Who Owns Your Loan?

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A Forbearance Agreement Can Help

Entrepreneurs should move quickly to work out a deal with their new creditor. Typically, that means a forbearance agreement, in which the business owner makes a concession—perhaps by pledging additional collateral—in exchange for lenience on the part of the lender.

Tom Hendrickson, president and owner of Monticello (Ark.)-based furniture maker L&P Industries, visited his new lender as soon as he heard that his company's $850,000 loan had been sold to a Warren (Ohio) company called Landmark America. L&P was current on loan payments, but the 40-person, $2.5 million company was in default because its ratio of cash flow to debt service had dropped too low. The loan was about to mature, and because L&P was losing money, Hendrickson knew he'd have trouble refinancing. Hendrickson laid out his turnaround plan, which focused on selling to hotels instead of retail stores. Landmark agreed to roll his loan over for three more years. W. Jeff Buskey, vice-president of operations at Landmark, says Hendrickson's "effort to come to our office improved our relationship with him and gave us a feel for the type of businessman he was."

Hendrickson didn't know what to expect when he showed up in Warren, but says Landmark has been "amazingly good to deal with." He gives Landmark monthly updates on the now-profitable business. He hopes to refinance in 2009 with a new bank loan, paying Landmark off in full.

If there's no promising turnaround plan on hand, a new debt holder will probably move quickly to foreclose. Michael Oliver, owner of Pro Electric, a 30-person electrical contractor in Gainesville, Fla., found out last fall that Wells Fargo had sold his line of credit and that it was now held by Sacramento-based National Credit Acceptance. Pro Electric had been struggling, and Oliver says he was 60 to 90 days behind on his payments when the line was sold. In a court filing, NCA claims Pro Electric owes $80,940. Oliver says he was hoping to work something out with NCA, but in December, NCA got a judgment against his company. Oliver says that in January, NCA sent trucks to his office, asking for payment and threatening to seize some of his assets. Pro Electric immediately filed for Chapter 11 bankruptcy protection, blocking the seizure. (That Chapter 11 filing has since been dismissed.) Through its attorney, KCA declined to comment for this story.

Reeling from the Downturn

In the "loan to own" scenario, loan holders use their leverage to get equity in the company, often through bankruptcy or a forbearance agreement. Case in point: Castle Precision Industries, a Sylmar (Calif.) company that makes and overhauls airplane components, found out in June 2004 that Signature Capital Partners had bought its $2.65 million bank loan from the FDIC. (The FDIC ended up with the loan after the bank that originated it failed.) At that time, Castle had about 120 employees and was still reeling from the downturn in aerospace after September 11, 2001. In 2006, when the loan came due, Castle could neither pay nor find refinancing, and entered into a forbearance agreement with Signature.

Signature contends that, thanks to that agreement, it should now own 20% of Castle. An attorney for Castle says this is not the case. In a court filing, Castle says it has paid off the loan as well as an additional $250,000, and that Signature is not entitled to shares. The two are in litigation. Says Signature's Noell: "It's not that uncommon for things to become contentious because it is frequently the case that an entrepreneur who has started a business does not want to lose control." But when negotiations go poorly, that's the least of what is at stake.

Barrett is a senior correspondent for BusinessWeek SmallBiz.