This article has been written by Niketa Chitnis, pursuing a Diploma in US Contract Drafting and Paralegal Studies from LawSikho.

Introduction

Sponsor Term Loan Agreement refers to  a loan given by the Sponsor to the Borrower. It provides a lump sum of cash to the borrower in exchange for specific borrowing terms. Normally Sponsor Term Loan Agreements are meant for established small businesses with sound financial statements. Borrower agrees to repay such loans according to a certain repayment schedule for a fixed or floating interest, in exchange for a specified amount of cash. These loans require substantial down payments to reduce the payment amounts and the overall cost of the loan.

Sponsor Term Loan Agreements offer more flexibility to the borrower along with lower interest rates. These agreements for short and intermediate terms may require balloon payment, unlike long-term facilities which come with fixed payments.

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However, it is vital to understand the important clauses in Sponsor Term Loan Agreements before drafting such an agreement. Sponsor Term Loan Agreement is a complex document, and it is an agreement with the sponsor and the borrower that the borrower signs to get their loan. It is always important to draft water-tight agreements to prevent disputes and ensuing heartaches for the client, in the future.

Simple Sponsor Term Loan Agreements can be a little more than short letters, explaining how long a borrower has to pay back the money and what interest would be added to the principal. Whereas, others including mortgages, are elaborate documents that shall be filed as public records and allow the Sponsor to repossess the borrower’s property if the loan isn’t repaid as agreed under the Agreement.

Sponsor Term Loan Agreement and its conditions for repayment are governed by both state and federal guidelines in order to prevent illegal or excessive interest rates on repayment of such loans.

Key Clauses to Consider while drafting Sponsor Term Loan Agreement in the US

Sponsor Term Loan Agreement generally include covenants, the value of collateral involved, interest rate, guarantees, term and duration to repay the loan, etc. One should take extra care while drafting the following clauses:

Definitions

After the recital of the contract, it is important to define terms that have a technical meaning or to which you intend to give a technical meaning. This clause can be also used to put one word for a list of things. For instance, assets may be defined as “assets may include movable as well as immovable items”.

Interest

In Sponsor Term Loan Agreement, the interest clause is crucial as it states the interest rate on the loan. This clause gives a clear understanding of the exact amount of interest rate obligation associated with the loan. There are two main categories of interest rates:

(a) Fixed fee rates:

Fixed fee rate is set at a given number. It does not change during the period of repayment of the loan. (i.e., 13%). Calculations of fixed fee rates are much easier and not at all complex. 

(b) Floating fee rates:

Floating fee rate is just the opposite of a fixed fee rate. It is based on an interest rate margin added to a benchmark rate (i.e., 5%+ the benchmark rate). Under this, the interest rate fluctuates with time. 

Generally, more complex sponsor term loan agreements use a floating fee rate. However, the basic sponsor term loan agreements commonly use a fixed fee rate.

Interest is usually payable at either at the end of each interest period (including quarterly, half-yearly or annual) or at the term of the loan.

Default Interest

A well-drafted sponsor term loan agreement will also include a default interest clause. This increases the interest rate payable on amounts not paid when they fall due. The default rate shall accurately reflect the cost amount not paid by the due date. If the default interest rate is excessive, it could be deemed as a ‘penalty’ rate. If this occurs, the sponsor term loan agreement will not be enforceable if a dispute arises.

Prepayment

The sponsor term loan agreement should allow borrowers to repay the loan earlier than the term period. This is called making a prepayment and it makes the loan more flexible. This clause should allow prepayment at the end of the interest period, so as to avoid any payment of breakage costs. This clause can also include mandatory prepayment of the loan under certain circumstances, such as on the sale of the borrower’s business.

There are certain prepayment clauses that penalise the borrower with prepaid fees and penalties for doing so. Prepayment penalties are applied to protect the sponsor, who expects a certain return on his loan over a certain period of time.

Committed or uncommitted loan agreement

Sponsor term loan agreement may be either committed or uncommitted. In case of a cothe committed sponsor term loan, the sponsor is contractually obliged to lend the borrower the loan amount, once they satisfy certain conditions precedents. Such condition precedents are to be set out in a schedule of the sponsor term loan agreement. If the sponsor term loan is not committed, there is no need for a condition precedent schedule.

Events of Default

In the case of sponsor term loan agreement, it is essential to contain an event of default clause. The event of default brings the borrower into default. This definition could change depending on the type of loan and the position of sponsor and borrower. 

The major events of default would include:

(a) Cross-default, if a default is made under any other on-demand facilities provided by the sponsor to the borrower, it will automatically cause a default under this sponsor term loan agreement.

(b) Any breach in terms of sponsor term loan agreement will automatically cause a default.

(c) Non-payment of interest or capital automatically triggers default.

(d) Insolvency of the borrower is also an event of default.

It makes the borrower liable for a myriad of potential legal damages to compensate the sponsor for any losses suffered. This clause protects the sponsor from borrowers not repaying their loans. Under this clause, the sponsor can refuse to lend more money to the borrower, or request immediate repayment of the loan, or take possession of the secured property and sell the same for repayment or ask any guarantors of the loan to repay on behalf of the borrower.

Repayment and Method of Payment

Sponsor term loan agreements are sponsored for specific tenure and repayment schedules. Such repayment schedule or a set date shall be mentioned in the agreement. This clause should also include the method by which the loan shall be repaid to the sponsor.

Secured or Unsecured

A Majority of sponsor term loans are secured against an asset. However, in certain cases, the parties may agree to not secure the facility. This usually increases the sponsor’s risk, leading to a flow effect to other areas of the sponsor term loan agreement, For instance, the sponsor may charge a higher interest rate on the loan.

Bilateral or Syndicated

Bilateral loans are funds provided by a sponsor to one borrower. Whereas, on contrary, a syndicated loan involves two or more sponsors jointly providing loans to one or more borrowers. Between these two types of loans, bilateral loans are more common in simpler basic transactions. Generally, a loan may be syndicated if the sponsors are corporate, or investment banks and the amount of loan is very significant.

Choice of Law

A Sponsor term loan agreement should also mention the choice of law under which the agreement would be governed. Laws governing specific parts of the agreement in one state of the US may differ from the same law in another state of the US. Thus, it is important to identify state laws to which the agreement will be subject. This term is also called “Conflict of Law”.

Severability

This clause states that the terms of the agreement are independent of each other. Thus, if one condition of the sponsor term agreement is deemed unenforceable by law, the remaining conditions will continue to be valid.

Arbitration

This clause requires the parties to resolve their disputes through an arbitration process as opposed to the traditional court system. Nowadays mandatory arbitration is an increasingly popular provision in sponsor term loan agreements. 

Amendment Clause

A Sponsor may amend any clause in the sponsor term loan agreement, that they want with or without intimating the borrower. 

Notification Clause

This clause states that the customer has to inform the sponsor of any change in his employment, or profession, or business, or change in income levels, or residential address, change in residential status, etc. during the term of the loan. This clause shall include the time frame within which such information has to be notified by the customer and also the mode of notification.

Conclusion

Sponsor term loan agreements are governed by federal and state guidelines to ensure that the interest rates agreed in the agreement are both legal and reasonable. These agreements are beneficial for both sponsor and borrower for many reasons. This is a legally binding agreement and protects the interests of both parties, if either of them fails to honour the agreement. It helps the sponsor as it legally bounds the borrower to pay the money owed to the sponsor and also allows recourse in case of default on the loan by the borrower. Similarly, it benefits the borrower as it provides them with clear records of the loan details, like interest rate, term of repayment, etc. It allows them to keep a track of their payments. 

Regardless of whether the sponsor term loan agreement is between friends, family, or major corporations, it is essential to take time to draft a comprehensive loan agreement to avoid frustration in the future.

Sources

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