Silk Purse or Sow’s Ear? What to Consider When Negotiating a Forbearance Agreement
By David R.M. Jackson on 2013/11/28
Once default occurs and a lender refrains from enforcement or otherwise requiring strict compliance with lending conditions, forbearance has occurred. There used to be a certain banality with forbearance. If a debtor had cash flow difficulties, there was a reasonable expectation its lender would agree to provide time to pay or defer an instalment. Where a lender discovered a covenant breach, such as a debt to tangible net worth ratio being offside, it would rarely document the default. Informal extensions, deferrals and other accommodations were provided as common courtesies in ordinary lending situations – often taken for granted in well-established bank-customer relationships. Historically, even when a customer was in obvious financial difficulties, it was not unusual for the lender to be fairly generous with time extensions to enable the customer to work through its difficulties. Is it any wonder that Webster’s Dictionary included “patience”, “tolerance” and even “leniency” amongst the common synonyms for forbearing? But times change.
Whether it can be attributed to greater lender and advisor sophistication, recognition that our insolvency legislation has shifted to a debtor in possession model that has significantly altered creditors’ enforcement rights or other factors, forbearance has taken on a much more critical role in our restructuring regime. What may have been previously treated as informal accommodations, sometimes covered off by a brief exchange of correspondence between parties or counsel, has mushroomed into long, detailed and often complex Forbearance Agreements. Lenders, debtors and sureties devote substantial time and professional resources to prepare, negotiate and then comply with the agreed forbearance terms. The underlying premise of the debtor requiring time to work out its difficulties remains the same, but accommodation is rarely provided gratuitously. The lender’s willingness to provide time has a price or, as is frequently stated in the industry, you have to “pay to stay”.
While the pay to stay approach may include an express fee component to the lender, the ultimate consideration sought is not additional revenue. Lenders have had too many nasty experiences with informal time extensions. How many times has a lender freely extended deadlines only to discover after the fact that the customer has not only failed to accomplish what it had promised to do but now blames the lender for the predicament and threatens litigation? Such problems arise when lenders and debtors fail to formalize their accommodations into documentary form. What the lender is really prepared to trade time for is certainty – certainty that in the event the customer cannot honour its commitments there will be “no surprises” and that the lender may proceed with its remedies without challenge.
The debtor-lender forbearance tango requires at least two willing participants. The debtor needs time and likely other concessions to fix the predicament it finds itself in. It also wants some comfort that the lender will not pull the rug out from under it before time expires. Provided there is some reasonable trust, the lender also wants to give its customer time to rectify the problem; it just does not want to give away the time, watch its security position evaporate and then face road blocks to enforcement. It should be recognized that there is an inequality in bargaining positions: the debtor is in distress, needs money and has little time available to raise it, while the lender controls both the financial resources and the stop watch. As one popular information source noted in the wake of the recent U.S. housing crisis:
“When a lender offers forbearance, they are taking control of the situation so that they can maneuver whichever way best serves the lender”.
That said, where there are mutual advantages to be gained from entering into a Forbearance Agreement, such cynicism should not prevent the parties from endeavouring to negotiate a solution.
Lenders and restructuring professionals have generally adopted Forbearance Agreements as a useful tool in their workout kits. Flexibility, familiarity and an absence of known disasters add to their attraction and industry proliferation. “Negotiate forbearance terms” has become an almost universal prescription whenever the debtor is in default but is not at the point of a formal filing to restructure.
It must be recognized that a Forbearance Agreement is not a magic wand that a cabal of restructuring experts can simply waive over a distressed debtor and transform it into a successful business. If properly prepared, it is just a “contract”, the consideration of which is the mutual exchange of intended actions between the parties; enforceable by the courts to the extent permitted by the law. As one experienced practitioner put it:
“A properly drafted Forbearance Agreement is an important and strategic tool for a creditor to assist in getting a borrower to cure defaults and return to a normal lending relationship, or in instances in which an exit is desired, to put an exit plan in place, while preserving the lender’s rights and defaults.”
If not properly negotiated or prepared, and the debtor is unable to cure its defaults or otherwise exit the relationship, the remedies contemplated under the Forbearance Agreement may prove difficult to enforce or the lender’s rights prejudiced.
It is also important to recognize that although industry use of Forbearance Agreements appears to have increased dramatically over the past decade or so, jurisprudence on the subject has not. Certainly, we have witnessed more Forbearance Agreements being included as exhibits to both CCAA Initial Applications and receivership proceedings. They are generally accepted as the best evidence of the parties’ intentions and their reasonable terms recognized and enforced. However, the jurisprudence is not entirely positive. For example, one court very narrowly construed the enforcement terms of a Forbearance Agreement while another disregarded the Forbearance Agreement altogether when it considered a challenge to the underlying security. It may take a few more years before the jurisprudence on Forbearance Agreements reaches the stage where there is certainty of application and interpretation.
During negotiations with the debtor, the lender and its advisors must also try to remember that there is an “elephant in the room” – subordinated creditors. While there are exceptions, Forbearance Agreements are generally entered into by the debtor and its first lien lender. First lien lenders tend to focus on their priority ranking and fixate on being paid first. Once satisfied their security is sound, first lien lenders also tend to gloss over the existence and rights of other creditors unless one of them has the audacity to interfere with their priority. This is not the right approach to take when considering forbearance terms for an operating business.
The lender’s over-riding duty and obligation to enforce its security in good faith and in a commercial reasonable manner should have equal application in the context of a Forbearance Agreement. Forbearance terms which are too onerous on the debtor – for example an unjustified increase in interest rates, punitive forbearance fees, an inordinate restriction or control over the debtor’s ability to pay other creditors or imposition of an unreasonably short time frame for a sales process – may not only jeopardize the lender’s security position but possibly lead to other exposure. While a thorough review of the topic of lender liability is beyond the scope of this paper, imposition of forbearance terms which unduly prejudice or unreasonably disregard the rights of other stakeholders, take operating control of the debtor, constitute wrongful or inequitable conduct or ultimately lead to an improvident realization may leave the lender open to challenge in the courts whether it be under general lender liability principles, unconscionable transactions legislation, oppression relief or even equitable subordination. The point is this: even though other creditors may not have a seat at the negotiating table, they have a very real interest in the results and the right to challenge the lender’s conduct when it exceeds what is considered to be commercially reasonable. The potential impact of the contemplated forbearance terms on other stakeholders should be kept front of mind.
1. The Need for a Plan
The parties endeavouring to negotiate forbearance terms should be able to articulate what their respective goals or objectives are, and be able to agree on clear deadlines when those goals or objectives are to be met. Depending upon the nature of the debtor’s financial difficulties the approach may be as simple as implementing costs reductions which may enable the debtor to meet its obligations. It may involve locating and injecting additional working capital or finding a new lender. Sometimes it involves having the debtor enter into a sales process for the business (either in whole or in part) with the hope of paying out the lender.
Perhaps the first consideration should be whether or not a Forbearance Agreement is even appropriate in the circumstances. Where the debtor is basically sound and simply requires time to resume acceptable business operations, the lender should consider amending the existing loan agreements. If the goal is to “de-market” the customer and its prospects for locating a replacement lender are strong, perhaps all that is required is to provide a notice of divestiture. However, where there are material defaults, appropriate forbearance terms should be formalized.
Another consideration is whether the restructuring can be accomplished informally or is a formal filing or court administered process necessary? If the former, a Forbearance Agreement can and should be entered into. Where a formal filing is inevitable, consideration should be made to just proceed with immediate filing. That said, there are mutual benefits to be obtained by formalizing the pre-filing relationship under a Forbearance Agreement. This could enable the lender to better position itself before a filing becomes necessary. A properly negotiated Forbearance Agreement can also be a useful tool to gently nudge a reluctant debtor towards taking the appropriate restructuring actions.
It becomes more difficult where the parties have not been able to identify or agree on what needs to be done. The debtor may well be in denial that there even is a problem – other than the lender wanting to get paid out sooner than the debtor thinks appropriate. In such circumstances, the lender may be prepared to forbear for a brief period of time provided that the debtor engages a restructuring professional to conduct a business review and develop a plan. The unarticulated major premise of requiring debtors in denial to engage a restructuring professional is not just to secure necessary restructuring advice but to educate the debtor – a.k.a. take the debtor “to the woodshed”. With such engagements it is not unusual to witness a miraculous transition from what was once a debtor in denial into one fully committed to a sales, liquidation or other process (even supportive of a court filing). On rare occasions, with the structured breathing space afforded by a Forbearance Agreement, strenuous effort by the debtor and a lot of luck, special loans officers who were otherwise committed to divesting the customer may be persuaded to sit tight through the restructuring and experience the satisfaction of returning a now viable customer to the commercial account manager.
2. Common Terms or Considerations
Once the lender and the debtor have reached a mutually acceptable plan or approach, the more specific forbearance terms can be addressed. While the nature and extent of forbearance terms may be limited only by the imagination of the parties, most agreements include the following:
The initial consideration is “how long is this process going to take?” If the plan is for the customer to inject additional working capital and the source of that working capital has already been identified, then a fairly short time frame should be contemplated. If the lender has decided to divest and the customer must seek out and obtain a new lender then the process could take a few weeks or months; if the objective is to sell the business as a going concern it may take longer particularly where market conditions are depressed.
Much of the lender’s flexibility or willingness to grant time will be a function of the customer’s liquidity and the amount of trust it has in management. The tendency of lenders is to limit the initial forbearance period but allow for discretionary renewals. It is not unusual to see an initial three month forbearance period contracted for under the Forbearance Agreement with multiple extensions where the lender is satisfied that the plan is being met and its security position is not eroding. One way to encourage a lender to grant additional time is to provide additional security or capital injections. However, where longer time frames are used expect that the lender will insist upon some combination of date specific interim targets or milestones with an ultimate payout deadline. Also expect an agreed cash flow forecast to be incorporated into the agreement which will enable the parties to track results. For example, if the payout is to be sourced from the sale of substantial parts of the business, the milestones could be:
1. Engage a financial advisor acceptable to the lender – two weeks.
2. Development of a Confidential Information Memorandum and a Sales Process – 30 days.
3. Deadline for receipt of non-binding letters of intention – 60 days.
4. Receipt of executed Asset Purchase Agreement acceptable to the lender – 90 days.
5. Lender paid out – 120 days.
The milestones can be either expressly set out in the body of the agreement or in a separate schedule. Setting such milestones gives the lender the comfort of knowing it can declare default and proceed with enforcement where interim targets are not met.
Similarly, the lender and the debtor, with the assistance of the restructuring professional, can develop an agreed weekly cash flow forecast over the forbearance period which projects receivables, anticipated cash collections, inventory levels and other borrowing base information, planned cost reductions, liquidation and other items. If the debtor fails to operate within reasonable parameters of the forecast, default will be deemed to have occurred and the forbearance period can be terminated. The acceptable parameters, or negative variance between net cash flow forecast and actual results, as well as the evidence upon which that variance is to be measured, should also be negotiated and clearly stated whether in percentage or monetary basis within the agreement. For example:
“The negative variance between actual net cash flow (as evidenced by the Weekly Reports prepared by the Restructuring professional), and the projected net cash flow amending to the forecasts shall not exceed $150,000.00 during any 4 week period or $400,000.00 on a cumulative basis.”
With respect to extensions, it is the lender’s preference to retain absolute discretion on whether or not to grant additional time after the initial forbearance period has expired. Similarly, it is not unusual for the debtor to try to build in a commitment to extend if, for example, the debtor has negotiated an acceptable sales agreement before the end of the forbearance period but the sale cannot be closed until some reasonable time period thereafter. Where there are mutual benefits to continuing the process, extensions will be negotiated and typically formalized into a written Agreement to Extend.
b) Confirmations, Acknowledgements and Releases
As noted previously, one of a lender’s worst fears is to have granted significant time to the debtor only to discover after the fact that the debtor disputes the amount of the debt, the extent or enforceability of the security or raises lender liability issues. Accordingly, most Forbearance Agreements contain detailed covenants and representations from the debtor and guarantors confirming the existence and quantum of the debt, exact particulars of all security held in support of the debt including guarantees and other collateral documents, acknowledgement that the security is valid and enforceable, as well as an acknowledgement of the defaults and any other conditions precedent to enforcement. The debtor and the guarantors must unequivocally waive and release all defences and claims they might have against the lender including any right of set off. Lenders also require a release from any lender liability or other claims of the debtor and guarantors. It is unusual for a lender to abandon these requirements but debtor’s counsel may be able to negotiate limits to the nature and extent of the Release.
c) Forbear from What?
What exactly is the lender agreeing not to do during the forbearance period? Is it simply not to enforce the security against the debtor provided that the forbearance terms are being met? Does the lender also agree to forbear from pursuing the guarantees or other third party security? Does this include judicial or civil enforcement actions? Does the agreement to forbear mean not issuing demands and the statutory 10 day Notice of Intention to Enforce Security under Section 244 of the Bankruptcy and Insolvency Act R.S.C. 1985 c.B-3 as amended (“BIA”) or other applicable statutory notice requirements such as those prescribed under the Farm Debt Mediation Act S.C. 1997, c.21?
Some counsel make a distinction between “Forbearance Agreements” and what are sometimes referred to as “Standstill Agreements”. In that context, forbearance is an agreement not to issue demands on the debt, whereas if demands have already been issued or the lender otherwise intends to be in a position to immediately enforce security upon expiry or default of the agreement, then it is agreeing to standstill. Most current authorities on the subject no longer make that distinction and whether the agreement is to refrain from issuing demand during the agreed time period or not to enforce security both are referred to as Forbearance Agreements.
That said, practical considerations must apply to whether the agreement should include the issuance and acknowledgement of demands and all applicable statutory notices of enforcement. Usually if the lender has not already issued demands and statutory notices, it will want to do so as part of the agreement. The debtor and guarantors will be required to acknowledge service and waive the notice periods. That will entitle the lender to proceed with enforcement immediately in the event there is either a default under the Agreement or the forbearance period expires.
There are circumstances, however, where it may be appropriate for the lender to refrain from issuing demands and notices or consider withdrawal of demands and notices previously sent. Where formal issuance of a demand may trigger covenant breaches with other lenders, suppliers, landlords, security holders or regulatory authorities who may jeopardize operations during the forbearance period, it may be preferable for the lender to defer that step and accept the risk of delayed enforcement.
Notwithstanding the absence of demands and statutory notices, some Forbearance Agreements purport to have the debtor provide advance waivers and consents to immediate enforcement. Although this is useful to set out the parties’ intentions, it should be recognized that advance waivers or consent may not be enforceable. For example, BIA s. 244(2.1) prohibits waivers or consents provided before the BIA s. 244 notice is served.
The Forbearance Agreement should clearly identify when the lender’s obligation to forbear expires, what events constitute default and how the lender’s obligation to forbear may be terminated in the event of default. Some defaults are more obvious than others. For example, failure to meet stated deadlines for defined targets should be straight-forward but what if there are minor compliance or reporting discrepancies? Must the debtor continue to comply with all original loan covenants during the forbearance period? In a classic bricks and mortar/mortgage lending scenario, reporting or borrowing base information would be less of a concern than to an operating lender. If the debtor is obliged to comply with cash flow forecasts how much negative variance is permissible on a week over week and/or cumulative basis? Both the lender and the debtor must carefully review the terms of default under the Forbearance Agreement to ensure that potential breaches are as objectively identifiable as possible.
Similarly, is the debtor entitled to a cure period in the event of default? While the majority of lender prepared Forbearance Agreements do not require notice, let alone a cure period, it is not unreasonable for the debtor to negotiate written notice requirements with at least a 24 hour cure period. One compromise for the parties to consider is a two-tiered approach – identify specific defaults which entitle the debtor to a reasonable cure period and those which may permit the lender to immediately terminate and enforce without notice.
e) Enforcement Remedies
While Forbearance Agreements generally confirm that upon expiry or default the lender may proceed with its legal remedies including those available under its security, some lenders insist the debtor provide them with a formal consent to a specific Court Order, such as judicial sale, foreclosure, receivership or other relief. Similarly, in real estate lending situations where there are no other covenants or guarantees of value to pursue, the Forbearance Agreement may have scheduled to it an executed transfer of the mortgaged lands to the lender or a nominee with quit claim. Such documents should be held under escrow conditions set out in the agreement and with appropriate authorization to the escrow agent to file based upon a defined triggering event. In such circumstances it is appropriate to attach draft form Consent Court Orders as schedules to the Forbearance Agreement. Execution and delivery of the Consent Court Order to the lender or its counsel under escrow or trust conditions should be a condition precedent to the lender’s obligation to forbear.
Enforceability of Consent Court Orders, particularly where there have been no pre-existing court proceedings filed, is a matter of some uncertainty. Again, a Forbearance Agreement is only a contract and a court may be reluctant to allow contract terms to dictate its actions or “fetter its discretion”, particularly where extraordinary remedies such as receiver appointments are concerned. By the same token, where parties have clearly waived defences and consented to a specific Court Order as part of a Forbearance Agreement, the court will generally accept it as the best evidence of the parties’ intentions and will form the basis on which it may grant the agreed to remedy, provided it is otherwise appropriate in the circumstances.
f) Prohibition and Restrictions on Future Court Proceedings
The court’s reticence with contract terms that may fetter its discretion also impacts a lender’s ability to restrict debtor protection filings or dictate creditor status in future court administered restructurings such as CCAA. While it is not unheard of for Forbearance Agreements to purport to prohibit the debtor from filing for BIA or CCAA protection, such provisions are not enforceable. The same reasoning may limit the enforceability of a pre-filing acknowledgement that the lender is an “unaffected creditor” in a CCAA filing.
g) Parties to the Agreement
Clearly, both debtor and lender need to be parties to a Forbearance Agreement. The real question is what other parties should be included? To the extent that there are parties which have guaranteed or otherwise provided financial or other support for the credit facilities in question they should be parties to the agreement failing which there is a risk that the guarantee or other support could be impaired. Where other lenders or significant trade creditors may be critical to the debtor’s go-forward plans during the forbearance period, particularly where such creditor may be providing additional working capital or other credit (or whose forbearance of their own enforcement rights are critical during forbearance), consideration should be made to including them as parties. Recognizing that a proliferation of unrelated or independent parties may unduly complicate negotiations or otherwise inhibit finalizing an appropriate Forbearance Agreement between debtor and lender, it may be more practical to leave them out of the negotiations but insist the debtor provide their separate written consent to forbearance.
h) Ongoing Status of Credit Facilities
Does the lender insist on terminating the operating line or will the debtor be allowed to continue to utilize that facility and revolve the credit? If the former, the agreement should acknowledge that the facility has been terminated and is no longer available. If the latter, it is a good opportunity for the creditor to set out the conditions that need to be met to enable the facility to revolve. For example, will the maximum limit on the line be reduced and if so how quickly? It is not unusual to see graduated reductions to the maximum amount available on the line over the course of the forbearance period. To the extent that there have been margining issues it may be necessary to set out whether the line can continue to revolve up to the maximum limit notwithstanding margining or borrowing base requirements are out of compliance. If that occurs, it may be advantageous to set up milestones or deadlines for the debtor to bring the borrowing base back within margin within a reasonable time frame. A similar approach can be taken regarding other covenant defaults. Where such changes are made, the Forbearance Agreement should either set out specific amendments to the existing credit facilities or require the parties to execute separate amending agreements to accomplish these objectives.
Consideration should also be made as to whether the debtor is in a position to service principal payment obligations under the term facilities. To the extent that ordinary principal payments cannot be made based upon existing cash flow forecasts consideration can be given to including an express undertaking by the debtor to apply the net proceeds from the sale of capital or other assets out of the ordinary course of business against the term facilities.
i) Interest Rate Increases
When an operating lender discovers that its customer is in jeopardy, it will typically require an increase in the applicable interest rates, particularly where the lender continues to permit the debtor to revolve the operating facility. This is common practice and it is not unusual for operating lenders to insist that rates which were previously prime plus one will bump up to prime plus 4 or 5 in recognition of increased risk rating. Such an interest rate increase does put additional pressure on the debtor when free cash flow is at a premium. That said, the debtor should appreciate that if it was forced to go out to the market to obtain operating credit, rates would be significantly higher and possibly only available through a DIP lender under a formal filing. Interest rate increases may encourage the borrower to obtain financing from another lender, which may be part of the lender’s strategy in any event. But, there are other considerations that should be kept in mind when a significant interest rate bump up is contemplated.
There is a prohibition against charging a “Criminal Rate” of interest: Criminal Code R.S.C. 1985 c. C-46 as amended (“Criminal Code”) s. 347. Charging an effective annual rate (“EAR”) of interest of more than 60 percent not only constitutes a criminal offence but may jeopardize recovery of the entire facility. Given the expansive definition of “interest” under the Criminal Code it is not that difficult for a lender to inadvertently exceed the 60 percent threshold. Firstly, given that most financial institutions compound interest, even a 40 percent rate compounded on a monthly basis will result in a 60.103222 percent EAR and cross over into the criminal category. Secondly, the definition of interest for the purposes of the Criminal Code factors in other fees and charges (including forbearance or other administration fees, loan application fees, monthly fees, commitment, standby or late fees, bonus payments, processing fees, NSF and other return charges). While it is less of a concern for ordinary commercial lenders, venture capital and more adventurous lenders may be at risk with convertible debentures or debt instruments that entitle the lender to share their customer’s success by exchanging debt for equity.
To the extent a lender’s existing facility may already impose significant ongoing administration charges it may be worthwhile to review the situation carefully before increasing an interest rate as part of the forbearance terms. Take the example of a lender who charges an overdraft fee of $6.00 on transactions as well as a standard overdraft interest rate of 24 percent compounded monthly. If the debtor overdraws its account by only $300.00 but brings the account current within 5 days, the $6.00 fee is only 2 percent of the amount of the credit overdrawn. However, converting that $6.00 charge plus 24 percent into an EAR when repaid in 5 days results in an interest charge of 146 percent. The impact of the Criminal Code on such overdraft or administration fee charges has led to several significant class actions against a number of West Coast Credit Unions.
The practical concern to lenders who even inadvertently charge a criminal rate of return is the risk their loan may be unenforceable. As noted in Still v. M.N.R.  1 F.C.J. No. 1622 at para. 39 (F.C.A.):
“A contract which is either expressly or impliedly prohibited by statute is normally considered void ab initio. That is to say, prima face neither party is entitled to seek the court’s aide.”
While the Supreme Court of Canada’s decision in Transport North America v. New Solutions Financial 2004 SCC 7 has to some extent tempered such a draconian result where the lender inadvertently exceeds the criminal rate, full loan recovery may still be jeopardized. Assuming the court is satisfied that loan agreement is not otherwise unobjectionable it may sever the criminal interest rate provision and enforce the balance of the loan. This approach has been used to reduce the offensive rate to one just under the criminal cap but it has also been used to sever off the interest component entirely. Where the magnitude of the applicable interest rate and other charges is a concern it may be useful to insert a notwithstanding provision that acknowledges the total interest owing shall not exceed the criminal rate.
While it should be less of a concern with demand based facilities, problems may arise with interest rate increases on unmatured instalment facilities, particularly where real property security may be involved or where there is a significant interest rate bump up on default. To the extent that a default interest rate increase cannot be justified as a genuine reflection of the increase in the risk rating, the courts may construe it to be a “penalty” and unenforceable at law. In Place Concord East Limited Partnership v. Shelter Corporation 2003 CanLII 49373; affirmed 2006 CanLII 16346 (Ont.C.A.) a Promissory Note which provided for an increase in the interest rate on default from prime plus 1.75 to prime plus 6 (i.e. a 4.25 percent increase) was found to be a penalty. The court exercised its discretion to substitute the interest rates on the note for what was available under the Ontario Courts of Justice Act – significantly below market rates. Furthermore, even where an interest rate increase can be justified based upon risk ratings, but the interest rate on arrears is greater than the rate of interest payable on principal not in arrears, it will be deemed to be unenforceable as a penalty if the loan facilities are secured in whole or in part by a Real Property Mortgage by virtue of Section 8(1) of the Interest Act R.S.C. 1985 c.I-15 as amended.
While there is no dispute that interest rate increases are common in Forbearance Agreements, the lender should not ignore the potential impact such increases may have upon other creditors and stakeholders when setting any increase. An inordinate rate increase which impacts other creditors’ recoveries may precipitate a court application for review.
In situations where full recovery is in doubt, or for other reasons the lender wants to create incentives for the debtor to expedite payment, discounts can be negotiated as part of the forbearance terms. A graduated discount which decreased over time creates incentive for early payment. Where a discount is negotiated it is important to structure it on the basis that lender receipt of the payment of the discounted amount is a condition precedent, and that there are no other defaults, to prevent premature accord and satisfaction.
j) Forbearance Fees
Most lenders insist upon forbearance fees as an essential part of any agreement to forbear. Some may question why a lender who has determined its customer’s ability to repay the debt is in jeopardy would further fan the flames of insolvency by insisting upon payment of additional administration or forbearance fees. In fairness, the additional administration required once a loan is placed in special loans or the equivalent recovery department is not insignificant. Troubled loans require more hands-on attention. Many security agreements contemplate adding additional charges for the administrative time consumed by the lender with such matters. But how much is a reasonable forbearance fee? Some authorities have identified a .25 percent to 2 percent per annum range while others up to 5 percent. The reality is the quantum of forbearance fees is a function of negotiation and bargaining position.
Again, the fact that the lender convinces its customer to accept a certain level of fees does not mean that they will not later be subject to challenge or court scrutiny. A lender who insists upon an inordinate or arbitrary forbearance fee faces the same risks of a lender who charges an overly high interest rate or imposes other oppressive or improvident conditions.
Also, not unlike interest rates and discounts, forbearance fees can be used to create incentives for early pay out. For example, reducing or waiving the forbearance fees for early payout or where other negotiated milestones are met.
k) Reporting and Monitoring
Typically operating lenders are already in receipt of monthly reports which enable them to assess the debtor’s business operations and potential erosion to their security position. It is important to consider whether the pre-default reporting obligations continue or if there is a need for enhanced reporting. In mid to large restructurings it is usual for the lenders to require weekly variance reports comparing actual results with forecasts. Where the lender has concern about the debtor’s ability to provide reliable reporting it may insist on engaging, or having the debtor engage a restructuring professional to provide the level of reporting it requires. Reporting should also include progress updates on sales, refinancing and any other restructuring efforts.
l) Fixing Deficiencies
It is not only important for the Forbearance Agreement to have the debtor/guarantors acknowledge the validity and enforceability of the lender’s security but it may well be the last opportunity for the lender to shore up any defects in its position. Before negotiating forbearance terms the lender should have had its loan and security documents vetted by legal counsel and be well aware of any gaping holes in its position – whether it be a failure to provide the security and other documentation contemplated under the Credit Agreement, identification of unregistered or unperfected security interests, or the painful recognition that there is insufficient realizable value in collateral to cover the entire facility. With the debtor wanting time or other accommodations, the lender should have the leverage to compel the compliance necessary to correct any technical deficiencies.
The importance of remedying defects or deficiencies in the security cannot be overstated and must be specifically addressed and rectified by the parties. It also may not be sufficient to rely upon a debtor’s or guarantor’s acknowledgement of validity contained in Forbearance Agreement and expect courts to overlook any fundamental defects. A recent decision out of the Prince Edward Island Court of Appeal provides a useful example of this – as well as the need to ensure that the Forbearance Agreement itself has been properly executed. Lewis v. Central Credit Union Limited 2012 PECA 9 (CanLII) dealt with a situation where two mortgages the lender sought to enforce contained inherent defects which the court refused to enforce notwithstanding the subsequent execution of a Forbearance Agreement which acknowledged the security.
Lewis was a classic farm problem. When Orville Lewis’ potato farm experienced financial difficulties in 2004 the Credit Union sought additional security to shore up its position on the existing farm loan. Orville owned an additional 100 acre parcel jointly with his 80 year old mother. They both readily granted the mortgage. The Credit Union insisted that the elderly Ella Lewis obtain independent legal advice before executing the mortgage that was done. In or about 2008, Orville discontinued potato operations and started growing carrots. This required more credit. When the Credit Union insisted upon additional security before granting the loan Orville offered another parcel of land, this being 68 acres in his name but subject to a life interest for Ella. Ella signed the consent to the mortgage but the Credit Union did not request and Ella did not obtain independent legal advice. That said, the mortgage was provided, duly registered and the Credit Union advanced additional credit.
The conversion from potato to carrot farming turned out to be disastrous: Orville lost his crop and had no crop insurance. The Credit Union issued its Notices of Intention to Realize on Security, the parties went through Farm Debt Mediation without success. Eventually, the Credit Union and the Lewis’ entered into a Forbearance Agreement and Ms Ella Lewis did obtain independent legal advice before executing the documentation. When the prescribed forbearance period expired the Credit Union proceeded with mortgage enforcement whereupon the Lewis’ brought application for injunctive relief to prevent mortgage sale.
As should have been anticipated, any court case involving a financial institution, an 80 year old mother and defective ILA will not go well for the lender. Ultimately, the majority of the PEI Court of Appeal (McQuaid, J.A. dissenting) came to the following conclusions:
1. Notwithstanding the ILA obtained for Ella on the 2004 mortgage, as the Credit Union did not advance new monies under the mortgage and it was thereby granted only for past consideration, it was unenforceable.
2. The 2008 mortgage was not enforceable as against Ella Lewis’ life interest as she had not been provided with independent legal advice before executing the consent.
3. With respect to the impact of the Forbearance Agreement executed by Ella Lewis with the benefit of independent legal counsel, the court concluded that it was “moot”.
The reasons for decision are somewhat murky on the Forbearance Agreement as well as to its specific terms but the court appears to have taken the position that as the forbearance period had already expired before the Credit Union commenced security enforcement the Forbearance Agreement had no relevance to the mortgage validity issues. The court also seemed to frown upon whatever else may have been contained in the Forbearance Agreement given that there were discrepancies between the form of the agreement Ms Lewis received the ILA on and the version ultimately signed by the parties.
While Lewis may be a case of “hard facts making bad law”, it does suggest that if lender’s counsel relies solely upon the security acknowledgement set out in a forbearance agreement to buttress defective security, the court may choose to disregard that document in its deliberations. As such, it is imperative for lender’s counsel to ensure that all i’s are dotted, t’s are crossed and to effect whatever other “belt and suspenders” approach that can be taken to rectify any existing security of questionable integrity.
m) Additional Security
Once lenders have internally or otherwise reviewed their security position there may be a need or desire on the lender’s part to request additional collateral or guarantees. To the extent that the lender seeks new or additional recourse against the borrower’s principals, investors, family or any other source, the lenders should be sensitive to the usual legal requirements of same – adequate disclosure, independent legal advice and some consideration. To the extent that the lender’s existing security does not already cover all of the debtor’s or guarantor’s undertaking, property and assets, obtaining additional security from the debtor or guarantors at this stage is at risk of subsequent challenge as a preference or other reviewable transaction. The real question is whether or not this preference is one susceptible of being overturned by other creditors or their representatives as a fraudulent preference, conveyance, or transfer under value pursuant to BIA ss. 95 and 96 or applicable provincial fraudulent preference, conveyance or assignment legislation.
To the extent that additional credit is advanced following provision of the new security or there is sufficient evidence to justify that the security was granted in order to permit the debtor to continue to carry on business, the lender is in a fairly strong position to rebut the presumptions under the BIA and provincial preference legislation. While the pre-existing debt is not valid consideration, there is some jurisprudence to support the notion of true forbearance as constituting good consideration for the granting of additional security. That said, in practice and particularly when the challenge is launched under provincial preference legislation, the courts have been insistent that there must be a fresh monetary advance before the new security can survive a preference challenge. In Re Harry Snoek Limited Partnership 2012 ONCA 765 (CanLII) the Ontario Court of Appeal was unwilling to accept the submission that restructuring payment terms, including interest rate reductions, a term extension and a willingness to forbear constituted sufficient consideration to withstand the Trustee’s preference challenge absent a monetary advance. What if the pre-existing unsecured indebtedness was $100,000.00 and an additional say $50,000.00 was advanced as a condition of granting the new security, would that be sufficient “value” to prevent a successful preference challenge absent other defences? There is case law to support an argument that the pre-existing portion of the debt should remain unsecured notwithstanding the additional advance given at the time the new security was granted.
n) Independent Legal Advice
I may be trite to say but all parties should receive independent legal advice when negotiating a Forbearance Agreement. While it is not unusual for some lenders to simply require the debtor to acknowledge having had a reasonable opportunity in which to receive and obtain independent legal advice, if there be an apparent inequality in bargaining positions, independent legal advice should be required. Although there is no common law duty imposed upon a lender to insist upon independent legal advice an exception arises in circumstances where a presumption of undue influence arises. More practically speaking, independent legal advice offers the lender, as well as the other parties to the agreement, a shield against others raising such defences as non est factum, unconscionability, fraud and undue influence. It is rare for the lender not to insist upon ILA as a condition of forbearance.
o) Additional Obligations
With a view to maintaining the status quo and avoidance of unanticipated surprises, consideration should also be made to having the debtor and the guarantors acknowledge and agree to term such as:
a) They shall not grant any additional security interests or charges including purchase money security interests or enter into any lease commitments without the consent in writing of the lender;
b) They shall not incur any additional debt or assume other obligations outside the ordinary course of business or as otherwise contemplated by the cash flow forecast;
c) They shall give the lender prompt written notice of any material adverse changes;
d) Assuming the lender provides the operating credit or otherwise is entitled to priority on receivables, they should confirm all proceeds shall continue to be deposited in the operating account with the lender;
e) They shall pay and keep current all employee withholdings (i.e. source deductions) under the Income Tax Act, CPP and employment insurance; GST and/or related obligations which may otherwise have priority over the lender’s security;
f) They should acknowledge that the lender is not exercising management or control over the debtor’s business;
g) They shall not issue any dividends, make any shareholder distributions nor make any similar payment without the written consent of the lender;
h) They shall make no repayment of debts to the guarantors, shareholders, parties who have provided postponements, or any related parties;
i) Save and except as contemplated under cash flow forecasts they shall not make any capital expenditures without the lender’s prior written approval.
Again, the Forbearance Agreement is a contract and it should include such regular and ordinary contract terms as the solicitor drafting the document considers to be necessarily incidental to a commercial document of this nature. These may include:
a) Lender’s records prima face proof: the parties should acknowledge that the lender’s records shall constitute prima face proof of the outstanding amount of the indebtedness, payments made, interest accrual and so forth;
b) Non-assignability: the debtor and guarantors should acknowledge that they may not assign the Forbearance Agreement without the prior written consent of the lender and that such consent may be arbitrarily withheld;
c) Choice of law/Forum Conveniens: the parties should identify the province whose laws shall govern the Forbearance Agreement and acknowledge attornment to the courts of that province to adjudicate any disputes;
d) Notice: Confirm the agreed method of notice to any party under the agreement, typically e-mail or facsimile transmission with the addresses set out therein;
e) Severability: acknowledgement that if any provisions contained in the agreement is determined to be invalid, illegal or unenforceable by a Court of competent jurisdiction, the remaining provisions shall not be affected or impaired;
f) Execution in Counterparts: for ease of execution the parties should agree that the Forbearance Agreement may be executed in counterparts with the parties’ signatures exchanged by way of e-mail or facsimile transmission.
Despite the best efforts of the parties involved in the negotiation and drafting process, it is not uncommon for Forbearance Agreements to require amendments from time to time. During the restructuring process circumstances change and parties recognize that it is in their mutual interest to alter or extend interim milestones or other commitments. For example, it may be necessary for the parties to revise and update cash flow forecasts or to push back the deadline for receipt of a refinancing package or an acceptable Asset Purchase Agreement. When this occurs, it is imperative for the parties to document changes by way of an Amending Agreement. Similarly, where restructuring efforts are ongoing but additional time is required to complete the process, best practice is to enter into a formal Amending and Extension Agreement to incorporate the revisions to the go-forward plan. The same care and attention to detail required for the Forbearance Agreement should be put into any Amendment and Extension Agreements.
A properly planned, negotiated, drafted and executed Forbearance Agreement enables the parties to formalize their mutual duties and obligations while the debtor tries to find a way out of its difficulties. The debtor is provided with time and additional accommodations to restructure its affairs with the comfort of knowing that the lender cannot take precipitous action if terms are being met. For the lender, the Forbearance Agreement provides certainty that although it is providing accommodations to the debtor it has preserved and possibly enhanced its remedies in the event of further default. There are numerous traps and pitfalls, particularly if the lender gets greedy. However, if appropriate care and attention to detail is exercised the Forbearance Agreement may provide the structure necessary to reach a mutually successful solution.
 See: definition of “forbearance” in Black’s Law Dictionary, Ninth Edition (2009: West, a Thomson Business) p. 717
 Webster’s Third New International Dictionary (1986, Merriam-Webster Inc.) p. 886
 One industry expert suggests that the use of Forbearance Agreements accelerated with the abundance of cheap easy credit prior to the 2007-8 financial crisis. Before the crisis many debtors were able to locate replacement lenders with liberal lending policies and did not need to initiate formal filings to restructure: Robert W. Jones et al “As Purpose of Forbearance Agreements Change, So will Terms”, Turnaround Management Association, May 2007 p. 30
 Some restructuring professionals prefer to say “you have to pay to play”
 See for example: John C.M. Sayers et al “To Forbear or Not to Forbear” 11 Comm Insol.R No. 1; Robert W. Jones et al: “As Purpose of Forbearance Agreement Change, So Will Terms” Supra, p. 30; Beverly Weiss Manne et al “Restructuring Options: The Forbearance Agreement” Turnaround Management Association, August 2008 p. 4; William E.J. Skelly and Benjamin La Borie, “To Forbear (or not) – The Inevitable Question “Annual Review of Insolvency Law 2012 p. 301
 Beverly Weiss Manne, “Restructuring Options” Supra, p. 7
 See for example Royal Bank of Canada v. Walker Hall Winery 2012 ONSC 4236 (CanLII); Alexander v. 2025610 Ontario Limited 2012 ONSC 3486 (CanLII)
 See for example Bank of Montreal v. Maple City Ford 2002 Can LII 23166 at para. 142-3; aff’d 2004 CanLII 36048 (ONCA)
 Lewis v. Central Credit Union 2001 PESC 4 at paras. 44 and 45 (CanLII); aff’d 2012 PESA 9
 See: Lee Casey and Lilly Coodin, “Assessing ‘Lender Liability’ in Workouts” (2013) Nat. Insol. Review, Vol. 20, No. 1, p. 9; also see: Bulut v. Brampton (2000) 16 CBR (4th) 41 (ONCA); leave to appeal refused 142 OAC 399;
 The Unconscionable Transactions Relief Act CCSM c. U20 and similar statutes in other provinces; also see for example HSBC Finance v. Lazar (2008) MBQB 39 (CanLII) and CAPS International v. Kotella 2002 MBQB 142 (CanLII) where this legislation was recognized as a tool to reduce excessive but not criminal interest rates.
 Whether under the Canada Business Corporations Act RSC 1985 c. C-44 as amended ss. 238-241 or provincial counterparts; see also: Adecco Canada v. J. Ward Broome (2001) 12 BLR (2d) 275 (Ont.S.C.); C.J. Covington Fund v. White (2000) 10 BLR (3d) 173; affd’s (2001) 17 BLR (3d) 277
 The SCC’s recent decision in Re Indalex 2013 SCC 6 at para. 77 again points out that this doctrine has not been endorsed but does remain open for future determination. See also Canada Deposit Insurance Corp. v. Canadian Commercial Bank (1992) 16 CBR (3d) 154 (SCC); C.C. Petroleum v. Allen (2002) 35 CBR (4th) 22 (ONSC)
 Courts have recognized and enforced waivers of defences contained in Forbearance Agreements. See for example: Central 1 Credit Union v. Stewart Restoration 2010 ONSC 7218 at para. 33 (CanLII); Bank of Montreal v. Baysong Developments 2011 ONSC 4450 para. 40 (CanLII)
 Sayers, “To Forbear or not to Forbear”, Supra p. 3; Weiss “Restructuring Options”, Supra p. 4; Skelly “To Forbear (or Not)”, Supra pp. 310-311
 BIA s. 244(2.1) required the notices to be served on the debtor before the n notice period can be effectively waived by a consent to early enforcement. See also: Bank of Montreal v. Maple City Ford, Supra at para. 142 and 143. Farm Debt Mediation Act notice periods cannot be waived even after service: Intec Holdings v. Grisnich 2003 ABQB 993; additional reasons at 2004 ABQB 43 (CanLII)
 As noted in BMO v. Maple City Ford, Supra para. 142 and 143 consenting to a right to enforce security in the Forbearance Agreement was not interpreted by the court to be a consent to a Receivership Order
 See for example Metropolitan Stores of Canada Limited v. Unigraphics 1999 CanLII 14087 (MBQB)
 Alexander v. 2025610 Ontario, supra, Tuerr Holdings v. Vrankovic 2012 ONCA 5 (CanLII); Royal Bank of Canada v. Walker Hall Winery Ltd., Supra 4236; Canadian Western Bank v. Vinterra 2011 BCCA 170
 Callidos v. Carcap 2012 ONSC 163 at para. 32 (CanLII); Manne et al “Restructuring Options”, Supra, p. 6
 Although not in a BIA proposal if the lender has issued the BIA s. 244 notice and the 10 day period has lapsed or been waived: BIA s. 69(2)(b) and (c), 69.1(2)(b) and (c), Alexander v. 2025610 Ontario, Supra
 Bank of Montreal v. Wilder (1986) 32 DLR (4th) 9 (SCC)
 360305 British Columbia v. Payless Gas 1994 CanLII 791 (B.C.S.C.); Garland v. Consumers’ Gas Company 1998 CanLII 766 (S.C.C.); DeWolf v. Bell Express View 2009 ONCA 644
 C.T. Shaw, “Criminal Interest Rate Has Zero Tolerance”, 24 Nat.B.L. Rev. 29 at 35
 Parsons v. Coast Capital Savings 2010 BCCA 311 (CanLII); McKinnon v. Vancouver City Savings 2004 BCSC 1604; Bodnar v. Community Savings 2012 BCSC 589
 For examples of the different court approaches to ‘severance’ see Lydian Properties v. Chambers 2007 ABQB 541; Milani v. Banks 1997 CanLII 1765 (ONCA) and Kilroy v. Payday Loans 2006 BCSC 1213 at para. 46 (CanLII)
 Reliant Capital v. Silverdate Development 2006 BCCA 226 (CanLII); see also Equitable Trust Co. v. Richardson 2012 ABQB 411 at para. 82 (CanLII) where Romaine, J. used s. 8 of the Interest Act to strike down an administration fee
 Beverly Weiss Manne et al “Restructuring Options”, Supra at 5; Robert W. Jones et al “As Purpose of Forbearance Agreements Change So Will Terms”, Supra p. 30 at 31
 See for example: Manne “Restructuring Options” Supra p. 5; Johan C.M. Sayers et al “To Forbear or Not to Forbear”, Supra p. 4
 Counsel for the lender has advised the author that the Forbearance Agreement would have contained recitals acknowledging the mortgages to be enforced
 For example, Assignments and Preferences Act R.S.O. 1990, CA-33, Fraudulent Conveyances Act R.S.O. 1990 c.F-29 and similar legislation in other provinces
 Re Gavin (1962) 5 C.B.R. (N.S.) 180; Re Mac-Wall Contracting (1970) 14 C.B.R. (N.S.) 52 (Ont.S.C.); Touche Ross Ltd. v. Weldwood of Canada Sales Ltd. (1983) 48 C.B.R. (N.S.) 83 (Ont.S.C.); Bank of Montreal v. Shore (1983) 46 C.B.R. (N.S.) 294 (N.S.T.D.); Dapper Apper Holdings v. 895453 Ontario 1996 Carswell Ont. 440
 Glegg v. Bromley (1912) 3 K.B. 474
 Grep Properties II v. 371154 Alberta 1995 Carswell Alta. 432; Dapper Apper Supra 16; Harry Snoek Limited Partnership 2012 ONCA 765 (CanLII)
 McAsphalt Industries v. Six Paw Investments (1995) 34 C.B.R. (3d) 147 (Ont.C.A.). There is also some case law to suggest that all advances would be unsecured, see for example Re Titan Investments LP 2005 ABQB 637
 See for example: Lewis v. Central Credit Union Supra at para. 112
 Sayers Supra at p. 3
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