Work-out agreements must be carefully drawn.

Many lenders get into trouble in attempting to work out (renegotiate) defaulted loans due to inartfully drawn work-out agreements. A lesson that a carefully drawn work-out agreement will protect a lender is learned from the case of Sawyer Savings Bank v. Fred Kent, Chase Manhattan Bank N.A. and Selma Kent (600 N.Y.S. 2d 807).

Fred Kent owned three tracts of land in Woodstock, New York. They were 45 acres, 35 acres and 23 acres respectively. Sawyer Savings Bank held a first mortgage on the 45 and 35-acre tracts. The 23-acre tract was free and clear. Subsequently, Chase Manhattan loaned $550,000 to Fred Kent, of which $100,000 was secured by a second mortgage on the 45 and 35-acre tracts, but the remaining $450,000 of that loan was unsecured. Three years later, Kent's mother, Selma Kent, obtained a $408,000 judgment by confession against him, which was docketed as a third lien against the 45 and 35-acre tracts. The 23-acre tract still remained unencumbered.

Sometime later, Fred Kent experienced financial difficulties and defaulted on the Chase loan, which prompted Chase to commence legal action to collect payment. During the pendency of that action, Fred Kent and Chase entered into a work-out agreement under which the debt to Chase was restructured and which also provided for Chase's discontinuance of its action against Kent without prejudice as long as Kent complied with the work-out terms. The work-out agreement was expressively conditioned upon Kent granting Chase a mortgage on all three tracts of land (including the 23-acre tract) as an additional security for the $450,000 loan which was previously unsecured, and required that Fred Kent obtain a subordination of Selma Kent's $408,000 judgment lien to the newly created Chase mortgage. The work-out agreement further stated that "failure by Fred Kent to make payments under the work-out shall terminate the agreement, as well as Chase's obligation to discontinue its actions for collection."

The document expressively provided that it was a continuing irrevocable agreement that will remain in full force and effect until all of Chase's claims were paid in full. Fred Kent executed the mortgage with Chase for $450,000 covering all three tracts of land. Selma Kent agreed to subordinate her lien and executed a subordination agreement.

Later, Fred Kent again fell into default under the work-out agreement and Chase notified Kent that the work-out agreement had by its terms become null and void. At the same time, Fred Kent had also defaulted on Sawyer's first mortgage, thus prompting that bank to commence an action to foreclose. Chase, Fred Kent and Selma Kent were among those named as defendants by Sawyer Savings Bank.

Fred Kent claimed that Chase's mortgage as well as Selma Kent's subordination agreement should be invalidated on the theory that Chase's declaration that the work-out agreement was null and void amounted to a rescission of that agreement, with the result that the Chase mortgage and subordination agreement of Selma Kent would no longer have any legal effect.

This argument was rejected by the court and Sawyer continued its foreclosure and ultimately the property was sold. The purchase price was sufficient to pay off Sawyer Savings Bank and provided a surplus of almost $300,000 over the Sawyer indebtedness. Both Chase and Selma Kent filed claims to this surplus money.

Chase claimed all of the $300,000 surplus money, since its initial $100,000 mortgage was placed on the property before Selma Kent docketed her $408,000 judgment and in addition, the remaining mortgages of Chase were superior to the claim of Selma Kent because of her subordination agreement, under which her judgment lien became secondary to the new Chase mortgage.

Again, Selma Kent argued that Chase's declaration that the work-out agreement was null and void caused the subordination agreement to be discharged.

The Appellate Division agreed that the declaration by Chase that the work-out agreement was null and void did not terminate the subordination agreement of Selma Kent. The court relied upon the carefully worded subordination agreement, which provided that it was given by Selma Kent to "induce Chase to discontinue its law suit against Fred Kent." The preamble to the work-out agreement, as well as the agreement itself, clearly and unambiguously demonstrated that the subordination agreement was given in consideration of Chase's forbearance in pursuing its legal remedies to collect a delinquent debt of Fred Kent; and that the new mortgage and the subordination agreement were to act as security if Kent defaulted under the more lenient restructured schedule; and that upon default by Fred Kent of the work-out agreement, the new mortgage and the subordination agreement would remain a valid and enforceable mechanism by which Chase could recover its money. The new mortgage itself provided that it stands as security for payment under the work-out agreement and provided for the remedy of foreclosure in the event of Fred Kent's default. It thus clearly contemplated enforcement by foreclosure in the event of default. The subordination agreement was explicitly made continuing and irrevocable until all of Chase's claims were paid in full, again contemplating survival after default.

It was clear from the carefully drafted mortgage and subordination agreement, as well as the work-out agreement, itself that the mortgage made by Fred Kent to Chase as well as the subordination agreement made by Selma Kent remained in full force and effect following Kent's default under the work-out agreement. The lender was protected because the work-out agreement was carefully drawn and its terms were clear and unambiguous.