Virtually every bank's form lending program agreement we've negotiated for our fintech clients has come with an exclusivity provision.
The bank's policy behind them is simple: We've put in the time, effort, expertise and expense to build the program's launching pad, and we should reap the whole bank benefit when the program takes off and soars.
The fintech company's counter-policy against exclusivity is reasoned and just as simple: We can't have a single point of failure for our business if the bank can't handle the volume, its regulator limits or terminates its programs, or it limits, suspends, or ends our program as a business decision or for any other reason.
Exclusivity provisions come in various shapes and sizes. Some are served up ironclad without any exceptions. Others seek to go beyond the program loan product and grasp at covering other financial products and services that the fintech may offer in the future (e.g., deposit accounts and debit cards). It's reasonable to cut back exclusivity to just cover the program loans because that's precisely what each side has due diligenced the other on. The bank may counter with a right of first refusal (ROFR) on other products and services. Fintechs should hold the line on not giving a ROFR for a couple reasons. First, if you have a term sheet for a new product or service with a different bank, that term sheet will almost certainly have a confidentiality or nondisclosure provision that prohibits you from sharing deal terms with third parties on a ROFR or any other basis. Second, again (and understandably), you shouldn't have to give a ROFR to anyone on a new product or service without having due diligenced them on that product or service. Perhaps settle in the middle by offering a non-binding right of first offer to the bank.
In the face of an ironclad exclusivity provision, here are some reasoned exceptions fintechs should be able to negotiate in:
- De Minimis Exception: It's not enough to permit a fintech to enter into a backup arrangement with another bank to effectively address single point of failure risk. If the fintech has to immediately pivot to a bank in the bullpen that it's not actively producing loans with, the fintech will be caught flat-footed, taking time to begin production. Five years ago, our team negotiated the first de minimis exception to exclusivity in a bank lending program agreement we had seen to that point, allowing an active second bank to originate up to 10% of program loan volume not in violation of exclusivity. Since then, we've seen this number run as high as 25%. A de minimis exception has become a market exception to exclusivity.
- Cap Exception: Many program agreements place a dollar cap on the outstanding balance of loans or receivables held by the bank, allowing the bank to stop originating if the cap is hit. The cap provisions usually have a mechanism for the fintech to seek the bank's approval to increase the cap up to a certain amount, with any approval in the bank's sole discretion. Naturally, exclusivity should drop away if the bank won't increase the cap and continue originating.
- Standstill Exception: A bank's form program agreement often has a number of ways for the bank to pause originations that are outside the fintech's control. For example, many agreements call for the bank to not have to make loans if it's experiencing reasonably supported and documented safety and soundness issues that are having a material adverse effect on the bank. If for whatever reason the bank is unable or unwilling to originate loans under the program, exclusivity should not apply.
- Material Adverse Change Exception: For regulatory and true lender reasons, the bank must control the program. As indicia of its control, program agreements call for the bank to be able to make changes to the program, including changes to the underwriting criteria, pricing, and various program guidelines. Some reasonable guardrails should be negotiated around this ability to make unilateral changes, including notice periods; a requirement to meet and confer with the fintech before making changes and to consider in good faith input from the fintech; and, in the end, an agreement to act in the best interest of the program. If the bank makes a change to the program over the fintech's objection and that change has a material adverse effect (MAE) on the program, the fintech, or its customers, exclusivity should be forfeited. An MAE like this should also give rise to a termination right in favor of the fintech.
- Own Authority Exception: The ultimate goal for some fintechs is to get their own bank charter to be able to punch their own ticket and control their own destiny. Think about aspirationally including an exception for obtaining control of a bank or obtaining lender licenses.
Controlling single point of failure risk runs through the De Minimis Exception. Once a client's bank lending program has scaled, we routinely check in with the client and raise single point of failure awareness and prompt thinking about executing on the De Minimis Exception and getting a second bank up and running. Unless a fintech is producing loans with a second bank, the Cap, Standstill, and Material Adverse Change Exceptions are dead letters — you can't take advantage of them until you're live with a second bank.
Finally, we've negotiated exclusivity out of a number of program agreements. Success on this is usually a function of bargaining power, track record, and the amount of any monthly minimum.
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