Understanding the Basics
A loan agreement, also known as a promissory note or a business loan contract, details the terms under which one party (the lender) agrees to lend money to another party (the borrower, which in this case is your business). The agreement should cover all critical aspects of the loan, including repayment terms, interest rates, collateral, and any covenants or conditions that apply.
Key Elements of a Loan Agreement
To draft an effective loan agreement, you need to include several key elements:
- Parties Involved
- Lender: The person or entity providing the loan. This could be a bank, financial institution, private lender, or even another business.
- Borrower: Your business, which will receive the loan and is responsible for repayment.
Clearly identify both parties by their full legal names and addresses. If your business operates under a different name (a DBA), include both the legal and trade names.
- Loan Amount and Disbursement
- Principal Amount: Specify the total amount of money being loaned.
- Disbursement: Outline how and when the loan funds will be disbursed to your business. This could be in a lump sum or in installments.
Example: “The Lender agrees to lend the Borrower the principal sum of $100,000, which shall be disbursed in one lump sum on [Date].”
- Interest Rate and Fees
- Interest Rate: State the interest rate applicable to the loan, whether it’s fixed or variable, and how it will be calculated.
- Fees: Include any origination fees, late payment penalties, or other charges that may apply.
Example: “The loan shall bear interest at a fixed rate of 5% per annum, calculated on the basis of a 365-day year.”
- Repayment Terms
- Repayment Schedule: Detail the repayment schedule, including the amount of each payment, the due dates, and the final maturity date of the loan.
- Payment Method: Specify how payments will be made (e.g., by check, wire transfer, or automatic debit).
- Prepayment: Address whether the borrower can prepay the loan without penalty, and if not, what penalties apply.
Example: “The Borrower shall repay the loan in 60 equal monthly installments of $1,885, beginning on [Date], with the final payment due on [Maturity Date].”
- Collateral and Security
- Secured Loans: If the loan is secured, describe the collateral being offered (e.g., real estate, equipment, inventory). Include details about how the lender can take possession of the collateral if the borrower defaults.
- Unsecured Loans: If the loan is unsecured, acknowledge that the lender has no collateral to claim in the event of default.
Example: “This loan is secured by the Borrower’s equipment, detailed in Exhibit A, which the Lender may repossess in the event of default.”
- Covenants and Conditions
- Affirmative Covenants: These are actions the borrower agrees to take, such as maintaining insurance, providing financial statements, or complying with laws.
- Negative Covenants: These are actions the borrower agrees not to take, such as incurring additional debt or selling major assets without the lender’s consent.
- Conditions Precedent: Conditions that must be met before the loan is disbursed, such as providing proof of insurance or obtaining necessary permits.
Example: “The Borrower agrees to maintain general liability insurance with coverage of no less than $1,000,000 and to provide the Lender with annual financial statements.”
- Default and Remedies
- Events of Default: Clearly define what constitutes a default, such as missing a payment, breaching a covenant, or becoming insolvent.
- Remedies: Outline the steps the lender can take if the borrower defaults, such as accelerating the loan (demanding immediate repayment of the full balance), seizing collateral, or taking legal action.
Example: “Failure to make any payment when due shall constitute an Event of Default, upon which the Lender may declare the entire outstanding balance immediately due and payable.”
- Governing Law and Jurisdiction
- Governing Law: Specify that the agreement is governed by the laws of the state most convenient to you and your location..
- Jurisdiction: Determine where any legal disputes will be resolved, typically in the courts located in the lender’s or borrower’s jurisdiction.
Example: “This Agreement shall be governed by and construed in accordance with the laws of the State of Tennessee. Any disputes arising from this Agreement shall be resolved in the state or federal courts located in [County], Tennessee.”
- Miscellaneous Provisions
- Entire Agreement: State that the written agreement constitutes the entire understanding between the parties, superseding any prior discussions or agreements.
- Amendments: Describe how the agreement can be amended, typically requiring a written document signed by both parties.
- Severability: Include a clause that ensures if any part of the agreement is found invalid, the rest remains enforceable.
Example: “This Agreement constitutes the entire agreement between the parties and may only be amended in writing signed by both parties.”
Best Practices for Drafting a Loan Agreement
- Consult Legal Counsel: While this guide provides a general overview, it’s important to consult with an attorney who can ensure that your loan agreement complies with Tennessee laws and meets your specific business needs.
- Be Clear and Specific: Ambiguity can lead to disputes. Clearly define all terms and ensure both parties fully understand their rights and obligations.
- Review Regularly: As your business grows and changes, your loan agreements may need to be updated. Regularly review your agreements to ensure they remain relevant and enforceable.
- Get Everything in Writing: Verbal agreements can lead to misunderstandings and are difficult to enforce. Ensure all aspects of the loan are documented in writing.
Conclusion
Drafting a well-structured loan agreement is essential for protecting your business and establishing clear expectations with your lender. By including all necessary elements, consulting with legal professionals, and adhering to best practices, you can create a loan agreement that safeguards your business’s interests and fosters a positive relationship with your lender.
