Quick read

What’s the purpose of the purpose clause?

Gateley Legal

A tightly drafted and clear purpose clause in a facility agreement can help a lender recover any funds not applied for its proper purpose.

A quistclose trust will arise if a lender transfers funds to a borrower for a specific purpose set out in the facility agreement, for example, to use the funds to purchase a property as detailed in the agreement.  Importantly, if there is a quistclose trust, the funds transferred remain the property of the lender unless and until the borrower applies them for the specified purpose. If the borrower becomes insolvent before using the funds for the specific purpose, the funds cannot be used to satisfy other creditors. This is of great comfort to lenders.  If a loan is made for an exclusive purpose and a quistclose trust exists, the borrower has a duty to use it for that purpose and no other.

This duty exists alongside the contractual obligations the borrower owes to the lender.  In addition, the borrower must keep the funds separate from its own assets and must return monies to the lender if the purpose of the loan fails or can no longer be carried out.

The courts consideration

The courts have considered the law surrounding quistclose trusts in a recent case*. The Court held that neither the terms of the facility letter nor any of the surrounding circumstances in this case suggested that the funds loaned to the borrower were not at the borrower’s free disposal.  The borrower used the majority of the funds under a loan to purchase a property from a company with common ownership but the facility letter stated that the purpose of the loan was “to assist with the costs of development of the Property”. The Court found that the terms of the facility letter did not impose an obligation on the borrower as to apply the loan money for a specific purpose and, therefore, a quistclose trust had not arisen, despite the borrower being an SPV established solely for the purpose of developing the property.

A lender will find it easier to establish that loan monies are subject to a quistclose trust if:

  1. the purpose clause is tightly drafted
  2. amounts are required to be segregated
  3. further evidence can be provided as to the agreed intentions of the parties such as a clear purpose clause stating that monies advanced are to be used for a sole purpose.

Any evidence which can be provided by the term sheet, correspondence and express instructions which clearly indicates the agreed intentions of the parties may also help to establish that a quistclose trust has arisen.

*Gabrielle v Little and others

For more information visit: http://www.bailii.org/ew/cases/EWCA/Civ/2013/1513.html

Gateley Plc is authorised and regulated by the SRA (Solicitors' Regulation Authority). Please visit the SRA website for details of the professional conduct rules which Gateley Legal must comply with.