Loan Agreements and Covenants
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Questions and Answers

What is the primary purpose of conditions precedent in loan agreements?

  • To protect the lender from potential risks by verifying the borrower's creditworthiness and ability to use the loan for its intended purpose. (correct)
  • To establish a clear timeline for the disbursement of loan funds to the borrower.
  • To ensure the borrower's ability to repay the loan by requiring ongoing financial reporting.
  • To provide the borrower with flexibility in drawing down the loan funds as needed.

    • What is the main objective of 'continuing conditions' in loan agreements?

  • To provide the borrower with access to additional loan funds if needed during the loan period.
  • To ensure the borrower's continued financial stability and responsible use of the loan throughout its term. (correct)
  • To establish clear guidelines for the repayment of the loan.
  • To allow the lender to adjust interest rates based on the borrower's financial performance.

    • Why are 'covenants' considered essential in business loan agreements?

  • To ensure the borrower's compliance with environmental regulations.
  • To establish a clear process for resolving disputes between the lender and the borrower.
  • To provide the borrower with legal protection in case of default.
  • To allow the lender to monitor the borrower's financial performance and protect their investment until the loan is repaid. (correct)

    • What is the main reason behind categorizing covenants as 'restrictive' and 'non-restrictive'?

    <p>To clarify the degree of control the lender has over the borrower's actions and decisions. (C)</p> Signup and view all the answers

    Which of the following best describes the role of a credit officer in relation to covenants?

    <p>To monitor the borrower's compliance with the covenants and enforce them if necessary. (A)</p> Signup and view all the answers

    What is a 'minimum equity covenant' designed to achieve?

    <p>Protect the lender from losses by requiring the borrower to invest additional equity if their financial position deteriorates. (C)</p> Signup and view all the answers

    Which of these aspects is NOT considered a crucial principle in designing and applying covenants?

    <p>Maximum leverage for the lender in controlling the borrower's decisions. (B)</p> Signup and view all the answers

    Why should covenants that are difficult to comply with or monitor be avoided?

    <p>All of the above. (D)</p> Signup and view all the answers

    Who retains the legal ownership of the shares in a borrowing arrangement?

    <p>The borrower (C)</p> Signup and view all the answers

    What are investors entitled to when they invest in a unit trust?

    <p>Dividends and bonuses (D)</p> Signup and view all the answers

    What is cash surrender value in the context of insurance policies?

    <p>The cash amount paid if the policy is cancelled (D)</p> Signup and view all the answers

    Which type of life insurance policy is most likely to be taken as credit support due to its higher cash surrender value?

    <p>Endowment policy (C)</p> Signup and view all the answers

    What document creates a security interest for stocks and shares?

    <p>Memorandum of Deposit (MOD) (A)</p> Signup and view all the answers

    Which policies do not provide cash surrender value and access for lenders upon default?

    <p>Term life and whole life policies (B)</p> Signup and view all the answers

    What must lenders do after creating a legal assignment over an insurance policy?

    <p>Inform the insurance company of the assignment (B)</p> Signup and view all the answers

    What is the primary function of an endowment policy in terms of security?

    <p>Offering savings and higher cash value (B)</p> Signup and view all the answers

    What is the primary function of security in lending?

    <p>To mitigate the risk of losses in the event of default. (C)</p> Signup and view all the answers

    What is the main factor that determines the adequacy of security?

    <p>The type of collateral offered. (B)</p> Signup and view all the answers

    Which of the following is NOT a characteristic of good security?

    <p>Depreciating value. (A)</p> Signup and view all the answers

    What is the lender's responsibility regarding collateral value that fluctuates?

    <p>To periodically update the value and potentially request additional collateral. (C)</p> Signup and view all the answers

    What is the purpose of a security agreement between the lender and the security provider?

    <p>To ensure the validity of the collateral against third-party claims. (C)</p> Signup and view all the answers

    Which collateral type requires the lender to ensure legal enforceability?

    <p>Stable collateral (A)</p> Signup and view all the answers

    What is the importance of a security-to-loan coverage ratio for a lender?

    <p>To ensure adequate protection against potential losses. (B)</p> Signup and view all the answers

    Which of the following is NOT a reason for engaging a professional valuer for potentially depreciating collateral?

    <p>To ensure the collateral is not susceptible to market risks. (A)</p> Signup and view all the answers

    What is the purpose of restricting changes in majority shareholdings within a company?

    <p>To prevent aggressive investment practices that deplete cashflows (B)</p> Signup and view all the answers

    Which of the following types of properties requires an issued document of title?

    <p>Property with issued document of title (D)</p> Signup and view all the answers

    What type of legal charge is applicable to both freehold and leasehold land?

    <p>First and Second Legal Charges (A)</p> Signup and view all the answers

    Which legal framework applies to freehold land in Peninsular Malaysia?

    <p>National Land Code 1965 (C)</p> Signup and view all the answers

    What is a characteristic of properties without an issued document of title?

    <p>They are considered high-risk for lenders (B)</p> Signup and view all the answers

    What is the main function of a legal charge on property?

    <p>To provide security for a loan (B)</p> Signup and view all the answers

    In the context of land ownership, what does 'grant in perpetuity' refer to?

    <p>Freehold land titles (C)</p> Signup and view all the answers

    Which of the following types of charges would you find in a legal context related to property?

    <p>First Party Charge (A)</p> Signup and view all the answers

    What is the consequence of defaulting on two consecutive instalment payments for motor vehicle financing?

    <p>A repossession notice will be issued after 21 days. (D)</p> Signup and view all the answers

    Which of the following parties are involved in a guarantee agreement?

    <p>Guarantor, lender, and borrower. (A)</p> Signup and view all the answers

    Who cannot act as a guarantor for a business loan?

    <p>Sole proprietors and partners of the business. (B)</p> Signup and view all the answers

    What does a guarantee require from the guarantor in the case of borrower’s default?

    <p>The guarantor is required to pay the lender. (A)</p> Signup and view all the answers

    The bank may appoint which of the following if the borrower defaults?

    <p>An official receiver. (C)</p> Signup and view all the answers

    What type of document signifies the lender's claim on a motor vehicle?

    <p>Vehicle registration card. (C)</p> Signup and view all the answers

    Which of the following is NOT a form of credit support?

    <p>Letter of resignation. (A)</p> Signup and view all the answers

    What must lenders comply with when repossessing assets?

    <p>Hire Purchase Act. (C)</p> Signup and view all the answers

    Who is eligible to provide a guarantee for a sole proprietorship or partnership?

    <p>A third party individual (B)</p> Signup and view all the answers

    What type of guarantee allows lenders to recover the guarantee amount from any guarantor?

    <p>Joint and Several Guarantee (C)</p> Signup and view all the answers

    What is a requirement for a Corporate Guarantee to be valid under section 133A of the Company Act?

    <p>It must come from a company within the Corporate Group (A)</p> Signup and view all the answers

    Which of the following scenarios would necessitate a lender to seek a guarantee?

    <p>The loan tenor exceeds the expected lifespan of financed assets (C)</p> Signup and view all the answers

    What is the usual nominal fee for stamping a guarantee?

    <p>RM10 (B)</p> Signup and view all the answers

    Which aspect is not necessary for the enforceability of a guarantee?

    <p>It must be attested (A)</p> Signup and view all the answers

    Who typically provides a personal guarantee?

    <p>The director and/or majority shareholder (C)</p> Signup and view all the answers

    What happens if one guarantor is discharged in a Joint and Several Guarantee?

    <p>The discharge is not effective for remaining guarantors (D)</p> Signup and view all the answers

    Flashcards

    Security in Lending

    An assurance for lenders in case of borrower default, but does not eliminate default risk.

    Adequate Security Value

    The necessary worth of collateral to satisfy lending bank's credit policy.

    Quality of Security

    The essential attributes of good security including stability, marketability, and legal enforceability.

    Characteristics of Good Security

    Must be stable in value, liquid, quantifiable, transferable, and free from claims.

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    Collateral Categories

    Different types of collateral based on their stability and market conditions.

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    Depreciating Collateral

    Assets whose value decreases over time, e.g., vehicles and machinery.

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    Fluctuating Collateral

    Assets with volatile values, like stocks and bonds, requiring regular valuation updates.

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    Stable Collateral

    Assets like fixed deposits that maintain their value and are legally enforceable.

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    Conditions Precedent

    Requirements that must be fulfilled before a loan is made available.

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    Conditions for Drawdown

    Specific conditions that need to be met for each loan drawdown.

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    Continuing Conditions

    Ongoing requirements for the borrower to maintain loan discipline.

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    Covenants

    Credit control mechanisms imposed to ensure financial discipline.

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    Restrictive Covenants

    Covenants that limit borrower’s actions to protect lender’s interests.

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    Non-Restrictive Covenants

    Covenants that encourage certain actions by the borrower.

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    Compliance Monitoring

    Ongoing checks to ensure borrower meets covenant requirements.

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    Minimum Equity Covenant

    Requires borrower to inject new capital to cover losses.

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    Legal Ownership of Shares

    The borrower retains ownership of shares while having rights to redeem them by settling the loan.

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    Equitable Rights

    Borrowers have the right to redeem shares by fully settling outstanding loans.

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    Encumbered Assets

    Assets that are frozen and cannot be sold or moved without lender approval.

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    Motor Vehicle Financing

    Financing where ownership claims are registered with the lender's endorsement on the vehicle registration card.

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    Unit Trust

    A collective investment scheme where investors receive trust units for dividends and distributions.

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    Cash or Surrender Value

    The amount payable by an insurance company if a life insurance policy is canceled early.

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    Repossession Notice

    Notice issued after two missed payments, allowing the lender to repossess assets after 21 days.

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    Endowment Policy

    A life insurance policy that provides savings and protection, with higher cash surrender value.

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    Hire Purchase Act

    Regulates repossession procedures and asset disposal for financed goods.

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    Guarantee in Lending

    A legally binding contract where a guarantor agrees to repay the loan if the borrower defaults.

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    Whole Life Policy

    A non-participating life insurance policy with no cash surrender value accessed only upon death.

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    Role of Guarantor

    A secondary debtor who agrees to cover the borrower's debt in case of default.

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    Term Life Policy

    A life insurance policy that does not accumulate cash value, providing coverage only for a term.

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    Third-Party Guarantee

    Guarantee provided by someone not directly involved in the loan, often a separate entity.

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    Memorandum of Deposit (MOD)

    A document that allows lenders to create security interests over stocks and shares.

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    Forms of Credit Support

    Various assurances for loans, including Guarantee, Indemnity, and letters of comfort.

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    Aggressive Investment Practices

    Investment strategies that significantly increase risk and deplete cash flows.

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    Property Security

    Physical assets like land used as collateral for loans.

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    Issued Document of Title

    A legal document affirming ownership of a property.

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    Freehold Land

    Land owned indefinitely with full rights.

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    Leasehold Land

    Land owned for a specified period under a lease agreement.

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    Legal Charge

    A formal agreement that gives a lender rights over a borrower's property.

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    National Land Code 1965

    Legislation governing land ownership in Peninsular Malaysia.

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    Personal Guarantee

    A commitment by an individual, often a director or majority shareholder, to be liable for a company's debts.

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    Joint and Several Guarantee

    A type of guarantee where multiple guarantors are collectively responsible for the full guarantee amount.

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    Corporate Guarantee

    A guarantee provided by a corporation typically within a corporate group to support a loan or obligation.

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    Considerations for Guarantee

    Factors that justify the need for a guarantee, such as high debt servicing ratio or unstable income.

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    Perfection of Guarantee

    The process of ensuring a guarantee is properly documented to prevent forgery, does not require attestation.

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    Discharge of Guarantors

    The release of one guarantor from liability; does not relieve others from their obligations.

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    Corporate Group Guarantees

    Guarantees obtained from companies within the same corporate group to satisfy regulatory requirements.

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    Study Notes

    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.
    • 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.

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    Loan Securities and Documentation PDF

    Description

    This quiz examines key concepts related to loan agreements, focusing on conditions precedent, continuing conditions, and covenants. Understand their roles, objectives, and the implications of compliance within loan structuring. Test your knowledge on the fundamentals of business financing agreements.

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