What Are the Legal and Commercial Implications of Lender’s Due Diligence for My Business?

If you want a bank loan for your business, you may be curious about the criteria lenders use to make decisions, such as if they will lend to your business and on what terms. As a business owner, you want to ensure you receive the best possible rates for any loan. This article will explain the steps lenders take before they reach a lending decision so that you can prepare for the process. This article will also explain your legal obligations to facilitate the due diligence process. 

Why Do Lenders Undertake Due Diligence? 

From the bank’s perspective, there are some key questions it needs to answer before deciding to lend to your company. These are whether:

• your company will likely be able to pay back the loan; and 
• the bank will have security over your company’s property if your company defaults on the loan.

The bank will want to inspect your company’s finances and operations to answer these questions. It will also want to know the purpose of the loan. The process of inspecting your company’s performance is known as the lender’s due diligence.

Due Diligence in Loan Transactions

There is no standard due diligence process. Consequently, each bank will have its own protocols. But in general, your company will be appointed a loan or account officer that will be your company’s point of contact with the bank. This officer will prepare a high-level overview of the amount and terms of the loan when it matures and the essential conditions of the loan called covenants. 

The bank will then subject the proposal to credit analysis. To do this, they will request certain information, including your most recent published financial accounts, interim accounts, and other relevant information. 

Your Obligations During Due Diligence 

A bank does not conduct the due diligence process on its own. Instead, the borrower plays an active role as well. As a borrower, you should always try and accommodate the bank’s requests to facilitate the due diligence process. This can make the process more efficient. 

The bank will ask you to affirm certain representations if your company has cleared the due diligence process. These include you affirming that:

• your company is appropriately incorporated;
• the loan agreement will not conflict with any laws or the company’s constitution; 
• the directors have the authority to enter into the loan; 
• your company does not owe any taxes or that the loan will trigger specific tax implications; 
• you have appropriately prepared your company accounts;
• your company is not in default of any other loan agreement or at risk of defaulting under the terms of the present loan agreement; 
• you have not misled the bank throughout the process; 
• you have disclosed the material facts of other loan obligations; and
• your company is not subject to any insolvency proceedings. 

The bank may also ask you to affirm that there is nothing you have disclosed that would change the lender’s decision to lend. This is a catch-all provision, which can impose undue obligations on your company. This is a reason to have an experienced lawyer review the loan agreement!

What is the Outcome of the Due Diligence Process? 

It can be helpful to think of the loan process as a transaction rather than an application you are making based on the fundamentals of your business. For example, you want money to grow your business; the bank wants to earn a return on the loan while remaining confident you will not default. 

If the due diligence process reveals a sufficiently high credit risk, such as an unsustainable cash flow or too much pre-existing debt, they are unlikely to lend. This does not necessarily mean that your business is not successful; it might just mean that risk-averse lenders like a bank may not be the best source of financing. 

On the other hand, if the due diligence process reveals a sound business model with high cashflows and little to no pre-existing debt, they are more likely to lend to you at a lower interest rate and smaller fees. 

Key Takeaways 

Due diligence in a loan transaction is a lender’s investigation to ensure your business is creditworthy. The process requires both the lender and the borrower to engage in constructive dialogue. Consequently, the lender will ask you to supply certain information like accounts and other financial information. If the bank is prepared to lend your business money, it will likely ask you to affirm the information you provided was accurate.

If you need help with your loan agreement, our experienced business lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. So call us today on 0808 196 8584 or visit our membership page.

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