Loan Agreements are complex documents with many provisions to consider. Below we set out the five key terms to negotiate from a lender’s Perspective.
1. Events of Default
Default is the occurrence of an event which the lender seeks protection against. The borrower will generally be allowed a period of time (known as a grace period) in which to cure a default. If the default remains uncured at the end of the relevant grace period it will usually become an event of default. An event of default will create certain contractual rights for the lender under the loan agreement.
The lender’s rights as a consequence of an event of default may arise either as soon as an event of default has occurred or if an event of default has occurred and is continuing. There is an important distinction to make here. The former creates rights in favour of the lender as soon as the event occurs, regardless of whether the borrower cures the default very quickly thereafter. The latter is more favourable to the borrower as it gives the borrower an opportunity to remedy the default. Only if the default is continuing does the lender have rights. The lender should push for the former approach.
The lender needs to make sure that the events of default are wide enough to cover any situation which could lead to the borrower being unable to pay the lender. In addition, the lender should try to limit any grace periods. If it becomes clear that the borrower is in difficulty, the lender will want to call the loan as soon as possible to ensure it gets paid.
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. A lender will want to make sure that the undertakings are extensive so that the borrower dos not do anything which could affect its risk profile.
3. Representations and Warranties
A loan agreement will typically include a number of statements made by the borrower. The lender relies on these statements in deciding whether or not to enter into the loan agreement with and whether to advance money to the borrower. These statements are referred to as representations and warranties.
Representations and warranties are always made on the date that the loan agreement is entered into. The loan agreement may also state that representations and warranties are to be repeated on other dates during the term of the loan, for example on each drawdown date, on each interest payment date or on every date during the term. The latter is arduous on the borrower as the borrower has to ensure that the representations and warranties do indeed remain true. However it is important for the lender to know that the information it based its decision on remains accurate and that, for example, the borrower retains a good credit risk profile.
4. Fees, Costs and Expenses
A lender might charge the borrower a fee for entering into the loan agreement and lending money to the borrower. In addition the parties will usually agree up-front who is to pay for all costs and expenses incurred by the parties in connection with entering into the loan agreement. If the lender has a strong bargaining position then it is not unusual for the borrower to have to pay for all costs and expenses, even those incurred by the lender.
5. Conditions Precedent
The lender will usually protect itself by insisting that various conditions are inserted in the loan agreement and, only once these conditions have been satisfied, does it have to advance the Principal.
The type and extent of the conditions precedent inserted in the loan agreement will depend on, for example, what the loan is for, the bargaining position of each party, whether the loan is secured or unsecured and how much the loan is for. If the borrower is low risk it will have a higher bargaining power as against the lender than a high risk borrower and therefore will generally not need to satisfy as many conditions. If the borrower is high risk then the lender will want to see more evidence that it is going to be able to comply with its obligations.
The loan agreement should state that the borrower must use its best endeavours to satisfy the conditions precedent and they need to be completed in form and substance satisfactory to the lender (in its absolute discretion). Furthermore the lender usually has the discretion to waive conditions precedent (conditionally if it so chooses) given it flexibility to advance the loan amount even where some of the conditions have not been satisfied, if it believes that doing so is low risk.
There are many important clauses in a loan agreement. It is important for a lender to ensure that it is adequately protected and confident that it will get its money back before it enters into a loan agreement.
To find out more about loan agreements, or for any other finance law related matters, please contact us on 1300 544 755. One of our finance law specialists would be delighted to assist!