Introduction
As the requirements of the Corporate Transparency Act (“CTA”) phase in to cover companies in 2024 and 2025, many borrowers and guarantors will have new reporting obligations with stiff penalties for non-compliance. These penalties could pose risks to lenders, but through proper planning and procedures, the penalties are avoidable. Lenders have traditionally managed risk through a combination of underwriting, legal documentation, and relationship management. Handled properly, each of these avenues is an opportunity to reduce risk and improve client service.
Diligence and Underwriting
Early in a potential commercial lending transaction, lenders verify the ownership of their borrowers and guarantors. Certain covered financial institutions, and specifically banks, are subject to the Beneficial Ownership Rule1 and are required to obtain ownership information and evidence on their customers. Non-bank lenders are generally exempted from the Beneficial Ownership regulations2 but will typically have much of the underlying information from diligence.
The diligence or underwriting stage is the first and best opportunity for a lender to assist a potential client with CTA compliance. Because both bank and non-bank lenders are running a parallel process in underwriting or diligence where most of the relevant information is available, this is an opportune time to ensure clients are in compliance. Lenders can help clients by ensuring compliance at this stage, where clients are already having to produce entity and personal information in connection with the lending transaction. Lenders also help themselves at this stage by protecting themselves from lending to a client who has financial or criminal risk.
Loan Documents
As the parties draft and negotiate loan documents, lenders have another opportunity to both protect clients and help themselves. Loan documents drafted prior to CTA and perhaps even those in use today will be silent on CTA. However, lenders looking at their standard form documents will likely find several relevant provisions3. Most of these relevant provisions will address CTA only indirectly and may not adequately protect a lender. For example, a compliance with laws covenant may have a materiality or material adverse effect qualifier, which could put a lender in the unenviable position of arguing the gravity of CTA non-compliance.
Lenders should consult with their counsel and consider revising their forms to specifically address CTA. This could take the form of a new affirmative covenant including requirements that clients (i) timely make any CTA required filings or updates, (ii) provide copies of these filings, and/or certificate compliance, to the lender, (iii) promptly pay and remedy and penalties, and (iv) include a catch-all for further actions and documents requested by the lender to ensure the client’s CTA compliance. This affirmative covenant could be accompanied by a corresponding representation and default provision. These are suggestions not tailored to any specific lender or borrower, and lenders and borrowers should consult with their own counsel to determine the best path forward.
These proposed CTA loan agreement provisions have a dual benefit: they protect both lenders and their borrowers. Although borrowers generally favor fewer obligations to their lenders, they are aligned with lenders in needing to ensure CTA compliance. The penalties for CTA non-compliance are potentially extreme, so the relative weight of an additional compliance obligation may be seen as minimal. This analysis will differ based on the particular borrower and lender.
For relationships with pre-existing documents, lenders can document these in amendments or certificates and should consider including these provisions in connection with larger amendments or amendments and restatements. Less formally, most loan agreements will generally permit lenders to request that their existing borrowers and guarantors are in complying with or will comply with CTA. By helping clients, lenders help themselves.
Conclusion
Lenders should carefully review their due diligence and underwriting procedures to ensure that CTA compliance is included in the analysis. Further, lenders should examine their existing form documents and documents for each relationship to ensure CTA coverage or understand which amendments or modifications are needed. Lenders and borrowers are aligned in needing to ensure CTA compliance, and a proactive lender will be well positioned to help its clients as CTA coverage expands in 2024 and 2025. If you need assistance or have questions, we encourage you to contact us at Shields Legal Group.
1 31 CFR 1010.230
2 31 CFR 1010.230
3 A few examples often in credit agreements are covenants covering compliance with laws, beneficial ownership, and further assurances and corresponding representations and default provisions. Lenders should carefully review their forms with counsel given the myriad forms and variations.
