Workout Agreement: What it is, How it Works

What Is a Workout Agreement?

A workout agreement is a contract mutually agreed to between a lender and borrower to renegotiate the terms on a loan that is in default, often in the case of a mortgage that is in arrears. Generally, the workout includes waiving any existing defaults and restructuring the loan’s terms and covenants.

A workout agreement is only possible if it serves the interests of both the borrower and the lender.

Understanding Workout Agreements

A mortgage workout agreement is intended to help a borrower avoid foreclosure, the process by which the lender assumes control of a property from the homeowner due to a lack of payment as stipulated in the mortgage agreement. At the same time, it helps the lender recoup some of their funds that would otherwise be lost in the process.

The renegotiated terms will generally provide some measure of relief to the borrower by reducing the debt-servicing burden through accommodative measures provided by the lender. Examples of relief can include extending the term of the loan or rescheduling payments. While the benefits to the borrower of a workout agreement are obvious, the advantage to the lender is that it avoids the expense and trouble of payment recovery efforts, such as foreclosure for workouts in real estate or a collection lawsuit.

Other types of workout agreements can involve different kinds of loans and even involve liquidation scenarios. A business that becomes insolvent and cannot meet its debt obligations may seek an arrangement to appease creditors and shareholders.

Special Considerations with Workout Agreements

For borrowers, general best practices to consider when negotiating, or thinking about negotiating, a workout agreement with a lender include the following:

• Providing ample notification. Giving the lender advance notice of an inability to meet any and all debt obligations is a good courtesy to extend. Most lenders will likely be more accommodating when borrowers seek a workout agreement if they are aware that default could be an issue. Providing notice engenders confidence that the borrower is on top of their loan management and interested in being a reliable business partner whom the lender can trust.
• Being honest and flexible. A lender is not under any obligation to restructure the terms of a loan, so it is incumbent on the borrower to be honest, direct, and flexible. However, the lender will likely want to limit its losses and maximize recovery of the loan, so it is likely in the lender’s best interest to help the borrower to the extent that it can.
• Considering the credit score and tax implications. Any type of adjustment to the terms of a loan in a workout scenario could negatively affect the borrower’s credit score, though likely not as badly as a foreclosure would. With regard to taxes, the Internal Revenue Service (IRS) typically treats any loan reduction or cancellation as taxable income, which means the borrower could end up owing a larger tax amount in the year that the workout agreement goes into effect.