In response to the surge in lender-liability claims against mortgage lenders commencing in the mid-1980s -- especially in connection with affirmative claims or defenses of borrowers based on breach of an alleged oral agreement to extend, modify or refinance an existing loan, to forgive debt, or to forbear from exercising contractual remedies such as foreclosure and rental assignments, many commercial mortgage lenders began requiring borrowers to execute pre-workout agreements before agreeing to engage in workout discussions.
Both federal and state courts have upheld the validity and enforceability of a carefully drafted pre-workout agreement (also often referred to as a pre-negotiation agreement; the document will hereafter be referred to as a “pre-workout agreement” in this article) that explicitly disclaims any modification or amendment of the existing mortgage loan documents or any intention to modify or amend any such loan documents, absent a final written agreement executed by the parties. Such agreements are intended to protect the lender from any claims by the borrower based on equitable theories such as reliance, waiver, estoppel, oral modification, or breach of the duty of good faith and fair dealing. This article will examine the case law in this area and provide sample documents to hopefully assist in the drafting and enforcement of such agreements.
There are only a relative handful of court decisions that have dealt with the issue of the enforceability of a pre-workout agreement; most likely because the chances of successfully challenging a well-drafted pre-workout agreement signed by the borrower are slim. For example, in Travelers Ins. Co. v. Corporex Properties, Inc., 798 F. Supp. 423 (E.D. Ky. 1992), the court, in a case of first impression, expressly upheld a pre-workout agreement entered into by The Travelers Insurance Company ("Travelers") and the borrower in connection with a proposed negotiated workout of a $6.4 million nonrecourse commercial mortgage loan on an office building in Covington, Kentucky. The borrower stopped making payments on the loan on October 1, 1990, and the parties executed a pre-workout agreement on January 10, 1991. The pre-workout agreement specifically stated, among other things, that Travelers' agreement to enter into negotiations for a workout of the loan was without waiver of any of its rights under the loan documents.
The negotiations subsequently failed, and Travelers filed a foreclosure action on July 12, 1991. The borrower claimed that Travelers had waived its right to foreclose because of its acceptance of partial payments of interest after the borrower's default, and argued that Travelers "was under an obligation to reach an agreement on the terms of a workout" (although the borrower cited no case authority for such an obligation). The borrower also argued that the equitable theories of waiver, estoppel, and inequitable conduct applied in connection with the workout discussions.
The court held in favor of Travelers and stated that the cases cited by the borrower were inapposite because of the existence of the pre-workout agreement signed by the parties (which the court quoted verbatim in its opinion), which provided that Travelers was not waiving any of its legal rights by agreeing to attempt to negotiate a workout. The court also noted that “It is not ‘inequitable’ or a breach of good faith and fair dealing in a commercial setting for one party to act according to the express terms of a contract for which it bargained.” Id. at 425.
The court further noted that Travelers had sent a letter from its in-house counsel to the borrower after the receipt of each partial payment, acknowledging such receipt but expressly reserving all of its legal rights and remedies. The borrower's attorney even expressly acknowledged Travelers' non-waiver in a letter accompanying one of the partial payments from the borrower. The court also was impressed by the fact that, at a meeting of the parties on July 18, 1991, the borrower executed a letter reaffirming that the pre-workout agreement executed by the parties on January 10, 1991 would continue to apply to all subsequent discussions between the parties.
Because the borrower in Corporex had conveyed the mortgaged property during the negotiation discussions to a corporation controlled by the borrower in violation of the due-on-sale clause in the mortgage, to better position the borrower for a "new debtor" bankruptcy, to avoid negative publicity, and to put the borrower -- in its own words -- "in a better position to negotiate on an even basis," the court, in an unusual form of relief awarded to Travelers, ordered a reconveyance of the property to the borrower. The borrower appealed the court's decision to the U.S. Sixth Circuit Court of Appeals based solely on the court's order of reconveyance, but Travelers and the borrower subsequently reached a settlement providing for conveyance of the property to Travelers by a deed in lieu of foreclosure, and the appeal was dismissed with prejudice.
Numerous other courts have upheld the validity and enforceability of pre-workout agreements. See, e.g., 51382 Gratiot Avenue Holdings, LLC v. Chesterfield Dev. Co., 835 F.Supp. 2d 384, 402 (E.D. Mich., 2011) (noting that defendant’ borrower’s equitable counterclaims against plaintiff lender were likely to fail because “Defendants executed a Prenegotiation Agreement with Plaintiff . . . acknowledging that they held no claims against Plaintiff based on the Loan Agreement.”); Livonia Props. Holdings, LLC v. 12840-12976 Farmington Road Holdings, LLC, 399 F. App’x 97, 103 (6th Cir. 2010) (stating that lender “would likely have valid equitable defenses of estoppel and laches” against borrower’s challenge to assignment of loan agreement because borrower “expressly acknowledge[d] that [t]he Loan Documents are in full force and effect and are binding on the Borrower in accordance with their terms” in the pre-negotiation agreement executed by the parties); SMA Portfolio Owner, LLC v. Corporex Realty & Inv., LLC, 112 F. Supp. 3d 555, 573 (E.D. Ky. 2015), aff'd sub nom. Bank of Am., N.A. v. Corporex Realty & Inv. Corp., No. 15-5698, 2016 WL 4376434 (6th Cir. Aug. 17, 2016) (holding that based on pre-negotiation agreement executed by the parties, “the evidence at best supports a finding that [Bank of America] was unwilling to reach an agreement to modify the loans unless it was on its own terms—a position [Bank of America] was permitted to take”).
Although pre-workout agreements are generally enforceable, such agreements should be drafted to comply with general principles of contract formation and enforcement, including adequate consideration. For example, the borrower may argue that no consideration for the agreement exists because the lender has given up nothing in return for the borrower’s acknowledgement of default and waiver of lender-liability defenses. But forbearance to take action to which a party is legally entitled is generally recognized as consideration and this should be stated in the pre-workout agreement, and perhaps a nominal monetary consideration such as $10 should be included. See, e.g., SMA Portfolio Owner, LLC v. Corporex Realty & Inv., LLC, supra, 112 F. Supp. 3d at 566–67 (rejecting borrower’s argument that no consideration existed for pre-workout agreement because it did not require lender to discuss loan modification or release known claim; court held that consideration existed because lender agreed to delay foreclosure and also released borrower from all future claims based on loan communications; court ruled that “[a]s long as a party has a good faith belief that it is giving up a claim, the relinquishment constitutes valid consideration”).
