A borrower defaults. They ask for “a little time to work things out.” You don’t want to foreclose if you don’t have to, so you enter into a forbearance agreement.
Forbearance is a standard workout tool that can benefit both parties when structured properly. But the key is getting the documentation right from the start. A well-drafted forbearance agreement protects your position while giving the borrower a genuine opportunity to cure. Here’s what every forbearance agreement should include.
Table of Contents
What Is Forbearance?
A forbearance agreement is not a waiver or modification. The default still exists. The bank simply agrees to temporarily refrain from exercising remedies while the borrower takes specific actions to cure. This distinction matters. If you waive the default, you need a new default before taking action. With forbearance, if the borrower doesn’t perform, you immediately proceed with enforcement.
Six Clauses Every Forbearance Agreement Needs
1. Acknowledgment of Default and Waiver of Defenses
The borrower must explicitly acknowledge that the loan is in default, specify each default that exists, confirm the outstanding balance, admit the bank has the right to accelerate and foreclose, and waive any defenses, counterclaims, or setoffs against the bank. This prevents the borrower from later claiming there was no default or that the bank’s willingness to forbear proves the default wasn’t real. Include language like: “Borrower acknowledges that but for this Forbearance Agreement, Lender would be entitled to immediately accelerate the loan and foreclose on all collateral.”
2. Specific Performance Conditions with Deadlines
The forbearance must be conditioned on specific, measurable actions with deadlines. For example: “$25,000 due by the 15th of each month for six months,” or “Provide monthly financial statements within 10 days of month-end,” or “List business equipment for sale by [a specific date] and accept any offer at or above $X.” Vague conditions like “borrower will make best efforts to improve cash flow” are unenforceable. You need objective milestones you can point to when the borrower fails to perform. If the borrower doesn’t make the $25,000 payment on the 15th, the forbearance immediately terminates with no ambiguity.
3. Automatic Termination Triggers
The forbearance should automatically terminate without notice upon failure to make any required payment, any new default under the loan documents, any material misrepresentation to the bank, filing of bankruptcy, any other creditor filing suit or obtaining judgment, or any liens filed against collateral. Upon termination, the bank may immediately exercise all remedies without further notice or opportunity to cure. You don’t want to be stuck in forbearance if the borrower’s situation deteriorates further. The borrower already got their cure period – that’s the forbearance itself.
4. Fixed Termination Date
Set a specific end date: “This forbearance terminates on [date] at 5:00 p.m., unless earlier terminated or extended in writing by the bank.” Typically, 120 to 180 days is appropriate. You can always extend if the borrower is making progress, but never start with an open-ended forbearance period. Language like “Bank agrees to forbear while borrower attempts to sell the property” gives the borrower indefinite time and you no ability to terminate unless they breach other conditions.
5. Preservation and Enhancement of Bank’s Position
During forbearance, all existing collateral pledges remain in full force. The borrower should grant additional collateral or guarantees if available, provide updated financial statements monthly rather than quarterly, supply updated collateral valuations or appraisals, and cooperate with any third-party sale or refinancing process. The bank retains the right to inspect collateral and business operations on reasonable notice. All costs, expenses, and attorney’s fees are added to the loan balance and secured by all collateral. Make clear: “Borrower will pay all of bank’s costs and expenses, including all attorney’s fees, with no requirement that such fees be ‘reasonable.'” Forbearance shouldn’t weaken your position. Use it as an opportunity to get additional collateral, more frequent reporting, or guarantees from principals that you didn’t have in the original loan documents.
6. No Modification of Loan Terms
The agreement must explicitly state that it does not waive any defaults, modify the loan documents, create any obligation for the bank to forbear beyond the stated period, establish a course of dealing requiring future forbearance, reduce the interest rate or extend the maturity date, or limit any of the bank’s rights or remedies. Borrowers and their lawyers will argue that forbearance creates an implied obligation to continue working with them or that it waives the bank’s right to strict enforcement later. Explicit language negates these arguments. The bank reserves all rights to accelerate and foreclose upon termination of forbearance. Don’t reduce the interest rate or extend the maturity date in a forbearance agreement. That’s a modification that may require bank board approval and could affect your loss reserve calculations.
When to Use Forbearance
Use forbearance when the borrower has a credible plan to cure, collateral value still exceeds debt, you’re dealing with a short-term problem rather than fundamental business failure, and the cost of forbearance is less than the cost of foreclosure. Don’t use forbearance when the borrower is insolvent with no realistic cure plan, you’re underwater on collateral, the borrower is diverting assets or operating in bad faith, or delay will only worsen your position.
The Bottom Line
You’re in a position of strength. The borrower is in default. You have the right to foreclose. Forbearance is a concession you’re offering, not an obligation. Don’t give away that leverage with vague conditions, open-ended timelines, or limitations on your enforcement rights. A well-drafted forbearance agreement gives the borrower a clear path to cure while preserving your ability to enforce if they fail to perform.
DISCLAIMER – This article is provided for informational purposes only and does not constitute legal advice. The information contained herein is general in nature and may not apply to your specific situation. No attorney-client relationship is created by reading this article or contacting the author in response to it. For legal advice regarding your particular circumstances, please consult with a qualified attorney.
About the Author: David A. Lutz is the owner of Lutz Law Firm in Minneapolis, representing financial institutions, businesses, and individuals in banking law, secured transactions, and commercial litigation. He can be reached at [email protected] or 612-424-2110.
