Overview of Wire Drawdown Agreements
Wire drawdown agreements are agreements between clients or other parties ("Drawdower") and a bank or financial institution ("Bank") to transfer funds from an overdraft facility (of the Drawdower with the Bank) or a line of credit (issued by the Bank to the Drawdower) to the account of a person other than the Drawdower through the payment instruction of the Drawdower. The agreement records in writing the understanding between the parties that the Bank will honour payment instructions from the Drawdower for payments made from the Drawdower’s bank account to parties other than the Drawdower (known as the "Third Parties"). The agreement requires that the Drawdower must be able to introduce funds into the overdraft facility or line of credit, as these funds will be used by the Bank, upon its discretion, to honour the Drawdower’s payment instructions. A wire drawdown agreement will be comprehensive and will set out procedures for effecting payments , including specifying the information the Drawdower must provide to the Bank when given delivery instructions. A wire drawdown agreement is used when the Drawdower wants to make payments without having funds actually available in the Drawdower’s transaction account. A wire drawdown agreement is usually entered into by a Drawdower who has funds available to pay Third Parties in an offshore account (as an offshore account usually does not have any infrastructure (i.e. Account number, beneficiary, etc.) in place other than its bank account, interest on deposits typically is lower than with its onshore bank account, funds can only be accessed while the Drawdower is present in the country where the offshore bank is located, etc.). Accordingly, having a wire drawdown agreement will allow the Drawdower to use its funds in their offshore accounts to make payments to Third Parties without having to transfer the funds to its onshore bank account.
Elements of a Wire Drawdown Agreement
A wire drawdown agreement should contain language that sets forth who the lender is and what conditions must be met in order to disburse proceeds. This includes such requirements as that the buyer has not terminated the real estate purchase agreement and that there are no pending liens, judgments or other encumbrances that are not being satisfied at closing. The seller also should be required to provide a certificate stating the representations and warranties set forth in the loan documents remain true and correct at the time of disbursement. There may be an affidavit that states that no undisclosed or off-balance sheet liabilities exist. In addition, in the case of a corporate borrower, the lender usually will want to see a bylaw certificate.
Other important provisions will typically include terms of payment, such as the interest rate and timing of payment, and repayment terms, including potential penalties. The loan will specify whether the loan is secured or unsecured, and in what way. In the event of default, there may be language regarding a right to charge default interest.
Attorneys should be mindful of the right-to-cure provisions, which are typically written into the loan document and often apply for both defaults that are subject to waiver and for those that are not. Generally, in the case of an uncured default that relates to the failure to comply with a specific term or covenant, a lender can immediately declare a default or provide the borrower with a notice of default and a specific time period (usually 30 days) to cure or remedy the default. When a default is cured, the lender will then notify the borrower that the loan remains in good standing and the original terms of the loan apply. If the borrower does not cure the default in time, the lender may immediately declare the note and security instrument due and payable.
However, if the default is significant (may trigger acceleration upon the happening of a certain event) or involves the borrower filing for bankruptcy, the right-to-cure provisions may not apply. In this case, the lender may just declare the note and security instrument due and payable and proceed with foreclosure. If the borrower is a business, the lender may not wait until the borrower defaults before selling the collateral to pay off its debt as it would under the terms of a right-to-cure provision.
All parties involved in the transaction should review the wire drawdown agreement carefully as all closing requirements are enumerated within, which can help avoid any potential surprises at closing.
Legal and Regulatory Aspects
In order for the Seller to be able to draw down on the buyer’s pre-paid funds, the buyer must first send a wire transfer notification to the bank or other financial institution (an "Agent") that is holding the buyer’s funds (a "Drawdown Notice"). The Agent must then verify the Seller’s right to the funds in accordance with the proper instructions contained in the Drawdown Notice. Assuming that the Agent can do this, the Seller may then withdraw funds from the account.
The Agent, however, can be liable for paying out funds to the wrong party, which in turn, opens up a potential causes of action against the buyer for breach of contract, and/or an action against the Agent to recover from the Seller. Therefore, parties to wire drawdown agreements should ensure that their counsel become involved at the outset when negotiating the agreement itself (particularly the details of the manner in which funds are to be disbursed), and, subsequently, when advising on the proper procedures for drawing down on the accounts.
Advantages of Wire Drawdown Agreements
The use of wire drawdown agreements may not be as common as one might think considering the tight regulations associated with bank loans. To the uninitiated, wire drawdown agreements are agreements between lenders and borrowers where the borrower agrees that the lender may transfer all or a portion of the funds in a deposit account maintained by the borrower to repay any loan held by the lender in the event of a default. These agreements benefit both lenders and borrowers because they allow for the pre-approval from borrowers to conduct wire transfers which makes cash flow management easier. It may also allow a lender to provide a borrower with flexibility to withdraw funds in instances where the lender may have a first priority lien or assignment over the deposits within the account. In other instances where bank fees may apply to wire transfers, the fees may be reduced when the borrower pre-authorizes such transfers on a recurring basis. An example of a recurring transfer may be monthly payment to a landlord. These incremental reductions in fees may be advantageous.
Potential Risks and Mitigation Strategies
There are several common risks associated with wire drawdown agreements. For one, wire drawdown agreements do not create a lien on the colat that is replaced by the proceeds delivered to the bank. As noted above, when funding via wire transfers, more often than not the bank is not creating a replacement lien on the deposited funds automatically, except when a bank so expressly provides for it in its wire agreement or under applicable articles of the UCC. Although some banks do provide language to aid in this protection, banks are cautioned that such language by the bank may infer an adverse determination by a court or a judge that the wire drawdown agreement creates a secured loan under applicable rules of the UCC or the applicable provision of the bankruptcy code. Additionally , a bank may be exposing itself to liability from the creditor of its borrower by lending to its borrower the proceeds of a wire transfer if the bank does not have either a secured lien on the colat which is intended to be replaced, or the right to receive the previously-determined replacement lien on the deposited funds. The burden is an especially heavy one on banks who have not previously reviewed their wire drawdown agreements.
In order to mitigate these risks, banks should review their agreements and modify those drawdown agreements as necessary to protect against the above-stated risks and any other risks to which the bank may be exposed as a lender in a nonconventional lending transaction.
Negotiation Insights for Wire Drawdown Agreements
Parties can maximize the certainty and protections granted under wire drawdown agreements by carefully considering a number of issues during negotiations. The following identifies a few key areas that parties should evaluate when negotiating their respective wire drawdown terms: In any event, determination of whether to extend short term draws will depend largely on specific transaction and borrower needs, as well as lender risk tolerances. It is important that the lender and borrower carefully evaluate in advance the manner in which the flexibility provisions will be utilized so as to provide the parties with the best balance of flexibility and lender protections. Many flexibility provisions are granted by the lender to allow for unsecured draws in circumstances when the transaction does not strictly comply with the requirements for borrowing under secured provisions. Thus, if a deal warrants a consistently non-strict approach in enforcing conditions precedent, it may warrant negotiating a separate unsecured set of provisions with appropriately protective terms. Alternatively, if a borrower has a high level of certainty concerning the timing and structure of its transactions and wants to avoid potential challenges from lenders to unsecured draws, this may warrant stronger restrictive language than is typically included in unsecured draw provisions.
Examples and Practical Scenarios
To further illustrate the use of wire drawdown agreements, consider the following scenarios:
- Technology Company A is in desperate need of funds to bring its software product to market. A venture capital firm, Venture Capitalist B, agrees to invest $5 million in a pre-IPO round, but wants an assurance of a guaranteed exit. The company and Venture Capitalist B reach a compromise and decide to adopt a wire drawdown agreement, whereby the investment will only be released upon the completion of the IPO at an agreed level of stock price achievement. The IPO is completed within 12 months post-investment at the IPO price of $20 per share.
- Metal Industry Company C, a local producer of industrial metal components, is requiring working capital in order to gear up for a government contract that it can’t afford to wait for to generate returns. Steel manufacturer, Steel Manufacturer D, a new entry in the metal industry, commits to invest $5mm in Metal Industry Company C. But Metal Industry Company C agrees to grant Steel Manufacturer D the rights of first refusal on all its tenders going forward, to be priced against the lowest bid. In essence, Steel Manufacturer D is hedging on the project that Metal Industry Company C cannot afford to lose and Metal Industry Company C is getting the much needed working capital with practically no strings attached.
- Construction Company E has laid its hands on a new property construction project worth $25mm. It has already invested $4mm in land acquisition and has undertaken a documented budget for the entire project. Because Construction Company E is unable to raise short term financing for the remaining amount, it is considering invoking a wire drawdown agreement in which the investor is also a buyer of its finished product and has requested an upfront deposit against undelivered products. The investor is seeking a minimum IRR of 20%.
Conclusion: Wire Drawdown Agreement Suitability
The above identifiers may quickly help to determine whether a wire drawdown agreement is right for you. Analysis should, however, extend into whether the transaction is subject to the Bank Holding Company Act, which is a federal law applicable to certain financial institutions. For example, if the money being borrowed will be used to fund your mortgage on a residence, it could be possible that qualifying for a consumer loan rather than a commercial loan may provide a better overall deal for you , the consumer.
Suppose the transaction is not subject to the BHC Act. The nature of the transaction must be understood. For example, where the drawing is to fund an acquisition, it may be appropriate or even desirable to be secured, without an Australian style mortgage. This negotiation largely depends upon what you, as a borrower, believe you can afford.
With the above considerations in mind, you should have a solid understand of the appropriate use of a wire drawdown agreement, how it can be applied to your situation, who you may be able to trust to help you.