As has been well chronicled, many credit unions are moving into the world of business lending to varying degrees. Some credit unions are only participating in commercial loans, while others are directly involved in lending to their business members.
Credit is the lifeblood of many businesses. In the rush to obtain a loan, business owners often sign loan documents with provisions they do not understand and that the loan officer has difficulty explaining. In fact, we frequently see businesses and lenders enter into complex loans without either side being represented by counsel.
Lenders usually have their own documents, and nearly all contain certain basic terms. However, these documents vary widely in how those terms apply to the borrower. Although most people would prefer a tax audit to reading the fine print of loan documents, the terms contained in the loan documents have a substantial impact on a lender’s ability to protect its collateral and be repaid in the event of a default.
Here are just a few of the most common provisions found in commercial loan documents and what those terms mean (in plain English):
Right of Setoff — The right of setoff is reserved by the lender as a means to access the borrower’s accounts with the lender in the event of default. For example, if the borrower fails to make a timely payment, the lender can then take funds contained in borrower’s accounts held with the lender in order to make up the deficiency, without the borrower’s further consent.
Acceleration—An acceleration provision allows the lender, upon default, to require payment of the entire balance due under a loan due at one time and prior to the end of the term of the loan.
Condemnation Proceeds— Loan documents nearly always contain a provision which states how proceeds of a condemnation will be distributed. For example, 25 feet of borrower’s property is condemned by the Department of Transportation for a road-widening project and DOT has offered the borrower $50,000 for the condemnation. The loan documents frequently require the full $50,000 be paid to the lender. Such provisions can usually be negotiated with the lender for more favorable terms.
Monetary Default— Most loan documents provide that if a borrower is even one day late with a payment, the borrower is in default. Such provisions need to be addressed with the lender. Lenders, when asked, will typically allow a “cure period” allowing the borrower a certain period of time (often ten days) in which to “cure” the default by making the required payment.
Non-Monetary Default— These are defaults which are not related to payment. They frequently include failure to adhere to laws and regulations, and other issues. For example, if a restaurant borrows from a lender and the borrower receives a notice of a health department violation (or sometimes even a warning) the borrower could be considered in default. This is something that can be cured by negotiating with the lender to ensure that only “material” or “significant” infractions are actionable. Another common example is when the loan documents state that any lien placed on the collateral is a default. This can be cured by simply amending the terms to state that the borrower is not in default if contesting such liens in good faith.
Cross-Default— As an additional method of securing loans, lenders often place a “cross-default” provision in loan documents which states that a default under any loan between the borrower and lender, triggers a default under all of the loans between the borrower and lender. For example, if the borrower has three separate loans with the lender (sometimes other lenders also) and default on just one of them, the lender can accelerate or take other actions under all three loans.
Cross-Collaterallization— Much like cross-default, cross-collateralization provisions typically give the lender the right to foreclose on all collateral securing any loan to the borrower by the lender, the event of default on any of its loans.
Integration— Although a fairly standard “boilerplate” term found in many contracts, “integration” clauses are quite important. These clauses mean that all prior discussions, agreements, and negotiations between the parties on the subject at hand are meaningless. For example, a borrower and lender have extensive negotiations in which the lender promises the borrower a number of favorable terms for the loan. The loan is then closed, however the loan agreement contains an integration clause, but none of the favorable terms discussed between the parties. It would be very difficult for the borrower to argue in court that the parties’ intent was to include other, more favorable terms absent an allegation of fraud, which is extremely difficult to prove.
Whether obtaining a loan for $100,000 or millions of dollars, it is in the best interest of every credit union to carefully review all of the loan documents, understand what they say and explain them to the borrower.
Remember, the fine print counts.
Dustin H. DeVore is co-chair of Kaufman & Canoles’ nationally recognized Credit Union Team. He works closely with a number of credit unions on regulatory and lending issues. Dustin can be reached at (757) 259-3808 or firstname.lastname@example.org.
Given their structure and governance, credit unions have very specific legal needs. Kaufman & Canoles’ Credit Union Team understands the credit union difference – member owned, not-for profit financial institutions that are governed by volunteer boards. Our attorneys are familiar with all the state and federal statutes and regulations that must be followed in order to run a successful credit union. We use our knowledge and detail-oriented approach not only to help credit unions with commercial litigation and real estate transactions, but also with daily operations, regulatory compliance issues and human resources assistance. We not only understand a credit union’s unique needs, we anticipate them.