How to Better Manage Loan and Credit Risks and Problems
Business credit or loans are sought, and business credit or loans are granted, because each of the customer borrower and the creditor lender believe one truly fundamental assumption: there will be operating revenues either (a) sufficient to make principal and interest payments to retire the debt, or (b) sufficient to make interest payments until a property or asset sale or refinancing will pay the principal.
Many business owners and lenders have been experiencing the unhappy consequences of the failure of this fundamental assumption. Either revenues are down so there are insufficient funds for debt service, or because credit markets have tightened and acquisition spending is off, the debtor’s repayment plan based on sale of property, sale of assets or refinancing is defeated.
All business owners and business lenders are vulnerable, but the impact has been pronounced in certain businesses. Examples include automobile dealers, real estate developers and contractors/subcontractors, as well as the lenders and vendors serving these businesses.
What should a prudent business owner or business lender or financial institution do in times like these? Remember that any business granting credit to customers is a business lender, meaning any business that operates other than strictly c.o.d.
Examine Documents for Deficiencies and Act on Defaults
Review the governing credit agreement or loan documents and attend to what you find! Consult a qualified attorney early and often. Below are examples of questions you should be asking and addressing with a qualified attorney.
Are the parties correctly identified? Is there proper documentation of the existence, organization and authority of the parties signing? Are the executions complete and correct? Are financing statements and recordable instruments properly filed? Are the business terms correct? Errors and omissions can injure a borrower as well as a lender.
Are the documents’ provisions appropriate, adequate, well articulated and in compliance? If not, seek amendment or accommodation from the other party to address the issues.
Have there been payment defaults? Have there been covenant defaults? Would the creditor lender even know if there have been covenant defaults? What has been said or done about defaults? Are any defaults curable?
Have there been delivery defaults? Financial statements, tax returns, insurance certificates, and the like. Deliver or request them as applicable promptly. However, be cautious not to provide information not required that would raise issues unnecessarily.
What you discover and your attorneys’ advice will govern your response—or non-response to what you discover. Remember, first do no harm!
Defaults and Workouts: Be Proactive!
Whether you are a debtor or a creditor, act early upon learning of a default, and also when a default that has not occurred is unavoidable. Engage a qualified attorney immediately. Inaction or inappropriate action could impair your rights or increase your exposure.
Cure curable defaults. Devise for your company, or require for the customer debtor, a plan for overcoming defaults not readily curable, whether they are payment defaults or covenant defaults. Provide or require reasonable financial and other information that helps demonstrate the viability of the work out plan. Consider the benefit (and risks) of obtaining appraisals and other assessments of the debtor or the collateral.
The suspension or reduction of payments, and an extension of the time for payment, are usually the key elements of a work out plan; but they are often the hardest terms to extract as borrower, or to decide to grant as lender. Establish reasonable (not overly optimistic) time and performance requirements. Reset covenants to achievable reality. Negotiate such concessions as make business and legal sense under the circumstances. Seek to improve, or to alter for practicality, the potentially applicable default, indemnity and remedies provisions of the governing documents. Be fair and not overreaching.
Consider other credit relationships of the debtor and their significance. As the creditor lender seek cross-default, cross-collateralization and provisions to better address the situation overall. As the customer debtor, seek to avoid such provisions, except for a fair concession from the creditor lender. Determine if an intercreditor agreement is needed.
Would a forbearance agreement be beneficial? (A forbearance agreement is an agreement on certain conditions that gives the debtor/borrower an opportunity to resolve its financial problems and satisfy the debt.) Exculpation, covenant not to sue, release and other provisions for the benefit of the creditor are the norm in workout arrangements and forbearance agreements. Seek to employ such provisions as a creditor lender and to avoid or circumscribe them as a debtor borrower.
Whether assessing risks and options, amending loan documents or customer credit arrangements, entering into forbearance agreements, or dealing with collection efforts upon default, neither the customer debtor nor the creditor lender should be acting without guidance from qualified attorneys. The consequences of missteps and missed opportunities can be high.
John Northey is a partner with Wishart, Norris, Henninger & Pittman, P.A., a law firm with offices in Charlotte and Burlington serving institutions, professionals, businesses and business owners. Contact him at 704-363-0010 or visit www.wnhplaw.com.