Condition Precedent: How a Loan Reaches Drawdown

A credit approval is given on assumptions: that the property is worth what the borrower says, that the shareholders will put in their share, that the insurance exists and the directors have authority to sign. The lender's approval is only as good as those assumptions, and conditions precedent are the way it tests them before any money leaves.

A signed facility letter is usually a binding contract from the day it is accepted, with the lender's duty to lend conditional on the list being satisfied. The borrower can have fee and cost obligations while the conditions remain open, and the lender may withhold funds until they are met or waived. Because the conditions exist for the lender's benefit, the lender is ordinarily the party able to waive them. The precise drafting varies, so some agreements instead make the whole contract conditional.

The items fall into two groups. Documentary conditions are things to deliver, once, before first drawdown: signed facility and security documents, directors' resolutions and certificates, a valuation addressed to the lender, insurance noting its interest, identity checks, proof of equity, a payout figure and discharge from an outgoing lender, a subordination of shareholder loans, and legal opinions where the deal calls for them. Many are required "in form and substance satisfactory to the lender", which leaves it the judgment on whether what arrives is good enough.

Continuing conditions apply at every drawing, usually confirmed in the drawdown notice: no default exists or would result, and the representations are still true, sometimes with no material adverse change as well. They explain why a revolving facility that has been available for years can stop being so. Development and construction loans add a further layer, with invoices, certificates or updated valuations required before each progress drawing.

On larger deals the lender's lawyers keep a checklist showing each item, who is responsible and where it stands. On smaller bank facilities the relationship team often keeps it. Either way, the borrower is the party that needs the money, and it does well to ask for the list early.

A craft distillery, constructed for this page like every figure in it, signs a contract to buy the warehouse next to its still house for US$3.0m, settling on 30 September, with no finance condition in the purchase contract. Its bank approves a loan of US$2.1m, 70% of the price, secured by a first mortgage over the warehouse and a general security agreement. The 70% belongs to the example and is not offered as a market norm. The approval says the loan may not exceed 70% of value on a registered valuer's report, and the founder's US$400,000 shareholder loan must be subordinated.

The valuation arrives a week before settlement, and it is below the price.

The condition is not met, and the banker has no power to ignore it. There are three ways through: the company finds another US$210,000; it offers additional security, which the bank's credit team must approve; or credit approves a higher ratio and records why. The directors find the money from a shareholder and the founder signs the deed abroad and sends it by courier, each by 29 September. The bank's solicitor confirms the list is clear, and funds move on the day. Had the US$210,000 not appeared, the company would have been bound to settle a purchase its loan no longer covered, with its deposit at risk. That exposure came from the purchase contract and not from the facility letter.

The insurance item shows the other route. The bank let it move behind drawdown as a condition subsequent, thirty days out.

The two differ in who holds the risk when something goes wrong. A condition precedent keeps the money in the lender's hands until the item is done. A condition subsequent lets the money go and relies on a deadline, with a breach as the remedy. A lender moves an item behind drawdown when it is confident of delivery and the deal cannot wait, and it is more willing to do so for a late insurance endorsement than for a mortgage.

Registration deadlines limit how much can be left for later. In the UK, a charge created by a company has to reach Companies House within 21 days beginning with the day after its creation, unless a court extends the time, if it is to hold against a liquidator, an administrator or other creditors. New Zealand and Australia have their own timing rules for perfecting security. Conditions precedent also differ from covenants and undertakings, which govern conduct after the loan is drawn, and from representations, which are statements of fact the conditions may require to be true.

DEFINED IN ONE PARAGRAPH → · READING YOUR FACILITY LETTER → · CONDITION SUBSEQUENT →

Inside the bank, a condition is a term of approval, so a banker who releases funds without it has changed the approval. A waiver has to go to someone with authority to give it and be written up. A condition that is quietly dropped is the kind of thing a later reader of the file finds after the loan has gone wrong.

On the borrower's side, sequence decides most outcomes. Items that depend on third parties, such as valuers, outgoing lenders, landlords' consents and signatories abroad, should start first, and any contract with a fixed date should be read against the list before it is signed. The drawdown notice deserves attention too: it restates that nothing is wrong, and a statement that turns out to be untrue is likely to be a default of its own.

DEVELOPMENT LOANS → · IN-PRINCIPLE APPROVAL →