WORK OUT. Two little words which send shivers down the spines of bankers, accountants and anyone involved in the finance industry. Although liquidation and defaulting loans are certainly not in your client’s definition of the prime loan portfolio, bankers and the attorneys who represent them can take the opportunity to strengthen the Bank’s position on a particular credit through a carefully drafted workout agreement. Certain clauses should be present in all workout agreements:

NOTARY: It is unusual for guarantors and/or borrowers to personally appear to execute the workout agreement. For this reason, a notary jurat should appear to add a certain degree of protection that the individuals actually signed the agreement.

FEES: Generally, the Bank can require the borrower to pay all fees incurred in collection of the debt, either over time or in one lump sum. The terms of the payment can be utilized as a "bargaining tool" in the negotiation of the workout agreement.

REAFFIRMATION OF THE DEBT: Whenever possible, the Bank should get the borrower to reaffirm the debt in the case of a commercial transaction. Include any outstanding late charges or default interest rate, if applicable. The borrower should acknowledge a default exists and the amount should be unequivocally stated in the workout agreement. The amounts outstanding should be reflected up through the date the workout agreement is executed. Be weary, however, of reaffirmations in the context of consumer lending. The judiciary does not look favorably upon this practice.

REAFFIRMATION OF THE LOAN DOCUMENTS: This is equally as important as the prior clause. The agreement should acknowledge the underlying loan documents and it is advisable to set forth each loan document individually (including the date of each document as well as the recording information & instrument number). Additionally, the borrower should acknowledge it has no defense to any of the underlying documents and that each remains in full force and effect, except as modified by the workout agreement. Lastly, the borrower should acknowledge the Lender has the right of set-off in case of default and the borrower waives any defenses it has against the Bank, its officers, directors and/or agents.

MODIFICATION: Leave nothing to guess work when it comes to modification of the original loan documents. The workout agreement should be precise and set forth the exact terms of the agreement to include what sums are to be paid, when and how those sums are to be applied (ie. Toward arrearage? Against regular principal?) Be specific! Be careful not to add any arrearage(s) to principal which may impair lien priority.

LEGAL REPRESENTATION: If the borrower elects not to have legal representation (and had adequate ability and time to do so), this should be stated in the workout agreement. If counsel was consulted and/or the borrower had legal representation, this should also be set forth. As in the case of all binding contracts, the borrower cannot be under duress for the document to be legally binding. This should also be stated, as well as the fact that the borrower received consideration in exchange for executing the agreement (continued use of the loan proceeds).

BANKRUPTCY: The Federal Bankruptcy Code continues to change and you as Bank counsel should be well versed in how those changes may affect the collateral or the Bank’s ability to collect on the collateral if a bankruptcy is filed within ninety (90) days. New collateral offered as security for the debt would be lost due to preference in many cases and the Bank should be careful not to release other collateral in connection with entry into the workout agreement until the "preference period" has passed. It may also be prudent to consider a clause consenting to relief from the automatic stay generally imposed by a bankruptcy filing. Such as clause has been upheld by some courts, but on a case by case basis. In summary, anytime a Bank has the opportunity to strengthen its position, Bank counsel would be well advised to do so even if the terms of a transaction change ever so slightly. Use of a well drafted workout agreement specifically outlining the expectations of all parties can be used to ameliorate prior inadequacies in the underlying loan documents, clarify the terms or take additional collateral. Lender liability acts from prior actions may be waived and disputes over the validity of the prior documentation can be resolved. Rather than "recasting" a commercial transaction, running the risk of losing one’s lien priority and incurring additional legal fees for the borrower, many attorneys elect instead to utilize workout agreements as an opportunity to improve upon the original terms of a transaction and view this otherwise unfortunate turn of events as a chance for perfection. 

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