A Loan Agreement (also known as a Facility Agreement) can be a complex document. In order to help you review and understand such a document, we’ve put together a checklist of the most important points to consider. The list is by no means exclusive, but is a good starting point for any review of a Loan Agreement.
The interest clause is clearly one of the more important clauses in a Loan Agreement. There are two main types of interest rates:
- fixed fee rates; and
- floating fee rates.
A fixed fee rate is set at a given number, which will not change during the course of the loan (i.e. 8% fixed). A floating fee rate is based on an interest rate margin added to a benchmark rate (i.e. 3% + the benchmark rate).
In Australia, the benchmark rate used is generally the bank bill swap rate (BBSW). BBSW generally moves in line with the Reserve Bank of Australia’s cash rate target. It’s important to bear in mind that only more complex loans generally use a floating free rate.
Basic loan agreements generally use a fixed rate fee. Interest is normally payable at the either end of each interest period (generally 3, 6 or 12 month period), or at the term of the loan.
2. Default Interest
A well-drafted Loan Agreement will also contain a default interest clause. This increases the interest rate which is payable on amounts which are not paid when they fall due. The default rate must accurately reflect the cost to the lender of the amount not being paid when due. If the rate is excessive there is a risk that it will be deemed a “penalty” rate, and there not be enforceable.
It is important that a Loan Agreement allows the borrower to repay the loan early (make a prepayment). This makes the loan more flexible. Prepayments should only be allowed at the end of an interest period in order to avoid any payment of breakage costs. In certain circumstances, a Loan Agreement should also require mandatory prepayment, such as on the sale of the borrower company.
4. Repayment – On Demand or Fixed Term
One of the major elements of a Loan Agreement is whether it is repayable on demand, or is only repayable at the end of a fixed term. If the loan is repayable on demand, there will be no need for an “Events of Default” clause. This is because the lender can recall the loan at will, meaning there is no need for the borrower to be contractually obliged to maintain certain covenants. If, however, the loan is a fixed term loan, then it will be necessary for the Loan Agreement to contain an “Events of Default” clause.
An Event of Default is simply an event which brings the borrower into default. The definition of an Event of Default is therefore of crucial importance, and will change depending on the type of loan the parties are entering into, the positions of the two parties and many other factors. The major Events of Default you should look out for are:
- Cross Default: whereby a default under any other on demand facilities provided by the lender to the borrower will automatically cause a default under this Loan Agreement;
- Breach of the Loan Agreement: whereby any breach of a term of the Loan Agreement will automatically cause a default;
- Non-Payment : whereby any non-payment of either interest or capital automatically triggers a default (note that this provision will generally include a grace period to cover administrative difficulties); and
- Insolvency: whereby the borrower going into insolvency is an event of default. There are many other Events of Default that a fixed term Loan Agreement will generally include.
5. Committed or Uncommitted Loan Agreement
A loan can be either committed or uncommitted. If a loan is committed, the lender is contractually obliged to lend the loan amount to the borrower once certain Conditions Precedent (CPs) have been satisfied. These CPs will be set out in a schedule to the Loan Agreement. If the loan is not committed there is no need for a CP schedule.
6. Repayment – On Demand or Fixed Term
Another key term relates to the repayment provisions of the Loan Agreement. Is the facility to be repaid on demand or on a set date or schedule? Generally the parties to a Loan Agreement will agree or a fixed repayment schedule, however on occasion, particularly if the borrower has poor credit, the lender may insist on an on demand facility.
7. Secured or Unsecured
The majority of loans, for instance home loans, are secured against an asset (in the case of a home loan it’s obviously the property itself!). In certain circumstances, however, the parties to a transaction may agree to not securing the facility. This generally increases the lender’s risk, which will have a flow on effect to other areas of the agreement (for instance the interest rate may be higher, and the loan may be on demand rather than fixed term).
8. Bilateral or Syndicated
Finally, it’s important to check whether a loan is bilateral or syndicated. A bilateral loan is most common in simpler, more basic transactions. Generally a loan will only be syndicated if the lenders are corporate or investment banks and the amount lent is very significant.