Covenants: Make them work for you … or else!
Oct 13th, 2011 | By Ernie Brown | Category: UncategorizedWhen a staffing company said they were talking to two other factoring companies about working capital and were all confused by the contracts why should it come as a surprise?
A necessary ‘evil’ in all contracts are called COVENANTS. These little devils, sometimes inserted in a seemingly harmless manner, can have the teeth of a piranha and the aggression of a female bear protecting her cubs.
Many a borrower can tell you about these if they’ve violated them … so what is to be done? As negative as these sound the reality is that covenants create warning signs and/or limits as indicators that a borrower/client’s financial position is changing and whose intention is to allow the lender/funder to begin corrective action early on … if they choose to. Sadly … a lender/funder can also come down hard on their client if they choose to.
Covenants are also put in there to ensure that a borrower doesn’t run amock and jeopardize being able to pay back a lender/funder … but some will say that they are there to entrap a borrower and nothing less!
Most of us are familiar with what credit card covenants i.e. if you pay a few days late or a day late twice in six months and your rate can go from 9% to 29% … plus late fees. These are covenants … therefore …
RULE NO. 1: NEVER SIGN A CONTRACT WITHOUT READING IT AND UNDERSTANDING IT!
RULE NO. 2: MANY THINGS IN A CONTRACT ARE NEGOTIABLE UNLESS IT JEOPARDIZES THE FUNDER’S OR LENDER’S COLLATERAL POSITION. REMEMBER: THEY WITH THE GOLD MAKE THE RULES …
RULE NO. 3: IF YOU DON’T ASK YOU WON’T GET … AND WHAT YOU DON’T KNOW CAN – OR MIGHT – HURT YOU.
That said we offer invoice factoring so I asked the owners of the company I was working with what they had learned thus far. They had a minimal handle on the process as in only what they had been told … so I referred them to some materials and information so they could educate themselves fully. Why? The success of their company depends on this … and then came their feedback … and perceptions … and where the confusion was coming from.
Terms such as …
- Advance Rates … were these guaranteed or conditional?
- Concentration Limits … was any one customer too powerful?
- Return of Reserves … what was the obligation of the funder to send monies back when an invoice was paid?
- Late payment schedule … were there penalties if a customer paid late?
- And others …
were in all of the contracts but described differently and even appeared multiple times … so what does one do? Read carefully … and get it explained to your satisfaction!!!
The contract ? In reality a contract should be simple in format and easy to read so that most anyone can comprehend what it says or doesn’t say. It should also have things flow together so that you don’t have to chase information in several parts of the contract either. If it’s more complicated than that the odds are someone is trying to hide something so buyer beware! This is never to say that there won’t be a few terms or conditions that need to be clarified but it does mean that a document should not be written in a way that is confusing, misleading, or worst of all: Hiding something!
A good guideline is that anything in a contract that pertains to collateral, timeliness of payments, and/or process is a great opportunity for a covenant to tie back to it. In executing any agreement ensure that …
- The operating relationship is clearly defined as in “Here is what we’ll do and here is what you are going to do until we (the lender/funder) are paid back” … Works for me!
- If the borrower gets cute (I use this terminology vs. saying: INTENTIONALLY VIOLATES THE TERMS OF THE AGREEMENT as in tries to cheat the lender/funder etc.) the contract should spell out what the lender/funder can and/or cannot do to protect their position.
- If something changes with the financial status of the borrower/client the actions and/or limits of the actions a lender/funder can make needs to be clearly stated.
- A lender/funder should be happy, if not proud, to go over the terms of their agreements … and if they aren’t then our advice is to watch out!
In closing: Remember that your business depends on you making the right decision and the devil may be in the details but make sure you understand what you are signing and if not make sure it’s explained thoroughly!
My best to you in Health, Happiness, and Prosperity!
Ernie Brown Ph: 1-978-256-8634
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