Terms that decide what happens in a downturn
Financial covenants require the borrower to stay within measures such as leverage or debt service coverage, and a breach can be a default even when every payment is current. Events of default often reach further than borrowers expect, including a default under another agreement, a material adverse change, or a change in ownership. Once a default occurs, a lender may be able to accelerate the loan, charge default interest, freeze or sweep accounts, or enforce against collateral. Personal guarantees from owners can put personal assets at risk, and their scope varies widely, from full repayment guarantees to narrower ones tied to specific misconduct.
Security, reporting, and the paper trail
Secured business loans usually come with a security agreement and a financing statement filed under the Uniform Commercial Code, and sometimes with mortgages on real property and control agreements over deposit accounts. Read the reporting obligations carefully, because a late financial statement or compliance certificate is a common technical default. Keep a calendar of reporting dates, covenant tests, and required notices, and keep copies of everything delivered to the lender. If you expect trouble meeting a covenant, it is generally better to discuss an amendment or waiver before the breach than after, with counsel involved. Many ordinary business moves, such as selling significant assets or bringing in a new owner, may need the lender's consent, so check before acting.
Before signing, or after a default notice
Before signing, we look at covenant levels and definitions, cure rights, materiality qualifiers, limits on additional debt and distributions, prepayment terms, and the scope of any guarantee. Borrowers have the most leverage before closing, and small drafting changes can matter a great deal later. If a default has been declared or threatened, we review the lender's notice, the agreement's cure and waiver provisions, and the borrower's other obligations, and discuss options ranging from a forbearance agreement to a broader restructuring. Avoid signing acknowledgments or releases the lender presents without review, since they often give up defenses.
