Loan Agreement Representations and Warranties
Loan Agreement Representations and Warranties
Loan Agreement Representations and Warranties
An overview of representations and warranties found in financing documents, including the purpose, description,
specific issues and consequences of a breach.
• A representation is an assertion about a current or past fact. It is true as of the date the representation is
made and is intended to induce the party to whom it is addressed to enter into a contract.
There are different remedies for a breach of a representation versus a breach of warranty. In practice, however, the
differences between representations and warranties do not matter because the parties contractually agree on the
remedies for a breach of a representation and warranty in the loan agreement (see also Consequences of a Breach).
• They are a tool for allocating risk between the borrower and the lenders. Lenders make a credit decision to
lend to the borrower based on facts and information provided by the borrower about itself and its business.
Lenders feel strongly that they should not have to take the risk and bear the consequences of any facts being
false. The lenders typically ask the borrower to make specific representations, whether or not the borrower
knows for certain that a particular representation is true on the date given or will be true in the future (for
example, that there is no threatened litigation affecting the loan transaction). The borrower, therefore,
assumes the risk if the representation is found to be false and bears the consequences of a breach.
• They force the borrower to carefully examine its affairs before entering into the financing transaction so that
it is certain it can make the representations on the closing date.
• To the extent the borrower cannot make a particular representation because it is not true, the borrower must
tell the lenders. Representations become a tool for discovering and disclosing adverse issues.
• Once a borrower has made a representation, it is prevented from taking an inconsistent position in the future
against the lenders.
• Representations and warranties help establish the lenders' good faith in entering into the loan agreement. If
the lenders enter into the loan agreement in violation of the law or if entering into the loan agreement caused
the borrower to breach its other agreements, the lenders may be liable for tortious interference of contract,
or their rights under the loan agreement may be impaired. Lenders may avoid such liability if they can show
they acted in good faith.
• Representations and warranties are typically a condition to closing and to each future advance (unless
agreed otherwise). If the condition of the borrower has deteriorated and a representation that is required to
be remade is no longer true, the lenders are not obligated to make loans as long as the breach continues.
• Each new drawdown under the loan agreement (but typically not when existing loans are rolled over to a new
interest period or converted to another type of loan).
• Any material change in the terms of the loan documents under a waiver, consent or amendment (such as
consenting to an asset acquisition or formation of a new subsidiary that is not otherwise permitted under
the loan agreement). Lenders may not ask that the representations and warranties be remade for non-
substantive or minor changes to the terms of the loan documents because it puts the borrower at risk of
defaulting under the loan agreement if any representation is not true.
Borrowers with strong bargaining power (such as investment grade borrowers) may negotiate certain
representations to be made only on the closing date (rather than being repeated) to reduce the risk of breaching
the representations in the future or providing the lenders with a reason not to lend future advances. These
representations typically include:
• No litigation.
For the full text of representations and warranties typically included in corporate loan agreements plus negotiating
tips for borrowers and lenders, see Standard Clauses, Loan Agreement: Representations and Warranties.
Most of the representations and warranties made in a loan transaction are contained in a separate article of the loan
agreement. Lenders' counsel typically drafts the first version of the loan agreement, including the representations
and warranties that it expects the borrower to give (see Practice Note, Loan Agreement: Overview.)
Representations are typically made by the borrower and each other loan party that signs the loan agreement (such
as a parent guarantor) and may apply to any one of the following:
• The borrower.
• The borrower and its subsidiaries. This is typically the case if there are no guarantors.
• The borrower, each loan party and each of their subsidiaries. This is typically the case if there are parent
and/or subsidiary guarantors.
• The borrower and its restricted subsidiaries. This is more often the case with the most creditworthy
borrowers because it limits the number of subsidiaries subject to the representations (thereby minimizing
the chance of a breach of a representation).
Lenders typically prefer the representations and warranties to cover as many parties in the credit group as possible
so that adverse events affecting one company (rather than just the group as a whole) will come to light. This means
that the lenders may discuss any breaches early on and use any remedies available to them without delay. If the
borrower's subsidiaries or parent company are parties to any related agreement (such as a guaranty or a security
agreement), the scope of the representations and warranties is typically expanded to include these entities. Lenders'
counsel should confirm which parties are covered by the representations and warranties.
Financial Condition
Lenders rely heavily on the borrower's (or consolidated) financial statements in making their decision to lend
money. The borrower represents that its financial statements fairly present its financial condition in accordance
with generally accepted accounting principles (GAAP) and that assumptions used in the forecasts were fair.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: Financial Condition.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: No Material Adverse Effect.
As a result of the financial crisis, several lawsuits were brought over MAE clause claims, either in connection with
acquisition agreements or related loan agreements. For example, see In Dispute: Hexion/Huntsman.
Existence
The borrower represents that its organizational documents were properly prepared, executed and filed under the
laws of the state of its formation and it is a validly existing legal entity. The requirements for good standing vary by
state but generally mean that all franchise taxes have been paid and all required reports have been filed with the
states in which it does business or owns significant assets.
A company that is not in good standing typically cannot bring a lawsuit in the courts of that state, may have
restrictions placed on its business operations and may be subject to fines and penalties. Although it can take several
weeks, it usually is not difficult to reinstate good standing status; filing reports or paying taxes or minimal fees is
usually all that is required.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: Existence; Compliance with Laws.
• From third parties (including governmental agencies, creditors and third parties to its other contracts).
A borrower's organizational documents sometimes place restrictions on borrowing (most often found with public
utilities that issued preferred stock). Regulated companies require the approval of the relevant regulatory authority
to borrow money or give collateral.
As part of the due diligence review, lenders' counsel should review the organizational documents of the loan parties
for such issues (see Due Diligence Checklist: Lending: Organizational Documents). Most state corporate laws allow
companies to engage in all lawful acts so authority under state law is not usually an issue.
The borrower also represents that it has taken all necessary organizational action to authorize the execution, delivery
and performance of the loan documents. Whether the loan documents have been properly authorized, executed and
delivered by the borrower depends on:
For example, states may require that loan documents be signed in blue ink and not in multiple counterparts, and
organizational documents may require the approval of the board of directors and the signature of two officers.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: Power; Authorization; Enforceability.
Authorizations Obtained
The borrower represents that all authorizations have been received and notices and filings with regulatory agencies
or other third parties have been done in connection with the loans and that all waiting periods have expired. This
representation is important as it helps the lenders identify any regulatory restrictions, or restrictions in third party
contracts, that require approval or other action.
Violation of certain regulations may make the loan unenforceable or mean the lenders may face criminal liability or
fines (for example, Investment Company Act borrowings by an investment company that are not approved under
this Act are void (see Investment Company Act of 1940)). Also, borrowers in regulated industries (such as the
telecommunications industry) often require regulatory approval to borrow money and give collateral and guaranties
(see What's Market: Credit Agreements in the Telecommunications Industry).
Third-party contracts (such as partnership agreements, licenses, leases, customer contracts and other financing
documents) often prohibit assigning the contract or pledging it as collateral without the consent of the third party
and may contain other covenants that restrict the actions of the borrower. The UCC renders certain of these anti-
assignment provisions void (see Practice Note, UCC Creation, Perfection and Priority of Security Interests: Third
Party Consents to a Security Interest). However, if the loan documents conflict with valid provisions in other
agreements, the lenders' loan or security interest in any collateral may be subordinated to other loans or security
interests of third party creditors whose agreements are violated. For more information on the wording of this
representation and negotiated points, see Standard Clauses, Loan Agreement: Representations and Warranties:
Power; Authorization; Enforceability.
The expiration of all waiting periods refers primarily to the Hart-Scott-Rodino Antitrust Improvements Act of 1976
(HSR) which imposes a waiting period on acquisitions while the transaction is reviewed by the Federal Trade
Commission and the Antitrust Division of the US Department of Justice. This representation is mainly relevant to
acquisition financing.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: Power; Authorization; Enforceability.
Borrowers often request an exception to the enforceability wording for the effect of bankruptcy laws and equitable
principles since it cannot be known in advance what the courts will determine in those cases.
For more information on when a lender may agree to this exception, see Standard Clauses, Loan Agreement:
Representations and Warranties: Power; Authorization; Enforceability.
No Contravention
The borrower represents that there will be no violation of law which may affect the lenders' rights (such as a violation
of state usury laws that may mean interest payments are void). It is important that the loan transaction does
not breach the borrower's organizational documents or other agreements which could make the loan agreement
unenforceable or mean the lender is liable for tortious interference of contract.
This representation helps establish the lenders' good faith in entering into the loan agreement and minimizes their
potential liability to third parties.
The borrower must also let the lenders know of any other agreements where liens may be placed on the borrower's
assets or where collateral may be shared with other creditors (such as bond indentures which may require "equal
and ratable" sharing of collateral) if the borrower enters into the loan documents.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: No Contravention.
No Litigation
This representation aims to uncover pending or threatened litigation, investigations or proceedings that could
adversely affect the borrower or the loan transaction. Litigation could result in substantial liability to the borrower
or adversely affect its operations. It is, therefore, important for lenders to consider any potential costs involved as
a result of litigation when deciding whether to make the loan. This representation is intended to apply to material
litigation only and is often negotiated by the borrower.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: No Litigation.
No Default
The borrower is asked to represent that there is no default or event of default continuing under:
• Any other contractual agreement to which the borrower is a party (called a cross-default). In this case, it is
typically limited to defaults that would have a material adverse effect.
Lenders do not want to lend to a company in default because it increases the risk that they will not be repaid.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: No Default.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: Ownership of Property; Liens; Investments; Material Contracts; Etc.
• The loan party owns (or has rights to) all IP used in its business.
• There are no material claims asserted or that could be asserted to challenge that ownership or right to use
such IP.
• The use of the IP does not infringe on the rights of any other person.
If these representations are included in the security agreement, they do not need to be included in the loan agreement
provided all loan parties with IP are parties to the security agreement.
For more information on IP, see Practice Note, Intellectual Property Issues: Lending. For more information on the
wording of this representation and negotiated points, see Standard Clauses, Loan Agreement: Representations and
Warranties: Intellectual Property Matters.
Tax Matters
Tax representations try to ensure that the borrower has paid all its taxes (other than those being properly contested).
Outstanding taxes can result in tax liens on the borrower's assets which reduce the value of the lenders' collateral.
Tax liens generally have higher priority than the lenders' liens so the taxing authority is repaid before the lenders
with the proceeds of the attached collateral.
For information on negotiating points and specific tax representations, see Standard Clauses, Loan Agreement:
Representations and Warranties: Tax Matters.
Margin regulations
Regulation U (12 C.F.R. §§ 221.1-221.7) (REG U) of the Federal Reserve Board prohibits a lender from making a loan
if the loan proceeds are being used to buy margin stock (generally, publicly traded stock) and the loan exceeds 50%
of the value of margin stock securing the loan. Failure to comply could expose the borrower and the lenders to SEC
censure, sanctions and civil money penalties.
For a detailed discussion of REG U, see Practice Note, Margin Rules for Banks and Non-Broker-Dealer Lenders
(Reg. U). For more information on the wording of this representation and negotiated points, see Standard Clauses,
Loan Agreement: Representations and Warranties: Margin Regulations.
Labor Matters
The borrower is also asked to represent that:
• It complies with work hours and compensation requirements of the Fair Labor Standards Act and other
similar employment laws.
• All payments due under employee health and welfare insurance have been made.
Failure to comply with these employment regulations can result in litigation, liens being placed on the borrower's
assets to secure amounts due to employees and publicity which can damage the borrower's reputation.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: Labor Matters.
ERISA Matters
The borrower represents that it complies with Employee Retirement Income Security Act of 1974 (ERISA)
regulations and identifies any pension plan liabilities that may arise because it has not sufficiently funded its plans.
Violations of ERISA can lead to a claim on the borrower's assets by the Pension Benefit Guaranty Corporation
(PBGC). The borrower may be liable to pay large amounts if its employee benefit plan is underfunded or, if at the time
of the plan's termination, its liabilities exceed the value of the plan's assets. If the borrower does not fund the plan
or make up the difference between the employee benefit plan's asset value and its liabilities, a lien may be attached
on the borrower's property in the amount of the unpaid liability up to 30% of the net worth of the borrower.
This lien may have a higher priority than any liens that the lenders may have (meaning that the pension plan claims
will be paid before the loans). Borrowers taking part in multiemployer plans with other companies may also be liable
for any shortfalls in funding within the group.
Since ERISA liabilities can be substantial, a violation of ERISA is often a separate event of default under the loan
agreement. The representation is often more onerous (and easier to breach) than the ERISA event of default. If the
representation is breached (but an ERISA event of default has not occurred) the lenders can refuse to lend more
money but are unlikely to demand that the loans be repaid.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: ERISA Matters and Practice Note, Guide to ERISA Provisions in Credit
and Financing Agreements.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: Investment Company Act of 1940. For more information on the Act,
see Practice Note, Investment Company Act of 1940 Exceptions: Guide for Transactional Lawyers.
The ownership structure of the subsidiaries is typically listed in a schedule so that the lenders know the percentage
of equity interests owned by each loan party. Only equity interests owned by a loan party support the loan. Any third
party owning an equity interest in a subsidiary can vote, receive distributions, sell its equity interest and receive a
portion of the subsidiary's assets in a bankruptcy proceeding.
• The borrower's board of directors (or comparable governing body) authorized and approved issuing the
borrower's equity interests.
• The borrower's equity interests were properly issued for adequate consideration (such as cash received from
stockholders) as required under state law and the borrower's organizational documents.
• Any related certificates (such as stock certificates) were properly executed by the borrower's officers.
• The borrower does not need to make any other payments in connection with the equity interests (referred to
as non-assessable) which could decrease the borrower's cash available to repay the loan.
It is important that there are no liens on the borrower's equity interest because foreclosing on the liens could result
in a third party owning the equity interests. Also, lenders want to ensure there are no restrictions on the equity
interests that limit the rights of the borrower in its subsidiaries or the rights of the lenders in the equity interests
pledged as collateral.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: Subsidiaries; Equity Interests.
Use of Proceeds
Typically term loans are used to finance acquisitions or refinance existing debt. Revolving loans are used for working
capital, smaller capital expenditures and general corporate purposes. In some acquisition financings, lenders may
prohibit the borrower from drawing on the revolving loan facility on the closing date, or limit the amount that can
be drawn, to ensure that the borrower has sufficient cash when the deal closes.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: Use of Proceeds.
Environmental Matters
The environmental representations try to identify the most significant issues that may expose the borrower (or
the lenders) to liability. Not complying with environmental standards or cleaning up hazardous materials may be
extremely costly for a borrower.
Lenders can also be liable for environmental clean up costs if they are found to be a "controlling entity" under
the Comprehensive Environmental Response, Compensation and Liability Act of 1980. Such costs are usually
significant.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: Environmental Matters.
Accuracy of Information
This representation typically mirrors the language of SEC Rule 10b-5 and states that all information (other than
future financial projections) given by or on behalf of the borrower is:
"complete and correct in all material respects and does not contain any untrue statements of a material fact or omit
to state a material fact necessary in order to make the statements contained therein not misleading."
The exception for financial projections should confirm that the projections were based on good faith estimates and
reasonable assumptions at the time they are made. Lenders are generally hesitant to make many changes to this
representation.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: Accuracy of Information.
Insurance
The borrower is asked to represent that it has sufficient insurance to protect its assets and cover liability claims in
line with insurance coverage typical in the borrower's industry and location. If the borrower maintains adequate
insurance coverage it should be able to replace its assets and repay the loans if a casualty event occurs (such as a fire
in its warehouse). Insurance typically obtained by companies may include:
• Liability insurance covering third party injury claims or damage to their property caused by the borrower.
This also includes worker's compensation insurance which the borrower is required by law to carry on its
employees.
• Business interruption insurance covering loss of income if the borrower cannot operate its business because
of damage to its property (not usually required by lenders).
• Key man life insurance which pays life insurance to the borrower on the death of a specified individual that is
essential to the operation of the business (not routinely obtained).
For more on covenants contained in a security agreement which typically cover insurance requirements, see Practice
Notes, Security Agreement: Overview: Insurance and Insurance Issues for Lenders in Secured Loan Transactions.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: Insurance.
For more information on the wording of this representation and negotiated points, see Standard Clause: Loan
Agreement: Representations and Warranties: Perfected Security Interests. For more information on perfecting
security interests, Perfection Steps Checklist.
Solvency
The borrower represents that it is solvent. Lenders use this representation to rebut any fraudulent conveyance claims
that:
• The subsidiary guarantors were insolvent when (or were rendered insolvent by) granting a guaranty to the
lenders.
• In the case of leveraged buyouts or dividend recapitalizations (where the loan is used to pay a large dividend
to the shareholders), the borrower was insolvent (or was rendered insolvent) by the transaction.
Loan repayment obligations and related security interests can be voided as a fraudulent conveyance in a bankruptcy
proceeding if the loan party did not receive "reasonably equivalent value" and is insolvent (or rendered insolvent)
at the time of the transaction. For a discussion of these issues, see the following Practice Notes:
• Fraudulent Conveyances: Issues and Strategies for Lenders and Private Equity Sponsors: Intercorporate
Guaranties.
• Fraudulent Conveyances: Issues and Strategies for Lenders and Private Equity Sponsors: Dividend
Recapitalizations.
In addition, lenders generally do not want to lend to an insolvent borrower (other than DIP financings made to
borrowers in bankruptcy).
For more information on the wording of this representation and negotiated points, see Standard Clause, Loan
Agreement: Representations and Warranties: Solvency.
Senior Debt
If the borrower also has subordinated debt (such as high-yield subordinated notes), the lenders will want to confirm
that the loan is designated as (or falls under the definition of) senior debt in the subordinated debt document to
ensure the loans are repaid before the subordinated debt. If the loans are not considered to be senior debt, then
the agreement to subordinate payments on the subordinated debt will not apply to the loans. For information on
subordination, see Practice Note, Subordination: Overview.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: Senior Debt.
For more information on the wording of this representation and negotiated points, see Standard Clauses, Loan
Agreement: Representations and Warranties: Casualty, Etc.
• Restrict transactions in or with persons or countries that are deemed to be hostile to the US.
These restrictions are primarily spelled out in the USA PATRIOT Act and under the rules of the Office of Foreign
Assets Control of the US Department of the Treasury (OFAC). Loan agreements have for years included a provision
informing borrowers of the lenders' obligations under the USA PATRIOT Act and requiring borrowers to provide
the lenders with such information as they may request to comply with these obligations (see Standard Clauses,
Loan Agreement: Boilerplate Provisions). Until fairly recently, loan agreements did not typically include a specific
representation about OFAC regulations. Following an escalation in OFAC-related sanctions and fines in the last few
years, lenders are increasingly including OFAC related representations and covenants in their loan agreements. For
more information, see Practice Notes, OFAC, USA PATRIOT Act and other Anti-Terrorism Regulations Relevant for
Lenders; USA PATRIOT ACT and Know Your Customer Requirements for Lenders and US Anti-money Laundering
and Trade Sanctions Rules for Financial Institutions.
Cross-border Representations
Loans made to foreign borrowers have special representations that address specific cross-border issues. For a list
of cross-border representations (including drafting tips), see Standard Clauses, Loan Agreement: Cross-Border
Provisions.
wording of this representation and negotiating tips, see Standard Clauses, Loan Agreement: Representations and
Warranties: Accuracy of Information.
In addition, the lenders' commitment to lend money will not be effective on the closing date or the initial date of
funding unless the representations and warranties contained in the loan documents (and specified on the term
sheet attached to the commitment letter) are also true and correct on such date. This raises issues with acquisition
financings (see below).
In many acquisition agreements, financial buyers do not have the right to rescind their offer to buy the target
company if the lenders do not provide the financing on the closing date of the acquisition (called a financing out).
If the borrower (who is also the buyer) cannot raise the money to finance the acquisition, it may have to pay a
termination fee to the seller if it backs out of the deal.
In situations where the borrower is a sponsor with strong bargaining power that wants certainty that the lenders will
fund the loan on the closing date of the acquisition, lenders may agree to include a clause in the loan commitment
letter which limits the representations and warranties required to be made on the closing date so that they match the
representations and warranties in the acquisition agreement. This ensures that a breach of a representation gives
both the lenders and the borrower the right to terminate their obligations (because both the lenders' commitment
letter and the borrower's acquisition agreement are breached) without the borrower having to pay termination fees
to the seller. This clause is called the "SunGard" language. For more information and wording of this clause, see
Standard Clause, Commitment Letter: "SunGard" Clause and Practice Note, Sponsor/Lender Negotiating Issues in
Acquisition Finance: "SunGard" Language.
For a list of representations and warranties typically found in security agreements, see Practice Note, Security
Agreement: Overview: Representations and Warranties.
Guaranty Representations
Each guarantor is typically required to make all representations that the borrower makes in the loan agreement (see
Practice Note, Guaranties: Representations and Warranties). The loan agreement representations and warranties
are often incorporated by reference into the guaranty (rather than repeated in full in the guaranty).
• There are no conditions precedent to the guaranty that have not been satisfied.
• The guarantor has made its own credit analysis and independent decision to enter into the guaranty, without
reliance on the lenders or the administrative agent, if any, and has established adequate means for obtaining
information from the borrower about its business and financial condition on an ongoing basis.
These representations are intended to establish that the lenders (and the administrative agent) have no duty or
liability to the guarantor and to rebut any legal defenses of the guarantor to this effect which may relieve the
guarantor of its guaranty obligations.
Borrower Concerns
The borrower must consider if it can give each of the representations in the form set out in the agreement. If it
cannot, the borrower must negotiate with the lenders to ensure that the representations contain suitable carve-outs
(exceptions) and materiality thresholds appropriate to it and its business. Borrowers should also carefully review
any representations repeated after the initial drawdown. The main concern for a borrower is that a breach of a
representation typically triggers an event of default under the loan agreement.
Consequences of a Breach
Loan agreements generally provide that an event of default occurs if a representation and warranty proves to be
incorrect when made. On the occurrence and during the continuance of an event of default, the lenders have the
right to exercise all remedies provided by law and specifically set out in the loan documents, including:
• Calling the loans immediately due and payable and terminating their commitments to make future loans.
In practice, lenders may agree to waive the default (often for a fee) or amend the loan document if the borrower
is no longer able to make the representation and warranty going forward. Lenders may negotiate a satisfactory
resolution with the borrower depending on the representation breached and the importance of the representation
to the financial condition of the borrower.
If the lenders do not waive the default, the most common remedy for a breach of a representation and warranty is
for the lenders to refuse to make further loans to the borrower.
Lenders rarely demand repayment of the loan because of a breach of a representation and warranty, but their right to
do so provides incentive for the borrower to ensure the representations are correct and to disclose any exceptions to
the lenders throughout the term of the loan. For further information about lenders' remedies on an event of default,
see Practice Note, Loan Agreement: Events of Default.
END OF DOCUMENT