Deal Modification Made Easy: Three Tools to Help Avoid Grief in Factoring Agreements
Covering your bases in documentation can go a long way in avoiding any possible trouble down the line. Steven N. Kurtz explains how side letters, amendments and waivers or forbearance agreements can help minimize confusion and document all pertinent information to help factors avoid potential disputes.
BY STEVEN N. KURTZ, ESQ., LEVINSON ARSHONSKY & KURTZ, LLP
We operate in an industry where things move fast. Frequently, factors are called upon to make important decisions on the fly. These decisions can range from changing an advance rate, making an over-advance or working through a sudden and unexpected problem. Important and large dollar decisions are often evidenced by cryptic text messages, which often don’t make sense when reviewed by a stranger to the conversation, and if litigated, you can be assured your version will be the polar opposite of what your factor client or borrower says.
When things don’t get documented, you are in danger of the other side testifying to something opposite of what you intended, opening the door for a court to hear a “course of dealing” testimony, or even worse, a court ruling that there has been a modification to the agreement completed by performance. Thus, it is obviously critical you document what is happening in real-time. The three tools you can utilize to document your modifications are a side letter, an amendment and a waiver or forbearance agreement.
Agreement Foundations
Before we discuss the forms of documenting your modifications, it is important to understand the foundations of your agreements that exist for your protection. All factors and many asset-based lenders operate with discretionary financing facilities. This means a factor or asset-based lender can refuse to fund for any reason. While they are in the business of putting out money and collecting it all back plus fees and interest, the discretionary feature is a safety valve which factors and asset-based lenders can rely upon for not advancing. Most factors likely have something in their agreements allowing them to adjust the advance rate up or down by their discretion. This feature is important because it allows factors to be flexible on the fly. Advancing at a lower percentage of the eligible account can help a factor catch up and hopefully get its facility into formula.
Factoring agreements also contain an integration clause, most likely found in the boilerplate terms. This means all prior negotiations which are not contained in an agreement are of no force, the contract contains the entire agreement and no proposed changes to the agreement become operative until signed by all parties. A strong integration clause is essential. The Uniform Commercial Code allows parties to set forth standards of commercial reasonableness in agreements. Often, the standards of commercial reasonableness, which govern things like collections and liquidations, may require a factor client or borrower to inform a factor in writing of any issues which violate the standards of commercial reasonableness. Many reading this may have a private statute of limitations provision in their agreements which provides that any action against them must be commenced within a short time after the event took place. These things in factorings agreements, as well as some others, exist for a factor’s protection in the event something does not go as planned.
Side Letters
Although there are fewer actual paper letters these days, the purpose of the side letter is to document something that does not rise to the level of an actual amendment in writing. For example, there might be a condition to closing a transaction that does not happen when planned, but the parties will still want to close and allow for the event to happen at a later, post-closing date. This is often documented in a side letter. Another example may involve a concentration limit or dollar exposure limit for a particular account debtor, but because things are going well and the client has a solid opportunity, a factor may allow for a variance on the concentration or credit limit in order to allow for a large order. This situation would also be a candidate for a side letter. The purpose of the side letter is to put what you want in writing and have it signed off by the parties and guarantors. This avoids a pattern of waiving provisions in agreements, without a writing, which in a problem, can result in a factor client or borrower forming a recollection not consistent with reality. A good side letter can come in handy from time to time.
An Amendment
When something rises to the level of a change in a provision in the agreement, then the modification must be documented in the amendment. All amendments should be numbered sequentially and must spell out exactly what is being done. The amendment should contain statements reporting every representation and warranty in the agreement are in full force, the agreements are enforceable according to their terms and the terms are to be signed off by all guarantors.
If the amendment is a major change in the agreement, or if it takes the credit limit up significantly, it would be helpful to get a release. Most amendments do not ask for releases, but it is always nice to have one when possible. Releases are good for when things go wrong and a factor client or borrower tries to raise defenses. A good and straightforward release can quash that problem. Because amendments usually happen when things are positive and the factor or lender is not thinking about a release, a well-drafted amendment without a release can still take away claims from the other side if something goes wrong later, provided the amendment is drafted correctly.
Waiver or Forbearance Agreements
Not all changes to an agreement are agreeable changes. Things invariably can and do go wrong. Frequently, something happened with the client or borrower, putting the deal in a default. Provided there is no fraud or bad conduct by the client or borrower, and the factor is confident the problem can be resolved, not all defaults require going into liquidation mode. The key is to know which defaults require a liquidation and which defaults can be favorably resolved. However, if a factor elects to stay in a deal when things go wrong, the documentation is handled by either a waiver agreement or forbearance agreement. These are not necessarily the same thing and it’s best to ask counsel how to proceed with the documentation at this stage.
A waiver agreement acknowledges there is an event of default and states a factor will not enforce the default, provided certain conditions occur within a time frame. The waiver will contain acknowledgments that the agreement is enforceable according to the terms, acknowledge the default provided there are no defenses to enforcement and contain a comprehensive one-way release. The document will be signed off by all guarantors. If any further events of default happen, then, of course, the factor has all of its rights.
A waiver agreement, in my opinion, is used for defaults, but it is usually less serious than a forbearance agreement. A forbearance agreement contains the same acknowledgements and release provisions as a waiver agreement, but it usually contains a time frame in which to cure the defaults, including multiple conditions and consequences if the defaults are not cured in a timely manner. There are certain UCC waivers which are only enforceable after default, including rights to notice of a foreclosure sale, the right to redeem the collateral and the time limits in which to dispose of collateral once in the secure party’s possession. These waivers should be in the forbearance and waiver agreements. Once a default happens, a factor will have to check many things and should fix any problems in documentation.
When things go wrong, clients and borrowers do and say some crazy stuff. There are also some cases which have eroded the parole evidence rule, allowing an external party to explain a document. Because of this, it is imperative factors maintain a good paper trail which evidences what has happened and puts the understanding in writing as part of the written record and the agreement. Taking the time early on to create the written evidence trail can save grief later down the line.
Steven N. Kurtz, Esq. has represented factors, banks and asset-based lenders on a continuous basis since 1987. He is the co-general counsel to the IFA and a founding partner of Levinson Arshonsky & Kurtz, which has offices in California and Oklahoma. He practices in the areas of commercial law, insolvency, workouts, loan documentation and trade finance, in both transactions and litigation matters. He can be reached by phone at 818-382-3434 or by email at skurtz@laklawyers.com.