Loan Commitment Letters Benefit Both Lenders and Borrowers
by Stephan Aliber and Sandra Hawley
Whether you are a borrower or a lender, you know the drill.
After what may be, or at least seem to be, weeks of negotiation, you think you have verbally agreed upon the terms of a proposed loan transaction that satisfies the needs of both parties. What now?
Often, the parties proceed immediately to preparation of the definitive loan documents while the lender conducts its final underwriting and due diligence. This process omits what in many cases can be an important step—the commitment letter.
A commitment letter is, in essence, a written offer by a lender to make a loan to a borrower, subject to satisfaction of specified conditions and contingencies. The letter is executed by the lender and countersigned by the borrower. Commitment letters are viewed by many as a “nuisance”, an unnecessary step in the loan process that wastes time and money. Eliminating negotiation and preparation of the commitment letter can get everyone to the closing table faster, and isn’t that the goal? True, in this atmosphere of increased competition for borrowers, one goal of lenders is, and should be, efficient service. Equally important, however, is development of a strong, trusting relationship between borrower and lender. Commitment letters can help establish that relationship early in the process.
Commitment letters can preserve the parties’ understanding of the terms and provide an effective means for communicating the parties’ respective expectations as to how meaningful, and sometimes competing, issues are to be addressed. Once the essential terms are reduced to writing rather than discussed in multiple conversations over a period of time, the borrower and lender may determine early on that the loan transaction makes no sense at all. If agreed upon by all involved, a commitment letter can induce the parties to “tie up” the deal in the time frame specified for closing. Similarly, a well drafted commitment letter can avoid unexpected and unpleasant surprises as the closing approaches. If the letter specifies conditions that must be satisfied for the lender to fund
the loan, it provides a roadmap for closing and gets
the lender/borrower relationship off to a good start.
Granted, an executed commitment letter (particularly one without commitment fees) may provide the basis for the borrower to “shop” for better loan terms with a different lender. However, it can also have the opposite effect by providing a borrower with the assurance it needs that the lender is committed and willing to proceed, thereby eliminating the need to continue the search for financing. If the letter requires the borrower to pay the lender’s out-of-pocket costs should the loan not close due to no fault of the lender, the borrower will be further inhibited from shopping the terms. To the borrower’s advantage, an executed commitment letter can provide assurances required by third parties that financing is in place. This enables the borrower to continue moving forward with its third-party relationships on a parallel track.
By their terms, most commitment letters do not create binding legal obligations for either lenders to loan or borrowers to borrow. Nonetheless, they are an important prelude to a loan and should, at a minimum, carefully and accurately identify the parties; loan terms; collateral; guarantors or other credit enhancement; use of proceeds; closing documentation; fees; and expiration date for the commitment and closing. Additionally, conditions and contingencies that must be met in order to close and fund the loan should be outlined in detail. Consideration should also be given to those pro-visions (i.e. indemnification, payment of fees and confidentiality) which should survive and be binding even if the transaction does not close.
As we enter 2008, we look ahead to continued competition among lenders and a continued focus on customer relationships. Topping our wish list for this year is the hope that both lenders and borrowers will view commitment letters not as a waste of time and money, but rather as a means of strengthening lender-borrower relationships early in the process and facilitating the efficiencies of loan closings.
Stephen Aliber is Partner, Shook, Hardy & Bacon L.L.P.
P | 816.474.6550
E | saliber@shb.com
Sandra Hawley is Partner, Shook, Hardy & Bacon L.L.P.
P | 816.474.6550
E | shawley@shb.com