90 Second Lesson: Early Warning Signs of a Troubled Loan

Editors’ Note: This is part of our irregular series in which we answer readers’ questions. If you have a question, submit it to [email protected], and we will try to answer it.

Question

B. James asks, “I own a company that sells inventory to another company. I am considering making my customer a large secured loan. What are some ways I can monitor its performance?

Answer

Gary P. Segal and Mark A. Silverman write, “Secured creditors should be diligent in watching for early signs that a borrower is experiencing financial difficulties. Most secured loans are governed by a carefully negotiated loan or credit agreement that should contain covenants and reporting requirements that will signal the existence of problems before a payment default occurs. Many times a distressed borrower will violate a financial covenant, go out-of-formula if a revolving loan is based upon a borrowing base, stretch its accounts payable, or fail to deliver a financial statement, borrowing base certificate, or covenant compliance certificate. We are not suggesting that one or more of these events always precedes a workout, but these events should be investigated. Many times there are valid business reasons for these situations, and the secured party will be comfortable that the borrower will continue to perform as originally anticipated. However, if the secured party cannot get comfortable with the results of its investigation, then the secured party should understand that it has a distressed borrower and should start thinking about a loan workout.”

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[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can listen to at your leisure and each include a comprehensive customer PowerPoint about the topic):

• Business Borrowing Basics – 101
• Business Borrowing Basics – 201
• Leveraged Finance
• A Distressed Company and its Secured Lender

This 90 Second Lesson is based, in substantial part, on material reprinted from “Commercial Bankruptcy Litigation” and “Strategic Alternatives For and Against Distressed Businesses,” with permission of Thomson Reuters. If you are a Westlaw subscriber, you can read more about this particular subject here.]