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Breach of commercial loan covenants
Sometimes called undertakings, loan covenants are a promise by the borrower to the lender to do, or refrain from doing, something while the loan is outstanding.
A borrower’s undertakings set out the agreed parameters within which it may operate. These parameters form a key assumption in the lender’s decision to lend and their confidence that the borrower’s will repay.
It is important to look not just at whether a loan is affordable and offers the best available payment terms but whether the additional requirements on capital, reporting and compliance are too onerous.
During difficult economic circumstances the focus is naturally on complying with financial covenants but even apparently minor, technical breaches of loan covenants such as providing cash flow forecasts a few days late can result in lenders seizing on this as an opportunity to demand early repayment.
Loan covenants which often cause problems can include:
Loan to value or ‘LTV’ covenants
These specify the minimum value of the business as percentage of its debt. These are frequently breached without businesses even being aware without careful monitoring of indebtedness. The new accounting standard FRS 102 require the break cost of interest rate hedging products such as swaps, collars and caps to be reported which may put businesses in breach.
Financial reporting covenants
Sometimes ignored or neglected but essential to comply with, these require the business to report to the lender with cash flow and accounts.
Breach of a loan covenant can result in dramatic action by the lender such as:
- Varying terms as to interest rates and repayment dates
- Imposing further, more onerous terms such as revaluations of the borrower’s business
- In extreme circumstances, repayment in full may be demanded immediately
Deciding whether a breach has occurred is not always a straightforward objective test, it can depend on subjective interpretation of accounts and forecasts of future performance. Often it is a matter of putting your case to the lender in order to prevent action being taken at an early stage.
If the lender has already taken action to enforce the loan agreement, it may be possible to negotiate a settlement.
For a frank evaluation of a loan agreement call 01392 207 020 to speak to our finance and banking team or email email@example.com.