Borrowers’ Undertakings

Representations and Warranties I

Contractual representations and warranties are promises on the part of the borrower in relation to existing matters. The representations should represent the truth and accuracy of the facts which constitute the basis on which the loan has been underwritten. The bank relies on the truth of the representations or warranties in advancing the loan.

Warranties and representations are provided for a number of distinct purposes.  Information warranties are designed to disclose matters of fact which are desirable and relevant to the loan and which may have been presupposed in the underwriting processes.

Breach of a warranty or representation is likely to be an event of default, which entitles the bank to refuse to lend or make further advances and permits it to demand immediate repayment of all sums due.

Representations and Warranties II

The bank will have obtained information and documents to vouch for the borrower’s corporate/personal and financial status. There are usually representations and warranties in relation to such basic matters as the borrower’s legal capacity, the absence of adverse litigation, insolvency, the accuracy of information and the priority of the loan. There will often be a clause to the effect that there has been no material adverse change between the loan agreement and drawdown date.

Compliance with representations is usually a condition precedent to drawdown.  Representations may be deemed repeated on each drawdown or periodically. Some loan agreements require representations to be repeated every day throughout the loan. Representations are usually expressed to survive the execution of the agreement and drawdown.

A secondary function of representations is to secure disclosure of adverse matters. This is akin to the procedure in the acquisition of a private company. The disclosure letter may consist an agreed list of items which would ordinarily constitute a breach of the representation, but which the bank agrees to waive and accept.

There is no obligation of good faith on a borrower to disclose material matters, in the absence of representations and covenants otherwise. From the bank’s perspective, representations require the borrower to disclose information which might otherwise not be available.

Types of Representations

Representations will often be given in relation to the following matters:

  • the capacity of the corporate borrower (or an individual) to borrow and enter the loan agreement and documents;
  • in the case of a foreign borrower, where its domestic legislation so requires, that it be in good standing and if applicable, that it furnish a certificate of good standing;
  • in the case of international lending, its validity and the absence of adverse taxation consequences;
  • that the entry of the loan agreement does not constitute a breach of another agreement.  This is designed to deal with a claim that the bank has procured the breach of another contract;
  • that the lending will rank at least equally with other unsecured borrowings; this is appropriate to unsecured lending;
  • no actual or threatened litigation affecting the borrower;
  • no insolvency proceedings;
  • no defaults under other contracts with third parties;
  • that the accounts give a true and fair view of the company’s business;
  • that information provided is complete and accurate (including all management accounts and equivalent);
  • that the borrower has title to the security and that the bank’s charge or mortgage will rank in priority;
  • Environmental Issues;
  • Material adverse change.

Covenants and conditions

A covenant or condition is a promise / obligation by the borrower which applies throughout the loan agreement. Breach of covenant generally entitles the bank to terminate the loan and require repayment. A wide range of covenants, varying significantly in scope and sophistication, is possible.

Covenants play a variety of functions.  They should be tailored to the particular circumstances. They may apply to the borrower and also to group members and guarantors.  Covenants may seek to preserve a particular state of affairs.  They may be negative or positive. They may oblige the borrower to do or refrain from doing something.

Breach of a covenant can be a means of bringing the borrower “to the table” for negotiation, even if it is not desired to declare an event of default, demand repayment and resort to enforcement. This may give the opportunity to re-negotiate the security or the other terms of the loan agreement.

Covenant Types

The nature and extent of the covenants and conditions in the loan agreement will depend on the nature of the loan. More extensive covenants and conditions are likely to be required for higher value and more complex loans.

The following types of covenants are commonly provided in loan agreements:

  • Positive – non-financial covenants;
  • Negative – non-financial covenants;
  • Financial covenants;
  • Information covenants;
  • Asset/security protective covenants.

Positive and Negative Covenants

Positive covenants have a number of purposes.  Non-financial positive covenants may include the following: –

  • preservation of corporate existence;
  • maintenance of borrower’s assets;
  • prohibiting asset striping;
  • maintenance of priority;
  • compliance with licenses, consents required for its business;
  • notifying any event which would be a breach of the covenants, representations or warranties;
  • notifying events of default;
  • informing the bank of prejudicial or events likely to prejudice its ability to perform.

Negative non-financial covenants may include obligations;

  • not to cease to carry on business;
  • not to extend credit other than to trade debtors in the course of trading;
  • not to dispose of subsidiaries;
  • not to grant further security,
  • not to dispose of assets, other than in the normal course of business.

Information Covenants

Information covenants entitle the bank to information and act as an early warning mechanism. Annual accounts, management accounts, cash flow statements, forecasts, and budgets may be required. The bank will usually be entitled to further specific information on request and to access to books and records.

Covenants may require information in relation to the financial status of the business of the borrower. Financial covenants may be tied to the borrower’s business plan and its projected performance. This may have been the basis on which the loan has been underwritten. If key targets fail to be achieved, then the bank may wish to call a default.

The borrower will generally be obliged to furnish financial information at regular intervals, including statutory and financial accounts. This will enable the bank to monitor loan performance.  A potential problem may be identified at an early stage, rather than when it is too late.

In practice, statutory accounts will be significantly out of date. Internal management accounts may also be out of date.  However, they may be useful in identifying pending or growing problems.

Financial Covenants I

Covenants may require the borrower to meet financial conditions in relation to its business and the security as shown in the accounts.  Financial covenants may set out limits on ratios of financial performance and other benchmarks. These may be set by reference to the borrower’s projections and the bank’s minimum necessary requirements.

There may be a commitment by the borrower to maintain a minimum net worth.  This is more common in corporate loans.  There may be limits on other outstanding exposures.  There may be commitments on profitability, liquidity, interest cover and other key ratios.  There are a number of recognised ratios which are key indicators of the strengths and weaknesses of the borrower and the business. The covenants may require compliance with one or more key ratios.

There may be limits on total financial indebtedness. A minimum net worth may be required.  The bank may need to look to the borrower’s assets to repay the loan. If the net value of the business assets falls, the security is undermined. In practice, many assets may be difficult to value on an ongoing basis.

The higher the gearing within a company (i.e. total borrowings) the greater the risk of default, all things being equal. The Debt to Equity ratio shows the balance between total borrowings and the shareholders’ own funds (which rank after all external creditors). The financial gearing or leverage ratio compares net borrowings to net worth.  The measure of shareholders’ funds may be not only constituted by accounting values but may change over time by reference to the realisable net worth of realisable assets.

Liquidity ratios give an indication of the borrower’s ability to pay its debts as they fall due.  If monies are tied up in stock and other assets which cannot be quickly realised, the borrower may become insolvent and be subjected to formal insolvency proceedings with little or no warning.

Financial Covenants II

The current ratio is the ratio of current assets to liabilities.  This is a common measure of liquidity.  The appropriate ratio will depend on the type of business.  Deterioration in the ratio will be of concern. A more sensitive guide to liquidation risk is the asset test ratio or quick ratio. This excludes stocks.  It is the ratio of current assets less stock to creditors due within one year.

Profits and earnings are critical to the repayment of loan facilities. Profits before interest and tax (PBIT) or earnings before interest and tax include exceptional items but exclude extraordinary items. The measure may be made before or after depreciation.  The Interest cover ratio shows the ratio of PBIT to total finance charges.

Asset Preservation Covenants

There are usually covenants which seek to protect the value of the security. Insurance and licences will be required to be maintained. The covenants are usually supplemented in the security documents.

A negative pledge clause is an undertaking not to create a further security over the assets to any entity, other than the lender.

There may be restrictions on substantial acquisitions and disposals. In the case of a company, there may be pre-conditions and limitations on paying dividends.

References and Sources

Irish Texts

Breslin Banking law + Supplement     3rd Ed  2013

Mortgages Law & Practice     Maddox 2nd Ed            2017

NAMA Act 2009: A Reference Guide Raghallaigh, Kennedy, Whelan

Money Laundering & Anti-Terrorist Financing Act 2010

Financial & Emergency Provision Legislation Annotated      2011

Shelley & McGrath     National Asset Management Agency Act Annotated 2011

Dodd & Carroll            Law Relating to NAMA 2012  0

Ashe & Reid    Anti-Money Laundering: Risks, Governance & Compliance             2013

Johnston & Ors           Arthur Cox Banking Law Handbook               2007

Dr Mary Donnelly  The Law of Credit and Security, 2nd Ed, 2015

UK Texts

A Hudson The Law of Finance 2nd Ed (Sweet and Maxwell 2013)

Veil (Ed) European capital markets law (Hart Publishing 2013)

IG MacNeil An Introduction to the Law on Financial Investment 2nd Ed ( Hart Publishing 2012)

E Ferran Principles of Corporate Finance 2nd Ed ( OUP 2014)

Gullifer (ed) Goode and Gullifer on legal problems of credit and security (6th edn Sweet and Maxwell London 2017).

MA Clarke et al (eds) Commercial Law: Text, Cases and Materials (5th edn OUP Oxford 2017)

McKendrick (ed) Goode on commercial law (5th edn Penguin London 2017)

G McCormack Secured credit under English and American law (CUP Cambridge 2004)

L Gullifer and J Payne Corporate Finance (2nd edn Hart Oxford 2015)

D Sheehan The Principles of Personal Property Law (2nd edn Hart Oxford 2017)

Ross Cranston, Emilios Avgouleas, Kristin van Zwieten, Christopher Hare, and Theodor van Sante Principles of Banking Law 3rd Ed 2018

E.P. Ellinger, E. Lomnicka, and C. Hare Ellinger’s Modern Banking Law 5th Ed 2011

Andrew Haynes The Law Relating to International Banking  Bloomsbury Professional 2009

Charles Proctor Mann on the Legal Aspect of Money 7th Ed 2012

Charles Proctor The Law and Practice of International Banking 2nd Ed  2015

Sheelagh McCracken The Banker’s Remedy of Set-Off   2010 Bloomsbury Professional

Louise Gullifer, Jennifer Payne Banking & Financial Law 2018

Hubert Picarda QC The Law Relating to Receivers, Managers and Administrators 4th Ed  2006 5th Ed 2019

Lightman & Moss on the Law of Administrators and Receivers of Companies 6th Ed  Sweet & Maxwell 2017

Timothy N Parsons  Lingard’s Bank Security Documents 6th Ed 2015