Many of these clauses, cobbled together over decades or more, contain antiquated clauses that no longer serve their intended purpose.

So that you don’t have to Google it, a hobgoblin is a mischievous imp (or sprite); a small, ugly creature that causes trouble. Something that causes fear (like a boogeyman).

Embarrassingly, legal documents are replete with hobgoblins. Innovation isn’t just about technology, data analytics, or risk assessment methodologies. Sometimes, it’s about rethinking the very documents underpinning our industry—the loan agreements themselves.

Many of these agreements, cobbled together over decades (perhaps even centuries), still contain antiquated clauses that no longer serve their intended (or any) purpose. It’s high time we examine and remove these relics to streamline processes, reduce confusion, and foster a more transparent and efficient lending environment.

The Historical Context

Loan documents evolved from handshake agreements to complex legal instruments filled with jargon and clauses designed to protect lenders from a variety of risks. The lawyers got involved, you see. A document that means “I’m giving you $, which you will pay back; if you don’t, I can sell your house,” has become 140 pages long.

Lawyers are both superstitious and lazy. They use documents that worked before. So, a smart lawyer wrote a contract during the 1800s, and everyone in his firm copied it for a hundred years. Each would reword this-or-that. Periodically a clause would be added to address new rules, regulations, law, or a problem arising in another matter. Never, though, is anything removed.

Historically, these clauses were vital. They addressed issues ranging from the financial instability of borrowers to the lack of regulatory framework governing loans. The financial landscape has dramatically changed. The regulatory framework is robust (perhaps you have noticed), financial markets are more transparent, and technology allows for real-time data analysis and monitoring. Many loan documents haven’t caught up with these advancements. They are still riddled with terms and conditions that made sense in the past but are now contrary to existing law, redundant, confusing, or just unnecessary.

Let’s delve into some of these antiquated clauses and discuss why they need to be retired.

Legalese and Jargon

The language used in many loan documents is an area ripe for modernization. Legalese and jargon make loan agreements difficult to understand, leading to confusion and potential disputes. Clear, plain language should be the standard for all loan documents. Have you ever read any of the following in documents: “witnesseth,” “to wit,” “heretofore?” Do you know what any of them mean? They’ve just been copied and pasted since before Hector was a pup. And here they are—hobgoblins.

Simplifying the language in loan agreements can enhance transparency and trust between lenders and borrowers. It can also reduce the time and cost associated with negotiating and finalizing loan documents. By prioritizing clarity and simplicity, lenders can improve their customer service and foster stronger, long-term relationships.

Personal Guarantees

Personal guarantees were historically used to ensure the borrowers had obligations and to provide additional security to lenders. However, in today’s diversified and often corporatized business environment, personal guarantees can be a major deterrent for potential borrowers.

Additionally, contracts of guaranty might be unenforceable and provide payment defenses. Is the loan to the borrower/entity really made to skirt an antideficiency statute and enable collection against the individual guarantor? These sorts of “sham guaranty” arrangements are forbidden in some jurisdictions. The risk here is that the lender chooses to foreclose without going to court, based on the belief they can collect on the guaranty. But if they later discover the guaranty can’t be enforced, they lose the chance to recover the remaining debt. If the lender had known this beforehand, might they have opted for a court foreclosure? Perhaps.

Choice of Law Provisions

Choice-of-law provisions dictate which jurisdiction’s laws will govern the interpre-tation and enforcement of a loan agreement. These clauses were historically included to provide certainty and predictability, especially in transactions involving parties from different jurisdictions. However, they can sometimes complicate matters unnecessarily, particularly when outdated or overly complex legal frameworks are chosen.

Do you even know which jurisdiction your document chooses? Do you know why? If the answer to either question is “no,” then take a hard look into it.

Some jurisdictions have more ”friendly” statutes for lenders. Choose those. Some choice-of-law provisions are selected because the lawyer you used 50 years ago knew the law there—and nowhere else. Get rid of those. In today’s globalized and interconnected world, lenders and borrowers benefit from choosing jurisdictions that are not only predictable but also modern and efficient in handling financial disputes. Updating choice-of-law provisions to reflect jurisdictions with streamlined legal systems can reduce litigation costs, speed up dispute resolution, and provide a more equitable legal landscape.

Furthermore, selecting jurisdictions that embrace digital documentation and electronic signatures can enhance the efficiency of executing and enforcing loan agreements. What is the rule of evidence related to using copies in lieu of originals in the jurisdiction you’ve selected? Seems like you should know. This approach aligns with the broader trend of digital transformation in the financial sector and supports the move toward more agile and responsive legal frameworks.

Venue Provisions

Venue provisions specify the location where any disputes arising from the loan agreement will be litigated: Where will we go to court? Although these clauses were initially designed to provide convenience and predictability for lenders, they can often place an undue burden on borrowers, especially when the chosen venue is distant or inconvenient.

Similar to the choice-of-law provision, know why you’ve chosen this. Is it a holdover from the venue nearest the office of the attorney your dad used when this was his company? Selecting the venue nearest your lawyer’s office does make some sense; however, that selection can’t be made without being relative to some other fact. The venue must have a reasonable relationship with the transaction (i.e., situs of the collateral; principal place of business of the lender, or borrower, or guarantor). Don’t pick Wyoming as the venue unless you’ll later be able to articulate why.

Usury Laws

Usury laws, which set maximum allowable interest rates, were established to prevent lenders from charging excessively high rates that could exploit borrowers. These laws have a long history, dating back to ancient civilizations, and they have been incorporated into modern legal frameworks. However, the application and relevance of usury laws can vary significantly across jurisdictions, often creating confusion and legal challenges in the private lending sector.

Some jurisdictions (like California) have so many exceptions to usury there isn’t much left after applying them. However, a lender must fit into an exception or the penalty for violating usury will likely eliminate all interest due or collected on the loan. Do you qualify for an exception? Are you sure? Best to verify.

In today’s complex financial landscape, some usury laws may appear outdated or overly restrictive, particularly given the sophisticated risk assessment and mitigation tools available to lenders. Modernizing usury provisions within loan documents can involve:

1. Reevaluating interest rate caps. Adjusting interest rate caps to reflect current economic conditions and market dynamics can ensure lenders remain competitive while protecting borrowers from predatory practices.
2. Incorporating flexibility. Introducing flexibility in interest rate provisions to account for varying risk profiles and economic environments can benefit both lenders and borrowers. This might involve tiered interest rates based on creditworthiness or specific loan purposes.
3. Transparency and disclosure. Ensuring interest rate terms are clearly disclosed and easily understood by borrowers is crucial. Transparent practices build trust and reduce the risk of disputes related to perceived unfair lending practices.
4. Aligning with market standards. Reviewing and aligning usury provisions with contemporary market standards and regulatory guidelines can help lenders maintain compliance while offering competitive loan products.

Default Interest Provisions

Default interest provisions are designed to penalize borrowers for late payments by increasing the interest rate applied to the outstanding balance. Although intended to incentivize timely payments and compensate lenders for the increased risk and administrative burden, these provisions can sometimes be excessive and counterproductive.

High default interest rates can exacerbate a borrower’s financial difficulties, making it even harder for them to get back on track. This can lead to a cycle of default and delinquency, ultimately harming both the borrower and the lender. Modernizing default interest provisions involves several considerations:

1. Reasonable penalties. Setting default interest rates that are reasonable and proportional to the actual increased risk and administrative costs can prevent undue financial stress on borrowers while still providing a deterrent against late payments.
2. Grace periods. Incorporating grace periods before default interest rates kick in can provide borrowers with a buffer to manage short-term cash flow issues without immediate penalization.
3. Transparency and clarity. Clearly outlining the conditions under which default interest rates will apply, along with the specific rates and potential penalties, ensures that borrowers are fully informed and can take proactive steps to avoid default.
4. Flexible arrangements. Offering flexible repayment arrangements or temporary forbearance in cases of genuine financial hardship can help borrowers recover and ultimately benefit lenders through improved recovery rates and long-term borrower relationships.

By modernizing default interest provisions, lenders can create a more supportive and sustainable lending environment that encourages responsible borrowing and repayment while minimizing unnecessary financial distress.

Prevailing Party Attorney Fees

Prevailing party attorney fees provisions dictate the losing party in a legal dispute must pay the legal fees of the winning party. These clauses were intended to deter frivolous lawsuits and ensure the prevailing party is not financially burdened by the cost of litigation. Determining who “won” isn’t always so easy. If you sued for $400,000 and recovered a judgment for $135,000, did you prevail? It will be for the court to decide.

Change your provisions to specify that all attorneys fees and costs of collection, including litigation, will be added to the balance owed by the borrower. That way, all you need to do is win. Easy, right?

Confession of Judgment Clauses

Many confessions of judgment clauses are outdated (or outlawed). This clause allows a lender to obtain a judgment against a borrower without notice or a hearing. Historically, it was used to swiftly deal with delinquent borrowers. Today, it’s considered draconian and has been outlawed in many jurisdictions.

Confession of judgment clauses to some jurisdictions undermine the principles of fairness and due process. Modern lending practices and legal systems provide more balanced and just ways to handle defaults. Removing this clause not only modernizes loan agreements but also aligns them with contemporary legal standards and ethical practices. Does your jurisdiction allow confessed judgments? If not, this clause can be cut.

The Path Forward

Transitioning away from antiquated clauses requires a concerted effort from all stakeholders in the private lending industry. Here are some steps to facilitate this change:

1. Review and audit existing documents. Conduct a thorough review of current loan agreements to identify clauses that are outdated or redundant. Engage your attorneys to ensure compliance with current laws and regulations.
2. Embrace technology. Leverage modern technology to streamline processes, from application to reporting. Automated systems can handle tasks that were once managed through restrictive clauses and outdated reporting requirements. Consider using Lightning Docs, the official legal documents of AAPL. They comply.
3. Don’t be a fossil. Polish up a bit. Stay fresh. Be young (again).