Standing Still: Legal and Market Standards for Forbearance Agreements

At the onset of a loan workout, a forbearance or standstill agreement is one of the first and most important documents to be executed, but many borrowers and lenders lack a clear understanding of what constitutes a legally sufficient forbearance agreement that is consistent with market standards. By Michael Hamilton.

At the onset of a loan workout, a forbearance or standstill agreement is one of the first and most important documents to be executed. The primary purpose is to halt the exercise of remedies by lenders while the parties proceed to negotiate the terms of a workout. Notwithstanding its importance, many borrowers and lenders lack a clear understanding of what constitutes a legally sufficient forbearance agreement that is consistent with market standards.

Following are the essential legal elements in any forbearance agreement:

  • An agreement to forbear need not be in writing. Courts will imply an agreement if the conduct of the parties supports the same. If a lender actually refrains from exercising remedies, and if another benefit concurrently has been bestowed upon the lender (such as a new guaranty), a court may conclude that the lender has agreed to forbear. Because of the potential for implied agreements and/or terms, borrowers and lenders should seek to memorialize the agreement.
  • Mere delay in the exercise of remedies (without some other exchange) is not typically enough. In one case, the lender refrained from exercising remedies for nine years, yet the court did not find a basis for an implied forbearance agreement. A borrower must show that it relied to its detriment on the lender’s delay and that it changed its position through the incurrence of some additional obligation or undertaking. A borrower attempting to capitalize on mere delay proceeds at their own peril.
  • Forbearance as to one default does not mean forbearance as to all defaults. A lender will not typically be enjoined from enforcing remedies for new or previously unknown defaults. Lenders should, however, be consistent in their responses to similar defaults to avoid course of conduct claims by borrowers.
  • If the agreement to forbear does not state when it ends and when the lender may resume the exercise of remedies, courts typically will imply a “reasonable” forbearance period. However, some courts have imposed an indefinite forbearance period, thereby affording the lender substantial discretion and rendering any such perceived forbearance agreement unreliable. Other courts have construed an agreement without a specified period of forbearance to mean perpetual forbearance—covenants by the lender not to sue until the default is resolved. This is obviously not preferred by lenders.
  • Guaranties given as consideration for a lender’s agreement to forbear are enforceable. Case law is replete with claims by guarantors that a new guaranty is not enforceable because the lender did not truly give anything in exchange for the guaranty. Courts have almost uniformly rejected this argument.
  • Unintended third parties, such as mezzanine lenders or competing creditors, have successfully asserted standing where an implied or express agreement to forbear is sought to be voided by lenders (even when the agreement contains conventional “no third-party beneficiary” boilerplate provisions). A lender is well advised to obtain the express agreement of all potentially affected parties to the terms and conditions of the forbearance.

Defining “Market”

An analysis of 100 forbearance agreements, primarily from the past three years and involving more than 50 lenders, 100 borrowers and loans of $50,000 to $250 million (averaging $24 million in size) indicates that the provisions identified below occur with the frequency indicated:

  • Specified forbearance period: 96% (80% of the agreements we analyzed contained a forbearance period of less than three months)
  • Admission of default by the borrower: 93%
  • Borrower’s agreement that the loan documents remain in full force and effect notwithstanding the forbearance: 82%
  • Borrower’s waiver of all defenses to the enforceability of the loan documents: 85%
  • Borrower’s waiver of all claims against the lender for events prior to the forbearance agreement: 64%
  • Borrower’s waiver of all claims (pre and post forbearance agreement): 24%
  • Automatic termination of forbearance if the agreement is violated: 91%
  • Automatic termination of forbearance if another default occurs (this typically includes a bankruptcy filing by the borrower): 85%
  • Automatic termination of forbearance if there is a material adverse change in the condition of the borrower or the property: 20%
  • Imposition of a forbearance fee: 34%
  • Agreement of borrower that the subject default is not being waived (preserving the right of the lender to exercise remedies after the forbearance period ends): 84%
  • Statement that forbearance does not create a course of conduct: 57%
  • Down-dating of the representations in the loan documents: 53%
  • Ratification of the mortgage lien: 66%
  • Confidentiality provision: 4%

These empirical results and the legal foundations outlined above should assist borrowers, lenders and counsel in reaching a reliable forbearance agreement that is grounded in the law and consistent with market practices.

Michael Hamilton is a partner in the Los Angeles office of DLA Piper L.L.P. (US) and focuses his practice on business transactions, with a particular emphasis on finance and real estate matters.