With the festive season now in full swing, many (well, some) borrowers will be sending their season’s best wishes to their lenders. But how many corporate borrowers know their lenders? Most will likely think they do but the answer is not always straightforward.
In this article we take a brief look at the ways in which a day one lender may change during the life of a loan.
Bilateral, club and syndicated loans
Bilateral loans are made with just one lender. Club loans are where several lenders club together from day one to provide portions of a loan facility. Syndicated loans are organised by one or more arranging banks, who will look to sell loans and/or commitments to new lenders. Club and syndicated loans are typically papered using the Loan Market Association’s template documentation. Some lenders will take and hold their interests, whereas others may look to sell their loans in the secondary loan markets either to meet regulatory requirements or for some other reason (for example, based on the performance of the underlying borrower and its business). The point here is that if you have a bilateral loan, you have relative certainty as to who your lender is. But with club and especially syndicated loans, your lender(s) can change relatively easily over time.
Transfers, Assignments and Sub-participations
There are typically three ways in which lenders can sell their loans in the secondary loan markets:
- novation or transfer;
- assignment; and
- sub-participation.
Novation is appropriate where both rights and obligations need to be transferred by the selling lender to the new lender. So this is useful if there are outstanding, undrawn commitments under a loan facility. By contrast, assignment effects a transfer of rights only.
Sub-participations represent a back-to-back contract between an existing lender (as seller) and a third party (as purchaser), with the result that the purchaser has no direct relationship with the borrower. As such, whereas transferees and assignees become lenders of record (i.e., persons with whom a borrower has a direct contractual relationship), sub-participants do not. Unless a loan prohibits sub-participations (and most do not), it is entirely possible that lenders of record might enter into participation arrangements behind the scenes with participants effectively calling the shots.
Types of transferee
Syndicated loans (including those based on the LMA templates referred to above) usually allow lenders to transfer or assign their loans to (i) another bank or financial institution or (ii) any trust, fund or other entity which is regularly engaged in or established for the purpose of making, purchasing or investing in loans or other financial assets.
It’s worth mentioning a couple of cases here. Firstly, “banks or financial institutions” is unlikely to be limited to your typical high street banks and such like alone. On the contrary, the UK Court of Appeal has made clear previously that to qualify as a financial institution in the context of a loan, it is sufficient that the organisation is a “legally recognised form or being, which carries on its business in accordance with the laws of its place of creation and whose business concerns commercial finance” (Essar Steel Limited v The Argo Fund Limited [2006] EWCA Civ 241).
Secondly, and more recently, it seems that “vulture funds” – including a newly established entity with a share capital of £1, no trading history and that has been set up for the sole purpose of acquiring a defaulted loan with a view to realising a profit on enforcement - may themselves qualify as a financial institution for the purposes of the transfer provisions in a loan. This seems to be the lesson from the recent case of Re Olympia Securities Commercial plc (in administration) and ors v WDW 3 Investments Ltd and anor [2017] EWCH 2807 (Ch).
The key takeaway here then is that if a borrower wants to limit the kind of persons who can become its lender, then be sure to define more precisely which persons can become new lenders – simply requiring transferees to be “financial institutions” alone is unlikely to provide much restriction.
Other transfer restrictions
What other restrictions might a borrower look for in a loan agreement to restrict the persons to whom their lender can transfer the loans? Below are a few potential options:
Require transferees to be “Qualifying Lenders” – in other words, those to whom interest can be paid gross (i.e., without deduction of withholding tax).
Minimum transfer / hold amounts – some loans will specify a minimum threshold on the amount of transfers or a requirement for the original lender(s) to maintain a minimum participation in the loan facilities. These are worth considering where a borrower fears a syndicate might become so large that it becomes unmanageable.
Require borrower consent to transfers – this is likely only appropriate for particularly strong borrowers. That said, it used to be the case that lenders could transfer without borrower consent at any time when an event of default is continuing. Interestingly, we have seen that position changing somewhat in recent times, with some strong borrowers watering down such provisions so that the requirement for borrower consent only falls away in the case of certain specified defaults only (but not all).
White and Black Lists - a borrower may at closing agree a pre-approved “White List” of potential transferees to whom transfers can be made without its consent, preserving however a consent requirement in relation to transfers to entities which do not appear on such list. Alternatively a “Black List” might be prepared, i.e. those entities to whom transfers cannot be made under any circumstances because the borrower has concerns that they will be difficult to deal with when it comes to requests for amendments, waivers and consents.
Summary
At the outset of a loan transaction, when the weather is usually quite sunny, borrowers are typically most focused on getting the loan monies to fund their business. Who their lender(s) might turn out to be doesn’t usually weigh heavily on the mind when entering into a loan. But when the weather turns for the worse, the ability of lenders to sell down their loans, or for others to buy in, can have significant repercussions for a borrower, especially if it needs to request consents or waivers to buy it more time. In other words, taking time to provide clear restrictions in loan documentation around how transfers can be made and to whom can provide real protection later when the vultures start circling.
Merry Christmas!
Matthew Padian
Jonathan Porteous