Bank borrowing

Big issues potentially lurking in the small print

Introduction

Bank debt remains a popular option for HEIs, both to fund capital projects, and more recently to provide some working capital headroom for Finance Directors trying to set short-, medium- and long-term budgets in the context of rapidly changing sources of funding in the HE sector.

For banks, the HE sector remains an attractive market for lending, with HEIs generally regarded as prestigious customers. Interest rates remain historically low and bank borrowing is relatively flexible. 

Starting point: Heads of Terms

If you decide to proceed with a bank loan you will rightly spend a lot of time selecting the preferred bank, and negotiating the main commercial terms of the deal – the pricing (including any related interest rate swaps), financial covenants, term, and an outline of conditions precedent – often in a Heads of Terms agreement.

Those Heads of Terms will also routinely mention that the loan facility document to be entered into will include “the usual covenants and undertakings for a facility of this nature”. This article is about some of those ‘usual’ or ‘standard’ terms.

Overall aims of negotiating the ‘small print’

Your overall aim must be to give the bank the protections in contract it reasonably requires to ensure you remain broadly the same institution, in the same financial state as you were when it decided to lend to you, whilst not unreasonably restricting your operational activities. You should also try to build in flexibility, or at least the principle that flexibility and reasonableness will be applied, if some future event should occur during the term of the loan which causes a breach of covenant or undertaking, but which should not really be regarded as material.

Most banks will include some HEI specific covenants and undertakings in their loan facility agreement (such as reference to HEFCE reporting and forecasting, and governing body or other specific constitutionally required approval processes for entering into contract). However, the bulk of the document will probably be based on market standard documentation from the Loan Market Association. Some of that ‘standard’ wording, though ostensibly inoffensive, could have an effect on your ability to comply with it in the future where perfectly legitimate and usual operations of HEIs fall foul of loan market definitions.

Careful analysis of the application of this wording to your operational activities will pay dividends in terms of eliminating or reducing the danger of breaches which, even though they might be regarded as technical and immaterial, are best addressed now rather than later. The original parties to the negotiation may well have moved on when an issue actually comes to light, and you will be doing your successors a favour by heading off potential pitfalls in advance. We now look in more detail at a couple of instances of this.

Financial Covenants

Although you will almost certainly have paid very close attention to these at Heads of Terms stage, as a pricing matter, once the deal proceeds to detailed negotiation, you need to ensure that the wording and definitions of terms such as ‘earnings’, ‘EBITDA’, ‘operating cashflow’, ‘net assets’ , ‘net debt’, ‘reserves’ etc. actually correspond to numbers as you produce them in your P&L and balance sheet.

The Loan Market Association standard wording for financial covenants will frequently need to be adapted to the way in which you display your accounts, to avoid potential future confusion or disagreement over the definitions.

In addition, carefully ensuring the covenants and your financial reporting are aligned will obviate the need to produce separate financial information for the bank to that which you will be producing to your governing body, HEFCE and other third parties during the lifetime of the loan.

Particularly in the case of medium- and longer-term borrowing (although consider any imminent or likely changes which could usefully be addressed specifically in the loan facility wording) you should try to build some flexibility into how future changes to applicable accounting principles, or accounting standards, will be dealt with if they have a material impact on financial covenant compliance.

As HEIs (and banks) begin to get used to FRS 102 and the 2014 HE SORP, it is sensible to build in some room for later review and readjustment of covenants.

One way of achieving this flexibility would be to agree the principle in the contract that the overall aim of any changes will be to ensure the same meaning and commercial effect as the HEI and the bank contemplated (usually on the basis of the last set of accounts signed off prior to the loan agreement being signed) when the deal was done. Additionally it would be worth agreeing to refer any dispute arising at this juncture to an independent expert, perhaps appointed by ICAEW. 

Negative Pledge

Bank lending to HEIs is often unsecured, but the bank will in those circumstances require a ‘negative pledge’ – a contractual promise not to give security (or allow in the future any security to exist) over any of its assets.

In addition the negative pledge wording will include restrictions on disposals. Clearly you can check your security register to find out if you have given security over assets, and then look to negotiate a carve out of that existing security from the restriction. Banks will usually be amenable to this if they already know about it, and the issue will probably have been identified by you as you work with them on the Heads of Terms.

The definition of ‘security’ for the purposes of the ‘negative pledge’ will be very widely drawn. You should therefore think very carefully about any grants or donations which have been made (perhaps under collaboration agreements with commercial or industrial businesses in the area local to your HEI), and whether they contain any rights of repayment or recourse to assets purchased with the grants. If they do, they are quite likely to fall within the definition of ‘security’, and you should in those circumstances seek specific carve outs of such projects from the restriction.

It is also worth trying to agree that such arrangements that might arise in the future will not give rise to a breach of the negative pledge, on the basis that the HEI would be no worse off if there was recourse against an asset purchased with a grant, because without the grant the asset would not have purchased in the first place. 

One last tip

The process of negotiating and finalising your new facility agreement can take several months. You will be briefing your governing body at stages before or during the negotiations, and at some point, your constitution will probably require a form of resolution to approve the borrowing. The timing of governing body meetings may well not coincide with the timing of completion of the loan and the requirement for funds. It is well worth involving your in-house lawyers or external legal advisers early on to ensure that any resolutions that need to be passed are expressed in a form that the bank’s lawyers will be comfortable with, to be able to sign off their legal opinion that the borrowing is intra vires. The lawyers will thank you for that! 

David Emanuel is the London Office Managing Partner at leading education law firm Veale Wasbrough Vizards. David is also a banking and corporate lawyer with significant experience of advising HEI clients on bank facilities.

David can be contacted on 0207 665 0848 and by email at demanuel@vwv.co.uk if you would like to discuss any aspect of this article. 

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