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Forbearance Agreements – When Can You Safely Walk Away From the Negotiation Table

Lenders who find themselves with a troubled loan that requires modification and a formal workout agreement can end up spending several weeks negotiating terms of the final forbearance agreement that will govern the remainder of the parties’ lending relationship, or at least get them past the immediate problem. During this process, the parties typically exchange term sheets, have phone calls and meetings discussing the major terms, and from the bank’s perspective usually presume that nothing is binding until a final agreement is executed by all parties. Is that really the case?

A recent opinion out of North Carolina says maybe not. In re RREF BB Acquisitions, LLC v. MAS Properties, LLC, 2015 NCBC 58 (N.C. Sup. Ct. Brunswick County Case No. 13 CVS 193)(filed June 9, 2015), the Court found a bank can assume a duty to negotiate a workout in good faith, if during the negotiation process there are a number of terms agreed upon and the bank’s words and conduct establish an agreement to continue to negotiate in good faith to a final agreement. In the North Carolina case the bank had negotiated for almost seven months, culminating in a meeting that resulted in an agreement on many but not all “deal” points. The meeting ended cordially with handshakes, but without final agreement. Thereafter, the bank walked away from all negotiations and sold the borrower’s loan to a third party who then sued to collect it.

The borrower sued the bank, in part claiming their action was a breach of duty to continue to negotiate in good faith. The bank moved to dismiss. In the borrower’s view the parties were close enough to a deal that there was an agreement to continue the negotiations and not just shut the door. The bank disagreed arguing the term sheets and negotiations had been non-binding and absent a final executed agreement it could walk away at any time unless the final deal was inked. To the bank’s dismay the Court denied its motion and allowed the case to proceed toward trial. The Court held the bank’s conduct could lead to breach of an agreed duty to negotiate the forbearance agreement in good faith. The bank’s abrupt stopping of all negotiations and selling the loan were clearly factors in this decision. In reaching the decision the Court specifically noted that both the First and Seventh Circuit, as well as other courts, had recently recognized similar duties to negotiate in good faith under such circumstance, and that this signaled a growing trend in the law. See e.g. Teacher’s Ins. & Annuity Ass’n, 987 F.2d 429, 433 (7th Cir.1993); Bulter v. Balolia, 736 F.3d 609, 614-15 (1st Cir. 2013). This presents an obvious concern for lenders working through a troubled loan. How can a lender avoid the risk that their efforts to try to reach a resolution does not inadvertently bind the lender to continue the negotiations when it wants to walk away?

There are a couple of potential solutions to this problem. If you are already in negotiations the first step is make sure the parties each understand that they retain the right to cease all negotiations at any time, making sure there is written confirmation of this understanding to protect you down the road. If negotiations are just beginning advise the borrower that before you can proceed you will need a pre-negotiation agreement so there are no misunderstandings. A pre-negotiation agreement is a written agreement that sets out the parties’ duties during the negotiation of the final agreement. It can be drafted to avoid the lender inadvertently assuming a duty to continue to negotiate in good faith after it is ready to walk away. Pre-negotiation agreements are usually in letter form, short, relatively inexpensive for your counsel to create and provide an important added layer of protection during a workout. If you find yourself in a workout setting and would like to discuss the use of such agreements in more detail, please contact me or any of the McGrath North Financial Services Group members listed herein.