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Credit Agreements 101: Key Provisions and Considerations

As a lender or a borrower, it is crucial to have a solid understanding of credit agreements.  In this article, we will delve into the key provisions and considerations of credit agreements, providing valuable insights.

Types of Credit Agreements

Credit agreements can be either syndicated or bilateral. Syndicated agreements involve multiple lenders, while bilateral agreements involve a single lender. The choice between the two largely depends on the commitment amount, with syndicated forms being more common for larger transactions. Most banks have their own preferred form or language for credit agreements, and they may require a syndicated form if the commitment amount exceeds a certain threshold.

Typical Structure of a Credit Agreement

While the format of credit agreements may vary, they generally include the following articles:

- Definitions and mechanics (commitments, extensions, taxes, EEL protection, interest rates)

- Conditions precedent

- Representations and warranties

- Affirmative and negative covenants

- Events of default (EODs)

- Agency provisions

- Miscellaneous items

- Schedules and exhibits

Importance of Definitions

Definitions play a crucial role in credit agreements and should never be overlooked. Most highly negotiated terms are defined terms, and they flow throughout the document. It is essential to review definitions carefully and ensure they align properly with the rest of the agreement. Pay close attention to how the parties (loan parties, borrower parties, borrower and parents) are defined, as this will determine the application of reps, covenants, and events of default. Other key definitions include applicable margin or applicable rate, change in control, and EBITDA.

Conditions Precedent

Conditions precedent outline the requirements that must be met for the loan to close and for subsequent borrowings. For the initial credit extension, typical conditions include:

- Executed loan documents (credit agreement, security agreements, guarantees, etc.)

- Officer certificates, resolutions, and incumbency certificates

- Legal opinions

- Payment of fees

- KYC (Know Your Customer) requirements

For subsequent borrowings, the borrower usually must represent that there is no default or potential default and bring down the representations and warranties.

Representations and Warranties

Representations and warranties are statements made by the loan parties to assure the lenders that they are lending money to the expected entities and that the business is operating as intended. Common reps and warranties include:

- Organization and good standing

- Authorization and enforceability of loan documents

- No conflicts with organizational documents

- Accuracy of financial statements

- No default or event of default

- No material litigation

- Compliance with sanctions and anti-corruption laws

Reps and warranties are typically made as of the closing date and brought down for subsequent borrowings, extensions, or increases in commitment.

Affirmative Covenants

Affirmative covenants are promises by the loan parties to take certain actions. They generally fall into three categories:

1. Financial reporting: This includes delivery of annual audited financial statements, quarterly or monthly unaudited financial statements, compliance certificates, and annual business plans and budgets.
2. Notice of material events: Loan parties must notify the lenders of defaults, material adverse events, litigation, investigations, defaults under other material documents, and other specified events.
3. Maintenance of the business: Loan parties must pay taxes and other liabilities, preserve their existence and rights, maintain property and insurance, comply with laws, and maintain proper books and records.

Negative Covenants

Negative covenants are promises made by the loan parties to refrain from certain actions during the life of the loan. These highly negotiated provisions are designed to create a fence around the loan parties' assets and limit potential claims on those assets. Common negative covenants include restrictions on:

- Additional indebtedness

- Liens

- Investments

- Fundamental changes (mergers, dissolutions, dispositions)

- Asset dispositions

- Restricted payments (distributions, dividends)

- Transactions with affiliates

- Use of proceeds

Negative covenants may also include financial covenants, such as leverage ratio, interest coverage ratio, and fixed charge coverage ratio, which act as warning systems for lenders.

Events of Default and Remedies

Events of default outline the circumstances under which the lenders can take action against the borrower. Common events of default include:

- Non-payment of principal or interest

- Breach of covenants (with or without cure periods)

- Breach of reps and warranties

- Cross-default on other debt

- Judgments against loan parties

- Insolvency proceedings

If an event of default occurs, the lenders may terminate commitments, accelerate the debt, and exercise remedies against collateral.

Agency Provisions

In syndicated loans, the agency provisions outline the role and responsibilities of the administrative agent. These provisions typically include:

- Recognition of the administrative agent by the lenders

- Exculpatory language limiting the agent's duties and liabilities

- Agent's right to rely on information provided by loan parties and lenders

- Resignation and replacement of the agent

- Lenders' acknowledgment of their own credit decisions

Miscellaneous Provisions

The miscellaneous section of a credit agreement contains various standard provisions, including:

- Waivers and amendments (specifying required lender consent)

- Assignments and participations

- Notices

- Governing law and jurisdiction

- Expenses and indemnities

Schedules and Exhibits

Schedules and exhibits to a credit agreement provide additional details and information referenced in the main document. These may include:

- Commitments of each lender

- Addresses for notices

- Existing indebtedness, liens, and investments

- Material contracts and real property

- Compliance certificate form

- Assignment and assumption agreement form

Conclusion

Understanding the key provisions and considerations of credit agreements is essential.  By carefully reviewing and negotiating the terms of a credit agreement, lenders and borrowers can achieve their business objectives while managing the inherent risks. As the legal landscape and market conditions continue to evolve, it is important to stay informed about developments in credit agreement structuring and negotiation.