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Detailed Practice Notes written by our Professional Support Lawyers, guiding you through the key issues in each topic.
Lending - overviewTypes of loans
The need for borrowing money may arise as part of any transaction involving an individual or a company, eg a company may borrow for working capital purposes or to fund an acquisition while an individual may borrow to start up a business.
The purpose for which money is being borrowed and the nature of the lender will determine the type of loan entered into:
an overdraft (sometimes referred to as a working capital facility) is an uncommitted facility repayable on demand, commonly used to meet temporary shortfalls in working capital
a term loan is a committed facility provided over a specified period, repayable at or by the end of the specified period usually on the basis of a predetermined schedule; the loan will be available for a short period of time after the agreement between the borrower and lender has been signed and may be available to drawdown in tranches (with each tranche having its own availability period)
a revolving facility is similar to a term loan but provides more flexibility as the borrower may draw and repay tranches of the available funds as required, usually for short periods of time ie one, three or six months - if the tranche is still required at the end of such period the tranche will be technically repaid and redrawn; the loan is a committed facility subject to a maximum amount with the availability period extending over the whole life of the loan
The term sheet
After investigating the borrower and, if required, obtaining credit clearance the lender will usually provide the borrower with a term sheet outlining the proposed key aspects of the loan. A term sheet has moral force but is usually not binding. However, certain provisions may be binding, eg a confidentiality undertaking from the lender or the borrower undertaking to pay the lender's expenses whether or not the loan is completed.
The loan agreement
The loan agreement governs the relationship between the lender and the borrower for the life of the loan, the mechanism for the drawing and repayment of the loan as well as providing protection to the lender. A lender and a borrower will have different perspectives on various clauses within the loan agreement.
The lender will want to protect its recovery of the loan capital and provide for receipt of interest payments promptly by:
controlling the amount of the loan, when the borrower may draw on the loan, the purpose of the loan and the circumstances for early termination
having a mechanism to monitor the borrower by using conditions precedent, representations and warranties, and financial and information covenants, and
obtaining security from the borrower
The borrower will want to use the loan in a flexible and practical manner without the terms of the loan impacting on its business by:
minimising fees, costs and expenses (particularly those of the lender)
ensuring its business is not hindered by the lender's monitoring
qualifying its obligations with reasonableness and materiality thresholds, and
maximising grace periods and mitigation provisions
No two loan agreements will be identical, being tailored to the specific loan and the negotiations between the lender and the borrower. Generally, the loan agreement will contain clauses dealing with the following matters:
the type and the amount of the facility and details of how and when the loan may be used and drawn by the borrower
the applicable interest rate payable, the interest periods, the dates on which the interest is to be paid and whether such interest will be compounded or not as well as details of any default interest and when this becomes payable
the conditions that the borrower is required to satisfy before the borrower may drawdown any of the loan
the lender's fees, costs and expenses payable by the borrower and when these will be paid
representations and warranties given by the borrower, eg the validity, legality and enforceability of the borrower's obligations, the financial and commercial conditions of the borrower, and when these representations and warranties will be given and repeated
covenants of the borrower to either act or refrain from acting in a particular way that provide a useful early warning system for the lender; covenants fall into three main categories:
financial - to ensure that the business, assets, finances of the company remain in limits satisfactory to the lender and its credit criteria
non-financial - dealing with areas of the borrowers business that are important, and
informational - relating to the supply of accounting and other information on an agreed regular basis, and
events of default that trigger the process by which the lender may place the loan on demand, avoid making further loan amounts available, demand immediate repayment of the outstanding loan and interest, terminate the facility and/or enforce any security held by it - events of default would include non-payment of amounts due on the due date, breach of warranty or covenant, insolvency, a material adverse change etc
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