By: John B. Newman, Retired
Every time a bank enters an agreement to reinstate or extend a loan which is in default, it should take advantage of the opportunity to enter into a well drafted work out agreement. Although the financial terms of every work out agreement are different, every work out agreement should have certain provisions. In addition, certain other provisions should always be considered.
- Acknowledgment of Debt. The borrower and guarantors should always acknowledge the sums due, including any applicable late fees and default interest rate. They should also acknowledge the existence of a default. The amount should be specifically set forth.
- Terms of Modification. The precise terms of the work out arrangement should be set forth including what sums if any are to be paid upon execution, how those sums are to be applied and how the remaining sums are to be paid. It is generally best to state the arrearage, the total monthly payment to be applied to arrearage and the total monthly payment to be applied against the regular principal and interest payments going forward. In this way, the arrearage is not added to principal and will not imperil lien priority.
- Reaffirmation of Loan Documents. Each of the principal loan documents should be listed by date or recording information. The borrower and guarantors should reaffirm their obligations under the loan documents and state that they have no defense or offset to any of them and that each remains in full force and effect except as modified by the work out agreement.
- Enforcement. The work out agreement is a wonderful opportunity to improve the bank’s ability to enforce its loan documents. Since litigation is often pending, sometimes more than one proceeding, the pending case or cases can be settled with stipulations or consent judgments so that if there is a default the bank can proceed to immediate judgment or execution sale. Inasmuch as the bank has spent a great deal of time any money in moving an action to the point of judgment, it should not have to go back to first base when it makes a settlement. Rather it should sit on third pending a default. The default provision may or may not have a grace period and it may or may not have notice as may be negotiated in each particular case. If the original loan documents had a notice period that was onerous to the bank, this would be an opportunity to cure that. Likewise, if the original loan documents did not provide for late fees or default interest, this would be a good opportunity to add those provisions.
- Legal Fees. The bank can usually require the borrower to pay its legal fees in the pending actions through the negotiation and execution of the work out agreement. Sometimes they will be paid in a lump sum on execution. Other times, they will be added to the arrearage to be paid over time.
- Financial Reporting. The bank can usually require borrower to furnish financial at the time of the work out agreement and can require the borrower to agree to furnish financials on a period basis going forward. Again this is an opportunity to improve upon the original loan documents.
- Waiver of Defenses. Every work out agreement should contain language in bold type in which the borrower and guarantors agree that they have no defense to the pending complaints, if any, or to the enforcement of the loan documents. The borrowers and guarantors must waive any and all claims that they have against the bank or its officers, directors, employees or agents, including any which could result in defense, set off or counterclaim.
- Right to Counsel. If the borrower consulted counsel, that should be recited. If not, the fact that the borrower had adequate opportunity to do so should be recited. The agreement should also state that the agreement was entered voluntarily, without duress and that the borrower received substantial consideration for entering the agreement.
- Execution. It is rare for the borrower and guarantors to make a personal appearance to sign a work out agreement. Therefore, adding a notary clause is some degree of protection for a later claim that the agreement was never signed.
- Additional Provisions. As the work out agreement may be the one and only time the bank has an opportunity to improve its position, if it can obtain more collateral or cross-default or cross-collateralization provisions, it should consider negotiating for these provisions.
- Bankruptcy Considerations. Particularly if any additional collateral is given to the bank in work out agreement, careful consideration should be given to what will likely be the effect on the work out agreement of a bankruptcy filed within 90 days. Obviously, any new collateral given to the bank would be lost as a preference in most cases. Care should be taken not to release other collateral as part of a work out agreement until the preference period has passed. Likewise, consideration should be given including provisions which would reinstate the loan documents to their status quo ante in the event of a bankruptcy proceeding filed within the preference period. It may also be possible to negotiate for a provision providing for consent to relief from the automatic stay in the event of a bankruptcy. Such provisions have been enforced by some courts but not universally.
Because the routine provisions in a work out agreement are so beneficial to the bank, often times it is best to enter into a work out agreement even if there is little change in the payment terms. Any lender liability claims from prior acts are waived. Any disputes about the validity or enforcement of the loan documents or the amounts due are resolved. In addition, there are many opportunities to improve upon the original loan documents both legally and practically.
This publication is intended for general information purposes only and does not constitute legal advice. The reader should consult legal counsel to determine how the law may apply to specific situations.