Negotiating Loan Agreements Post Credit Crunch

November 5, 2009

This article was written for International Resource Journal
 
The collapse of North Sea oil producer Oilexco earlier this year as a result of defaulting on its substantial loans to RBS demonstrated the importance of bank lending to the oil and gas sector. Ernst & Young, the accountants brought in to act as administrators, said Oilexco began experiencing difficulties in the middle of 2008 when it needed to raise cash for new developments, just when banks were cutting back on lending: "This is a problem that a lot of smaller oil and gas companies are facing. This is likely to become a trend".
 
This view is also backed up by Al Stanton, an oil analyst in the Edinburgh office of Royal Bank of Canada who commented: “There were some problems unique to Oilexco but there are some wider problems for the sector. Banks are unwilling to lend money to companies with a relatively small cash flow. I know Oilexco will not be the end of it.”
 
The problem does not just apply in the UK. In India, Great Offshore Limited has recently run into solvency issues after Axis Bank decided to pull out of a deal to lend it 350million Rupees to fund the purchase of oil drilling equipment. Great Offshore is now completing the investment utilising its own cash reserves.
 
For those natural resources companies lucky enough to be offered facilities, has the banking process changed post credit crunch? Can borrowers still negotiate the loan’s terms or are they non-negotiable? Are the directors obliged to give personal guarantees as well as the company’s assets being charged?
 
Set out below are our top ten tips for borrower companies embarking on the loan process.
 
1. Can I shop around?
 
In short, not as much as you used to be able to. In the good years, many borrowers could almost be accused of being “rate tarts” as they accumulated a whole array of borrowings from different lenders.
 
Borrowers will no doubt be aware that the credit crunch has severely restricted the number of loans being authorised by credit committees. You will have a greater chance of getting your loan application approved by a bank you have been a customer of for many years. Also, if loyalty is demonstrated to one bank, borrowers would hope (although it is not always the case) that the bank would repay such loyalty when the borrower needs support in a tougher economic climate.
 
If the option of borrowing from several different banks has diminished, a finance director should also review the differing types of facilities available from your existing bank (e.g. finance and operating leases etc).
 
2. Consents

 
Before entering into the negotiation process, a borrower should consider what third party consents are needed. Is there is a shareholders’ agreement containing consent matters? Shareholder approval may be required for the taking out of loans/granting of security. Has other security already been granted such as a charge over a specific operating licence? These may contain "negative consents", prohibiting the borrower from granting further security without the consent of the existing security holder.
 
Post credit crunch, consents are often taking longer to come through.
 
3. Term Sheet
 
Once you have decided on the bank, the type of facility and obtained any necessary consents, it makes sense for the main terms to be set out in a term sheet. This will detail key terms such as the amount of the loan, interest rate, repayment date, early repayment fees, financial covenants etc.
 
The borrower should make sure the terms accurately reflect the negotiations with the bank. Once signed, don't start spending the facility just yet. There are several hurdles still to overcome!
 
4. Legal Representation
 
Lawyers for the Borrower

 
Before the term sheet is signed, instruct lawyers to make sure that there is nothing unusual included and the commercial terms are accurately reflected. Once a provision is included in a signed term sheet, it will be harder to negotiate away (when it comes to negotiations on the final binding documents).
 
Lawyers for the Lender

 
Most of the term sheet will not be legally binding (allowing the bank to withdraw their indicative funding offer). However, some terms, such as costs and confidentiality, will be in force from signature. When the term sheet is signed, the borrower will often be committing to paying the bank's legal costs. The borrower may be obliged to pay the bank's costs even if the loan facility isn't made available. The borrower should make sure they have agreed a cap on such fees.
 
5. Timetable
 
Be realistic, the process will often take longer than the borrower first thinks. The bank will want to get comfortable with its ongoing due diligence. The borrower will also be faced with the onerous logistical task of satisfying a large set of conditions precedent requirements, not to mention reviewing and, if they’re lucky, negotiating the terms of the documents.
 
Post credit crunch, there are an increasing number of tales of credit committees taking forever and a day before coming to a decision on a loan. The bank’s salesman, who makes first contact with the borrower and markets the loan, may represent a very unrealistic timetable. Build in some leeway to any indicative timetable.
 
6. Standard or bespoke
 
Particularly for a smaller loan, a bank may try to argue that the arrangements are documented on their standard terms. Not surprisingly, such documents will be very bank-friendly. However, in the age of word processing, documents can be changed easily and few banks still use pre-printed documents.
 
A Finance Director would be failing in his duties if he signed up on standard terms without at least getting them reviewed and, if possible, negotiated. This is particularly true for larger term loans. Again, post credit crunch, lawyers for borrowers are finding banks increasingly pushing back on requested changes. The responses are often “if you don’t like it, go elsewhere” or “if we make this change, we’d never get it through the credit committee”.
 
7. Focusing your Fire
 
When reviewing the documents, a borrower and their lawyer would be well advised to focus their fire. A bank will not be pleased if their security documents come back substantially re-drafted. Such documents are, by their very nature, designed to protect the bank. Amongst other provisions, they set out, in considerable detail, the rights of the bank if a loan isn't repaid.
 
There are, however, some clauses where negotiation is essential, for example Events of Default. These will set out the circumstances when a bank can demand immediate repayment of their loan e.g. if a borrower is insolvent, has breached the terms of the loan/security etc. The borrower will have paid an arrangement fee for the comfort of a fixed-term loan and harsh events of default could jeopardise such benefit. Here the borrower should seek "grace periods" for certain defaults, which would typically allow them several days to rectify any alleged breach.
 
Another area for negotiation concerns Representations and Warranties – the assurances each side gives to the other. Again, these should be thoroughly reviewed and any necessary disclosures made. For example, if the borrower is engaged in any litigation, it should be expressly disclosed to the bank.
 
8. Security
 
The bank's gut reaction will be to try and get as much security as possible. If not happy with the unencumbered assets put forward by the borrower, they will often seek personal guarantees from directors and/or shareholders.
 
Directors should try and limit security to the assets of the borrower, as otherwise this negates the point of operating the business through a limited company. However, this is often easier said than done. With the squeeze on funding, lenders/suppliers are looking to impose more stringent terms.
 
If personal guarantees are unavoidable negotiate hard on total caps on recovery and consider performance criteria whereby the guarantees will be cancelled if the borrower hits certain targets.
 
9. Conditions Precedent
 
Often, the facility agreement will list numerous requirements to be satisfied before the loan is made available.
 
For example, board minutes, directors' certificates, accounts, insurance and proof of third party approvals are often required. These ‘CPs’ should be reviewed early in the process, to see if any will be problematical to obtain.
 
10. EFGs
 

In the UK, under the government’s Enterprise Finance Guarantee scheme, the Government promised to underwrite up to 75  per cent of qualifying loans in an attempt to get some liquidity back into the system. There have been complaints from businesses about the way banks are applying the scheme. In particular, there have been allegations that, because of the Government’s guarantee, banks are focusing on EFG loans (capped at £1million) at the expense of more substantial lending.
 
Borrowers looking to borrow £1 million or less in the UK may find themselves a more attractive proposition to the banks. There may also be similar incentive schemes available in other countries or related to where your resource assets are located.
 
Summary
 

The borrower should also have a Plan B during the negotiations with the bank. For example we are seeing an increasing number of emergency bridging loans made by shareholders/directors to their companies.
 
Just because heads of terms have been signed and the loan negotiations are progressing well, it does not preclude the credit committee from getting last minute cold feet.
 
Once the facility has been drawn down, the Finance Director only needs to start worrying about generating the funds to repay it!


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