Repayable on Demand: What the Words Change

A committed loan is a bargain with a length. Unless a listed event happens, the lender must leave the money where it is until the end of the term. On-demand wording removes that length. The lender keeps the option to end the arrangement, and the borrower is using money for as long as the option goes unexercised.

Lenders ask for this on facilities that are meant to move with daily trading, chiefly overdrafts, where the balance cannot sensibly be scheduled. It is cheap to arrange and quick to change. The risk arises when a facility designed for timing differences ends up funding something permanent such as stock, equipment or an accumulated loss, since the business has then matched a long need with money it can be asked to return this week.

A demand is normally a written notice saying that the amount owing is to be paid. Absent other wording, nothing in the phrase requires the lender to give a reason. English courts, following the decision reported at [1987] Ch 335, have allowed a debtor time only for the mechanics of making the payment, not time to find the money. An English court in 2001 also held a development facility payable on demand despite a stated maximum intended exposure of twelve months. Those decisions do not bind courts in Australia or New Zealand, where the time allowed depends on local authority and on the words of the document. General law on unconscionable or unfair dealing may also apply.

The Australian Banking Code of Practice addresses this directly for small-business loans from subscribing banks. It says the bank may not be required to give notice when it requires repayment of an overdraft or on-demand facility, but if the failure to repay also counts as a default under another loan with that bank, the Code's notice rules apply to enforcement of that other loan.

The words also reach the accounts. Companies reporting under the Australian and New Zealand versions of the international standard classify a loan as current unless they have a right at the reporting date to defer settlement for at least twelve months. A lender's right to demand removes that right. Smaller companies on special-purpose accounts may not apply that standard. In the UK, the accounts regulations for large and medium-sized companies treat a loan as falling due on the earliest date on which the lender could require repayment. Where those rules apply, the repayment schedule does not change the result.

A wholesale florist, constructed for this page like every figure in it, has a US$900,000 overdraft and a US$1.5m loan over its cool store, with US$200,000 of principal due in the coming year. Over the past twelve months the overdraft moved between US$340,000 and US$860,000 and was US$700,000 at balance date.

The business is the same in both halves. A supplier granting credit, or an auditor considering going concern, sees very different balance sheets. The 1.33 and 0.77 are the example's arithmetic, and no level is implied as adequate.

Then take the bad week. Mothers' Day stock has been bought, and the bank, unsettled by late management accounts, makes its demand on the overdraft.

Few banks would act this abruptly against a trading customer. But the florist's position does not rest on any contractual right, only on that being so. The US$340,000 that sits in the overdraft all year is the part that has outgrown it: on a term loan, with a schedule, it would no longer be exposed in that way, and the remaining line would do the job an overdraft is for.

Two different freedoms are often run together. An uncommitted facility leaves the lender free to refuse the next advance. A repayable-on-demand facility leaves the lender free to recall what is already out. Many overdrafts have both features, but a document can have one without the other, so a loan drawn once and repayable on demand is not uncommitted in the usual sense, and it is not committed either.

A committed facility can be recalled early only through its events of default or similar triggers. That is the distinction between a line of credit and a term loan in substance, whatever each is called. A separate idea with a similar name is the on-demand guarantee, under which a guarantor or issuing bank must pay against a demand; the phrase there concerns what the beneficiary has to prove, not a borrower's repayment.

DEFINED IN ONE PARAGRAPH → · BUSINESS OVERDRAFT → · UNCOMMITTED FACILITY →

A bank does not usually use the right. Its decision to keep money available is made in practice at the annual review, where the file is read as a whole. The right matters because of what it does to every other conversation: a borrower asking for a waiver on a demand facility has less to bargain with, and a lender with a demand right has less need of a covenant.

For a borrower, the reading is simple to do and easy to skip. Look for the words in each facility, including those with a term or a schedule, and in the general terms the letter incorporates. Look at how much of the balance has stayed drawn all year. And look at what a demand on one facility would set off elsewhere, because a cross-default in another agreement may treat an unpaid demand as a default there.

THE BANK ANNUAL REVIEW → · READING YOUR FACILITY LETTER →