With the current economic upheaval, many of our clients have begun the painful process of renegotiating lease terms and either entering into Lease Amendments or Forbearance Agreements. The distinction between these types of agreements can be blurry. But generally with a Lease Amendment, the payment, term and perhaps other elements of the lease are changed for the remaining life of the lease. With a Forbearance Agreement, the lessor will generally allow the lessee to either skip payments or make reduced payments for a period of time with the original lease terms enforced after this forbearance period.
Forbearance Agreements are generally a better idea if the nature of the arrangement is to allow the lessee some temporary breathing room but preserve the lessor’s right to call default and move forward should there be any deterioration of the lessee’s credit or further failure of the Lessee to honor its commitments.
What follows is a brief set of principals to consider when negotiating a Forbearance Agreement. It is not a substitute for getting your lawyer involved early in the process and we always advise that counsel should draft the actual forbearance agreements.
1. Make it clear to the lessee from the first discussion that what is offered is a forbearance and not a permanent amendment. The lessor is not waiving rights or releasing the lessee from any of its obligations, simply agreeing not to enforce its remedies if everything goes according to plan. It is important to be clear in your discussions and written communications with the debtor and not inadvertently amend the agreement. Attorneys will frequently prepare letter agreements setting out the ground rules and expectation of the negotiations.
2. Include guarantors. Guaranty agreements frequently provide that the lessor and lessee to modify the terms of the lease without impacting the guarantor’s liability under the guaranty even if the parties to not obtain the guarantor’s consent to the modification. However, the better practice is to require each guarantor to consent to the forbearance by signing the Forbearance Agreement or a side letter, acknowledging the forbearance and all of its terms. Guarantors should acknowledge that the guaranty is in full force and effect and they have no defenses or claims against you. This means that the guarantor should be involved at the beginning of the negotiations and not at the last minute, after time and money has been spent working out a deal only to find that the guarantor is unwilling to stand behind it.
3. Consider everything that might be affected by the lessee’s default and whatever changes in terms are contemplated. If the rental is going down, does that mean that the term is being extended? Is the lessee required to make up the past rent shortfall at some point? How is casualty value affected? Is there effect on tax assumptions? Does a change in the lessee’s permitted use of the equipment require additional indemnities or insurance?
4. If things do not go well for your distressed customer, you may soon be filing suit to collect the debt. You should take this opportunity to address matters which the debtor may raise in a lawsuit. The lessee should acknowledge all existing defaults and that the lease is in full force and effect. Make it clear to the lessee that you are going to insist that the lessee comply with all terms of the lease, as modified by the Forbearance Agreement and waive any claims or defenses it might claim to have against the lessor. Your lawyer (if he or she is familiar with drafting Forbearance Agreements) will have some boilerplate language that may be a surprise to the lessee. Be sure the lessee is aware that there will be various waivers and consents that are necessary and non-negotiable. That will save time and money and is actually “market” for this sort of agreement.
5. Be absolutely clear what the Forbearance Agreement will provide:
* What defaults will be covered?
* How long will you agree not to exercise remedies? (Be sure to consider how you will react to the following issues).
* What if there is a subsequent default? If the lessee’s condition deteriorates? If the general economy or the lessee’s industry experiences a decline
* Will you require that the lessee perform some additional obligations or provides some additional collateral?
* Who pays for additional costs related to the Forbearance Agreement such as UCC searches, counsel fees, etc.?
6. If the lease is to be amended, the terms should be absolutely clear and your counsel should be asked to check whether changing one section affects something later on. (Example: Changing the lessee’s maintenance obligations might affect return conditions and residual value). If the lease amendment/forbearance is contingent on some future event or subject to an unwind, make these trigger events clear and quantifiable, otherwise, they will be difficult to enforce.
7. Do not unwittingly make changes to your original lease. If you simply use a free form from the Internet it may have provisions that make changes to your lease that you do not intend or include provisions that make no sense in the context of your transaction. Such provisions could make it more difficult to enforce your lease.
Ideally, a Forbearance Agreement will be a means of relieving pressure on the lessee while keeping the lessor’s rights in place, at least after an agreed period of time. While proper drafting is important, starting off on the right foot with the lessee and guarantors may be the difference between rehabilitating a good customer and adding to the impending disaster.