Lenders and customers should not enter into a forbearance arrangement without properly understanding its terms and risks, and any conditions imposed on the customer must be clear, realistic and achievable within the specified timeframe.
The vast majority of risk inherent in a forbearance arrangement can be managed through careful and strategic planning at the outset. By and large, the benefits to both the lender and customer in reaching a consensual arrangement can significantly outweigh the alternative outcomes of continued uncertainty for the parties or enforcement by the lender under the more traditional and formal insolvency appointments in Australia.
Both parties should be aware of the potential risks of making, or accepting, a forbearance request. Though often manageable through proper documentation and implementation, our experience suggests that a forbearance can often involve increased lending, extension of maturity dates, interest holidays and increased advisor costs. It is prudent for these matters to be negotiated upfront and factored into pricing and fees.
Even if the forbearance makes sound commercial sense and the parties have a genuine belief in the success of the plan, lenders and customers should not enter into a forbearance arrangement without properly understanding its terms and the risks associated with it. As we have stressed, any conditions imposed on the customer must be clear, realistic and achievable within the specified timeframe. The lender should also ensure that there is transparency and good information flow throughout the period of forbearance.
A practical framework for forbearance
A forbearance arrangement (which is often prepared as a deed) is a bespoke document reflecting the specific circumstances of the customer's distress (including the nature and significance of the existing defaults), the particular issues underlying the customer's distress and the plan to remedy the default situation. There is, however, a certain degree of commonality across most forbearance agreements.
We have set out below a number of the more typical features of a well-structured forbearance arrangement which might operate as a base line for both lenders and customers to inform their negotiation strategy and general approach to documenting forbearance terms.
- Acknowledgement of debt: It is important for a customer to acknowledge in the forbearance agreement the outstanding principal balance of any relevant facilities as at the date of the forbearance. This not only provides certainty for all parties, it is a platform for the establishment of a debt reduction programme which can be set out in the forbearance arrangement (if desirable and achievable).
- Other security If any additional security will be offered by the customer, any guarantors or directors.
- Scope of defaults: The specific defaults and circumstances which have given rise to the need or desire for a forbearance and the specific rights which the lender will forbear from exercising during the term of the forbearance should be recorded in the forbearance agreement.
- Interest and repayments: The agreement between the parties regarding interest and repayments required during the forbearance should be documented. For example, the forbearance deed should stipulate if the loan is to be amortised and how interest is to be dealt with. Most often, and of course depending on each customer's particular circumstances, lenders will require a customer to meet its interest payment obligations during the term of the forbearance. Alternatively, interest may be capitalised during the term of the forbearance.
- Forbearance conditions: The forbearance deed should identify the conditions which the customer must satisfy to keep the forbearance in place, which typically involves actions within the control of the customer or other security/guarantee providers, such as requiring the marketing and sale of property and/or to pay down debt by certain milestone dates.
- Timing and extensions: A forbearance arrangement should contain a limited and defined forbearance period with an express end date. The length of the forbearance should strike a balance between providing a reasonable time for the forbearance conditions to be completed and the lender's willingness and ability to continue to forbear.
The forbearance may also contain a mechanism for the forbearance period to be extended upon some form of trigger event or milestone being met, such as receipt of an executed sale document in respect of the disposal of certain material assets (normally these must be to the lender's satisfaction).
Further, the lender will usually have a right to extend the term at its absolute discretion, such as where there are events outside of the customer's control which have affected the customer's ability to complete the task on time, or where the customer has and continues to make good progress on satisfying the forbearance conditions.
- Forbearance fee: It is typical for a forbearance or restructure fee to be paid by the customer as consideration for the lender not exercising its enforcement rights and remedies. This is usually calculated based on the expected costs and expenses to be incurred by the lender (including those of its legal and accounting advisors) during the term of the forbearance. It may be paid as a condition to the forbearance coming into effect or debited from the customer's account.
- Release and discharge: It is common for the lender to seek a release and discharge of any claims the customer has or may have against it and its staff (whether or not such claims are known) as consideration for the forbearance.
- Effectiveness of security: Confirmations and ratifications from the customer and the security providers in respect of existing securities and guarantees are important to ensure those instruments continue in full force and effect, particularly where the scope of the secured obligations is increased or varied in any way. Accordingly, the customer and all relevant security/guarantee providers should be parties to the forbearance arrangement, particularly where there is any variation to the finance documents
- Incentives: The forbearance agreement should document any incentive strategies which encourage the customer to remedy the circumstances of the default, or to satisfy the forbearance conditions, as quickly as possible, with a view to a debt reduction, financial restructuring or a co-ordinated exit, which may include reward interest caps or discounts on the final payout amount.
- Other conditions: There are many other issues which can and should be considered when negotiating a forbearance arrangement, too many to list, however, other issues the parties might take into consideration include:
- restrictions on the customer drawing down or requesting further funds from the lender during the term of the forbearance;
- the application of monies received by the lender in relation to the customer's accounts;
- treatment, in terms of ranking and subordination, in respect of any new capital injections;
- agreement and acknowledgement of certain professional fees (accounting, tax, legal and other consultants) and other taxes, fees and expenses to be covered by the customer (and express confirmation of existing indemnities in favour of the lender) and confirmation of the timing of payment of such fees;
- insolvency terms, such as the customer confirming it will not appoint a voluntary administrator without first notifying the lender and consents to the lender appointing receivers or other such controllers on the occurrence of certain events. In certain circumstances, the forbearance agreement may also include consents to judgment from the customer and the other security/guarantee providers; and
- an agreement (or acknowledgment/confirmation) of the lender's right of inspection or right of access to accounts or records and a right to appoint a restructuring officer or advisor – particularly if those things have been omitted from the relevant loan documentation.
Dare to forbear…
Although a forbearance in favour of a customer is, in effect, an indulgence by the lender, it should be viewed as an opportunity for both the lender and the customer to agree a plan for the continuation of their relationship or if there is to be an exit, for that exit to occur in an orderly manner. It is also a useful tool to preserve value in a wider restructuring plan, through stakeholder buy-in.
Given the complex nature of the respective rights and interests of the lender and the customer under typical finance documents, it is critical that any adjustment to those rights be carefully considered and documented from a legal perspective, otherwise there is a significant risk of such rights and interests being lost through a forbearance or standstill arrangement.
Neil Sher and Kevin Shum