A loan agreement is an agreement between two parties whereby one party (usually referred to as the ‘lender’) agrees to provide a loan to the other party (usually referred to as the ‘borrower’). The borrower will have various obligations under a loan agreement. Obviously the terms of each loan agreement will differ but the most common obligations a borrower will have are set out below
What are the borrower’s key obligations under a loan agreement?
The most common obligations a borrower will have under a loan agreement are as follows:
- Purpose: The loan may state that the borrower has to use the money for a particular purpose. A lender often assesses the risk profile of the loan based on what the money is being used for. Furthermore, if the lender is a financial institution, the purpose of the loan will be relevant to whether the National Credit Code applies to the loan agreement.
- Repayment of the principal loan amount: The borrower is obliged to repay the principal loan amount back to the lender. Exactly when and how the amount must be repaid will depend on the terms of the loan agreement. Generally either the full amount is due and payable on one particular date or the amount is payable in instalments over time.
- Payment of interest: The borrower may be obliged to pay interest on the principal loan amount. If so, the loan agreement will set out the interest rate, the dates on which interest is payable and how interest is calculated. Generally, the more risky the loan, the higher the interest rate. In addition, default interest may be payable if the borrower fails to pay an amount on its due date. Again, if this is the case, the default interest rate and the manner in which default interest is to be calculated will be set out in the loan agreement. Default interest is designed to stop the borrower from defaulting.
- Payment of fees: The borrower may have to pay fees to the lender in consideration for advancing the loan. If so, the amount of the fee(s) and the date(s) on which they are payable will be set out in the loan agreement.
- Payment of costs and expenses: The borrower may be expected to pay or reimburse the lender for any costs and expenses in relation to the loan agreement and any security documents (such as lawyer’s fees, registration fees and stamping costs). If this is expected, it will be set out clearly in the loan agreement.
- Provision of a guarantee or security: The borrower may be asked to provide a third party guarantee or some form of security in relation to the loan, particularly if the borrower is low credit risk or if the loan amount is significant. This will be referred to in the loan agreement and the loan agreement may even contain the provisions of the guarantee. However, any security is generally provided for in a separate security document (usually a general security agreement, a specific security agreement or a real property mortgage). As mentioned above, guarantees and security are usually required where the borrower is high credit risk of the loan amount is high, as they give the lender an added layer of protection.
- Provision of financial information: The borrower is likely to be asked to provide on-going financial information (for example, an annual statement of its financial affairs, if it is an individual, or its annual financial statements, if it is a company). This is so that the lender can monitor the borrower’s financial position and ensure they remain able to repay all amounts due under the loan agreement.
- Other covenants: The loan agreement may contain other covenants. These are basically promises by the borrower to do/not to do certain things (such as disposing of valuable assets for less than market value, entering into other loan agreements, mortgaging its property). They are aimed at minimising the risk of the borrower being unable to repay the loan.
What are the consequences of non-compliance?
Failure to comply with an obligation is likely to be an event of default. Following an event of default, the lender will usually have the following contractual rights:
- if the loan amount has not yet been lent, the lender is no longer obliged to lend the loan amount to the borrower;
- if the loan amount has already been lent, the lender can make the loan and any other money owing by the borrower to the lender under the loan agreement (for example, any unpaid accrued interest and fees) immediately due for repayment; and
- if the loan is secured, the lender may enforce its security to ensure it is repaid in full for all monies owing by the borrower.
In addition to the above, if the event of default also constitutes a breach of contract or a misrepresentation, the Lender may also be able to make a claim against the borrower for any losses it incurs as a result of such breach or misrepresentation.
A borrower will have many obligations under a loan agreement. Above, we discuss the most common obligations imposed upon borrowers but each loan agreement is different and therefore it is essential to review and understand your loan agreement fully before you sign it. The consequences of a borrower not complying with its obligations can be great. If you would like us to draft or review a loan agreement for you, please do not hesitate to contact us. One of our specialised lawyers who would be delighted to assist.