MEDIATING LOAN RECOVERYS
The International Monetary Fund (IMF) reports that over four trillion dollars have been wiped out of the world's financial system as a result of the global financial crisis. A major part of these funds are leveraged i.e. borrowed moneys from financial institutions i.e. over 61% of the exposures. The effect of this loss to these financial institutions has been monumental and destabilizing. Forty-two global financial giants have so far gone under as a result of their exposures to the defaults. In fact the prevailing school of thought is that the crisis was itself a result of default in subprime loans in the United States. The scale of defaults is far reaching and the offenders are diverse ranging from individuals, to corporations and in fact Sovereign States with Iceland almost becoming bankrupt in 2008. Coming out of this debt quagmire will therefore require innovative methods as the traditional methods of loan recovery like bankruptcy, liquidation, compulsory managements, etc may be inadequate and in some cases inappropriate in dealing with the situation. For instance shutting down a factory for defaults and disposing its assets may in fact boomerang in these times because the massive loss of jobs is causing illiquidity which in itself is slowing down demand causing the factories to become redundant and thus unable to service their creditors. It is therefore in everybody's interest that the factory is open and running. Furthermore, the creditor attempting to dispose assets may discover to his chagrin that the illiquidity makes it twice as hard to get a sale even at half the price. The creditors must therefore be creative in going about recovery of funds keeping in mind the big picture.
Historically loan defaults have been viewed in an evolutionary manner. In the early days, default was viewed as a moral and legal sin and defaulters were ostracized and punished by society. Such punishments included imprisonment, slavery, physical mutilation and the death penalty. Over time, especially with the growth of corporations and complex financial transactions, credit defaults were viewed as purely legal situations and such legal sanctions as bankruptcy and liquidation became the acceptable way of treating defaults. However financial institutions learnt from sovereign defaults that legal remedies are limited in applicability as little can be done to compel repayment. Defaults were therefore viewed as business challenges to be tackled with the innovativeness of a commercial enterprise. Thus loan restructuring and arrangements became an integral part of the Credit Unit of most lenders. These could be court directed or out of court settlements. The out of court loan restructurings have come to be known as work-outs.
Given the scale of defaults in the wake of the financial crisis and the complexities involved courts in their present constitution are unlikely to cope with the challenges presented. The ball therefore seems to fall on the side of out of court or voluntary work outs. This is usually done by negotiation between the parties to the loan agreement. Where the work-out involves several creditors, it is usual to elect a committee of the creditors to represent others in negotiations. The signed agreement arising from such discussions will usually be enforceable as contract between the parties. Work-out sessions are however usually tension packed as emotions and interests usually conflict and if not managed properly, the negotiation could breakdown Example of these conflicting interests are the creditor's desire to recover full sums and interests thereon while the debtor seeks to maintain the viability of his business. Also there is the question of trust especially where the debtor is not as powerful as the lender or where the lender is more financially literate than the debtor and the later questions the fairness of the whole transaction. Regardless of the foregoing, the lender and the debtor usually have a shared interest to maintain business relationships.
In reaching an acceptable work-out, the parties may appoint a neutral third party or mediator who acts as an umpire during the transasction. Where chosen properly, the mediator serves as a facilitator of the negotiations ensuring that the parties stay focused on the issues rather than personalities. The role of the skilled mediator is to act as a catalyst by helping the parties in identifying and crystallizing each side's underlying interests and concerns; carry subtle messages and information between the parties; explore bases for agreement and develop a co-operative, problem solving approach. The common denominator to all these efforts by the mediator is the enhancement of communication between the parties. Mediation is very appropriate to loan recovery matters for several reasons which include confidentiality of parties; flexibility of the process; participatory nature; time saving; etc. One major attraction of mediation is that it aims at maintaining the business relationship between the parties.
Several drawbacks however impede voluntary workouts or loan restructuring which include unco-operative creditors who still pursue litigious means to their recovery without regard to the conclusion reached at a work out session with other creditors. This scenario usually plays out where there are several creditors. This can be avoided by taking the middle road i.e. the parties bringing the matter before a court which matter have joined all creditors known and unknown and requesting the court to make the direction for mediation. The agreement reached in such work-out sessions will be sent back to the courts as a report of settlement which the court endorses as a judgment of the court. In mediating loan recovery activities, the mediator must maintain a very neutral stance; be creative and fair in problem solving and have adequate knowledge of the basics of loan agreements, documentation and banking practice. This would reduce the tendency of contests of the outcomes.
Mediating Loan reconstructions and ultimately recovery was made popular in the 1970s by the proactive stance of the Bank of England as recession led to massive defaults companies and individuals which threatened to destabilize the entire banking industry. The strategies employed have worked upon and developed into what is termed the London Approach. It is pertinent at this time to state that the conditions prevalent in the United Kingdom then are very similar to the conditions in Nigeria today and a prudent modeling of the action of the Bank of England by the Central Bank of Nigeria may be a viable part of the panacea to the imbroglio being experienced by the Nigeria Financial Institutions. While the London Approach was developed by an interventionist act of the State, the principles are workable even in private sector led reconstructions as experienced in the creditor-led work-outs in Argentina therefore independent creditors may organize a successful work out.
While the mediation style adopted in each transaction will depend on the particular circumstances the overriding principles governing work-out sessions are generally settled to include the following:
- Unanimity in Choice of Mediator and Mediation Venue: Both parties to the loan agreement i.e. lender and borrower, must agree on the choice of the mediator. The kernel of mediation is the consensual nature of the process and once the mediator is chosen unilaterally, the whole essence is defeated. A party may however suggest a mediator and the other accepts. If possible such agreement must be reduced to writing.
- Confidentiality: A hallmark of successful workout processes is the confidentiality of the information relating to the process. Leaks and indiscreet use are vices that undermine the parties and the process, thus, each party and the mediator must seek to ensure and be accountable for the confidentiality of the process.
- Independent Due Diligence: The mediator should ensure that there is an independent due diligence report on the debtor's cash position, financial standing and long term viability. This exercise is conducted by financial experts or auditors appointed by the lenders but based on information produced by the debtor and other generally available sources like government policy, market trends etc. This is to determine the viability and thus relevance of the workout session.
- Standstill Period: The creditors may have to grant several waivers and moratoriums during the period of the process to maintain the going concern of the business. Also if it involves a line of credit, the creditor may maintain it during this period and refrain from court actions against the lenders or any action that they affect the reputation of the debtor among his suppliers or business partners. The troubled debtor on his part must not do anything to adversely affect the interests of the creditors during the work-out process. Where collateral covers the credit all parties must ensure, within the limits of its powers, that the security is preserved in substance and value.
- New Money and Collateral: Since an underlying principle of the process is maintaining the going concern value of the debtor, creditors must be willing to grant new money or credit lines if this will promote the overall goals of the work out process. It must however be stated that this must be done with clear-headedness and appreciation of the facts as issues of poor management cannot be resolved by financial bailouts. The debtor must also be ready to provide fresh collateral for funds where necessary.
- Steering Committee and Chair: Where a series of creditors are involved, the creditors may need to agree on a committee to represent their interests and determine whether they need a chair or representatives only.
- Fair Burden Sharing and Pari Passu: The parties, lender and debtor must be willing to absorb a fair percentage of losses. Also the seniority and rankings of the lending parties with regard to repayments and actualization of the security must be respected in the process.
- Co-operation and Fairness: Both parties must co-operate and participate in the process of reaching their agreement. The mediator must bear in mind that the agreement is the parties' and theirs majorly. There must be a free channel of information between the parties especially the debtor with regard to the present value of his business.
- Outer Time Limit: The mediator must be aware of the time cycles of the process as it cannot continue indefinitely. The time cycles are usually dependent on the parties fatigue or poit of saturation. A timely closure must therefore be a goal of the process but never so much as to make the process too hasty to reach conclusions.
- Flexibility and Dynamism: The mediator and parties must ensure that their mindset to the work out process is creative and dynamic while within the ambits of the broader laws governing the transaction, parties and security.
- Exist Option: The mediator must realize that the work out is only one method among several and is thus not a do or die option. It is important to note that not all work-outs succeed but the parties must be proud to know that even where it failed, they had employed their best endeavours towards its success and thus go on to other options. At this juncture, the parties must be made to maintain cordiality even if litigation or some other method is to be adopted.
Finally, the aim of reconstruction is to maintain going concern while maximizing the creditors' recovery efforts. This spirit should underscore all efforts at loan recovery especially at this time with so much emotion and desperation within the financial clime to clear their balance sheet of nonperforming loans and frustration of investors with the foreign exchange, capital and commodity markets. Also, as stated earlier, parties and mediators must not be afraid to take the middle road of having a court grant the order for settlement, thus bringing all creditors to the table and sanctioning their agreement as a consent judgment. The Apex Bank should also look at coordinating an industry wide exercise as experienced in the United Kingdom as much of the debt exposure involve banks who are within the radar of their regulation.
- Kanayo Chuks Okoye is an Associate in the law firm of Aina Blankson, LP
Tuesday, 06 April 2010 04:42
Medaiting Loan RecoveryWritten by Rizwan Butt
Published in Banking and Finance
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