Lending agreements can be quite restrictive on borrowers. If your business is entering into a loan agreement, this article outlines some key considerations for borrowers.
1. Consequence of a breach
Loan agreements typically contain the right to 'accelerate' the loan should a term of the agreement be breached. This means that the entire amount of the loan is immediately due and repayable. For many borrowers in long term debt arrangements, this could cause significant financial distress, and in some cases, result in an insolvency situation. This is why it is imperative that the terms of the loan agreement are carefully considered before it is entered into to ensure that:
- they are not going to be easily breached by the borrower; and
- that the lender's right to accelerate the loan is delayed where possible – for example, a borrower may be able to negotiate grace periods whereby they could remedy any breach, or by including exceptions to give the borrower more freedom to operate before a breach occurs.
2. Changes to shareholding: an often overlooked trigger
A significant change in shareholding can sometimes trigger immediate repayment of a loan (the so called 'change of control' clause). These provisions are often included in loan agreements as they give the lender the ability to exit the loan if they are unhappy with the identity of the new shareholders. It is important to consider the change of control clause carefully when negotiating a loan, and to be aware of its existence if, for example, there are any changes to the shareholder base (such as investment rounds and other share issues) happen during the term of the loan. If you know your change of control clause is likely to be triggered by a transaction, it is often possible to obtain consent from the lender in advance to the change in shareholding and agreement to waive their right to be repaid.
3. Restrictions on the borrower
Loan documentation often contains unexpected and onerous restrictions which are surprising to those who are unfamiliar with these documents. These may include:
- restrictions on incurring further debt, which may include hiring vehicles, employee loans, and loans to directors and shareholders;
- restrictions on payments of dividends to shareholders; and
- restrictions on disposing of assets.
Breaches of these restrictions give the lender the right to 'accelerate the loan' (as mentioned above). It is key for the borrower to carefully consider what it may need during the life of the loan and include it in the documentation at the outset.
4. A new lender? Not without our consent!
Loan agreements often contain a right for lenders to assign the loan agreement to a new lender. Lenders want the ability to freely exit the loan, for example, if their appetite towards a particular sector changes. Borrowers, on the other hand, may want to consider whether they are happy to let the loan be freely assigned to any party without their consent – wishing to avoid transfer to an unscrupulous lender who you may not trust to be reasonable should a breach occur. So, in a well negotiated loan agreement it is common to find a provision which requires the borrower's consent to the lender assigning the loan.
5. Read (and negotiate!) your documents
Given the potential devastating impact of a breach of a loan agreement, and how restrictive their terms can be, it is imperative that these agreements are carefully considered, and where possible, negotiated to allow the borrower to operate in its ordinary course of business throughout the life of the loan. Any big events, such as a significant change in shareholding or large disposal, will need lender consent, which is usually given if the request is reasonable.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.