Loan Documentation for “Secured”

Commercial Lending Transactions

Presented by: Osburn & Associates, LLC

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Author/Lecturer

DAVID L. OSBURN, MBA, CCRA

David Osburn is the founder of Osburn & Associates, LLC that specializes in providing seminars, webinars, and keynote speeches to bankers, CPAs, attorneys, and credit managers on topics such as Banking/Finance/Credit, Negotiation Skills, Marketing, and Management.

David also functions as a Contract CFO and works with financial institutions, CPA firms, construction companies, and real estate developers. He is also an adjunct faculty member of both an accredited MBA program and the accounting department of a community college with over 30 years of teaching experience.

David’s extensive professional background includes 18 years as both a Business Trainer and Contract CFO and 16 years in banking (commercial lending) including the position of Vice President & Senior Banking Officer.

David has an MBA in Finance/Marketing from Utah State University and a BS degree in Finance from Brigham Young University. He is also a graduate of the ABA National Commercial Lending School held at the University of Oklahoma.

David also holds the professional designation of Certified Credit and Risk Analyst (CCRA) as granted by the National Association of Credit Management (NACM).

Osburn & Associates, LLC

A Business Training & Contract CFO Firm

David L. Osburn, MBA, CCRA

Managing Member

7426 Alamo Summit Drive

Las Vegas, Nevada 89129

Direct: (702) 655-1187

E-Mail: dlosburn@cox.net

Web: dlosburn.com

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Loan Documentation for “Secured” Commercial Lending Transactions

I. Introduction: Loan Documentation for “Secured” Commercial Loans

II. “Secured” Commercial Loans (Non-Real Estate Transactions):

A. Lines of Credit

B. Equipment Loans

C. Letters of Credit

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III. Basic “Business” Structure:

A. Sole Proprietorship

B. C Corporation

C. S Corporation

D. LLC

E. Other: REIT, Series LLC

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IV. Loan “Structure”

A. Six (6) Elements of a Proper Loan Structure

1. Loan Purpose: (A = L + O/E)

2. Sources of Repayment

3. Adequate Amount

4. Appropriate Term

5. Appropriate Pricing

6. Framework for Monitoring

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B. Six (6) Elements of a Proper Loan Structure (Continued)

Line of Credit Equipment Loan

1. Loan Purpose: (A = L + O/E)

2. Sources of Repayment

3. Adequate Amount

4. Appropriate Term

5. Appropriate Pricing

6. Framework for Monitoring

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V. Loan “Support”

A. Four (4) Aspects of Adequate Loan Support

1. Collateral

2. Guaranties

3. Business Loan Agreement

4. Subordination Agreements

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B. Four (4) Aspects of Adequate Loan Support (Continued)

Line of Credit Equipment Loan

1. Collateral

2. Guaranties

3. Business Loan Agreement

4. Subordination Agreements

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VI. “Secured” Loan Documentation:

A. Promissory Notes

Contract (Components):

1. Genuine mutual assent (Offer & Acceptance)

2. Legal contractual capacity

a. Minors

b. Drunken/drugged individuals

c. Insane persons

3. Consideration (of value)

4. Must be legal

5 Must be in writing (sale of land, guarantee other’s debts, more than one year, over $500)

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A. Promissory Notes (Continued):

1. Commercial vs. Consumer Notes

a. Commercial (less disclosure)

b. Consumer (APR, Finance Charge, Monthly Payments)

2. Signature Requirements

3. Authority and Capacity

a. Resolutions

b. How do you verify Authority and Capacity?

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A. Promissory Notes (Continued):

1. Payment Obligations

2. Events of Default

3. Confession of Judgment Clause

Generally, when a party defaults upon a contract, you can be assured of a lengthy and costly

battle in court to enforce your rights. However, a minority of states permit contractual

mechanisms to bypass the litigation process and obtain a quick judgment. These

contractual mechanisms are called confession of judgment clauses and, if properly utilized,

can assist you in enforcing contractual obligations quickly.

Confession of judgment clauses traditionally appear in commercial agreements known as

“cognovits notes”. They favor the lessor or lender in that it allows them to obtain a

judgment against a party in default without a protracted litigation process, including

notice. The confession of judgment clause contained in the commercial contract serves an

important function by immediately allowing a party to enforce its rights under the contract

without opposition.

While due process arguments against confession of judgment clauses have limited their

widespread use, there are some states that allow them such as Illinois.

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4. Jury Waiver

5. Arbitration Agreement

A. Promissory Notes (Continued):

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B. Business Loan Agreements:

1. Everything including the “Kitchen Sink”

2. Affirmative and Negative Covenants

C. Security Agreements

1. A/R and Inventory

2. Titled Vehicles (VIN)

3. Non-Titled Equipment (Serial No.)

4. “Blanket” Description

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UCC-1 financing statement (an abbreviation for Uniform Commercial Code-1)

is a legal form that a creditor files to give notice that it has or may have an

interest in the personal property of a debtor (a person who owes a debt to the

creditor as typically specified in the agreement creating the debt).

This form is filed in order to "perfect" a creditor's security interest by giving

public notice that there is a right to take possession of and sell certain assets

for repayment of a specific debt with a certain priority.

D. UCC Financing Statements (Article 9: Secured Transactions)

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D. UCC Financing Statements (Article 9: Secured Transactions)

Pursuant to the standards set forth in the UCC, the financing statement need only

contain three pieces of information:

1. The debtor's name and address

2. The creditor's name and address

3. An indication of the collateral, which may be very general

UCC-1 filing: Perfect security interest (Specific vs. “Blanket” Filing)

UCC-3 filing: Amendment (termination, assignment, continuation, party

information change)

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E. Small Business Jobs Act Certificates

The law authorized the creation of the Small Business Lending Fund

Program administered by the Treasury Department to make capital

investments in eligible institutions, in order to increase availability

of credit to small businesses.

F. Corporate Resolution

“All actions of the corporation must be supported by a corporate

resolution”

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G. Guarantees:

1. General and Continuing

2. Limited

3. Secured vs. Unsecured

H. Regulation B Notices

Prohibited Basis:

(See Exhibit # 1)

VII. Commercial and Industrial (C&I) Lending Defined:

Any type of loan made to a business or corporation and not to an

individual. Commercial and industrial loans can be made in order to

provide either working capital or to finance major capital expenditures

(such as equipment).

This type of loan is usually short-term in nature and is almost always

backed with some sort of collateral.

Renewed emphasis on C&I Lending versus Commercial Real Estate

Lending due to changes in the Commercial Real Estate market.

A. Change of Supply & Demand for Commercial Real Estate Loans

B. Change of Attitude of Banking Regulators- FED, FDIC, OCC, State

C. Shift Back to Original Banking Roots!

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VIII. Commercial & Industrial (C&I) Loan Products & Structure

a) Working Capital Line of Credit: 12 months, interest only

1. Structure

2. “Mechanics”

3. Risks

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b) ABL Facility: 12 months, interest only

An asset based business line of credit is usually designed for the same purpose

as a normal business line of credit - to allow the company to bridge itself

between the timing of cash flows of payments it receives and expenses.

A non asset based line of credit will have a credit limit set on account opening

by the accounts receivables size, to ensure that it is used for the correct

purpose. An asset based line of credit however, will generally have a revolving

credit limit that fluctuates based on the “actual” accounts receivables balances

that the company has on an ongoing basis. This requires the lender to monitor

and audit the company to evaluate the accounts receivables size, but also allows

for larger limit lines of credits, and can allow companies to borrow that normally

would not be able to.

Generally, terms stipulating seizure of collateral in the event of default allow the

lender to profitably collect the money owed to the company should the company

default on its obligations to the lender.

c) Other Financing: Factoring

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c) Equipment Financing:

1. Loans: 3, 5, 7, 10 year amortization

2. Leases: 3, 5, 7, 10 year amortization

Note Payable (regular promissory note)

TRAC Lease

This lease contains a Terminal Rental Adjustment Clause (TRAC) that guarantees

your business a certain residual price for the vehicle when the lease expires. This

is the most common type of lease for business owners who want the option of

buying the vehicle for a pre-determined price at the end of the lease.

“True” Lease

Leasing commercial equipment with a True Lease or Tax Lease means you will not

have legal ownership of equipment, but will have use of such equipment for the

term defined in the lease. If the equipment you need is subject to rapid

advancements in technology, such as computers, the Tax Lease/True Lease is

could be the best option. Financing commercial equipment with this lease option

can mean lower monthly payments and in many cases tax deductions for lease

payment amounts. (Lessor often retains “depreciation” rights).

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IX. Accounts Receivable & Inventory Assessment and the Borrowing

Base Certificate (BBC)

BBC Defined:

Borrowing base is the total amount of collateral against which a lender will lend

funds to a business. This typically involves multiplying a discount factor by each

type of asset used as collateral.

For example: Accounts receivable. 60% to 80% of accounts receivable less than

90 days old may be accepted as a borrowing base. Inventory. 50% of finished

goods inventory may be accepted as a borrowing base. It is also common for a

lender to only use the accounts receivable of a borrower as collateral - it may not

accept any inventory as part of the borrowing base.

As an example of a borrowing base, ABC International applies for a line of

credit. ABC has $100,000 of accounts receivable and $40,000 of finished

goods inventory. The lender allows 70% of the accounts receivable and 50%

of the inventory as the relevant borrowing base, which means that ABC can

borrow a maximum of $90,000 (calculated as $70,000 of accounts receivable

and $20,000 of inventory) against its collateral.

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X. Accounts Receivable & Inventory Assessment and the Borrowing

Base Certificate (BBC) (Continued):

a) Formula Based:

1. Ineligible A/R

2. Advance Rate

b) Timing: Monthly, Quarterly, Per Advance

c) Basic BBC Example: (See Below)

d) Monitoring: Loan Officer vs. Annual Audit (Time, Costs,

Actual Work, etc.)

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XI. Accounts Receivable Issues

a) General Source & Quality of the A/Rs?

b) Are Governmental A/Rs Always Strong? Collectability? Timing?

c) How Do You Measure the Risk of the Individual A/Rs?

d) Does the Borrower ever “Re-bill” or Make Adjustments to its

A/Rs? What about the “Hidden” 30 Day Period?

e) Does the Borrower Use the “Direct Write-Off” Method

or the “Allowance Method” for Managing Bad Debt?

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XI. Valuation and Quality of Inventory (including Inventory Costing

System)

a) Raw Material, Work-In-Process or Finished Goods Inventory?

b) Inventory Costing System (Timing):

FIFO

LIFO

Average

c) Age/Quality of Inventory

d) Site Visit

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XII. Equipment Issues in Lending (including Depreciation)

a) Quality/Age of Equipment

b) Value of Equipment (How do you determine the FMV of the

equipment?)

c) Depreciation Methods:

1. Straight-Line (Book)

2. Units-Of-Production (Book)

3. Double Declining Balance (Book)

4. Modified Accelerated Cost Recovery System (MACRS) (Tax)

d) Other Depreciation Tax Issues:

1. Section 179 Depreciation (Form 4562)

2 Bonus Depreciation

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XIII. BSA Loan Rating Matrix, Collateral Rating Matrix, and C&I Borrower

Rating Matrix

(See Exhibit # 2)

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XIV. Conclusion: Loan Documentation for “Secured” Commercial

Lending Transactions

A. Determine where you are at with your documentation!

B. Create a “game plan” to address the “actual” loan situation

C. Cover your “bases” in all aspects of documentation!

D. Follow-up, follow-up, follow-up!