The pandemic has hurt many companies. Fortunately, at the urging of the Federal government and with relief from regulators, many secured lenders have refrained from taking action against borrowers in default under the terms of their loan. However, lenders are now becoming less patient and more enforcement-oriented. In requesting further forbearance or a loan modification, what information should borrowers provide to their lenders? What do lenders need to be accommodating? How can a borrower best prepare to obtain relief?
To start, books and records should be up to date. Lenders will review whatever their borrowers provide to them. Lenders will only make fully informed decisions, which means they will require up-to-date results.
Lenders will also require realistic financial projections for ongoing operations. Pre-pandemic financial projections should be bridged to actual results during the pandemic and also to current financial projections. They should show the line items that have changed since the original forecast.
You should be able to identify what happened during the pandemic that caused weak operating results. Identify the things over which you had no control. Was there a decline in sales due to less foot traffic, an inability to obtain sufficient raw materials, a spike in the cost of raw materials, lost operating efficiencies, or a labor shortage? Further, identify operating issues that existed before the onset of the pandemic over which you had control. Rather than denying that a problem existed, acknowledge the problem and explain how it was being addressed and how the pandemic hampered the implementation of the solution.
You should also adjust actual operating results using historical data and percentages (such as gross margin). Use reasonable top-line numbers consistent with your actual pre-pandemic performance. This should show “but for the pandemic” results to convince the bank that the business is still worth supporting through unprecedented times.
You should be prepared to discuss all assumptions made in preparing the projections. Each assumption will be carefully vetted by the lenders. The lenders will compare your assumptions with industry standards as well as to those used by other bank customers. You do not want to be an outlier. Assumptions should be citable to industry trade journals, to your prior period operating results, or to both.
The goal is to demonstrate that the business was performing satisfactorily pre-pandemic, that the business suffered solely (or primarily) because of the pandemic, and that the business will return to pre-pandemic performance.
In considering your request for further forbearance or loan modification, lenders will want to know what you have done to help yourself. So, be prepared to address such things as expense reductions, employee headcount reductions, idling of production lines, lease terminations or concessions obtained from equipment lessors, and landlord concessions. Lenders are more inclined to forbear if their borrower has done everything possible to help itself. The bank should not have any suggested actions that management has not already thought of.
Most important, you must convince the bank that there is no need to write off any of the loan and that it is in the bank’s interests to grant relief. Consequently, a borrower should ascertain the following:
- The liquidation value of the bank’s collateral;
- How it would need to be liquidated in the event of a foreclosure (such as by public auction or by private sale);
- How weak or strong the market is for the bank’s collateral;
- Whether the bank’s collateral is the type that the bank would not want to take possession of due to environmental issues;
- Whether the bank will be bombarded by consumer complaints if it shuts down the borrower;
- Whether the bank’s collateral can readily be sold apart from other assets on which it does not have a lien;
- Administrative costs; and
- Whether the collateral can readily be sold in place or will need to be disassembled and moved.
For sales in place, there is rent, insurance, security, etc., in addition to the auctioneer’s fees and expenses. Additionally, some large machinery must remain in place at the borrower’s premises so that prospective buyers can witness the operation.
Lenders also like to see that principals have skin in the game. Things that enhance credibility are salary and perquisite reductions by executives. If dividends were paid to shareholders or insider loans were paid down, the bank will view recoupment of those payments as a source of working capital. Of course, nothing impresses a lender more than equity holders putting more of their own money into the business — even if it is structured as a loan.
Most of all lenders value thoughtfulness and honesty. Be prepared to have an open and honest conversation regarding the difficulties faced and how management is addressing every issue. It is most important to propose solutions, not simply disclose problems for which you don’t have answers.
Thoroughly analyzing your own business, knowing what the bank will require in negotiations, preparing the information on a sound basis, and having everything ready when the negotiations commence will make the negotiations easier and will facilitate a faster and better result.
Kenneth A. Rosen is a partner and chair emeritus, bankruptcy & restructuring department, Lowenstein Sandler LLP. Jeffrey D. Prol is a partner and vice-chair of Lowenstein Sandler’s bankruptcy & restructuring department.
The views expressed herein are those of the author alone and are not necessarily shared by other persons at Lowenstein Sandler LLP. Each case is unique. The law is subject to interpretation. This article does not constitute legal advice.