What A Lender Should Do When A Commercial Loan Goes Bad
These tough economic times is a phrase you can’t get away from in business news today. As credit tightens and the markets continue a downward trend, commercial lenders are examining their portfolios and looking at troubled loans to see what if anything can be done. Today, lenders are using a number of options to assist the borrower when possible and working at maintaining the loan. However, once a loan is in default, lenders have some basic responsibilities that they must do in order to ensure they are properly repaid.
Review the Documents
First, the lender needs to review its loan file and the original terms of the loan and any and all amendments that changed those terms. Knowing and being aware of the fees, the default rate (if any), all of the events of default under the loan documents to which the borrower is subject and additional information will help in the workout process. Often, it turns out that what was approved in the credit write-up is not always what is reflected in the loan documents. Moreover, even when credits were properly documented at the loan’s inception, the passage of time can sometimes alter lien rights, and agreements can be modified by the course of subsequent conduct.
Ask for the Money
Next, the lender should ask for the money back. This seems obvious, but it is a frequently overlooked step in loan management. Lenders sometimes hesitate to confront the borrower because they fear the loss of the depository relationship and future opportunities. But if the indebtedness is deemed legally due and payable, the lender must send a clear and concise statement requesting that payment, including all fees and interest, and all of the events of default. That statement must state that only full payment will satisfy the lender and present the when and how the lender will accept payment.
Additionally, the lender needs to realize that collecting and working out problem loans can require a great deal of time and effort. Outside counsel will often need to be employed and, if loan collateral is eventually foreclosed on, there are extra costs involved. Therefore, when looking at the fees that are to be collected from the borrower, the lender should include in its request for payment all foreseeable and allowed fees necessary to complete the collection. It will be difficult for the lender to realize repayment for additional fees after collections are complete.
Timing of Repayment
The lender should realize that a borrower is often going to request more time to work out a repayment plan, but more time is not always going to solve the problem. This is why examination of the original loan file and credit approval is important. Is this a seasonal downturn or a long term downward trend in the borrower’s business? The lender should not grant an extension of time for repayment without actual consideration. Borrowers seldom want to give more than a promise to repay, which is not adequate consideration once the loan is in default. By the time a loan is in workout, the borrower’s business net cash flow has ceased to be a source of cash. Also, the lender is often in competition with other creditors for the borrower’s rapidly dwindling resources.
Sometimes a lender will establish short-term deadlines for certain repayments. Other lenders will pursue legal remedies while also negotiating for a resolution. Legal remedies, like attaching liens to collateral and beginning the process of foreclosure proceedings, are part of the lender’s arsenal of tools in dealing with the borrower. In addition to saving time, pursuing parallel courses of action offers the advantages of creating “real” negotiating deadlines and possibly helping the lender to beat out a competing creditor with the same idea. The longer a lender waits the fewer resources a borrower will have left.
What Can the Assets Do?
The lender needs to look at what assets the borrower has and answer two questions: can those assets produce income or can those assets be sold for sufficient cash to pay off the indebtedness in full? The lender then has two options:
- Negotiate the pledge of the assets to secure the repayment plan, and
- Pursue legal means to ensure that the proceeds of the assets come to the lender first.
Act Early and Decisively
The number one requirement in a problem loan situation is to act early and decisively. It will be much harder, if not impossible, for the borrower to repay indebtedness when there is no cash and no assets than when these resources are more plentiful.
As the workout process continues, ensure that the loan file is reflective of all the negotiations and actions related to fixing the problem. Lenders should negotiate for more collateral, gain greater control over collateral the lender has liens on, seek additional guarantees and enforce all legal remedies. Companies with continued success plan for the good times and bad. Some borrowers are willing to recognize problems early and take corrective action at the first sign of trouble. While the borrower needs a contingency plan, the lender does as well. The plan needs to be formulated in advance of actual events. The lender will create repayment plans, workout plans, forbearance agreements, but the lender must decide what it will do if the borrower fails to comply.
What additional steps will the lender need to take to ensure repayment? The lender will often need to consult a legal expert to ensure that all problems in a loan gone bad are identified and any documentation deficiencies, collateral issues or workout agreements are taken care of. Legal counsel will help the lender develop a realistic plan for addressing the problem loan and present legal alternatives.
Arnie Spevack is an experienced creditor’s rights attorney who assists both borrowers and lenders in workout negotiations and helps them refinance existing real estate mortgages and business loans. For more information about working out troubled loans, contact Arnie at firstname.lastname@example.org or (301) 657-0749.