A pre-negotiation is a simple contract that the borrower and lender sign before starting substantive discussions over a troubled credit relationship. Pre-negotiation agreements can be more or less comprehensive, depending on the complexity of the credit relationship. For simple loan modifications they are often in the form of a simple letter, countersigned by the borrower. However they are structured, though, the lender benefits in two important ways: (1) The pre-negotiation agreement helps protect the lender from claims that a binding agreement was reached when it hasn’t been; and (2) it communicates to the borrower the seriousness of the situation and can help modulate the borrower’s expectations of the work-out or loan-modification process.
To download my standard form of Pre-Negotiation Agreement for commercial loan workouts CLICK HERE.
Whether simple or complex (and my preference leans towards simplicity) the pre-negotiation agreement should include at least the following features:
An Admission of Current Defaults. The borrower needs to ‘fess-up that he is presently in default and therefore the parties are going to try and work things out without enforcement proceedings.
Affirmation of Current Loan Covenants. As a condition of negotiations, the lender should require the borrower to affirm the continued validity of the existing loan documents. This assures the lender that it is not waiving any rights by negotiating, and that the borrower cannot later assert that the lender had made any pre-default waivers.
All Negotiations Are Inadmissible Settlement Discussions. Under the Federal Rules of Evidence and its state law analogs, the substance of settlement negotiations are generally inadmissible. If the matter is apt to attract the attention of the press, the lender may wish to include a non-disclosure covenant, particularly where third parties might benefit from knowing the lender’s negotiating strategy in the case at hand.
Nothing is Agreed Until a Definitive Agreement is Signed. This is vital. The borrower agrees going into the negotiation that it’s all just so much pleasant conversation until a final, definitive writing is signed by the parties: Any writings short of that – correspondence and emails, term sheets, etc. – will not bind the parties to anything. The pre-negotiation agreement should plainly state that neither party can rely on any discussions, term sheets or correspondence outside of a formal, final contract modifying the existing loan documents. This provision allows the bank to safely (or at least, more safely) discuss various work-out options and proposals without having to worry about a borrower later claiming that those incomplete, undocumented discussions somehow became a binding agreement modifying the loan.
An Outline of the Approval Process. The pre-negotiation agreement should identify the individuals who are authorized to negotiate for the borrower and the lender, and should contain a description of the bank’s internal approval process for modifying the loan. Bank personnel responsible for the credit can change over time, especially where the relationship has not been troubled, and you want to be sure that the borrower is clear about the bank representative they should be dealing with. By the same token, where the borrower's business is in trouble there can be disagreements in the borrower's control group, so the bank should be interested in a single point of contact who is authorized to bind the borrower.
Waiver of Claims Against Lender. Finally, the pre-negotiation agreement should contain a broad release of the lender for any defaults under the existing loan documents. If the borrower has no such claims against the lender, then she shouldn’t resist signing such release provisions. If, on the other hand, the borrower intends to assert claims against the lender, it is important to know that before embarking on comprehensive settlement negotiations.
A well-crafted pre-negotiation agreement with these terms will enable the lender to more freely negotiate a mutually agreed upon loan modification.
This post was written by attorney Rick L. Knuth
*This article was published in the Winter 2013 edition of Utah Banker Magazine