D7-38-51.pdf CRC US Body of Knowledge PDF

DIMENSION 7 - 38 NOTES: WORKOUT RESOLUTION: SAVING THE CREDIT A workout resolution is the most probable option. When warning signs are recognized early enough, it may be possible to save the credit and limit your loss. GAINING CONTROL OVER YOUR EXPOSURE Gain control over your exposure by doing the f...

DIMENSION 7 - 38 NOTES: WORKOUT RESOLUTION: SAVING THE CREDIT A workout resolution is the most probable option. When warning signs are recognized early enough, it may be possible to save the credit and limit your loss. GAINING CONTROL OVER YOUR EXPOSURE Gain control over your exposure by doing the following: Manage the loan to the collateral level. Re-size your line of credit availability to an amount that is appropriate to your earlier financial analysis findings. Apply line limitations and restrictions, such as limiting or eliminating advances against inventory, to help ensure your exposure is covered by the most liquid collateral possible. Shore up all deficiencies including loan documentation, loan structure, and advance rates early in the process. If you do not currently apply advance rates, engage the help of a qualified field examiner to determine eligible collateral and to recommend appropriate advance rates. Consider a cash collateral account and lockbox together with a borrowing base certificate requirement to manage the loan-to-value position. If the borrower is undercollateralized, add collateral or design a plan that allows the borrower to phase back into compliance with an acceptable loan-to-value position. CRC US Body of Knowledge Have your legal counsel draft a comprehensive loan workout agreement. DIMENSION 7 - 39 ADDING COLLATERAL If you identified unencumbered assets during your review, you could require the borrower to grant security interests or mortgage interests in those assets to secure the loan. When you take additional collateral you need to be aware of two issues: NOTES: You must be able to prove that you gave value for the new collateral. If no new funds are being advanced you need to be able to prove you waived an event of default, extended the time for payment or otherwise gave up some right. Even if you can prove you gave value, the new collateral can be lost if the borrower either files a petition in bankruptcy or has one filed against it within 90 days after you obtain the new collateral. The 90 days is the bankruptcy preference period and applies to transfers of assets (new collateral) to secure an already existing debt. If the lender is deemed an insider, the period would become one year rather than 90 days. You could obtain guaranties to bolster a troubled credit. You need to determine whether the guaranties add strength to the credit and are enforceable. A guaranty is not enforceable unless it is supported by present or future consideration. In this situation, you would be taking guaranties in connection with a loan that already exists. You would have to prove that you had loaned more money, waived an event of default, extended the time for payment or otherwise given up some right in exchange for and reliance on the guaranties. Even if you could prove you gave present or future consideration, a new guaranty could be lost if the guarantor either filed a petition in bankruptcy or had one filed against it within 90 days after you obtained the new guaranty. The 90 days is the bankruptcy preference period and applies to transfers of assets (new collateral) to secure an already existing debt. If the lender is deemed an insider, the period would become one year rather than 90 days. If you have a Small Business Administration (SBA) guaranty, you must notify the SBA of the problem loan and obtain their consent to workout and/or liquidate as required in SBA rules and regulations. Module 7 // Identify and Develop Strategies for Problem Loans GUARANTIES DIMENSION 7 - 40 NOTES: OTHER SUPPORT Third party security interests and subordinations are additional types of support that could be obtained to bolster a troubled credit: A third party security interest is a collateral interest obtained from a party other than the borrower or a guarantor (see Third Party Support, Collateral Agreements, and Collecting from a Third Party Security Interest Grantor in Event of Default in Dimension 6). A subordination agreement could cover either debt or a collateral position. The subordinating creditor agrees to take a junior position to your institution as to repayment of debt or distribution of proceeds from collateral sales. Bankruptcy courts generally honor subordination agreements. However, the subordination can be lost if the subordinating creditor either files a petition in bankruptcy or has one filed against it within 90 days after you obtain the subordination. The 90 days is the bankruptcy preference period and applies to transfers of assets (subordinations) in connection with an existing debt. If the lender is deemed an insider, the period would become one year rather than 90 days. BUSINESS PLAN If you want to save the relationship rather than exit, you should require the company to establish a realistic business plan. This is the most likely strategy to assist the company in returning to profitability. CRC US Body of Knowledge FINANCIAL CONSULTANT If the borrower cannot establish a realistic business plan to improve performance, an outside consultant or turnaround specialist may be able to help management revive the company. This can be especially effective if your analysis has shown that many of the company’s problems are related to management and operational issues. You cannot require that the company hire a consultant named by you, because this would expose you to a lender liability risk. DIMENSION 7 - 41 EXIT STRATEGY We will now discuss various options and procedures for exiting the credit. NOTES: OUTPLACEMENT AS AN OPTION Once you decide on outplacement, there’s usually no going back. Irreparable damage can be done to the relationship. Changing your mind could involve course-of-dealing and waiver issues that could be raised in lender liability actions. KEY QUESTIONS TO ASK Do you want this borrower? Has the borrower done something that has reduced your confidence in them? For instance, did the borrower sell collateral without telling you and not use proceeds to pay down the loan? What are the consequences of outplacement for you? The risk of loss from continuing in the credit may be less than the risk of loss in bankruptcy or litigation. What will be the cost to your financial institution if the loan becomes a non-performing asset? What will be the cost of managing the credit? What will be the costs in litigation? What is the cost of lost opportunity? ISSUES TO CONSIDER Can the borrower refinance with another financial institution? The ability to transfer marginal credits varies from market to market, depending on how aggressively lenders are seeking new business. What is your history with the borrower? Is the borrower’s current condition worse than it has been in the past? Have you routinely waived defaults in the past? If so, why are you changing your attitude toward borrower’s defaults? Module 7 // Identify and Develop Strategies for Problem Loans Will your financial institution’s reputation suffer from outplacement? Do you want to be known as the lender that moves customers out? DIMENSION 7 - 42 NOTES: What is management’s ability to adapt in a crisis? You should grant extensions if the borrower 1) is making substantial progress toward obtaining takeout financing, 2) has a firm purchase commitment for sale of an asset that will result in reduction of your debt, or 3) is providing other forms of consideration sufficient to warrant a reasonable extension period. Are economic factors part of the company’s problem? Are they likely to get worse or are they likely to improve? Is the industry (service/product) in which the company is engaged viable? (see Industry Risk Analysis in Dimension 1) EFFECTIVELY COMMUNICATING THE DECISION You should communicate your decision to the borrower in a face-toface meeting and confirm the decision in writing. Provide the letter to the borrower at or immediately after the meeting. PROVIDE ADEQUATE NOTICE Loan agreements typically require notice periods of 10–15 days for normal defaults. Adequate notice of a decision to exit a credit is usually 90–120 days, unless the project is very complex or your past course of dealing with the borrower has included longer notice periods. Obtain and keep evidence of delivery of notice. CONTENT OF NOTICE Be simple and direct. Avoid citing specific reasons; otherwise, the borrower may attempt to invalidate them. Address the following: CRC US Body of Knowledge – You will not honor overdrafts. – You will make no payment of checks against uncollected funds. – Outline the conditions under which you may be willing to make advances. – Provide a copy of the letter to all guarantors. Have the borrower and each guarantor sign a copy and return it to you. DIMENSION 7 - 43 ANOTHER LENDER There are lenders that have a higher tolerance for credit risk who may be willing to assume the debt. You may be able to sell your loan at a discount. If you have done an effective review of the problem loan, the discount you give today will most likely be less than the loss you could suffer in foreclosure, litigation, or bankruptcy. If you decide to sell the loan, you must fully disclose to the buyer all that you know about the relationship. For instance, if you have a customer that has rapid growth but limited capital, causing over-advances on its line of credit, the best strategy could be to move the loan to an asset-based lender. NOTES: LIQUIDATION This option is only suggested when there is a high probability that this is your only source of repayment. You can expect a charge-off and the business and its entrepreneurs will lose their entire investment. Most guarantors never expect to be called upon to pay. In many cases guarantors look for ways to avoid having to pay. Many states provide guarantors with legal defenses that make collection difficult. Your position will be strengthened if you have obtained and kept evidence that the guarantor understood the terms of the loan that was guaranteed. This is easy if the guarantor is someone directly involved in the business, more difficult if the guarantor is not involved. If you have obtained written consent from guarantors to subsequent changes in the loan, you will have a better chance of enforcing your guaranties. Module 7 // Identify and Develop Strategies for Problem Loans CALL ON GUARANTOR DIMENSION 7 - 44 NOTES: BANKRUPTCY CONSIDERATIONS When financial burdens become too difficult, many borrowers and guarantors seek protection in bankruptcy court. When this happens you should immediately inform your legal counsel and turn the matter over to an attorney. Two bankruptcy considerations will immediately affect you and your relationship with the filer: You will need to determine whether you have benefited from a preference. You will also have to know and follow the automatic stay rules. PREFERENCE PERIOD The trustee in bankruptcy has the power to void some transfers of a debtor’s property made within certain time frames prior to the bankruptcy petition filing. Both voluntary and involuntary transfers are included. Payments made by the debtor to the lender could be reversed. The trustee could also recover property seized by you prior to the filing. A avoidable preference is a transfer of an insolvent debtor’s money or other property to a creditor as payment on a debt, which gave that creditor a greater percentage of repayment. Besides payment of money and seizure of property, voidable transfers include grants of security interests, perfection of unperfected liens, and attachments of involuntary liens. The preference periods are: CRC US Body of Knowledge 90 days for non-insiders. The trustee would have the ability to reverse only those transfers that occurred within the 90 days prior to the petition filing. You would be allowed to retain regularly scheduled loan payments made during that time. One year for insiders. The trustee would have the ability to reverse only those transfers that occurred within the one year prior to the petition filing. As the term implies, insiders are persons operating the debtor’s business. A creditor could also be categorized as an insider for preference purposes. This would happen if the bankruptcy court found that the creditor had become involved in the day-to-day operations of the debtor’s business. This would be deemed excessive control. DIMENSION 7 - 45 AUTOMATIC STAY An automatic stay comes into place immediately when a petition in bankruptcy is filed. At that point, all actions to collect a loan are prohibited. You must close all accounts of the borrower and open new ones as debtor-in-possession accounts. You may not legally: NOTES: Commence or continue any judicial, administrative, or legal process against the debtor. Enforce a judgment against the debtor or its property obtained prior to the filing. Obtain possession or exercise control over the property of the borrower. Create, perfect, or enforce any lien against the property. Collect, assess, or recover a claim against the debtor that existed before the filing. The automatic stay does not stop any action taken against a guarantor to recover a claim that arose before the filing. LENDER LIABILITY When a financial institution sues to collect a debt, it is often faced with a borrower counterclaim that the institution be found liable for some action it took or failed to take. These counterclaims are called lender liability claims. The following are among the theories put forth in such claims: Failure to negotiate in good faith. Interference/control risk. Failing or refusing to lend. Improper acceleration or foreclosure. Exchange of credit information. Breach of fiduciary duty. Module 7 // Identify and Develop Strategies for Problem Loans Set off any claim against the debtor for debt that existed prior to filing. DIMENSION 7 - 46 NOTES: FAILURE TO NEGOTIATE IN GOOD FAITH Many lenders send letters to customers representing that they would lend certain amounts at a certain rate for a certain period of time (basically a commitment letter) subject to certain factors. These factors could include: Financial statements and other information to be provided by management. Collateral requirements. Appraisals. Proof of corporate existence. Negotiated terms in the loan agreements. The lender feels protected from a final commitment by language that typically states that the loan “will be at the lender’s sole discretion” or the loan will be “contingent upon the lender’s satisfaction with the company’s response and the execution of acceptable documents.” COMMITMENT LETTER RISK The problem with commitment letters is that, in a dispute, a court must judge (frequently in the absence of any further information) whether your decision not to fund a loan was based on evidence that is clear. CRC US Body of Knowledge For example, courts have found that when a borrower refused to execute the lender’s loan documents, it was because they contained clauses that were not included in the commitment letter and that the lender should have known would be unacceptable to the borrower. Even though the commitment letter included such a statement, as “borrower will execute documents in a form acceptable to the lender,” the court could decide that the lender did not negotiate the additional terms in good faith. Unacceptable terms include standard clauses such as waiver of jury trials, confessions of judgment, and exclusive jurisdiction. PROTECTING THE FINANCIAL INSTITUTION You can protect your financial institution in several ways. If you don’t intend to commit, don’t send a commitment letter. If you send a commitment letter, have it drafted or reviewed by your legal counsel and include as many of the loan documents, including clear definitions of terms and conditions, as are available. DIMENSION 7 - 47 COMMENTS Disputes over what was said between the two parties can cause lender liability suits to occur. Whenever you meet with the borrower, have another representative of your financial institution with you and document what transpired for the credit file. NOTES: INTERFERENCE/CONTROL RISK This risk arises when you interfere with or control a borrower’s business to the extent that you dominate the borrower and misuse that control for your own purpose, i.e., repayment of your loan. A court may hold you liable for any damages that result to the borrower or any third parties. PROTECTING THE FINANCIAL INSTITUTION To avoid interference/control risk, do not: Serve or have another employee of your financial institution serve on the borrower’s board. Exert or appear to exert pressure on the borrower’s board. Involve yourself in the selection of the company’s management or a consultant to management. Involve yourself in the direction or development of the firm’s strategic or tactical plans. Make suggestions to management as to which of the firm’s checks should be honored or returned. Module 7 // Identify and Develop Strategies for Problem Loans Attend or solicit others to attend the borrower’s board meeting on your behalf. DIMENSION 7 - 48 NOTES: FAILING OR REFUSING TO LEND Many lenders provide discretionary lines of credit to borrowers with a demand note evidencing an obligation to repay advances. Under these credit facilities, the lender reserves the right, at its sole discretion, to refuse to make any advances. The lender is not required to have a reason for the refusal to lend. When it refuses to lend, however, the borrower may claim that the lender did not act in good faith. FAILING-OR-REFUSING-TO-LEND RISK Typically, problems with discretionary line of credit agreements are few if everyone understands the contract. Lenders get into trouble when they make statements to the borrower that go beyond the written documents. For example, indicating, “Although the documents state that the line is available at the lender’s discretion, all things being equal, we would expect to honor your request for advances,” exposes the lender to possible future litigation. PROTECTING THE FINANCIAL INSTITUTION To avoid failing-or-refusing-to-lend risk: Have all agreements and amendments relating to the loan and security in writing and signed by all parties. Keep a written record of all the borrower’s defaults and related conversations. Limit credit file comments to factual matters. In litigation, all written materials are subject to discovery. Provide the borrower with written notification of an event of default. Include any actions you plan to take. CRC US Body of Knowledge If you are waiving this event, indicate that you are waiving this event only, and that any other default, whether the same or some other, will be dealt with as it occurs. Consult with senior management and/or your legal counsel, before refusing to fund or calling a loan. Notify the borrower, in writing, if you are contemplating calling a loan or intend to make a substantive change in the way you deal with the borrower. Your prior course of dealing with the borrower may limit your ability to make changes. Allow time for the borrower to seek alternative arrangements. Failure to do so will enhance the possibility of legal action. Have the letter relating to this action reviewed by your legal counsel. DIMENSION 7 - 49 IMPROPER ACCELERATION OR FORECLOSURE NOTES: When a lender takes action against a borrower, either by accelerating a loan or taking possession of collateral, it is an extremely serious event. Even if the loan is in default, this event may result in legal actions against the lender. A court might find that the lender had acted in bad faith. IMPROPER ACCELERATION OR FORECLOSURE RISK If you continually accept delayed payments from a borrower, you may be deemed to have, by your course of dealing, modified the terms of the loan agreement. You will lose the right to accelerate in the future based on delayed payments with that borrower. You must give adequate notice to a borrower before you can call a loan in default. You can then take possession of collateral if the problem is not resolved. This rule may apply even if you have a loan agreement in place that says that notice is not required. Always consult with your legal counsel before you demand payment on a loan. Module 7 // Identify and Develop Strategies for Problem Loans PROTECTING THE LENDER DIMENSION 7 - 50 NOTES: THE EXCHANGE OF CREDIT INFORMATION Financial Institutions exchange credit information on a regular basis with their borrowers’ customers or other third parties. To facilitate the exchange of information, The Risk Management Association, the national association of credit professionals, was founded. One of its original purposes was to standardize the exchange of credit information. Despite this standardization, many lenders are giving credit information about their customers that could expose their lenders to potential liability. EXCHANGE OF CREDIT INFORMATION RISK Your financial institution may incur liability if an individual responding to a credit information request makes representations or omissions of material facts that are false at the time. The institution may also have liability if the person does not exercise reasonable care and diligence to see that the information is accurate. The plaintiff would have to prove the following: Misrepresentation or omission of fact that is material or significant. Failure to exercise that degree of diligence and expertise the public expects of reasonably competent financial institution representatives. Reasonable reliance by the plaintiff on the institution’s misrepresentation or omission. Damages incurred as a direct and proximate result of such reasonable reliance. PROTECTING THE FINANCIAL INSTITUTION CRC US Body of Knowledge To limit the possibility for litigation in this area: Consult a Lender’s Guide to Commercial Credit Information Exchange (available in the Credit and Lending Studies Pack Credit Information Exchange). Refer all credit inquiries to a central group or single individual that can assure consistency and standardization. Make a record of who called or wrote requesting information, when the contact occurred, what was asked, and finally, how the financial institution responded. Be sensitive to the implied agreement that exists between you and your borrowers regarding confidentiality. Get an agreement from your borrower that you can release information to those who appear to have a legitimate business reason for inquiring. DIMENSION 7 - 51 BREACH OF FIDUCIARY DUTY Borrowers have not often raised this claim successfully. They are generally required to prove that the individual handling their account was perceived to have knowledge superior to that of the borrower and used that knowledge to pressure the borrower to make decisions that benefited the lender to the detriment of the borrower. NOTES: Module 7 // Identify and Develop Strategies for Problem Loans Example: The president of a small financial institution in an agricultural community was asked to approve a loan to a local cattleman. The president said he was sure the cattleman’s ranching activities would improve if he would purchase a registered bull owned by the president. The bull was purchased and the loan was made. If the bank had to sue to collect the loan, the cattleman could counter with a claim that the president had breached his fiduciary duty.