Following the occurrence of a default by a borrower, a lender may have to quickly decide on the best course of action in order to protect its investment. If the default is minor, the lender may agree to waive the default, but a lender is less likely to agree to a waiver if the default is serious or a sign of looming problems. In the latter case, entering into a forbearance agreement with the borrower and its guarantors may offer the lender an attractive option.
By entering into a forbearance agreement, the lender agrees to refrain (or forbear) from exercising its rights and remedies under the loan agreement and related security documents for a certain period (the forbearance period) in exchange for certain acknowledgements and agreements from the borrower and any guarantors. From the lender’s perspective, entering into a forbearance agreement has many potential benefits, whether or not the intention of the lender is to continue the lending relationship with the defaulting borrower at the end of the forbearance period or terminate the lending relationship. Some of these benefits are:
- Avoiding any argument by the borrower that the lender has waived the default(s), and therefore its ability to take enforcement action in respect of such default(s) at the end of the forbearance period, by including express statements in the forbearance agreement to this effect
- Avoiding the lender having to incur the time, cost and potentially adverse connotations of taking enforcement action, by giving the borrower the time to cure the default(s) or repay the lender, for example, by arranging alternative financing or an equity injection or selling assets with the lender’s consent
- Giving the lender time to meet with its advisors to assess in more detail the financial position of the borrower and develop an enforcement strategy if the borrower is not able to cure the defaults or repay the lender at the end of the forbearance period
- Requiring the borrower to provide additional reporting to the lender, to enable the lender to better assess and monitor the ongoing financial performance and position of the borrower
- Allowing the lender to amend the terms of existing facilities, for example, by increasing the interest rates in certain circumstances, amending the repayment schedule and tightening existing or introducing new financial covenants
- Allowing the lender in certain circumstances to obtain additional fee income, by requiring the borrower to pay a forbearance fee
- Allowing the lender the opportunity to correct any deficiencies with the existing security package, or in certain situations where fraudulent preference concerns are appropriately addressed, take additional security and/or guarantees that were not previously available or forthcoming.