The Loan Commitment or Term Sheet – Have You Thought Through Everything That You Are Agreeing To?

By: Serge Filatov

With interest rates still at historically low rates, many people here in Silicon Valley and San Jose are taking out inexpensive debt to finance their business and real estate needs . The first step in obtaining commercial debt is obtaining a loan commitment or term sheet from a lender. Loan commitments set forth the basic economic terms of the loan and include items like:

  • loan amount;
  • maturity date;
  • interest rate;
  • payment terms; and
  • security that the lender will take (if any).

While the items listed above are certainly important, many people often only focus on these “major” items and do not worry about the other details of the loan. Unfortunately, those “less important” details are often the major cause of future headaches for the unwary borrower.

When reviewing a term sheet or loan commitment, and before entering into an agreement with a lender, a potential borrower should consider the other common restrictions or requirements often imposed by lenders, which may include:

  • Financial covenants, including debt service coverage ratios;
  • Entity structure requirements;
  • Loan fees;
  • Prepayment fees and restrictions;
  • Reporting requirements;
  • Reserves for taxes, insurance premiums, capital expenditures, or other future costs and expenses;
  • Guarantees; and
  • Affirmative and negative covenants.

While the list above is by no means exhaustive, it is representative of the type of items that a borrower should consider when reviewing a loan commitment or term sheet. It is important to know about all that you are agreeing to – even the details. In many loan agreements, if you breach any part of the loan agreement, you will be in default of the loan and the lender could potentially accelerate all of the amounts owed under the loan. Will you be in the financial position to pay back the loan in full when the lender demands payment? Don’t put your business or property at risk by not thinking through the details of the loan.

Alternatively, if you are a lender, it can be advantageous to include the points above (and perhaps others, depending on the transaction) to minimize later negotiations with the borrower and ensure you do not invest more time in working on a transaction that will not get to closing because the parties are unable to agree on important final terms.

A term sheet or commitment letter can also be construed as a binding agreement in some instances, and the parties must use care to avoid this – assuming they do not want the term sheet or commitment letter to represent an actual, binding agreement.

If you are interested in avoiding problems later, it may be wise to have an attorney help you navigate the potential pitfalls of a term sheet, commitment letter and debt package and provide you with the best possible outcome for success.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.