The Art Of Foreclosure: Applying Sun Tzu’s 6th Century Principles To 21st Century Asset Recovery

With the continuing turbulence in the financial and credit markets, it comes as no surprise that the rate of commercial loan defaults has dramatically increased over the past several months. As the economy appears to move toward a state of affairs last seen during the Great Depression, every lender must have a strategy to handle defaults on its secured commercial loans. But perhaps that strategy should be premised upon lessons learned long before the Great Depression.

Over 2,500 years ago, the legendary Chinese military commander Sun Tzu wrote his military treatise The Art ofWar. Since then, not only military figures, but business schools, CEOs, public administrators and others have applied Sun Tzu’s treatise to their endeavors. Quite simply, The Art of War is applicable to any situation where two or more parties are pursuing opposing objectives.

This article applies The Art of War to the lender/ borrower relationship when a loan goes into default. Under such circumstances, the lender’s relationship with its borrower becomes, to varying degrees, adversarial as each pursues its own interests. As set forth, Sun Tzu’s time-honored principles provide guidance to succeeding in this conflict too.

Acknowledge the Situation and Act with Purpose

The art of war teaches us to rely not on the likelihood of the enemy’s not coming, but on our own readiness to receive him; not on the chance of his not attacking, but rather on the fact that we have made our position unassailable.

Perhaps the most difficult step a lender must take in the asset-recovery process is the first one: accepting that its borrower, its customer, may soon be its adversary. In contrast, the borrower is naturally aware of its own financial status long before its lender is. Hence, while the astute borrower understands its predicament and is implementing a stratagem, a lender can be uninformed. Certainly, amicable resolutions are possible and preferable. No lender wants to alienate its customer. Nevertheless, the savvy lender will prepare itself for the potential clash with its borrower even while constructive conversations are ongoing. Thus, when it becomes apparent that an event of default has occurred or will shortly occur, the lender should begin the process of making its position unassailable.

Ponder and deliberate before you make a move.

Too often,lenders implement default procedures as a matter of rote, with computer-generated default letters. Consequently, the adversarial process commences without sufficient information or reflection. A lender should handle its more important credit relationships with greater particularity and make well-reasoned decisions based on adequate information. Asset-recovery actions often take on a life of their own when begun without due deliberation. By setting clear goals in advance, the lender will control the process and not be controlled by it.

Assess the Circumstances

If you know neither yourself nor your enemy, you will always endanger yourself. If you only know yourself, but not your opponent, you may win or may lose. If you know your enemies and know yourself, you will fight without danger in battles.

Just as the wise general knows both himself and his opponent, so too does the prudent lender engage in a thorough assessment of Its borrower, its collateral and its relationship with its borrower in the event of default. Too often a lender reacts to an event of default and begins to exercise its rights under its applicable loan documents before it has undertaken this requisite analysis. The more astute course is to first achieve a comprehensive understanding of both its and its borrower’s situations and the circumstances pertinent to the applicable default(s) before any actions are undertaken.

Adjusting to Changed Circumstances

He who can modify his tactics in relation to his opponent and thereby succeed in winning, may be called a heaven born captain.

Despite the best of planning, there will inevitably be unanticipated events during the course of any litigation, particularly one in which a lender is seeking to realize upon collateral that the defendant borrower controls. Thus, the lender and its counsel must be nimble enough to react to changed circumstances while continuing to pursue their defined objective. As in any conflict, understanding the opponent’s strategy is a prerequisite to countering it. Thus, while the lender’s objective may remain the same, the lender will often need to modify its tactics to achieve that objective in response to the borrower’s actions. For example, a “scorched earth” strategy employed in a state-court litigation may be counterproductive in a bankruptcy-court setting. As in any battlefield situation, there is no substitute for experience in assessing a situation and modifying one’s tactics accordingly.

Victory Without Battle – The Workout

To fight and conquer in all your battles is not supreme excellence; supreme excellence consists in breaking the enemy’s resistance without fighting.

Again, if the campaign is protracted, the resources of the State will not be equal to the strain.

The best victory is when the opponent surrenders of its own accord before there are any actual hostilities … It is best to win without fighting.

Not all game plans consist of litigation. After carefully assessing its and its borrower’s respective positions, t he lender may conclude that ultimate success could be delayed due to issues that surfaced during the course of its initial prelitigation analysis. Even in an uncontested foreclosure action, several months will likely pass before any foreclosure sale is accomplished. Hence, a lender’s initial objective may be a comprehensive restructuring/forbearance agreement, particularly one that includes an acknowledgement of the debt without defenses, bankruptcy-protection provisions, a release of the lender, a critical path to which the borrower must adhere, and well-defined remedies for any breach thereunder, including the filing of a consent judgment containing the ultimate relief the lender will seek in any recovery action. Such an agreement may result in a victory without battle. Indeed, even if a restructuring does not transpire, the lender may have fortified its position through the use of the “pre-workout letter” by which, among other things, the borrower concedes various key points -including, for example, agreeing to the amount of debt and that it has no defenses to the payment of the debt- as the “ticket price” for its entering into nonbinding negotiations with the lender.

Minimizing the Costs While Maximizing Rewards

There is no instance of a country having benefited from prolonged warfare.

It is only one who is thoroughly acquainted with the evils of war that can thoroughly understand the profitable way of carrying it on.

By their very nature, contested asset recovery actions are unproductive. The lender is expending resources to recover collateral that is concomitantly diminished by its borrower’s efforts to thwart its efforts Thus, one must be both cost efficient and effective when undertaking any such actions. By following the steps outlined in this article, a lender may maximize its recovery by adhering to a thorough, but economical and well planned, course of action.

In war, then, let your great object be victory, not lengthy campaigns.

Originally published in Secured Lender magazine and republished with permission of by Secured Finance Network.