Key Terms of an Overdraft Agreement in England

For many businesses, the first kind of loan they receive from a bank is an overdraft agreement. This agreement allows your business to draw more cash from its account than it has on hand. While overdrafts are similar to other kinds of loans, there are some expectations to note. This article will explain the key terms of an overdraft agreement. 

Overdraft Agreements

An overdraft is an agreement between your business and its bank that your business can draw from its current account more cash than it has on hand. Overdrafts smooth over any interruptions in a business’ cash flow. From a financial point of view, this is quite advantageous — if not necessary — because your business may need to pay expenses such as wages or invoices, even when you are not making sales or profits. 

Notably, most overdrafts are unsecured. This means the bank does not have rights to your company’s property. Most other bank loans tend to be secured. 

Uncommitted Facility 

Most loan agreements are “committed”. However, overdraft agreements usually are not. 

For your business, this means two things:

1. the bank is not obligated to honour any charges against your current account; and
2. the bank can demand you repay the outstanding amount immediately, even if you are not in breach of any terms of the agreement. 

We will now go on to evaluate some of the key terms of an overdraft agreement. 

Terms Unique to Overdrafts 

The Facility 

Overdraft agreements tend to be unsecured and uncommitted, which is usually not the case for other business bank loans. Typically, these elements will be set out in a single term, called “The Facility”.

In an overdraft facility, it will specify three things:

• the maximum amount of money available on credit under the terms of the loan; 
• a statement that the agreement is uncommitted; and 
• reference to the fact the overdraft is unsecured (if applicable). 

Repayment

An overdraft agreement will also detail the bank’s right to demand repayment of the loan. This provision will usually address:

• how much notice the bank is obligated to give your business; and
• whether the bank will review your company’s ongoing eligibility to make use of an overdraft.

Terms Common to Other Loans 

Conditions Precedent

Conditions precedent are certain actions you or the bank must complete before the overdraft agreement officially begins. At this point, the bank will provide your company with the loan. Alternatively, they may describe certain circumstances that must be in place before the contract will take effect. 

One common example of a conditions precedent is that the borrower must supply the bank with certain documents, such as its constitutional documents and financial records. 

If you fail to meet any of the conditions precedents, the bank has no obligation to loan your company money. 

Interest 

This term will define the interest payment and when your company must make interest payments on its overdrawn bank account. In an overdraft agreement, interest is usually given as a per annum (yearly) figure, as is the case for most loans. 

In an overdraft agreement, the interest term will usually state that the interest will be assessed on a daily basis. Accordingly, each day you utilise the overdraft facility, the bank will charge your bank account interest. 

Default Interest

In the event your company does not make its interest payment, the loan agreement will usually have a term that allows it to collect interest on the missed interest payment. 

For example, if you borrow £100,000 under a term loan with an interest rate of 5% paid annually, you will owe £5,000 in interest. If you miss this payment, you may have to pay 10% per annum on this amount (£500). This percentage will usually be pro-rata the number of days it takes your company to repay the interest amount. 

Fees 

Many business loans also contain a provision that entitles the bank to collect a fee for packaging and servicing the loan. The details of this fee, such as if it is one-off or paid on a regular basis, will be set out in a term of its own.

Representations and Warranties 

Additionally, your overdraft agreement will likely contain representations and warranties. These are certain promises about your company you give the bank throughout the course of the loan negotiation process. If the bank later determines that these promises are not kept, you will have breached the term of the loan. In most cases, this is a serious breach and will qualify as an event of default. 

Key Takeaways 

Overdraft agreements are among the most common loan agreements that banks provide companies. The biggest distinction between overdraft agreements and other loans is that the amount available under the overdraft agreement is not committed, meaning the bank is under no obligation to honour any credit under the agreement. It can also demand repayment, even if your company has not breached any agreement terms.

If you need help understanding the key terms of an overdraft agreement, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us on 0808 196 8584 or visit our membership page.

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