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Focus Area: Coronavirus/COVID-19

Facing Troubled Borrowers During the Coranovirus Pandemic: What should you do?

In just the past month, the national economy has morphed from a full employment steady growth state to one in which a substantial part of the workforce is idle, and many businesses have been forced to close indefinitely.  Although federal assistance packages such as the SBA emergency loan program will help, many borrowers will be unable to withstand the damage caused by the pandemic.  You should start thinking both on a short-term and long-term basis on deferrals and restructurings. Here are a few steps you should take:

SHORT TERM:

  1. Your borrower is going to ask you for a deferral. Should you agree to the request?  Usually you would ask your borrower for a cash flow projection to determine what kind of deferral is necessary and for how long. In these times, projections will be educated guesses, at best. Deferrals made under the Interagency Guidance may be a good idea so longer term plans can be put in place but both financial institutions and their borrowers should start thinking about long term options.
  2. Is your borrower going to request a loan from the SBA under the CARES Act or any other assistance package from the SBA or elsewhere?  Is your borrower going through your financial institution to obtain the loan? Whether your borrower obtains a loan from you or another lender under the CARES Act or otherwise, how does this affect your existing loans with the borrower?
  3. Whether your borrower is simply asking for a deferral or another loan as well, you should review your loan documents and UCCs. Are all the documents signed by the correct person? Did you file UCCs and did you continue them, if necessary? Do you have your final loan title policy? If not, this is the time to fix any deficiencies.

    If you haven’t filed or continued your UCCs or recorded your mortgage, filing it now means that you face an avoidable preference problem. It’s a complicated issue but, in short, if the borrower files for bankruptcy within 90 days or a receivership within 120 days of the filing of the UCC or mortgage recording, your  UCC or mortgage filing can be set aside and you aren’t perfected in that collateral. So, you should file your UCC or mortgage, but you will want to wait 90 or 120 days before taking any action on the loan or collateral that would result in the borrower filing for bankruptcy or receivership. Of course if the borrower files a bankruptcy or state insolvency proceeding within that window anyway, then you have a potential problem. Lenders do have some defenses so it’s best to talk to a lawyer about the potential problem.

LONG TERM:

  1. If your documents are all in order, do you want or need an appraisal? Any appraisal done in these times may not be reliable until the country recovers from the pandemic. If you’re also working with the SBA, you should contact them to see whether the SBA is currently requiring an appraisal for workout situations. If the appraisal on file is out of date, a new one could help you decide whether a liquidation or rehabilitation is feasible.
  2. Do you want to switch responsibility for the borrower from the current lender/ relationship officer to a workout person or credit officer? This is the time to do it. While the current lender may have a long-standing relationship with the borrower, the lender might not be able to make the tough decisions when necessary. Every bank has a different perspective on this question and, depending on the size of the bank and the personnel available to it, the ability to switch. Regardless of your decision, this is the time to think about relationship management of the borrower.
  3. Analyze whether the borrower can recover from the financial impacts of forced closure. If you need to meet with the borrower in order to make this determination, conduct a preliminary analysis of the situation before you do so. In your preliminary analysis, consider the following, for example:
    • Has the borrower sought loan deferral?
    • Has the borrower sought government assistance, from the SBA or elsewhere.?
    • What, if anything, needs to be done to help this borrower survive and recover from the financial distress caused by the pandemic?
    • Did the deferral period help? Would putting them on interest-only status for a period of time alleviate the current situation sufficiently to help them turn around?
  4. Meet with your borrower to determine how to resolve the default. Bear in mind that the borrower might be upset that you even think the borrower is in trouble. Or, the borrower might know that you are calling to talk about troublesome issues and will consequently avoid your calls and emails – the head-in-the-sand approach.  If the borrower takes the head-in-the-sand approach, you might have to send a default letter from your attorney to catch their attention. When your borrower responds to you, have a frank and honest face-to-face meeting (or several). Among other things, you should consider the following in your conversation(s) with the borrower:
    • Listen to how your borrower intends to come out of the current difficulties. Is it pie in the sky? Does it depend on someone coming in to save the operations or a sale of the company? If so, what steps has the borrower taken to effectuate these efforts?
    • Do not tell the borrower what to do. If you do, you face issues of lender liability – the borrower does what you told it to do, it fails anyway and then the borrower turns around and says, “I only failed because the lender forced me to take this course of action. It’s his fault I’m in this horrible situation.” 
    • Even if you don’t tell borrower what to do, given your own analysis, is the borrower realistic or reasonable? If not, you can tell the borrower that, in your view, the course of action is not viable under the circumstances but, again, don’t tell the borrower what to do.
  5. After your meeting with the borrower, review the following:
    • The borrower’s operations;
    • How the borrower intends to cure the default;
    • The liquidation value of your collateral and what the guaranties are; and
    • If you think it’s feasible and worth delaying collection efforts, then consider the terms of a forbearance or restructuring agreement. A forbearance agreement makes sense if there’s a realistic chance the borrower will be able to turn its operations around or if there’s a reasonable chance the value of the collateral will increase in the future. As well, if the bank is concerned about lender liability claims on the transaction, the forbearance agreement will wipe the slate clean by requiring the borrower and guarantors to fully release the bank from any claims the borrower or guarantors could have brought prior to the date of the forbearance agreement. This release is valuable in certain situations and might be worth entering into a forbearance agreement to obtain.
  6. If the bank decides to enter into a forbearance agreement, what should it provide? In addition to the release, this is the bank’s opportunity to include covenants and provisions that might have been lacking in the original loan agreement. For example, the bank may wish to consider the following:
    • Can you obtain additional collateral or guaranties?
    • Should the bank require more frequent financial reporting?
    • Is the bank willing to delay collection efforts if the borrower meets a certain debt service coverage ratio?
    • If a white knight is going to save the day, how long is the bank willing to wait for the borrower to find an investor or buyer?
    • Where are the borrower’s deposit accounts? If they are not with your institution, require such accounts be moved to the bank concurrently with the execution of the forbearance agreement.
    • Because each borrower’s situation is unique, there’s no boilerplate conditions and covenants for the forbearance agreement. The term of the forbearance agreement also varies. Obviously, the borrower will want a long period of time to turn operations around and the lender will want a shorter time. If you agree to a long window, make sure that you include shorter milestones or benchmarks that the borrower must meet and if not, the forbearance agreement would terminate.
    • If a guarantor has guaranteed the loan(s) and the terms of a forbearance substantially modify the terms of the loan(s), think about whether you should obtain a reaffirmation of the guarantor’s obligations under the existing guaranty.

Once the forbearance agreement is signed, continue to monitor the borrower closely. If the borrower is required to provide financial reports weekly or monthly, make sure they are timely provided.  If a debt service coverage ratio is shot, act on it. If the situation worsens, you will have to repeat your analysis on whether to continue with the current course or begin exercising your rights and remedies.

  1. Finally, think about any loan participants, the SBA, or other third party lender involved.  Do you need consents or notices to these other entities?  If you do, make sure you’ve met their requirements as you go through the process outlined above.

In the end, the hope is that the borrower comes out of its difficulties and becomes a performing customer again.  But if not, the bank will be protected.

DISCLAIMER: The information provided is for general informational purposes only. This post is not updated to account for changes in the law and should not be considered tax or legal advice. This article is not intended to create an attorney-client relationship. You should consult with legal and/or financial advisors for legal and tax advice tailored to your specific circumstances.

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