There are many ways that small and medium-sized businesses can find themselves facing financial difficulties that lead to trouble in their commercial lending relationship. When this happens, many times business owners become paralyzed, shutting down and failing to communicate with their lender. While that is understandable, it is the wrong thing to do, says David M. Hunter, chair of the Real Estate Practice Group for Brouse McDowell.
“When a business anticipates that it is entering a period of financial challenge, one of the first things it should do is get competent legal counsel,” says Hunter.
Often, business owners only do this as a last resort. However, retaining knowledgeable counsel early on allows you to obtain practical pointers when there is often greater flexibility to negotiate an agreeable outcome, he says.
“Once a lawsuit is pending, things become much more difficult to negotiate, even with a lawyer involved,” he says.
Smart Business spoke with Hunter about how to work with your bank to preserve good relations during difficult financial times.
When a company realizes it may be headed for financial difficulties, what should it do first?
Small and medium-sized businesses typically have a large file that contains the underlying governing documentation when the business took out the credit facility. In the event that your business is slipping into financial turbulence, locate that file and review the terms and conditions of your loan.
However, most businesspeople are overwhelmed by the paperwork. This is a good reason to get counsel involved early. Your counsel will determine the secured or unsecured position of your lender. If your loan is secured, what are the assets that secure it and what are the current valuations of those assets? Is the loan in default? If not, what is the time period you project you could make the required payments and otherwise adhere to the terms of the loan agreement?
How can an attorney help?
A good attorney either has knowledge to assist a borrower facing a potential loan default or is with a firm with others who have knowledge of the federal bankruptcy law protections or other approaches that would aid a borrower facing an approaching problem.
Once you have secured counsel and discussed the issues, the next step is to contact your lender. Bankers appreciate knowing that a borrower is alert to the problem and wants to collaborate with the bank to address it or explore what remedial options are available.
Business owners often believe that banks want to seize a borrower’s property or shut down a borrower’s business. No bank really wants to do that. If it is reasonably achievable, banks want to rehabilitate nonperforming loans and transform them back into performing loans that pay as agreed. They want to lend money to borrowers that use loan proceeds effectively and to create an improved economic performance for the borrower, which will allow the borrower to repay the loan.
Are there risks in alerting a bank of a potential missed payment?
Some businesses, regardless of efforts taken to head off financial difficulties, can face a situation in which the next loan payment might be missed. No bank will think unkindly of a call from a borrower saying an upcoming payment might not be paid timely. Some borrowers might worry that if a bank finds out about a potential missed payment, an awful consequence will be triggered. But if that is the impulsive reaction you receive from the bank, you are likely dealing with the wrong bank.
However, after 90 days of delinquency, the loan will likely go into a nonaccrual status — a consequence which immediately and negatively impacts the bank’s earnings. This is a more serious situation. If you alert your bank early enough, it will likely work with you to find a solution. But it gets more difficult to take these steps the longer a borrower waits.
At what point does this become a legal issue?
There are legal issues every step of the way. But these become more acute when the evolving facts empower a lender to take steps that can disrupt a borrower’s business. Many loans contain a cognovit provision, a tool a bank can use if a loan is in default. This authorizes a bank to obtain an expedited judgment against a borrower. This expedited judgment can quickly empower the bank to attach the bank accounts or levy upon the assets of its debtor.
It’s important to communicate with your bank before such a provision is implemented in an effort to find a way to augment the terms and conditions of the loan to give the borrower a window of opportunity to make payments. This often leads to the creation of a forbearance agreement — a mutually agreeable written understanding between the bank and its borrower as to how the parties will treat this troubled loan. Forbearance agreements customarily provide that as long as the borrower adheres to the agreement, the bank will refrain from pursuing certain remedies, such as obtaining or enforcing a cognovit judgment.
Preservation of value should be paramount for both the borrower and the bank. Under potential default circumstances, borrowers and banks can do things that can negatively impact a business’s value, and banks know that. If a bank acts aggressively to prompt a forced sale of assets, often the value realized when the assets are sold will be reduced.
Before a borrower gets to that point, the borrower would be well advised to work with a lawyer and devise a strategy to deal with the situation. Often, the owner and lawyer can come up with a plan of payment and present it to the lender. If the plan is reasonable, many times the lender will be receptive.
What are some other potential resolutions?
There is often relief available in bankruptcy. But its practical effectiveness hinges on the size of the company, as the pursuit of such a remedy can often be cost prohibitive. Chapter 11 cases, for example, can come at a high cost and be labor intensive. But a Chapter 11 filing can make sense in certain circumstances.
David M. Hunter is chair of the Real Estate Practice Group for Brouse McDowell. Reach him at (330) 535-5711, ext. 262, or [email protected].
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