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2.4.1 Analysis of the Transaction and Term Sheet

Generally speaking, the information exchanged between the bank and the borrower during the initial stages of negotiations will contain the following information:

• a description of the project's sponsors;

• an illustration of the structure of the company applying for the loan;

• the project business plan, setting out in particular the deadlines for the various project stages along with economic and financial projections, including pro forma accounts, cost forecasts, the project's capital structure, and the cash flows generated through it.

In some cases, especially where the sponsor is assisted by a financial advisor, an information memorandum will be presented. This is a single document setting out the details of the real estate project to be financed along with the project's sponsors and a working proposal for its capital structure. In other cases, especially where it is necessary to involve more than one bank in the project, the sponsor will ask the bank itself to draw up this document in order to carry out a preliminary review of the bankability of the project.

This stage is extremely important, since it is vital that the project is presented in such a way that enables the bank to understand the characteristics of the real estate project in terms of revenues, costs, cash flows, and risks. This will make it possible to verify whether the underlying assumptions presented by the prospective borrower are tenable. In other words, when disbursing a structured loan, the bank will carry out an analysis which is very similar to that carried out by an equity investor when investing in a real estate project.

During the first meeting with the bank, the borrower will generally present the structure of the transaction and the amount of the loan requested. He may also ask the bank to draw up a document before a particular date setting out the main terms and conditions of the loan with a view to initiating formal negotiations. This document is referred to as the “term sheet'' and it is used by the parties in order to conduct negotiations on the main terms and conditions of the loan. It is updated when the real estate project is finalized and during the loan negotiations. Essentially, this document summarizes all of the terms and conditions, the parties involved, the contracts to be signed and the guarantees to be provided, as well as the deadlines for concluding the transaction. The document also specifies:

• the parties which will sign the subsequent loan agreement and their roles;

• the amount and term of the loan; if the amount is not approved in advance the amount is to be capped at the lowest of either:

• specific amount;

• specific max % of LTV and/or min ICR and/or min DSCR;[1]

• specific % of the purchase price/construction costs (loan to cost);

• the purpose of the loan;

• the property description;

• the forms and procedures regulating the drawdown and the repayment of the loan;

• the determination of the applicable interest rates, margin, and fees that will be paid to the bank arranging the loan (also called the arranger) and/or to the other participating banks when a pool financing is organized;

• the interest hedge (in case of variable interest);

• the repayment;

• the interest period;

• the security package to be issued;

• the main rights and obligations of the parties, and any special terms, condition precedent, and conditions required by the concession or the nature of the construction work planned;

• the covenants which will be required upon conclusion of the agreement;

• the temporary limitation of the term sheet;

• the representations and warranties;

• events of default;

• any other terms and conditions which must be complied with in order to obtain the approval of the bank and the drawdown of the loan;

• choice of law/jurisdiction.

Due to its characteristics and to the high level of detail in the conditions which the term sheet may contain, the problem arises as to whether it amounts to a genuine preliminary agreement or, instead, to a non-contractual undertaking, namely a pre-contractual act intended to “crystallize” the state of negotiations or the preliminary agreements reached, thereby facilitating the conclusion of the overall agreement. The settled view is that the term sheet is a pre-contractual act which is as such capable of establishing a pre-contractual liability and an obligation to compensate damage as protection for the legitimate expectation created for the counterparty.

In fact, although the contents of the term sheet may differ significantly and be more or less binding depending upon the level of agreement that has been reached, the parties themselves usually wish to specify that the term sheet does not have the status of a preliminary agreement by including explicit clauses to that effect. The efficacy of the term sheet is generally conditional upon the subsequent approval of the conditions contained in it by the credit committee of the parties involved. Generally speaking, the bank will include a clause at the end of the term sheet stating that.

“The term sheet constitutes only a draft outline of the terms and conditions on which the bank would be prepared to consider making available a facility and is in no way to be construed as an offer or commitment to provide finance. Any decision regarding the provision of finance requires the approval of the lender's credit committee.

In this way (no binding offer) the term sheet is not considered (in most jurisdictions) an offer which already leads to a requirement to allocate equity on the side of the lender.

The above applies unless the borrower requests a binding commitment, that is an irrevocable proposal corresponding to a binding commitment by the bank (which is generally requested when the loan has been negotiated with various banks in competition with one another, following a kind of tender procedure conducted by the project's sponsor). In such cases the bank will have to take a specific decision to authorize the signature of the term sheet.

The term sheet may be drawn up during different stages of the loan negotiations:

(a) during a preliminary stage, if the borrower requests an offer from more than one bank:

(i) in this case the borrower will attend the first meeting with the bank with an information memorandum containing a detailed analysis of the real estate project and its financial requirements;

(ii) interested banks will formulate their offer before a predetermined date on the basis of the data contained in the information memorandum, specifying that the subsequent approval of the loan will be conditional, inter alia, on the verification of the accuracy and validity of the information contained in the memorandum, which will be carried out by the bank's analysis team;

(iii) the tenn sheet will be signed by the borrower and the bank which has made the best overall offer;

(b) during an advanced stage of negotiations: in this case, the bank may request the costs of the due diligence to be paid up-front on a preliminary basis, regardless of whether it actually decides to grant the loan.

Though it does facilitate the parties' negotiations, the signature of the term sheet is not essential in order to conclude a financing agreement.

  • [1] Loan to Value Ratio (LTV), Interest Cover Ratio (ICR), and Debt Service Cover Ratio (DSCR) are financial covenants; for a complete description please refer to paragraph 3.15.2.
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