Once the bank has undertaken a due diligence exercise with respect to the borrower, and the proposed terms of the loan are given credit clearance, a term sheet will be drawn up. The term sheet is the loan facility equivalent of heads of terms on an acquisition which sets out the principal terms of the loan, is usually non-binding and forms the basis of the provisions of the loan agreement (or facility agreement).
The loan agreement will contain a list of conditions precedent (or CPs) which the bank requires the borrower to fulfil before the money may be drawn down. A bank may also require additional reassurance in the form of a legal opinion from the bank’s lawyers confirming the enforceability and validity of the loan documents and any other problematic areas, helping the bank to assess any associated risk.
The bank will require that the borrower gives numerous representations and warranties in the loan agreement similar to those warranties given by a seller in a sale and purchase agreement. The borrower will also make disclosures against the warranties in a disclosure letter in a similar way as on an acquisition. The bank will also require the borrower to give covenants in order to assist the bank to monitor and control the borrower once the loan agreement is executed. These generally consist of: financial covenants, which are financial targets which the borrower undertakes to meet; information covenants, which are promises to provide certain information, such as accounting information, to the bank on a regular basis; and non-financial covenants, such as the negative pledge, which is an undertaking by the borrower not to create any further security over its assets.
Interest will be charged by the bank on the loan in order for the bank to make a profit. If the borrower fails to pay any sum due under the loan agreement, default interest on any overdue amount will be charged by the bank, which will generally be a fixed rate above the usual interest rate payable.
A breach of covenant, representation or warranty or a failure to make a payment when due will usually constitute an event of default under the loan agreement. An event of default is an event which permits the bank to terminate the loan, cancel any commitment and demand repayment of all outstanding principal and interest (known as acceleration). Other typical events of default include late payment of amounts due, default by the borrower under another contract (known as cross default), the insolvency of the borrower, a change of control of the borrower, and a material adverse change (MAC) in the borrower’s position or circumstances which will prevent it from complying with any provisions of the loan agreement. Some events of default, such as the failure of the borrower to make an interest payment, will allow for a grace period (or cure period) of a few days within which to remedy the default.