Loan document terms are ambiguous when they are reasonably capable of being interpreted in more than one manner. Contract law often provides that an ambiguous term in a loan document is interpreted against the drafting party. This is especially true in a situation where the parties have unequal bargaining power. For lenders, this means that if a loan document contains ambiguous language, a court might interpret the disputed language in a way that favors the borrower and results in a disastrous or costly outcome for the lender.
Even in situations where the above principle is inapplicable, such as a loan involving a sophisticated commercial borrower being represented by sophisticated counsel, loan document ambiguities may mean that the “best case” outcome for a lender still requires long, contentious and costly litigation in order to achieve.
Lenders should take the following steps to avoid the above outcomes:
- Avoid cutting and pasting summaries of key requirements contained in credit approvals directly into loan documents;
- Be careful not to overly complicate important loan terms, such as financial covenants, payment structures, release terms, default provisions and rights and remedies;
- Define important terms within the loan documents themselves or refer to a credible and commonly used outside source (such as GAAP or the UCC) for definitions;
- Ensure consistency within each loan document and across multiple loan documents;
- Ask a colleague to review and provide their interpretation of key points or provisions;
- Consider having loan documents (or certain key provisions) drafted or reviewed by legal counsel to help identify any potential ambiguities; and
- Maintain records of communications and negotiations with the borrower to support the intended meaning of key terms.
