One of the key factors in setting up and keeping your business running smoothly is financing. For most business owners, the majority of this early financing comes from a bank and is usually in the form of an overdraft agreement. It is important to know exactly what will be covered in your overdraft agreement to ensure you are making the correct financial decisions for your business. In this article, we will explain what an overdraft agreement is, how it is different to other kinds of loans and what the clauses to be aware of are.
Overdraft Agreement
An overdraft agreement is an agreement entered into between a bank and your business giving the bank access to an approved amount of credit. There are a number of benefits in having an overdraft agreement. These include certainty of access to funds, allowing you to run or expand your business.
Unique Terms in an Overdraft Agreement
What is particularly unique about an overdraft agreement is that it is unsecured and uncommitted.
Unsecured means that the bank does not have rights to your company's property. That is, it cannot try and take or sell your property in the event you default.
Uncommitted means that the bank:
- is not obligated to honour any charges against your current account; and
- can demand you repay any outstanding amounts at any time without there being any breach of the agreement.
These terms differ from ordinary bank loans. In effect, because it has no security over your property, the bank's obligations to you are weaker.
An overdraft agreement will ordinarily have an overdraft facility. This document will:
- outline the maximum amount of money available on credit under the terms of the loan;
- a statement that the agreement is uncommitted; and
- a reference to the fact that the overdraft is unsecured.
The facility will also typically state the bank's right to demand repayment of the loan at any time. This provision will outline how much, if any, notice they are obligated to provide you with and whether they will review your ongoing eligibility to utilise the overdraft. In this review, they may choose to either completely stop providing your business with the overdraft ability, or reduce your overdraft limit.
Other Terms in an Overdraft Agreement
Many of the terms in an overdraft agreement are common to other bank loan agreements, including conditions precedent, interest, fees and charges, variation and representations and warranties.
Conditions Precedent
As with any loan, there are certain conditions you must meet to be eligible. Conditions precedents are conditions or actions that you or the bank must meet prior to the overdraft being available. This can include, for example, a requirement to provide the bank with your business's corporate governance documents and financial records to prove your current financial position.
Interest
This is a particularly important clause in the agreement as it will outline exactly what the interest repayments will be and when they are due. A standard overdraft interest clause states:
- interest accrues daily; and
- is debited to your account in arrears at the end of each month or before you close your account.
There will also ordinarily be a default interest clause. This will state the higher interest rate that you will owe if you miss any interest payments.
Fees and Charges
This clause will outline any fees that are payable on top of the interest rates, including, for example:
- enforcement expenses incurred by the bank; and
- any government changes or duties on receipts or withdrawals.
It may also outline any fee the bank may charge for packaging and servicing the loan.
Variation
A variation clause will outline:
- any changes the bank may make to the arrangement;
- how they will notify you of the changes; and
- what rights you have in those instances.
Some examples of changes that may occur are to the interest rate, default interest rate and amount, frequency and number of repayments required.
Representations and Warranties
A representations and warranties clause will outline certain statements of fact or promises that your business provides the bank as a loan condition. If you breach these promises, you are essentially breaching a term of the loan. In most cases, the overdraft facility will treat the breach of a representation or warranty as an event of default. This will, in turn, entitle it to demand immediate payment and recall any commitments it has made.
Covenants/Undertakings
Similar to representations and warranties, an overdraft facility likely contains a covenant clause. This provision sets out what your business can and cannot do under the terms of the loan. For instance, you may have to file quarterly accounts with the bank. If you breach a covenant, usually, the bank can treat the breach as an event of default.
Overdraft agreements do not typically contain as many onerous covenants as other kinds of loans because it is payable on demand, and the bank has no security. Covenants may also be called undertakings.
Key Takeaways
An overdraft agreement is similar to ordinary loan agreements, but there are a few differences. The key difference is that an overdraft arrangement is unsecured and not committed, which means that the bank is under no obligation to honour credit under the agreement and can demand repayment of any outstanding amounts at any time. It is important to have a lawyer review any overdraft agreement for your business before signing it, to ensure that it is in line with your commercial understanding.