Purpose of Commercial Loan Agreements Guide

This guidebook introduces borrowing microfinance institutions (MFIs or borrowers) to important provisions of a standard commercial bank loan agreement. It does not provide an exhaustive description of the contents of a loan agreement. (In any event, standard forms of loan agreements vary depending on several factors, including the lender, the country in which the lender is located, borrower characteristics, and loan size.) This guide-book, therefore, should be used by borrowers as general guidance. Typically, lenders will want to use their own agreement form as the basis for nego-tiating with borrowers. Much of a draft loan agreement comprises standard (boiler-plate) provisions, and banks are sometimes reluctant to consider changing these pro-visions. Other clauses in a loan agreement, however, are specific to the transaction. They may need to be customized to reflect the individual features of the lending relation-ship in question. The first draft of a loan agreement proposed by lenders is just that—a draft. Borrowers should study its terms carefully and, where necessary or commercially reason-able, negotiate the terms to ensure funds will be available to them when needed and they will be able to carry on their normal business per the agreement. Theoretically, every loan agreement provision can be negotiated, but in practice, a borrower’s negotiating strength depends on its bargaining power. A local borrower may find that bargaining power increases with the longevity of its relationship with the lender. This guidebook offers tips for drafting standard clauses. Borrowers should use this guidebook to help them understand the risks associated with some of the important pro-visions of a loan agreement. This guidebook also can help borrowers identify departures from generally accepted provisions that may negatively affect their interests.

Loan agreements commonly are evidenced by the signing of a loan agreement, a promissory note, or both. A loan agreement is a contract between the lender and the bor-rower that sets forth the terms and conditions of the loan (including its repayment) and the rights and obligations of both parties.

A promissory note, by contrast, is simply a written promise by the borrower to pay a stated amount of money in accordance with certain terms, which include the principal amount of the loan, a specified rate of interest, and a maturity date. The main difference between a loan agreement and a promissory note is length. Promissory notes typically are much shorter and less detailed than loan agreements. Moreover, promis-sory notes often are used together with loan agreements to provide supplemental evidence of the promises to pay the amounts specified in the loan agreement. Occasionally, the debt obliga-tion represented by a promissory note is secured by the borrower’s specific assets, in which case the promissory note may be called a collateral note. Although promissory notes are not essen-tial, because a loan agreement alone sufficiently records the transaction and binds the parties, they may provide some advantages to the borrower in certain jurisdictions. (For more informa-tion, see “Alternatives to a Loan Agreement—Promissory Notes.”) This guidebook addresses only standard commercial loan agreements governed by laws of common law legal systems.1 However, it does flag, in broad terms, some notable distinctions between the way common and civil law handle terms and practices with respect to loan agreements and promissory notes. The type of legal system that applies to the loan agreement is critical, because common law and civil law legal systems involve different approaches to the respective rights of credi-tors and debtors. Common law and civil law systems may use different legal terms; may rec-ognize different types of liens (legal interests in the borrower’s assets); may offer different types of self-help remedies to creditors; and may apply, through local courts, different interpreta-tions to terms and conditions. Borrowers should ask local legal counsel whether the law gov-erning the loan agreement follows common law or civil law principles and what the related implications are. Indeed, borrowers should seek local counsel to understand how this issue (as well as a number of other issues highlighted throughout this handbook) applies to them. This guidebook describes various loan agreement structures and standard provisions, including those relating to representations and warranties, covenants, events of default, remedies, enforcement, and confidentiality. It also covers commercial loan agreements and certain alternative loan products, defines loan agreement terminology, and explains the risks and benefits of some common loan structures.