During the COVID-19 crisis, an unprecedented number of borrowers requested loan payment deferrals from their lenders. But even without a national crisis, sometimes borrowers hit hard times and need help for a short period to manage loan payments. Lenders will need to evaluate a particular borrower’s facts and decide whether to proceed with a loan forbearance, and if so to make that the agreement is properly documented.
Lenders are strongly recommended to put a forbearance form on their website for borrowers to use when requesting a payment deferral. This form should include information about the loan, the borrower’s reason for the request, and supporting documentation evidencing the need for the deferral. These forms can facilitate the processing of many requests into a condensed period of time.
That said, some borrowers may submit their payment deferral request informally. Even so, the lender’s reply should be more formal than just a simple email or telephone call. Formality is extremely important when lenders are modifying or waiving any rights under the loan documents. Oral misrepresentations were often the cause of borrower lawsuits against lenders during the Great Recession. As such, all calls should memorialized in writing, in particular when rights are or are not being waived. Lenders should follow up calls with an email, and in some cases, a formal letter sent to the notice address for the borrower provided in the loan documents. If the lender agrees to delay loan payments, a formal Forbearance Agreement needs to be used to make sure the parties are agreeing on what is being waived and what is not.
Best practices regarding terms during this time include: (1) providing a 60-90-day payment deferral for borrowers in actual need; (2) automatic lender discretionary extensions of the forbearance period; (3) no late charges or default interest on deferred payments; (4) deferral of payment of missed payments to the maturity date of the loan. The recitals in the forbearance agreement should also spell out that the lender is making the forbearance as a gesture of goodwill to the borrower. The agreement should reaffirm the amounts due, the business purpose of the loan, and include itemization of the amounts due under the loan.
A strong forbearance agreement should include addressing what the lender is forbearing from (e.g. recording a Notice of Default, charging late fees, or the accrual of default interest) and for how long the forbearance will last. Prior to the forbearance agreement being made effective, payment should be required for things like legal costs, processing costs, taxes, insurance, and other charges. In the event a borrower is not able to pay for such costs at the time of the agreement, the best practice is for lenders to cover third-party costs where possible.
Lenders will also want to include a release of all claims in the agreement. This way, if there is the possibility of a dispute under the loan documents the borrower will have released the lender from any such issue, even as to unknown claims. The forbearance agreement is also a great time to evaluate the underlying loan file for any defects. For example, was signature authority clear in the original loan? If not, then including reps and warranties that the previous signer was authorized, along with an entity certificate signed by all members should clean up any argument that the documents were signed by an unauthorized party.
The forbearance agreement should specifically define what a future default looks like. For example, the agreement should make it clear that other defaults under the loan will cancel the forbearance. Lenders should carefully define out the following as additional future defaults under the loan and forbearance agreement: other defaults under the loan documents (e.g. transfer of property); other creditors take adverse action; seizure, repossession, or other adverse property action; and fraud or misrepresentation.
To protect the lender and borrower, the lender should require a date down of their Title Policy when a new forbearance agreement is established to ensure that no additional liens have been recorded against the property, taxes are current, and no other surprises exist. Lenders should also ensure that the person who signs the forbearance agreement is authorized to do so on behalf of the lender. Some loan servicing agreements do not allow for loan servicers to sign for their lenders, so it may be prudent to review those agreements ahead of time. The final protection for lenders is to include a reaffirmation in the forbearance agreement that all other provisions in the original loan agreement remain in force.
With or without a pandemic, there will always be borrowers under pressure, so lenders should take note to follow the best practices and including the terms suggested above to put both borrowers and lenders in a stronger position to exit a loan successfully.