Loan Agreement - Representations and warranties

Representations, warranties and covenants all have particular meanings in English law but in a loan agreement they all mean something quite different. Whereas the normal meaning of representation is a statement made by one party to the contract to the other made before the contract is entered into which, if incorrect, may give rise to either a claim for damages or rescission of the contract and the normal meaning of a warranty is a term of the contract which is of lesser importance than a condition and only breach the latter entitles an injured party to treat the contract as repudiated and a covenant is a special type of contract entered into by means of executing a deed, in loan agreement parlance all are effectively terms of the contract. In this book the special meaning of the words as used in loan agreements is intended unless otherwise stated.

In practice, representations and warranties are grouped together and constitute statements by the borrower which the lender considers should be true at the inception of the loan contract. The covenants are promises which the borrower is making about the future, about what will and will not happen during the term of the loan. This temporal distinction is clouded, however, by the practice of making representations and warranties "evergreen" which has the effect of having the borrower promise that the matters will not only be true on day one but will not adversely change through the life of the loan.

In the loan contract the effect of a breach of any of the representations and warranties or covenants is that this will constitute an event of default and the effect of that is that the loan is effectively terminated and the lender can refuse to advance further funds and is legally entitled to immediately seek recovery of all sums already lent. If a lender enforces his right to do this, it is known as an 'acceleration' of the facility, because it has accelerated to maturity. It is further provided that it is a condition precedent to the advance of funds under the facility that the representations and warranties remain true. It is difficult to see how this takes the matter any further since the lender already has the right to cancel the facility if any evergreen representation or warranty becomes untrue. It also follows that a lender should not need to be concerned with whether there has been a misrepresentation (in the usual legal sense of the word) that entitles him to seek rescission of the contract or to recover damages as he has such powerful remedies provided in the contract. Likewise he should not need to be concerned with whether a term of the contract is a condition or a warranty (in the usual legal sense of the word) as the contract entitles him to effectively treat the contract as repudiated.

Representations and warranties can be divided into those of a legal nature and those of a commercial nature. Those of a legal nature echo the contents of the conditions precedent. It will be warranted that the borrower is properly incorporated, that he has the necessary powers to enter into the loan, that he has obtained the required consents and that he has the necessary exchange control consents etc. Of course the effect of any of these statements being untrue is likely to be that the loan contract is void and unenforceable and a lender could not sue on such a contract, and therefore he could not sue on the basis that a statement in it was untrue. This is the reason for the documents proving the truth of the statements being required as conditions precedent. A lender needs to be sure that the matters are duly established, it is not enough that the borrower promises that they are. For this reason the legal representations and warranties are of doubtful legal effect. It might be that a borrower is estopped from arguing that the contract is void due to, for instance, an omission to obtain a board resolution when the borrower has himself stated in the contract that he had obtained the resolution.

Commercial representations and warranties relate to the financial position of the borrower at the inception of the loan. The lender would not be entering into the deal if the borrower was not financially strong or if there matters looming which threatened that strength. Thus the contract will provide that the last set of audited accounts of the borrower were true and correct and that here has been no material adverse change since the date they were prepared to. It will be stated that there has been no default on the borrower's other loans and that there is no litigation pending or possible against the borrower which would be materially adverse to him. It will be stated that the information prepared on the borrower preparatory to the loan is correct.