Definition and Examples of Cleanup Requirements
Cleanup requirements exist on some types of revolving loans or lines of credit. These loans allow borrowers to access credit up to a set limit as needed at predetermined rates. Borrowers make payments based on how much they have currently borrowed. A cleanup requirement on a revolving loan or line of credit mandates the borrower periodically pay their balance down to $0 and maintain a $0 balance for a set period of time.
Alternate name: Cleanup clause
For example, a business might be given access to a renewable, revolving line of credit that allows them to borrow up to $1.5 million at a time. Because this line of credit is always available, the lender may want to ensure the business isn’t too reliant on it. So the lender may include a cleanup clause in the loan agreement that requires the borrower to maintain a $0 balance for 30 consecutive days during every 12-month period that the credit line is available. Cleanup requirements are sometimes found on working capital loans or seasonal loans. These are both forms of short-term financing that allow companies to purchase supplies or cover operating needs during their business cycle. Businesses draw from the line of credit if they need to buy inventory or supplies, or cover other costs before payments from customers come in. The cleanup requirement ensures the business isn’t overly reliant on the borrowed funds. However, cleanup requirements are becoming less common on loans.
How Does a Cleanup Requirement Work?
Lenders impose cleanup requirements to ensure a business is not too reliant on debt. Lenders who offer working capital or seasonal loans may also want a company to clean up the loan once per year to ensure the loans are being used for their intended purpose, rather than for financing long-term asset acquisition or propping up a failing business. Cleanup requirements included in loan agreements specify how often a borrower must pay the loan balance down to $0. They also specify how long the balance must remain at $0. For example, a cleanup requirement might mandate a borrower pay off their loan in full and maintain a $0 balance at least once per calendar year. Typically, lenders require the balance to remain at $0 for around a 30-day period, although specifics can vary. A borrower subject to a cleanup requirement needs to plan for full payment during the required time period. Otherwise, they risk the lender imposing consequences, such as demanding full repayment of the loan.
Pros and Cons of Cleanup Requirements
Pros Explained
Businesses do not become overly reliant on borrowed money: Cleanup requirements protect lenders by ensuring businesses do not rely too heavily on debt to finance operations. Lenders are protected against risk of borrower defaults: This is a major advantage for lenders, as it reduces the borrowing risk.
Cons Explained
Can pose a financial hardship for a business: Cleanup requirements could cause financial hardship for a business if it has difficulty maintaining a $0 balance for the requisite time. May slow business growth: This could especially be a challenge for new and growing businesses that want to use their capital for other things besides putting it all toward a revolving debt. Penalties for noncompliance may undermine the ability to pay back the loan: Lenders face a risk of having to impose consequences when a borrower can’t fulfill a cleanup requirement. Taking steps such as mandating a capital infusion or seizing collateral could undermine business operations and make it less likely the borrower could repay the loan in full.
