Synopsis: Understanding your closing documents holds significant importance for a smooth and successful loan experience. These documents solidify the agreed-upon terms, including repayment details, potential fees, and your obligations. Therefore, getting yourself familiarized with these documents empowers you to make informed financial decisions for your business.

What is Meant by Closing Documents in a Business Loan?

Closing documents are legal contracts that solidify your business loan agreement with the lender. This final step formalizes the terms you negotiated. The document outlines the loan amount and the repayment details, including interest rate, and any prepayment penalties. If you have pledged any assets as security for the loan or have produced personal guarantees to back the loan, they all go on record in closing documents. It also contains borrower and lender obligations that outline your responsibilities as a borrower to maintain a good financial standing during the entire course.

Why Closing Documents Matter?

Signing these documents serves as a vital record for both parties to finalize the loan process and initiate the fund disbursement. In case of any disagreements, the closing documents act as a clear reference point for the agreed-upon terms. That’s why it is imperative for borrowers to understand each clause mentioned in these documents before getting signatures.

Closing Documents Involved in a Business Loan

Let’s take a look at some important sections that appear in standard closing documents.

Loan Agreement

A loan agreement is often called a loan contract or a credit agreement. This is an official contract between the lender and the borrower that outlines loan terms and repayment requirements. It typically highlights the following information:

• Counterparty information
• Counterparty responsibilities
• Loan amount
• Amortization schedule (if applicable)
• Loan maturity
• Loan Type
• Prepayment penalties
• Collateral security
• Interest rate
• Credit terms
• Repayment schedule
• Representation and warranties
• Covenants
• Promissory notes

A copy of the loan agreement is imperative in closing documents as it legally binds both parties together. In the absence of a clear loan agreement, there would be no legal recourse against one party should the other party fail to meet the promised obligations.

Promissory Note

A promissory note, also known as a written promise, represents the borrower’s commitment to pay off the loan, either on demand or as per a fixed deadline. The note contains all essential information, such as:

• Principal amount
• Rate of interest
• Date of maturity
• Payment schedule
• Lender’s signature
• Date and place of issuance

There are two types of promissory notes; secured and unsecured. In the former type, the borrower is required to provide collateral in case they fail to pay off the loan amount. The unsecured promissory note doesn’t include any such obligations. If the borrower does not repay the loan in time, the lender can proceed with standard debt-collection procedures. However, in either case, the promissory note stays valid until the debt is repaid.

Security Agreements (if applicable)

If the business loan requires collateral, this document outlines the specific assets used and grants the lender a security interest in them. All terms and conditions regarding the same are determined during the drafting process. If the borrower fails to pay off the loan in time, the lender has the authority to seize the pledged collateral and sell it to collect the debt. A secured promissory note may also include a security agreement as one of its terms.

You’re likely to find the following details in a general security agreement:

• The debtor representation
• Warranties and covenants
• A description of collateral
• Terms and conditions
• Enforcement rights in the event of defaults

Such an agreement can secure most types of personal properties, including machinery, inventory, accounts receivable, trademarks, stocks, and bonds.

Contract of Guarantee (if applicable)

For a high level of assurance, lenders often require a guarantor (an individual) to pledge their personal assets to repay the loan if the borrower defaults. This is outlined in a closing document under a contract of guarantee. Section 126 of the Indian Contract Act 1872 defines the Contract of Guarantee as a contract to perform the promise or discharge the liability of a third person in case of his default. So, there are three parties involved under the contract of guarantee:

• Principal debtor: one who accepts the loan
• Creditor: one who grants the loan
• Surety: one who gives a guarantee of debt on behalf of the principal debtor to the creditor

This type of agreement inks deals between:

• Principal debtor and creditor
• Creditor and surety
• Surety and principal debtor

It is also termed as a tri-party agreement.

UCC Financing Statements (for filing a lien on business assets)

A UCC (Uniform Commercial Code-1) statement is a public document filed by lenders to announce a legal claim on the borrower’s business assets listed in the agreement if the borrower defaults on business loans extended by the lender. There is a special section of the law under Article 9 of the Uniform Commercial Code that requires UCC-1s for most business loans. These filings show details about the borrower and what they are putting up as collateral, such as, buildings, vehicles, equipment, inventory, or even stocks.

These notices are typically published in local newspapers to alert potential future creditors of the existing loan. The document helps determine who gets paid first if the borrower defaults on multiple loans.

Deeds of Trust/Mortgages (for loans involving real estate)

A deed of trust (also known as a trust deed) is generally used in real estate financial transactions to transfer the legal ownership of a property to a 3rd party (trustee), such as a financial institution or an escrow company, who holds it as collateral for promissory notes. As long as the borrower keeps up with their payments, the trustee eventually transfers the ownership title to the borrower completely. If the borrower defaults, the trustee claims the legal ownership of the property.

Deeds of trust often get confused with mortgages. Though both are utilized to create liens on real estate, both are different in a couple of ways. They both have different foreclosure processes and involve different numbers of parties. A mortgage is signed between a borrower and a lender, whereas a trust deed involves a trustee as an additional party.

Insurance documentation (proof of required business insurance)

The lender may require proof of specific business insurance policies to protect against potential losses. In this regard, the insurance company issues a Certificate of Insurance (COI) to the borrower that verifies the existence of insurance coverage and describes the conditions of the policy. Typically, a standard COI covers the following details:

• Name of the policyholder
• The effective date of the policy
• The coverage type
• Policy limits
• Other policy details

A COI comes into the picture where liability and significant losses are of concern, such as in real-estate businesses where contractors stay reliable for damage, injury, or substandard work. Without a COI, the contractor may find it difficult to obtain a business loan from the lender.

Resolutions (for corporations or LLCs)

If your company has a board of directors, a formal resolution documents their approval to borrow the business loan. In short, it verifies the company’s authorization for the loan. Though it is not mandatory by law, its presence in the closing documents strengthens corporate governance and record-keeping. The document typically highlights the loan amount, purpose of the loan, and the lender details. Resolutions highlight that the board has the authority to take on the debt and act in the best interest of the company.

End Thoughts

Closing documents are your final hurdle before your business loan funds are released. These documents hold significant importance in terms of your loan agreement. Therefore, it is imperative to review all documents carefully without skimming files in the signing frenzy. Unless you are opting for a digital loan from a streamlined platform like Protium, loan closings can be bogged down by mountains of paperwork and the potential for human error. Ensure everything aligns with the negotiated terms. If you come across any unfamiliar clause or legalese, do not hesitate to ask for clarification with your loan officer. After all, a thorough understanding is the key to avoiding unwanted surprises down the road. 

FAQs

1.    Can I negotiate the terms at closing?

Generally, all negotiations typically take place beforehand. So, there is hardly any chance for negotiation during the closing. However, you can address any errors you find in the documents before signing.

2.    What happens after I sign the closing documents?

Once you sign the documents, funds are disbursed to you from the lender and the agreed-upon terms take effect. It is imperative to maintain the copies of your closing documents for future records.

3.    What if I find errors in the closing documents?

Don’t sign! Point out any mistakes or inconsistencies to your loan officer and have them corrected before proceeding further.

4.    How long does the closing process take?

There is no exact timeframe. It can vary depending on loan complexity and lender procedures. Typically, the process usually spans from a few days to several weeks.