Commercial Law and Practice LG05 D1

LEGAL PRACTICE COURSE

Commercial Law and Practice
Large Group 5


Topic(s):
 Bank lending
 Selecting a bank facility – overdraft, term loan or revolving credit facility
 Interest rates and calculation
 Chronology of a loan finance transaction
 Overview of a facility agreement


Learning Outcomes:
By the end of this session you will be able to:
 Outline the commercial considerations which may influence the decision as to why, how
and when to raise funding
 Explain the difference between an overdraft, a term loan and a revolving credit facility
 Explain how interest rates are calculated under a typical credit agreement
 Understand the chronology of a loan finance transaction
 Understand key finance terms and how a Facility Agreement is structured


Session Activities:
 As set out in the session outline


Materials Attached:
 Session outline

Preparation for Session:
 Read Chapters 1, 3 and 4 of the Banking and Capital Markets manual
 Review the attached session outline
 Bring the draft Facility Agreement from Workshop 10 with you to this Large Group (you
will find this attached to document d1).


Post-Session:
 Review your notes of the session in order to consolidate your understanding




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Commercial Law and Practice
Large Group 5: Session Outline


1. Introduction to Bank Lending

Real property being used as security for lending

We look at the borrower, the lender, finance and why a business why want to borrow money,
growth and concept of interest being returned on the money

Facility agreement is just a contract in which a bank agrees the basis on which it is prepared
to lend to a company. It would usually set out things like the criteria that needs to be satisfied
for the money to be lent, when the money must be repaid, how interest would be calculated
and when the payments must be made or interest must be paid (in practice can be acting for
either borrower or lender so consider both perspectives, we advice on commercial aspects
but client ultimately makes the choice)

Contents of a facility agreement are driven by practical and commercial considerations.
Those decisions are your clients choice. We advise clients on legal aspects and they know of
the commercial aspect because they know their business best.

We are not covering capital markets elements in the module.


2. The Commercial Background

 The Borrower(s) : why borrow? debt finance (not equity finance)
 Start-up costs
 Buyer major assets
 Cashflow issues
 Expansion
 Refinancing
 Leverage

Debt finance ie borrowing from the bank being done as part of start up costs for a new
business because its unusual for a new business to have that ready capital.

Regarding financing a business there are 2 options ie equity finance and debt finance. Equity
finance ie raising money through shares. That will bring money at the start if the company is
issuing 1000 £1 shares but it’s not going to be enough to purchase significant capital
machinery for example. Its typical for a business at its early stages to get some debt finance
borrowing from a lender. Maybe you need to purchase some sort of machinery, those assets
are expensive so do you have that ready cash available for that expenditure and even if you
do, from a cashflow perspective its not a good idea to use all your available cash on
purchasing a significant asset because then your cash is tied up. You might consider debt
finance as a way of purchasing the funding of that asset i.e. real property equipment,
machinery etc.

Other reasons you might borrow and that might relate to cashflow issues. This is a big issue
for businesses. Cashflow issues could occur anytime for example customers company might
not pay their invoices properly but the company still needs to pay its employees at the end of
the month so even if the money is not coming in, money is still flowing out and that’s the
cashflow issue that could arise.




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Expansion – so you might want to expand your business by purchasing another business or
company. To do that you need significant funds to pay the seller of that company. You could
do that by borrowing from a lender.

Refinancing – e.g. paying off an existing debt. If the company has several small loans
already, the company might want to consolidate that by borrowing a single large amount and
then paying off and satisfying those several small loans. That will have the advantage that
they will only have to deal with 1 lender. They might be able to negotiate more favourable
rate of interest overall from 1 lender rather than smaller loans with multiple lenders.
Refinancing depends on the financial standing of the borrower because if their financial
standing is poor then its not going to be attractive for a lender to finance refinance with them
on favourable terms. If you’re a borrower and you are in a strong position then you’re going
to be able to negotiate more favourable terms than a company who’s in a poor position.

Leverage so concept of gearing. The relationship between debt and equity. There are all
sorts of measures to use to look at liquidity.

Gearing aka leverage is the balance between the amount of share capital in issue and the
amount of debt owed by the company. The highly leveraged (or highly geared) company
means one that has a lot of debt but a small share capital. Highly leveraged company is the
one that has a lot of debt in proportion to the share capital. That can be danger because if
you got a high proportionate debt to equity and then your debt becomes repayable perhaps
there has been a problem and then company is not in a good position so the lender calls in
their debt, that can be very problematic. However, if a company does very well, the
shareholders do well because the banks are not taking more because the company is
making lots of profit, the bank just gets repaid what they are due and the interest. So the
bank is not sharing the success of the company in the same way you do as a shareholder.
That’s a crucial distinction.

The Bank(s): why lend?

 Interest
 Arrangement fee
 Agency fee
 Commitment fee
 Reputation
 relationship

Reputational benefit of being involved in a particular loan or the importance of maintaining
and creating a particular client relationship. Banks lend to make a profit on the loan.

Lender makes money from interest and fees. People are likely to have an overdraft or a loan
on which you’re charged interest by the bank. They make a facility available to you or they
make a loan and in return you agree to repay that money ie the capital but you also agree to
pay the lender interest which represents a return to them on their investment of lending you
money because that’s a risk to them. So the interest represents a return on that risk. The risk
is borrower may not repay and if he doesn’t repay then its difficult for the lender to get their
money. Borrower may be thinking, the lender can have security and enforce that security.
That’s true but there are costs in doing so. There are still risks attached.

In a commercial lending context there are lots of fees i.e. arrangement fees, agency fees,
commitment fees.

The higher the banks risk is so non payment by the borrower the higher they are going to set
their charges particularly the interest rate. That’s why people with credit issues are unfairly
subject to high interest rates because the lender looks at their credit history and sees it as a
risk of non-payment. That’s how they mitigate their risk.
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