A Loan Note is a legally binding 'promissory' agreement made between parties that the borrower will repay money they have borrowed.
It is, in essence, a fancy form of IOU! An agreement that the borrower will repay the loan amount, usually with interest, to the lender over a period of time, along with other specified terms that would be agreed between the two parties.
What goes into the document?
The physical document is called the Loan Note Instrument. It will contain information such as:
the names and contact information for parties (including, if the borrower is a company, the company registration number that appears on Companies House)
the original amount of the loan,
the interest rate being applied over the term of the loan, if it has been agreed that interest will accrue,
the "term" (duration) of the loan,
when payment(s) will need to be made, ie the date that the first payment must be made by, and then the frequency of the rest of the payments (monthly, quarterly etc),
any penalties for late payment or "prepayment" (early payment)
The Loan Note is then signed by the borrower to confirm that they agree to be bound by the terms.
Where are they used?
In the business world, Loan Notes are commonly used for raising funds for purposes such as investments, property development projects, creating start-ups, buying and selling businesses, and restructuring existing businesses.
Lenders typically require borrowers to agree to use Loan Notes instead of cash for high-value purchases, such as acquiring a high-value business or expensive properties.
If you work in corporate law or corporate finance, you may see Loan Notes be proposed as payment instead of the tried and tested cash.
When Loan Notes are used between businesses for, say, an acquisition transaction, the purchasing party can act as the borrower and make payments over time to the seller (acting as the lender). This can often be at a minimal interest rate too.
As for consumers, Loan Notes are commonly used for vehicle financing/car loans or when taking out a mortgage for a home purchase. Both of these are instalment-based loans as they involve monthly repayments. Loan Notes can also be used for many other forms of instalment-based loans, be they shorter-term like a vehicle financing loan (3-4 years) or longer-term like a mortgage (20-30 years).
Why use Loan Notes? What are the benefits?
Loan Notes can be structured as either a qualifying corporate bond (QCB) or a non-qualifying corporate bond (non-QCB). The way that Loan Notes are treated for tax purposes depends on how they are classified - as a QCB or non-QCB.
If the Loan Note is classified as a QCB, then it is exempt from Capital Gains Tax (CGT). If it is classified as a non-QCB, it will incur a CGT liability and losses are allowable.
For a Loan Note to be classified as a QCB, it must:
have been issued after 13th March 1984,
be expressed in sterling (£), and
not be able to be converted into any other currency.
A note issued on 1st February 1984 for 25,000 sterling and not convertible to another currency? Non-QCB.
A note issued on 25th May 1984 for £25,000 but can be converted into US Dollars? Non-QCB.
A note issued on 13th July 1984 for £25,000 sterling only? Ding ding, you have yourself a QCB! Enjoy your CGT exemption!
That being said, HMRC must also be satisfied that the issuing of a Loan Note is not for the purposes of tax avoidance.
Tip for drafters
If you are drafting a document, for instance a Share Purchase Agreement as part of an M&A deal, and you want to make it as clear and straightforward as you can for the client, then see what information is in the Loan Note Instrument and then have the document refer back to it.
This could also help if you're not getting the full picture or full instructions, but you're on a deadline or don't want to waste time in getting the transaction done for the client.
It can also help if you want the document to be as succinct as possible and eliminate excess wording, making it easier to read and digest.
If you want to learn more here, check out these further resources:
Credit: Cover image photo by Emily Morter on Unsplash
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