Financial Institutions and Business Lending: Creditors’ Rights
In the short time since the World Health Organization’s naming of the COVID-19 virus and its declaration of the spread of the virus as a pandemic, the social and economic systems that Americans have come to know have experienced seismic changes. For the foreseeable future, those swift changes are and will continue to affect how financial institutions and other business entities that extend credit to their customers conduct their business. It is important that those changes are met with equally swift recognition by each financial institution and business entity of how the changes are affecting their business and with the development and implementation of the appropriate business responses to those changes.
On March 13, 2020, the Federal Deposit Insurance Corporation (“FDIC”) issued a statement entitled Frequently Asked Questions for Financial Institutions Affected by the Coronavirus Disease 2019 (Referred to as COVID-19) (the “FAQ”). This statement provides significant guidance what the FDIC views as appropriate responses to both credit and operating issues arising as a result of the pandemic. The FAQ may be viewed at https://www.fdic.gov/coronavirus/index.html.
It is recommended that financial institutions review the FAQ and use it as a guideline for considering the following recommended actions: (a) the development of a plan of action to identify and address the instances in which a credit becomes non-performing as the result of the effect of COVID-19 on the borrower’s business operations and ability to service its obligations to the financial institution, (b) the review and the approval of the plan of action by the financial institution’s governing board, and (c) the implementation of the approved plan of action in a timely manner.
In this evolving landscape, an essential element of any plan of action must be the requirement of obtaining documentation on an ongoing basis that is sufficient to identify and distinguish a non-performing loan that is or would become non-performing regardless of the effects of the COVID-19 pandemic on the borrower’s ability to perform from those loans that have or will become non-performing as a direct result of the effects of the COVID-19 pandemic on the borrower’s ability to perform. This documentation should include both past and current financial information on an on-going basis and when applicable, appraisals of the current value of any assets that serve as collateral for the borrower’s obligations.
A second essential element is the preparation of and execution by each affected borrower of an agreement that sets forth the terms of any suspension of performance by the borrower and/or any forbearance by the financial institution of its rights under the loan documents. Such agreements serve at least three purposes: (i) documentation for future regulatory review of the non-performing loan, (ii) the specification of the period and terms of any suspension of the borrower’s obligations and the financial institution’s forbearance, and (iii) the acknowledgement by the borrower of the amount of indebtedness, the enforceability of loan documents, and the waiver of claims against the financial institution and defenses against the financial institution’s claims related to the loan.
Other businesses extending credit
Manufacturers, suppliers, and other businesses who sell or provide services on credit face similar issues and risks as financial institutions and a similar approach to both existing and future credit is productive in the reduction of risks. For example, the business that extends credit or sells product or services other than prepayment or C.O.D. should develop a plan of action to identify and address the customer credit that has or will become non-performing as the result of the effect of COVID-19 on the customer’s business operations and its ability to service its obligations to the business, (b) the review and the approval of the plan of action by the company’s governing board or executive committee and (c) the implementation of the approved plan of action in a timely manner.
As with financial institutions, the business extending credit should obtain current and ongoing financial information from its customers sufficient to allow the business to evaluate the credit risk of the customer and to determine whether the existing credit should be continued, modified or curtailed.
Businesses extending credit for the sale of goods should also evaluate and consider modification of the terms of any credit agreement, invoices, bills of lading and other transactional documents. Possible changes could include (i) specifying the laws of a particular jurisdiction govern the sales transaction and (ii) specifying when title to the goods transfer from seller to buyer, in order to obtain the maximum protection under the Uniform Commercial Code.
Both financial institutions and businesses extending credit should take into account the potential for one or more of their customers commencing a case under the United States Bankruptcy Code. The bankruptcy laws provide both some risks and protections to creditors. For example, section 546(c) of the Bankruptcy Code, in some circumstances, provides the right for a seller of goods to reclaim goods sold in the ordinary course of business in the 45 days before the filing of a bankruptcy petition. On the other hand, payments made within 90 days of the date of the filing of a petition may be recoverable by the debtor in a bankruptcy case, but that recovery is subject to several defenses, including providing “new value” after a payment and payments made in the ordinary course of business. Depending on the potential risk of a customer filing a bankruptcy petition, financial institutions and businesses extending credit should tailor their responses to the effects of the current crisis with those risks in mind.