Is a Forbearance Agreement in your future? Here’s what you need to know
Your business has been struggling and now the bank wants you to sign a Forbearance Agreement. This legal tool, which lenders use when borrowers breach the terms of their loan covenant, is intended to give the borrower time to resolve their financial issues and return to a payment schedule acceptable to the bank. In exchange for waiving breaches and giving the borrower time to get back on track, the lender will charge additional fees and will ask for certain conditions to be met.
Should you sign on the dotted line?
For entrepreneurs, a Forbearance Agreement brings a measure of relief because it gives them time to fix the business issues that have contributed to their current financial woes. Without this agreement in place, a bank could appoint a Receiver to sell the business’ assets and close the business. But, as is the case with all contracts, a Forbearance Agreement comes with conditions and consequences. That’s why it’s important for business owners to understand the ins and outs of a Forbearance Agreement before they sign on the dotted line.
Starting point: What can trigger a Forbearance Agreement
Defaulting one too many times on a loan can trigger a Forbearance Agreement, but it’s only one of many reasons a bank may decide to take this course of action. Other reasons or breaches of the loan covenant include:
- an adverse change in your debt-to-equity ratio, operating losses
- assets pledged as security to another lender e.g., a merchant cash advance company
- large amounts owed to creditors—such as Canada Revenue Agency (CRA)—who may rank ahead of the bank
Understanding the conditions in a Forbearance Agreement
The temporary relief provided by a Forbearance Agreement comes with strings attached. When business owners sign a Forbearance Agreement, they also agree to certain conditions imposed by their bank. These conditions may include:
- a reduced operating line-of-credit (LOC) or overdraft over a defined period, which could last several months
- a requirement to submit a cash flow statement prepared with the help of a financial consultant hired and paid by the business
- a requirement to obtain an appraisal, at the business’ expense, on real estate, equipment or other asset(s)
- a reduction of operating expenses through actions such as laying off or terminating some employees
- additional collateral such as a personal guarantee by the business owner, guarantee by a related company or providing additional security over the company’s assets
- in certain circumstances, a requirement that certain excess assets be sold
- a requirement to sign a ‘consent to judgement’ that, essentially, confirms in writing the amount you owe the bank. This document makes it easier for the bank to prove you owe this amount should it decide to pursue litigation in the future
What happens if you can’t meet the forbearance conditions?
Failure to meet the conditions in a Forbearance Agreement can lead to a receivership, litigation, or both, so you need to take time to consider whether or not the conditions your lender wants to impose on you are fair and realistic. For example, if your bank wants you to sell one of your real estate properties, will the forbearance period give you enough time to find buyers who will pay a fair price or do you need to extend the forbearance period?
In tough times, professional help can make a difference
It’s a good idea to seek the help of a professional, such as a licensed insolvency trustee, who can explain the implications of the Forbearance Agreement and guide you through these tough times. A professional with the right expertise can help you build a plan to ensure you can meet the terms of the agreement. They should also be able to provide recommendations on what conditions you can and should negotiate, as well as help you find another lender if that’s what makes the most sense in your circumstances.
You can pull through – with right plan and the right professional help
The thought of a Forbearance Agreement may seem daunting. But with the right plan in place – and with the guidance of a licensed insolvency trustee – you could restore your business to a healthier operational and financial state, and rebuild your relationship with your lender.