Why Should Financial Institutions Consider “Custom” Loan Documents?

Most financial lenders have a library of loan documents they can prepare in-house, and they are typically familiar and comfortable with those documents.Moreover, “form” loan documents usually integrate with the lender’s other systems, such as for loan administration, offering efficiency and reducing risk of data entry error.Sometimes, however, there are good reasons to use attorney‑prepared “custom” loan documents.

Facilitating The Deal

Occasionally lenders choose to use “custom” loan documents to facilitate reaching agreement with the borrower.“Form” loan documents come in different varieties even within one document library, so lenders have some flexibility in selecting which forms to use.Obviously, form documents have fields to complete with the data applicable in particular transactions.Often, they also have optional provisions that may be selected for inclusion or exclusion to tailor the documents to some degree.But fixed, uneditable form text can be an impediment to reaching agreement, and if the lender is willing to change a provision, it is frustrating not to be able to do so due to the limitations of the document assembly software.Custom loan documents can resolve that issue.

Sometimes a simple addendum to a form loan document is sufficient to address a small number of simple changes.For example, an addendum to the loan agreement might vary a provision in the form slightly, such as providing that, notwithstanding the requirement in the form that all financial reports be according to GAAP, the periodic financial statement from the guarantors need not be. Or an addendum might append a provision requiring a reserve account or creating a specific exception to a negative covenant, such as anticipating a transfer of equity interests to a trust for estate planning purposes despite a general prohibition on changes in ownership.

Sometimes, though, the number or complexity of the changes indicates that a custom loan document should replace a form loan document.Complex structure of a borrower and affiliates might be best described on a custom document.Unusual provisions concerning particular notice requirements, contingent or conditional opportunities to cure (e.g., “three strikes”), declining limited guaranty limits, unique definitions (e.g., of eligible collateral for a borrowing base calculation), or creative renewal or extension “options,” among many, many other special provisions, might be included in a custom document or document set.So the attorney-prepared documents allow the lender to memorialize a deal with terms that form documents could not accommodate.

Mitigating the Risk

Occasionally lenders are required to use “custom” loan documents by loan policy or a condition stated by the board or loan committee; the requirements to use attorney‑prepared loan documents are generally based on a desire to mitigate risk.(Of course, a lender might choose to use custom loan documents for this same purpose even when not required to do so.)Some lenders view attorney-prepared loan documents as though they include an “insurance policy” arising from the potential to make a claim against the law firm if a problem arises, but claims of that nature are rare and, when they do arise, are not as easy to make as one might believe.The greater potential benefit for purpose of mitigating risk comes from having another member on lender’s team, another “set of eyes” on the loan document package.

The role of an additional team member includes at least two parts:bolstering the accuracy of the loan document package (i.e., matching the documents to the terms negotiated and agreed by the lender and the borrower) and supporting the reliability of the loan terms (i.e., seeking to ensure the lender understands the potential effects of the terms that lender would accept).Extracting the “variables” from a loan presentation and completing custom loan documents that include them is fairly straightforward.A wise attorney will always urge – and a wise lender will always expect, whether urged or not – that the lender will double-check that the documents fairly capture the specified loan terms and are consistent with the lender’s expectations and preferences.The result should be an accurate memorialization of the loan terms.Probing whether the lender appreciates the legal risks of “creative” loan terms can be more challenging – less so if the lender and attorney have developed a rapport – but it is an important part of the process.And adapting loan documents and practices to address novel risks is another way value is added in the custom loan document process.Unusual collateral, for example, might necessitate unusual steps to perfect a security interest, accomplished in the loan documents and the instructions for closing the loan transaction.By discussing the terms and reaching consensus on what they mean, including in light of potential legal risks, the lender and attorney collaborate to create a custom loan document set that mitigates risk for a loan that is “large” or otherwise unusually complex.

The involvement of an attorney on the team does not relieve the other team members of their roles or responsibilities; a thoughtful lender will not perceive that, if an issue arises, “it is the attorney’s problem.”There have been successful claims against law firms for outright errors in loan documents.A prime example is the case, in New York perhaps thirty years ago, of Prudential Insurance Co. v. Dewey Balentine, in which case the law firm omitted three zeros, making a $93,000,000 figure a $93,000 figure!But it generally requires an egregious error like that, rather than a failure to anticipate an issue or a use of a provision that turns out to be less than ideal, to result in a valid claim to recover from a law firm.And there are procedural limitations, also, including, in Minnesota, a six-year limitations period.(Minn. Stat. § 541.05, subd. 1.)The limitations period almost certainly begins to run from loan closing, regardless when an error is actually realized.(See Herrmann v. McMenomy & Severson, 590 N.W.2d 641, (Minn. 1999).)So consider the term (i.e., maturity) of a loan with attorney-prepared loan documents; even if there were an opportunity to make a claim for a drafting error, it probably lapses after six years.Again, though, the real value comes from the collaboration with the attorney to create an accurate and reliable loan document set rather than from any opportunity to “point a finger” if an issue arises.

Custom, attorney-prepared loan documents can help to facilitate loan transactions involving novel provisions not well-accommodated by form loan documents, and custom loan documents and the inclusion of an attorney on the team can help to mitigate legal risk in larger or unusual loan transactions.

Nothing in this article is intended as legal advice. Every situation can involve unique facts and circumstances, and applicable law varies across jurisdictions and over time. Consult a professional if you believe you need legal advice.

This article was published in the Minnesota Bankers Association monthly magazine Jan/Feb 2022.