exercising remedies after a default: forbearance

Exercising Remedies After a Default: Forbearance Agreements and Other Workout Options

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THURSDAY, APRIL 29, 2021

Presenting a live 90-minute webinar with interactive Q&A

Brian J. Koenig, Shareholder, Koley Jessen, Omaha, NE

Kenneth Miller, Shareholder, Parker Milliken Clark O'Hara & Samuelian, Los Angeles, CA

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Exercising Loan Remedies After a Default – Forbearance Agreements and Other Workout OptionsBRIAN J. KOENIG & KENNETH MILLER

6

Omaha402.343.3883

Los Angeles213.683.6605

Brian J. Koenig

[email protected]

Kenneth MillerChair, Bankruptcy and Creditors’ Rights

[email protected]

Co-Chair –Financial Services Department

Shareholder

6

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Agenda• Initial Fact Gathering• COVID-19 Specific Issues • Development of Strategy• Initial Communications with the Borrower • Specific Concerns about Loans Secured by:

• Real Property• Intellectual Property• Equipment and Inventory• Accounts Receivable

• Forbearance Agreements• Remedies

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Initial Fact Gathering• Initial Points to Assess

• Why did the borrower default?• “technical” default vs. payment default

• Why didn’t the borrower default or why wasn’t the default more extensive?

• What are the current and long-term strengths and weaknesses of the borrower’s market?

• What are the current and long-term strengths and weaknesses of the borrower’s supply chain?

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Initial Fact Gathering• Initial Points to Assess (cont’d)

• Do other creditors exist?• Conduct a litigation search• Conduct a lien search

• What assets (including claims) and liabilities does the borrower have?

• Does the creditor need to perfect any security interests?

• Has the borrower been honest, trustworthy, and reliable to the Lender?

• Has the borrower been honest, trustworthy, and reliable to other creditors?

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• Assess collateral values and present and future financial strength of borrower and any guarantor(s)

• Review appraisals; should outside counsel order new appraisal?

• Assess likely changes in value of collateral• Evaluate whether lender is fully or under-secured • Identify any environmental issues that may exist• Assess industry trends• Assess borrower’s key customers/tenants• Assess critical vendors and employees

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• Assess uncertainties/risk factors• Assess whether bankruptcy of borrower or related

entity is imminent and possible effect of same• Assess possible cash collateral issues• Discuss whether lender might provide DIP

financing if borrower files for ch. 11 bankruptcy• Determine whether the lender is vulnerable to a

preference claim, fraudulent transfer, equitable subordination, or recharacterization claim

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• Ask whether borrower’s name has changed• Review organizational documents

• Has borrower’s business changed during the pandemic and will changes go forward

• Understand working relationship with borrower• Determine whether any course of conduct argument exists

• Evaluate special timing issues that may exist• Evaluate existing or potential work-outs between

borrower and other creditors

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Initial Fact Gathering• Review Loan Files

• Review BOTH loan files AND correspondence• Check contractual default, cross-default,

acceleration, notice, and cure requirements• Assess any intercreditor arrangements• Identify all the relevant parties• Identify (and, if possible, address) any issues

concerning perfection of collateral• Obtain updated copy of organizational documents

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Initial Fact Gathering• Review Loan Files (cont’d)

• Determine whether any course of conduct exists that may suggest an implied waiver

• Analyze whether loan documents are properly executed

• Check if collateral is insured• Review financial statements to assess business • Determine whether loan files are complete• Ensure lender complied with terms of loan

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Initial Fact Gathering• Review Loan Files (cont’d)

• Based on review of loan documents, do certain loan provisions need to be modified in light ofrecent events:

• Addition, suspension, or enhancement of financial covenants• Addition, suspension, or enhancement of financial reporting

requirements • Revisions and additions of definitions – e.g., account receivable

financing – eligible accounts receivable, construction financing –out of balance, treatment of mechanic’s liens

• Revisions and additions of events of default• Notice provisions (e.g., addresses for notice)

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COVID-19 Specific Issues• Check Local Proclamations, Recently-Enacted Legislation,

and Regulatory Guidance re COVID-19• Do foreclosure or eviction moratoriums exist? • Does recently-enacted relevant legislation exist?• OSHA standards regarding construction

• Analyze effects of COVID pandemic on supply chain – e.g.retail/restaurant, construction

• Analyze effects of COVID pandemic on sequencing• Analyze potential claims related to COVID-19, as against

borrower by tenant or account debtor• Consider impact to EBITDA and borrowing base

• Do covenants need reset for defined periods? Would a payment holiday work?

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COVID-19 Specific Issues• Lender Liability Concerns

• RiverIsland Cold Storage, Inc. v. Fresno–Madera Production Credit Assn., 55 Cal 4th 1169 (2013) and the expansion of the parol evidence rule

• Jolley v. Chase Home Finance, LLC, 213 Cal App 4th 872 (2013) and the expansion of lender’s duty to exercise reasonable care

• Common Defenses• Impossibility/Impracticability • Commercial Frustration of Purpose• Force Majeure

• Consider Pros/Cons Defaults under Material Adverse Change or Effect Language or for Anticipatory Breach

• Affect of Paycheck Protection Program funds

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COVID-19 Specific Issues• If grace was extended to the borrower:

• Was it documented? If not, is there a near-term opportunity to document the consent, waiver, or amendment?

• Were significant amendments acknowledged by guarantors?

• The longer the accommodation goes undocumented the greater the exposure the creditor has to course of dealing and bad faith claims

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Development of Strategy• Coordinate Legal and Business Needs

• What legal deficiencies exist with documents, if any?• What claims/defenses does the borrower have, if any?• How best to deal with uncertainty? • Is there a reasonable likelihood that borrower will be

able to resolve issues that led to default?• Does the lender desire a long-term relationship with

borrower?• Will value of collateral or financial condition of borrower

and guarantors change materially in immediate future?• Is additional collateral or a guarantor available?

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Development of Strategy• Coordinate Legal and Business Needs (cont’d)

• Could a default trigger cross-defaults from other creditors of borrower?

• Is there any reason to waive default(s) and enter amendment instead of forbearance agreement?

• What is the lender’s alternative to a forbearance agreement and what is the cost to do the same?

• Could a potential modification of the borrower’s loan affect the lender’s regulatory capital requirements relating to the loan or the accounting treatment of the loan?

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Initial Communications with the Borrower• Notice of Default and Reservation of Rights Letter

• Follows notice requirements and establishes that Lender • considers default material;

• default vs. event of default

• is not waiving any rights or remedies; and• is merely accommodating borrower if Lender is continuing to fund and is not

obligated to continue to fund

• May provide• opportunity for cure, if applicable • notice of intent to accelerate or notice of acceleration• notice to stop any subordinated debt payments or dividends

• Notice of Default and Demand Letter• Provides notice of default• Provides notice to stop any subordinated debt payments/dividends

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Initial Communications with the Borrower• Pre-Negotiation Letter

• Fundamental Provisions:• Lender is not waiving defaults;• term sheets and discussions are not binding; • statements made during open negotiations are not admissible; and• formal signed, written approval is required to change terms of loan

• Optional Provisions:• Release of known and unknown claims;• Acknowledgement of default and outstanding debt;• Agreement to pay lender’s legal fees; and• Identification of Borrower and Guarantor(s) representative(s),

address(es), and contact(s)

• Signed by Borrower and any Guarantor(s)

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Specific Concerns about Loans Secured by Real Property • Is insurance being paid?• Do outstanding issues regarding rent and tenants exist? • Co-tenancy, exclusivity issues in lease• Do any possible issues regarding condition of the property,

such as environmental concerns, exist?• Does lender have a current rent roll and complete copies of

lease agreements?• Does lender have enforcement concerns regarding the one

form of action rule?• Do any possible title issues exist?

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Specific Concerns about Loans Secured by Real Property • Construction Loans

• Do mechanic’s liens exist?• Do valid lien waivers exist?• Is the loan out of balance?

• Impact on title insurance coverage• Review of prior notices from sub-contractors,

monthly/weekly meeting notes• Is the contractor able to complete construction

timely? Were costs of construction increased and how were such increases handled?

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Specific Concerns about Loans Secured by Intellectual Property • How is the security interest in the IP to be perfected?• How does the lender obtain control of the IP?• Does a source code escrow agreement exist?• Do maintenance fees need to be paid?• How is the IP monetized? • Is there a readily available market for sale of the IP?• Is it possible a challenge to invalidity could be raised

to the patent?

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Specific Concerns about Loans Secured by Hard Assets • Where are the hard assets located?

• Owned or leased property? • Possessed by another party?• Transportable?

• Is the value of the assets being preserved?• Are the hard assets accessible and insured?• Is there a readily-available market to sell hard assets? • Does lender need borrower to sell hard assets?• Are there titles or other records of ownership to the

hard assets necessary for resale?

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Specific Concerns about Loans Secured by Accounts Receivable • Who are the account debtors?• Does the lender have current and accurate

information about the account debtors, such as their addresses and the nature and amount of their outstanding obligations?

• How may the lender obtain this information?• Is the lender’s lien in a senior priority position?

• Conduct a lien (UCC) search

• Is the loan secured a revolving line of credit?

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Specific Concerns about Loans Secured by Accounts Receivable • Has the lender made any future advances that it was

not committed to make since another lien creditor’s lien attached and is not a “buyer”? See § 9-323(b)

• Within 45 days, even with knowledge of lien – ok• More than 45 days without knowledge of lien – ok• More than 45 days with knowledge of lien – trouble

• Will sending a notice of assignment directly to account debtors hinder collection of the debt and/or borrower’s business relationship with the account debtors?

• Pros and Cons of Sending Notice of Assignment

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Specific Concerns about Loans Secured by Accounts Receivable • Impact of delay in collection of accounts receivable• Differences between notice of assignment and

foreclosure• What happens when A/R changes character and

becomes proceeds in a borrower’s “deposit account”?

• Lender maintains perfected security interest in identifiable proceeds or if it has “control” over the “deposit account” (§ 9-104—control)

• Special rules re Government receivables

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Forbearance Agreements • Lender Benefits:

• Correct deficiencies and strengthen weaknesses in loan documents

• Perfect unperfected security interests• Acquire additional collateral or guarantees• Receive release, waiver, and indemnity• Certainty as opposed to litigation• Attain key acknowledgements from borrower • Increase borrower reporting requirements• Avoid later disputes with borrower

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Forbearance Agreements • Borrower Benefits:

• Provide more time • to pay the obligations by refinance, recapitalization, sale, or

liquidation; or• to cure defaults and return compliance with loan documents

• Forbear from enforcement of loan remedies • Continued financing if complying with terms• Clarification of ambiguity and uncertainty

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Forbearance Agreements • Differences Between Forbearance Agreement

and Loan Modification / Amendment• Acknowledgement of default

• Forbearance Agreement – yes• Loan Modification / Amendment - no

• Finality• Forbearance Agreement as a “short term fix” or bridge to loan

modification and allow lender more time to evaluate• Forbearance Agreement as opposed to deferral agreement • Forbearance Agreement may eliminate need for serial loan

modifications, especially in the context of a maturity default or liquidation

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Forbearance Agreements • Standard Terms

• Preamble and Recitals• Identifies parties, loan documents, facts, amount of indebtedness

• Acknowledgements of Borrower• truth, correctness, and accuracy of recitals• loan is due and owing and outstanding balance of the same• event(s) of default and strict enforcement of rights and remedies• validity and enforceability of security interests and loan documents • no continued obligation of lender to make loan advances• fees and default interest are due and owing • no defenses or counterclaims exist• proper notice provided/received

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Forbearance Agreements • Standard Terms (cont’d)

• Conditions Precedent• Identifies the conditions that borrower and any guarantors

must meet to make forbearance agreement effective• Common conditions precedent:

• Delivery of docs (weekly cash budget, 13-week cash-flow forecast, others)• Payment of fees (forbearance fee (0.25% to 2%) and professional fees)• Retention of turnaround professional(s)

• Forbearance• Identifies scope, period, renewals, etc.

• Scope – lenders prefer limitations; borrowers prefer broad• Period – lenders prefer short; borrowers prefer long• Renewal – potential for automatic extension if conditions precedent occur

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• Continued Financing, if any, and/or Use of Cash Collateral

• Specifies pricing and other terms and conditions• Payments

• Amount due, including principal, interest, and fees• Representations and Warranties

• Contain statements of fact and assurances made by borrower and any guarantors and will trigger a default if untrue

• Consider potential non-standard reps and warranties specific to your factual scenario, including those that may help in the future in the event of a borrower bankruptcy

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• Covenants• Specify the actions that borrower agrees to perform during

forbearance period• Common covenants:

• sale of assets/collateral with lender’s consent• compliance with budget and financial covenants• maintenance and use of bank accounts with lender exclusively• notification of lawsuits or demands by other creditors• continued retention of workout professionals• continued compliance with all terms of original loan documents• no payments to owners (reduced compensation for owners)• assistance with collection of accounts

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• Events of Default• Specifies events that allow lender to terminate forbearance and

to begin exercising its rights and remedies• Common events of default:

• borrower or guarantor breaches a term in the agreements• third-party takes possession of assets of borrower or guarantor• bankruptcy• tax lien filed• challenge to enforceability of any agreement• lawsuit filed against borrower or guarantor by another creditor• expiration of forbearance period• catch-all provision: action inconsistent with any provision of forbearance

agreement

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• Waiver of Automatic Stay• Waives borrower’s right under the Bankruptcy Code to prevent

immediate enforcement of the Forbearance Agreement terms• Rarely enforceable

• Formerly strongly disfavored; becoming more acceptable, but still disfavored

• Courts use balancing process to determine enforceability• Factors supporting enforceability of waiver:

• Lender incurred risk and granted borrower concessions;• Lender provided material and substantial consideration;• Borrower (and its sophisticated counsel) acknowledged waiver voluntarily;• Borrower’s rights not materially affected because no equity exists and

property is not necessary to reorganization because no prospect for a reorganization exists – include as representation?

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Forbearance Agreements • Tool to Satisfy Lender’s Post-Pandemic Objectives

• Minimizing Uncertainty• Revising/Creating Definitions in Loan Documents• Revising/Creating Financial Covenants• Revising/Creating Reporting Requirements

• Benefits of Projections and Actual Cash Flow Statements• Creation of milestones and deadlines• Establishing an orderly liquidation• Use of successive forbearance and loan modification agreements• Shortening Maturity Dates (with and without extension options)

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• Minimizing Litigation Risks• Drafting tips – recitals and acknowledgments• Waiver of Defenses and Release of Claims

• Should include known and unknown claims• Typically only valid for conduct through the date signed

• Reaffirmations by borrower and guarantors• Stipulating to judicial remedies• Confession of judgments

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• Enhancing Position in Future Borrower Bankruptcy • Use of financial reporting for cash collateral budget• Relief from automatic stay – 11 U.S.C. § 362(d)

• No equity interest in the collateral• Use of stipulated value of collateral

• Not necessary for an effective reorganization• Use of projections/financial reporting

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Remedies – Overview • Review of Typical Remedies for Secured Creditors

• Forbearance Agreement• Offset• Foreclosure (UCC / Trustee’s Sale)• Lawsuit (for deficiency and/or against guarantor)• Deed in Lieu• Self-Liquidation of Borrower

• Non-typical Remedies for Secured Creditors• Receivership• Assignment for Benefit of Creditors• Bankruptcy: Support Borrower’s Reorganization under Small Business

Reorganization Act

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Remedies• Offset

• Lender with “control” of a deposit account has priority and may set off amounts due

• contractual and/or statutory right

• Three Requirements (and an Exception):• mutuality (i.e., same right, same parties in same capacities)• liquidated debt (i.e., debt subject to precise calculation)• mature debt due and owing (i.e., default or maturity date)• Exception: Government Receivables May Not Be Offset

• Garnishment vs. Offset Right• Majority (default and non-waiver) vs. Minority (no default

and/or waiver) Rule

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Remedies• Foreclosure

• Judicial vs. Non-Judicial• One form of action rule• Anti-deficiency statutes• Possibility of transfer taxes/fees• Right of redemption?• Effect on leases

• Do they terminate automatically?

• Shortened statute of limitations for deficiency lawsuit if exercising non-judicial remedy?

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RemediesPublic UCC Sale• Auction or competitive bidding

process• Formal marketing process

• Secured party may credit bid• Risk of being outbid• “Commercial reasonableness”

• Public disclosure to noticed parties and auction attendees

• Notice requirements:• Same as Private UCC Sales

Private UCC Sale• Specified buyer; no auction or

overbid process• Secured party typically cannot

bid unless publicly-traded securities

• No risk to buyer of being overbid and no public disclosure of buyer or terms of sale

• Notice requirements:• Contents – 9-611(c)• Safe harbor – 9-613• Time – 10 days (25 if fed. tax liens)

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Remedies• UCC Strict Foreclosure Sale

• Little known / used alternative • What is it? – A written proposal by secured party

to debtor to accept collateral in satisfaction of all or a portion of the debt

• Two types:• Full satisfaction of debt (no objection within 20 days

by debtor is sufficient)• Partial satisfaction of debt (debtor must affirmatively

consent; NA for consumer)

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Remedies• UCC Strict Foreclosure Sale (cont’d)

• Mechanics:• Notify Debtor

• Pursuant to any notice provisions in agreement• Retain proof of notice

• Notify other secured parties • Conduct UCC search to identify

• Notify any secondarily-liable parties• Wait 20 days for authenticated objection

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Remedies• Courts – Judgment/Foreclosure Decree

• Likely slow • Post-judgment remedies:

• garnishment • levy• attachment • execution• debtor’s exam • charging order • judgment lien

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Remedies• Deed in Lieu

• Transfers to the beneficiary of the deed of trust or mortgage the encumbered property to avoid foreclosure

• Lender must work closely with the title company to ensure no junior liens

• Unlike foreclosure, a deed in lieu typically will not eliminate or “wipe-out” junior liens or encumbrances

• Once a deed in lieu is recorded, a rebuttable presumption arises that beneficiary consents to the transfer

• If the beneficiary does not consent to the deed in lieu, the beneficiary should immediately record a notice of non-acceptance

• Typically, the consideration for a deed in lieu is the cancellation of the secured debt. However, it is imperative that the deed in lieu be fully and properly documented, especially if there is a guarantor

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Remedies• Receivership

• Judicial proceeding involving the appointment of a neutral and independent third-party (“Receiver”) as agent of the court and custodian over the property of another; court’s order may allow the Receiver to operate the borrower’s business and sell its assets

• Typically provides more flexibility than bankruptcy in terms of cost, timing, and procedural requirements

• Statutory schemes differ widely from state-to-state and is less practical when assets exist in more than one state

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Remedies• Assignment for Benefit of Creditors

• Assets of borrower/debtor conveyed to an independent third party (the “Assignee”) who liquidates the assets for the benefit of all creditors

• Product of state statute or common law• Typically less expensive than bankruptcy and

receivership• Downside is it may not adequately deal with

preferences and fraudulent transfers

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Remedies• Self-Liquidation

• Likely best alternative if borrower is trustworthy and capable

• Allows borrower to collect outstanding A/R giving borrower better chance of collecting

• Some borrowers likely will be able to sell assets more efficiently and for higher prices

• Typically involves a trade off of some sort of benefit to borrower in return

• Practice tip: use personal guaranty as leverage if applicable• Saves costs of enforcement and may minimize exposure

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Omaha402.343.3883

Los Angeles213.683.6605

Brian J. Koenig

[email protected]

Kenneth MillerChair, Bankruptcy and Creditors’ Rights

[email protected]

Co-Chair –Financial Services Department

Shareholder

53