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loan agreement Covenants/Negotiating points 1. Purpose of Loan. Many lenders will try to make this section as specific as possible, which limits the Borrower’s flexibility. Instead, the purpose of the loan should normally be for “general corporate purposes”, or something similar. The Lender will have plenty of other ways in which to check on the use of funds and the Borrower’s financial viability without having the limitation specified in the Purpose section. 2. Availability/Commitment Fee.
The period of availability – the time period during which funds can be drawn under the loan agreement – should be as long as reasonably required by the Borrower. During this period, the Lender may require the payment of a Commitment Fee on the undrawn portion of the loan. This fee should be reasonable and is typically about ? of 1% per annum. Theoretically, this Commitment Fee is paid to the Lender for their “reserving” the funds for the Borrower. Practically, this is just a way for the Lender to increase the overall effective return on the financing arrangement. . Notice of Borrowing. The Lender will typically require that the Borrower give a Notice of Borrowing, essentially to give the Lender time to line up the funds for the Borrower. However, since this normally only requires several days in most foreign markets, this notice period should be reasonable and give the Borrower flexibility in planning its cash needs. A 3-5 day notice period should be sufficient. 4. Interest Payment. Try to stretch out interest payment intervals. The longer, the better.
Never agree to pay interest in advance, which effectively increases the cost of the loan. Interest should always be paid in arrears. 5. Prepayment. The right to prepay is very important to have on a long or medium term loan. Interest rate conditions may change dramatically or the tax position of the Company may change, requiring an adjustment to the debt/equity structure of a subsidiary. Typically, the fairest way to accomplish this is through “broken funding” language, whereby the Lender is “made whole” in their return on the loan, despite the prepayment.
This assumes the Lender is able to relend the prepaid funds to another borrower of similar credit at a similar spread over the remaining life of the loan, or, puts the funds on deposit for a similar period of time. It is hard for a lender to argue against such a fair arrangement. 6. Penalty Interest. Many lenders want very high penalty interest on overdue payments, as a way to discourage borrowers from missing or delaying payments. However, conditions may occur in the normal course of business in some countries that will cause delays.
It’s fair for a lender to earn a “penalty” or “premium” in such cases. A premium such as 1-2% over the rate stated in the underlying agreement, paid during the period of delay, is typical. 7. Withholding Taxes. It’s preferable to pay interest net of withholding taxes, but many lenders prefer a gross up in those cases where a withholding tax attaches to payments. If this is the case, then it’s reasonable for the Borrower to ask for an undertaking from the Lender to refund tax credits it may get for such taxes paid by the Borrower. . Representations and Warranties. It’s best to qualify all representations and warranties as being true “to the best of Borrower’s knowledge and belief”, as of the date of the loan agreement. The Borrower should not be in default for unknowingly saying something was a fact when it really was not, or where it may not have all the necessary information available to make the rep. /warranty. Likewise, representations and warranties should not automatically continue throughout the term of a loan.
It’s reasonable for a Lender to have to ask for a rerepresentation/warranty during the life of the loan, with the Borrower providing as required. 9. Material and Adverse Change. Many loan agreements require that the Borrower warrant that there have been no adverse changes or occurrences since a certain date (typically the date of the last financial statement provided) or provide that the loan can be terminated if there are any adverse changes or occurrences. In all cases, it’s better to use the word “material” when referring to uch adverse changes or occurrences. This discourages lenders from having the right to terminate loans for minor or insignificant reasons. 10. Events of Default. This is the section of a loan agreement where the Lender tries to put many clauses which could trigger the acceleration of payments under the loan agreement, if such “tests” are not met by the Borrower. This is called “Default”, which can have significant legal ramifications, including the acceleration of other financings of the Borrower with other lenders.
Having such Events of Default in a loan agreement is reasonable, but such covenants and clauses should be objective and measurable, so that whether or not the Borrower is in default is not just left up to the judgement of the Lender. In addition, the Borrower should have some flexibility to “fix” or “cure” the condition causing the problem, before the legal Default kicks in. Some typical clauses: A. Cross Default. This is the clause whereby the Borrower is considered in default under all agreements if in default under one.
Therefore, the Borrower may ask for some flexibility in clearing its default under the subject agreement before triggering a cross default in others. Typically a “bucket” is negotiated, whereby the Borrower may be under technical default in other agreements, up to some specified limit (thereby “filling” the bucket), possibly based on capitalization or some other measure. B. Cessation of Operations. Most loan agreements provide that if the borrower stops operations, it is in default.
Given what can happen in many countries, it’s possible for a government to temporarily suspend the operations of a company – missing documentation, union issues, etc. – for reasons that really have no bearing on the profitable running of the business. Such an occurrence shouldn’t create a default situation under a borrowing arrangement. The loan agreement should therefore refer to the “permanent and general cessation of operations”, or, at a minimum, “shall cease operations for 30 consecutive days”, as an event of default. C.
Notice and Cure. It is imperative that the Borrower receive written notice of any “default” and be given some reasonable period of time (30 days? ) to “cure” the default before the Lender is allowed to declare the loan in default and accelerate the entire principal amount. The notice is critical, as is the opportunity to cure in order to avoid acceleration of the loan. Such a requirement for the notice and permitted cure period is typically put into the preamble to the Events of Default section of the loan agreement. D. Pari Passu.
It’s reasonable to agree that a Lender will always remain on an equal footing with all other unsecured creditors. In other words, one unsecured creditor should not be favored over another in terms of preference of payment. The legal word for this is “pari passu”. E. Negative Pledge and Dividends. A Lender may insist that the Borrower agree that it will not pledge or mortgage its assets during the life of the loan. This is known as a “negative pledge” and may be a perfectly reasonable request, depending on the type of credit support it may be getting on the loan from the Borrower’s parent, affiliate, etc.
However, to give the Borrower flexibility in running its business, it’s a good idea to negotiate a “bucket”, similar to that for cross default, for possibly pledging some assets to other lenders in the normal course of business. Leases, purchase money mortgages, etc. might fall under this category and the Borrower should have the ability to avail itself of them without triggering a Default under a loan agreement. Likewise, the Lender may try to restrict the payment of dividends by the Borrower, as a way of maximizing cash flow available to service the loan.
Given the flexibility needed by most multinational corporations for tax planning, this should not agreed to by the Borrower. At best, it can agree not to pay dividends if in default. 11. Changes in Law/Other Conditions. If legal or other conditions change in some country which either increase the cost to the Lender of funding its loan or impact its net return on the loan, then it’s typical that the Lender ask for the loan to be “grossed up” to cover this additional cost. In this ituation, rather than face the increased cost, the Borrower should have the right to prepay, without penalty, since the increases cost is beyond its control. 12. Notice. It’s very important that written notices be given to the Borrower by the Lender, as required under the loan agreement. Likewise, such notices should be “effective upon receipt” – there is evidence like registered mail, etc. that the notice was actually received. This is different than “constructive” receipt, where it’s assumed the Borrower got the notice “x” days after it was mailed.
Given mail systems in most countries, effective receipt is much safer. 13. Governing Law. Local currency loans are typically governed under the law of the locale of the Lender, and this is normally acceptable. For US Dollar loans, however, it’s typical to pick New York or London law, since they are more international jurisdictions. 14. Assignment. The loan should not be assignable by the Lender without the Borrower’s consent, and it’s typical to state that the Borrower’s consent “will not be unreasonably withheld. Given today’s financial markets, in which many lenders sell assets to enhance returns on capital, a Borrower may not want its paper sold to someone, or the market in general, without its knowledge. 15. Expenses. It’s reasonable for the Lender to ask for the Borrower to cover costs of putting a loan together. However, the Borrower should not agree to cover the Lender’s in-house legal expenses (a normal cost of doing business) but should only agree to pay outside legal expenses. As such, these should be reasonable and, if possible, should be agreed to upfront, so the Borrower knows what its all-in cost of borrowing is going to be.