Introduction: Loan Agreement
A loan agreement is a contract between a borrower and a lender which regulates the mutual promises made by each party. There are many types of loan agreements, including “facilities agreements,” “revolvers,” “term loans,” “working capital loans.” Loan agreements are documented via a compilation of the various mutual promises made by the involved parties.
Prior to entering into a loan agreement, the “borrower” first makes representations about his affairs surrounding his character, creditworthiness, cashflow, and any collateral that he may have available to pledge as security for a loan. These representations are taken into consideration and the lender then determines under what conditions (terms), if any, they are prepared to advance money.
Loan agreements, like any contract, reflect an “offer,” the “acceptance of the offer,” “consideration,” and can only involve situations that are “legal” (a term loan agreement involving heroin drug sales is not “legal”). Loan agreements are documented via their commitment letters, agreements that reflect the understandings reached between the involved parties, a promissory note, and a collateral agreement (such as a mortgage or a personal guarantee).
Loan agreements offered by regulated banks are different from those that are offered by finance companies in that banks receive a “banking charter” granted as a privilege and involving the “public trust.”
Loan agreements are usually in written form, but there is no legal reason why a loan agreement cannot be a purely oral contract (although oral agreements are more difficult to enforce).
Types
For commercial banks and large finance companies, “loan agreements” are usually not categorized although “loan portfolios” are often broadly characterized into “personal” and “commercial” loans while the “commercial” category is then subdivided into “industrial” and “commercial real estate” loans. “Industrial” loans are those that depend on the cash flow and creditworthiness of the company and the widgets or service that it sells.
“Commercial real estate” loans are those that repay loans but that depend on the rental revenues paid by tenants who lease space, usually for extended times. More granular categorizations of loan portfolios exist but these are always variations around the larger themes.
The loan agreements originated by commercial banks, savings banks, finance companies, insurance organizations, and investment banks are very different from each other and all feed a different purpose. “Commercial banks” and “Savings banks,” because they accept deposits and benefit from FDIC insurance, generate loans that incorporate the concepts of the “public trust.”
Prior to interstate banking, that “public trust” was easily measured by State bank regulators who could see how local deposits were used to fund the working capital needs of local industry and businesses, and the benefits associated with those organization’s employment.
“Insurance” organizations, who collect premiums for providing either life or property/casualty coverage, created their own types of loan agreements. “Banks” and “Insurance” organizations’ loan agreements and documentation standards evolved from their individual cultures and were governed by policies that somehow addressed each organizations liabilities (In the case of “banks,” the liquidity needs of their depositors; in the case of insurance organizations, the liquidity needs associated with their expected “claims” payments).
“Investment banks” create loan agreements that cater to the needs of the investors whose funds they attempt to attract; “investors” are always sophisticated and accredited organizations not subject to bank regulatory supervision and the need to cater to the public trust. Investment banking activities are supervised by the SEC and their main focus is on whether the correct or proper disclosures are made to the parties who provide the funds.
Types of Loans:
• bilateral loans
• syndicated loans
Categorizing loan agreements by type of facility, usually results in two primary categories:
• term loans, which are repaid in set installments over the term, or• revolving loans (or overdrafts) where up to a maximum amount can be withdrawn at any time, and interest is paid from month to month on the drawn amount.
Forms of loan agreements vary tremendously from industry to industry, country to country, but characteristically a professionally drafted commercial loan agreement will incorporate the following terms:
1. Parties to contracts with their addresses
2. Definitions or interpretation provisions
3. Facility and purpose
4. Conditions precedent to utilization
5. Repayment provisions
6. Prepayment and cancellation provisions
7. Interest and interest periods
8. Provisions dealing with gross-up in relation to any withholding imposed
9. Payments provisions
10. Representations of the borrower
11. Representations of the lender
12. Covenants of the borrower
13. Events of default
14. Remedies in the event of default
15. Provisions for penalties and liquidated damages
16. For syndicated loans, provisions relating to the facility agent and security agent and voting of the lenders
17. Formulae for calculations
18. Provisions for fees of the lenders
19. Provisions for expenses
20. Securitization provisions
21. Amendments and waivers provisions
22. Covenants relating to changes in parties
23. Set-off clause
24. Severability clause
25. Counterparts clause
26. Addresses for notices
27. Language provisions
28. Choice of law clause
29. Forum selection clause
30. Appointment of a process agent
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