In Part 2 of our Step-By-Step Guide to Facility Agreements, our Banking & Finance specialists-Emma Donaghue and Kate Dart-explain the differences between representations and warranties and how they are distinguished from undertakings. Part 1 introduced the key features of drawdown mechanisms and the importance of accurately describing conditions precedent in a facility agreement.
Most parties involved in commercial and lending transactions will encounter a standard list of representations and warranties when entering into contracts and loan agreements. Although their importance may not always be appreciated at the time, a borrower should be aware of the emphasis a lender may place on these statements and the implications where a breach of those terms may occur.
It is critical for a borrower to pay particular attention to the drafting of these provisions and to ensure they fully understand their obligations. It is just as important for a lender to ensure the representations, warranties, and undertakings are well drafted so that their internal credit requirements are met, and the financial health of the borrower and the value of their security is maintained throughout the term of the loan.
KEY TAKEOUTS
- Representations and warranties are provided by one party to induce another party to enter into a contract.
- A 'representation' is a statement of fact, a 'warranty' is a condition of an agreement, and a 'covenant' or 'undertaking' is a promise to do or not do something.
- The representations, warranties, and undertakings contained in a facility agreement will be determined by the borrower involved and tailored to the type of transaction being entered into. The lender will push for broadness; whereas a borrower will require narrow and specific representations, warranties and undertakings.
- Representations and warranties are often repeated by a borrower at various intervals throughout the term of a loan.
- Where a representation, warranty, or undertaking is breached by a borrower and not rectified or cured to the lender's satisfaction, the lender may be able to cancel their commitment and demand full repayment of the outstanding loan.
REPRESENTATIONS AND WARRANTIES-WHAT DO YOU NEED TO KNOW?
In general, representations and warranties are statements of past or present facts and circumstances, whereas undertakings are a promise to do or not do something.
Although 'representations' and 'warranties' are often used interchangeably, the key difference is the remedy available to the innocent party when a breach occurs.
A representation is a pre-contractual statement of fact which is made by a party to a contract to induce another party to enter into that contract. If a representation is incorrect or misleading it may give rise to a claim for misrepresentation where the remedy would be recission and/or damages depending on the type of misrepresentation.
In comparison, a warranty is a term of the contract, so a breach gives the innocent party a right to sue for damages but not rescind the contract.
However, when included in a facility agreement, providing an incorrect or misleading representation or breaching a warranty constitutes a default, which will generally enable the lender to accelerate the loan and, potentially, take enforcement action.
Well drafted representations are a useful tool for a lender to draw out information from a borrower which can then be used to determine whether a lender's internal credit requirements are satisfied and provide a loan to that borrower.
Representations and warranties may be classified according to their subject matter and usually relate to legal matters (eg the validity of a borrower's obligations under a facility agreement) or commercial matters (eg the existence of known disputes within the borrower group).
REPETITION
Many standard representations automatically continue or 'repeat' for the duration of a loan facility upon each drawdown date and each interest payment date. Representations that are repeated are mostly legal representations, as opposed to commercial representations.
Repetition of commercial representations should be resisted by a borrower on the basis that it agrees to take change of law risk but not, for example, the risk of change to the commercial environment. This is particularly important for an outsourced trustee where the investment manager will generally have knowledge and management of the assets of the trusts, limiting the trustee's ability to ensure the representations and warranties remain accurate.
Other examples of representations that should not require repeating are matters which would otherwise be covered under an undertaking or event of default, or those relating to information which would usually be updated after entering into the agreement.
A borrower should take care when agreeing which representations are to be repeated and it is common for this to become a subject of negotiation on a contract or loan facility.
Lenders may face challenges in establishing liability for misrepresentation. In the recent case of Anchorage Capital Master Offshore Ltd v Sparkes, the borrower issued a number of drawdown and rollover notices to its lenders prior to being placed into voluntary administration. The lenders had sought to establish that the borrower had issued drawdown notices containing false misrepresentations which the lenders relied upon when making further advances. The lenders were unsuccessful. This case serves as a reminder lenders should not solely rely on representations made by borrowers, but undertake their own independent assessment before making further advances.
UNDERTAKINGS-WHAT DO YOU NEED TO KNOW?
Undertakings are easily distinguished from representations and warranties as they relate to enforceable promises by a borrower to do or not do certain things during the term of a loan facility or contract. They may be separately referred to as 'positive' and 'negative' undertakings and differ from warranties as they relate to future conduct rather than past and present facts.
Undertaking provisions are likely to be heavily negotiated between a lender and a borrower depending on the relationship between those parties and the nature or strength of the borrower's business and financial position.
Undertakings provide a lender with the ability to set parameters to ensure, amongst other things, a borrower's continual financial performance and ability to service its loans, and to ensure assets to which the lender may have recourse to following a default are safeguarded. The degree of control imposed on a borrower depends upon several factors, including-
- whether the loans are secured or unsecured-if unsecured, the negative pledge undertaking assumes more importance
- the legal nature of the borrower (ie an individual, corporate entity, or trustee).
A borrower needs to ensure they can continue to operate their business with little to no interruption from their lender. A lender will be concerned about whether it has control over certain matters relating to the borrower or its business which may have a direct impact on the value of the secured property or affect the ability of the borrower to service its loan.
Examples of 'positive' undertakings include-
- provision of information generally
- financial statements
- compliance with laws
- notification of defaults.
Examples of 'negative' undertakings include-
- a negative pledge (ie a contractual undertaking which prohibits or restricts the borrower from creating or permitting the creation of encumbrances over its assets)
- asset disposal restrictions
- restrictions on making loans or granting credit or giving guarantees
- restrictions on changing the nature of the business of the borrower.
Other undertakings of importance which are commonly seen are security value maintenance clauses, to ensure the value of the asset remains at a sufficient level to make good the loan, and financial covenants used to measure the health of a borrower and to ensure the satisfaction of certain financial or balance sheet tests.
If a representation, warranty, or undertaking is breached by a borrower and not rectified or cured to the lender's satisfaction, an event of default may be triggered providing the lender with the ability to cancel their commitment and demand full repayment of the outstanding loan.
WHAT'S COMING UP IN PART 3?
In Part 3 of our Step-by-Step Guide to Facility Agreements we will look at events of default and the consequences of defaults.
Later, we will explore the likes of-
- secured vs unsecured loans and security types, including the function of a security trustee, and
- practical considerations for a trustee entering into a facility agreement.
