For lenders dealing with troubled loans, a loan workout agreement is often a great first step to address a tricky situation. A loan workout agreement may be a simple short-term standstill agreement, a mechanism to implement a long-term solution to the borrower’s woes, or a path toward a palatable exit strategy to the relationship. Loan workout agreements, which often take the form of a loan modification agreement or forbearance agreement, may include, among other things, modifications to payment terms, forbearance from exercising certain rights and remedies, pledges of additional collateral, or an agreement to liquidate existing collateral.
Obligors often welcome such an agreement, which can afford them breathing room to get back on the path to compliance. Nonetheless, defaults may nonetheless persist. Two recent decisions from the Tenth and Fifth Circuits illustrate that, even when a workout fails, a well-drafted workout agreement can provide lenders protection against lender liability claims once the relationship turns adversarial.
I. Twiford Enterprises, Inc. v. Rolling Hills Bank & Trust, No. 20-8048, 2021 WL 2879126 (10th Cir. July 9, 2021)
In this case, the borrower operated a cattle ranching business in Wyoming. The borrower refinanced its cattle loans with a new lender, who later convinced the borrower to refinance its real estate loans with the lender the following year.
Thereafter, the lender stopped advancing funds to the borrower on the cattle loans, and those loans went into default. Over the next year, the lender and the borrower entered into several loan modification agreements and forbearance agreements to revise payment terms, extend maturity dates, and provide for additional credit advances. Crucially, all the modification and forbearance agreements contained releases or waiver provisions in which the borrower and the guarantors waived any claims or defenses relating to the loans.
The borrower later filed a Chapter 11 bankruptcy petition, and the guarantors filed an adversary complaint against the lender, alleging breach of contract, breach of the implied covenant of good faith and fair dealing, negligence, fraud, and negligent misrepresentation. The guarantors claimed that the lender misrepresented its confidence in the borrower’s business to induce it to refinance its real estate loan and then the lender manufactured a default.
The trial court granted summary judgment in favor of the lender based primarily on the applicable statute of frauds, but it also held that regardless of the statute of frauds, the claims would be barred by the releases contained in the forbearance agreements.
On appeal, the guarantors did not argue that their claims fell outside of the releases’ scope. Instead, the guarantors asserted that the releases were not enforceable because they were wrongfully obtained through economic duress.
The Tenth Circuit affirmed the trial court’s ruling, noting that under applicable state law, an alleged victim of duress may not obtain part of the benefits of an agreement and disavow the rest. Since the guarantors obtained valuable concessions in connection with the forbearance agreements, such as credit advances, the Court held that they could not evade the releases under an economic duress theory.
II. Lockwood International, Inc. v. Wells Fargo Bank, N.A., No. 20-40324, 2021 WL 3624748 (5th Cir. Aug. 16, 2021)
In this case, the borrower companies obtained two sizable lines of credit from their lenders. Within a year, the borrowers breached some of their obligations. Thereafter, the parties agreed to modify the lines of credit. In connection with the modification, the borrowers’ sole owner executed a personal guaranty. Also, at the lenders’ urging, the borrowers hired a chief restructuring officer (CRO).
Despite the loan modification and the appointment of a CRO, the borrowers’ struggles persisted. The lenders grew frustrated, believing that the borrowers and the guarantor did not fully empower the CRO to address the borrowers’ financial issues. The lenders gave the obligors an ultimatum: fully empower the CRO to operate or right-size the business within 48 hours or face an acceleration of the debt. The obligors agreed, but still defaulted on a sizable loan payment. To stave off acceleration, the obligors then executed a forbearance agreement in which they confirmed that the amended loan agreements were valid and enforceable, and waived and released the lenders from all claims. Before this forbearance period expired, the obligors executed a second forbearance agreement, which contained the same confirmation of the debt and releases in favor of the lender.
After the second forbearance agreement expired, the lenders accelerated the debt. This acceleration led to litigation among the parties that eventually was pared down to the lenders’ breach of guaranty claim against the guarantor.
In his defense, the guarantor claimed the lenders engaged in a bait-and-switch scheme to obtain his guaranty and then install the CRO to control the business. Claiming that he only agreed to execute the guaranty and forbearance agreements under intense business pressure, the guarantor asserted affirmative defenses of fraudulent inducement and duress, both of which were rejected by the trial court on summary judgment.
On appeal, the Fifth Circuit noted that because the guarantor ratified his guaranty in connection with the forbearance agreements, the guarantor would need to invalidate the forbearance agreements before he could escape liability. The court found no basis to support a fraudulent inducement defense since the guarantor signed the first forbearance agreement after he already agreed to cede control over the companies to the CRO.
The Court also held that the guarantor’s duress defense lacked merit. The guarantor argued that he only agreed to relinquish control to the CRO and execute the forbearance agreements because the lenders threatened to accelerate the loans. The court rejected this defense, noting that duress requires a threat of unauthorized action. The lenders were authorized to accelerate the loans and were simply using their leverage to extract a concession that they desired (i.e., installing the CRO). The court further noted that “difficult economic circumstances do not alone give rise to duress.” Indeed, the Court opined that loan modifications would become rare if a borrower could later invalidate the agreement because of the economic pressure that precipitated the modification in the first place.
While the crush of loan delinquencies that we feared at the outset of the pandemic has not materialized, many observers believe that defaults and resulting workout volume will increase once government support and intervention wane. Lenders can expect that at least some of their borrowers will assert lender liability claims in the face of enforcement efforts.
To that end, these recent decisions offer a compelling reminder that a well-crafted workout agreement can serve multiple purposes. On the one hand, workout agreements are great opportunities for lenders to develop retention or non-retention strategies for troubled loans. On the other hand, even if the workout strategy fails, these agreements can help mitigate potential exposure to lender liability claims. Moreover, as the Lockwood case illustrates, so long as a lender is acting within the bounds of its loan agreement authority, it may elect to apply its leverage to obtain valuable concessions from a troubled borrower in a workout scenario.