When facing defaults on a loan or other obligation from any debtor, whether a borrower, tenant, business vendor or customer, it can be tempting to immediately pursue the most aggressive approach. However, sometimes overaggressive enforcement can backfire. As one example, foreclosing liens or security interests against a corporate debtor whose business is struggling might push the business over the edge into insolvency, thereby shutting off the flow of future revenue that could otherwise have been a source of additional recovery. When developing an enforcement strategy, creditors must carefully consider all the tools in their toolbelt to pick the approach that maximizes recovery and reduces risk. An oft overlooked but extremely valuable legal tool that offers flexibility without sacrificing enforceability is the forbearance agreement—a contract in which the creditor agrees to temporarily forbear from exercising its rights and remedies following a debtor’s default in exchange for new compensations, promises, or other consideration from the debtor.
What Is a Forbearance Agreement?
Forbearance agreements can serve as a valuable pre-foreclosure workout tool that creditors can use to preserve relationships and avoid litigation while simultaneously shoring up their security and otherwise strengthen their legal position.
A forbearance agreement is not a waiver of rights—it is a temporary pause. When a debtor defaults, the creditor may have the right to accelerate the debt, foreclose a deed of trust on real property or security interests in personal property, evict a commercial tenant or seize property under a landlord’s lien, or initiate litigation against the debtor or guarantors, among other options. However, debtors will sometimes make the case that, if given additional time, they will be able to catch up on their past due obligations and comply with their commitments going forward. If after carefully considering all relevant information the creditor believes that it would prudent to grant the debtors the requested reprieve and delay enforcement, the creditor should memorialize their decision in a formal written forbearance agreement, usually in exchange for new concessions from the borrower such as partial payments, additional collateral, or operational changes.
Key Provisions to Include
While forbearance agreements should always be tailored to fit the unique circumstances of each case, there are a few essential clauses creditors should consider including:
- Acknowledgment of Debt and of the Default: The debtor should admit their default, the amount of their debt, and acknowledge the creditor’s right to exercise its remedies under the applicable contracts, which strengthens the creditor’s position if enforcement becomes necessary.
- No Waiver of Rights by Creditor: The Debtor should ratify the existing contracts and loan documents, reaffirm that the creditor retains all rights under those documents, and acknowledge that the agreement does not constitute a waiver of any rights or remedies. Be particularly clear that the creditor is not waiving the default nor any remedies it may have against the debtor by virtue of the default, but is merely promising to pause enforcement for a specified period under certain conditions.
- Release by Debtor. The debtor should waive and release any and all defenses they might raise, as well as any claims they have or might have against the creditor. One of the most important features of a forbearance agreement, this debtor release will eliminate any risk of potential creditor liability (at least through the date of the forbearance agreement).
- Forbearance Period: Define the specific duration during which the creditor will refrain from enforcing remedies.
- Termination Triggers: Identify events that will immediately end the forbearance period (e.g., failure to meet interim obligations, new defaults).
- Accrual of Interest and Fees: Clarify whether default interest, fees, or other charges will accrue during the forbearance period and become payable upon its expiration.
- Payment or Forbearance Fee. Specify the debtor’s financial obligations during the forbearance period. Consider requiring an up-front lump sum payment, and specify whether that payment will be applied to the outstanding balance and how it will be applied (principle, interest, fees, etc.), or whether it is a separate fee paid solely to secure the forbearance that will not be credited against any portion of the balance. If the debtor will have ongoing financial obligations during the forbearance period, clearly spell that the timing and amount of those payments.
- Additional non-monetary covenants. Forbearance agreements can be a good opportunity to shore up weaknesses in your contracts. Consider adding new non-monetary covenants, such as financial reporting, or modifying or removing existing provisions that have proven to be disadvantageous,
- Additional Security or Guarantees: Consider requiring new collateral or personal guarantees to secure the forbearance.
- Subordination and Intercreditor Agreements: If other financing is involved (e.g., bridge loans), address how those lender’s liens interact with your position.
Conclusion
Forbearance agreements are a powerful tool for Arizona lenders navigating borrower defaults. When properly structured, they offer a path to resolution without immediate litigation or foreclosure, while preserving the creditor’s rights and remedies, eliminating adverse claims, and potentially even strengthening their security. However, they must be drafted with precision and foresight. If you are considering a forbearance strategy, consult experienced Arizona counsel to ensure your agreement is enforceable and tailored to your specific risk profile.
Michael P. Rolland is a passionate and committed advocate that represents individual and business clients in commercial litigation, Chapter 11 bankruptcies, receiverships, loan workouts, and appeals.