Loan Documents & Small Business – What Does All That Fine Print Mean!?!
Credit is the lifeblood of small businesses. In the rush to obtain a loan, small business owners often sign loan documents that are unnecessarily onerous in their terms. In fact, in Hampton Roads, many small businesses enter into fairly complex loans without being represented by counsel. Signing standard or form documents can have a devastating impact on the future of a small business. Area lenders usually have their own documents, and nearly all contain certain basic terms, however, these documents vary widely in how those terms apply to the borrower. It is the responsibility of the borrower’s counsel to not only explain these terms to his or her client but also to negotiate with the lender to ensure that these terms are fair to the client. Although most people prefer a tax audit to reading the fine print of loan documents, the terms contained in one loan can often have a substantial effect on a business borrower’s ability to obtain additional loans in the future and on its ability to manage its financial affairs.
Here are just a few of the most common provisions found in loan documents and what those terms mean (in English):
Right of Setoff- The right of setoff is reserved by the lender as a means to access the borrower’s accounts with the lender in the event of default. For example, if the borrower fails to make a timely payment, the lender can then take funds contained in borrower’s accounts held with the lender in order to make up the deficiency, without the borrower’s further consent.
Acceleration- An acceleration provision allows the lender, upon default, to require payment of the entire balance due under a loan due at one time and prior to the end of the term of the loan.
Condemnation Proceeds- Loan documents nearly always contain a provision which states how proceeds of a condemnation will be distributed. For example, 25 feet of borrower’s property is condemned by the Virginia Department of Transportation (VDOT) for a road widening project and VDOT has offered the borrower $50,000 for the condemnation. The loan documents likely require the full $50,000 be paid to the lender. Such provisions can usually be negotiated with the lender for more favorable terms.
Monetary Default- Most loan documents provide that if a borrower is even one day late with a payment, the borrower is in default. Such provisions need to be addressed with the lender. Lenders, when asked, will typically allow a cure period allowing the borrower a certain period of time (often ten days) in which to cure the default by making the required payment.
Non-Monetary Default- These are defaults which are not related to payment. They frequently include failure to adhere to laws and regulations, and other issues. For example, if a restaurant borrows from a lender and the borrower receives a notice of a health department violation (or sometimes even a warning) the borrower could be considered in default. This is something that can be cured by negotiating with the lender to ensure that only material or significant infractions are actionable. Another common example is when the loan documents state that any lien placed on the collateral is a default. This can be cured by simply amending the terms to state that the borrower is not in default if contesting such liens in good faith.
Cross-Default- As an additional method of securing loans, lenders often place a cross-default provision in loan documents which states that a default under any loan between the borrower and lender, triggers a default under all of the loans between the borrower and lender. For example, if the borrower has three separate loans with the lender and goes in default on just one of them, the lender can accelerate or take other actions under all three loans.
Cross-Collateralization- Much like cross-default, cross-collateralization provisions typically give the lender the right to foreclose on all collateral securing any loan to the borrower by the lender, in the event of default on any of its loans.
Integration- Although a fairly standard boilerplate term found in many contracts, integration clauses are quite important. These clauses mean that all prior discussions, agreements, and negotiations between the parties on the subject at hand are meaningless. For example, a borrower and lender have extensive negotiations in which the lender promises the borrower a number of favorable terms for the loan. The loan is then closed, however, the loan agreement contains an integration clause, but none of the favorable terms discussed between the parties. It would be very difficult for the borrower to argue in court that the parties intent was to include other, more favorable absent an allegation of fraud, which is extremely difficult to prove.
Whether obtaining a loan for $100,000 or millions of dollars, it is in the best interest of every small business to carefully review all of the loan documents and request changes from the lender where appropriate. Although the lender has the greater bargaining position, all lenders want their customers to be repeat customers, giving the borrower some ability to negotiate. Remember, the fine print counts!
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2020.