The Coronavirus pandemic, in addition to the tragic consequences of prolonged illnesses and even deaths, has created havoc to the economy and led to massive uncertainty about the future. No sector of financial life has been spared the harsh effects. This is no less true for commercial borrowers. Whether the owner of a commercial shopping center, multifamily property or office building, commercial borrowers are increasingly facing their income stream dissipating from struggling and failing tenants and residents unable to pay rent. There are options that such borrowers can and should discuss with their lenders, including forbearance agreements and loan modifications.
In a forbearance agreement, the lender agrees to reduce or suspend loan amounts for a predetermined amount of time. It is generally considered a short-term solution. During the forbearance period, the borrower makes reduced loan payments or payments are suspended altogether. Also during the forbearance period, the lender agrees to not commence any foreclosure-type proceedings or take other efforts to collect the debt. In exchange, the borrower agrees to re-commence payments following the forbearance period. A lender may ask for a lump sum payment initially followed by routine monthly payments, extra amounts added to the previous payments until the missed payments have been made or other modifications to the original loan.
Forbearance agreements vary widely. Some factors include lender policies, the history with the borrower, the existing structure of the loan, the proposed forbearance terms and the circumstances giving rise to the particular hardship. Typically, the lender will consider the reasons for the temporary hardship, whether the hardship is likely to pass, the business prospects for the borrower if given a temporary reprieve, and the financial ramifications to the lender.
It is important to have the discussion with the lender as soon as possible. Under this plan, the lender is agreeing, in advance, to allow the borrower to miss payments.
A loan modification is a permanent restructuring of an existing loan in a situation where a change of circumstances has made it difficult or impossible to make monthly payments. It is generally considered a long-term solution. Loan modifications typically involve modifying one or more of the terms of original loan with the ultimate goal of reducing the monthly payment. It could be a lower interest rate, converting a variable rate to a fixed rate, extending the maturity date of the loan or deferring balloon payments.
For a lender to consider a request for a loan modification, a borrower must be able to demonstrate a current inability to pay. This might include providing the lender proof of income (or lack thereof), recent tax returns, rent rolls bank statements and a general statement of hardship. In demonstrating the hardship, a borrower should also provide a plan for when the hardship decreases in order to show an ability to make the modified loan payment. Borrowers should be prepared for a time-consuming process that may entail many lender requirements. From a timing perspective, loan modification requests can be initiated prior to default or later in the process, perhaps after the lender has initiated foreclosure proceedings.
Whether a borrower desires to pursue a forbearance agreement, loan modification or other payment/repayment plan with a lender, the assistance of counsel can improve a borrower’s chances for a successful outcome. Also helpful in improving results is being proactive. It is oftentimes better to approach the lender before the situation is critical or the loan is already in default.