Let's talk law: Rural lending and all those funny words

Since mid-2019, credit for dairy and beef and sheep farming borrowers has been much more difficult to obtain. Photo / Bevan Conley

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GSA, DOPAS, priority amounts, undrawn facility fee, negative pledge, establishment fee, CARL facility, preapproved equipment finance facilities... these are just some of the abbreviations and terms used by rural lenders.

Both their application and meaning often confuse borrowers, guarantors, accountants and even lawyers. Often clients are sent a loan offer letter from their banking relationship manager and are happy to sign the offer after only reviewing the amount of the loan and the interest rate. Sometimes the devil is in the detail.

Since mid-2019, credit for dairy and beef and sheep borrowers has been much more difficult to obtain. Anecdotally there have been reports of the tap being "turned off" at some rural lenders with either a hiring freeze or restructuring or both. This has resulted in some banks losing market share and other banks picking up market share (such as Rabobank).

What this has meant for borrowers is that there hasn't been as much competition for their borrowing and potential purchasers of rural property are struggling to get pre-approval before auctions.

Anecdotally too, we are hearing that people are turning up to rural auctions hoping that the property will pass in so that then they will then be able to negotiate a conditional offer with the vendor. In these uncertain times it pays to be aware what you are signing up to when you do finally get credit approval.

Banks naturally takes a mortgage over your property. A mortgage is different to a loan agreement – the mortgage secures the loan whereas the loan agreement is for how much you are borrowing, and at what interest rate.

If you do not pay what is required pursuant to the loan agreement, the mortgage kicks in. If there is a second mortgage (often a family vendor loan where parents are keeping money in), this will always be second in priority behind the bank.

What this means is that either lender can exercise their power of sale (mortgagee sale), but a second mortgagee needs to pay the first mortgagee (up to its priority amount) from the sale proceeds before taking its money.

Nearly every mortgage has what is known as a "priority amount" – this is applicable where there are two mortgages. The priority amount is how much the first mortgagee has blocked out for its benefit. From that amount onwards, the second mortgagee will kick in.

Family mortgages are commonly used in farm successions and the parents giving a vendor loan are often required to sign a deed of postponement or a deed of priority and subordination (the above DOPAS).

This can often be confusing for the parents, but it is a key part of the bank's consideration of the succeeding child's equity position and/or cashflow. The deed of postponement might say that the succeeding child shall not pay the parents' debt until he or she has paid the bank debt.

Alternatively, that might say that the succeeding child shall not pay any of the parents' debt if such payment would result in a breach of the bank's debt. They might say that the succeeding child may pay interest but no principal.

This is important for parents when assessing how much income they will receive upon transfer of the farm.

Banks often also take what is known as a General Security Agreement. This is similar to what used to be known as a stock mortgage.

A bank will take a charge over all present and afteracquired property of the borrower – this is everything the borrower owns at the moment and everything that will own in the future, with the exception that it does not apply to real estate.

Banks will also often require personal guarantees from directors of a farming company.

Sometimes people wonder what the point of them are if the directors have no personal assets because the company or family trust owns them.

Banks will require them for several reasons but two common reasons are that the guarantee will capture any introduced capital into the company (i.e. shareholder loans) and reputational – most people don't like being made bankrupt.

A negative pledge is a common stipulation that a borrower shall not further encumber the bank security. For example, the bank has taken over your charge of stock and you go and borrow more money from a stock lender who then takes a charge over the purchased stock.

That would be in breach of a standard negative pledge to a bank. A more restrictive negative pledge is where a borrower says he or she will not borrow any more money from anybody unless the lender agrees.

One item that often catches borrowers out is the establishment fee. This is a fee charged by the bank in order to take out the loan. This can often be 1 per cent of the loan amount but is often between $300 and $500.

This will be simply added to the amount outstanding on the day of drawdown. Some banks will also charge an un-drawn facility fee on their revolving credit facilities/overdrafts.

If, for example, you are offered a $400,000 overdraft but yet you only use $50,000, you will be charged a fee on the undrawn $350,000. This fee might be in the order of 0.25 per cent. In the example given, this amounts to $875 per year.

This may be a scary number for some people when they think that they're not even borrowing much money.

Borrowing money is an integral part of farming life and everybody involved should pay attention to all of their obligations - no matter how big or small.