Forbearance Agreements and Financial Covenant Defaults

By Stan Duran | July 15, 2009
Biofuel producers have experienced material financial covenant defaults relating to their loan documents since renewable fuels' "perfect storm" of 2007 and 2008. For ethanol and some biodiesel producers, the combination of rising commodity prices, falling petroleum prices and the saturation of the market with new production facilities, was that proverbial perfect storm. Unfortunately these conditions have only been exacerbated by the financial markets crisis. The result is that many biofuel producers have defaulted, or are on the verge of defaulting, on their contractually required financial covenants.

Lenders have had a difficult time accepting what has been happening in the biofuels industry. Recently, however, they have been more willing to restructure many debt transactions for facilities that can provide reasonable and positive projections over the long term-that is, a period of time reasonably expected to extend beyond the current recession. One reason why the lenders are agreeing to restructure is because they have witnessed the poor returns received from the sale of foreclosed production assets, and believe that a restructured loan will provide the lender a greater return. The other reason why lenders are restructuring is they realize that many borrowers will immediately opt for bankruptcy protection rather than face a foreclosure. Once in bankruptcy, lenders will need to have court involvement with and approval of any and all actions and agreements between the parties. As a result, the lenders will have less control over a bankruptcy as compared to the control a lender can exert in a debt restructure negotiated directly between the borrower and lender. Alternatively, borrowers can use the threat of bankruptcy to keep the lenders cooperating during a restructure. Having said this, lenders are not completing any restructures for free; substantial charges are usually imposed by the lenders for a restructure.

The parties will want to use a forbearance agreement (sometimes referred to as a "Standstill") in order to arrive at a final restructured transaction. Under such an agreement, the lender agrees to refrain from taking foreclosure or any other actions until some later date. If there are many material financial covenant defaults, the forbearance agreement will probably be written to address how activities between the borrower and lender will occur until new loan documents are finished. Alternatively, if there are just a few financial covenant defaults that are expected to be easily corrected, the forbearance agreement may act as the amendment to the existing loan documents and the forbearance period will continue until some specified date. There is no standard form for a forbearance agreement so the parties can negotiate and agree to almost anything, including revised interest rates, amortizations and covenants.

Forbearance agreements are typically heavily negotiated. Borrowers can help themselves with respect to their credibility during negotiations by making sure they are truthful and accurate with the lender; suggest reasonable and attainable solutions; and, have complete command over their operating projections and the related underlying assumptions. Most importantly, a borrower should remember that its credibility with the lender has been formed by the history of how the borrower has dealt with the lender. If the borrower has dealt honestly with the lender, provided the borrower's reports and certificates to the lender on a timely and accurate basis, and has not otherwise hidden any issues from the lender, then the borrower will be in a very credible position when it comes time to negotiate a forbearance, workout or restructure.

Stan Duran is a partner in Lindquist & Vennum's Agriculture and Renewable Energy practice group. He can be reached at (612) 371-3285 or [email protected].
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