Clint M. Hanni
The loan agreement isn’t the only document in a loan transaction. Other documents (sometimes dozens of them) can come into play. Here are a few to consider:
- 1. Security Agreement. If the loan will be secured by personal property, such as accounts, inventory, equipment or IP (patents, trademarks, copyrights), there will be a security agreement. Many borrowers make the mistake of assuming security documents are simply standard agreements off the shelf and nothing to worry about. The truth is different: security agreements can be used by lenders to add additional terms into the deal. The most important consideration in a security agreement is to make sure it correctly describes the collateral. If the loan is to be secured by all the assets of the borrower, the collateral description is less of an issue, but if the loan is to be secured only by a certain type of collateral (e.g., inventory), an overly broad collateral description can get the borrower in trouble, especially if the borrower wants to reserve some of its assets to use as collateral on another loan. To avoid costly mistakes, have this document reviewed by an experienced finance lawyer.
2. Pledge Agreement. Loans are often secured by stock or limited liability company membership units. A Lender may require a borrower to pledge the stock of its subsidiaries. A parent company or other affiliate may be required to pledge its stock as collateral. For all the stock pledges, the lender will insist on taking possession of the original stock certificates (if they exist) until the loan is paid back. In addition, the bank will ask for stock powers, a document that gives the bank the power to transfer the stock into its own name if an event of default occurs. During the loan period, the borrower will not be allowed to sell the pledged stock.
3. Guaranty. The lender may require that a third party closely related to the borrower (such as a parent company, a subsidiary or a major stockholder) agree to provide a guaranty of the loan, which is essentially a promise to pay off the loan if the borrower fails to do so. Not all guaranties are the same. Some are limited in amount and revocable; others are unlimited and irrevocable. As with all the loan documents, you need a good finance lawyer to make sure you are getting the deal you agreed to.
4. Promissory Note. A promissory note is a short document that represents the borrower’s obligation to pay back the loan and details the payments of principal and interest to be made. This document should be carefully reviewed by a professional to confirm that it correctly states the terms found in the term sheet and doesn’t introduce additional terms the borrower has not agreed to.