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If a bank has offered your business a loan, the terms and conditions of the loan will be contained in the loan agreement. You are probably familiar with some terms, such as the amount you can borrow and interest rate. However, there may be some less familiar terms, such as indemnities and events of default. This article will, therefore, summarise some of the key terms of a loan agreement.
Key Terms
The exact terms in the facility agreement will depend on the type of loan your business intends to obtain. However, many terms and their effect on your business are the same across most loans.
The Facility
The facility is the term that summarises the kind of loan your company will obtain. It will also contain the total amount the bank will make available to your business, called the principal amount.
Conditions Precedent
Conditions precedent are certain things you or the bank must do before the bank will provide your company with the loan. Alternatively, the conditions precedent may describe certain circumstances that must be in place before the contract will have an effect.
Interest
This term will define the interest payment and when your company must make interest payments. Usually, the interest follows the Bank of England’s base rate (0.25%) and then adds a margin. So, for instance, the rate may be the base rate + 5%.
The interest term will usually specify interest periods, which may be one month, quarterly, biannually, or annually. The date you must make an interest payment will usually be when the period ends or some specified time afterwards.
As interest is expressed annually but is often payable at shorter intervals, the amount of interest to be paid will be pro-rated to consider the number of days it takes your company to repay the interest amount.
Fees
Many business loans also contain provisions that entitle the bank to collect a fee for packaging and servicing the loan. The details of this fee, such as if it is a one-off or paid regularly, will be set out in a term of its own.
Repayment, Prepayment, and Cancellation
The facility agreement will usually include one or more terms that specify:
- when the principal amount is to be repaid;
- the conditions under which your company can repay the amount earlier than scheduled (called a prepayment); and
- when the bank can order prepayments (other than in events of default).
Indemnities
Indemnities obligate the borrower to reimburse the bank for certain expenses the bank incurs under certain circumstances. These circumstances will be specified in the facility agreement.
The most common indemnity clause requires the borrower to reimburse the bank for any costs it incurs if the borrower defaults under the terms of the loan. For many loans, there is also an indemnity clause for unauthorised prepayments.
Representations and Warranties
Representations and warranties are promises you make about your company’s performance that you must give the bank when entering into the loan. If you do not keep these promises, you will be liable for breach of warranty. In most cases, this is a serious breach and will qualify as an event of default.
Undertakings and Covenants
Undertakings and covenants are terms that codify other sets of promises you give to the bank. These refer specifically to things your business can and cannot do throughout the life of the loan. Some common examples include:
- not to borrow additional sums of money;
- not to grant other security interests in the company’s property; and
- to maintain certain financial performance indicators.
Like representations and warranties, if you breach an undertaking or covenant throughout the loan, this usually amounts to an event of default.
Events of Default
Events of default are circumstances that, if they arise, allow the bank to terminate their agreement with you. In practice, this means the bank can:
- demand you repay the outstanding amount and any interest due;
- refuse to provide you with any further money; and
- enforce their security over your property if the loan is secured.
Security
Most bank loans are secured, meaning the lender obtains rights to your business’s assets. Hence, if you default under the loan terms and cannot repay the amount, the bank has the right to take possession of that asset and sell it.
While security is a vital part of the loan agreement, you might be surprised to know that most loan agreements do not set out the nature of the bank’s security interest. Instead, details on the security exist in a separate document called a debenture. Therefore, you must review the terms of the debenture to ensure you understand what security you are required to provide.
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Key Takeaways
The key terms in the facility agreement will depend on the loan your business intends to obtain. Above all, you should remember that a loan agreement is a legal contract. If you do not uphold your obligations under the loan’s terms, the bank could pursue various remedies, such as selling your company’s property or suing your company in court.
If you need help with business loans, our experienced commercial 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.
Frequently Asked Questions
The main terms of a loan agreement are the amount of the loan and the interest your company will pay for it. However, there are other important terms like representations and covenants.
If you breach some terms, the effect might be minor. However, if breached, other terms are quite serious, the most serious of which constitute events of default. An event of default allows the bank to call in the loan.
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