The Dangerous Allure of Form Loan Documents

• Publication year: 2019
• Author: Jerome A. Grossman

The Dangerous Allure of Form Loan Documents

Jerome A. Grossman

Mr. Grossman is Senior Counsel with Gresham Savage Nolan & Tilden, PC, working out of San Diego. His practice concentrates on commercial and real estate financings of all types, including real estate loans, secured and unsecured credit facilities, and asset-based financings and secured transactions. Among other professional activities, he is a Fellow of the American College of Commercial Finance Lawyers, has been a member of the Editorial Board of the Business Law News since October, 2013, and is currently serving as Editor-in-Chief.

Many smaller banks—and even some larger banks, when documenting smaller loans—use preprinted form documents. In some cases, the documents really are preprinted; in other cases, the documents are generated by a document production program that takes an information sheet containing pertinent facts about the loan parties and the terms of the loan and generates a completed set of loan documents. In either case, making changes to the documents can be a challenge. One purpose of the documents, of course, is to allow someone without a law degree, or even an informed understanding of the provisions of the documents themselves, nevertheless to generate a serviceable set of loan documents.

In an effort to provide a one-size-fits-all solution (and to reduce transaction costs by avoiding the involvement of lawyers), however, form documents often fail to adequately address real-life concerns. Even though the forms may be offered in a manner that does not contemplate negotiation, it is imperative that a prospective borrower read them before signing, and read all of them, not only those most tailored to the transaction in question, such as the loan agreement. In the author's experience, form documents often include a boilerplate provision to the effect that "in the event of any conflict within the provisions of this document or between this document and any Related Document, and notwithstanding any other provision to the contrary in any of the foregoing, the provisions most favorable to Lender shall control."¹ A borrower might prefer to ferret out, and eliminate, any conflicts between documents.

The following are samples of provisions that an alert borrower might see:

1. Prepayment provisions with an unexpected bite: It is not uncommon to see a prepayment provision in a promissory note that permits the borrower to prepay the note "in whole or in part" at any time, upon payment of the applicable prepayment fee. Sometimes, however, the person preparing the note may (by mistake?) include a prepayment formula that states the prepayment fee as a percentage of the original principal balance of the note—a formula appropriate for a prepayment of the note in full, but not for a partial prepayment (for which the fee, if stated as a percentage of principal, is typically based on the amount of the prepayment). This author has personally dealt with a provision that permitted whole or partial prepayments, but which—most likely due to error on the part of the preparer of the note—provided for a prepayment fee based on the entire principal of the note. The note was secured by multiple rental properties, and the borrower, having contracted to sell one of the properties, was (as required by the terms of the note) applying the proceeds to prepayment of a portion of the principal of the note. In accordance with the prepayment provision of the note, the lender imposed—and required the borrower to pay—a prepayment fee based on the entire principal amount of the loan, despite the borrower's surprise at the manner in which the provision was being applied.

2. Provisions that purport to govern several different extensions of credit: One popular brand of loan document production software includes the following provision in its form loan agreement:

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Borrower has received prior commercial loans from Lender or has applied to Lender for a commercial loan or loans or other financial accommodations, including those which may be described on any exhibit or schedule attached to this Agreement. Borrower understands and agrees that: (A) in granting, renewing, or extending any Loan, Lender is relying upon Borrower's representations, warranties, and agreements as set forth in this Agreement; (B) the granting, renewing, or extending of any Loan by Lender at all times shall be subject to Lender's sole judgment and discretion; and (C) all such Loans shall be and remain subject to the terms and conditions of this Agreement.

In other words, all extensions of credit by the lender to the borrower will be governed by a single loan agreement—even though other provisions, such as financial covenants (e.g., a debt service coverage ratio based on income from the property financed with the proceeds of one loan and the debt service on that loan), will have been negotiated and drafted solely on the basis of the instant credit. The author has seen multiple loans made to the same borrower, on the same day, for different purposes, each represented by a different "Business Loan Agreement" incorporating the quoted provision. Although it might be...