The following is a transcript of a simulated presentation to an audience of lawyers at the monthly meeting of a Bankruptcy Association. The participants are Professor Arnold B. Cohen, who serves as the moderator, and Sherry Kajdan­Vetterlein, Esq. Ms. Vetterlein specializes in lending and financial restructuring matters.

Professor Cohen: I'd like to welcome everyone to the monthly meeting of our Lending Association. Our speaker this morning is Sherry Kajdan­Vetterlein, an attorney specializing in working capital loan transactions. Sherry's topic is the process that lawyers follow in preparing working capital line of credit agreements. Although these agreements frequently are secured by various assets of the borrower, our focus today is on the loan or line of credit portion of the agreements.

Sherry, you represent banks for which you prepare these working capital financing arrangements. Who is the bank employee who contacts you?

SKV: Generally, I am called by one of the bank's loan officer who tells me that the bank has a customer to which it is extending a credit facility. The loan officer and I then talk about the type of facility that is contemplated. Our focus today, of course, is on a line of credit that can be drawn on by the company. Usually, the line of credit arrangement will provide that the customer has the discretion of drawing against the line when funds are needed and paying down the balance when it has extra cash. It is the fluctuation potential in the loan balance that gives this type of facility the name "revolver."

Note that revolvers differ from the typical term loan in which the customer makes a single borrowing which it repays over the term of the loan.

Professor Cohen: With respect to the revolver type of facility, what facts do you need?

SKV: Well, I need an overview about the bank's customer ­­ e.g., the nature of its business, its funding needs, any peculiarities relating to the customer's accounts, and whether it is contemplated that the customer will be closing down or selling any divisions or any sizeable amount of its assets.

In addition, I obviously need to know the size of the loan facility ­­ i.e., what is the maximum amount of the bank's exposure. I need to know the interest rate ­­ usually, this is stated to be a certain number of points above the bank's prime or base reference rate. I want to know whether there are any fees to be set forth in the agreement. And, of course, I need to know whether the line of credit will have a sub­limit based on the company's inventory or account receivable values.

Apart from these loan details, I want to obtain information on the basic structure of the company ­­ i.e., whether it is a corporation or partnership, whether it has subsidiaries or affiliates, where it was incorporated, the states in which it conducts its business, whether the company is subject to governmental regulation, whether the company is publicly or privately owned, the names under which the company does business, and the location of any collateral that the bank will have.

Also, I want to know the size of the company, and whether the proposed financing transaction is replacing one with another bank or whether it is an extension or replacement of an arrangement that the bank already has with the company. And I will want to know the nature of the company's computer system, the kinds of financial reports that can be generated, how long it takes to obtain a report, and the identity of the company's outside auditors.

I also want to know the average days outstanding of the receivables and whether there is a seasonality factor. This average days outstanding information is necessary in order to evaluate whether there should be adjustments in determining any sub­limit formula. Usually, I will request detailed breakdowns of the company's inventory and accounts receivable.

Professor Cohen: Concerning the company's payment obligations under the revolver, how frequently is interest paid? If principal isn't paid until the end of the contract period, what happens when a sub­limit shrinks to a level below the loan balance at the time?

SKV: Generally, interest must be paid periodically during the period when the agreement is in force. And, in most cases, interest will be due and payable on a monthly basis. The maximum amount of credit which will be available usually remains unchanged, but if a sub­limit falls below the loan balance at the time, the company will be required to pay down the over advance.

Professor Cohen: Who actually selects the interest rate and the sub­limit formulas?

SKV: These are business decisions made by the bank's loan officer or the bank's loan committee. They are not made by the lawyers. However, a lawyer might point out certain exposures that the loan officer may not be sensitive to. For example, certain inventory may be inherently risky. If such inventory is not disposed of in a certain number of months, the risky nature of this "old" or "stale" inventory may warrant a reduction in the sub­limits or in the otherwise permissible maximum loan balance.

The loan officer's or loan committee's write­up report or term sheet may have commented on the problem of risky inventory becoming stale but may not have included an appropriate adjustment in the sub­limit formula or in the payback requirements. The lawyer's task, in this instance, would be to point out the advisability of adjusting credit or repayment provisions to accurately reflect the business reality.

In most cases, of course, the loan officer is going to make all business related decisions. And, the decisions normally have been reached before you are called. In fact, in most cases the bank will have issued a commitment letter to its customer. Nonetheless, there always is some inter­play between business issues and legal issues. So there are going to be little things that will continually be worked on by you, the loan officer, and the borrower. But, as I've noted, things are likely to be relatively straight forward for the most part and only minor modifications will be made.

Professor Cohen: Will all of these informational details be covered during the initial telephone conversation between the loan officer and you, or will there be a series of conversations, possibly interspersed with faxed or delivered copies of documents?

SKV: It will depend on a number of factors, including (1) the complexity of the transaction, (2) whether the attorney has dealt with the loan officer in the past, and (3) whether the financial arrangement is similar to ones that have previously been handled. Nonetheless, one is always going to have questions that haven't been covered during the initial conversation with the loan officer.

Obtaining and digesting this information will occur over one or two weeks. Moreover, as I prepare a draft of the agreement, I may have questions that require additional information or clarification from the loan officer. And in some instances, the loan officer will contact the borrower.

Professor Cohen: Do you generally work from a form when you begin the drafting process?

SKV: Yes, but one must remember that the worst thing that a lawyer can do is to take a form and merely change the names of the parties. I usually start with a base form that is on my firm's computer system, but the form will inevitably contain provisions that are irrelevant or inconsistent with the negotiated transaction. These provisions must be deleted. Similarly, the form will frequently be missing provisions that are absolutely necessary in order to accurately reflect the transaction between the parties. My job is to add those provisions.

In most cases, I start with a form that our firm has developed. In some cases, however, I may use a form that is favored by the bank. Whether or not I use the bank's form or my own will depend on a variety of factors, such as the size of the bank and its internal legal department, the personal idiosyncrasies of the loan officer and any internal bank lawyer who is involved with the transaction, and the size and complexity of the financial arrangement.

Note that if the credit facility offered by the bank is rather straightforward, or the bank has significant experience in making the kind of loan it is making in the present case, the bank may actually have prepared the draft and may only want me to review it. In these cases, I will carefully review the draft agreement and make any suggestions that I feel are appropriate.

Professor Cohen: Focusing on the drafting process, is there usually a typical structure to these working capital agreements?

SKV: There's definitely a standard format. After a paragraph identifying the parties to the transaction, there usually is a long section setting out the definitions of technical terms that are used in the agreement. This definitional section is followed by a provision setting forth the basic terms of the loan, such as the maximum amount of the line, sub­limits based on eligible accounts and eligible inventory, the period during which the line of credit will be available to the bank's customer, interest rates and payment dates, the grant of the security interest, the collateral, and the obligations being secured by the collateral.

In addition, any related fees will be spelled out in the agreement.

Professor Cohen: If there are fees, are they actually paid or do they become part of the monies drawn down against the line?

SKV: Sometimes the fees are actually paid, although frequently it is treated as part of the initial advance.

Professor Cohen: What comes next?

SKV: I prefer to have a provision setting forth any conditions to the line of credit becoming available to the bank's customer.

Professor Cohen: Can you provide us with some examples of conditions that would typically be in an agreement of this nature?

SKV: If the line of credit is to be collateralized and part of the collateral is to consist of stock, a pledge agreement may be required. If some of the collateral is located and maintained in leased premises, landlords' waivers may have to be obtained. If the collateral includes accounts receivable and the receivables are to be collected by the bank, a lock box agreement may have to be executed. If the collateral includes real estate, then a real estate mortgage may have to be prepared and signed. Title reports or title insurance may be required. UCC financing statement searches may have to be done and satisfactory reports received.

Regardless of whether the line of credit is collateralized, the receipt of certified copies of Articles of Incorporation will always be required. And good standing certificates, audited financial reports in certain instances, and satisfactory opinions of counsel must be received. Since the execution of these separate agreements, receipt of certificates, etc., or occurrence of certain events may be conditions to the bank making the funds available, the loan agreement will reflect these requirements.

Professor Cohen: By the way, will you independently check or review the title reports, title searches, etc., to determine that they are appropriate or will you leave this to the loan officer?

SKV: Normally, we will prepare these ancillary agreements ­­ e.g., the landlords' waivers, mortgages, lock box agreement, etc. ­­ and will determine the appropriateness of any reports, searches, or certifications that are required.

Professor Cohen: What typically follows the conditions section in these line of credit agreements that you draft?

SKV: Provisions setting forth representations and warranties. These provisions reflect the assumptions that the bank made in reaching its determination to enter into the credit facility. What is needed, of course, is a statement by the borrower that these assumptions are in fact true.

Professor Cohen: What are some of the major reps and warranties?

SKV: That the board of directors of the company has approved the transaction and its terms; that the officers are directed and authorized to sign agreements on behalf of the company; that all necessary consents have been obtained; that entering into the loan agreement will not result in a default under any other agreement to which the company is a party; that the company has been duly incorporated and is authorized to conduct business; that the company is in good standing; that the company has timely filed and paid all applicable taxes; that the company's property is unencumbered except as disclosed to the bank; that the bank has received a list of all the company's leases; that the financial statements delivered to the bank are true and correct; that the company has been audited by the IRS for certain years and the results of the audits have not result in additional tax assessments; that its inventory values and the currency of its inventory meets certain minimums; that its accounts receivable that are, for example, less than 90 days old, amount to at least a certain amount; that its cash on hand is at least a certain amount; etc.

Professor Cohen: When there are conditions to the finalization of the bank's loan commitment, there will be some period of time between the date when the agreement is signed and the date when it is finalized. This latter date, I believe, is usually referred to as the date of "Closing." Since the representations apparently would read as if they were made as of the date when the agreement is signed, how do you handle the fact that events will occur between the signing and Closing dates?

SKV: In most agreements, statements pertaining to past or present events are set out as representations and warranties ­­ e.g., "As of the date of this Loan Agreement, Company hereby represents and warrants the following." When this is the structure that is used, matters pertaining to the period of time between the signing of the agreement and the Closing date are referred to as "covenants," or obligations to be performed in the future. The portion of the agreement containing the covenants will usually be inserted after the reps and warranties section.

Examples of covenants include the following: the company is maintaining appropriate insurance in force and effect; the company has been paying its liabilities as they become due and payable; the company is keeping appropriate books and records; no judgments have been entered against the company; no liens, claims, or encumbrances have attached to any of the company's property; the company continues to be in good standing in those states in which it conducts business; the company's assets are kept in good condition and repair; the inventory and accounts receivable levels stay within certain parameters; the company's working capital ratio continues to be in excess of a given number; the company has not entered into contracts requiring capital expenditures in excess of a certain amount; etc.

Professor Cohen: If you're going to have financial covenants, which I assume are fairly common, who sets the formulas?

SKV: A loan officer would work with the borrower and set those formulas. Note that there are certain industries standards to which the loan officer would look.

Let me return to the section of the agreement covering representations and warranties and the section setting forth covenants. Although it would be possible to lump these provisions together, my preference is to keep them separate. I believe that it is helpful in the drafting process for the lawyer to separate the underlying assumptions that the bank made in reaching its decision to make the loan ­­ making these representations and warranties ­­ from the obligations that the company is required to perform or avoid in the future ­­ making these covenants.

Professor Cohen: Continuing with the basic structure of the agreement, I assume that there will be a provision that sets out those those events that will constitute a default by the Borrower. One of the basic default provisions is likely to be the Borrower's failure to make an interest payment that was required to have been made. What other kinds of defaults might there be?

SKV: Apart from a Borrower's failure to make a payment when due ­­ whether the required payment was an interest payment or a payment of principal ­­ the breach of any representation or covenant will constitute a default. In fact, it's not unusual that a bank will go out and actually check to be sure that the covenants, schedules, borrowing certificates, etc., are accurate.

Professor Cohen: Is it likely that there would be notice and grace or cure periods included in the agreement to enable the Borrower to avoid a default? In other words, will most agreements provide that the Borrower will have the opportunity to cure an omission or other default before the bank may exercise its remedies, such as the right to terminate the line of credit or cause any loan balance to become immediately due and payable?

SKV: In some instances, a loan agreement will provide for the borrower's right to cure a default. In other cases, however, there will be no cure period and the occurrence of a default will give rise to the bank having an immediate right to exercise its remedies.

But, let me return to the topic of defaults being triggered by the breach of a representation or covenant. These representations and covenants are critical to the loan officer and need to be monitored very closely. If adverse events occur and are not monitored, the bank will not be able to declare a default and may continue to improvidently make additional advances. Then, in the event the Borrower suffers financial reverses, the bank might not be able to recoup as much of the loan balance as it could have recovered in the event that it had declared a default.

Professor Cohen: Okay. So the loan agreement will contain a provision spelling out the circumstances when a default will be present entitling the bank to assert certain remedies. This leads us to examine the kind of remedies that the bank will have in the event the Borrower has committed an event of default. Let's first focus on those remedies that relate solely to the lending aspect of the transaction as opposed to relating to any security that the bank has obtained ­­ in other words, let's assume that the bank has made an unsecured loan.

SKV: The primary remedy for the bank is to accelerate the loan balance ­­ i.e., provide that the entire loan balance will be immediately due and payable. Related to this right is the possibility under the laws of some states that judgment may be confessed by the bank upon the borrower's default when the agreement contains an appropriate confession of judgment provision.

Professor Cohen: Do you usually attempt to include a confession of judgment clause in the loan agreements that you prepare on behalf of the bank?

SKV: Absolutely.

Professor Cohen: Is it your experience that such a provision is accepted without argument by the borrower?

SKV: For the most part, yes. The borrower is not in the higher leverage position. Nonetheless, bank's do not automatically declare a default and exercise its remedies unless the default is deemed serious ­­ such as the borrower's failure to make a payment when due. A default resulting from a borrower's failure to meet a less substantive covenant ­­ such as its failure to meet a working capital ratio requirement ­­ is not likely to result in the bank immediately declaring a default. More often than not, such a failure merely will cause the loan officer to investigate whether or not the ratio default signifies a major problem or only a temporary hiccup in the borrower's financial picture. In the latter event, the bank may elect to amend the loan agreement to excuse this particular technical default.

Professor Cohen: Banks, of course, are subject to lender's liability lawsuits in the event that they declare a default for a relatively insignificant technical breach of a representation or covenant. Accordingly, banks must balance this exposure with the risk that their failure to declare a default for a technical breach may be deemed to estop them from subsequently declaring a default for a similar breach when the bank believes that the borrower is failing. How do lawyers deal with this?

SKV: One of the things that you attempt to do is to put in the agreement a provision that the bank's failure to exercise a right will not be deemed to preclude it from exercising the right in the future. Of course, there is always the possibility that courts will render such language ineffective. Accordingly, a better practice is for the bank to take some action against the borrower, such as (1) notifying the borrower that it has committed a default, and (2) following up this notice with the preparation and execution of an amending agreement. The amending agreement would provide that no action will be taken by the bank for the current default, but that the bank is reserving its right to declare a default for any similar breaches in the future.

Professor Cohen: Young lawyers have always heard about portions of an agreement that are called boiler­plate provisions. I assume that these provisions include the assignability or nonassignability of the agreement, notice rules, any grace periods, integration clauses, amending the agreement, choice of law, that kind of thing. How do you draft them?

SKV: First of all, I don't simply press a button and incorporate them from a form book. Some of these provisions, such as one relating to the state law under which the agreement is to be construed and applied, will be critical when a lawsuit occurs. Similarly, the fact that non­exercise of a remedy on one occasion will not be deemed a waiver of the bank's right to exercise its remedies on another occasion may be important if the loan officer does not enter into some amending agreement every time a default occurs and is not acted upon ­­ although the risk is always present that the non­waiver provision will not be enforced.

Assignability provisions also are critical. The bank does not want its borrower to assign anything, although the bank wants the right to assign the loan and its rights associated therewith.

Notice and grace period provisions are exceptionally important. You want to know exactly when you can exercise a remedy or the length of time a borrower may have to cure a default.

A severability clause, although fairly standard, will be important when the agreement contains extreme remedy provisions. The bank doesn't want to lose its basic remedies because of the unenforceability of some tangential provision.

In conclusion, you only want to include provisions that are applicable to the particular facts and circumstances of the loan that you are working on. Otherwise, a seemingly innocuous provision that isn't needed will bite you down the road.

Professor Cohen: This seems to cover the major provisions that one would include in a line of credit or working capital loan agreement. On behalf of our Lending Association, I want to thank Sherry for sharing her experience with us. And I hope that she will return and talk to us about the security interest aspect of the typical revolving credit agreements. Once again, Sherry, thanks for coming.

SKV: You're certainly welcome, and I look forward to returning.