As Recession Concerns Rise - Prepare for Default and Guarantees with Documentation

Handshake Deals Were Never A Good Idea, Now They May Be Catastrophic

In good economic times, we occasionally see long term business relationships where a handshake has served as the agreement over the years and little or nothing has been put into writing. While this is obviously not a good idea in general, as long as everyone is happy and making money, these relationships are not always a complete failure.

Now is the time to move to a written agreement. This may hurt some business relationships, but it is far better to have this discussion now rather than later as the risk of handshake deals goes dramatically up during the threat of recession or difficult economic times.

Now Is the Time to Review Old Forms

Standard forms have made all of our lives easier in the legal world. Banking, financial and real estate professionals utilize an array of form documents to help guarantee that terms of transactions are upheld in a consistent manner across their portfolio. This is generally a good thing. However, the law is not static, and in Washington particularly, there have been notable changes in some heavily used forms. Now is the time to review any old forms and make sure they are up to date. Using an old form might make the whole transaction process seem more efficient, but it ignores the current and future risks with old forms.

Slow Down

There are a variety of reasons why people might not spend time at the start of a transaction to draft the proper documentation required to facilitate and then enforce transaction terms. Collecting, maintaining and updating documents can be expensive and time-consuming. In the heat of the moment while a deal is underway, sellers or buyers may be more concerned about the deal itself as opposed to securing proper documentation required to fully necessitate and guarantee the transaction.  

But, this rush to a deal has big implications for all parties (including guarantors, buyers, and sellers) should a default occur or a buyer back out.

Document, Document, Document  

With a recession on the minds of many, it’s critical to take a look at all of the documents and agreements you have on hand and the terms they establish for your transaction. If it’s not clear who will pay amongst the guarantors following a default, it’s time to reflect on that and create clarity. Particularly with regard to guarantees and contribution agreements on development projects, it is in periods of economic recession or uncertainty, when we find out how sound and accurate the documentation is.

If There Are Multiple Guarantors Or Members – Consider A Contribution Agreement

Almost all commercial loans have some form of guaranty. If there are multiple guarantors, they are typically jointly and severally guarantying the debt obligation. This means the lender can proceed against any one of the guarantors or some of them, or all of them. It also means that the lender can obtain a judgment for the full amount against one of the guarantors without proceeding against the others. If there are multiple owners of a business entity, and only one owner/member is guarantying the loan, that is also an area that may cause uncertainty. If you’re a guarantor of a loan with multiple guarantors or other owners of the business, and it is not clear who is going to pay in the event of a default where one or more guarantors pay the debt, now is the time to shore that up.

A contribution agreement is an agreement that clarifies that if one or more guarantors pay the obligation on behalf of another guarantor, they can seek repayment from the non-paying guarantor up to a certain amount or percentage in addition to attorney fees. The parties may provide that the amounts are pro-rata in the same percentages as their membership interest in the business entity, but not always.  

If there is not a contribution agreement, the parties can try to look to the operating documents of the entity, but those are often not intended to discuss such issues, or they omit them. There are common laws and entity laws that provide some protections to help guarantors and obligors when a transaction falls apart or a default occurs. Guarantor law, fiduciary duties and statutory rights stemming from those duties do afford some protections. However, these are not what you want to rely on when you have a problem enforcing the terms of a transaction or collecting a contribution.

 If There’s A Change, Document It In A Signed Writing

If there are any changes or modifications to an agreement, they should be documented in a signed writing. As noted above, some transactions or amendments/changes to transactions are completed with just a handshake or an email. The time for that has passed. Sure, all deals have an element of trust in them, however, in a recession, responsible parties do not want to be testing those trust relationships, they want accurately documented transactions so that the terms are enforceable. A simple amendment updating the terms of the agreement is not a time-consuming endeavor and can alleviate a lot of time and legal expenses in the event of a default.

To Review – Here Are Some Steps You Should Take Heading Into A Recession:

1)     Reduce any and all handshake agreements to writing.  

2)     Have old forms reviewed and updated.

3)    Slow Down. Speed in a declining economy is a killer.

4)     Prepare and execute contribution agreements.

5)     Document all amendments and changes to existing agreements.

Finally, have an attorney review anything you are signing. As always, it’s critical for transaction documents you need to sign to be reviewed by legal counsel. If it’s time to review your transaction documents, our real estate and business attorneys are available to help provide document review to ensure your purchase and sale transactions operate smoothly and soundly and are fully enforceable in the long term. Contact us today.