Purpose of the Loan
The borrower will prefer a very wide definition of the purpose of the loan to be ‘for working capital purposes’ but the lender will most probably not agree. The borrower should then ensure the purpose for which the loan is required is covered. This usually appears in the schedule to the loan.
Conditions of Utilisation
It is usually a condition precedent for the borrower to deliver all documents and other information as needed by the lender ‘in a form and substance satisfactory to the lender’ before being able to deliver a utilisation request to draw down on funds. Words such as ‘and such further details as the lender may require’ should be avoided by the borrower as if any conditions precedents are not met, the lender will be entitled to withdraw from making the loan.
The lender will also insist that the agreement is drafted in such a way that parts of the contract will become operable immediately upon execution and hence fees will become payable instead of waiting for the borrower to draw the funds.
It will also be a condition prior to utilisation that no default is continuing or would result from the proposed loan, and that the repeating representations made by the borrower are true on the proposed utilisation date. The borrower should ensure that remedied defaults would not cause any problems in drawing down funds.
The practical conditions for the drawdown of the facility such as notice and time limits should also be sufficiently flexible for the borrower.
Interest and Fees
Default interest (the rate of interest that a borrower must pay in the event of material breach of the loan covenants) is usually charged at an additional margin of 1% but if the borrower is unable to seek a reduction, it should seek a grace period instead.
A commitment fee is usually charged by the lender to compensate it for earning no interest while the loan remains allocated but remains undrawn. The lender might also charge arrangement or amendment fees which should be checked for reasonableness.
Representations and Warranties
The lender’s decision to lend will usually be determined by the answers to questions put to the borrower, and the answers to which the borrower will be required to warrant. The subsequent breach of any of these warranties will usually be classified an event of default and the lender will have the right to take any action as what was agreed in the agreement. These warranties serve the purpose of ensuring full disclosure by the borrower to the lender.
Warranties are usually related to the validity, legality and enforceability of the borrower’s obligations (such as the borrower has to be properly incorporated, has the power to borrow, and is not in default of any other loan agreement) and the financial and commercial condition of the borrower (that it is not aware of any litigation against it and that the accounts are properly audited and accurate).
Lenders will usually resist the suggestion for the borrowers to limit its representations to matters within its knowledge. A disclosure letter is often used, written by the borrower’s solicitors to the lender’s solicitors to qualify any warranties and to disclose any facts relevant to the warranties that might affect the giving of the warranty. This ensures that the borrowers will not be in breach.
Repetition of Representations and Warranties
Representation and warranties are usually repeated periodically to ensure that the borrower’s status remain unchanged throughout the agreement. Lenders will want this to apply throughout the loan on a daily basis but borrowers will want it to apply only on drawdown and interest payment dates.
As an alternative, covenants and events of default clauses can be used to regulate the changes in the basis of a loan agreement.
A borrower should also ensure that the de minimis provisions or other concessions relating to covenants and events of default will also be valid for repeating representations.
Common covenants include conditions precedent to draw down the loan, covenants to ensure that the status of the borrower remains unchanged and covenants with regards to events of default where lenders can enforce early repayment in circumstances where the lender considers the loan to be at risk. They may be extended to apply to guarantors, a parent company or even a subsidiary.
Covenants have to be considered carefully as they might restrict the activities of the borrower if drafted too harshly, or if they are too soft the lender will risk not having sufficient control of the loan.
Covenants which relate to the status of the borrower include:
1) Financial covenants which ensure that the business, assets and financial condition of the borrower remain acceptable to the lender. This may be measured by certain financial ratios.
2) Non-financial covenants which cover specific areas of the borrower’s operation. These might include restricting the borrower in incurring contingent liabilities, changing the nature of the business, making any investments, utilising resources on capital expenditure or disposing of particular assets. These however may be subject to the express permission of the lender.
3) Information covenants which promise to supply regular and accurate accounting information to an agreed standard or any financial information that the lender might need.
Covenants should not be too cumbersome as to restrict the activities of the borrower.
A negative pledge is a general prohibition on creating security and usually will include any other agreement under which a third party might acquire a better claim to the borrower’s assets than the lender. This will protect the lender’s position as to other creditors. Negative pledges usually cover the borrower and all its subsidiaries. Borrowers may also negotiate a number of exceptions referred to as ‘Permitted Security Interests’.
An example of a negative pledge might be:
(1) The borrower shall not create or permit to subsist any security over any of its assets other than permitted security.
(2) The borrower shall not:
- sell, transfer or otherwise dispose of any of its assets on terms whereby they are or may be leased to or re-acquired by the borrower;
- sell, transfer or otherwise dispose of any of its receivables on recourse terms;
- enter into any arrangement under which money or the benefit of a bank or other account may be applied, set off or made subject to a combination of accounts; or
- enter into any preferential arrangement having a similar effect,
in circumstances where the arrangement or transaction is entered into primarily as a method of raising Financial Indebtedness or of financing the acquisition of an asset other than Permitted Financial Indebtedness.
Events of Default
Events of default essentially give the lender the contractual right to ‘accelerate’ repayment without recourse to the courts and the power to terminate the loan immediately upon discovery of a breach.
Events of default clauses will set out the circumstances in which a lender can place the loan on demand, avoid undertakings to make further loans, demand repayment of the outstanding principal and interest, terminate the facility and enforce the security.
The events would usually include non-payment of interest or principal, breach of financial covenants, misrepresentations, cross default (arising from a breach of another unrelated agreement), material adverse change, insolvency, illegality, change of control (of the borrower) or any other obligations specifically set out in the agreement.
A borrower will want the clause for remedies that is triggered ‘on or at any time after an event of default has occurred’ to be neutralised by ‘unless such event of default has been remedied’.
This clause is usually mitigated by exemptions, exclusions and thresholds and, in most cases, a de minimis qualification.
Events of Default: Material Adverse Change
This clause makes a material adverse change an event of default and it can accelerate the safeguards in the agreement found in the acceleration clause. The acceleration clause will allow the lender to (in the event of default) cancel the facility and/or declare that the loans will become repayable immediately.
This could be very widely defined as ‘any event or set of circumstances which, in the opinion of the lender, indicates that the borrower may not (or may not be able to) perform or comply with its obligations under any loan agreement or other finance document to which it is a party’.
The harshness of such a wide clause can be mitigated by including that the lender should act reasonably in all circumstances, that the test of the opinion of the lender should be that of his reasonable opinion and that the clause should only be used if an adverse change is likely to impact the borrower’s ability to meet its obligations under the terms of the loan agreement itself rather than just on the business of the borrower in general. It should also not be triggered by a deterioration in the financial condition of a particular subsidiary but of the group as a whole and should not include a change of merely the borrower’s prospects. The borrower could also negotiate for the harshness of the financial covenants clauses to balance against this clause.