Is Pricing All That Matters When Borrowing?

March 01, 2023

Written By Pat Brennan and Taylor Davis

For many borrowers, pricing is the most significant factor when deciding on a lender. If you are borrowing from a mid-market lender (MML), it is more than likely that the deal will be papered on that MML's standard form documents (SFDs). SFDs are usually non-negotiable, lender-friendly and drafted with a "one-size fits all" approach. The cost of a borrowing transaction with an MML is not always evident from the term-sheet, and there may be restrictions on your business in SFDs that you were not expecting. We have selected a few of the more commonly encountered issues with SFDs to help you make a more informed decision before entering into a financing arrangement with an MML.

The Security Provided In Respect of a Particular Loan Likely Secures All Obligations You Have Owing to That MML

The security interests granted in connection with most SFDs typically secure any and all obligations, indebtedness and liabilities of the debtor to the MML. This means that the security provided under a particular security agreement is not just collateral for the debt associated with that security agreement, but also any other debts owing to that MML. This is particularly important to consider in circumstances where a debtor is granting an unsecured guarantee for one loan but a secured guarantee for another. The security agreement granted in respect of the second guarantee will often technically secure both guarantees, contrary to what was otherwise intended.

You May Not Be Able to Pay Dividends

Some SFDs will have outright prohibitions on the payment of dividends by a debtor. For owner-operators who pay themselves through the issuance of dividends, rather than a salary, this will not be feasible.

There May Be Onerous Restrictions On Your Regular Business Operations

SFDs typically have a number of covenants that are not reasonable, feasible or practical for many business types, including:

• Prohibiting the sale of any collateral, other than "inventory" sold in the ordinary course of business. There is usually no exception for "goods" or "equipment" sold in the ordinary course of business, or the disposition of used or worn collateral. To the extent any sale of collateral is permitted, typically the proceeds of that sale are supposed to be held in trust (occasionally in a segregated account) for the benefit of the MML and not available for use in reinvestment in the debtor's business without the MML's consent.
• Prohibiting the lease or rental of collateral.
• Requiring that all collateral remain located at the business address of the debtor. For debtors that use equipment on various job sites in their normal operations, this will not be possible.

You May Not Have Certainty With Respect to Your Reporting Obligations

Reporting covenants in most SFDs are substantively vague. Key financial covenant terms, like "debt" and "EBITDA," are usually left undefined or defined generally, without taking into account add-backs or alterations specific to a debtor's business. Many SFDs include covenants to deliver financial statements "at the request of the Lender" in addition to the regular monthly, quarterly or annual financial reporting requirements. The MML usually also has very broad powers to access books and records of the debtor at their discretion if they want access to information not contained in, or over and above, the regular reporting requirements which were otherwise negotiated in the term sheet.

In addition to the financial reporting covenants, SFDs frequently include onerous notice covenants with respect to any acquisition, loss or damage of collateral. These covenants are often not qualified by materiality, but instead, have either no qualifier at all, or require notice of the acquisition, loss or damage of collateral in excess of a nominal dollar amount threshold (as low as $5,000).

You May Not Have Certainty With Respect to What Constitutes an "Event Of Default"

In most financing arrangements, "Events of Default" are tied to the occurrence of distinct events, the happening of which, are inherently obvious to the debtor. Events of Default generally include incidents of non-payment, bankruptcy, dissolution, breach of covenants, etc. Often these Events of Default can be anticipated, and debtors can proactively work with the MML to avoid or manage their occurrence at the time. Unfortunately, most SFDs also include less-obvious Events of Default which are left to the discretion of the MML, such as, if the MML "believes that the prospect of payment or performance of the debtor's obligations is impaired, or likely to be impaired" or "if a corporate dispute arises which may hamper the business operations of the debtor." Many SFDs also contain Events of Default that are nearly impossible to comply with, for example, prohibitions on all liens without any allowance for those liens that arise in the ordinary course of business or through statute (e.g., in respect of taxes or mechanics liens).

For many debtors, it is particularly important to consider whether the simple "occurrence" of an Event of Default will trigger a cross-default under another agreement to which the debtor is a party, regardless of whether an MML actually intends to enforce the Event of Default and accelerate repayment. For example, breaching a covenant in an SFD restricting the lease of equipment may give a lessee of the debtor rights to terminate unilaterally a lease.

You May Not Be Able to Pay or Incur Other Debt

Most SFDs have a prohibition on incurring further debt and/or a requirement that any other debt (existing or future) be entirely postponed to the debt owed to the MML. This is usually problematic for debtors that have loans outstanding to shareholders, or circumstances where money is intended to move freely within a corporate group. Often, some practical allowances can be negotiated, but most SFDs do not provide any, or very little, flexibility as a starting point.

You May Need New Insurance

Nearly all lenders require a debtor's property insurance to list the lender as a first loss payee and their liability insurance to list the lender as an additional insured. However, SFDs often have property insurance coverage requirements that are not appropriate for all business types. The requirement to list the MML as first loss payee may also be problematic in circumstances where the debtor has other existing financing arrangements, pursuant to which, their existing lender is already listed as first loss payee.

Changes In Ownership Are Likely Restricted

Most SFDs prohibit any change to the ownership structure of the debtor regardless of whether it is likely to constitute a market definition of "change of control." This is can be a significant issue for debtors held by multiple owners/shareholders where there is likely to be future share issuances, buy-outs or redemptions of shares in the debtor.

For further information on this blog topic, please contact the authors.

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