A loan agreement will typically include a number of promises by the borrower to engage in or refrain from a specified action. These promises are referred to as positive undertakings or covenants (where the borrower is promising to engage in an action) or negative undertakings or covenants (where the borrower is promising to refrain from an action). These undertakings are all aimed at minimising the likelihood that the borrower’s risk profile will be adversely affected during the term of the loan. The borrower will have to make sure it complies with the undertakings at all times during the term of the loan. Therefore, before entering the loan agreement the borrower should read each undertaking carefully to make sure it is able to comply with it on an on-going basis.
Typical types of positive undertakings are as follows:
- Information undertakings, where the borrower agrees to provide the lender with certain types of information (for example financial statements and management accounts) periodically throughout the term of the loan; and
- Loan specific undertakings, for example where the borrower is borrowing money to purchase an asset, a promise to keep that asset insured for the term of the loan; to operate it in accordance with the law; to keep it maintained; and to keep it registered in accordance with the law; and
- Undertakings relating to any security, for example to keep all security interests granted in favour of the lender properly registered and perfected.
Typical types of negative undertakings are as follows:
- A promise not to create security over any of the borrower’s assets (other than any security granted in favour of the lender);
- A promise not to sell any of the borrower’s assets; and/or
- A promise not to take on any more debt.
Non-compliance with an undertaking
If the borrower does not comply with an undertaking then it will be in breach of the loan agreement. There are various remedies available to a lender if the borrower is in breach of the contract.
If the borrower does not comply with an undertaking then the normal remedies for breach of contract will apply (including specific performance, damages and/or termination, where applicable).
Event of Default
In addition to the above remedies, if the borrower does not comply with an undertaking this will generally (and indeed you should make sure it does if you are the lender) constitute an event of default under the loan agreement. We will discuss events of default in more detail in Part 6 (Events of Default) of this series but, if an event of default occurs and continues for an agreed period of time (the grace period), it means that the loan is immediately due and payable on demand by the lender and any security is enforceable.
There are many important clauses in a loan agreement. We have already explored some of them with you and will be exploring some of the other clauses over the next couple of weeks.
Undertakings are a particularly important clause and, due to the implications of non-compliance with an undertaking, a borrower must ensure that it is able to comply with each undertaking in the loan agreement before it enters into the loan agreement.