Loan Agreements: The Nitty-Gritty (Part II of III)

Introduction

In Part I of this series we took a look at the contracting parties to a loan agreement and the commercial details of a loan. Once the parties have agreed on the commercials of the loan, the lender generally prepares the relevant loan documents detailing the standard commercial terms and conditions on which the lender is willing to extend the loan to the borrower as agreed.

The standard terms will include various representations, warranties and undertakings.

Representations and warranties

Representations and warranties relate to a variety of legal and factual issues which are included in the loan agreement to address particular risks in relation to the loan and the borrower.

The standard representations and warranties required by lenders will include confirmation of:

• the legal status and capacity of the borrower and their power to own assets and carry on a business
• the power and authority of the borrower to enter into the loan agreement and accept the loan
• the validity, legality and enforceability of the obligations of the borrower under the loan agreement
• non-conflict between the loan obligations and any other obligations of the borrower or any applicable law
• no default being outstanding under any contract to which the borrower is a party which may have a material adverse effect on the present loan
• the borrower not being aware of any actual or threatened legal proceedings against it

Representations and warranties are made on the date that the loan agreement is signed. In addition, certain of these may be deemed to repeat on certain dates, such as the date on which a utilisation request is issued or an advance of the loan capital is made.

Should any of the representations and warranties included in the loan agreement be untrue or misleading in any material respect on the date on which they are expressed to be given, then such misrepresentation will give rise to an event of default under the loan agreement.

Undertakings

Undertakings to be given by a borrower under the loan agreement require the borrower to engage in, or refrain from, specified actions, and are aimed at minimising  the likelihood that the initial risk profile compiled by the lender is adversely  affected during the life of the loan.

The standard undertakings required by lenders can be categorised as follows:

• Information undertakings

Lenders need continuous information in respect of borrowers and their businesses in order to evaluate the financial stability of the loans granted. The information undertakings set out the requirements for information to be delivered to lenders and may require the borrower to:

• deliver semi-annual/annual financial statements
• notify the lender of the existence of a default
• notify the lender of material litigation
• deliver information when reasonably requested

• Financial covenants

Lenders may wish to measure and monitor the financial condition and performance of a borrower through the use of financial covenants. Inclusion of these undertakings will depend largely on the borrower’s creditworthiness and the risk analysis of the loan provided to the borrower. Financial covenants may include:

• Interest cover ratios
• Debt cover ratios
• Cashflow cover
• Minimum net asset value

• General undertakings

The loan agreement will include various restrictions in relation to the operations of the borrower’s business which will remain in force throughout the term of the loan. General undertakings may require the borrower to:

• comply with applicable law
• only make a substantial change to the general nature of their business after procuring the lender’s consent
• refrain from allowing any security to exist over their assets
• refrain from disposing of any asset other than in the ordinary course of business

Any breach of an undertaking will, subject to the expiry of any applicable grace period to remedy, give rise to an event of default under the loan agreement.

Qualifications, limitations and exceptions

Borrowers are urged to pay close attention to the type of qualifications, limitations and exceptions included in respect of the many representations, warranties and undertakings included in the loan agreement in order to ensure that the loan is operationally workable. Borrowers would also need to consider whether these terms are applicable to themselves or to each member of the group of companies that it forms part of.

The qualifications or limitations can take on the form of a reference to materiality or the borrower’s knowledge in respect of a specific matter. Specific exceptions relating to the borrower’s activities may also need to be included as the standard terms may not fit the borrower’s circumstances. The borrower can also require that a “basket” exception with reference to a maximum amount is included in order to allow the borrower to take restricted actions, provided that the value of the action does not exceed the specific value agreed.

Conclusion

The representations, warranties and undertakings included in a loan agreement are therefore of particular importance to borrowers and, due to the serious implications of misrepresentation and non-compliance, a borrower must ensure that they are able to comply with these provisions before concluding a loan agreement.

In Part III of this series we will shine a light on the dark side of a loan agreement that may come back to haunt a borrower should a default under the loan agreement occur,as well as  the remedies available to lenders in such instances.

Nadia Smith

Nadia has a BCom and LLB and was admitted as an attorney in 2006 after having completed her articles at Jan S De Villiers Attorneys (now Werksmans). Nadia then joined Freshfields Bruckhaus Deringer LLP in Amsterdam as an associate for 4 years before returning to ENS Africa as a senior associate in the banking and finance department. Nadia joined Caveat in 2015 focusing on corporate and finance law.