This article is written by Ritika Sharma, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.com.

Introduction

Very few people sail through life without taking loans. Be it car loan, home loan, education loan or loan for medical emergencies, all these borrowings are a common sight. Borrowing money is a big commitment, no matter the amount, which is why it is important to protect both the parties [1]. This is where a Loan Agreement comes into play. 

A Loan Agreement is an overly complex document which encompasses an agreement between a borrower and a lender about the details of what is being loaned out and when the borrower has to pay it back as well. Why is it called complex, you may ask? This is because it is a very lengthy document in most cases, and borrowers tend to consider it as a mere formality and ignore a few important clauses.   

The Agreement is drafted by the bank (lender) and hence it is quite obvious that their interest is dominant in the agreement. Therefore, it is highly advisable that the borrowers read through the agreement very carefully, so as to not have any sorrows later. 

Restrictions imposed by Bank in a Loan Agreement

• Loan amount not to be used for any other purposes: This is a very standard clause in any loan agreement, which basically mandates that the loan amount shall only be used for the purpose initially subscribed for by the borrower. However, in some cases the borrower shall be given some relaxations, like here: 

“The Loan shall not be used for any other purpose by the Borrower without the prior written consent of the Lender.”

Another sample clause for a loan taken by a company, which can be referred to:

a) The Borrower undertakes to apply the proceeds of the Facility only for the Purpose.

b) If for any reason, the Borrower is unable to comply with the above clause, it shall immediately inform the Lender in writing, of the same, and reasons thereof and shall, unless otherwise agreed to by the Lender, repay forthwith, the Loan together with the other Secured Obligations.

Under no circumstances shall the Facility be utilized by the Borrower, directly or indirectly, for: 

1. Subscribing to or purchasing any shares/debentures or any acquisition of equity in companies or buyback of shares;
2. Extending loans to its subsidiaries or making any inter corporate deposits;
3. Real estate activities/capital market activities or land acquisition;
4. Entering into speculative transactions or activities and/or illegal or prohibited activities;
5. Carrying out any activities not eligible for bank credit as per RBI’s guidelines.”

So, hereby the Borrower will have to get a written consent from the bank before using the loan amount for any other purpose or activity. If the Borrower uses the amount without the written consent, the bank may wedge the loan amount and further withdrawals, and at the same time ask for repayment of the loan amount.

• Variability of Interest Rates: Banks generally offer either: Floating Rate or Fixed Rate. For a fixed rate of interest, the rate remains constant for either the entire tenure or for a certain part of the tenure. The EMI of a fixed interest rate is known in advance. This is where even a reset clause is used. The bank may reset the rate of interest after 3-5 years, in respect with the prevalent market rate trends.

The floating or fluctuating rate of interest changes with respect to the market interest rate. If the rates in the market increases, the rate of interest rate for the borrower would increase, and when it decreases, the interest rate for the borrower would fall as well. This fluctuating interest rate is usually seen when taking home loans.

• Cleanup clause: A cleanup clause states that the borrower shall not be entitled to get another loan for a specified period upon the repayment of the initial loan. This clause is usually used to prevent the borrower from using their loans as a means of a long-term financing option. However, it must be noted that the cleanup requirement is becoming obsolete nowadays by banks. This is because banks are now more concerned with interest and principal payments within the scheduled time. 
• Obligations regarding insurance: The bank may want to include this clause mostly in the case of a secured loan, wherein it will ask the borrower to insure all assets for a specified value or the replacement value of the assets. The bank may also mention the insurance company which shall be engaged for insuring against any loss or damage. Here is a sample clause: 

“The Borrower shall from the Effective Date until closing, maintain fire and extended coverage insurance on the Assets (as mentioned in Schedule-1) which is at least equivalent to their replacement value with Kotak Insurance under such policies as the Lender may approve”.

• Event of default: This clause would generally state that in the event of a default, the lender would give a written notice to the bank, and the loan amount shall become immediately payable. Now, the term ‘event of default’ does not only include default in paying one or two monthly instalments, but also a series of situations. Here are a few examples which could be under the definition of ‘Event of Default’: 

1. A change of control of the borrower (in case of a company);
2. The borrower has defaulted another loan;
3. If the Bank thinks that the business or operations of the borrower are not being conducted efficiently or responsibly. 

Here is a sample clause:

“Occurrence and continuance of one or more of the following events (each an Event of Default) will constitute an Event of Default hereunder:

a) Failure by the Borrower in the payment of the Loans and/or interest on the Loans and/or any amounts payable under the Finance Document on the respective Due Date, unless such failure is caused by administrative or technical error in the banking system relating to the transmission of funds, which is outside the control of the Borrower and such sum is paid within three days of Due Date.

b) If Borrower breaches any of the terms and conditions of the Finance Documents and the same is not remedied by the Borrower within thirty days after notice thereof has been given to the Borrower by the Lender.

c) If the Borrower ceases to carry on its business, or if all the assets of the Borrower essential for its business or operations are damaged or destroyed. 

d) If in the opinion of the Lender, there occurs any change from the date of this Agreement, in the general nature or scope of the business, operations of the Borrower, which could have Material Adverse Effect.”

• Prepayment charges: The bank may impose prepayment charges in case the borrower returns the loan amount before the stipulated time period. Borrowers should note this before thinking about prepayment of the loan. Usually the prepayment charges prevalent in the industry is 0.5 -2 percent of the loan amount. These penalties may look like a punishment to the borrower, despite the borrower repays the entire amount of loan, but it is to protect the banks. This is the bank’s prediction of getting interests for the remaining period vanishes off. 

Rights & Duties of the Borrower

Even when a borrower defaults, the lenders do not have a complete walkover. The borrower does not surrender all his rights to the assets. Here are some rights that a borrower must keep in mind:

1. Borrowers have an option to take a legal recourse against the bank if the agents harass them [2];
2. Borrowers also have a right to adequate notice. Banks usually initiate proceedings under SARFAESI Act, where the repayment is due for over 90 days. The bank would have to first issue a 60 day notice to the borrower. If the borrower fails to pay within this time frame of 60 days, the bank can sell the assets but not before serving another 30 days public notice, which would specify the sale;
3. The borrower has a right to be heard during the notice period. He can make representations to the authorised officer and the officer is obligated to reply within 7 days if he rejects the representations and obligations of the borrower with proper reasonings.

The borrower has certain duties that must be fulfilled. These duties are not only obligations towards the bank but also help to have a good credit score. A borrower must always be aware of the below mentioned obligations on his part: 

1. Notify the bank in an event of default;
2. Notify the bank in case of change of personal information, for example a change of permanent address;
3. The loan amount must only be used for the purpose subscribed for; 
4. Timely repayment of the principal and interest amount;
5. Reimburse the bank for any costs or expenses in relation to the agreement;
6. Provide guarantors or securities (as desired by the bank) and not dispose off any asset, which acts as a security;
7. Provide the bank all financial information (for example: annual financial statement of the company) This is to monitor the borrower’s ability to repay the loan amount. 
8. The information furnished by the borrower for availing the loan must be true, complete, and correct and should not in any way be misleading.

Rights of the Bank

Whenever money is lent, it is done so with the expectation that it will be returned. This expectation is no different for a bank. Banks will adopt all necessary steps to recover the loan amount. Some of the rights of a bank are as follows: 

• To refuse the disbursement of loan and even ask for immediate repayment, in the following cases:

1. In the event of default (which would also include defaulting any payment obligation);
2.  any misrepresentation by the borrower; 
3. if he fails to perform obligations or 
4. if he fails to perform the preconditions for execution of payment of loan.

• Right of lien over the assets of the borrower and the guarantor(s) : In case of secured loans, the underlying mortgaged asset(s) can repossessed by the bank through Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests (SARFAESI) Act, 2002, by giving adequate notice to the borrower.
• Right to amend the agreement at any time, by providing a notice to the borrower;
• Right to opt for legal proceedings against the borrower in case the borrower is wilfully neglecting to pay the loan amount.

Case laws

The borrowers carefully go through the loan agreements while also being aware about the RBI directions in place. One such case decided in the High Court of Kerala was Against the judgement in WPC. 270/2012 v. Advs. Sri. R.S. Kalkura [3]. The repayment clause stated that the loan EMIs would start after 1 year of completion of course or 6 months after getting employment and the duration of the course was 4years. However, due to circumstances out of her control, she could not complete the course within the stipulated time. The bank initiated recovery proceedings and demanded that the mother’s property be attached. Jwala and her parents raised an argument that they were neither guarantors nor were their house kept as a security. The RBI directions stated that any education loan below 4 lakhs need not have any security. But the High Court said that the father of the borrower acted as a co-borrower, and therefore he waived the benefit which accrued to him by virtue of the directions, which is why a recovery proceeding against him was valid. 

The courts have time and again helped borrowers from falling prey to the bank’s one-sided agreements.

On the issue of prepayment charges, there was a case decided in the Delhi High Court- DLF Limited v. Punjab National Bank [4]. DLF Limit had taken a loan of Rs. 1,000 crores and furnished securities for the same. The company paid the entire loan amount with the interest thereon, but the bank withheld the security since the company refused to pay the prepayment charges of Rs. 20 crores at the rate of 2% of the loan amount. DLF contended that the bank had never disclosed about such prepayment in the loan agreement. The Delhi High Court gave its verdict in favour of DLF Limited, since they did not find the pre-payment charges of Rs, 20 crores baseless and quashed it. 

Draft Loan Agreement

Here is a draft loan agreement with some important clauses that must always be checked that can be referred to: 

This Loan Agreement (hereinafter referred as Agreement) is entered into on 5th May, 2019 (hereinafter referred to as Effective Date): 

BY AND AMONG: 

(1) BVF Bank Limited, a public company, incorporated under the laws of India, with CIN 8999009,  and having its registered office at C556, Janpath Road, Delhi- 100999, India, hereinafter referred to as the Lender;

(2) KGH Private Limited, a private company incorporated under Companies Act, 2013, with CIN 9990009, and having its registered office at 6 Prithvi, Rajrudram building, Delhi-1000066, India, hereinafter referred to as the Borrower;

The Lender and Borrower are hereinafter collectively referred to as the Parties.

WHEREAS: 

1. The Lender is a national bank engaged in the business of providing finance to a wide range of customers including small and medium enterprises;
2.  The Borrower is a private company engaged in the business selling fashion apparels in Delhi and further activities as set out in Schedule 1;
3. The Borrower has approached the Lender for a business loan (hereinafter referred to as Loan), for the purpose of expanding its business (hereinafter referred to as the Purpose). The Parties have therefore decided to enter into this Agreement. 

NOW THEREFORE, in consideration of the promises and the mutual covenants set forth herein, the Parties hereto, intending to be legally bound, hereby agree as follows:

• Loan Amount, Interest and Repayment

1. The Lender agrees to lend to the Borrower a sum not exceeding INR 50,00,000/- (Rupees Fifty Lakhs only) (hereinafter referred to as the Loan amount) for a period of 29 (twenty-nine) months (hereinafter referred to as the Tenure) with an interest rate of 5 (Five percent) % per annum from the Effective Date for the first year, after which the interest rate for the remaining Tenure shall be 6 (Six)% per annum. The Borrower accepts the loan and agrees to repay the amount in accordance with the terms and conditions set out in this Agreement.
2. The schedule of repayment in respect of the Loan shall be as specified in Schedule 1 as set out herein or as may be amended in accordance with this Agreement from time to time. 
3. The Borrower has requested the Lender to disburse the Loan in the manner specified in Schedule 2 hereto;
4. In consideration of the Lender extending the “Loan”, the Borrower and Guarantor shall jointly and severally repay the Loan along with Interest in accordance with the Repayment Schedule set out in Schedule 1 of this Agreement;
5. The Borrower hereby confirms having perused, understood that the interest is applied on the principal on a yearly basis and agreed to the method of computation of EMI and the effective or rate of interest as stipulated in Schedule 1.

• Borrower’s covenants

• The Borrower shall deliver to the Lender:

1. its audited Balance Sheet and Profit and Loss Account by December 1 of every year or within 15 days of adoption of accounts in the Annual General Meeting of the Company, whichever is earlier; 
2. quarterly utilization certificates commencing from the first drawdown certifying that the disbursements have been utilized for the Purpose for which Loan was sanctioned.

• The Borrower undertakes to use the Loan Amount only for the Purpose.
• If for any reason, the Borrower is unable to comply with the above clause, it shall immediately inform the Lender in writing, of the same, and reasons thereof and shall, unless otherwise agreed to by the Lender, repay forthwith, the Loan.
• Under no circumstances shall the Loan Amount be utilized by the Borrower, directly or indirectly, for: 

1. Subscribing to or purchasing any shares/debentures or any acquisition of equity in companies or buyback of shares;
2. Extending loans to its subsidiaries or making any inter corporate deposits;
3. Real estate activities/capital market activities or land acquisition;
4. Entering into speculative transactions or activities and/or illegal or prohibited activities;
5. Carrying out any activities not eligible for bank credit as per RBI’s guidelines.

• Event of Default

If one or more of the events specified in this section shall have happened, then the Lender may by a written notice to the Borrower, declare that the Loan Amount and the Secured Obligations have become payable forthwith by the Borrower to the Lender and upon such declaration, the same shall become due and payable forthwith:

1. 1. If the Borrower fails to pay any monies payable as per Schedule II (ii);
   2. If the Borrower fails, defaults, omits or neglects to observe or perform or commits or allows to be committed a breach of any of the terms, conditions, provisions or stipulations of this Agreement;
   3. Any information given by the Borrower is incorrect or misleading, or a representation, warranty, undertaking or statement made hereunder or in connection with any other Agreements by the Borrower is incorrect or misleading in any respect; 
   4. Any insurance contracted or taken by the Borrower is not, or ceases to be, in full force and effect;
   5. If the Borrower is unable to pay its debts within the meaning of Companies Act, 2013 or a resolution for winding-up of the Borrower is passed or any petition for its winding up is filed or any order for winding-up is made against the Borrower or if a liquidator is appointed in respect of any property or estate of the Borrower;
   6. Any person acting singularly or with any other person (either directly or indirectly) acquires control of the Borrower either directly or indirectly, without the approval of the Lender.

• Assignment

1. The obligations herein shall bind not only the Borrower but its executors, legal representatives, administrators and/or as the case may be its successors;
2. The Borrower shall not be entitled to transfer or assign any of its obligations herein without the written approval of the Lender;
3. The Lender may however transfer or assign any of its rights or obligations under this Agreement at its sole discretion. Upon such assignment, the Borrower shall fulfil and perform all its obligations to such assignee, in accordance with the terms and conditions of this Agreement, as if such assignee were the Lender herein and shall execute all documents required in this behalf by the Lender.

• Prepayment

1. The Borrower shall not prepay/foreclose any portion of the outstanding loan amount either in part or full during the Lock-in period as set out in Schedule 1 of this agreement;
2. The Borrower may exercise the option of pre-payment post Lock-in-period, where applicable, subject to the Borrower and the guarantor complying with the following conditions and at the absolute discretion of the Lender. After the expiry of Lock-in Period as provided in Schedule 1 hereunder, the Borrower shall give the Lender a notice of 21 days intimating his desire to pre-pay the loan and the Lender may accept pre-payment together with pre-payment charges / foreclosure charges as specified in Schedule 3, hereto and such charges is payable by the Borrower together with applicable taxes.

IN WITNESS WHEREOF, the Parties hereto, acting through their duly authorized representatives, have caused this Agreement to be signed in their respective names as of the date first above written. 

Witness1                                                                                                         Witness2

Signature:                                                                                                    Signature: 

Name and Address                                                                             Name and address 

Common Seal of the Borrower

Conclusion 

As Thomas Jefferson had once said, “I sincerely believe that banking establishments are more dangerous than standing armies…”.

It is extremely important for borrowers to read and understand the loan agreement. If any clarifications are needed as to some clauses, the bank itself would help you out and make you understand the agreement. Enter into the agreement with your eyes wide open and with the assumption that things may not be in your favour.

References

[1] Loan Agreements: Everything you Need to Know, Legal Nature. (see more at: https://www.legalnature.com/guides/everything-you-need-to-know-about-loan-agreements)

[2] Refer to RBI Notification https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=3961&Mode=0

[3] WA. No. 974 of 2012 () IN WPC/270/2012: https://indiankanoon.org/doc/4091164/

[4] W.P.(C) 8520/2010: https://indiankanoon.org/doc/417200/

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