#16807 - Syndicated Loans - Banking Law Notes

Loan Finance

• Equity vs Loan financing?

  • Equity is highly standardise. The rights associated with shares are regulated by statute. A company may structure its shares in different ways, but there is a very limited number of ways.

  • There is however, no such standardisation of loans. The parties are free to structure the loan within the (much broader) constraints of English law.

• Almost all firms today are organised as corporate groups.

  • It is important to figure out who is the actual borrower. It is often the holding company, rather than the operating subsidiaries who actually hold the cash flow-generating assets. The operating subsidiaries may then grant to the lender security over the assets that they hold, such as equipment, intellectual property rights, real estate, etc.

Revolving Facilities and Term Loans

• Revolving Facilities (e.g. overdrafts)

  • Borrower can draw down and repay from time to time.

  • Recurrent expenditure.

  • Lower costs of financing, but constant re-financing needs.

• Term loans

  • For a specified period of time (i.e. short-term, medium-term, or long-term).

  • Available all at once or in tranches.

  • Repayment of the whole at one time (i.e. a “bullet” loan).

  • Repayment schedule over time (i.e. a “amortised” or a “balloon” loan).

• Interest

  • May be fixed or floating (e.g. 300 BPs above LIBOR)

    • Floating = Usually fixed to certain benchmarks such as LIBOR.

    • London Interbank Offered Rate (“LIBOR”) = The interest rate at which the lender can attract short-term deposits from other bankers.

  • Margin or spread (difference above LIBOR) is the bank’s profit.

  • Maturity mismatch: borrow short and lend long.

    • What does maturity mismatch mean?

• The bank is lending out long-term loans, but is only holding on as creditor to short-term debts.

• What is the danger here?
  If a huge amount of depositors withdraw their deposits at one go, the bank will not be able service all of these deposits at the same time. This is called a bank run. The bank must then start dumping its loans onto the market at cutthroat prices, and is at a high risk of not being able to pay all its customers. If so, the bank must be liquidated.

• Interest periods usually = 1, 3, 6, 9, or 12 months.

• Failure to pay interest typically constitutes an even to default.

• The longer the principal remains outstanding, the more interest can be earned.

• Conditions and Representations

  • Conditions precedent before funds may be drawn down may include:

    • No default;

    • No material adverse change in financial conditions; or

    • That representations and warranties are true.

  • Representations and warranties

    • Legal Warranties as to the validity of the agreement, i.e. the agreement had been entered into by the relevant bodies with the necessary powers. This may relate to incorporation, authorisation, etc.

    • Commercial Warranties. E.g. The borrower’s financial condition, credit standing, no litigation, etc.

Loan Syndication

• The loan is provided by a multitude of lenders, thereby spreading (and reducing for any one lender) the risk of non-payment by the borrower.

• The agreement is the same for all the lenders in the syndicate.

  • There are identical conditions and warranties.

  • But the rights and obligations of each lender in the syndicate is several, and not joint and several.

    • I.e. If any one amongst the lenders does not lend, the rest of the lenders are not liable to cough up money to cover that shortfall.

  • This means that the syndication agreement essentially = separate loans to the borrower up to the agreed commitment.

• The several nature of the lenders’ rights and obligations.

  • Separate loans to the borrower up to the agreed commitment.

  • Each lender can enforce its rights separately as against the borrower.

  • Each lender has an individual right to set-off.

  • If the loan is secured, the security trustee holds for all the participants.

  • “Pro rata sharing” clause:

    • E.g. A and B each lend 100 to X under a syndicated loan. X has a deposit account with B, in which there is 50. X then encounters financial problems.

    • Under normal circumstances, B can set-off that 50. This means X still owes A 100, but now only owes B 50.

    • But, with a pro rata sharing clause, that 50 must be shared. X now owes 75 to A and B each.

    • Set-off generally means that the creditor has a claim against the debtor, but the debtor also happens to have a claim against the creditor. Under a setting-off agreement, the two claims are netted out, and, assuming that the creditor’s claim is of a greater amount, there is now only a claim by the creditor against the debtor of the net remaining amount.

• A well-developed secondary market.

• The parties to a syndicated loan:

  • The borrower;

  • Lending banks;

  • The arranging bank; and

    • This is usually the borrower’s house bank, who has been given a “mandate” to solicit other banks to join the syndicate.

    • The arranging bank sometimes underwrites the loan in its entirety.

  • The agent bank.

    • Simply oversees the day-to-day administration of the loan.

    • This will typically be the same bank as the arranging bank, though this is not necessarily so.

• The role of the arranging bank is particularly relevant.

  • Information memorandum:

    • Drafted by the borrower on the advise of the arranging bank.

    • Contains all the relevant information.

  • Solicits the participation of other banks on instruction of the borrower.

  • Undertakes negotiation of documentation on behalf participants.

    • The arranging bank thereby acts on behalf of both the lenders and the borrower.

  • Does the arranging bank owe fiduciary duties to the borrower and/or the lenders?

    • Under normal circumstances, no.

    • May be the case if such responsibility has been clearly assumed, but this is highly unlikely.

  • What if a lending bank lends to a borrower under a syndicated loan on the back of a financial statement that turns out to be shit?

    • Recourse against the borrower?
      This is very unlikely if the borrower is in administration. There will likely be a comprehensive moratorium in place preventing the lender from enforcing such claims against the borrower.

    • Recourse against the arranging bank?
      Misrepresentation? Negligence? Breach of fiduciary duties?

    • The arranging bank is unlikely to owe fiduciary duties to either the lender or the borrower because it performs a dual-role in respect of both these parties.

    • Misrepresentation?
      But does the financial statement amount to a representation? And, even if it does, who precisely made the representation? It is indeed a representation, but it is made by the borrower itself and not the arranging bank; there is, in fact, typically a clause in the syndication agreement saying that the information memorandum is made by the borrower and not by the arranging bank, even if the arranging bank had advised the borrower in drafting it.

    • Negligence?
      Possibly, but this depends upon the facts of each individual case.

• Lender majority

  • Important decisions require a majority of the lenders. This is typically contained in an express provision.

    • Modification of the agreement.

    • Waiver of breaches.

    • Determination of default.

    • The majority threshold is typically set at lenders representing 50% or 66% of total amount of the loan.

  • Unanimity.

    • Usually in relation to the “pro rata sharing” clause.

    • And also subordination provisions.

• Loan Covenants

  • Giving the lenders some control over the borrower’s business.

  • The covenants in debt securities appear to be less in number and less restrictive. This is because debt securities are much more liquid, and there are many exit opportunities for the lender.

    • C.f. Syndicated loans, which tend to be more covenant-heavy. There is indeed a secondary market, but exit opportunities are still not as plentiful.

  • Positive covenants

    • The borrower promises to do certain things.

    • E.g. Provide financial information (at regular intervals).

  • Negative covenants

    • The borrower promises to refrain from doing certain things.

    • E.g. Disposal of assets or change of business

• Positive Covenants

  • Typically aimed at preventing the financial deterioration of the borrower.

  • Positive financial covenants to meet certain target ratios:

    • Minimum net worth (ratio of total assets to total liabilities);

    • Maximum gearing ratio (borrowing or tangible net worth)

    • Minimum EBITDA ratio or financing costs;

    • Minimum current ratio or quick ratio;

    • Minimum credit rating (possibly with a downgrading of the rating as trigger).

  • Termination and acceleration as consequences arising from a breach of these covenants so as to put pressure on management.

    • Note that termination and acceleration may not be automatic consequences; they are imposed at the lender’s discretion.

• Negative Covenants

  • Restrictions on disposal of assets:

    • To prevent asset stripping.

    • Only where the lender is unsecured. This is because, in secured lending, the lender’s security is already in place.

    • Disposals in the ordinary course of the borrower’s business are excluded. The borrower will not typically dispose of its key cash flow-generating assets.

    • What are the potential problems? Recall the corporate group context, and the implications of intra-group transfers of assets involving the borrower. Whether a disposal of assets has occurred thus depends on the precise structure of the corporate group in question.

    • This is because the interest rate that the lender has charged on the loan is dependent on the...