When entering into a loan agreement, a borrower often has to agree to do more than make monthly repayments. Undertakings are one of the most common ways that these additional obligations are added to a loan contract. You should read any undertakings carefully before entering into a loan contract to make sure that you can comply with them. There are often very serious consequences if you cannot comply, including termination of the loan agreement. This article will explain what undertakings are and what can happen if you do not comply with them.

What Is an Undertaking?

At its most basic level, an undertaking is a promise. However, it is a promise that has very serious consequences if broken. That is because lenders use undertakings as a way of ensuring that their risk remains at an acceptable level. 

Generally, there are three types of undertakings: 

  • positive undertakings;
  • negative undertakings; and
  • financial covenants.

Positive Undertakings

Positive undertakings are promises to do specific things. This could be at a specific time or at the request of the lender. Positive undertakings usually relate to providing information or providing and maintaining security for the loan. The reason that lenders ask for positive undertakings is so that they can monitor their risk exposure and ensure that they have adequate security in place. 

For example, a lender may want to ensure that a customer’s house is insured. That way, they can still recover money from the insurer if the house burns down.

You should ensure that you are able to take any required action in the correct way and within the required timeframe. For example, if it takes you a few months to put together your annual forecasts, you should not undertake to provide them to the lender before they are ready.

Examples of positive undertakings

  • providing information about the financial position of the borrower annually or on request;
  • insuring and maintaining any secured property;
  • operating in accordance with applicable laws; and 
  • keeping all security interests registered and perfected.

Negative Undertakings

Negative undertakings are promises not to do specific things. Their main purpose is to stop you from taking action that would increase the lender’s risk or make it more difficult for them to recover their money if you default. It is important to make sure that the things that you are promising not to do are within your control. Do not promise that someone else will not do something or make promises about a situation that you have no control over. 

Examples of negative undertakings include a promise not to: 

  1. make the security property a security for any other agreement (for example, by taking a second secured loan over the same house);
  2. sell important assets without the lender’s consent; and 
  3. borrow any further money from a different lender.

Financial Covenants

Financial covenants are positive or negative undertakings relating specifically to a borrower’s finances. Borrowers should exercise particular care to ensure that they are realistic and provide sufficient flexibility for their businesses to operate without breaching any covenants.

Examples of financial covenants include that the: 

  • lender’s facility will always take priority over the borrower’s other debts;
  • borrower will maintain a certain loan to value ratio for a secured property; and 
  • borrower will not declare any dividends or make any other shareholder payments without the lender’s consent.

What Happens if I Don’t Comply?

Usually, failure to comply will be an event of default under the loan agreement. This means that if you break your promise (and cannot fix it within any grace period), the lender will be able to demand immediate repayment of the loan. In addition, they may be able to bring a claim for breach of contract.

Top Tips to Ensure Compliance

Once you have entered into a loan agreement, you should note down and date any important dates relating to undertakings. For example, the deadline for the provision of information or the date for renewal of property insurance. You should also check that entering into your current loan agreement will not violate any undertakings contained in other existing loan agreements.

Key Takeaways

Undertakings are one of the key clauses in a loan agreement, and you should read them carefully before entering into a loan agreement. It is particularly important to make sure that you can comply with each undertaking and that it is within your control. You can take simple steps to ensure that you comply with your loan’s undertakings. For example, diarising important dates and ensuring the undertakings in your existing loan agreements do not clash with your current one. If you have any questions about your loan agreement, get in touch with LegalVision’s banking and finance lawyers on 1300 544 755 or fill out the form on this page. 

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