The Trouble with Forbearance Fees

In the lending context, a forbearance agreement is a contractual obligation of the lender to refrain or forbear, for a definite period, from requiring a borrower to repay a currently due debt. Forbearance agreements are typically granted to beleaguered borrowers that the lender believes can find a way to satisfy the debt through a finance or otherwise. Lenders typically require their borrowers to release the lender from any claims the borrower may have at the time of forbearance. For the lender, a release is one of the primary attributes of a forbearance agreement. The forbearance benefits the borrower as it affords a brief respite from the collection process so the borrower can focus on finding a way to satisfy the past-due loan. Oftentimes, the lender will charge a fee to forbear. As discussed below, the lender needs to ensure that the forbearance fee does not violate its state’s usury laws. 

Usury laws are designed to prevent the imposition of finance charges on a debt from exceeding a legislatively determined amount. All states have limits on the amount that can be charged, but those amounts vary and can depend on the type of debt. From a lender’s perspective, Colorado has a generous usury cap that limits “interest” rates to 45% per annum. 

“Interest,” under Colorado’s civil usury statute, is the sum of all charges payable directly or indirectly and imposed as an incident to, or as a condition of, an “extension of credit.” To “extend credit” is to make or renew any loan or to enter into any agreement where satisfaction of a debt is deferred. From a simplistic standpoint, Colorado’s usury statutes prohibit charging interest in excess of 45% to make a loan or to defer repayment of a debt. The latter suggests that a forbearance agreement is an “extension of credit” and no more than 45% can be charged to forbear. Sounds easy enough. However, the Blooming Terrace case establishes, it is not quite so simple.

In Blooming Terrace, the lender granted the borrower bridge financing in the amount of $11,000,000. The lender charged 11% interest, which increased to 21% upon default. When the borrower defaulted, the lender granted a short forbearance in exchange for a fee of $110,000 (1% of the outstanding principal balance); nevertheless, the borrower was unable to satisfy the debt at the end of the forbearance period. Therefore, the parties amended the forbearance agreement affording the borrower more time, in exchange for another $110,000. This time, the borrower was able to pay-off the debt.

The borrower thereafter sued the lender claiming violation of Colorado’s usury laws. The borrower alleged that it was charged interest in amounts exceeding 100%. Shortly after the case was filed, the trial court dismissed it. The trial court added all of the finance charges (including the $220,000 forbearance fee) and divided those charges by the principal amount loaned. Based on that method, the trial court determined that over the term of the loan, the borrower was charged about 17% interest. The borrower appealed and the Colorado Court of Appeals, in a split decision, generally agreed with the trial court and determined there was no violation of the usury laws.

The Colorado Supreme Court agreed to review the case. The Supreme Court concluded that, based on the information available to it, there may have been a violation of the usury laws. In reaching that conclusion, the Supreme Court appeared to conclude (but did not expressly state) that the underlying loan and the forbearance agreement were two separate extensions of credit. It then concluded that the forbearance fee translated to about 29% interest over the period of forbearance. Finally, the Supreme Court suggested that the interest rate charged on the loan during the period of forbearance (21%) should be added to the rate charged to forbear, which amounted to about 50% (29% plus 21%). In short, the Supreme Court added the rate charged for the loan with the rate charged for forbearance during the period of forbearance.

This result may present some challenges for lenders. The Blooming Terrace case suggests that in Colorado, a lender cannot combine a forbearance fee with all other interest charged for the loan and then spread those amounts over the term of the loan to calculate an interest rate. Instead, the loan interest needs to be calculated independently from the forbearance fee and the rates for each need to be combined.

In summary, any time a lender is considering entering into a forbearance agreement, it should confer with its counsel, particularly when a fee is charged. Additionally, there may be alternatives to a forbearance agreement, such as an amendment to the underlying loan which extends its maturity date. Of course, there is not a “one size fits all” solution and each situation requires its own analysis. However, the Blooming Terrace case should be kept in mind each time a lender considers forbearing.

"This article was originally published by the Independent Report.