Philip Jones, a finance lawyer, and Alan Margolis, Head of Bridging Finance at United Trust Bank, consider the merits of bridging finance, a growing form of funding.
The use of bridging finance has become more widespread in recent years such that it is now regarded as part of the mainstream of financial products. Despite this growth it remains less well-known than other forms of finance, and is not always considered in circumstances where it may be appropriate.
Philip Jones, a Consultant Solicitor with Keystone Law, and Alan Margolis, Head of Bridging Finance at United Trust Bank, consider some advantages and disadvantages of bridging finance and outline some of the issues which are relevant to this form of funding.
Uses of bridging finance
Traditionally bridging finance has been used in the property sector to enable prospective buyers of property, usually residential but also commercial, to take advantage of short-term opportunities. In the domestic market, the classic example would involve someone wishing to buy a new property before they had sold their current property and received the sale proceeds. However, in more recent times the range of circumstances in which bridging finance is being used has significantly expanded.
Alan Margolis has seen bridging finance used in a range of situations including where the structures have involved combinations of personal borrowers, companies (both off shore and onshore) and trusts. Examples include:
- bespoke short term finance solutions allowing customers to refinance away from mainstream lenders, with portfolios comprising residential and commercial property where the existing loan term had expired or was about to expire. The bridging facility enabled customers to avoid default and incurring additional bank charges, as well providing the customer with a breathing space to refinance or sell all, or part, of their portfolio;
- facilitating the purchase of shares in a joint venture where a substantial deposit had already been paid and the customer’s main concern was the preservation of their relationship with the joint venture partner, as well as the risk of forfeiting their deposit;
- where developers having completed a development but, prior to achieving sufficient sales, wished to repay their development finance in order to release equity from the development for their next project;
- the use of a development site to anchor a facility, allowing the developer to draw funds as required from a pre-agreed facility; or
- in corporate transactions where short-term funding, raised against the assets of a business or a director’s personal assets, is part of a plan to obtain longer term financing.
Consideration of finance terms
Whilst bridging finance can be appropriate in a range of situations, as with any finance product, it should be used carefully.
Philip Jones says “Bridging finance can be an extremely useful form of funding enabling short-term opportunities to be realised. However, a prospective borrower must make a realistic assessment of the cost and terms of any bridging facility and of their ability to refinance it within a suitable timescale”.
Despite the short term nature of bridging facilities, borrowers must still examine the proposed terms to the same level of detail as with other types of funding. For example, you need to consider:
This may include:
- a monthly rate of interest;
- an arrangement fee;
- a prepayment or exit fee, which may include a redemption administration fee, if the loan is repaid earlier than the proposed final repayment date;
- costs of professional advisers, both of the lender and the borrower and which may be payable whether or not the loan completes; and
- if a broker put the lender in contact with the borrower, a broker fee which will be paid by the lender to that broker.
The loan terms may provide that interest will be capitalised on specified dates during the period of the loan. If so, that is an additional cost for the prospective borrower to consider.
This will almost always include security over land but, depending on the complexity and structure of the transaction, may also include:
- all assets debenture;
- cross-corporate guarantee(s), unsecured or supported by security;
- personal guarantee(s) of individual, unsecured or supported by security over personal assets.
Is the security to be “all monies” security which covers any amounts owing by the borrower to the lender or is it to be limited to the particular facility? If the borrower will only have one loan with the lender this may not matter to the borrower. However if the borrower has, or intends to have, other loans with the lender the borrower may wish to limit the security to the particular loan in relation to which it is given.
Draw down conditions
The borrower will need to satisfy various requirements before the loan is made available by the lender. Providing the required security and in some cases, paying the necessary set-up fees will need to be completed before drawdown, unless those fees are to be deducted by the lender from the loan monies. In addition there may be other requirements. The loan may only be made available when certain milestones are achieved. For example, some of the loan might be retained pending works being certified as having been completed, by an architect or building surveyor appointed by the lender for this purpose.
The borrower should carefully check the commitments with which they must comply during the period of the loan. For example there will almost certainly be insurance which the lender requires to be maintained to protect the value of assets which are the subject of the lender’s security and in relation to which insurance the lender is to have rights. If so can the borrower satisfy those requirements and what is the cost of doing so?
The loan will set out the agreed repayment period. However, assuming the facility is a term facility, it will specify circumstances in which the loan must be repaid earlier than the end of the agreed repayment period. Examples include the borrower becoming insolvent or failing to comply with other terms of the loan. The circumstances in which the latter may occur should be carefully considered by the borrower. Such circumstances may be stand-alone. For example if the loan is to finance development work it may provide that it will become immediately repayable in full if such development work ceases to be carried out. Alternatively there may be a link with other terms of the agreement under which the borrower is required to undertake obligations, such that breach of those obligations will mean that the loan becomes immediately repayable. The stricter those obligations the greater the need to consider the repayment provisions, including, for example, whether there should be any grace periods for the borrower to remedy any breaches or any materiality carve outs which make clear that a breach of the borrower’s obligations, or of specified obligations, under the agreement will only be relevant if material.
It is very common for the loan documentation to make clear that the benefit of the loan can be transferred by the lender without the borrower’s involvement. If the prospective borrower is particularly concerned to ensure that its relationship remains with the lender it has selected this may be of concern to them.
A range of regulatory issues may also arise. For example, if the loan is to an individual borrower (or trustee), and is to be secured by a first charge over land in the UK, at least 40% of which is to be used as or in connection with a dwelling by the borrower or the borrower's family, then the loan may be a regulated mortgage in which case the financial services legislation becomes relevant. If the loan is secured by way of a second charge and made to an individual, a partnership of not more than three partners or an unincorporated body, such as a club, the consumer credit legislation may be relevant.
Alan Margolis advises that “All responsible lenders will focus on the exit strategy. There is a misconception that the exit needs to be arranged prior to drawing down the bridging facility, but this is not the case and indeed genuine ‘closed bridges’ are rare. Instead, what is required is a viable and realistic exit strategy which can take many forms.”
Exit may be achieved through the sale or refinance of the security property, but it may be through the sale or refinance of other assets of the borrower. Alternatively one does see exits being achieved through the maturing of investments or even the settlement proceeds of litigation.
In addition to the focus on the exit, another distinctive feature of bridging loans is that interest is often, if not usually, rolled up into the facility so that the borrowers do not have to find the interest from their own resources. Some lenders add on and retain the interest.
However, as bridging loans are bespoke there is flexibility. For business or corporate customers it is possible for interest to be part serviced and part rolled and for rental payments from security properties to be mandated to the lender. There is also the ability to have stepped rates where the monthly interest rate reduces when a hurdle is met, such as the reduction of the loan to value achieved by the sale of a security asset or the obtaining of planning permission.
Due to the short nature of the loans, usually less than 12 months, responsible lenders will maintain regular contact with their borrowers to ensure that the exit strategy remains achievable. This approach can be bolstered by specific loan conditions. For example, the borrower may be required to provide regular updates on the progress of the sale and marketing of a property which is to provide all or a substantial part of the repayment monies.
Alan Margolis notes that “The last few years have seen the short term sector mature with specialist lenders increasingly filling the funding gap created by the mainstream lenders shrinking their balance sheets. There is, of course, a huge range of reasons why short term finance may be required, but what is particularly noticeable is the complexity of deals that are being proposed as well as the quality and calibre of the customers.”
It is clear that bridging finance is now available for a wider range of financing needs than was the case in the past. Used appropriately it can enable a borrower to secure valuable short term opportunities. It is essential to consider carefully the bridging terms being proposed and to have a clear exit strategy. Where appropriate, advice from relevant professionals, such as accountants, surveyors, solicitors and insurers, should be taken. This is particularly important in the more complex cases where the exit is less straightforward and the loan and security documents more intricate and where matters need to be completed within what can be very restricted time frames compared to traditional banking facilities.
This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.