Finally this month we consider revolving credit facilities. In many ways, a revolving credit facility shares features of both a term loan and an overdraft which have both been discussed in previous issues.
Common features of revolving credit facilities
A revolving credit agreement is similar to a term loan because it is usually a committed facility that provides a maximum amount of capital over an agreed period. (A committed facility is one that once the facility agreement has been executed, the lender is under an obligation to advance money when requested by the borrower, subject to compliance with certain pre-agreed conditions by the borrower.)
However, it is also similar to an overdraft because the distinguishing feature of a revolving credit facility is that the availability period extends for almost the entire life of the loan (except at the end when the final tranches need to be repaid). This means that the borrower may draw and repay tranches of the available funds whenever it chooses throughout the life (or “term” as it is commonly known) of the loan.
The revolving element of the loan facility is reflected in the fact that the borrower may take a tranche for an interest period and at the end of that interest period decide whether to repay that tranche or "roll over" into the next interest period, provided that an event of default has not occurred and is continuing.
Further funds can be drawn down at any time with interest periods running in parallel. As with term loans, the borrower must give the lender a drawdown notice and the borrower must specify its chosen interest period. Interest periods are usually 3 or 6 months long.
Revolving facilities tend to be used if a borrower requires a substantial advance but gives the borrower greater flexibility than if it used a term loan.
Advantages of a revolving facility
A revolving facility is usually a committed facility but its advantage from the borrower’s perspective is maximum flexibility; it can draw as much or as little as it requires at any time, and if cash flow is sufficient it can repay outstanding tranches that are no longer required and thereby reduce its borrowing costs.
Disadvantages of a revolving facility
A revolving facility is likely to include more restrictions than an overdraft. For example, there may be minimum notice periods before a sum is advanced; the lender may set upper and lower limits on the amounts which may be drawn at any one time or the number of interest periods that may exist in parallel at any one time (in order to reduce the administrative burden on the lender) and the lender may reduce the available funds towards the end of the term. As the availability period for draw downs is long, the total commitment fees will be higher. (Commitment fees are fees payable to a lender on available but undrawn amounts and is calculated as a percentage of those undrawn funds from time to time. The commitment fee is not as much as interest because the lender is not actually taking any risk on the money.)
Friday, February 17, 2012
Types of Loan Agreements: Revolving Credit Facilities
Thursday, January 5, 2012
Contractual Set-off Clauses in Loan Agreements
Where two parties owe each other money, it often makes sense for one of the parties to employ the concept of ‘set-off’ to reduce or eliminate its liability to the other party.
For example, assume that Party A owes RO 100 to Party B under a loan agreement; but that Party B also owes RO 60 to Party A under a separate (and perhaps unrelated) arrangement. In this scenario, Party A could in theory ‘set-off’ the RO 60 that Party B owes to him against the RO 100 that he owes to Party B – with the result that Party A now owes RO 40 to Party A (original debt of RO 100 minus set off of RO60 equals remaining debt of RO 40) and Party B no longer owes anything to Party A (original debt of RO 60 minus set-off of RO 60 equals zero).
Of course, for this to work in practice, Party A also must have the legal right to employ such a set-off mechanism. Such a right can arise by force of law, or by contract.
In the United Kingdom and certain other jurisdictions, there is detailed legislation and case law specifying various types of set-off available, for example:
• Legal set-off – a defence to a court action where more than at least one claim and cross-claim is being contested;
• Banker’s set-off – where a customer has more than one account with a bank, at least one of which is in debit and one in credit;
• Equitable set-off – available to a debtor where his cross-claim arises from the same or a closely related transaction;
• Insolvency set-off – often triggered by a party’s entry into liquidation; and
• Contractual set-off – where set-off is included as a provision of a contract.
In Oman, while the Law of Commerce (Royal Decree 55/90) does contemplate the set-off concept, as a practical matter set-off rights frequently arise as contractual rights – e.g., via set-off clauses in loan agreements governed by English law, or by the laws of another foreign jurisdiction.
The contractual set-off rights often found in loan agreements typically will allow the lender to set off a matured obligation due from a borrower against any matured obligation owed by the lender to that borrower, regardless of the place of payment or currency of either obligation. If the obligations are in different currencies, the lender often may negotiate the right to convert either obligation at a market rate of exchange in its usual course of business for the purpose of the set-off.
The result of exercising a contractual right of set-off is similar to enforcing security. However, set-off is a personal right rather than a proprietary right; unlike a security right, it does not grant an interest in the counterparty’s property.
It should also be noted the Omani Courts are unlikely to apply a set-off unless a contractual set-off scenario exists.
Finally, it is important to note that set-off provisions in loan agreements often favor the lender over the borrower. While set-off clauses in commercial contracts often will apply symmetrically (e.g., permit or prohibit set-off altogether), in many loan agreements the right of set-off is accorded only the lender, with the borrower prohibited from setting off any amounts owed to it by the lender.
Friday, April 8, 2011
Events of Default in a Loan Agreement
There is typically an ‘events of default’ clause in every loan agreement, except for those loan agreements relating to an overdraft facility only. (An overdraft facility is simply repayable on demand by the lender so no events of default are required.)
The events of default clause sets out the events or circumstances that will give the lender the right to accelerate the repayment of the loan (i.e., declare the loan due and payable before the scheduled repayment date), cancel any further loan installments due under the loan agreement and/or declare the loan immediately due and payable. In addition, the lender will have the right to enforce any security. These are clearly drastic powers which should only be exercisable while a default is continuing, and should cease once the default has been remedied or waived.
There may be a large number of triggering events or circumstances – perhaps twenty or more – listed in the events of default clause. Typically, the clause would include at least the following as events of default:
This article explores two key events of default from the above list – cross-default and material adverse change – in further detail.
Cross-Default
A cross-default provision allows the lender to call a default under the loan agreement when there is a default between a third party and the borrower in relation to any other agreement, even if such third party does not choose to exercise its right to call a default under the other agreement. The lender could be in a difficult position if the borrower defaults under other agreements (particularly other facility agreements) and the lender is unable to protect its own position. The lender will clearly need to know that the borrower is in default under the other agreements, therefore, the information undertakings in the loan agreement should include requiring the borrower (i) to notify the lender if there is a default under the loan agreement, and (ii) to confirm to the lender (following a request from the lender) whether there is a default at such time.
For the borrower, it is important to ensure that the scope of this provision is limited appropriately because a technical breach of one agreement could trigger cross-defaults in other agreements, creating a domino effect with serious consequences. The borrower should ensure that the provision is subject to a threshold de minimis amount (which amount would depend on the borrower, the size of the loan and the other agreements). The cross-default provision should also be limited to other agreements relating to borrowings, or perhaps to a wider class of financial indebtedness, but should exclude trading contracts where there could be late payments or other breaches in the ordinary course of performance of those contracts. There should also be no default if the relevant debt is being disputed in good faith, or is paid within applicable grace periods, and there should be time to pay amounts repayable on demand.
Material Adverse Change
However, from the borrower’s perspective, the uncertainty that a material adverse change provision introduces can be problematic and, while it may rarely be used by the lender to call an event of default, there are occasions where such provisions have been used to freeze facilities. At the very least, it can give the lender leverage (e.g., to impose a tough deal or higher pricing) in negotiations with a borrower which is in a difficult situation. Generally, a borrower should seek to ensure that any material adverse change provision (i) is not triggered by deterioration in the condition of individual companies, but only by deterioration in the condition of the group as a whole, and (ii) is limited to something which materially affects the ability of the borrower to comply with its payment obligations under the loan agreement.
The material adverse change provision is usually very broadly drafted to protect the lender from any unforeseen adverse change. There will often be specific events of default to cover the areas of concern that the lender can foresee. The broad nature of this provision means that a lender is often reluctant to call a default based on it, as it is not clear-cut whether it has been breached or not. Lenders usually prefer to call a default following a non-payment as there is no room for discussion as to whether the payment has been made or not – it is just a question of fact.
