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Finding the Quirks in a Loan Agreement

Exclusions and fees can sour a financing.

While competition for corporate borrowers may be heating up, the memory of the financial crisis dies hard. First-time borrowers or those with spotty credit histories, therefore, should assume that the default position of any lender is “fairly stringent documentation” and “fairly significant financial covenants,” says Martin Robins, a partner in the Chicago office of FisherBroyles.

Receivables-based and other asset-based financings can be particularly tricky, because the definition of what a financier will lend against may be long, complex, ambiguous or all three. If a business borrowing against its receivables negotiates an advance of 80 percent, the CFO might presume that a $10 million receivables balance will translate into $8 million in financing. But after the lender does its due diligence, it may decide to advance just $5 million based on exclusions, says Robins. “The lender may say, ‘We can’t lend against this one because it’s too old, or this one because the customer is a nonprofit, or some other company because they are based outside the U.S., or another company because we heard a rumor it is in trouble.’”

Many exclusions in a lending agreement make good sense, Robins notes. But there are others that “are kind of quirky and short of a quantitative standard,” he says, such as an “omnibus” exclusion that lets the lender exclude from the borrowing base any instance in which it has a “reasonable concern” or “general insecurity” about the account debtor’s business health. Borrowers, beware.

Fees are also an issue in some transactions. A lender might quote an attractive rate, and then follow that with assorted commitment fees, documentation fees, collateral due diligence fees, even a “backdoor” fee covering the lender’s legal fees, says Robins. “You can call it whatever you want; it’s additional money out of the borrower’s pocket, so it raises the cost of the financing.”

Finally, there may be lender conditions that are justified but just plain shocking to a new borrower, like a lender imposing obligations as to where and how financed inventory can be warehoused. In a deal he is currently working on, Robins says, a client’s lender is insisting that the inventory be segregated in a warehouse, because the lender is afraid of a possible bankruptcy.

“The lender wants to be able to levy on that collateral without competing claims,” Robins says. “If that inventory is commingled with [another party’s] collateral and the warehouse gets padlocked and there is a bankruptcy filing, there will be a lot of confusion and litigation.”

In any of these situations, Robins says, the key is full awareness of the agreement by both the borrower and lender at the commitment stage. “The idea is for neither party to pull a ‘gotcha,’ says Lipton, “and for each party to end up with the economic outcome they are seeking.”

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