Loan Agreements and Covenants

Loan Securities and Documentation

• Loan security provides lenders with a backup plan if the borrower doesn't repay the loan.
• Security doesn't eliminate the risk of default, but it mitigates potential losses.
• Credit officers must ensure the security's value and security-to-loan ratio meets bank policy.
• A good security has stability in value, is marketable with liquidity, is quantifiable, and is freely transferable.
• It should be free from prior claims letting the lender enforce their rights legally.

Collateral Categories

• Depreciating Collateral: Lenders need to accurately assess collateral value at loan origination. High margins should be avoided when dealing with depreciating items (e.g., vehicles, machinery, plants).
• Fluctuating Collateral: The value of this type needs to be periodically updated (e.g., stocks, bonds, shares). Collateral needs to maintain a sufficient security-to-loan ratio.
• Stable Collateral: Lenders must ensure the legal enforceability of the collateral (e.g., Fixed Deposit).
• Potentially Appreciating Collateral: Valuations should be updated regularly. The lender must ensure the security interest is created and perfected to protect against claims from third parties.

Loan Agreement

• The loan agreement details the contractual and legal relationship between the bank and borrower.
• It includes loan terms and conditions, relevant parties, the date of execution and other requirements.
• The agreement must be properly drafted, signed by authorised parties, stamped correctly, and registered by the appropriate regulatory bodies.

Loan Facilities: Structure and Terms

• This section describes the various loan facilities, their amounts, and availability for drawdown.
• It details the interest rates, repayment schedules, instalment amounts, and security requirements.
• Conditions Precedent: Conditions the borrower must meet before the loan facilities are provided (e.g., board resolution, title documents).
• Conditions for Drawdown: Conditions that must be met for each drawdown of funds from the available facilities.

Continuing Conditions

• These conditions ensure the borrower maintains proper conduct during the loan period.
• Failure to comply with these conditions may result in a default event.
• Covenants relate to financial matters and business continuity.
• These commitments may be considered restrictive or non-restrictive, positive or negative covenants.

Common Financial Covenants in Business Loan Agreements

• Minimum equity covenant: Borrowers must maintain a minimum amount of equity.
• Working capital maintenance: Maintain a specified working capital ratio.
• Sinking fund requirement: Create a fund for asset replacement or loan redemption.
• Borrowing and debt restrictions: Limit borrowing and liabilities.
• Dividend payment restriction: Limit dividend payments to preserve cash flow.

Common General Covenants in Business Loan Agreements

• Valid licenses and trade agreements: All relevant licenses and agreements should be valid.
• Insurance coverage: The borrower must maintain insurance covering their assets.
• Non-disposal of key assets: The borrower cannot sell key assets without prior consent.
• Restriction on investments outside normal operations: Investments outside the core business need approval.
• Restriction on change of business ownership: No change in ownership without prior lender consent.

Property Security

• Properties are a valuable security in lending. They are categorised as properties with issued documents of title or without issued documents.
• Freehold and Leasehold land are examples of property with title.
• Types of Legal Charges: First party charge / second party charge; First party / Third party charge; Main clause / Subsidiary clause
• Legal Charge as Security over Property with and without Title - A memorandum of charge is required, which is known as Form 16A under the National Land Code (NLC).
• Legal charges must be registered within 30 days of creation to maintain priority.

Creation and Perfection of Memorandum of Charge

• Involves verification of details and executing and attesting the memorandum.
• Stamp duty must be paid to complete the process for documentation
• Registered at the appropriate registry of land.

Legal Assignment as Security over Property without Title

• Absolute assignment transfers the borrower’s rights over the property to a lender.
• Includes relevant loan agreements and deed of assignment (LADA).
• Important steps to be taken in an assignment to safeguard against risks.
• A caveat needs to be lodged to prevent challenges from third parties affecting the transfer.

Property under Construction Stage

• Lenders need written undertakings from developers before disbursement. That include confirmation for the projects’ completion status, title documentation, and refund in specific cases (termination or abandonment of the project)
• This protects against risks associated with ongoing developments.

Completed Property under Sub-Sales

• Lenders need written verification from the vendor about the original title and memorandum of transfer.
• Vendors should confirm the balance ownership before settlement to avoid rejection of the transfer.

Property under Redemption

• Verification of redemption amount before agreement signing, and the process.
• Lenders need an undertaking from the chargee bank about releasing the charge upon receipt of the redemption sum.

Other Security and Documentation

• Other security forms like fixed deposits, stocks, shares, unit trusts, insurance policies and assets under hire purchase financing.
• Documentation needs for each type to be considered as collateral.

Guarantee and Indemnity

• Lenders require further support beyond tangible assets.
• Credit support includes guarantees, indemnities, letters of undertaking, and awareness.

Characteristic of Guarantee

• A guarantee ensures the borrower’s debt is paid off.
• Involves three parties (guarantor, lender, and borrower).
• Guarantors are secondary debtors, responsible for repayment if the primary debtor defaults.
• Guarantees must come from third parties, not the borrower or partners/proprietors of the business.
• Lenders can request guarantees either from individuals or corporate entities.

Consideration for Guarantee

• A guarantee is considered when borrower debt servicing ratio exceeds lender norms.
• The loan tenor exceeds the expected retirement age or asset lifespan.
• Unstable income or missing documentation for income verification can be a reason for a guarantee requirement.

Perfection and Enforcement of Guarantee

• Ensuring proper documentation from the guarantor, such as witness and stamping, is essential.
• Legal proceedings for non-payment, including court orders, attaching assets, and garnishee, need to be completed correctly.
• Lenders take actions against guarantors according to the amount of debt owed and whether or not they have regular monthly remuneration.