To Forbear or Sue: An Easy Decision for Creditors

Creditors are frequently confronted with the quandary of either suing a debtor immediately, or offering to forbear from taking legal action, thus allowing the debtor some time to continue working with the creditor to resolve the debt. While one could argue that filing suit is the fastest way to a conclusion, I believe there is a compelling case for offering forbearance first.

It is important to note that when the decision is forbearance, the creditor should provide an agreement for the debtor to sign that formalizes and memorializes the time period and conditions of the forbearance. Because the Illinois Credit Agreements Act (and similar statutes in other states) negates financial contract terms that are strictly verbal, it is critical that any forbearance agreement be formalized.

Why Forbear?

The first argument for a forbearance is the “human judge factor.” In other words, judges are people first, and people like for other people to get along. If the creditor is hard on the debtor when a default first occurs and the judge perceives ill will, then it will likely be the judge who first strikes the debtor with a blow of compassion. This compassion on the part of the judge—who runs his or her own docket and determines when events occur—could mean at least one setback for the creditor and perhaps several delays in the litigation process. That is not to say that judges are failing to meet their requirements under the law. To the contrary, a judge’s discretion is an important part of his or her job description. It is in our best interest for members of the judiciary to show patience and compassion to the people who appear before them, as we may someday be one of those people.

The second argument for forbearance is what I call “one step back equals three steps ahead.” When a creditor files a suit against a debtor, say, on a breach of contract, the creditor is one step ahead. In other words, the creditor started the action by filing suit. The next step in the process is for the debtor to file an answer or other type of response. Once that response is filed, the creditor is no longer one step ahead. The parties in that suit are now involved in litigation, with the ending point of that litigation being uncertain.

In order to get two steps ahead in litigation, a creditor must (prior to filing suit) make sure that the contracts entered into between the debtor and creditor are free from error and that, where appropriate, the creditor has perfected its security interests properly and, in any case, documented the debtor’s defaults and damages. By taking these measures, the creditor may be able to end the litigation quickly by showing the judge that the required elements for a summary judgment are present. A “summary judgment” is when a judge determines, upon review of the complaint filed by the creditor and response filed by the debtor, that no discovery or trial is necessary because there are no issues of fact or law that would prevent the court from entering judgment, and no discovery or trial would change the outcome. By being two steps ahead, a creditor knows that it can prove the debtor’s defaults and the amount of damages the creditor is owed.

But what happens when a debtor raises legal and equitable defenses that do not appear to be present on the face of the plaintiff’s documents? For instance, what if the debtor raises the defense that the creditor agreed it would not file suit for eight months if the debtor put a certain amount of his or her own money into a project? If the creditor still filed suit, then the debtor would raise the affirmative defense of promissory estoppel. “Promissory estoppel” is, in its most general form, a defense that says “to my own detriment, I did things in reliance upon your promise to do or not do something.” In our example, the debtor put its own money into a project, on the creditor’s promise not to sue for eight months. It was to the debtor’s detriment because he or she didn’t get the benefit of the eight months and is out the invested money. In addition to promissory estoppel, there are many other types of affirmative defenses a debtor may raise—depending on the facts and circumstances of the relationship that existed between the creditor and debtor—to partially or completely avoid liability or damages.

But here’s the most important thing for creditors to take away from this article. Affirmative defenses and other defenses and claims can be contractually waived. Therefore, if a creditor is able to obtain the debtor’s waiver of all claims and defenses, then the creditor has now achieved a three-steps-ahead advantage over the debtor in a four- or five-step race (step four being obtaining judgment and step five being turning that judgment into money). In order to obtain a written waiver of claims and defenses from a debtor, the creditor needs to offer a loan modification, forbearance, or other form of contract that provides legal consideration from both sides. The creditor must provide the debtor with some financial accommodation (usually extra time) and the debtor must provide the creditor with some assurances, terms for repayment and a waiver of claims and defenses. In other words, with the creditor’s inclusion of the waiver of claims and defenses provision, the creditor is saying to the debtor: “I will give you a break, but I don’t want you to turn around and sue me or claim that you don’t owe me anything.” The document evidencing the forbearance may be called many different things, but the essence is usually the same. The most important aspects of this forbearance are that (1) it must be in writing, signed by both parties, and (2) other provisions of the agreement are not so onerous or against public policy that they make the entire document void.

By offering and obtaining a written and duly executed forbearance agreement, the creditor can be assured that it has provided the debtor with a financial accommodation with impunity, and that the debtor will not be able to come back to defeat the creditor’s claims for damages when it finds it must sue the debtor to collect the debt.

Recent Illinois Example

An Illinois example that illustrates the benefits of pausing, working with debtors and obtaining claim and defense waivers is the “Block 37” case, which was decided March 31, 2010 by the Appellate Court of Illinois. That case involved Bank of America (as successor to LaSalle Bank) and 108 N. State Retail LLC, the developer of a retail complex (known as Block 37) in Chicago’s Loop. The bank worked with the developer through 23 separate letter agreements, whereby the bank would fund when the developer met certain conditions. In the context of that agreement, the developer waived claims and defenses. With the bank’s offer and extension of at least 23 different loan modifications, one could argue that the creditor-bank worked too much with the developer. The developer lost the case, primarily because it waived all of its defenses and claims within those loan modification letters. The case, then, illustrates that there is value for the creditor in working with the debtor, and that value is primarily for the creditor to obtain a waiver of claims and defenses.

Can a creditor obtain a waiver of claims and defenses without providing anything to the debtor in return? Like any other contract, there must be legal consideration (i.e., a thing of value) in order for there to be a valid contract between parties that have agreed on terms. Therefore, the only way to obtain a debtor’s waiver of claims and defenses to a contract that already exists is for the creditor to provide some legal consideration to the debtor in exchange for something of value (i.e., its claims and defenses relative to the existing contract). Under Illinois law (and in most other states), a party may contractually agree to waive all defenses.

Why is it important to have a waiver? Usually, when a defendant asserts affirmative defenses (i.e., defenses used to defeat a plaintiff’s claim of liability or damages, in whole or in part), the plaintiff must answer those affirmative defenses in a timely manner. If the plaintiff’s response is not timely, the affirmative defense is deemed admitted. Even if the plaintiff responds in a timely manner, affirmative defense can create issues of fact that may drag out the proceedings. Such affirmative defenses may prevent the plaintiff from obtaining summary judgment. However, if the plaintiff has first obtained a valid waiver of defenses, and the defendant raises affirmative defenses, the plaintiff need not file an answer. Instead, the plaintiff need only file a motion to dismiss, alleging that the defendant contractually agreed to waive all of its defenses and claims.

Although a creditor can incorporate waivers of claims and defenses into a contract at its inception, this approach does not effectively address acts, statements or omissions on the part of the creditor that post-date the contract. That is to say, once the contract is under way and the creditor does something (real or imagined) in violation of the contract, the existing waiver and release provisions may not, most effectively, protect the creditor. Only a waiver and release that post-dates any perceived breach by the creditor will effectively and persuasively release the creditor and allow it to shed unwanted affirmative defenses that a debtor may assert in response to a complaint to enforce the creditor’s rights and remedies.

Letter agreements, loan modifications, forbearance agreements, revised vendor credit terms or any other written and formalized accommodation that the creditor extends to the debtor stands as sufficient consideration for a waiver of claims and defenses. It is important, however, for the waiver of claims and defenses to be memorialized and signed by the debtor (and any guarantor). Getting the debtor to agree to sign such a document may require some hard bargaining on the part of the creditor. However, keep in mind that Illinois law and its courts allow creditors to threaten legal action or other enforcement remedies provided by the original contract. Only threats that are legally or morally wrongful may render a contractual term invalid as being the result of duress. Threats of proper legal action are deemed just “hard bargaining” by the courts of Illinois, and that is something that may be pointed out to debtors and their counsel during the negotiation process.

Giving up time, conceding on interest or default rates, and forgiving credit term defaults are just a few classic examples of actions a creditor can take to obtain a waiver of claims and defenses. This may be extremely valuable when the original contract is weak on or completely devoid of waivers of claims and defenses. Or, it may be of equal value if the creditor’s “relationship manager,” the person responsible for the relationship with the debtor, engaged in activities that may have made good business sense at the time, but ultimately exposed the creditor to some unnecessary claims or defense, like the promissory estoppel example illustrated above.

The Final Analysis

What is the upshot for creditors? Filing suit immediately without (1) working with the debtor for some period of time, and (2) obtaining a waiver of claims and defenses will likely result in increased litigation time and expense. In fact, the debtor may be able to create a complete defense to the creditor’s claims, resulting in compounding losses. Furthermore, the creditor will have lost considerable time and money, and will have nothing at the end of the litigation to show for it. Of course, if a debtor is not responsive or unwilling to work with the creditor, then the creditor is left with little choice but to sue.

While it may seem like a waste of time and money, pausing on the front end to allow the parties to work together, and granting some financial accommodation in order to obtain a waiver of claims and defenses allows the creditor to effectively leverage itself—with a little hard bargaining—into a position where virtually nothing is left to chance. This forbearance period will put the creditor in good stead with the court’s equitable conscience, and will prevent the debtor from raising claims and defenses that will, at a minimum, make the litigation more lengthy and costly.

The approach that at first blush appears to be the slow, plodding tortoise often turns out to be the hare that finishes best, and first.

This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.

Kurt M CarlsonKurt M. Carlson | Creditors’ Rights, Insolvency & Bankruptcy Litigation & Resolution

Kurt’s practice concentrates on representing creditors, assignees and businesses of all sizes in a variety of ways, including complex business litigation, workouts, insolvency proceedings, bankruptcy reorganization cases and complex settlement negotiations. Kurt has extensive experience in a broad range of quasi-business and legal issues companies must address. If you need assistance with a related matter, contact Kurt.