While equity financing remains one funding method for Angie Masuke’s maize flour milling business, she may choose loan financing as it could help her to maintain control over the business. This option is, however, dependent on the modicum of cash flows to meet the interest and principal payments. Moreover, if Angie’s business uses a lot of borrowed money to acquire assets (i.e. is highly financially leveraged), this could burden its operations.
Therefore, in this second part of our 30-part article series on secured transactions, corporate recovery and insolvency and banking litigation, we discuss the key issues that Tanzanian business owners like Angie need to consider when taking up loan financing from banks and other lenders. We also explain how a loan facility agreement may affect those issues.
First, the size of the loan facility matters. If the business project is expensive, it may require a large loan which may surpass a bank’s exposure limits. If it does, some banks would form a syndicate to arrange the loan with the objective of diversifying risk. Business owners need to understand the legal issues which underpin syndicated lending and to manage the relationship with participating banks effectively. But it could be that a loan from one bank is suitable for the project.
Second, what’s the most useful type of loan facility? Business needs and future strategic goals are different, and there is a range of loan facilities: overdraft loan, working-capital loan, revolving loan, term loan, vehicle and asset finance (VAF), etc. Although a formidable hurdle, banks should be fully aware that their customers could sue them for failing to provide the right loan facility. Such a claim would require showing that the bank was under a duty in common law and the bank breached that duty. But wait a minute—would the bank be liable if it breached Bank of Tanzania (BoT) regulations incorporated in the loan facility agreement? Is a breach of BoT regulations a breach of contract?
Third, business owners need to consider the proposed terms of loan repayment. Scheduled repayments should be squared with the business’ ability to generate revenue to meet the repayments. Cash flows should be robustly “stress tested” for certainty, especially where the bank is entitled to call the loan—such as an overdraft—at any time upon demand. And what if early repayment is envisaged? Does the proposed loan facility agreement provide for whether, and if so how, early repayment can occur?
Fourth, in terms of cost of borrowing, Tanzanian tax law supports loan financing because interest (unlike dividends) is tax deductible. Even so, business owners need to cogitate about the interest and fees charged on various loan facilities. Interest and fees depend on the bank’s risk-bearing capacity. It’s also important to consider the internal cost of ensuring compliance with loan obligations since it adds to the overall cost of borrowing.
Fifth, business owners need to consider if the collateral security and directors’ personal guarantees and undertakings required by the bank make practical sense. There is a view that directors’ personal guarantees corrode the essence of Section 3(2) (a) and (b) of the Companies Act, 2002 on forming limited liability companies. So, how do we reconcile that view with the August 7 judgment of the Court of Appeal of Tanzania declaring that a personal guarantee is a contractual commitment to pay the company’s loan or face seizure of personal assets? In any case, banks are unwilling to lend to businesses without personal guarantees—leaving no room for negotiation.
Sixth, default events, including what action the bank can take needs to be considered carefully.
Obviously, no business owner hopes to face receivership or liquidation; yet, these are seemingly on an upward trend (see, for instance: Kolumbia, Louis. “Mohammed Trans buses up for auction.” The Citizen. July 14, 2018). Business owners like Angie need to ensure that loan financing is a good fit for the needs of their businesses. If otherwise, negotiate with the bank for a modification or waiver of certain clauses in the loan facility agreement, and comply with the agreed terms, including using the loan for its specific purpose.