Loan Provisions Notes

Loan Provisions

Purpose clause and illegality

• Restricts borrower to agreed and legal purposes only.

• Violation = default of contract --> monies subject to a resulting trust in favour of lender (advantage on winding up).

• If lender aware of illegality --> English law sees loan as void and unenforceable and will disallow action to recover funds.

  • Cf. subsequent illegality of initially lawful agreement = lender can recover the funds.

The Facility

• Term loan = short period for drawdown ('availability period') - cf. RCF

  • Or may be available in separate facilities/tranches with different characteristics.

Lender's obligation to lend (only in syndicated facilities)

1. Several obligations as between lenders in the syndicate (members responsible for their own commitment only)

2. Separate loans ('proportion' = ratio of commitment against total syndicate commitments)

   • E.g. total syndicate loan of 25m. 5 banks agree to lend 5m each. If borrower draws down 20m, each lender will have a participation of 4m.

Conditions precedent

• CPs required will be determined by the due diligence (will be set out in a schedule to the agreement)

  1. CPs to the first utilisation (documentary in nature)

  2. CPs to each subsequent utilisation (representations repeated as still being true - exact representations to be repeated will be negotiated)

Function

• Lender's obligation to advance funds will be subject to CPs.

• CPs will be checked before completions - e.g:

  • Constitutional documents

  • Legal opinion(s)

  • Insurance policies

  • Financial information and auditors reports

  • Licences/consents relevant to borrower

  • Board resolutions and corporate authorisations

  • Compliance with 'know your client' requirements (usually lender's compliance team do this)

• Evidence that all fees have been paid

• Unique CPs for each transaction

• Can waive CPs or create 'conditions subsequent' which must be met within a certain time following completion.

• When acting for borrower, check:

  • Time limits

  • Approvals

  • Control

Interest and Interest Periods

• Term loans = interest during Availability Period until Maturity Date (successive interest periods)

• RCFs = each advance has its own interest period --> at the end of which the advance is either repaid or rolled over

Floating rate

• Cost of funds (LIBOR) - costs will form part of overall interest rate.

  • "Floating rate" since interest will fluctuate as LIBOR fluctuates

  • LIBOR rate fixed on the first day of each interest period until the end of that period

  • To avoid mandatory costs, a bank can set interest according to its own base rate (tracking the Bank of England BR)

• Margin = actual profit made by the bank

  • Fixed on top of LIBOR or the base rate

• Mandatory costs

  • Costs of compliance with regulators - lenders can:

    1. Use existing mandatory costs schedule

    2. Require each syndicate lender to calculate its own costs

    3. Remove mandatory costs as separate calculation and incorporate into margin

Fixed rate

• Provides certainty but also risky since the market may fluctuate above fixed rate

• Fixed rate tends to be higher than floating rate

Variable rate

• Variation on the fixed rate - according to pre-assigned schedule rather than the market.

• E.g. 8% for the first year, then 6% for the next 3 years and 5% thereafter until the end of the term of the loan.

Default interest

• Expressed as a fixed rate above the normal contractual rate.

  • Deterrent

  • Cover administrative costs of pursuing borrower

  • Reflect change in credit risk

  • Cover additional borrowing costs of lender & compensate

• If challenged - default interest clause may be deemed unenforceable as a penalty

  • Must be proportionate to legitimate interest of the lender (cannot be too high)

Fees (paid by the borrower)

• Commitment fee

• Arrangement fee/participation fee (arranger's front end fee) - % of overall amount

  • Arranger decided how much each lender in syndicate is to receive as a participation fee.

• Agent's fee (for administrative services)

  • Normally paid annually but can be paid quarterly

• Underwriting fee (paid to arranger if loan underwritten)

• Security Trustee fee

Withholding Tax and Tax Gross up

• Interest = lender's income on which it is liable to pay CT.

  • Tax must be deducted at source by borrower and paid to HMRC (withholding tax - 20%)

• s.879 Income Tax Act 2007: any borrower paying interest to a UK bank within the scope of corporation tax will not have to withhold tax and can pay interest to that bank gross.

  • NB. International transactions & impact of double taxation treaties which may also allow lenders to receive interest gross.

• Tax gross up clause: ensures that if withholding tax has to be paid, lender will still receive interest as if no withholding tax was paid (extra cost for borrower).

  • But at present, this clause is only a contractual protection against a change in law.

• Under a syndicated loan, the agent will calculate the amount of interest due to each syndicate member separately.

  • Some lenders may be subject to withholding tax.

Protections for borrower

• Borrower may be entitled to receive the amount paid to HMRC if the lender receives an equivalent amount in the form of a tax credit.

• Borrower may also have the right to prepay the affected lender if withholding tax would be required in future.

Increased costs

• Needed in case legislation increases lender's underlying costs.

• Included any change excluding:

  • Change in tax law

  • Change caused by lender's own breach of loan agreement

  • Where charge is already passed onto borrower as part of mandatory costs

• May include Basel III changes

Representations

• "Representations" and "warranties" used interchangeably for loan agreements.

• Statements of fact about the borrower and their business.

  • Misrepresentation under a loan agreement = event of default

  • Borrower discloses any representations it...

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