July 27, 2023
GSA, DOPAS, priority amounts, un-drawn facility fee, negative pledge, establishment fee, CARL, facility, pre-approved equipment finance facilities – these are just some of the abbreviations and terms used by rural lenders. Both the application of and meaning of these terms often confuse borrowers, guarantors, accountants and even lawyers. Often clients are sent a loan offer letter from the banking relationship manager and are happy to sign the offer after only reviewing the amount of the loan and the interest rate. Sometimes the devil is in the detail.
Banks naturally take a mortgage over your property. A mortgage is different to a loan agreement - the mortgage secures the loan, whereas the loan agreement is for how much you are borrowing and at what interest rate. If you do not pay what is required pursuant to the loan agreement, the mortgage kicks in. If there is a second mortgage (often a family loan where parents are keeping money in), this will always be second priority behind the bank. What this means is that either lender can exercise their power of sale (mortgagee sale) upon default, but a second mortgagee needs to pay the first mortgagee (up to its priority amount) from the sale proceeds before taking its money.
Family mortgages are commonly used in farm successions and the parents when providing a vendor loan are often required to sign a deed of postponement or deed of priority and subordination (the above DOPAS). This can often be confusing for the parents, but it is a key part of the bank's consideration of the succeeding child's equity position and/or cashflow. It makes the bank’s mortgage more powerful than the parents’ mortgage.
The deed of postponement might say that the succeeding child shall not pay the parent’s debt until he or she has repaid the bank debt. Alternatively, the deed might say that the succeeding child shall not pay any of the parents’ debts if such payment would result it being in breach of its obligations to the bank. Alternatively, it might say that the succeeding child may pay interest but no principal. This is important for parents when assessing how much income they will receive upon farm succession.
Banks often also take what is known as a General Security Agreement. This is similar to what used to be known as a stock mortgage. A bank will take a charge over all present and after-acquired property of the borrower - this is everything the borrower owns at the moment and everything they will own in the future, with the exception that it does not apply to real estate.
Banks will often also require personal guarantees from directors of a farming company. Sometimes people wonder what the point of these are if the directors have no personal assets because the company or family trust owns them. Banks will require them for several reasons but two common reasons are that the guarantee will capture any introduced capital into the company (i.e. shareholder loans) and reputational - most people don't like being made bankrupt.
A negative pledge is a common stipulation that a borrower shall not further encumber the bank's security. For example, the bank has taken over your charge of stock and you go and borrow more money from a stock lender, who then takes a charge over the purchased stock. That would be in breach of a standard negative pledge to a bank.
One item that often catches borrowers out is an establishment fee. This is a fee charged by the bank in order to take out the loan. This can often be 1% of the loan amount but is often between $300 - $500. This will simply be added to the amount outstanding on the day of drawdown.
Some banks will also charge an un-drawn facility fee on their revolving credit facilities– sometimes this is called a non-utilisation fee. If, for example, you are offered a $400,000 term loan facility but yet you only use $50,000, you will be charged a fee on the undrawn $350,000. This fee might be in the order of 1.75% per annum, which amounts to $6,125 per year. This may be a scary number for some people when they think that they're not even borrowing much money.
Borrowing money is an integral part of farming life and everybody involved should pay attention to all of their obligations - no matter how big or small. If you need advice or rural lending, we are legal experts in the rural sector and can advise you on farm financing, sales and purchases and other rural matters.