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A loan agreement will typically include a number of promises by the borrower to engage in or refrain from certain specified actions, called undertakings. These promises are referred to as:
- positive undertakings or covenants (where the borrower is promising to engage in an action); and
- negative undertakings or covenants (where the borrower is promising to refrain from an action).
These undertakings all aim to minimise the likelihood that the borrower’s risk profile will be adversely affected during the term of the loan. In other words, the undertakings and covenants contained in a loan agreement assure the lender that the borrower will maintain its financial position throughout the loan period.
The borrower will have to make sure it complies with the undertakings at all times during the term of the loan, otherwise it will be subject to a breach of contract. Therefore, the borrower should read each undertaking carefully before entering the loan agreement to make sure it is able to comply on an ongoing basis.
Types of positive undertakings include:
- information undertakings (where the borrower agrees to provide the lender with certain types of information, such as financial statements and management accounts, periodically throughout the term of the loan. The lender may also inspect property and records);
- loan specific undertakings (for example, where the borrower is borrowing money to purchase an asset, a promise to insure that asset 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).
Types of negative undertakings include promises not to:
- create security over any of the borrower’s assets (other than any security granted in favour of the lender);
- sell any of the borrower’s assets; and
- take on any more debt.
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Remedies for Non-Compliance With an Undertaking
If the borrower does not comply with an undertaking, 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, the normal remedies for breach of contract will apply (including specific performance, damages and termination, where applicable).
Specific performance requires a party to a contract to honour their promise to do something. Under an order of specific performance, the borrower must come good on their performance and undertaking obligations. However, enforcing a remedy of specific performance may force the borrower and lender to maintain a loan arrangement that is no longer feasible. In this case, damages may be a more appropriate remedy.
Damages operate to return the innocent party to the position they would be in had no breach of contract occurred. A loan agreement will provide for liquidated damages, which are the pre-agreed amounts owed in the event of a breach of contract. This may include the:
- pre-agreed termination fee; or
- establishment fee of the loan.
As long as these liquidated damages are not disproportionate to the amount of the principal loan and do not place excessive burden on the borrower, they will be enforceable.
If a loan was for $50,000 and these fees amounted to a small proportion of that principal, they may very well be enforceable as liquidated damages under the contract. However, if the fees amounted to $20,000, this would be extravagant when compared to the principal loan amount. Therefore, it would likely be deemed unenforceable as liquidated damages.
Event of Default
In addition to the above remedies, the borrower failing to comply with an undertaking will generally constitute an event of default under the loan agreement. If an event of default occurs and continues beyond a set period of time (i.e. beyond the grace period), the loan is immediately due and payable on demand by the lender and any security is enforceable. Events of default may be:
- actual (having happened); or
- potential (going to happen).
The occurrence of an event of default will generally create contractual rights for the lender.
Undertakings are a particularly important clause in a loan agreement. 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. To find out more about loan agreements, contact LegalVision’s banking and finance lawyers on 1300 544 755.
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