Businesses enter into loan agreements on a regular basis, but it’s crucial that that you review any loan agreement you sign off on.
You may not be able to negotiate the terms if a bank is lending you the capital and you’re running a small or medium business, but you can certainly look around for better terms.
If another company is lending you the capital (for instance to finance a sale), then you’ll have much more scope to negotiate.
This article sets out a checklist of 6 key clauses to keep an eye out for when reviewing a loan agreement.
1. Interest and default interest
Obviously the interest clause is key to the whole loan agreement. The vast majority of loan agreements are either fixed rate, or floating rate. A fixed rate loan agreement requires the borrower to repay interest a set rate, which doesn’t change, regardless of economic circumstances (i.e. 10% fixed).
A floating rate loan requires the borrower to pay interest based on a floating rate which will be calculated by adding a fixed fee to a benchmark rate. In Australia the standard benchmark rate is BBSW, which moves in line with the RBA’s cash rate target.
Whenever the RBA decreases the cash rate target, BBSW will also decrease, and hence the amount of interest the borrower is required to pay will also decrease. The reverse is of course also true. A floating rate loan agreement is more flexible and generally works better for businesses that are exposed to economic fluctuations.
It’s also important you check out the default interest clause. Default interest is charged if a borrower misses a payment on any amount which is due. It’s important that the default interest rate actually reflects the costs to the lender of not receiving payment in time, otherwise it won’t be enforceable.
You need to carefully check whether the loan in question is repayable on demand or at the end of a fixed term. If the loan is repayable on demand, you need to be in a position to repay it at any time. This makes planning your business expenditures extremely difficult. Generally you will want to enter into a fixed term loan.
Simple loans are generally committed, which means that as soon as the two parties enter into the loan, the borrower has the right to draw down on it. More complex loans, however, are uncommitted, which means that the borrower has to provide certain documents and information (known as Conditions Precedent) before the loan can be drawn down on.
If you enter into a loan agreement and later find a cheaper source of funds, you’re obviously going to want to be able to repay the loan as quicly as possible using the cheaper funds. In order to do this, you need to have a prepayment clause drafted into the loan agreement. Sometimes there will be a prepayment fee payable if you choose to prepay. Obviously as a borrower you will want this fee to be as low as possible
Many loans are either secured against the assets of the borrower, or require the borrower to provide a personal guarantee. As a borrower, it’s in your best interests to not provide security, however you are likely to have to pay a higher interest rate if the loan is unsecured.
Finally, it’s important to check if your loan can be syndicated or novated/assigned. Banks will insist of this, as they regularly sell loans, securitise them and repackage them. It’s not generally a bit issue if a bank’s looking to syndicate your loan, but if you’re getting a loan from a company, it’s something you may wish to object to. If a lender sells your loan to one of your competitors, you can be put in a difficult position.
It’s important that you make sure any loan agreement you enter into protects your interests. This checklist can assist, but it’s also important that you have a lawyer review the loan agreement.