The Break Clause
A ‘break clause’, ‘renegotiation clause’ or ‘interim review clause’ are all the same thing. Generally they are a fairly well hidden clause in most commercial term loan agreements.
The break clause allows the borrower and lender to renegotiate the terms of the borrowing at set anniversaries of the loan. It doesn’t matter whether you have made all the loan repayments or not, the clause still applies.
The reason most companies don’t realise these clauses exist is down to how they are now perceived, let me expand.
The Balance of Power Change
Roll the clock back to the 1990’s and the power within most lender/borrower relationships in the commercial world sat with the borrower. There was a competitive market, high loan to value mortgages and lenders competing on price with each other.
At this time many companies could get a comparative offer from another bank or lender, then return to their lender and negotiate a better deal.
Break clauses at this time were something that lenders would rather avoid discussing in depth, in other words the lender didn’t want to have a compulsory renegotiation date as that normally meant pitching for the business all over again. I can sort of understand that.
In the last 10 years the picture has changed. We have gone from an era of seriously low borrowing rates to an era of less competition between lenders and a shift in the balance of power toward the lender. This has coincided with some borrowers having low interest loans with the lender advancing new loans at a much higher rate of interest.
The break clause has gone from a period of risk for the lender to a period of opportunity.
The Unknown Factor
Most lenders are upfront about the clauses and covenants relating to any loan. This doesn’t mean that the borrower is really listening though. Most break clauses kick in around the 5th anniversary of a loan, then again at 3 or 5 yearly intervals thereafter.
What this means for many businesses is that those break clauses on low interest loans are starting to fall due, which means a renegotiation at a time when base rates may be inching upwards.
What To Do
The first thing to do is read your loan agreement. If you cannot find it then contact your lender and ask for a copy. Check the agreement and look for any wording which relates to a renegotiation. Not all loans have them, but for many banks they have been a standard criteria for some time.
If you are not sure if there is such a clause in your agreement then get in touch, I can read the agreement and let you know whether there is a clause in there or not.
Most banks and lenders are pretty reasonable when it comes to renegotiating on interest rates, there is often a ceiling to where the rate can go, however even a 1% rise in the cost of your loan is a far bigger impact than base rate creeping up. Just know what could happen and be prepared.
By Dave Farmer