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A loan agreement is a formal contract outlining important counterparty information and responsibilities, as well as credit terms like the loan amount, the type of loan being extended, the repayment schedule, and the interest rate.
A loan agreement is made between the creditor (the lender) and the borrower (the debtor), although it is generally prepared by the lender’s legal counsel in order to ensure the legal enforceability of the contract.
A loan agreement may be called a number of different things, including a loan contract , a credit agreement , a financing agreement , and in some cases, a promissory note .
When one party receives resources from another party in exchange for future payment, credit is created. When credit is created, both counterparties are agreeing to certain responsibilities and obligations to the other.
For example, the creditor (lender) must make funds available to the borrower at the agreed-upon date and time; they must also ensure these funds remain available until the loan’s maturity date (absent an event of default). The debtor (borrower) is also agreeing to abide by certain behaviors too, including timely interest and/or principal payments and any financial reporting required by the lender.
Without a formal contract (the loan agreement ) to bind these parties together, there would be no legal recourse for one party should the other breach one (or more) of their respective obligations.
Loan agreements vary in length and complexity depending on the borrower, the nature of credit, and the jurisdiction. But in general, there are some sections that virtually always appear in a standard contract. These include:
Loan agreements, especially for commercial loans , may include more than one loan – each of which has its own distinct loan structure . The following details and characteristics will be presented for each loan:
When an asset serves as collateral to backstop credit exposure, the loan is said to be “secured.” Any collateral that will serve as security for a loan is generally referenced in the loan contract, although separate security agreements are often employed to register liens over specific serial numbers or legal property addresses.
This section often starts with: “ The Borrower hereby represents and warrants… ”. These are best thought of as circumstances that are understood/assumed to be true at the time the loan agreement is executed and may include boilerplate statements like:
This is particularly true of commercial clients. Because the business environment is so dynamic and conditions in the broader economy can change quickly, many creditors want to periodically review the health of their borrowing clients and any underlying collateral.
Standard reporting requirements range considerably but may include things like quarterly or annual financial results, key customer contracts, inventory listings, or updated asset appraisals .
Covenants are small, highly specific, independent agreements within the broader loan contract. Loan covenants expressly define actions and/or behaviors that must (or must not) be engaged in by the borrower.
Covenants can either be standard or non-standard, positive or negative, and financial or non-financial. A breach of covenant is considered an event of default .
Default clauses help to proactively provide clarity around what will happen if an event of default is triggered, including consequences of covenant or reporting breaches. Accelerated repayment of loan proceeds is a common outcome, but specific details may vary depending on the nature of the credit exposure and the type of lender.
In general, underwriting commercial credit is far more complicated than personal lending. Business operations are inherently more complex than understanding an individual’s personal tax filing, for example. Additionally, sorting through security (ie. fixed vs. floating charges ) and the priority rankings of these claims requires more nuanced expertise.
As a result, commercial loan agreements tend to be highly complex and much more customized based on the specific borrowing request. Because of their complexity, commercial loan agreements are generally countersigned by the borrower’s representatives under the supervision of its legal counsel to ensure that all parties clearly understand the document and its enforceability.
A promissory note is a type of loan agreement that is signed by a borrower in favor of a creditor. Promissory notes are often used by private, non-bank lenders where credit may be shorter term and/or unsecured.
These are legally enforceable credit agreements, but may be less robust than the type of loan contracts used by traditional financial institutions.
Many promissory notes are supported by second- or third-ranking general security agreements (GSAs) , meaning that the exposure is subordinated to more senior lenders (like commercial banks or credit unions). In these cases, it would be common to see an intercreditor agreement negotiated among the various lenders.
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