Delinquent loans, mostly residential, are constantly in
the news, so it is easy to understand why some business owners may lose track
of the fact that missed payments are not the only way to get in trouble under
commercial loans, or leases or joint venture agreements, for that matter.
Contracts, and a loan is just a type of contract,
typically contain a number of promises, "covenants" in legalese, that the
parties make to each other. In a business loan, the lender promises to lend
money, and, in return, the business promises to repay that money plus interest.
The borrower's promises don't stop there, however, and a failure to keep any
one of those promises, a breach of covenant, can result in foreclosure or
bankruptcy as easily a failure to make payments.
A front-page story in a recent
Denver Business Journal highlights the importance of these covenants. A
local redeveloped retail center is in foreclosure despite the developer never
having missed a single loan payment. Unspecified loan covenants are cited as
Loan covenants can be expressed as things the borrower
must do (affirmative covenants) and things the borrower cannot do (negative
covenants). Affirmative or negative, it doesn't matter; breach of either can
land you in the same trouble as missing payments.
Covenants about the company's finances typically get the
most notice. These promises, in theory, are designed to help the borrower avoid
getting to the point of missing payments. Requiring the borrower to maintain a
minimum net worth relative to the loan is a common covenant, as are limitations
on the ability of the business to pay compensation or dividends to its owners.
Restrictive covenants not explicitly about finances are
also part of the loan package. These covenants may be buried in pages and pages
of loan documents, and are sometimes ignored in the rush to make sure the
financial aspects of the loan make sense. Not anticipating the limitations
these covenants impose on your business may hamstring your company, usually at
the worst times.
For example, you may not surprised by a covenant that
limits the borrower's ability to sell its business without paying off the loan
(though prepayment penalties may still apply), however, more than one business
has been surprised to learn that they need their bank's consent to acquire
another business, even if borrowed money isn't used in the deal.
Medical marijuana poses a special problem for Colorado
property owners. A typical covenant in a commercial real estate loan requires
that the property be used in compliance with laws. Legal under Colorado, not
legal under federal law; what's a landlord with a loan to do? The safest choice
is to not accept the tenant without lender consent.
Your best opportunity to negotiate flexibility into your
loan covenants is, of course, BEFORE you sign the loan. Have your lawyer
explain the proposed covenants to you and decide then what you can and can't
live with. Use the threat of losing your loan to another lender to your
advantage. Attempting to negotiate a forbearance agreement after your lender
has threatened to call, or even called, the loan for breach of covenant is a
poor second option.
There is one more covenant to consider: the term of the
loan. Even if you have paid the loan on time and haven't violated any
covenants, the bank may still choose not to renew your at the end of its term.
Business loans have short terms, 5 years typically, (distinguished from lines
of credit that are renewed annually). These loans don't fully amortize, meaning
large balances, or balloons, have to be repaid or refinanced at the end.
In this lending environment, take no chances and start
renewal discussions early enough for you to negotiate with new lenders in case
your current lender says no or imposes unacceptable terms on you. Lastly, be
sure to include your business lawyer in the process. Avoid potential loan
issues on the front end is always easier than negotiating out of them later on.
Read more posts about business law by Jim
Thomas at his blog, No
For more information about LexisNexis
products and solutions connect with us through our corporate site.