• A loan agreement is a contractual agreement between two parties whereby one party (lender) agrees to provide a loan to the other party (borrower)
  • There are two types of loans; secured loans and unsecured loans. Each type of loan has different obligations and protections for borrowers and lenders.
  • A Division 7A loan agreement covers loans that are made by a private company to a shareholder or associate, which are prevented from making tax free distributions to shareholders or their associates.

Loan Agreements in Australia

A loan agreement (or facility agreement), sets out the terms on which money has been lent. It is an essential legal document to enforce the terms of the loan and to show that it was, in fact, a loan and not a gift.

Unsecured and Secured Loan Agreements

There are two types of loan agreements: unsecured and secured loan agreements. Unsecured means there is no security against the loan should the borrower end up in default. A secured loan, on the other hand, ensures the lender can recover its money by taking possession of the borrower’s asset(s), selling them and using the sales proceeds to repay the debt. The majority of loans, such as home loans, are secured against an asset.

Division 7A Loan Agreements

A Division 7A Loan Agreement is used where a private/proprietary limited company is lending to one single borrower, and that borrower is a director, shareholder or associate of a director or shareholder of the lending company. The applicable legislation for this type of loan agreement is Section 109N of the Income Tax Assessment Act 1936 (Cth).

Division 7A applies to loans and payments made on or after 4 December 1997. However, if a loan or payment was made before that date and is subsequently varied or forgiven after that date then Division 7A may apply from the date of variation or forgiveness

Key Considerations

  • Before signing a loan agreement, a letter of offer for the loan will usually be the first document signed. The financier/lender may require the borrower to sign a personal guarantee.
  • A loan agreement should state that the loan must be used for a particular purpose to ensure it is used for the correct purpose.
  • A loan agreement will include an indemnity clause, which is an obligation by one party to provide compensation for a particular loss by the other. Make sure you clearly understand the indemnity clauses before signing.

Loan Agreement Clauses

Structure of a Loan Contract

A loan agreement contract is a complex and sophisticated document. While each loan contract is different, each contract will usually contain four main sections:

  • Definitions and Interpretation
  • Financials (operational terms)
  • Transaction (specific details of the transaction)
  • Boilerplate (sets out all the standard clauses)

Common clauses include:

Interest

As one of the most important clauses, a fixed-fee interest rate or floating fee interest rate will set the rate of interest payable on the loan. A fixed fee interest rate is set at a given number that will not adjust during the term of the agreement unless agreed by both parties. A floating fee will be based on an interest margin added to a benchmark rate. In Australia, this will be the bank bill swap rate (BBSW), which adjusts with the Reserve Bank of Australia’s cash rate target.

Default Interest

A default interest clause will apply where an owing amount is not paid when it falls due. This rate should accurately reflect the cost to the lender of the amount not being paid when due. Parties may agree that the lender can capitalise any part of the interest which becomes due and payable and is not paid on its due date.

Loan Clause

The operative loan clause sets out when and how money is to be advanced by the lender to the borrower, the amount of money being advanced, and what conditions have to be satisfied prior to money being advanced, if any.

Repayment Clause

A repayment clause sets out how and when the loan is to repaid by the borrower to the lender.

Frequently Asked Questions about Loan Agreements

Q: What is a bilateral loan or syndicated loan?
A: A bilateral loan is where there are only two parties, used in simpler, most basic transactions. A syndicated loan will be used in more sophisticated loan transactions where there are several lenders (usually banks and other financial institutions).

Q: Does the National Credit Code (NCC) apply to my Loan Agreement?
A: The NCC will only apply if the lender provides credit in the course of a business of providing credit or as part of, or incidental to, any other business.

Q: What is a lump-sum payment?
A: In a lump-sum payment, the borrower repays the lender with a single one-time payment at the end of the loan term.

Q: What is a principal and interest payment?
A: The borrower will make regular payments that count towards both the principal amount and the interest as it is compounded. At the end of the term, there will be no outstanding balance. For this reason, you can only choose a principal + interest payment plan when the loan agreement has a fixed term length.

Q: Are representations and warranties important in loan agreements?
A: Yes – ensure you have a lawyer read these clauses before entering into them. Repercussions of misrepresentation can be damaging. The borrower must ensure prior to entering into a loan agreement that all representations and warranties in the agreement are true.

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LegalVision assists businesses and individuals with tailored online legal advice for a fixed-fee, including drafting and reviewing loan agreements. Call LegalVision today on 1300 544 755.

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