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The introduction of increasingly stringent criteria by mainstream lenders has resulted in more widespread use of bridging finance in recent years. Bridging loans can provide welcome short term liquidity to businesses and individuals in appropriate circumstances. In order to utilise bridging finance successfully, however, it is essential for prospective borrowers to understand fully the objectives of short term lenders and the specific terminology and characteristics that distinguish bridging facilities from traditional mortgages.
The comparative flexibility and informality of the lending process is one of the key factors responsible for the increasing popularity of bridging finance. Provided a lender has confidence in the value of the underlying security, the integrity of the borrower and the proposed repayment plan, any issues identified during the course of due diligence are more likely to prompt a renegotiation of specific terms than a withdrawal of the offer. In our experience a lack of preparation by the borrower or a failure to disclose at the outset all salient information regarding the borrower’s financial circumstances or the proposed security are the issues most likely to stall the lending process.
As advisers to bridging lenders and borrowers, there are few situations that we have not encountered. In this article we list those legal issues which most commonly threaten to derail a bridging lend, and how to prevent them arising in the first place.
Bridging Finance in a Nutshell
A bridging facility is a short term loan secured over property and used to provide additional liquidity until longer term funding becomes available. Bridging loans have a variety of uses; from the provision of urgently required funding for an auction purchase or an acquisition out of insolvency, to the release of equity to enable a business to settle liabilities or take advantage of investment opportunities. Funds can be drawn down as quickly as a week after agreement of the initial term sheet assuming the lender is comfortable with the valuation of the secured property provided by its surveyor, and the proposed exit route (such as a refinancing or a sale of the secured property or other investments). The property valuation is key; provided this is in line with expectations, a bridging lender will not usually require the more detailed financial projections which are a prerequisite of longer term funding. Bridging lenders will typically require a loan to value ratio (the amount they are willing to provide against the value of the property) of between 60% and 70%.
Typical Terms
Whilst most clauses in a bridging facility letter will be similar to those in a standard term loan, certain provisions are unique to short term lending and their implications are not always fully appreciated by a borrower inexperienced in arranging bridging finance.
Interest is commonly fixed and expressed as a monthly percentage rate. Depending on the term of the loan, and the level of the borrower’s income and assets, the interest will not always be paid on a monthly basis. A bridging lender will often require some or all of the total interest payable over the term of the loan to be added to the principal amount, deducted from the drawdown and netted off against the monthly interest due, thus ensuring that the interest can be serviced. If the facility is prepaid, the retained interest not netted off against monthly interest already accrued will be deducted from the total repayment due.
Whilst bridging facilities are normally repayable early without penalty, the lender will usually require a minimum return on its advance; in other words, a minimum number of months’ interest will become due, regardless of whether the loan is repaid early. For example, if the term sheet specifies a three month minimum return and the loan is repaid after two months (during which the monthly interest has been serviced in the ordinary course) the lender will require a further month’s interest to be paid on redemption. If the loan is repaid after three months, and the interest for those three months has been serviced, no minimum earnings fee will be payable, as the lender will have already recovered its minimum return.
In addition to the arrangement fee and minimum return, the lender will also commonly charge an exit fee based on a percentage of the principal amount. If the loan is to be drawn down in tranches (for example, on a development loan, where a proportion of the facility will only be available for drawdown once a particular stage of the development work has been completed) it is not uncommon for a monthly non-utilisation fee to be charged on the unused portion of the loan.
Security
The lender will wish to identify and address any potential problems with the property offered as security, and which might impact on its value or the ability of the lender to dispose of the property in an enforcement scenario. The borrower should ensure that all appropriate consents including planning, building regulation and superior landlord consents and certificates, such as Energy Performance Certificates or Gas Safety Certificates for let residential properties, are in place and made available to the lender and its solicitor promptly. It is often possible to address defects in the borrower’s title to the property through defective title indemnity insurance and to avoid the delay that can arise waiting for up to date searches by utilising suitable no search indemnity policies. A lender will also require certainty regarding the terms under which any third party occupies a secured property and, if the property has been valued on the basis of a sale with vacant possession, that the occupational tenancy can be terminated easily on enforcement.
Depending on the specific circumstances of the lend, it may be possible for a bridging facility to be secured by a second charge over the relevant property; in other words property over which a first legal mortgage has already been granted to another lender to secure an existing facility. The bridging lender will accordingly rank behind the senior lender and be repaid out of the surplus proceeds of any sale of the secured property, once the senior loan has been repaid in full. In these situations, both lenders will usually wish to put in place a deed setting out the agreed priority between the respective securities, and each lender’s enforcement rights on default. Where there is more than one secured lender, this is the most common cause of delay; the incumbent lender has no inherent incentive to respond to requests to agree a priority arrangement. It is therefore important for the borrower or its adviser to initiate discussions with the senior lender at an early stage, even before terms are agreed in principle with the bridging lender. Bridging lenders will occasionally accept a simple letter of consent to the further security, together with evidence of the outstanding balance of the existing mortgage and confirmation from the senior lender that it will not make any additional advances without the bridging lender’s consent. A consent letter in the senior lender’s standard form can still, however, take some time to procure.
The borrower should also be aware that the minimum market value of any second charge property specified in the term sheet will be net of the senior debt secured over that property; in other words, the balance of the available equity in the property.
Anticipating Issues
If a bridging lender discovers prior to drawdown that a borrower has withheld key information which impacts on the value of the security or the ability of the borrower to service the facility, this will often kill the deal. In order to avoid any suggestion that the borrower has been less than transparent, it should liaise with its broker to volunteer all relevant details at the outset. A bridging lender will usually supply a template statement of assets, liabilities, income and expenditure for completion. Whilst this should be completed as fully as possible, the borrower should consider any questions that are likely to be raised by its responses. If a particular source of income is unclear, or a significant potential liability is listed, the lender will wish to know more. A sensible borrower will supply a more detailed explanation. If the borrower has had solvency problems, this will almost certainly come to light when the lender carries out its usual pre-completion credit searches. A borrower should therefore be upfront with the lender about its financial difficulties; this will not necessarily preclude the availability of finance if the lender can see that such issues are historical and are unlikely to impact on the serviceability of the loan.
When asked to carry out due diligence into a property by one of our lender clients, we sometimes find that an existing property offered as security has apparently been acquired by the borrower at a significant discount to market value. This will usually raise alarm bells given the risk of the purchase being set aside on an insolvency of the seller, if the property was genuinely acquired at an under value. There is often an explanation for the lower purchase price; for example, unusual market conditions at the time of purchase. It is, however, infinitely preferable for this explanation to be supplied as part of the initial information pack and demonstrates that the borrower understands and is willing to address the bridging lender’s typical concerns.
If the borrower is a corporate vehicle – because the individual wishes to limit their liability, or the facility is required for the purpose of the business carried on through the relevant company – the bridging lender will usually wish to take security (a so-called “debenture”) over all assets of the company. This will occasionally be unacceptable to a borrower, for example if it wishes to grant a first legal mortgage over another property owned by the company in order to secure a different facility. A borrower should think carefully about the security package which it is prepared to offer, and agree this clearly with the bridging lender at an early stage in the negotiations.
A bridging lender will more often than not require personal guarantees from the main shareholders/directors of the company – an individual is therefore unlikely to avoid personal liability to the lender by borrowing through a limited company. Again, if any director or majority shareholder is unlikely to be prepared to guarantee the obligations of the borrower, this should be made clear to the lender upfront, avoiding potentially difficult discussions further down the line.
The lender will usually require the guarantor to be advised by an independent solicitor (not the borrower’s adviser), particularly where the guarantor is a family member of the main director or shareholder of the borrower. The independent legal adviser will be required to confirm in writing that they have advised the guarantor at a separate meeting and that the guarantor appeared to understand their advice. If the guarantor is not fluent in English, a qualified translator will almost certainly need to be present; if the borrower and its adviser can anticipate all likely practical issues well in advance, the risk of embarrassing last minute delays is greatly reduced.
For tax reasons, the borrower company may well have been incorporated in an overseas jurisdiction, necessitating a legal opinion, at the borrower’s cost, from an adviser based in that jurisdiction regarding the capacity of the borrower to enter into the facility and security documents. The borrower should not assume that the lender will be prepared to engage its own adviser or an affiliated firm to supply the opinion; the lender will usually require the borrower to source an adviser, albeit that the opinion will need to be addressed to the lender.
As bridging finance becomes more widespread, we are increasingly seeing applications for bridging finance from charities and other third sector entities. In addition to the legal issues common to all other borrowers, charity trustees must also ensure that they comply with the requirements of charity law in respect of secured borrowing, including obtaining the required opinion from a qualified adviser as to whether it is reasonable for the trustees to enter into the bridging finance documents. The trustees should ensure that they instruct professional advisers familiar with such requirements at an early stage
If you are a bridging lender or prospective borrower and you would like to discuss any of the above issues, please contact Philip Round on 01902 328366 or e-mail PRound@georgegreen.co.uk or call Alex-Jayne Lowe on 01384 340541 or e-mail ALowe@georgegreen.co.uk.