Commercial Credit Agreements 101 - ABA YLD 101 Practice Series

By Krishna Walker
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Commercial loans are made for many reasons including to expand a business, to keep a business afloat during naturally slow times in the business cycle, or to purchase equipment.  As a lawyer being asked to draft or review a credit agreement, it is important to remember the relationship between the borrower and lender.  The borrower wants – or maybe even needs – the lender’s capital.    The lender wants the borrower’s business be successful so that the loan can be repaid in accordance with its terms. 

In the traditional lending scenario, a business (usually through the financial officer or head of the company) will approach one or more lenders with business reasons for wanting a loan.  The loan officer obtains information from the business, usually including financial records, budgets, and perhaps financial information about the officers in the business, to determine whether the business is a good credit risk. The loan officer, in turn, submits the credit application to the lending institution’s credit committee.  Based on the loan officer’s recommendation and the bank’s capacity to lend to a borrower with the business’s credit profile, the credit committee will decide the conditions under which the loan can be made.  The final product of the application and approval process is typically a term sheet which states concisely the major terms of the transaction.

Lawyers may be involved during the credit approval process, but it is not unusual for the client (borrower or lender) to approach the lawyer with the term sheet and ask the lawyer to draft a credit agreement that more fully memorializes the agreement between the lender and borrower.  A diligent lawyer will review the term sheet often throughout the drafting process to ensure that the terms agreed upon by the business people are not being altered in the credit agreement.

The following are the typical sections of credit agreements.

Introductory Statement/Recitals
This section of the credit agreement gives a brief background on why the credit agreement exists.  While courts may not necessarily rely upon the recitals for substance if the credit agreement comes under judicial scrutiny, the recitals can certainly provide good context to employees – who may or may not have originally negotiated the loan – reviewing the agreement in year ten of the loan.

Definitions
With large loans, one of the longest portions of the credit agreement may be the “Defined Terms” section.  Here the parties document the meaning of important terms used throughout the credit agreement to avoid misinterpretation throughout the life of the loan.  Definitions may make reference to specific portions of the credit agreement or may contain stand-alone definitions.

Amount and Term
This portion of the agreement sets forth the amount of money borrowed and the length of time for which the money is being borrowed.  Typical provisions in this section include the type of credit facility being extended, the interest rate(s), the length of time for repayment, prepayment rules, and fees.  If the loan is to be secured by collateral, there may be reference to a separate security agreement or mortgage document in this section.

Representations and Warranties
When the lender makes a commitment to lend, it does so only after the borrower has given the lender specific information about itself.  The representations and warranties section, also known as reps and warranties, lists all the characteristics of the borrower that the lender deems material.  As a condition of lending, the borrower promises that everything in the reps and warranties section is true as of the date agreed upon in the credit agreement.  If more than one borrowing is allowed under the credit agreement,  there is typically a portion of the credit agreement that requires the borrower to make the same reps and warranties with each borrowing.

Affirmative Covenants
Where reps and warranties provide for what is true of the borrower as of the date of the credit agreement, the affirmative covenants section provides for what the borrower will do throughout the course of the agreement.  Typical provisions include promises to provide the lender with periodic financial statements, to stay in substantially the same business, and to pay taxes when due.

Negative Covenants
The negative covenants are where the lender often exercises the greatest control over the business operations of the borrower.  Here, the borrower promises not to do certain things such as merge with another company, take out additional debt, or make capital expenditures without permission from the lender.  If the borrower wishes to make carve outs, the borrower will negotiate specific exceptions to the negative covenants and memorialize those exceptions in the credit agreement itself or in a schedule to the credit agreement.

Events of Default
This is exactly what it sounds like.  The defaults section lists a number of actions, which if they occur, will cause the borrower to be in default.  Typical provisions include a borrower filing for bankruptcy, missing a payment, or failing to abide by any covenant.  A diligent borrower’s attorney will attempt to include cure periods – an allotted time for cure of a default – before the default becomes actionable by the lender.

Remedies
The remedies section provides for lender’s remedies should the borrower default on the loan.  The most common remedy for the lender is the right to accelerate the loan, that is make the entire loan due and payable upon default.  If this sounds one-sided, that is because it is.  In most loan transactions, the borrower is likely left to remedies at law and in equity rather than remedies provided for in the credit agreement.

Miscellaneous
The miscellaneous section is where choice of law provisions and arbitration clauses usually lurk.  While it is tempting to gloss over the less glamorous provisions in the miscellaneous section, it is important to make sure that the client understands the ramifications of the various provisions in the miscellaneous section.

Depending on the size of the loan and the resources of the parties, the length of the credit agreement can be anywhere from a few pages to hundreds of pages.  For lawyers without a financial background, the financial terminology may be new and foreign.  Fortunately, there are several free resources online that define financial terms.  Free online resources include http://www.bloomberg.com/invest/glossary/bfglosa.htm, http://www.investorwords.com/, and  http://financial-dictionary.thefreedictionary.com/.    For further information on the legal aspects of commercial loans, the Commercial Finance Committee of the ABA Business Law Section provides numerous resources online and in print.

Resources

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About the Author

Krishna Walker is an Associate in the Real Estate and Banking group of Bryan Cave LLP.  In addition to her membership in the American Bar Association, she is a member of the Bar Association of Metropolitan St. Louis and the Mound City Bar Association.  Ms. Walker can be contacted at 314-259-2651 or krishna.walker@bryancave.com.

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