What is a Credit Facility Agreement?
A credit facility agreement refers to an agreement or letter in which a lender, usually a bank or other financial institution, sets out the terms and conditions under which it is prepared to make a loan facility available to a borrower. It is sometimes called a loan facility agreement or a facility letter. The detailed contents of a credit facility agreement depend on several factors, including the type of facility being offered and the purpose of the facility.
A credit or loan facility is a loan made in a business or corporate finance context. Types of credit facilities include committed facilities, revolving credit facilities, and retail credit facilities. The terms of a credit facility agreement are determined by a multitude of factors, including the creditworthiness of the borrower, the purpose for the loan, the collateral made available, and the negotiating strength of both parties.
Key Learning Points
- A credit facility agreement is a contract that details the binding terms and conditions under which a lender is willing to make available a loan facility to a borrower.
- A credit or loan facility is a type of business loan.
- A typical credit facility agreement carries clauses making provisions for the loan duration, interest rate, repayment terms, penalties for default, and loan warranties.
Understanding a Credit Facility Agreement
To get a better understanding of what a credit facility agreement is, it is important to examine the concept of a credit facility. A credit facility is a loan made in a business or corporate finance context. It permits the borrowing party to have access to funds provided by the lender over an extended time period rather than renegotiating for a loan each time it requires funds. Common examples of credit facilities include revolving credit, term loans, collateral loans, committed facilities, letters of credit, and most retail credit accounts.
A credit facility is an agreement between a lender and a borrower in which the lender agrees to make a loan or credit facility available to the borrower based on agreed terms. The lender initially outlines the terms in a letter. The borrower can then negotiate the terms and tailor them to their needs. A clear and concise understanding of a credit facility agreement is necessary to ensure that the borrower’s best interests are served and protected.
When drafting a credit facility agreement, the lender aims to protect its investment and ensure the capital is repaid, interest payments are made, and fees are paid when due. The lender attempts to meet these objectives by declaring when and how payments need to be made, monitoring the activities and financial position of the borrower through its representations and undertakings, and ensuring it has the power to demand repayment of the facility under specific circumstances. In addition, the lender can specify the conditions under which the borrower can draw down the facility and how the resulting proceeds may be applied.
On the other hand, the borrower in a credit facility agreement aims to keep the fees, costs, and expenses to a minimum, ensuring its compliance with the terms of the agreement is realistic. The borrower must also ensure the terms are flexible enough to allow it to carry on its daily operations and any reasonable activities outside of the ordinary within the life of the facility, without having to seek the permission of the lender. Furthermore, the borrower would want to minimize its administrative burden and maximize timeframes for complying with the demands of the lender and providing necessary reports and information.
Key Provisions of a Credit Facility Agreement
The provisions of each credit facility agreement are unique. That is, they are drafted specifically for the borrower in question. The lender considers the borrower’s creditworthiness, cash flow, and any collateral they may make available to pledge as security for the loan before offering a credit facility. The credit facility agreement includes the borrower’s responsibilities, loan warranties, lending amounts, loan duration, interest rates, repayment terms and conditions, and default penalties.
Some of the standard provisions included in a credit facility agreement include:
Description of the Facility
A credit facility agreement typically contains provisions for describing the facility provided. Common credit facilities include retail credit facilities, revolving credit facilities, and committed facilities. A retail credit facility is a method of financing or line of credit used by retailers and real estate companies. A revolving credit facility refers to a loan issued by a bank or other financial institution that provides flexibility to a borrower to draw down or withdraw, repay and withdraw again. A committed facility is a long- or short-term financing agreement provided to a borrower by the lender, which depends on whether the borrower meets specific requirements put in place by the lender. Term loans are an example of a committed facility. The funds are made available up to a maximum amount for a specific period with an agreed interest rate.
The purpose(s) for which the loan proceeds can be used is also outlined in the facility letter. This is especially important for the lender because it provides a certain degree of confidence that the borrower will be able to repay the loan when required, and the funds will not be used for imprudent or illegal purposes. The purpose is also related to the lender’s credit analysis and approvals. If the borrower is unable to use the proceeds of the loan for the stated purpose, the lender may benefit from a Quistclose trust. This is a trust that arises where the property is transferred by one party to another on terms that leave some or all of the beneficial interest undisposed. Whether or not a Quistclose trust arises when the funds are lent will depend on the wording of the purpose clause or any restrictions on the loan proceeds as defined in the facility letter.
The credit facility agreement will detail when and how the facility will be drawn down and repaid. It will give conditions to or limitations on the availability of the line of credit when the facility must be repaid or prepaid, and any restrictions on the prepayment or cancellation of the facility. The provision will determine whether the borrower repays the facility on a fixed date or schedule or if it must be repaid on demand.
The loan facility agreement will also contain provisions relating to the applicable interest rate(s). The interest rate may be fixed, which is typically the case for short-term or small commercial loans. Variable rates are commonly seen in large commercial loans, loans in non-domestic currencies, and long-term loans. A variable rate is usually quoted as an interest rate margin added to a benchmark rate.
Credit facility agreements prohibit the borrower from deducting or withholding an amount from any tax payment unless the deduction is permitted by law. Where deductions are required by law, the lender will expect its payments to be grossed-up with applicable taxes. This clause ensures that after the tax deduction, the amount paid by the borrower to the lender will be the same as it would have been if no tax deduction had been required from the payment.
Tax indemnity provisions are included in the facility agreement for the borrower to shoulder the burden on the lender for any taxes claimed or assessed, with respect to any obligation of the borrower under the facility agreement. The borrower is to compensate the lender for any tax suffered directly or indirectly by the lender with respect to their lending activities.
While the tax gross-up gives a lender protection from withholding tax when the borrower is making interest payments, the tax indemnity protects the lender from any tax once payment has been made.
The credit facility agreement makes provision for increased costs. The provision permits the lender to claim for any increases in the lender’s cost of funding the loan due to a change in the law. This allows the lender to reserve the right to require the borrower to pay any increased cost arising from any change in any law or regulation affecting the loan agreement.
Representation and Warranties
Representation and warranty provisions outline promises that the parties of a credit facility agreement have made to one another. Particular focus is placed on whether the borrower is legally capable of entering into a loan agreement and the nature of its business. These clauses set out the legal and factual basis on which the lender is willing to make the facility available to the borrower and place the risk of unforeseen circumstances on the borrower. The list of representations in a facility agreement depends on what kind of facility is offered, the parties’ respective negotiating strength, and whether or not the facility is secured. If there is a breach or false representation, the lender will usually use this contractual provision to call an event of default and demand repayment of the loan.
Covenants or undertakings are formal pledges or promises made by the borrower in a credit facility agreement to do or not to do something. These can be split into negative, positive, and financial undertakings.
Positive undertakings or covenants may require the borrower to submit financial information to the lender, provisions on insurance policies, and security. They do not impose any restrictions on the borrower. Negative undertakings set out various activities the borrower may not engage in without the lender’s consent during the life of the facility. The borrower must examine such covenants to ensure they provide enough flexibility to carry out ordinary business. Such undertakings might prevent the borrower from paying out dividends or other payments to shareholders. Financial undertakings are promises by the borrower to meet or comply with certain financial thresholds. It sets out various financial parameters within which the borrower must operate. These financial undertakings are a key element to any facility agreement and are most likely to trigger an event of default if breached.
Events of Default
An event of default is triggered when there is a breach of the credit facility agreement. Credit facility agreements include a mechanism under which the lender can take specific actions if the borrower breaches the loan agreement or other specific events occur. These events that permit a lender to take such action are set out in the contract and referred to as events of default. If an event of default arises, the lender can cancel its commitments, declare part or all of the loan to be repaid on demand, or immediately, and enforce any security.
Boilerplate provisions are standard provisions included in every credit facility agreement and are set out in the contract details of the parties and laws which govern the agreement. Governing law, jurisdiction, and arbitration provisions are particularly important in cross-border finance transactions.
A governing clause states the law governing any potential disputes between the parties. A jurisdiction clause establishes the jurisdiction in which a dispute will be heard. An arbitration clause will be included if both parties decide to have the option to settle any disputes by way of arbitration.
Borrowers wishing to have access to a line of credit to finance both short- and long-term capital requirements from lenders have to enter a credit facility agreement. This contract details the terms and conditions that both parties must follow to ensure the protection of one another’s interests. The description and type of facility, the purpose for which the funds will be used, undertakings and representation, and the events that might trigger a default and resulting actions are all included in the credit facility agreement. Both parties involved in a facility agreement must examine and negotiate the terms to arrive at a conclusion that best serves their interests and objectives.
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