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Loan Documents: Read the fine print

Published: 12th December 2017

Author: Neil Dent, Gifford Devine

Published in: Rural e.Speaking | Issue #25

Whether you like it or not, you will probably need to fund your farming operations with borrowing from one of New Zealand’s main trading banks.

The main terms that borrowers look at when signing loan facility documentation relate to the cost of the borrowing: interest rate, the amount of the repayment sums and the term of the lending. The security required is usually a mortgage over the farm land and, more often than not, a general security agreement which is effectively a mortgage over all of the farming entity’s assets that are not land such as stock, crops, machinery, receivables and so on.

The ‘standard’ conditions

Most banks have standard terms and conditions applying to their mortgages and/or their general security agreements. These days, the loan facility agreement tends to be a relatively short document setting out the main loan terms, with the bank’s standard terms and conditions usually in a separate document. However the loan facility agreement and the master terms and conditions, together with the mortgage and general security agreement terms, form the contract between the bank as lender and the farming entity (or entities) as the borrower.

Generally, most loan terms and conditions cover the following matters:

  • The obligation to repay any monies borrowed
  • Representations made by the borrower; for example, that the borrower must have the necessary Resource Management Act 1991 or Building Act 2004 consents for its farming operation and that it hasn’t breached the terms of any such consent
  • Covenants by the borrower to do, or not to do, certain things such as sell any of the borrower’s property without the bank’s consent – other than in the ordinary course of business
  • ‘Events of default’ which are a list of matters that enable the bank to take action under the security if those events occur, such as if there is a change in control of the borrower with, say, a new shareholder being introduced, and
  • Specific provisions regarding how the bank enforces its security.

Read that fine print

The natural assumption of most borrowers is that provided they meet their repayments, then the bank will be happy and therefore the terms and conditions, often running to 20–30 pages or more, are just ‘fine print’ and a working knowledge of what they say is not required. This isn’t the case. It’s essential that you know the representations and covenants.
While many of the terms and conditions tend to be general in scope, some can be quite specific. For example, in relation the farming sector, common representations could be that:

  • All, or substantially all, the livestock are in prime health and condition
  • The borrower will replace any livestock that die or are lost or destroyed with livestock of a like nature
  • Livestock must be tended and cared for in accordance with accepted methods of animal husbandry
  • That crops are in prime health and condition
  • The proceeds of the sale of the crops or livestock will be paid or delivered where the bank directs, and
  • Generally the bank will have rights of access to the borrower’s property to allow the bank to inspect its security.

Additional specific covenants

There will also, almost certainly, be specific covenants relating to compliance with relevant legislation such as the Resource Management Act 1991. Relating to that legislation, there will be a covenant to comply with any consents issued under the Act, not to allow any consents to be surrendered and to notify the bank if any action is taken under the Act against you.

Apart from specific covenants such as those mentioned above, the terms and conditions will inevitably have a ‘cover all’ event of default such as “any other event (or series of events) occurs which, in the opinion of the bank, may have a material adverse effect on the debtor ... or on the ability or willingness of the debtor to comply with the debtor’s obligations to the bank”.

What the above shows is that it is not only financial obligations in which the bank is interested. If, for example, a borrower has a series of Health and Safety at Work Act 2015 or Resource Management Act 1991 prosecutions, these could give a bank the ability to call up its loan or enforce its security.

The bank has more control than you think

Therefore, if you’re borrowing you must be aware that bank’s standard terms and conditions give it a great deal of control – not only over the farming business generally but also, in some instances, quite specifically in relation to what the farm can and can’t do without the bank’s consent. While some of these terms may seem unfair or ‘over the top’, generally the courts do not go too far past the wording of the contract between the borrower and the lender in the event of a dispute.

The lesson for farmers is that your bank is not just interested in receiving your repayments when they are due; it can take a wider view of your farming operation and the way it is being carried out as a whole.
Given the political nature of environmental, animal welfare, and health and safety issues these days, it would not be at all surprising if banks are more inclined to give these type of factors more prominence when dealing with farm customers, rather than just their ability to pay.

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