he coronavirus pandemic, stay-at-home orders and social distancing have put unprecedented strains on borrowers—hotels are closed or barely operational, retail properties are shuttered, tenants are not paying rents (and, in many jurisdictions, shielded from eviction)—yet owners must continue to meet their debt service payment (and other) obligations and fund their required reserves. In addition, the impact of Covid-19 on property valuations will likely result in borrowers failing to meet debt service, debt yield, loan-to-value or similar financial covenants.
The lender granting forbearance in the current Coronavirus crisis believes that the property’s cash flow or other issues (such as covenant defaults) are short term, “systemic” (and not property-specific) and will improve. A lender forbearing from enforcing remedies (or granting concessions) is not waiving defaults—but is simply giving its borrower time to work through this crisis.
In its simplest form, a forbearance agreement is not a loan modification. The borrower is requesting a waiver or deferment of payments (such as interest, default interest)—and the lender is agreeing to such forbearance. The actual agreement can be quite short.
Key provisions in a forbearance agreement often include:
- Forbearance Period—The forbearance agreement often includes a “forbearance period” —typically the earliest to occur of a specified date (say, 90 days, given the current crisis and existing expectations around the date on which the economy and “normal activities” will resume), the occurrence of an event of default under the forbearance agreement or the occurrence of a bankruptcy or other insolvency-related event. During this period, the lender will agree to forbear from accelerating the debt and exercising its remedies under the loan documents or at law.
- Borrower Acknowledgements and Reaffirmations; Guarantor Re-affirmation—In consideration for the forbearance, the borrower will often be expected to make certain acknowledgements intended to preclude claims or defenses following the expiration of the forbearance period. Typically, these include acknowledgements of the amount due on account of the loan, an admission of existing defaults, ratification of the loan documents and the representations and warranties in the loan documents, ratification of the validity and enforceability of the lender’s liens, rights and remedies, and confirmation that the lender is not waiving any existing or future defaults and reserving all its rights and remedies (except as specifically provided in the forbearance agreement). The guarantor will be expected to re-affirm its guaranties.
- Conditions—This section will specify the conditions that the borrower and, if applicable, the guarantors, must meet before the forbearance agreement become effective. Often the borrower must agree to pay a forbearance fee as well as the expenses incurred by lender in negotiating the forbearance agreement. If required by the lender, the lender may also require additional credit enhancements such as requiring the borrower to:
- Waiver and Release—Forbearance agreements often include a waiver (by the borrower and also by the guarantors) of defenses and release of claims and actions that the borrower and guarantor may each have against the lender based on the loan documents, the workout negotiations or the agreement itself. Lenders view these provisions as essential to avoiding future allegations of lender liability if the workout fails.
- A Few Tips for Lenders:
- Time permitting, lenders should audit the borrower and the property, as there may be defaults that exist other than inability to pay debt service or breach of a financial covenant.
- Specify that the forbearance is with respect to specified defaults—not all, possibly unknown, defaults.
- Be sure the borrower is represented by counsel—and so provide in the agreement.
- Keep track of the date on which the forbearance period terminates. Use this window of time to prepare for next steps.
- Get in front of potential new defaults that may arise.
Source: Caroline A. Harcourt, Zachary D. Bailey (Pillsbury law)
Photo/s credit to the owners