Negotiating the Loan Term Sheet: The Borrower’s Perspective

There are new signs that the Australian property market is on the rebound. As the property market recovers, so does the credit market and companies will increasingly seek financing for their business. Financing may take many forms: revolving credit loans, loans to finance the acquisition of a target company, or construction loans, to name a few.

Since most loan agreements are generally heavily one-sided in favour of a lender, it becomes extremely important when seeking finance that borrowers negotiate critical terms before signing.

Borrowers often wonder whether it is even possible to negotiate loan terms. The answer in our view is generally yes and the earlier, the better. Often, the best time to negotiate key loan terms is at the term sheet stage with the relevant loan officer. This is the moment when the loan officer will be the most flexible in order to get the loan in the door. Even though term sheets are usually not legally binding, it is important that the borrower recognise this and negotiate its wish list early before signing anything. Timing for engaging a lawyer is also critical. Many borrowers are often forced to live with an oppressive loan agreement and security arrangements because they only engaged a lawyer to review the final set of loan documents, which by then memorializes a deal already cast in stone.

The pitfalls that the borrower can run into are usually in the areas of:

• covenants and representations and warranties that it would give to the lender;
•  the securities and guarantees that the lender is seeking; and
•  reporting requirements that the lender may have in place.

If these are not properly negotiated upfront, what the borrower may find is that the defaults that are created become a real problem since there is no such thing as a technical default or non-material default from the lender’s perspective. As the saying goes you can’t jump into the pool and only be a little bit wet. Often, the loan documentation will create situations where the borrower is either in default or not in default.

To address the above issues, we would recommend the following:

1. The borrower should negotiate covenants and representations and warranties which provide room for itself in the cyclical business that it may be in and other normal ups and downs and experiences. Accordingly, if the term sheet provides for financial covenants such as debt service coverage ratios, tangible net worth requirements, or capital expenditure limitations, the borrower will want to make sure that even in the low times of its business, it can meet those financial covenants.
2. The borrower should consider whether the giving of certain security and/or guarantees might adversely impact the operation of the borrower’s business. If so, then the borrower should seek limits to those securities or only grant those securities and/or guarantees subject to appropriate carve-outs.
3. If the term sheet provides for reporting requirements such as providing tax returns, interim financial statements or providing inventory reports, the borrower should flag appropriately when those reports are due and make sure that the time is such that the borrower can meet those requirements and produce the documents in a timely manner.
4. The borrower should negotiate cure provisions upfront so that if the borrower breaches a key term of the loan, cure remedies can be provided to cure that breach and avoid a default.

If we can help you negotiate loan terms or deal with loan documentation with your lenders, please feel free to contact us.