A loan agreement (also known as a facility agreement) can be a complex document. Before taking out or providing a loan, it is crucial that you understand every aspect of your loan agreement. This will ensure that you are not signing yourself to be legally responsible for something that you were not prepared for. This article will go through eight key terms in a loan agreement and what you should consider about each of them.
In a loan agreement, the interest clause is crucial as is sets out the interest rate on your loan. There are two main types of interest rates:
- fixed fee rates; and
- floating fee rates.
A fixed fee rate is set at a given number, which will not change during the course of the loan (i.e. 8% fixed). A floating fee rate is based on an interest rate margin added to a benchmark rate (i.e. 3% + the benchmark rate).
In Australia, loan agreements generally use a type of benchmark rate called the bank bill swap rate (BBSW). BBSW generally moves in line with the Reserve Bank of Australia’s cash rate target. It’s important to bear in mind that, in general, only more complex loans use a floating free rate.
Basic loan agreements generally use a fixed rate fee. Interest is normally payable at either the end of each interest period (generally a 3, 6 or 12 month period) or at the term of the loan.
2. Default Interest
A well-drafted loan agreement will also contain a default interest clause. This clause increases the interest rate that is payable on amounts which are not paid when they fall due. The default rate must accurately reflect, to the lender, the cost amount that has not been paid when due. If the rate is excessive, there is a risk that it will be deemed a ‘penalty’ rate and therefore not be enforceable.
It is important that a loan agreement allows the borrower to repay the loan early. This is known as making a prepayment and makes the loan more flexible. Prepayments should only be allowed at the end of an interest period to avoid any payment of breakage costs. In certain circumstances, a loan agreement should also require mandatory prepayment, such as on the sale of the borrower’s company.
4. Events of Default
One of the key elements of a loan agreement is whether it is repayable on demand, or is only repayable at the end of a fixed term. If the loan is repayable on demand, there will be no need for an ‘events of default’ clause. This is because the lender can recall the loan at will, meaning there is no need for the borrower to be contractually obliged to maintain certain covenants. If, however, the loan is a fixed term loan, it will be necessary for the loan agreement to contain an ‘events of default’ clause.
An event of default is simply an event which brings the borrower into default. The definition of an event of default will change depending on the:
- type of loan that you enter into; and
- positions of yourself and the other party.
The major events of default that you should look out for are:
- cross default, where a default under any other on-demand facilities provided by the lender to the borrower will automatically cause a default under this loan agreement;
- breach of the loan agreement, where any breach of a term of the loan agreement will automatically cause a default;
- non-payment, where any non-payment of interest or capital automatically triggers a default (note that this provision will generally include a grace period to cover administrative difficulties); and
- insolvency, where the borrower going into insolvency is an event of default.
5. Committed or Uncommitted Loan Agreement
A loan can be either committed or uncommitted. If a loan is committed, the lender is contractually obliged to lend the loan amount to the borrower once they have satisfied certain Conditions Precedents (CPs).
These CPs will be set out in a schedule of the loan agreement. If the loan is not committed, there is no need for a CP schedule.
6. Repayment – On Demand or Fixed Term
Another key term relates to the repayment provisions of the loan agreement. Is the facility to be repaid on demand? Or, on a set date or schedule? Generally, you and the other party to the loan agreement will agree to a fixed repayment schedule. However, on occasion, the lender may insist on an on-demand facility. This is particularly likely if the borrower has poor credit.
7. Secured or Unsecured
The majority of loans are secured against an asset.
However, in certain circumstances, the parties to a transaction may agree not to secure the facility. This generally increases the lender’s risk, which will have a flow-on effect to other areas of the agreement. For instance, the interest rate may be higher, and the loan may be on demand rather than fixed term.
8. Bilateral or Syndicated
Finally, it’s important to check whether a loan is bilateral or syndicated. Bilateral loans are funds provided to a borrower by one lender. In contrast, a syndicated loan involves two or more lenders jointly providing loans to one or more borrowers.
A bilateral loan is more common in simpler, basic transactions. Generally, a loan will only be syndicated if the lenders are corporate or investment banks and the amount that is to be lent is very significant.
When entering into a loan agreement, you need to consider the terms of the contract carefully. The key terms to look out for include:
- default interest;
- events of default;
- committed or uncommitted;
- repayment plan;
- secured or unsecured; and
- bilateral or syndicated.
If you have any questions about drafting or entering into a loan agreement, contact LegalVision’s contract lawyers on 1300 544 755 or fill out the form on this page.
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