Before bankruptcy, try a commercial loan workout

When a business owner is having trouble making loan payments even after adjusting business economics as much as possible, it may seem like foreclosure is the only option with bankruptcy not far behind.

But savvy business owners know they can pursue one last option – a loan workout with the lender.

In a loan workout, both the lender and the borrower agree to restructure the terms and covenants of the loan.

Both parties must benefit

For a workout to be possible, both parties have to see some benefit. The lender is under no obligation to restructure the loan, but they likely want to limit their losses.

The borrower avoids foreclosure by working with the lender to ease the debt-servicing burden, usually through smaller payments over a longer period. Other options include deferred payments, interest-only payments for a period, or an agreement to tack delinquent payments on the end of the loan payment schedule.

Another possibility when negotiating a workout is a deed-in-lieu of foreclosure where the borrower voluntarily transfers the deed to the lender, who agrees not to start the foreclosure process.

A lender might also agree to a short sale, where a borrower sells the property and the lender agrees to take the sales price as payment for the loan, thus avoiding foreclosure fees.

Other scenarios

Private equity lenders – hedge funds – are allowed more leeway than banks in workout scenarios since their regulations are less strict. If a borrower has a loan with a private equity lender, options could even include a reduction of the loan amounts or interest rates.

A borrower can also get into trouble by not following the covenants of the loan. These circumstances come into play if the:

  • Borrower fails to maintain insurance or pay taxes on the property
  • Borrower fails to maintain the property
  • Value of the property drops below a prescribed percentage of the loan
  • Borrower fails to maintain liquidity or reserve ratios, or misallocates profits

For the borrower, the key is to provide the lender with ample notification that the loan is in danger of default. Many lenders are more amenable to a workout with borrowers before the loan reaches crisis stage.