What is a Loan Workout?

A loan workout is an agreement between a lender and a delinquent borrower to put the borrower’s loan payments back on track and/or to avoid foreclosure.

A loan workout can involve a variety of adjustments to the original loan agreement, such as

• spreading the payments over a longer period of time,
• writing off part of the loan balance,
• reducing the interest rate,
• a short sale;
• deed in lieu of foreclosure; and
• so forth.

The lender has an interest in allowing these adjustments, since the alternative may be the foreclosure on real property the lender does not want, bankruptcy of the borrower or the complete nonpayment of the loan, which will require the lender to engage in expensive foreclosure activities.In summary, a loan workout is acceptable for the lender when it is the most cost-effective option available.

“Workout” Broadly Defined

At the origination of a commercial loan secured by real property, the borrower and lender are generally focused on the negotiation of terms and conditions that will maximize their profits from the real property and loan, respectively.

As long as market conditions remain basically consistent with the borrower’s statement of assets and liabilities and the lender’s underwriting, the borrower and lender may have no reason to discuss the loan after the closing.

However, significant unanticipated declines in commercial real property values or credit market conditions may force the borrower and lender to revisit the terms and conditions of the original loan to respond to these unforeseen circumstances and seek to prevent or minimize losses. The legal and financial issues to consider usually go far beyond the potential impact of California’s foreclosure statutes.

In this context, the term “workout” is used to refer broadly to any predefault or postdefault negotiations or consensual actions that are undertaken by the parties to the loan to avoid an imminent default or to resolve a default or other problem between the parties without the borrower instituting bankruptcy proceedings.

Realistically, many loan workouts are negotiated in the context of a potential or impending borrower bankruptcy.

A workout might be consensual, such as an agreement between the lender and the borrower to refinance or modify the existing loan or the lender’s acceptance of a deed in lieu of foreclosure from the borrower, or a workout might be negotiated to resolve imminent or pending litigation between the parties to the loan. For example, the lender may decide to initiate foreclosure; the borrower might institute a court action against the lender; or the lender, the borrower, or both may bring actions against third parties connected with the distressed project or property.

A closely related transaction is a short sale, which a borrower might use to avert foreclosure by selling the property on the open market with the lender’s consent for a price that is less than the amount owing on the loan.  Sometimes, the lender will not enter into a loan modification with the borrower but may agree to a short sale.

In advising the lender or the borrower on the workout of a problem loan, you must be familiar with the basic tools of workouts. Generally, these are not only the relevant facts and circumstances, the loan file, and applicable law but are also the evaluations, analyses, and forecasts that the parties and their consultants may use to assess the situation and formulate the means to cope with the financial and other problems of the borrower or the borrower’s project.

TIP: Before beginning the task of formulating a workout strategy, you should first consider some basic questions.

• Is a workout consistent with your business goals?
• Are the problems facing the borrower and its project capable of being solved in this manner?
• Are the possible workout strategies that may be considered viable in light of other known constraints facing the lender or the borrower?
• Are the lender’s or borrower’s goals more realistically achievable through foreclosure, litigation, bankruptcy, or other means?