Simply Finance is a series of newsletters that we hope can contribute to increased understanding of financing law and to demystify financing documents. Our aim is to explain concepts, terms and expressions in a simple way so that anyone can understand them.
Conditions Precedent in Finance Agreements
What is it?
Conditions precedent are requirements for certain milestones of a financing to occur, like signing of the finance agreement, and disbursement of the loan. Conditions precedents will have to be evidenced by the borrower typically by submitting the required deliverables, like copies of certain agreements, permits, financial statements, corporate resolutions, insurance policies, etc. Conditions may also relate to events to be evidenced post disbursement. Such conditions are often referred to as conditions subsequent.
Conditions precedent example
The Lenders will only be obliged to comply with Clause 5.4 (Lenders' participation) in relation to any Utilisation if on or before the Utilisation Date for that Utilisation, the Agent has received all of the documents and other evidence listed in Part IA and Part IB of Schedule 2 (Conditions precedent) in form and substance satisfactory to the Agent. The Agent shall notify the Parent and the Lenders promptly upon being so satisfied.
From Schedule 2 Part IA:
- Transaction Documents
(a) A copy of each of the Acquisition Documents, the Shareholders' Agreement and the other Transaction Documents (other than the Finance Documents) executed by the parties to those documents.
(b) A copy of each of the Service Contracts.
Why is it used?
A lender grants a loan based on certain information provided by the borrower. This may be information regarding the borrower’s own business, the borrower’s financial status and operations, and certain transactions to be entered into. The use of conditions precedent in a finance agreement is a structured method of providing with the required documentation it needs to disburse the loan to the borrower. Therefore, a lender will commit to grant the relevant loan on the assumption only, that certain conditions will be met before disbursement of the loan. The satisfaction of such assumptions/requirements will be reflected as conditions precedent, to safeguard the lender’s investment.
How is it used?
Conditions precedent are either listed in a separate section of the financing agreement or in a separate schedule. Many conditions precedent are standard, but it is very important to consider which transaction specific conditions should be included for a new financing. After the finance agreement, or alternatively the term sheet, is final, the conditions precedent are typically included in a separate conditions precedent list where lawyers, borrowers and lenders can monitor the process.
Why should a lender pay attention?
Anything that is important for the lender and which forms the basis for the funds it agrees to provide, should be reflected in the conditions precedent if possible. For a secured financing, duly executed and perfected security documents should always be included as a condition (subject to a closing procedure where necessary). Once the conditions precedent have been satisfied, the lender is obligated to disburse the funds. Although the lender will still be protected by the covenants of the financing agreement after the funds have been disbursed, the credit risk materialises only after disbursement. If it turns out that one or more conditions precedent are impossible to satisfy for any reason, the lender will always have the option of waiving the condition.
What does it mean for the borrower?
The Borrower must satisfy the conditions precedent for the lender to be obliged to disburse the funds. If conditions are not satisfied, the borrower is dependent on the lender waiving such condition for the lender to be obliged to disburse the funds. Consequently, it is critical that the borrower ensures it will be able to satisfy the conditions precedent within the proposed timetable. Conditions outside the Borrower’s control are not advisable, at least not from the Borrower’s perspective. Borrowers occasionally experience that certain conditions are more difficult or time-consuming to satisfy than they initially thought, for example due to foreign requirements for perfection of security and notarization. This is an unpleasant surprise which may lead to a delayed disbursement of the loan amount, but which can be avoided through thorough preparations.
Important to note
Conditions precedent may not always get the attention it should during negotiations and drafting of the finance agreements. As they are critical for funds actually being disbursed, we strongly advise borrowers to carefully review and consider the proposed conditions precedent for any type of financing transaction.