By David M. S. Shaiken, Esq.
As businesses begin to spend their cash reserves during and following the lockdown caused by the pandemic, inevitably there are going to be cash shortfalls and defaults on commercial loans. Will lenders make concessions to keep companies from remaining in default, or will they push companies out of business or into chapter 11 bankruptcy? Time will tell.
One device used by lenders and borrowers is a loan workout. A workout is simply an agreement to restructure, temporarily or permanently, an obligation owed to a lender.
In the face of a borrower’s default, lenders may forbear from beginning litigation, lower interest rates, waive or capitalize past due interest payments, agree to a moratorium on payments, restructure notes into a combination of performing and nonperforming notes, make financial covenants less restrictive, require additional guarantors or collateral, require cuts in expenses such as payroll and insider compensation, provide for weekly or monthly financial reporting, establish lock boxes for collection of accounts receivable, or do anything else that creative minds can come up with to keep a borrower in business, and to give a lender greater information and control over a distressed situation.
Workout agreements usually come with increased responsibilities on the part of a borrower. For example, a borrower will be required to acknowledge in writing the amount owed, thus eliminating any dispute about the calculation of the debt or the application of past payments. A borrower may be required to pay the lender’s legal fees incurred in negotiating and documenting the workout agreement. Borrowers usually will be required to waive all defenses to the debt existing as of the time of the workout agreement, and, if not previously waived, to waive the right to a jury trial and to a hearing on prejudgment attachment and repossession of assets in the event of litigation. Borrowers typically are required to release all claims against the lender existing as of the date of the workout agreement.
Workout agreements also present an opportunity for the lender to scrutinize its loan documents, and correct any deficiencies or weaknesses in them that they identify.
While workout agreements benefit a borrower, they also provide a number of benefits to lenders. That said, when the parties can work out a defaulted loan relationship, the borrower and lender are saved from the cost, uncertainty and pressure of litigation, and of filing for bankruptcy.
The keys to a successful workout negotiation are:
- Early and frank communication between the parties.
- Sophisticated counsel on both sides.
- A genuine desire by both parties to find alternatives to resource-consuming litigation, liquidation or bankruptcy.
- Realistic cashflow projections.
Secured lenders have considerable leverage when a loan is in default, at least if the loan is adequately collateralized. Borrowers have leverage when a loan is unsecured or under-collateralized. At the end of the day, a good workout agreement is going to be driven by a mutual desire to come to an agreement that keeps a business operating, and is going to involve compromises for both sides.
For more information contact David Shaiken (860-606-1703), david@shipmanlawct.com.