Banking/Finance Contracts
The execution of banking & finance agreements is essential to protect the interest of the transacting parties as it is a measure taken to reduce the risk associate with lending/investing money. A banking & Financial agreement records the terms and conditions according to which a loan or investment is being made and how the amount will be returned to the lender. It also protects the lender against any default in repayment.
The terms and conditions can be recorded by executing (i) Hypothecation Agreement (ii) Letter of Continuity (iii) Letter of Guarantee (iv) Loan Agreement or any other Banking/Finance related agreement.
(i) Hypothecation Agreement
It is an agreement between a borrower and a lender where by the borrower pledges assets as collateral on a loan without the lender taking possession of the collateral. It especially applies to mortgages; the borrower hypothecates
when he/she pledges the house as collateral for payment of the mortgage, or he/she may hypothecate the mortgage in order to borrow against the value of the house. In both situations, the borrower retains possession of the house, but the lender has the right to take possession if the borrower does not service the debt. Hypothecation agreements also occur in trading; a broker will allow an investor to borrow money in order to purchase securities with those securities as collateral. The investor owns the securities, but the broker may take them if the debt is not serviced or if the value of the securities falls below a certain level.
So, a hypothecation agreement is an agreement that pledges the customers securities that are purchased on margin as collateral for the loan. The hypothecation agreement also allows the brokerage firm to take the same securities and re-pledge or re-hypothecate them as collateral for a loan at a bank to obtain a loan for the customer.
(ii) Letter of Continuity
Letter of Continuity means the letter of continuity to be delivered by the Borrower to the Lender, in the form set out in Schedule 3 hereto pursuant to the terms of this Agreement as continuing security to the Lender for all Obligations or part thereof then due
A letter of continuity is a legal document that is signed by the borrower before the loan amount is disbursed to him.
It is an acknowledgment by the borrower that the balance loan amount would continue until it is completely paid off.
(iii) Letter of Guarantee
A letter of guarantee is a type of contract issued by a bank on behalf of a customer who has entered a contract to purchase goods from a supplier. The letter of guarantee lets the supplier know that they will be paid, even if the customer of the bank defaults. To get a letter of guarantee, the customer will need to apply for it, similar to a loan. If the bank is comfortable with the risk, they will back the customer with the letter, for an annual fee.
A letter of guarantee may also be issued by a bank on behalf of a call writer guaranteeing that the writer owns the underlying asset and that the bank will deliver the underlying securities should the call be exercised. Call writers will often use a letter of guarantee when the underlying asset of a call option is not held in their brokerage account.
Basics of Letter of Guarantee
Letters of guarantee are often used when one party in a transaction is uncertain that the other party involved can meet their financial obligation. This is especially common with purchases of costly equipment or other property. However, a letter of guarantee may not cover the whole amount of the debt. For example, a letter of guarantee in a bond issue may promise either interest or principal repayment, but not both.
The bank will negotiate how much they will cover with their client. Banks charge an annual amount for this service, which is typically a percentage of how much the bank may owe if their client defaults.
Letters of guarantee are used in a wide variety of business situations. These include contracting and construction, financing from a financial institution, or declarations during export and import processes.
(iv) Loan Agreement
A loan agreement is a contract between a borrower and a lender which regulates the mutual promises made by each party. There are many types of loan agreements, including "facilities agreements," "revolvers," "term loans," "working capital loans." Loan agreements are documented via a compilation of the various mutual promises made by the involved parties.
Prior to entering into a loan agreement, the "borrower" first makes representations about his affairs surrounding his character, creditworthiness, cashflow, and any collateral that he may have available to pledge as security for a loan. These representations are taken into consideration and the lender then determines under what conditions (terms), if any, they are prepared to advance money.
Loan agreements, like any contract, reflect an "offer," the "acceptance of the offer," "consideration," and can only involve situations that are "legal" (a term loan agreement involving heroin drug sales is not "legal"). Loan agreements are documented via their commitment letters, agreements that reflect the understandings reached between the involved parties, a promissory note, and a collateral agreement (such as a mortgage or a personal guarantee). Loan agreements offered by regulated banks are different from those that are offered by finance companies in that banks receive a "banking charter" granted as a privilege and involving the "public trust."
Loan agreements are usually in written form, but there is no legal reason why a loan agreement cannot be a purely oral contract (although oral agreements are more difficult to enforce).