Forbearance and Variation Agreements
Apart from issues which might arise from bankruptcy law, there is very little constraint on what might be provided for in a forbearance or variation agreement in relation to an existing loan agreement.
The existing loan agreement should be reviewed to ascertain the current position. Care should be taken to ensure that the new agreement does not inadvertently weaken the lender’s position. The loan agreement and the variation / forbearance agreement should be read together to ensure that variation does not specifically or impliedly overwrite any important lender’s rights in the Loan Agreement.
The backdrop for a forbearance agreement or a variation of a loan agreement is generally that the borrower is in default under the loan agreement. Generally, the lender is in a position to enforce the loan agreement, call for repayment of all sums due and exercise all enforcement powers. The lender will therefore have a strong hand in negotiating its additional requirements.
Our earlier chapter on loan agreements is relevant in considering what might be provided for in a forbearance or variation agreement. The loan agreement as varied will form a new contract. This contract may be entered by exchange of letters or formal agreement. Once entered, the lender may be unable to pursue a breach of the earlier agreement unless the right to do so is reserved under the new agreement (e.g. if the variation agreement is breached, it is commonly provided that the original position is resurrected).
It is desirable to review the borrower’s full current position. A “know your customer” disclosure is more critical than ever in a default scenario. The borrower’s whole portfolio should be reviewed. There may be defaults on loans with other lenders. If there is no direct default, there may be cross default by reason of the current default.
The implication of cross default by the borrower on other loans and the effect on other securities should be considered. See our chapter on miscellaneous mortgagee’s rights. The issue of priorities between lenders is critical where two or more lenders are contesting the right to a particular security.
It is desirable that a variation is put in clear terms equivalent to the original loan offer and agreement, is accepted by the bank and the borrower and preferably signed. For example, the lender may send the terms of the agreement in the form of a letter to a borrower in duplicate to be signed and returned, in much the same way as the original facility letter.
It may be that there are commercial or security deficiencies with the current loan agreement or security. In this event, the forbearance or variation agreement might be the opportunity to strengthen the bank’s position. It may be appropriate, for example, that a tracker loan rate is converted to some other interest rate basis or that any ambiguity about cross security is removed.
The regulatory obligations to consumers and customers should be borne in mind in dealing with borrowers in the context of variation agreements. There may be some specific obligations which apply, such as the obligation to notify guarantors and various obligation to give information under the Consumer Credit Act and the Consumer Protection Code.
There are many other more general obligations in relation to fair dealing. It is difficult to assess how the Regulator or Ombudsman might apply some of the these very open and discretionary standards. The lender’s contract and property rights must ultimately be respected because they are protected by the Constitution. While the lender’s rights are likely to be ultimately pre-eminent, the way in which these rights are used may be curtailed where the effect would be unnecessarily harsh or unfair. These principles may be seen in the Code on Arrears.
It may be preferable that the agreement is a forbearance arrangement rather than an outright variation of the loan agreement. The essence of a forbearance agreement is that there is agreed to be a default that that lender could fully enforce, but instead agrees to forbear enforcement, subject strictly to certain conditions, which are then set out.
With a forbearance agreement in the above sense, the lender is entitled to exercise its full original rights, if there is default on the “new” conditions. In return, it agrees with the lender not to exercise these rights if the new conditions are complied with. If the conditions are breached, all of the original lender’s rights resume.
A variation agreement is a better label for an agreement that is a permanent change in the loan agreement. It operates as if the new terms are written into the original loan agreement. In a sense, the loan is underwritten anew.
A forbearance agreement may be for a temporary period, where the arrangement is more of a workout of a problem. However, there is no reason why a forbearance agreement may not last for the full term of the loan. The label on the agreement is not important. There is no fundamental difference between what might be labelled a forbearance agreement and a variation agreement; it is a question of the appropriate arrangement for the circumstances.
Care should be taken that a forbearance or variation agreement does not in any way prejudice or affect the main loan agreement, other than to the extent desired. The same covenants and events of default should continue to apply. It is important that nothing is done in the agreement which inadvertently weakens the lender’s position under the loan agreement. A clause to the effect that the loan agreement still applies, except to the extent of the conditional forbearance allowed or to the extent the arrangements are specifically varied, is desirable.
In the event that the borrower fails to perform, enters bankruptcy, insolvency arrangement or commits other default under the loan agreement, the lender should be entitled to terminate its obligations under the forbearance agreement or the varied loan agreement. It should be entitled to immediately demand all sums due and should be entitled to enforce all security.
A waiver is an arrangement short of a forbearance or variation agreement. There is no new legal agreement between lender and borrower, but there may be legal consequences.
A waiver occurs where the lender indicates that it will not insist upon the strict terms of the loan agreement (e.g. the right to take enforcement action for a default which has occurred). A borrower cannot generally claim that a waiver made for the borrower’s sole benefit, is a breach of contract by the lender. Even where there has been a waiver, it may generally be retracted, if this can be done without causing injustice.
With a waiver, the original loan agreement and the rights under it remain in being. However, the lender may not be able to enforce the strict terms it has waived, either at all or for a period until it makes clear the waiver no longer applies. Where the lender gives the borrower to believe that it will not take action by reason of a particular breach of the loan agreement, the lender may not be able to enforce that breach, if the borrower has relied on the waiver and acted accordingly.
This is not to say, that every non- enforcement of a breach is a waiver. Nor would it necessarily mean that non-enforcement on a particular occasion would mean the lender could not enforce in the event of another breach, For example, not enforcing when one payment is missed will not usually prevent enforcing because of another missed payment. As against this, a lender who rolls up a particular missed payment without any legal agreement to do so, may not be allowed to sue later for the full loan which fell due on the earlier breach, if it leads the borrower to believe it will not enforce that particular breach and the borrower is fully compliant from that point forward.
In dealing with a borrower in default, it is generally desirable not to do anything that implies that the lender waives its rights. This would not generally happen by simply failing to enforce. However, some further stronger assurance on which the borrower relies and acts on, may be enough to constitute a waiver of the right to enforce.
Contents of Variation Agreement
Preconditions and Immediate Obligations
A variation agreement may be conditional upon certain matters and upon certain short term commitments being immediately delivered on by the borrower. The position will be much the same as with the pre-conditions in a loan agreement. There may be a requirement for information to be vouched by accountants, other creditors, tax authorities etc.
There may be a requirement for new security with good and marketable title of specified value and/or, for payment by particular installments and/or in a lump sum. The consent of other significant creditors and mortgagees may be required.
The agreement should clearly spell out the conditions, the time line for compliance and the consequence for non-compliance. Care should be taken in waiving preconditions, so at to ensure that it is not interpreted as a wider waiver of the lender’s rights.
Warranties and Representations
The borrower should make a full and frank disclosure of his circumstances. A warranty or representation as to completeness of the information supplied should be stated or implied. Information may be sought and required to be backed up, in much the same manner as with the original loan offer. This could be vouched by reference to an independent adviser’s opinion.
The lender may seek confirmation in relation to the borrowers current financial position from third parties. It is desirable to include confirmation that that all information is accurate and that all material facts have been fully disclosed. It might also be stated that the lender agrees to the variation in reliance on the borrower’s disclosure of his financial position
Varied Commercial Terms
A variation may be made to the commercial terms such as the repayment period, the times of repayment, the interest, and the security.
The repayment method may be converted to interest only for a period. The variation agreement should expressly or by implication make clear the length of the interest-free period and the point in time at which capital payments resume. The loan term may also be extended. The period during which the capital sum will be amortised should be stated or be otherwise clear.
If the loan was originally a housing loan under the Irish Consumer Credit Act loan, the requisite statement of key terms (APR, payments amounts, effect of variations etc.) and statutory should arguably be inserted. The Act might be argued to require that the variation of a housing loan is treated as a new housing loan, where the variation impacts materially on the key terms.
Where a default has occurred which the lender has agreed to waive on terms and conditions, the need for loan covenants is greater than ever. The loan covenants in the original loan agreement should be reviewed and the appropriateness of additional covenants should be considered.
The lender may seek enhanced rights to information and access to financial accounts and the property itself so as to allow further and more careful monitoring. In some cases, a power to supervise or be involved in the business may be appropriate and be negotiated. In the case of a company, difficulties may arise for the lender if its representative is deemed a director or shadow director. There is a risk of liability as a shadow director, in particular, for insolvent trading. The role should be limited to supervision rather than participation.
In the case of investment properties, much tighter control of management, letting and re-lettings may be appropriate. A lender can take an assignment of rents without necessarily becoming a mortgagee in possession. It may be appropriate to ensure that rental income is paid to an account with the lender or with a third party that is subject to lender control and from which payments are mandated or otherwise secured to the lender. It may be that the lender has power to approve withdrawals from the account for operating expenses.
A full assignment of rents is taken by notifying the tenant that the rents are required to be paid to the lender. Short of an outright assignment, the tenant can be notified to pay to a particular account. It is desirable that the direction be given by the borrower and that it is stated not to be revocable without the lender’s consent. See our chapter on mortgagees in possession. If the lender takes complete control of management it may be deemed to be a mortgagee in possession. However, provided that a rent assignment and enhances supervision only is involved, this should not arise.
It may be desirable to put tighter control on the borrower’s ability to undertake other transactions and dispose of other assets. The borrower may have other borrowings and the position across his entire portfolio of assets needs to be considered. It would be desirable to limit the grant of further security to third parties.
It may be necessary to provide for monitoring by an independent professional, such as an accountant or surveyor. The agreement should oblige the borrower to cooperate, allow them access to information and the property as appropriate, provide that their consent or sole decision is required on key issues, require meetings and payment of their fees and expenses incurred.
Additional Security by Borrower
There may be provision for additional security. Further security or the addition of a guarantor might be sufficient to give comfort and to proceed on a new basis. If new property security is offered, the usual due diligence that would take place with a property security should be undertaken. A certificate of title should be given by the borrower’s solicitor. Any other existing security on the same asset must be evaluated. Existing security may appear to be for a limited amount, but might in fact be security for other sums due. If the secured property is a family home or the loan is a housing loan, there may be some limitations on the effect of an existing “all sums due” clause.
It may be that the default under the loan agreement triggers default under other loan agreements with the same borrower. Other loan agreements may thereby become enforceable. It may be that another property is held as cross security under another loan agreement already. It may be desirable to specify in the variation agreement that another property is security for the current loan. It might be desirable to amend another mortgage if necessary to ensure any equity under another mortgage is available as security under the varied loan agreement.
It may be necessary to co-operate with other lenders and creditors of the borrower. Many borrowers will be in difficulty with several lenders and creditors, because of direct default on facilities or cross defaults. It may be that the borrower’s partner on another facility is in default and this may trigger default and enforcement of security affecting the borrower.
The issue of priority of entitlement to security may be of key importance where there are multiple lenders. An inter-creditor/priorities agreement may be desirable. See our chapter on priorities. Where there are proposals which involve new security with an insolvent borrower, the implications of insolvency and the possibility of an arrangement with creditors should be considered. See our separate chapters on these issues.
A review of the borrower’s assets may disclose that there are other available assets which may be taken as security. These may include bank accounts, investment products, shares, other properties, pending legal claims, inheritances in the pipeline etc. A cash deposit might be appropriate. See our chapter in relation to non-property security that may be given over other assets.
There are certain types of assets over which it is not legally possible to take direct security, for public policy reasons. Pension funds and entitlement to a pension cannot be charged or mortgaged directly. There are a limited exceptions in respect of borrowings by pension schemes. So-called pension mortgages involve letters of comfort in respect of tax-free lump sums, that are assumed will be available on retirement.
It is possible in principle to take a charge over future streams of income. There are common law rules which render void certain significant assignments of future employment earnings or income assignments by public sector employees. These rules are unlikely to apply to other sources of earnings such as rental income, earnings from intellectual property etc..
Additional new charges over borrower’s assets may be vulnerable to challenge in the event of insolvency within a certain period. See our chapter in relation to impairment and invalidity of mortgage security on Irish insolvency law.
A guarantee by a third party is not strictly speaking a security. However, it is security in the everyday sense of the word as it is a significant credit enhancement. The creditworthiness of a new guarantor is available in the event that the borrower does not pay.
A guarantee may be limited as to time or as to amount. A guarantee may be limited to a maximum amount. This may include costs and interest depending on the wording. A guarantee for particular period may require that a demand of the guarantor is made (and necessarily that a default has occurred under the loan) within a specified period.
Guarantees are vulnerable to be set aside on a number of grounds. The main reason for these rules is that the person giving the guarantee is assumed to have no commercial interest in the loan. A guarantee given under undue influence or duress, can, for example, be set aide. There is a common scenario where a relative or spouse, particularly, a dependent spouse or elderly relative signs a guarantee under some form of pressure. This is particularly risky from the lender’s perspective, where the guarantee relates to an existing loan. It is essential that independent legal advice is given to the guarantor to reduce this risk.
Guarantees by companies are vulnerable to being rendered invalid by technical flaws. The law presumes that companies do not have power to do something that is not for the benefit of the company. It is often necessary to amend the company’s Memorandum of Association so as to ensure that a company has the requisite power to guarantee. Under Company law, certain guarantees by companies in favour of directors, persons connected with directors, controllers of companies and companies controlled by them are void. There are some limited exceptions, which may or may not be available.
Third Party Security
A guarantor may give a mortgage in support of a guarantee. Sometimes the guarantor may require that recourse under the guarantee is limited to the security. This means that, although judgment may be obtained against the guarantor for the loan, it can only be enforced against the security.
It may be desired to have a variation in force for a particular period, until a temporary deficiency is resolved. It might be provided, that conditional upon certain terms and conditions being complied with (e.g. satisfactory performance) that the additional security may be released, if the loan is satisfactorily serviced for the period. In a business or investment loan, additional security may be agreed to be released, if certain financial performance is achieved by reference to accounting ratios in financial accounts for a particular period e.g. sufficient earnings after tax for a particular period.
Effect on Existing Guarantee
A variation of a loan agreement which is guaranteed, may have an impact on the existing guarantee. The general rule is that any change in the underlying loan agreement may discharge the guarantor The reason is that the guarantor has guaranteed a particular deal on commercial terms (e.g. amount period term etc.) and that a variation of this is a material change to what is guaranteed.
Most bank standard form guarantee agreements specifically provide that they will not be rendered void by any change in the loan agreement. The particular wording of the guarantee should be considered. The Consumer Protection Code requires guarantors to be notified of any change in the loan agreement. It is desirable the guarantor is party to the new arrangement, unless the guarantee wording is sufficiently clear to cover the change.
Depending on the circumstances, the following additional provisions may be appropriate in a variation agreement.
It may be appropriate to provide in the agreement that the borrower accepts that:
- the debt and the current state of the account and that it is not subject to any dispute, defence or counterclaim;
- that the borrower has no claims against the lender or its advisors;
- that there is no obligation to extend future forbearance;
- that the lender has relied on the borrower’s and his advisor’s statements and information;
- that the agreement is not a waiver of the loan agreement other than as expressly stated;
- that no future dealings by the lenders, its consultants or agents is a waiver except to the extent specified;
- that time is of the essence (i.e. all time limits are strict and non compliance terminates the variation);
- that the borrower has not relied on representations by or on behalf of the lender (if this is the case);
- if it is the case, that the borrower has been independently advised;
- if it is the case, that the arrangement is not advised by the lender and is “execution only” at the borrower’s request.