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Loan Documents For Lessors:
Do You Know What You Don't Know?
Many of our clients take security interests in lessee/ borrower assets other than the financed equipment as additional collateral. The common question is: can we just add a sentence or two to our lease or EFA?
While pretty much anything can be drafted, something more than a couple of sentences is required, especially in the case of collateral for a lease. In some small ticket deals, all that the deal size merits is a short addendum or very brief security agreement (together with the customary lawyer qualifications and seat-covering cover email). For better protection, a proper security agreement is needed.
It is also not uncommon for an equipment finance company to take the step into doing working capital lending or otherwise find the need to document the transaction as a traditional loan. This scenario requires some form of note and security agreement and, in more complicated transactions such as lines of credit, a formal loan agreement.
We find that some of our clients have this documentation readily available. In most cases, new documents must be drafted and the question comes up "what should be in a proper loan and security agreement?" (OK, no one actually asks, but they should, or at least they should know WHY these things are included).
Obviously, there are a thousand variations on this theme, depending on whether the document is merely a security agreement creating a security interest in specific assets or is covering "all assets" and whether loan agreement provisions for multiple closings are necessary. The documentation can be fairly simple, running no longer than the typical EFA, or extremely complicated.
Subject to all the usual mealy-mouthed lawyerish qualifications, here is a very general overview of what you might expect in a properly - drafted short form loan and security agreement.
Opening and Recitals:
Agreement should clearly delineate parties, and basic nature of transaction.
Basic terms:
The Agreement should specify amount of loan (or, if line of credit, maximum commitment), the interest rate and term. If line of credit, the term during which line will remain open should be specified. Use of loan proceeds should be stated. If one or more promissory notes are to be executed, they should be described and a form attached as an exhibit unless only one note will be signed and the Note is executed simultaneously with the loan agreement.
Payment terms:
Unless these are to be covered in a separate promissory note, terms of payment should be clear.
Security:
A first priority security interest should be granted (if this is intended) and the collateral should be clearly specified. The grant should include proceeds, additions, replacements, etc. If UCC terms are used, reference to a state UCC version should be included. The language of this section may vary with the type of collateral. If real estate is involved, additional documentation such as a mortgage or deed of trust will be necessary. If the collateral is to be rented or sold by the borrower, special inventory procedures will be necessary. If accounts are taken as security, and a line of credit is established, the agreement should specify terms under which accounts will be accepted in calculating the borrowing base to determine the amount to be advanced should be specified.
The documents should limit the Borrower's rights to sell or otherwise deal with the collateral, specify its obligations regarding maintenance and movement of the collateral and address a casualty or theft of collateral. This will vary in importance with the type of collateral (a fleet of trucks, for example).
Conditions to Loan(s):
Generally, the Agreement should specify conditions to Lender's obligation to make loans, which may be different for the first and subsequent advances. Among other things, it is customary for:
- All documents to be executed and delivered
- The borrower should be in good standing and a secretary's certificate should be provided attesting to the incumbency of officers signing and the approval of the borrowing by the borrower's board of directors or other governing body. There should be similar requirements for guarantors.
- Special collateral (real estate) will require additional documentation and reports (title examination)
- There should be no material adverse change in the borrower's business or financial condition and no default.
- Evidence of satisfactory insurance is often required.
- All documents and conditions must be acceptable to the lender.
Representations and Warranties:
There is a long list of representations the borrower (and in many cases, the guarantor) should make, many of them backed up by documents to be delivered as a condition to the first or each loan. These include:
- The borrower is duly organized or incorporated, in good standing, and authorized to enter into and perform the obligations without violating any law, agreement or other binding impediment.
- The loan and agreements have been duly authorized, executed and delivered and are legal, binding, valid and enforceable in accordance with their terms.
- The borrower is not subject to any government or private action that would conflict with the loan or borrower's performance.
- There are no legal actions pending or threatened against the borrower that would affect its ability to perform.
- The collateral is free and clear of liens and the borrower has the right to grant a first priority security interest to lender.
- The borrower was formed in the indicated state and is located at the stated address.
- All information furnished by the borrower (particularly financial information) is accurate.
Covenants of Borrower:
The borrower should agree to certain affirmative covenants, including:
- To properly use and maintain the collateral
- To pay taxes, keep the collateral free of liens, and maintain insurance in agreed amounts
- To maintain its existence and not change its form of business or the state of its organization/incorporation
- To furnish required reports and financial information
- To indemnify lender against third party claims
- To furnish additional documents and assurances when requested
- To maintain agreed financial ratios, net worth targets and other financial covenants
- To permit the Lender to inspect books, records and collateral and to file UCCs
Defaults and Remedies:
The Agreement should specify that certain actions and events are defaults and provide adequate remedies for the lender. These defaults (which in some cases should include similar events as to any guarantor) include:
- Failure to pay principal or interest or any other amount due
- Breach of any representation, warranty or covenant (which may or may not include a brief cure period)
- Default on other obligations to lender or to others (this is often negotiable, with lender agreeing to some floor amount or other limitation)
- Change in management or business
- In some cases, material adverse change or the lender's becoming insecure as to the borrower's performance (often a sticking point for borrowers)
- Bankruptcy or reorganization
Remedies should include all those permitted by law, including UCC remedies as to any collateral, the right to accelerate payments on the note and specific remedies as to collateral. Remedies should be cumulative and borrower should agree that exercise of any one does not constitute an election not to exercise others.
Miscellaneous:
- Notices - specific means of communication and all to be in writing
- Governing law AND place for litigation to take place
- Waiver of jury trial
- Right of lender to assign its interest in the loan.
- Entire agreement (no other agreements except as specified, no oral agreements or modifications)
- Waiver of borrower right to claim ambiguities should be resolved against the draftsman
- Right to sign in counterparts, protection of chattel paper, severability of clauses if one found unenforceable
- General terms of construction (inclusion of plurals and genders).
- Usury savings clause (important for high yield loans)
- Right to perform for borrower (buy insurance, remove liens, etc.)
- OFAC and any other government-mandated programs (may depend on borrower)
This checklist is furnished to enable the reader to make a cursory examination of form or sample loan documents and determine the professionalism of the draftsman. It contains only very general information, does not purport to highlight all important issues and does not address important issues regarding wording. It is not a substitute for review by counsel. In many cases, issues may be addressed by other language in document as there are no "standard" forms.
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