If you are a business owner, you might reach a point with your company where you need to obtain financing from a financial institution, in order to purchase land or new equipment, provide cash flow for growth, or to remove some of your own cash investment. Whatever the reason, obtaining a commercial loan has requirements significantly different from that of a residential mortgage or a personal line of credit. The goal of this article is to explain some of the complexities involved in a commercial loan, from a legal perspective.
Security, and Then Some
In a residential mortgage, you sign a loan agreement and a mortgage. While these documents are also signed in a commercial loan, additional security is required by the financial institution. While a financial institution can include banks and credit unions, I will use the work “bank” in this article to refer to both. Security in this context means other legal documents which provide the bank additional rights to collect repayment of money loaned in the case of a default. In a situation where the mortgaged property could be rented out, the bank will also require an Assignment of Rents and Leases (Assignment). The Assignment allows the bank to request the tenant pay rent to them, instead of the Landlord/borrower, in the situation of a loan default.
It is also common for the bank to require a personal guarantee from the directors of a company. An incorporated company (one with an Inc. or Ltd. at the end of its name) has limited liability. This means the shareholder’s liability is limited to their shares and the value of the assets owned by the company. Banks recognize companies can have limited assets, so they sometimes require the shareholders of the company to be personally responsible for the loan. Similar to the Assignment, the personal liability arises when the borrowing company defaults on loan payments. The bank can take legal action against the company and the shareholders, usually at the same time. In some cases, a related company will guarantee the loan of the borrowing company. In this scenario the bank would require a corporate guarantee from the related company.
Another way the bank increases their security is by having the company sign a General Security Agreement (GSA). The GSA is an agreement where the company pledges additional assets to the bank. These assets can include existing and future equipment, vehicles, inventory and accounts receivable. The term normally used is All Present and After Acquired Personal Property or an ALLPAPP, for short. The GSA is registered with Personal Property Registry (PPR) for up to twenty five years.
Solicitor’s Letter of Opinion
The bank will require a lawyer to conduct a number of searches and also to review the Corporate Minute Book (CMB) of the borrowing company (and guaranteeing company where applicable), to ensure there is nothing that would impact the bank’s security. The searches conducted by a law firm include: a corporate search at Corporate Registry, a title search at the Land Titles Office, a bankruptcy search, a PPR Search, a courthouse judgement search, and a property tax search with their local municipality. The lawyer also reviews the CMB to ensure the company is up to date and has no agreements which limit or restrict the company from borrowing or repaying of the loan. The lawyer prepares a Letter of Opinion outlining their findings which the bank relies on, in part, when deciding upon loan approval. As the lawyer is putting their reputation on the line, due diligence on the lawyer’s part is serious business. While the lawyer is preparing this information for the benefit of the bank, the borrower agrees to pay for the lawyer’s due diligence as part of the loan requirements.
In some cases a company may have existing loans with other banks or credit unions with security registered at the PPR or Land Titles. Older registrations rank higher in term of priority in the case of foreclosure, sale or bankruptcy. The new bank may be prepared to advance loan funds provided the lenders of the existing loans agree the new loan will rank ahead, even though the new bank’s security will be registered subsequently. If the existing lenders are prepared to do so, they will sign subordination agreements which confirm their interests will rank behind the new financing.
Entering the world of commercial loans only begins with the signing of the loan documents at the bank. In order for the bank to agree to advance funds, they require several forms of security which can include a registered mortgage, assignment of rents, and a GSA registered at the PPSR. The bank will also require a legal opinion that your company has the requisite authority to request the loan and your company does not have any red flags based on the searches the law firm completes as part of their due diligence requirements. These additional steps increase both the time and cost involved completing a commercial loan transaction compared to a personal loan or line of credit. Understanding both the forms of security and legal due diligence requirements will help you better prepare for obtaining a commercial loan.