The old adage is that it takes money to make money. When an individual borrows money for a business venture, that individual will be responsible for paying back the loan. The same is applicable for an individual who borrows money for home improvement, a vacation or any other reason.

Like other creditor-debtor relationships, borrowing money will give the borrower debtor status. If the debtor cannot or has difficulty repaying the loan, debtor/creditor law will apply. Below is a primer of common debt instruments used by individuals.

Loan Agreement

A loan agreement is a contract between a borrower and lender that regulates the mutual promises between the parties. In a loan document, each party makes a range of representations about itself and its condition. The representations that the lenders provide in a loan agreement are similar to those provided by investors in equity financings: That the loan has been properly authorized and that there is no immediate intent to transfer or sell the promissory note. Note, however, that in simple bank loans, the banks never make representations. They just provide the money.

Covenants

Covenants are promises by the borrower to do or refrain from doing certain things. When the promise is to refrain from doing things, the covenant is often called a “negative covenant.” Covenants vary greatly from transaction to transaction but usually include restrictions against incurring additional debt, paying dividends, and selling the business venture to others, while requiring that the business venture operate in the ordinary course of business, maintain its assets in good condition, and provide regular financial reports to the lender. In addition, bank loans often contain requirements that the borrower maintain certain financial ratios within an agreed-upon range. One example is the ratio of current assets to current liabilities, known as the “current ratio.”

Events of Default

An event of default, regardless whether it actually occurs, triggers certain rights of lenders, such as penalty interest and immediate repayment. Default provisions operate as safety valves for the lender. If certain events occur that may impair the ability of the borrower to repay the loan, the lender then has the contractual ability to demand immediate repayment, among other things. Events of default are negotiated to conform to the borrower’s particular situation, but generally include the continued failure to repay the loan on schedule after a cure period; the institution or continuation of bankruptcy proceedings, default, or acceleration under any other debt; and the breach of any covenants in the loan agreement. Upon the occurrence of an event of default, the lender has the rights afforded it under the loan agreement. Events of default nearly always result in the lender’s right to accelerate the loan and may provide them with other remedies, such as foreclosing on collateral if the loan is secured. Where a loan is secured, the details of the security are usually set forth in a security agreement.

If you are borrower facing difficulty, know that you debtor-creditor law governs your relationship. To discuss your options, contact the law firm of Melanie Tavare.