What Is a Workout Agreement?

A workout agreement is a mutual agreement between a lender and borrower to renegotiate terms on a loan that is in default. 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.

How Workout Agreements Work

A workout agreement intends 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. Workout agreements apply to liquidation scenarios as well. A business that becomes insolvent and cannot meets its debt obligations may seek an arrangement to appease creditors and shareholders 

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

Key Takeaways

  • A workout agreement allows a lender and default borrower to renegotiate terms of a loan.
  • The purpose is to accommodate the default borrower so that the lender has a more likely chance of recovering the loan principal and interest without foreclosure.
  • Not all lenders are willing to make a workout agreement, and terms will vary on a case-by-case basis. Borrowers should also keep in mind credit score and tax implications.

Considerations When Negotiating Workout Agreements

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

Provide ample notification. Giving lender advance notice of an inability to meet any and all debt obligations is a 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 that the lender can trust. 

Workout agreement terms will vary. A lender is not under any obligation to restructure the terms of a loan, so it is incumbent on the borrower to be honest and direct. However, the lender will likely want to limit their losses and maximize recovery of the loan they granted, so it is likely in their best interest to help the borrower, to the extent that they can extent. 

There are tax considerations as well. Any type of adjustment to the terms of a loan in a workout scenario could affect the borrower’s tax situation. Typically, the Internal Revenue Service (IRS) treats any loan reduction or cancellation as taxable income