Following and sometimes in anticipation of a default by a borrower, the mortgage lender must decide whether to proceed to enforce its rights under its security as soon as its right to do so has crystallized, or whether to work with the borrower to attempt to resolve the pending or actual crisis in their relationship. Unless the lender is prepared to waive the default entirely, some positive action is almost always recommended to the lender by its legal counsel. Such action may be simply to demand payment of the amount in default (together with interest and costs incurred by the lender) or, where contemplated by the loan or security documents, repayment of the entire loan (including interest and costs). However, it may also include putting the borrower on notice of the default and providing an opportunity to the borrower to cure such default within a strict time period, especially if the borrower had bargained for and obtained such time before the lender is entitled to call in the loan or enforce its security. Finally, the lender may have a real interest in entering into an arrangement with the borrower by which it would agree not to enforce its remedies for a limited time, and, in return, the borrower agrees to remedy the unsatisfactory situation in a specified manner. This arrangement may also vary the terms of the existing loan and security documents and deal with any other issues related to the lender/ borrower relationship. This arrangement once finalized is often referred to as a "forbearance agreement."
How Does a Forbearance Agreement Work?
A forbearance agreement is not a court document, but rather a private contract that binds its signatories in the same way as the loan and security document binds them. It typically describes the unsatisfactory situation in place between the lender and debtor and requires the debtor to acknowledge and correct the situation on specified terms. It will often preserve the rights of the lender arising from the debtor's defaults during the "forbearance period" set out the agreement. Parties to a forbearance agreement should include in the agreement those additional parties who have some type of relationship with the lender arising out of the primary debt, such as guarantors. The Canadian Mortgage and Housing Corporation and various regulatory authorities may have to be notified of or involved in the forbearance agreement depending on the nature of the loan or the debtor's business. A forbearance agreement can be employed both before and after a borrower has gone into default.
What is Contained in a "Forbearance Agreement"?
While "forbearance agreements" take different forms, and may contain as many provisions as the parties feel are necessary to deal with the situation (so long as they are otherwise lawful), they typically contain the following:
(a) introductory recitals describing (i) the loan transaction and briefly describing the documentation relating to the loan and the security; (ii) the events of default which have occurred and (iii) the purpose of the agreement;
(b) acknowledgements by the lender and borrower, as is appropriate, confirming the accuracy of all recitals;
(c) the terms and conditions which the debtor must fulfill in order to have the lender agree not to enforce its remedies under the loan agreement and security, such as, but not limited to:
- amendments to the terms of the loan such as a temporary reduction in interest rates, delay in the frequency and timing of periodic loan payments and maturity date, requirements for additional security and/or credit enhancements and more detailed and more frequent reporting requirements;
- amendments to existing security where some flaw or defect has been discovered in them;
- increased control by the lender to be exercised over the security and the revenue and expenses relating thereto, such as placing a "monitor" or "soft receiver" over the prescribed assets; controls over bank accounts and expenditures; and "lock box" type arrangements;
- time period for expiry forbearance period; and
- payment of all costs of the forbearance arrangements.
When Would a Lender Consider Entering into a Forbearance Agreement?
The circumstances in which a lender may consider entering into a forbearance agreement or similar arrangement include the following:
(a) the borrower has made a good case that with some flexibility in amending the terms of the loan to reflect current market conditions and some period of time to "turn things around," the borrower will likely be able to put the loan into good standing;
(b) the loan and security originally provided by the borrower to the lender contain sufficient flaws, gaps or issues which would make it impossible or very time consuming and difficult for the lender to exercise its remedies;
(c) there is a general reluctance on the lender's part to enforce its remedies;
(d) if the lender wishes to better oversee the operations of the debtor, a forbearance agreement may address the appointment of a consultant or monitor of the lender's choosing;
(e) the lender wishes to apply pressure on the debtor's search to find replacement financing;
(f) the lender feels that "take out" financing for the debtor is imminent and the lender wishes to keep the debtor on a tight leash during the intervening period; and
(g) the lender wishes to take "fresh security" for the reasons described above.1
When Would a Borrower Consider Entering into a Forbearance Agreement?
The circumstances in which a borrower may consider entering into a forbearance agreement or similar arrangement include the following:
(a) the borrower wishes to continue managing and operating its real estate project, maintaining its cash flow, without having to satisfy all of its obligations under the initial loan agreement immediately;
(b) the borrower believes that when existing dire market conditions pass, it will be able to repay the loan, and does not want the lender exercising its remedies under the loan agreement (i.e. taking possession of the borrower's real estate project); and
(c) the borrower wishes to avoid acrimony with the lender, and to maintain the commercial relationship between the parties.2
Often, though a borrower is about to default on a loan, it would be disadvantageous for the lender to enforce its remedies immediately. Such situations include the situation where the default results primarily from a down market, when the project is otherwise solid and viable, and when the lender is reluctant to assume all the obligations of becoming the owner of the property of the debtor. In lieu of immediate remedial action, a lender would be wise in such circumstances to approach the borrower with the possibility of entering into a forbearance agreement. This arrangement enables the lender to acquire an additional modicum of control over the borrower's operations, while simultaneously allowing the borrower to continue on its path to solvency, wherein it can satisfy the full amount of the original debt. This strategy also enables the parties, before the lender employs the drastic and often irreparably damaging step of utilizing a remedy, to maintain their commercial relationship.
1 In this circumstance, lenders should be wary of taking new security from a debtor who is on the eve of insolvency, considering that sections 95(1) and 96 of the Bankruptcy and Insolvency Act allow a trustee to review transactions made, even between arm's length parties, in the three months prior to the date of bankruptcy and to potentially void those transactions.
2 Exercising a remedy may have irreversible consequences on the lender/borrower relationship. It can solidify a sense of mistrust, and once a lender has taken control of the property he has assumed the risks inherent in it and therefore there is no benefit for him to re-establish the original dynamic between the parties.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.