Forbearance agreements serve an important role in the lender-borrower relationship, especially in current credit market conditions. Forbearance agreements function to conditionally delay a lender's ability to exercise its remedies on a defaulted loan, thus permitting the borrower to either cure the defaults or pay off the defaulted loan by obtaining alternative financing, liquidating its assets, or by other means. While forbearance agreements range in complexity—some being very simple letter agreements that directly address the defaults, with others acting as a mechanism for complete restructuring of the defaulted loan—all forbearance agreements must address the following:

  • Acknowledgments by the borrower that the debt and defaults exist, and the amount of the existing debt;
  • The forbearance period and conditions to continued forbearance; and
  • Certain waivers and releases by the borrower and any guarantors in favor of the lender.

Acknowledgements By Borrower

The borrower must acknowledge not only that the debt created in the underlying agreement exists, but the amount of the existing debt. This provides assurances and confirmation to the lender that by agreeing to forbear, the lender is not forgiving any portion of the debt owed to it by borrower. In addition, the borrower is acknowledging the existence and enforceability of the debt, making it harder for the borrower to later dispute these points.

The borrower must also acknowledge the existence of the events of default. The importance of this is twofold: first, it defeats any potential future claim which casts doubt on the existence of such defaults, and second, it provides the consideration necessary to have an enforceable forbearance agreement. As the existence of defaults is the basic premise behind forbearance agreements, the lender should take extra care to clearly identify each of the known existing defaults by describing the actual event of default, setting forth the date of occurrence of such default, and referencing the section of the underlying loan document which identifies the default. This also preserves and protects the lender from any unknown or undisclosed defaults.

Moreover, the lender must set forth clearly that its agreement to forbear is not a waiver of any existing or potential events of default. This is critical because by preserving its remedies arising from the existing defaults, the lender, should it so chose, may exercise its remedies upon termination of the forbearance.

Forbearance Period/Conditions To Continued Forbearance

Generally, the lender provides a time period during which it agrees to forbear from exercising its rights and remedies, allowing the borrower to cure the existing defaults, repay the loan, or re-structure the facility. This forbearance period must be clearly defined. Typically, the forbearance period lasts from a few weeks to a few months. However, despite having a defined forbearance period, most forbearance agreements provide that the forbearance ends immediately upon the occurrence of certain events. These forbearance termination events generally include the occurrence of defaults not in existence or not disclosed at the time of the execution of the forbearance agreement, or the borrower's failure to satisfy certain benchmarks. Such benchmarks often include new financial or reporting covenants, raising additional capital, hiring consultants, taking specific actions to effect the sale of the company or the sale of assets by a certain date.

Waivers And Releases

Equally important is the borrower's waiver of rights to contest the existence of the defaults. Although this does not affect the enforceability of the agreement itself, it is valuable protection for the lender and helps determine whether the borrower is acting in good faith. A borrower acting in good faith and wanting to resolve existing defaults and issues, should readily agree to the inclusion of such waivers.

Furthermore, lenders are strongly encouraged to obtain a general release from the borrower and any guarantors, with respect to any and all known or unknown claims against the lender or its affiliates, agents or representatives. In addition to providing additional consideration for the forbearance agreement, this general release/waiver provides the lender with protection against claims by the borrower and/or guarantors and permits the parties to move forward in an attempt to resolve the issues at hand.

Although forbearance agreements appear simple, there are many pitfalls and complexities associated with their terms and lenders may need legal advice. For further information relating to forbearance agreements, please feel free to contact the authors of this article.

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.