Attorney John Durso, Ungaretti & Harris LLP

Our facility is encountering financial difficulties. What do we need to keep in mind about the legal implications of defaults under our loan documents and negotiating with our lender?

Financial and operational covenants contained in loan and security documents are usually breached before a payment default occurs. A lender may agree to a forbearance agreement and defer exercising remedies for a specified time period if timely communications with the lender are undertaken regarding the facility’s operations and the causes of the financial difficulties, allowing time to develop and implement a turnaround plan.

Options considered by the board and senior management may include operational improvements, restructuring of debt, sale of non-core assets, strategic affiliations or sale of the facility. It may be necessary to weigh the benefits and costs of a bankruptcy filing. 

Legal counsel should be consulted to advise the board and management regarding their fiduciary obligations and to identify and manage actual or potential conflicts of interest. 

Generally, directors and officers owe duties of care and loyalty to the organization and its shareholders (or, for a nonprofit, to its mission). However, some courts have held that separate fiduciary duties to creditors rise when the organization enters the “zone of insolvency.”

The board and management can be protected from future liability for their decisions under the legal doctrine known as the “business judgment rule,” if they act in good faith and make an informed judgment, so it is imperative that the board is properly informed, available options are carefully considered and that the decision-making process is appropriately documented.