Debt Workouts, Loan Modifications and Foreclosure
A transactional attorney is a risk manager. He or she structures transactions to avoid risks. When client defaults on a loan, the attorney plays a different, but related role – the crisis manager. The role of the crisis manager is not to avoid risk, but to mitigate and handle the fallout when the risk materializes.
Before discussing the role of the crisis manager, two obvious, but often forgotten points must be emphasized. First, if you or your company borrow money, you must repay the money, plus interest. Period. Second, if you do not repay the money when due, your creditor may foreclose its security and (depending on the state and the type of collateral involved) it may sue the borrower and/or any guarantors for the balance due.
These are the rights of your creditor. Your creditor generally has no obligation to “workout” your loan or to offer you a loan modification. If your creditor is going to accept a loan modification or agree to a loan workout, it must be in its best interests to do so. We have developed a process which increases (through positive and negative leverage) the chance your lender will see a loan workout as being in its best interest.
The process we have developed focuses on understanding your options and then developing legal, business and tax strategies to achieve the “best” outcome possible.
The first thing we will do is explain your options. Your options will depend on a number of factors, including, the nature of the loan (recourse or non-recourse; secured or unsecured), the nature, type and value of the security, the presence of and collectability of any guarantees, and the presence of any unique contractual, statutory or tort defenses that may be available.
Second, we will work with you to formulate a joint legal, business and tax strategy. The legal strategy operates as the proverbial“stick” and will include any claims, defenses and other legal steps such as an injunction or bankruptcy proceedings that we can employ to stop or delay the creditor’s enforcement proceedings. The goal of the legal strategy is to apply leverage to get the creditor to the negotiating table.
The business strategy operates as the proverbial “carrot.” Your business strategy will depend on your unique facts and circumstances, but generally involves presenting the creditor with (1) a plan to raise additional capital (e.g., raising equity capital, new debt financing, sales of company assets or interests in the company), and (2) a modified loan proposal that the borrower is capable of adhering to.
The tax strategy addresses the often significant tax consequences of a loan workout or foreclosure. If your loan balance is reduced or if your property is foreclosed upon you will receive a Form 1099 courtesy of your creditor showing that you “realized” income – often a
significant amount of income. This is often referred to as “cancellation of debt” income and it often comes a shock to many individuals. Tax planning in connection with distressed debt is
very complicated, but we understand the issues and will incorporate tax planning into your legal and business workout strategy with the goal of avoiding, reducing or deferring as much “income” as possible.
Finally, time is of the essence and your legal, business and tax options diminish the longer you wait to address the situation. The best time to take action is before you default.