A clean-up requirement is a clause in contracts for annually renewable lines of credit or revolving lines of credit. This clause requires the borrower to completely pay off the outstanding balance and not use it for a specified amount of time. Clean-up requirements are not commonly used on secured credit cards or credit lines.
Clean-Up Requirement Details
A clean-up requirement is also known as an “annual clean-up.” Businesses often take out a couple of different lines of credit to get started. Banks or Credit Unions include the clean-up requirement to prevent a business from becoming dependent on the line of credit.
If a company uses the credit line to pay things such as payroll, rent, or other bills, it is not generating enough income to pay its own way. This could lead to the company taking out so many lines of credit that no one will lend to them anymore. If a company gets to that point, there is no way to pay back the debt and continue to operate.
The exact terms of a clean-up requirement depend on what the bank writes into the contract. Sometimes the terms are to pay off the balance and then keep it at zero for 60-90 consecutive days within a 12-month period. Other times the terms are to keep the balance below a certain percentage for at least 30 consecutive days within a 12-month period. In addition, a clean-up requirement can be to not have an overdraft for 30-60 days each year the company uses a revolving line of credit.
Clean-Up Requirement Example
Company ABC borrows $1.2 million from Engine Bank. In the contract, Company ABC must pay off the line of credit by the end of the year and keep it at zero for the next 90 days.
ONB, Inc. borrows $5 million from Night Credit Union. Night Credit Union requires that ONB, Inc. must not have an overdraft for 60 consecutive days each year the line of credit is used. The credit union also requires that ONB, Inc. keeps the balance below a certain percentage for 30 days within a 12-month period.
Significance of Clean-Up Requirement
As stated before, financial institutions used clean-up requirements to keep a company from depending too much on borrowed money. Businesses are meant to generate enough income on their own to pay all of their bills or at least pay off their debt. Clean-up requirements also protect the bank or credit unions that lend money to the company. It guarantees that the institution will get back its money.
However, clean-up requirements are falling out of popularity. Banks and credit unions now assume that as long as a borrower’s account is up-to-date and payments are on time, then there is no need for a clean-up requirement.
A company should always plan to pay off its debt even if there is no clean-up requirement written into the contract. Making no plans to pay off debt is putting a company at too much risk. If you borrow money from a bank, you should write out a plan for yourself on how you will pay it back.