FRISBY IN DEFAULT ON LOAN COVENANTS Frisby Technologies has received a notice of default from two of its secured creditors. DAMAD Holdings AG and Bluwat AG have notified the company that it is in default of the tangible net worth covenant contained in its respective loan agreements with the lenders. The covenant requires the company to maintain a tangible net worth of not less than \($1,250,000\) as of the end of each fiscal quarter. A similar covenant is contained in the company loan
agreements with its other secured lenders, MUSI Investments
S.A. and Fin.part International S.A. As of September 30, 2002, the
company’s tangible net worth, calculated as provided in the
respective loan agreements, was a negative \($663,402\).
Under the terms of the DAMAD and Bluwat loan agreements,
the company has until December 18 to cure the default
or such longer period as it is diligently prosecuting a cure to
the reasonable satisfaction of the lenders. The company does
not currently expect that it will be able to cure the default
within the prescribed cure period.
If the default is not cured prior to the end of the cure period, then (i) the entire unpaid balance owed to the lenders, \($1.25\) million plus accrued interest, would become due and payable; (ii) the interest rate, to the extent permitted by law, could be increased by either or both lenders up to the maximum rate allowed by law;

(iii) any accrued and unpaid interest, fees or charges could be deemed by either or both lenders to be a part of the principal balance, with interest to accrue on a daily compounded basis until the entire outstanding principal and accrued interest is paid in full; (iv) either or both lenders could foreclose on its security interest in substantially all of the company’s assets;
and (v) each lender would have all rights available to it at law or in equity.
In addition, repayment of the loans is secured by a limited guaranty by COB/CEO Gregory Frisby of up to one-third of the total amount outstanding under the loans.
The company has requested waiver of compliance of the tangible net worth covenant from each of the lenders, but no such waiver has been granted. The company will continue to pursue a waiver or otherwise to seek to negotiate a forbearance agreement or other satisfactory resolution with the lenders. If the company is unsuccessful, it may voluntarily seek protection from its creditors under federal bankruptcy laws, which would have a material adverse effect on the company’s business, financial condition and prospects.

Required:
1. What is a minimum tangible net worth covenant, and what purpose does it serve in the Frisby loan agreements?
2. Why might lenders be reluctant just to waive Frisby’s covenant violation?
3. Among the options available to Frisby’s lenders is foreclosure: shuttering the company and selling off all assets. Why might lenders prefer to avoid this action?