Where a credit institution advances monies on credit to a customer, an obligation to repay will arise. Almost invariably, the lending will be governed by an express or implied contract between the lender and the customer. Subject only to constraints that apply in consumer cases, banks and their customers are free to agree on the terms of loan advances as they see fit.
If no written contract has been concluded, then the loan monies will be almost invariably repayable as a debt due under an implied contract or on restitutionary principles.
A key feature of a loan agreement is the extent to which the bank is contractually committed to provide the loan monies. A non-committed facility is one where the bank has discretion in relation to the advance of monies. A committed facility is one which obliges the bank to provide monies for drawdown at the borrower’s request, in accordance with its terms and conditions.
Commitment and Repayment
The extent of the bank’s commitment also is also reflected in the terms on which repayment may be demanded. If the monies are repayable “on demand,” then no more notice need be given than the time it would take, logistically, to make payment (assuming the money was available) through the payments system. Usually, one to two days will suffice.
An “on demand” loan is very different in nature to one which requires repayment over a longer period. From both the bank’s and the borrower’s perspective, the difference in repayment terms is critical. Lending which is not repayable within a year may comprise part of the borrower’s medium to long term funding. In contrast, lending that is repayable on demand may push the borrower into insolvency at very short notice.
As with contracts generally, a fundamental breach of contract by one party (the borrower) entitles the “innocent” party (the bank) to terminate its obligation (to lend) and to require repayment. The parties to a contract may designate what constitutes a fundamental breach, which entitles the innocent party to terminate (repayment) and to compensation (direct costs and expenses occasioned). Loan agreements usually provide for “events of default” (whether or not so described), the breach of which entitles the bank to demand and require repayment of all sums due, together with elements of compensatory interest and other sums.
Historically, most “on demand” facilities could be refinanced easily with another lender. Indeed, the very pressure of competition meant that the lender was less likely to enforce payment by reason of a technical or even substantial default. However, in the banking market that has existed since 2008, this has not necessarily been so. A customer may be very vulnerable if the lender becomes entitled to repayment of all monies, on demand. Some lenders have extended very considerable forbearance, while others have taken a different approach.
Loan agreements (contracts) are sometimes labelled “facilities” or “commitments.” The loan agreement may be called a loan “offer.” Most such expressions refer to what is ultimately constituted as a contract. The basic terms of lending are governed by the terms of that contract. General principles of contract law apply in relation to the formation of the contract, issues arising in the course of the relationship and its termination.
Under the “parol” (verbal) evidence rule, there is a strong presumption that where there is a written contract document (especially a signed one), that the entire contract terms are incorporated in that document (here, the loan agreement). It is possible in principle to have side agreements, variations, and waivers of contracts constituted by oral exchanges. In a number of recent cases, arguments have been made that the loan contract has been varied by a verbal or other contemporaneous exchange of correspondence so that (for example) recourse is limited to the secured property rather than to the entire assets of the borrower. However, significant evidential obstacles usually arise in proving such variations.
In practice, most loan agreements or facilities fit into a number of broad categories. The three most common types of general purpose loan facilities are: –
- term loans;
- revolving credit facilities.
An overdraft facility is generally a tool to aid cash flow by providing for shortfalls in the working capital cycle. Generally, overdrafts are repayable on demand, although the bank will not generally “call” the loan and “pull the plug” without good reason.
An overdraft will usually provide for a maximum amount which may be borrowed at any time (the limit). There will be a requirement of expectation that the balance is reduced over a particular period. In principle, the amount due should reduce substantially or completely at the end of the flow cycle. It is not intended to remain permanently drawn at its limit.
An overdraft may be constituted under an express agreement, or it may arise by implication from a course of dealing. A bank may formalise an overdraft by the issue of its standard terms and conditions in relation to an informal / implied facility, which was formerly undocumented.
Term Loans I
A term loan provides for an advance of monies and its repayment over time in accordance with an agreed schedule of repayments. It may not be demanded unless there has been an event of default. A term loan is generally for a lump sum advance which has a specific purpose. It may represent short to medium term finance, for the purpose of a particular project or financial need. It should not be used as a substitute for longer-term capital.
A term loan may be available for drawdown for a short time after the period of the execution of the loan agreement (the commitment period). The term loan may provide for an extended availability period during which the loan may be drawn down in a number of lump sums or “tranches.” Later drawdowns or tranches may be subject to particular pre-conditions relevant to the borrowing. By permitting drawdown in tranches, the borrower draws only what it needs.
The loan agreement should deal with the key issues of interest and repayment of capital. The commercial terms of the lending will determine the position. Interest is the price of the loan and will usually be payable on an ongoing basis. In some cases, interest may be rolled up for a period and added to the principal. The method of calculation and frequency of interest charges should be specified. Commonly, interest is charged in accordance with banking conventions.
Term Loans II
Capital may be repayable in regular amounts over the term of the loan. There may be an interest only period, following which capital is paid off over the remainder of the term. Where capital is repayable over a term, it is usually amortised in accordance with tables which seek to provide a constant payment comprised of interest and capital over the remainder of the anticipated term. In the early years of a term loan, the interest element will predominate. Capital payments will gradually make up a larger proportion of the loan over time.
Capital may be repayable by way of regular payments. There may be on or more “balloon” repayments at the end of the term. In shorter term and on demand facilities, capital may be repayable only at the end of the term as a single “bullet” repayment on a particular maturity date.
Once the repayment date arrives, the lender no longer contractually committed to provide the loan / facility. However, it may be rolled over or refinanced with the same lender or another lender.
A revolving credit facility provides for a maximum amount which may be drawn during a certain period. Sums may be drawn down and repaid in tranches depending on cash flow needs. This facility combines the flexibility of an overdraft with the certainty of a term loan.
Each tranche (slice) is borrowed for a relatively short period until repayable. However, provided that there is no default, the tranche can be repaid immediately or rolled over. The loan agreement will provide for notice periods for each drawdown, a minimum and / or a maximum number of tranches and for the timing of the repayment obligation.
A syndicated facility involves a syndicate of bankers participating as lenders in the loan. They are used principally in “big ticket” lending. The syndicate of bankers will participate on agreed terms under contract documentation. The arranging bank negotiates the loan agreement with the borrower. It usually has had a pre-existing relationship with the borrower.
An administrative agent may be appointed in higher value cases. Its duties and responsibilities and its relationship with the syndicate will be determined by the participators contract. The agent will perform certain functions under the contract, which will provide certain rights and protections for the agent. Generally, one syndicate member will hold the security in trust for all syndicate members (trustee security).
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