In this booming economy, money for small businesses is plentiful. As a small business owner, you've probably been approached by numerous lenders willing to extend credit to your company.
A word of caution: before signing on the dotted line, make sure you understand the fine print and know your legal rights as a borrower.
"The devil is in the details" can best describe the way loan documents are written today. By signing the documents without fully understanding them, you may later find that you have compromised your company's legal or financial position or your own personal assets and liability.
Some lenders, for example, require personal guarantees like pledges of homes, investment property, or other non-business items as collateral as clauses in their documents. Personal guarantees are designed to protect the lender but in the process leave the business borrower's assets vulnerable.
By adhering to the basic rules of borrowing, you can be confident you have done all you can to protect yourself and your company's legal borrowing rights.
Years ago, a lender's oral promises were considered in court to be almost as strong as its written vows. Under relatively new California statutes, banks can now make certain oral loan commitments to perspective borrowers and later back out of those promises or say the pledges were never made without fear of legal repercussions.
Let's say your company's loan documents do not exactly reflect the verbal lending agreement you and your banker have reached. Later, a dispute occurs over the term of the loan that you had discussed but was never incorporated into the loan documents. If the case goes to trial, the courts will most likely prevent you from testifying about what your banker verbally promised. The law looks only at what is contained in the loan documents.
Get it in writing
Nailing down the loan approval in writing is also important. For example, a manufacturer wants to buy new equipment and hire new workers to expand a product line. He's told by his bank (either orally or by letter) that his loan request is approved. The manufacturer begins to spend time and money to prepare for the expansion.
If the bank decides later that it doesn't want to make the loan, it does not have to honor the original commitment because it was not contained in a written loan document. The manufacturer, as a result, could lose not only the opportunity to expand but also considerable time and money.
As any small business owner knows who has approached a lender, most loan documents are presented with little option to negotiate. Only businesses with plenty of cash and collateral have negotiating leverage. Most business borrowers also know that if they do not agree to the terms offered, they may not get the loan. Faced with this dilemma, they end up signing a document that is packed with clauses that favor the lender and reduce the borrower's legal rights.
Borrowers who are bold enough to question a loan agreement's terms and conditions are often told, "Don't worry, we never enforce these clauses they are standard 'boilerplate,'" If a disagreement occurs over the clauses in question, however, the lender has every right to enforce those clauses.
Have a bank superior confirm your loan agreement in writing. Banks rely on a legal doctrine called "reasonable reliance" to claim a loan customer was overly optimistic in relying on a loan officer's promise to increase a credit limit or agree to a loan. In other words, if you are counting on a loan to go through, don't just take the word of the loan officer that the loan was approved.
Read and understand every document before signing. In the past, courts were lenient with people who didn't fully understand every clause of every document they signed. Not now. It is the borrower's responsibility to understand the consequences of everything written in a loan document even the fine print.
Anticipate the worst as you review the loan documents. What do the papers say will happen if your company is late on a loan payment? Are the documents allowing the bank to seize collateral immediately? If so, ask the lender to rewrite the terms to give you extra time to make the payment, or at least to receive notice from your bank that the company is in default before the lender can seize collateral.
You also need to be on the lookout for jury trial waivers and arbitration clauses. Lenders, including Bank of America and Wells Fargo, insert arbitration clauses in all their banking agreements with their customers. Whenever customers sign loan documents, credit card applications or savings account forms, they are automatically agreeing to forfeit their constitutional right to a jury trial if a disagreement arises with the bank.
Arbitration clauses might not seem like a big deal at first, but you need to ask yourself why banks insist on them. By avoiding trials, banks not only save money in trial costs but can avoid multimillion dollar jury verdicts against them and the bad publicity these cases can bring.
Have a lawyer review confusing loan documents. Lawyers are often the only people who can make sense of the gobbledygook put in the pages of documents that lenders ask you to sign, often without giving you time to read them.
Don't count on your banker to be your friend. Relationships can only go so far in business. If problems arise with your loan, and it comes down to a court battle or intense arbitration hearing, friendships with loan officers will go out the window.
No matter how friendly your banker becomes, your company is never guaranteed that its banking relationship will remain on track. Changing economic conditions, bank philosophy and management often change the way banks view and treat customers. A lending position that favors small business loans, for example, can be eliminated overnight if a new, more conservative management team takes over. Your loan could be viewed as a liability, and the bank will begin to treat it (and you) as one.
Letting the lender know you are aware of your borrowing rights will help ensure that your lender continues to deal with you and your company fairly and in good faith.
A. Barry Cappello is managing partner at the law firm Cappello & McCann. He can be reached at email@example.com.
Entrepreneur's Notebook is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California. Contact James Klein at (213) 743-1759 with feedback and topic suggestions.
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