Defaulting on a business loan is a reality for many Canadian businesses, especially during COVID-19. But what happens when you default? And are there any ways to avoid the worst consequences of a default?
What to expect when your bank demands payment
The first thing the bank will do will be to demand payment and to send a notice of intention to enforce a security.
Why do banks demand payment when you default?
Most loan and security agreements will say that the full amount of the loan is due if there is a default. However most loans will also say that, at any time, the bank can demand payment in full. The bank does not have to wait for a default. It can demand even if there is no default.
By demanding payment the bank ensures that the full amount of the loan is due. Even if it turns out that there was no default, the bank can rely on the demand to require payment in full.
Why the notice of intention to enforce a security and what is the notice anyway?
The Bankruptcy and Insolvency Act (the “BIA“) governs a bank’s ability to enforce on security. The bank can always demand payment and sue but if it wants to seize assets and sell them to recover the loan it has to comply with the BIA.
The BIA says that a secured creditor (such as a bank) who intends to enforce a security on all or substantially all of:
- the inventory,
- the accounts receivable, or
- the other property
of an insolvent person that was acquired for or used in a business shall send to the insolvent person a notice of that intention. Where such a notice is required to be sent, the secured creditor shall not enforce the security until ten days after the notice is sent.
The notice that the bank has to send is called a notice of intention to enforce a security.
The notice is a prescribed form and looks something like this:
What this means is that, before a bank enforces on its security, it has to send a notice of intention to enforce a security and wait for ten days. Once the ten days passes the bank can take steps to start enforcing on its security.
Two ways banks enforce when you default on a loan
The bank’s next steps will depend on the bank, the borrower, and the relationship between them. At this stage the bank has two choices: negotiate a forbearance agreement or continue enforcing on its security.
What is a forbearance agreement?
A forbearance agreement is an agreement with the bank where the bank agrees not to enforce on its security. There are many reasons why a bank might enter into a forbearance agreement but the main reason is that this may be the fastest way for the bank to be repaid.
Your bank is not interested in selling your assets. It wants to get paid. If the bank thinks that by giving some extra time it will be paid, the bank will wait. Typically a forbearance agreement will buy the debtor anywhere from three to, on occasion, six months of time to find a new lender. For more details on what a forbearance agreement is, including what you typically have to give up to get a forbearance agreement, click here.
What can you expect if the bank continues to enforce?
If the relationship has broken down completely, and a forbearance agreement is not in the cards, the bank will take steps to enforce on its security once the ten day notice period ends. The most typical way in which a bank enforces is to appoint a receiver.
What to expect when your bank enforces by appointing a receiver
A receiver is a licensed insolvency trustee who is appointed by the bank to take over the business and to sell it in order to recover the debt owed to the bank.
How is a receiver appointed?
There are two ways for a bank to appoint a receiver. Most security agreements allow a bank to privately appoint a receiver. The security agreement gives the receiver the power to take over the business, sell the assets, and pay the bank.
However a privately appointed receiver is constrained in a number of ways. The receiver cannot force anyone to do anything. Instead the receiver will rely on cooperation from the debtor. The receiver also has no protections if it makes a mistake or if anyone (other creditors, the owners of the debtor, other interested parties) complain about what the receiver has done.
For these reasons a receiver is typically appointed by court order.
Appointing a receiver by court order
To appoint a receiver by court order, the bank will bring an application against the debtor for an order appointing the receiver. The bank is required to give ten days notice of the application to allow the debtor to respond. The debtor may object to the application being heard so quickly however these matters are generally considered to be urgent. The debtor can ask for more time but even if it is granted, the debtor rarely gets more than an extra few weeks.
The unfortunate reality for business owners is that a receiver is usually appointed. If there is a default in paying the loan, there is little that can be done to prevent the bank from getting an order appointing a receiver.
How does the receiver enforce when you default on a loan?
Once the receiver is appointed, the receiver will take over the business, market it, sell it, and distribute the proceeds to the bank and any other secured creditors. The receiver can either sell the business as a going concern or sell the assets separately. The amount of time all of this will take will depend on the assets but it typically takes 3-6 months.
Each step (selling the assets, distributing the proceeds, etc.) is approved by the court. This gives the receiver the protection it wants. If anyone wants to complain that the price is too low or too much is being paid to a creditor those issues have to be raised in the receivership proceeding. Once the receivership is finished it is too late to make any complaints.
For example guarantors may want to argue that the assets were sold for too little (called an improvident sale). The guarantors will often raise these issues when they are sued on their guarantees. If the sale of the assets was approved by the court in the receivership it will be too late to raise these issues in the guarantee claim.
How can you avoid losing your business when you default on a loan?
The first way to avoid a receiver being appointed is to keep a good relationship with your bank so that the bank wants to enter into a forbearance agreement with you.
How do you keep on good terms with your bank?
Ideally pay your loans and otherwise comply with all of your obligations. But you don’t control this. If the business is suffering there may not be enough money to pay the loans. And even if there is enough money, the business may be breaching other covenants. If this is going to happen, communicate as soon as possible with your bank. The last thing you want to do is to surprise your bank. If you think there will be a problem, tell your bank. If you think you’re going to miss a payment, tell your bank. If you’re communicating with your bank then your bank is calm and is likely to give you more room to work out whatever problems you have.
What if it’s too late to negotiate?
If the bank does not want to negotiate a forbearance agreement or any other agreement to give you room to work through the problems, the only option is a formal restructuring.
There are two types of proceedings that a company can start in order to delay or stop its security creditors – a proposal under the BIA or an application under the Companies’ Creditors Arrangement Act (the ”CCAA“).
A proposal under the BIA will only stop a secured creditor if the creditor has not served its notice of intention to enforce a security or, if the notice has been served, the ten day notice period has not elapsed. For this reason, if the bank serves a notice of intention to enforce a security it is important to act quickly and to get proper advice.
An application under the CCAA can be brought even after the ten day notice period has elapsed but a company is only eligible to apply for protection under the CCAA if it has a minimum of $5 million in debt and the application is very expensive.
When should you get a lawyer involved to save your business when you default on a loan?
Getting the right advice quickly is key to ensuring that your business survives. You may have as little as ten days to decide what steps have to be taken. An experienced insolvency lawyer will be able to give you the right advice to make that decision.
Knowing how a forbearance agreement will affect your business is also important when you are negotiating with a bank. The bank has professional lawyers to protect its interests. This is not the time to “do it yourself” and learn on the job. An experienced insolvency lawyer will understand the short and long term consequences of all of the terms in a forbearance agreement.
At KMB Law we act for both lenders and borrowers. We understand your business needs and we know what lenders want. We can help you communicate with your bank, negotiate a forbearance agreement, or consider your insolvency options. If your company is facing financial difficulty contact Wojtek Jaskiewicz at email@example.com or visit our website at www.kmblaw.com.