In our extremely challenging economic climate, many commercial borrowers are experiencing major difficulties in meeting outstanding loan obligations. With tightening credit markets and increasingly strict underwriting guidelines, refinancing existing debt or selling assets to a third party are not feasible options. In addition, it is extremely likely that the person with whom you formed your lending relationship no longer works for the lender. Furthermore, it is probable that no one with institutional knowledge of your loan or situation is still employed by your lender.
If you know financial difficulty is on the horizon, keep in mind that the lender likely does not want to incur the expense and time associated with foreclosure and ongoing carrying costs – especially if a loan modification or forbearance agreement may result in the borrower’s ability to make payments, either presently or in the near future. Thus a loan “workout” may be an attractive alternative for you and your lender. A “workout” is an agreement between a borrower and a lender to modify or change the terms of the loan to maximize a borrower’s ability to pay and avoid both the costs associated with foreclosure and the delays and uncertainty associated with a borrower bankruptcy. If you are a borrower and are facing financial difficulties, consider the following:
Begin a dialogue with your lender.
Many borrowers make the mistake of waiting until they are in serious trouble before communicating their difficulties to the lender. The chances of reaching an agreement with your lender decreases as additional payments are missed and late fees and interest mount. As stated, there is a strong possibility that your relationship manager no longer works in the financial services industry, finding a new contact that has decision-making power or access to decision-makers is imperative.
Alter the terms of the loan.
If your project or business venture is viable, but facing temporary cashflow difficulties, the lender will be more likely to discuss alternatives. Is the value of your property based on a current appraisal? Does the property produce income? Is there additional collateral available for pledge to the lender? These are all important factors that impact a lender’s determination to change loan terms. However, in some situations, a lender may not view the project or business venture as viable even with concessions or modifications. For example, if a borrower has defaulted on other obligations and intervening liens have been created, the lender’s difficulties are amplified because of the decreased chance of repayment.
Understanding your obligations.
Always carefully review loan documentation to assess the risks. Consider whether personal guarantees were executed and the circumstances under which the lender may proceed against a guarantor. If the borrowing entity is involved in several business ventures, a default under the loan may have wide-reaching and unpleasant implications for the borrower.
Documentation is essential.
Do not rely on oral assurances or promises. Though these may be considered effective waivers under very specific circumstances, do not rely on a promise by a relationship manager under different economic circumstances. Ask yourself: if you would not have allowed your initial deal to go undocumented, why would you treat this situation differently?
Consider all alternatives.
If a workout is not a viable alternative, consider whether a deed in lieu of foreclosure is acceptable. A “deed in lieu of foreclosure” is a voluntary conveyance of the property by the borrower to the lender to avoid foreclosure. A deed in lieu of foreclosure may result in significant savings of time and money, as a foreclosure or a complex workout can be time consuming and expensive. However, if there is other encumbrances affecting the property, such as mechanics’ liens or subordinate deeds of trust, a deed in lieu of foreclosure will not allow the lender to “wipe out” these junior liens. If a non-judicial foreclosure can be conducted within a reasonable period of time, the lender may view foreclosure as a superior alternative.
Finally, consult with counsel to determine whether seeking bankruptcy protection is advisable. Bankruptcy may provide temporary relief from foreclosure and afford alternatives that were not adequately considered during workout negotiations. Again, if the borrower has assets that are not project-specific, bankruptcy may jeopardize otherwise viable portions of a project or business.