Structuring Loan Agreements - Elsevier

Structuring Loan Agreements - Elsevier

Structuring Loan Agreements Post Restructuring Provisions Preamble Amount and term of the loan Representations and warranties Conditions of lending Provisions

Default Provisions Description of collateral Covenants of the borrower Miscellaneous Preamble and Description The preamble sometimes does little more than name lenders and

borrowers, stating that an agreement has been entered into Statement of purpose may be included, as well as commitment fees, interest rates, prepayment rights and a definition of terms used in the agreement Amount and Term of the Loan Sets forth the amount of the loan, the manner in which the borrower may draw down amounts, the interest rate, fees, maturity dates,

and the provisions relating to prepayments If the commitment agreement supports a term loan, it will call for periodic equal payments Amount and Term of the Loan However, provisions are sometimes made for a balloon payment or "bullet payment" at maturity. Balloon payments require periodic equal payments made with a larger lump sum payment due at the end of the term loan. Similar to a

balloon payment, a "bullet payment" sometimes includes a provision requiring cash flows from operations or asset sales above a predetermined amount to be earmarked for loan amortization to reduce the balloon or bullet portion of the loan. Representations and Warranties Refers to the possession of adequate licenses, patents, copyrights, trademarks, and trade names to conduct business in addition to the economic,

financial, and legal circumstances prevailing at the time the original credit decision was made Representations and Warranties Is/does borrower legally incorporated. In good standing. has the power to make the agreement, execute the notes and to perform. submit financial statements that are correct and reflect the borrower's true financial

condition. is permitted to borrow under the borrower's charter and by laws, governmental regulation, and other agreements as authorized by the board of directors. Conditions of Lending This article is concerned with the conditions that must exist and the representations that must delivered to the lender in order to make the commitment binding. Before disbursing any monies under the loan, legal counsel must be satisfied with the documents submitted by the borrower which including:

Charter and by laws Conditions of Lending Resolutions adopted by the company's board of directors authorizing the contemplated transaction, together with any other required resolutions (for example, authorizing hypothecation of collateral, insurance, or

guarantees). Certificates of good standing from those jurisdictions where the major properties of the borrower are located or a substantial portion of the borrower's business is transacted. Copies of all consents and approvals which might have had to be obtained. Copies of other debt instruments to which the borrower might be subject. Conditions of Lending Copies of all consents and approvals which might have had to be obtained.

Copies of other debt instruments to which the borrower might be subject. Conditions of Lending On the financial side of the conditions precedent, lender should have obtained a signed copy of the loan agreement and note(s) to be issued in those instances where collateral is to be pledged, appropriate instruments should have been executed and, if

applicable, the collateral should be in the hands of the lender Conditions of Lending On the financial side of the conditions precedent, lender should have obtained a similar consideration evolves around the execution and delivery of guarantees certifications should also be obtained when a contemplated loan is part of a larger financing program involving the raising of additional capital funds, the discharge of other indebtedness, or the prior investment of the

borrower's own funds in a venture to be financed partly by the contemplated loan. Default Provisions All term loans have default provisions under which the long-term lender has the right to accelerate the payment of the loan This is mandated with an acceleration clause

which states that if certain conditions are not met, the total loan is immediately due, or at the very least, gives the bank the right to renegotiate the terms If such a clause is excluded from the agreement, the bank is obliged to wait until each installment is due before legal action can be taken against the borrower. The fact that the right exists does not mean that it is always used, but it does give lenders flexibility at a time when they need room to maneuver. Loan Covenants The

basic covenants in every term loan agreement should he constructed around these three principles: Limitation of other indebtedness. Prohibition of secured obligations or of obligations ranking ahead of the commercial term loan. A provision for the maintenance of a certain minimum working capital. Furnishing financial statements. Affirmative Covenants Bank furnished with financial statements periodically with any relevant information

as requested. Borrower carry insurance satisfactory to the bank to reduce those risks that are insurable. Borrower to maintain working capital at or above a stated amount. Management that is satisfactory to the bank Banks often require that key man insurance be carried on those people in responsible positions who cannot be readily replaced. Description of Collateral When the loan is a secured loan, the

agreement sets forth a detailed description of the collateral and how it is to be handled If the collateral consists of securities, the agreement normally specifies who is to receive the interest or dividends, who is to have the right to vote the stock, under what conditions the securities are to be sold, and if sold, who is to receive the proceeds from the sale Negative Covenants Objectives: prevent a dissipation of assets that would weaken the firm's financial strength, and the assumption of

obligations (definite or contingent) that might reduce the borrower's ability to repay the loan. Negative covenants are particulars the borrower agrees not to do during the life of the loan unless prior consent is obtained from the lending bank. Negative Covenants Example, if a borrower agrees not to pay dividends, it cannot

happen by accident that dividends are paid Financial ratios are usually treated as negative covenants Borrower agrees not to pledge assets as security to other lender Borrower aggress not to sell receivables Prohibitions regarding merger and consolidation, except with the approval of the bank, are also generally included for the bank's protection To assure that the productive ability of the concern remains intact, a prohibition is usually included against the sale or lease of substantially all of the borrower's assets

Not to make loans to others or to guarantee, endorse, or become surety for others Negative Covenants Prohibitions regarding merger and consolidation, except with the approval of the bank, are also generally included for the bank's protection To assure that the productive ability of the concern remains intact, a prohibition is usually included against the sale or lease of substantially all of the borrower's assets Not to make loans to others or to guarantee, endorse, or become surety for others

Restrictive Clauses and/or Secondary Covenants Restrictive clauses and/or secondary covenants seem similar to negative covenants but are basically different .Negative covenants in general prohibit certain acts of management, while restrictive clauses permit certain acts but restrict their latitude. Restrictive Clauses and/or Secondary Covenants

Prohibition of the sale, discount, or other disposition of accounts receivable with or without recourse. Prohibition of changes in other debt instruments. Limitation of prepayment or redemption of other long term debt. The purpose of such a provision is to prevent the bank from being the last to be repaid. It also prevents the firm from using the bank's funds to pay off some other lender. If a borrower owes long-term debts to others, a

limitation may be placed on the amount that may be retired annually without also retiring a portion of the term debt owed to the bank. Restrictive Clauses and/or Secondary Covenants Prohibitions on mergers or consolidations, asset sales, and acquisitions. Prohibitions on investments in other enterprises. Limitations on capital expenditures. The purpose

of this limitation is to prevent the firm from overextending itself. The amount that can be invested will vary considerably but may be limited to the company's annual depreciation charges. Limitations may also be placed on salaries, bonuses, and advances to officers and employees, as well as to others. The limitation on salaries and bonuses is a way of forcing a borrower to "tighten his belt" until he has adequate capital funds Restrictive Clauses and/or Secondary Covenants

Limitations on dividends. The restriction on dividends may be in terms of a certain percentage of cumulative earnings, or it may be specified that dividends not be allowed to reduce retained earnings below a certain level. Restrictive Clauses and/or Secondary Covenants Limitations on treasury stock purchases to prevent a weakening of the firm's financial strength. Restrictions on the purchase of securities, with the usual exception of United States government

obligations. This limitation is designed to prohibit speculation in securities. The Miscellaneous Section The final section sets forth any matter to be specified that does not logically fall in one of the previous sections. It includes where notices to borrowers or lenders shall be sent, what law governs the agreement, the duties of the agent bank in

syndicated loans, and the borrower's agreement to pay certain expenses.

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