Legal Definitions - commitment fee

A commitment fee is an amount of money paid by a prospective borrower to a lender. This payment secures the lender's promise to make a specific amount of money available for a loan, under agreed-upon terms such as a particular interest rate and within a specified timeframe. Essentially, it is a charge for the lender to reserve capital and guarantee the availability of the loan for the borrower at a future date, even if the borrower does not immediately draw on the funds.

Here are some examples illustrating how a commitment fee works:

• Corporate Acquisition Financing: Imagine a large corporation planning to acquire a smaller competitor in six months. To ensure they have the necessary capital when the deal closes, they approach a bank for a substantial loan. The bank agrees to provide the financing at a specific interest rate but charges the corporation a commitment fee. This fee guarantees that the funds will be available for the acquisition when needed, regardless of market fluctuations in the interim, and compensates the bank for reserving that capital. The corporation (potential borrower) pays a fee to the bank (lender) for the bank's promise to lend money (the acquisition financing) at a stipulated rate and within a specified time (when the deal closes).

• Multi-Phase Construction Loan: A real estate developer secures a large loan for a new commercial building project that will take three years to complete. The developer won't need the entire loan amount upfront but rather in stages as construction progresses. The bank charges a commitment fee on the unused portion of the approved loan. This fee ensures that the full amount of the approved loan is reserved for the developer throughout the construction period, allowing them to draw funds as needed without reapplying or facing new terms. Here, the developer (potential borrower) pays a fee to the bank (lender) for the bank's promise to lend money (the full construction loan) at a stipulated rate and within a specified time (over the three-year construction period), even though the money isn't drawn all at once.

• Standby Credit Facility for a Startup: A rapidly growing tech startup wants to ensure it has a financial safety net for unexpected expenses or sudden growth opportunities. They arrange a standby credit facility with a bank, which allows them to borrow up to a certain amount if needed. The bank charges a small commitment fee for this facility. This fee ensures that the funds are readily available to the startup should they need to access them, providing financial flexibility and peace of mind without requiring them to draw down the loan immediately. In this scenario, the startup (potential borrower) pays a fee to the bank (lender) for the bank's promise to lend money (the credit facility) at a stipulated rate and within a specified time (the term of the facility), even if the startup never actually borrows the money. It's a fee for the option or guarantee of funds.