Forbearance Agreements

It happens from time to time that even good credit risks have trouble repaying their debts. Serious illness, unemployment, a family emergency-each, when it occurs with a disquieting lack of notice, can wipe out savings and take a toll in other ways, as well. The agreement that goes a long way toward settling this unsettling situation is called a forbearance agreement. In this written contract, a lender agrees to abstain-that is, forbear-from taking action against a borrower that the lender would normally have the right to take. In other words, the lender agrees not to sue or foreclose on the borrower, permitting the latter more time in which to repay the debt.

The forbearance agreement is a formalized way of recognizing that there is a problem in the financial relationship and attempting to solve it. It contains a payment schedule created by both parties, which the borrower agrees to adhere to for the duration of the agreement. There is an implicit understanding in this recognition, however, that the problem is indeed resolvable, given a reasonable period of time for the borrower to regain his traction. If the borrower's problems are not short term and are instead more intractable, then the forbearance agreement will likely not come into play. The lender will probably foreclose, in other words.

However, to allow the borrower some breathing room and if the lender believes the repayment terms can be restructured to its satisfaction, then the forbearance agreement is an excellent compromise. Its purpose is different for each party. For the lender, the agreement allows for a cure period-where the lender may eliminate deficiencies from its existing financial documents. Further, the agreement preserves the lender's defaults and remedies against the borrower, and it allows the lender to secure a release of claims arising from actions previously taken on the credit. For his part, the borrower is afforded more time in which to get current on his payments.

Perhaps more than most contracts, forbearance agreements are not subject to strict formulas, for the essence of the agreement-the terms of repayment-is almost entirely dependent on the negotiations between the parties. What they decide, or rather, what the lender is willing to agree to, is what the agreement will state. At the same time, most forbearance agreements do contain a number of the same or similar clauses. The first is, of course, the lender's agreement to forbear. Another confirms the existence of the debt, as well as the lender's collateral interest. In still another clause the borrower affirms that he has no defenses against the lender's rights. A fourth preserves the lender's defaults and other rights against the borrower, if it comes to the point that the lender must invoke these. Forbearance agreements also contain affirmative and negative covenants, along with certain conditions-most often that the borrower will seek professional financial planning help or sell his assets to repay the debt. Lastly, there is frequently a "drop dead" clause in which the borrower is given a final date by which to repay his debt. After this date, the lender will likely begin foreclosure proceedings.

As the new payment schedule usually incorporates more interest from the borrower, the lender does not lose much in the use of a forbearance agreement. And the goodwill that the lender earns may be the best reason to create one.