Tweaking the Loan Agreement
You've applied for a loan, and the news is good. You can have the money, the lending officer says; just come in and sign the papers. Anyone who's read through a recent loan agreement knows how dense and legalistic the language can be. But do borrowers really have to accept the bank's terms as written, or can they propose changes?
Lawyers note that banks frequently include terms in loan agreements that afford them more than ample protection. "Some banks start out with everything but the kitchen sink," says Carl Norton, a lawyer with Norton & Blair in Houston. Here are some areas in which Norton and other lawyers suggest that borrowers can ease the burden of those terms:
Names on guarantees. Banks sometimes ask for more names on loan guarantees than they need. "If the assets you pledge as collateral are sufficient," Norton says, "there's no reason for a bank to require anybody else's signature." In light of the federal Equal Credit Opportunity Act, requiring a spouse's signature can be redundant, and possibly illegal, some lawyers say.
Specifying collateral. When borrowers run into problems, banks sometimes jump right over the business inventory and accounts receivable and go straight to the borrower's personal assets (including the borrower's home) for payment. If you want to make sure that doesn't happen, you need to define clearly what the collateral for the loan is and which assets the lender will look to first, says Michael McLaughlin of the Boston law firm Lane & Altman. "It doesn't matter what's agreed to verbally. It has to be in writing."
Advance formulas. At the time of the loan, the bank will usually say it plans to lend against assets based on a certain formula (say, 80% of receivables, 50% of inventory). But many agreements allow banks to change that formula at any time, which can wreak havoc on a growing business. "Ideally, you want to get a commitment that they won't change unless you breach a covenant, even if you have to pay a fee for it," says Con Chapman of McDermott, Will & Emery's Boston office.
Conditions for demand payment. Contrary to what many borrowers suspect, a lot of small-business loans are, in fact, demand notes, meaning that banks have the right to seek full payment for any reason at any time. The courts, moreover, have recently ruled that on demand means just what it says. So if you're concerned about the implications of having to pay up unexpectedly, see if the bank will set up certain provisions (for example, agreed-upon leverage ratios and minimum cash levels) that will give you a buffer.
Curing time. The best protection for borrowers is time. "If you have default provisions," Norton offers, "see if you can get the bank to agree to notify you when there's a problem and give you time -- say, 15 days -- to cure it." With demand notes (when the bank has full discretion), you should ask the bank to commit to at least 60 days' notice so you can attempt to line up other financing.* * *
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