fee, constitutes additional interest on such loan, so a lender will need to verify its compliance with the applicable usury laws when charging these types of fees.
In both a waiver and a forbearance agreement, the lender wants to know it is moving forward with a clean slate. Therefore, the lender typically requires that the borrower and any other obligors ratify their respective obligations to the lender, confirm all liens and security interests, and release the lender from any and all claims. It may be important to obtain such confirmations and releases from guarantors in order to avoid suretyship waivers. The obligors carefully should consider whether there are any claims against the lender before executing a release.
2. Collateral: If the lender does not have a lien on all of the assets of the borrower, the borrower's subsidiaries or other relevant affiliates, then the lender should analyze the possibility of obtaining additional collateral in connection with the waiver or forbearance agreement. If the lender does obtain additional collateral, the value given to the borrower under the waiver or forbearance agreement may limit the success of a preference or avoidance action on the transfer of collateral if the borrower ultimately seeks protection under bankruptcy laws.
The courts are split on whether, for fraudulent conveyance purposes, the transfer of collateral to the lender in connection with a waiver or forbearance constitutes reasonably equivalent value. A minority of courts have adopted a per se rule that the transfer of an interest in collateral to secure an antecedent debt in connection with a waiver or a forbearance agreement is always a transfer for reasonably equivalent value. The majority of the courts, however, have employed a fact-driven analysis to determine whether reasonably equivalent value has been exchanged for a grant of collateral. These courts either have compared: 1. the value of the collateral transferred by the debtor to the benefit that the debtor received under the forbearance or waiver; or 2. the value of the collateral transferred by the debtor to the amount of the antecedent debt.
Most courts have held that a forbearance by a lender does not constitute new value. In particular, in 2008 the U.S. Bankruptcy Court for the Western District of Missouri stated in In Re: Valley Food Services, LLC , that the "courts have consistently held that refraining from exercising a preexisting right is not new value for purposes of [the U.S. Bankruptcy Code] §547(c)(1), even if forbearance of that right enables the debtor to continue operating."
Further, the lender should consider obtaining certain post-default waivers in the agreement in anticipation of utilizing a foreclosure sale under Article 9 of the Texas Business & Commerce Code (the UCC) in the event the borrower's economic situation continues to deteriorate. During a default, a borrower can waive or modify many of its post-default rights under §9-624 of the UCC. These types of waivers can provide a lender with the option to conduct a more expedited foreclosure sale.
In determining the best course of action after a default, the borrower and lender carefully should consider the differences between a waiver and a forbearance agreement and the potential exit strategies for the credit. Once the parties choose a type of agreement, the lender should use it for self protection. Lawyers for the parties carefully should consider all specific issues related to the transaction to customize appropriately their post-default analysis and their waiver or forbearance agreement.
Scott G. Night of Dallas is a partner in and chairman of the Haynes and Boone finance section. He has experience in corporate, commercial, and real estate lending and workouts. His e-mail address is scott.night@haynesboone.com. Craig S. Unterberg of Dallas is a partner in the firm. He represents lenders and borrowers in secured and unsecured lending and structured finance transactions. His e-mail address is craig.unterberg@haynesboone.com.
