The Story of a Problem Loan

 

Recently Revitalization Partners was contacted by a company that needed help with their commercial loan.

The lender had, in addition to the original loan, issued three forbearance agreements, none of which the borrower had been able to comply with.

At that point, the latest forbearance agreement required that the borrower bring in a Chief Restructuring Officer to assume responsibility for the operation and financial performance of the company.

While this borrower was having problems with the lender, it is fair to say that the lender was also having problems.

 

PERSONAL & FAMILY ACTIVITIES …

Like many owners of small businesses, the borrower tended to use the business as a piggy bank.  

In addition to the normal business activities, a significant amount of money came out of the company for personal and family activities. To avoid income tax, this money was carried on the books as a loan to the borrower. By the time it reached almost a million dollars, it was clear that the funds were never going to be paid back.

By the time this loan reached the third forbearance agreement, there were some very unusual covenants associated with the agreement and loan.

The lender required that the company maintained a “joint account” with the lender. All funds were supposed to go into the account and the lender would approve checks. Therefore, the borrower ended up writing several bad checks as he was never sure which checks would get approved.

 

$ 250K EXIT FEE …

While the lender wanted to get out of this relationship, the cost to the borrower had escalated to a $250,000 “exit fee” in addition to paying off the original loan with interest due. 

In desperation, the borrower had opened a new account into which he deposited funds to pay for items that the original lender would not approve. 

As this was a violation of both the loan document and all the forbearance agreements, the borrower was in violation the second he signed the new agreement. 

 

Neither side trusted the other at all.

 

How did we get here?   

It began with a successful entrepreneur who ran a unique business for a number of years.

Then, due to a new product launch that went awry , he had a bad year and got into trouble with his bank.

The bank wanted him out, but given the short-term track record, he didn’t know where to turn.

 

 

A FRIEND OF THE FAMILY INVESTOR …

Then, a friend of the family “investor” offered to purchase a reasonable percentage of the company for enough money to settle with the bank. 

And since it would be equity, it would not have to be paid back.

While the “equity documents” were being drawn up and the borrower was negotiating with the investor, the investor suggested that, since the borrower needed the funds NOW, they just draw up a convertible note to move forward.

The borrower received his money, he made use of it and all was fine until the “investor” changed his mind and wanted his funds back. 

The borrower didn’t have them and after some unpleasantness, the investor went to court and got a judgment against the borrower.

 

AND NOW A LOAN BROKER …

At the same time, the borrower had turned to a loan broker that he found on the East coast. 

While a loan broker is supposed to distribute your application to several different lenders and to educate you about the pluses and minuses different lenders and loans, this broker found only one, the lender with which the borrower was having so many problems. 

The broker charged a reasonable fee of 5%, although the agreement did not specify if he received any further fees from the lender. 

The agreement was supposed to remain in place for only two months, however it renewed automatically if not cancelled and by the time in 2018 that all of this occurred, had been in place for about 3.5 years.

 

PROUDLY NEVER USED AN ATTORNEY ???

The other factor related to how we got here is the fact that the borrower had, over the life of his business, had never used an attorney.  And he was proud of that fact, having negotiated and signed every document himself. 

As a result, the loan documents, the “investor” agreements, etc. were all the product of his own knowledge.

At the time Revitalization Partners became involved, he had the lender insisting he execute the current forbearance agreement and refusing to authorize the retainer unless it got signed, while at the same time insisting that he get help.

There was already a judgment against him and two others ready to be filed. He had executed multiple personal guarantees and a stock pledge of the company’s equity.

 

AND A LACK OF REALISM …

Given the situation, we strongly suggested that he entered a receivership as the company had significant value when protected by the court.

He resisted as he believed that a Chapter 11 would allow him to end up keeping his company although he had no ability to fund debtor in possession, no ability to get a bankruptcy plan approved and would have to manage a personal insolvency simultaneously.

Given what we viewed as a lack of realism related to the situation, we declined to go forward.

No one, no matter how talented, can know everything. 

And financing is one of those areas where experience and knowing the lenders counts.

For example, Revitalization Partners has successfully helped 100% of the companies we have agreed to work with to get new loans.

And to avoid any conflict of interest, we do not accept a commission from either the lender or the borrower for that service.

 

 

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

A Forbearance Agreement: What Does It Mean?

 

When a borrower defaults on its loan agreements, a lender may (among other options) sue to foreclose on its collateral and collect from borrower, or agree to amend the loan documents, or enter into a forbearance agreement.

If the borrower can convince the lender that, within a reasonably short time, the borrower can cure the defaults and can perform or observe such new conditions as the lender may require in exchange for waiting, a forbearance agreement memorializing such new arrangements may be entered into by the parties.

 

IT’S NOT THE SAME AS A …

A forbearance agreement should be distinguished from an amendment agreement under which the terms of the original loan are changed. Suppose that the borrower fails to repay the entire principal due on the maturity date of a loan.

In response, the lender could agree simply to give the borrower more time to repay the loan – by amending the loan agreement and promissory note to extend the maturity date to some future date.  By amending the loan agreements in that manner, the lender would effectively eliminate the default and the lender’s rights arising from the default.

Thus the lender would no longer be entitled, for example, to accelerate repayment or to charge a higher, or “default rate” of interest as a remedy for the (now wiped clean) default.

 

THE BORROWER ACKNOWLEDGES …

In a forbearance agreement, the borrower acknowledges that it has defaulted on its obligations, while the lender agrees that it will refrain from exercising its remedies for such defaults as long as the borrower performs or observes the new conditions set out in the forbearance agreement, and, by a certain date, cures the defaults.

A forbearance agreement entered into after a maturity date default would typically provide that the lender will not exercise its rights arising from the default provided the borrower pays the lender the loan principal in installments over a stated period of time, often at a much higher rate of interest than under the original loan agreements.

The lender may wish to impose additional conditions, such as requiring borrower to meet new or enhanced financial covenants or to pledge additional collateral to secure its repayment obligations.

If the borrower fails to live up to the terms of the forbearance agreement, the lender may sue the borrower for a breach of that agreement and may also exercise any of its rights under the original loan agreements for the original defaults.

 

BEFORE ENTERING INTO ONE …

Before entering into a forbearance agreement, the prudent lender will conduct a thorough due diligence review. The location and financial condition of each non-lender party should be re-examined.

A lender should verify that all financial covenants and ratios are in compliance; excepting, of course, non-compliant covenants and ratios set forth as defaults in the forbearance agreement.

A lender should obtain new tax, lien, and judgment searches against the borrower and guarantors, and, if anything adverse is identified, take appropriate steps to remove or mitigate risks thus raised.

The lender should conduct an on-site audit of all collateral to verify existence and location. The lien search should confirm the priority and extent of the lender’s security interest in the collateral. If the collateral is real property, the title insurance should be updated to ensure no adverse liens or encumbrances exist.

 

CONTAINS SOME “KEY” PROVISIONS …

A well-drafted forbearance agreement will contain a number of key provisions:

First, the agreement must recite with specificity the indebtedness owed and all of the defaults that the borrower and the guarantors have committed. The recitation should include both monetary and non-monetary defaults. In many ways this aspect of the forbearance agreement is tantamount to a borrower’s confession of judgment.

The agreement should provide that: (a) the borrower and guarantors admit to their defaults; (b) the borrower and the guarantors have no defense against full payment of the indebtedness; (c) there is no material issue of fact as to the fact of such defaults; and (d) a summary judgment against the borrower and guarantors in the amount of the unpaid indebtedness is warranted and appropriate. A fundamental premise of the bargain in a forbearance agreement is that, should the borrower fail to live up to its obligations under the forbearance agreement, it is reasonable for the lender to have no further delays or other significant costs in obtaining the necessary judgment against the borrower and guarantors.

Second, the forbearance agreement should state that the lender’s forbearance is conditioned upon, among other things, the borrower and guarantors strictly observing and performing all of their obligations under the loan agreements other than those relating to the enumerated defaults. 

Any new default under the loan agreements must constitute a default of the forbearance agreement, which would give the lender the right to terminate its forbearance.

Third, if the loan agreements include any guaranties, the guarantors must each be a party to the forbearance agreement, which must provide that the guarantors reaffirm their obligations under their guaranties, notwithstanding the forbearance or any alterations to the loan indebtedness.

Most well-drafted guarantees recite that changes to the terms of the guarantied indebtedness, including any forbearance, whether or not the guarantor consented to them, will not vitiate the guarantor’s obligations under the guaranty. However, courts often bend over backwards to construe strictly and limit a guarantor’s obligations, or even to excuse a guarantor when loan terms change, by applying vague principles of equity and fairness. To eliminate any risk of this, a prudent lender will require a guaranty reaffirmation in the forbearance agreement.

Fourth, the forbearance agreement should provide for a liability release of the lender by the other parties. The release should cover, at a minimum, any loss or damage arising from: (i) the forbearance agreement; (ii) the loan documentation; and (iii) any other dealings the lender may have had with the borrower or any guarantor at any point. The release should be given by the borrower and each guarantor.

 

GET EXPERT HELP IF NEEDED …

It is important to fully understand any forbearance agreement that the bank is requesting.  

In many cases, the situation has become so desperate for the borrower, they will execute any document to relieve the pressure from the lender.

As in the initial loan, it is important that the borrower ensures that they understand the new commitment and they are capable of remaining in compliance.

The use of an experienced business and contracts attorney and a qualified financial advisor is critical.

 

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

How Timely Referrals Help Struggling Companies

 

In the restructuring business, many of our assignments come through referrals.

In 2015 we were able to assist a number of companies because a trusted advisor to the CEO or owner suggested that they might need help.

However, sometimes that suggestion comes too late or the CEO/Owner decides that they can fix their problem without assistance.

As we reached the end of 2015, we were referred to two companies that had reached the absolute brink of survival unnecessarily.

 

# 1 – A Family Owned Construction Company …

The first is a family owned company in the construction business. This company was successful in doing relatively small jobs but wanted to move up into large commercial projects. Due to the quality of their work and their status as a minority contractor, they were given the opportunity to participate in number of large public works contracts.

The problem was that management had no idea of what was required to operate in the larger environment. 

Neither did the people that they hired.  While they had a small line of credit from a bank, it was not sufficient to support even one large job, let alone the several that they undertook.  In one year, revenue almost tripled without the management or infrastructure needed to support their growth.

Almost Everything Went Wrong …

As time developed, almost everything went wrong.  Bids were underestimated; payments were often not as prompt as were needed; and overruns due to improper estimating were occurring on a regular basis. 

When the company decided it needed a new computer system to manage what was becoming a disaster, it began a transition without the proper understanding of how to do the job. As a result, invoices and change orders did not get out in a timely manner, worsening an already bad situation.

How did the company continue to operate?  By not paying federal and state payroll taxes, by not paying union dues or benefit plans and by not paying their subcontractors. 

As the large Project Managers began to see the threat of liens against their projects, they began paying the company’s subcontractors directly, reducing and in many cases eliminating payments to the company. Cash flow was further reduced.

By The End Of The Year …

By the end of the year, the company’s debt had ballooned to over $4 million, almost half of it “borrowed” from trust funds.  As the company searched for a loan to pay off these past debts, instead of just saying no, a lending source referred them to RP.  By this time the IRS and the state had issued seizure notices, and the unions had cut off all benefits including health insurance.

As the year ended, there is still a glimmer of hope. The company continues to get work and has new estimating and project management support.  And the IRS and state seem to be willing to cooperate with a workout plan.  But without major changes in thinking on the part of management, the hole will continue to get deeper.

Our 2nd Year End Example …

Our second year end example concerns a food distribution company that purchased a highly profitable, company twice its size.

To finance the purchase, an SBA loan and significant line of credit was obtained.

Shortly after purchasing the company, the new owner discovered that the company he had purchased really didn’t have systems in place to support the operation; it was successful due to the experience and knowledge of the sellers. 

 

Profitability Began To Evaporate …

As that was discovered and the profitability began to evaporate, a financial advisor suggested that he speak with Revitalization Partners early in 2015.  The owner declined, believing that he could resolve the issues without assistance.

As the months passed, the profitability situation did not get any better despite favorable projections. The company took on additional debt from an outside source. This violated the terms of the operating line of credit as well as a the several forbearance agreements issued by the bank as the losses mounted.

 

The Bank Decided …

Days before the expiration of the latest forbearance agreement, the bank decided that it would not go forward. As of the end of the year, the bank was declining to continue the relationship and would exercise its rights under the loan. The ultimate outcome will be determined in early 2016.

 

In Our Experience … Experience Matters

 

Operational and financial restructuring, like any profession, is a learned skill; and like most professions, experience matters. 

One of the skills required is the ability to remain objective and realistic about the business situation even as it rapidly changes; and to take rapid and effective action to insure that change is positive.