Lending in Latin America: Risks and Considerations (Part 2 of 2)

This post was written by Lee Ann Dillon and Constantin Souris.

In the second and last part of the series (click here for Part 1) we introduce additional considerations and risks associated with lending in Latin American jurisdictions. As previously noted, our observations are based on our interactions with Latin American counsel on cross-border transactions and surveys. However, we are not members of the bar in any such jurisdictions, and the considerations outlined herein should not be taken as legal advice.

1. Tax implications for lending in Latin American jurisdictions

Special attention needs to be given to the tax implications that a lending transaction to an individual located in a Latin American jurisdiction may trigger. In addition to any documentary taxes that may be applicable, withholding taxes may be imposed under the local laws of the jurisdiction in which the borrower is located in respect of the principal amount of the loan, interest payments and/or fees payable in connection with such a transaction. Similarly, local laws may impose particular requirements as to whether the borrower or the lender bears the burden of such tax and whether gross-up provisions would be enforceable under such laws.

2. Usury laws and consumer protection laws

When lending to an individual in a Latin American jurisdiction, a US lender needs to be aware that the local usury laws and other consumer protection laws may impose significant restrictions on the structuring of the transaction. Local usury laws may affect the enforceability of the interest rates and also the types of interest that may be charged (i.e. whether the interest can be paid in kind). 

3. US Lender’s KYC requirements

Lending in a Latin American jurisdiction can present unique issues for a US lender trying to identify the client for purposes of its know-your-customer checks. This is particularly true when the borrower is a family owned business entity or similar entity that is indistinguishable from its members/shareholders and the local jurisdiction in which such entity is organized does not provide for strict corporate (or the equivalent thereof) organization requirements. 

4. Enforcement in Latin American jurisdictions

Although the documentation for a particular lending transaction may be governed by the laws of the United State (including any State thereof) and a judgment would be sought from a state or federal court, enforcement in the Latin American jurisdiction in which the borrower is located will be important if that is where the borrower’s assets are located. Relevant considerations under the local laws of the Latin American jurisdiction would therefore include: (i) recognition of the choice of the laws of the United States (including any State thereof) as the governing law of the transaction documents; (ii) recognition of the submission to the jurisdiction of the federal and state courts in the United States by the obligors under the transaction documents; (iii) recognition and enforcement of a judgment obtained by a federal or state court in the United States by the courts in the Latin American jurisdiction; and (iv) enforcement of the US judgment in United States dollars as opposed to the local currency. The advice of local counsel is important in respect of these issues and US lenders should consider whether a legal opinion should be sought by local counsel in respect of these matters.

Questioning the form: Moayedi v. Interstate 35

This post was written by Theano Manolopoulou with Carol M. Burke

"Never blindly rely on forms and boilerplate terms - negotiating contracts is much more than just defending forms, even if you're dealing with a "repeat" transaction". In my few months as a secondee with Reed Smith's Houston office, this is some of the best advise I've received from the partners with whom I work.

The issue of deficiency offset waivers in connection with foreclosure proceedings, as demonstrated by Moayedi v. Interstate 35 / Chisam Road LP et al., case number 12-0937, currently pending before the Supreme Court of the State of Texas, is but a great example of how sound this advise actually is.

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Lending in Latin America: Risks and Considerations (Part 1 of 2)

This post was written by Lee Ann Dillon and Constantin Souris.

Lending by lenders located in the United States to high-net-worth individuals located in Latin American jurisdictions has grown tremendously in the recent years and this trend is expected to continue. Although Latin American jurisdictions present unique opportunities for business expansion for US lenders, they also present risks and issues different from those in the United States, which US lenders need to be aware of before conducting business in these markets. The purpose of this two part series is to introduce the fundamental considerations and risks associated with lending in Latin American jurisdictions, taking into account the significant differences in legal regime not only between the United States and these jurisdictions but also between Latin American jurisdictions.  Our observations are based on our interactions with Latin American counsel on cross-border transactions and surveys. However, we are not members of the bar in any such jurisdictions, and the considerations outlined herein should not be taken as legal advice.

1. Licensing requirement for conducting business in Latin American jurisdictions

US lenders conducting financial intermediation business and offering or marketing financial products to investors located in a Latin American jurisdiction may require licensing with a governmental body or entity supervising such activity in such jurisdiction. Special consideration needs to be given as to the extent and type of activity that may trigger such licensing requirement. Local legislation may have prescribed a definition for the “conduct of business” that would trigger such a licensing requirement and therefore the advice of local counsel located in the applicable jurisdiction is extremely important. Any violation of such a licensing requirement may carry both criminal and monetary penalties for a US lender.

In this respect, special consideration needs to be given to the location from which the business of the US lender will be conducted, i.e. whether the US lender will be conducting business in the Latin American jurisdiction solely from the United States or whether it will have representatives conducting business in the foreign jurisdiction. Although exemptions may apply in respect of a licensing requirement if the business will be carried out solely from the United States, stringent requirements may still apply in order to legally transact business from abroad. Primary points of focus for such licensing exemptions relate to the extent of, and the manner in which, business is conducted in the Latin American jurisdiction, and can include:

  • The extent of the US lender’s operations in the Latin American jurisdiction: Local laws in the Latin American jurisdiction may employ various factors that are based on the US lender’s operations in the jurisdiction that will trigger a licensing requirement, such as whether the US lender maintains an office in the jurisdiction, has a local address and/or phone number, whether a US lender’s representatives visit the country for a certain period of time and the type of business such representatives carry on during their visits in the jurisdiction.
  • The types of products offered by the US lender: The types of products a US lender makes available to an individual located in the Latin American jurisdiction not only may affect the extent of its operations in such jurisdiction but it may also trigger additional registration requirements such as if a particular product qualifies as a security under the securities laws of such jurisdiction.
  • The extent of client contact: Local laws in the Latin American jurisdiction may differentiate between business conducted with an existing client and a new client. Similarly, local laws may also draw a distinction as to whether the US lender initiated the contact with the client in the Latin American jurisdiction.
  • The form of client communications: The form that any communications between the client and the US lender take may also have an impact under the laws of the Latin American jurisdiction, i.e. whether the US lender is communicating with the client remotely by email, phone or fax or in-person in such Latin American jurisdiction. Additional limitations may also be applicable in respect of communications via the internet; local laws may deem a US lender to be conducting business in the foreign jurisdiction and to be deemed as targeting residents in such jurisdiction and any online communications may be strictly circumscribed.
  • Documentation used when conducting business: Sending account information and offering promotional materials may also trigger a licensing requirement under the laws of the Latin American jurisdiction.
  • The extent to which the business “touches” the Latin American jurisdiction: Relevant considerations would be whether the transaction documentation is governed by the laws of the United States (including any State thereof), where the collateral provided as security for the transaction is located, where the transaction documentation is executed, and whether executed transaction documents (and/or originals of such documentation) is sent to the client in the Latin American jurisdiction.

2. Loan Documentation used for Latin American transactions

As previously stressed, local laws in the Latin American jurisdiction in which the borrower is located may be significantly different from the laws in the United States that US lenders are familiar with and are used to lending under. Therefore, US lenders need to be aware that form loan documentation used for domestic borrowers will in all likelihood not be appropriate for a borrower in a Latin American jurisdiction. Local counsel in such jurisdiction will need to review the documentation and tailor it for the particular jurisdiction (particularly in respect of the representations and covenants of the obligors). Similarly, once local counsel has identified the particular risks relevant for their jurisdiction, US lenders should implement an internal policy in respect of what legal opinions should be provided in respect of enforceability, legal capacity of the obligors, recognition of foreign judgments and choice of law. Certain Latin American jurisdictions require that the transaction documentation be translated in the official language of such jurisdiction as a requirement to their validity and enforceability and the admissibility of such documents in evidence before the courts of such jurisdiction.

3. Transaction specific considerations for Latin American transactions

Local laws in the Latin American jurisdiction in which the borrower is located may impose additional restrictions and limitations in respect of the mechanics of the loan transaction particularly as they relate to funding, repayment of the loan and use of proceeds. Relevant considerations include: (i) whether funding of the loan is made to a local account or a foreign account; (ii) accepting deposits and payments from a citizen/resident of a Latin American country form a local account or a foreign account may have implications both for the borrower and the US lender from a tax standpoint and other legal implications such as the source of the proceeds for purposes of applicable anti-money laundering laws; (iii) the currency in which funding and repayment will take place considering certain Latin American jurisdictions have foreign currency restrictions in place as well as related reporting requirement and/or periodic limitations on the use of foreign currency; and (iv) certain restrictions may apply depending on the proposed use of the proceeds.

Comparing Agency Provisions in the United States and Europe

This post was written by Lee Ann Dillon, Helena Nathanson, Abbey Mansfield and Jordan M. Hook.

The Loan Syndications and Trading Association (“LSTA”) provides model agency provisions that reflect standard market practice in the United Sates primary loan markets, while the Loan Market Association (“LMA”) provides model provisions reflecting market practices in the European markets.  In the U.S., the administrative and collateral agent is typically the same institution as (or an affiliate of) the lead arranger.  By contrast, in Europe, the administrative agent is a separate institution from the lead bank and arranger, and may also be a different institution from the collateral agent.  This distinction leads to numerous differences in how the LSTA and the LMA provisions deal with agents, a few of which are discussed below. 
  • United States: The agent is not liable for actions taken (i) at the request of the majority lenders or (ii) in the absence of gross negligence or willful misconduct, as determined by a court of competent jurisdiction.  Further, the agent is not deemed to have knowledge of a default until notice is provided in writing. 
  • Europe:  Generally, the agent is also not liable for actions taken in good faith; however, this is becoming a point of negotiation in European transactions.  With regards to default, the LMA requires the agent to have “actual knowledge” (which it likely would not have until written notice is provided, given the third-party agent’s distance from the transaction). 
  • United States:  The agent may perform its duties and exercise its rights through sub-agents, and exculpatory provisions apply to sub-agents.  The agent is only responsible for negligence or misconduct of a sub-agent if a court determines the agent acted with gross negligence or willful misconduct in the selection of such sub-agent.  
  • Europe:  The agent may employ sub-agents, however under English law a person remains liable for acts by delegates.  Therefore, an agent will be responsible for the negligence or misconduct of a sub-agent, regardless of how the agent acted.
  • United States:  The agent may resign at any time by giving notice.  The majority lenders, in consultation with the borrower, have the right to appoint a successor.  If no successor is appointed within 30 days, the agent may appoint the successor itself.  However, the resignation becomes effective after 30 days regardless of whether a successor has been appointed. 
  • Europe:  The agent may not resign until a successor is in place.  Further, if the agent seeks to appoint the successor itself it typically must satisfy a number of preconditions (e.g., successor meets certain ratings or successor is approved by any number of identified parties).  

Are Those Bankruptcy Waivers in Your Intercreditor Agreements Effective?

This post was written by Michael J. Venditto, a partner in Reed Smith's Commercial Restructuring & Bankruptcy department.  A special thanks to Mike for contibuting to the lending lawyer blog! 

If you have negotiated an intercreditor agreement, you are familiar with the lengthy bankruptcy waivers typically drafted by counsel for first-lien lenders.  Intended to take effect if the borrower files a bankruptcy case, these provisions commonly include advance waivers (e.g., of the junior lender’s right to seek adequate protection of its interest in the common collateral), advance consents (e.g., to the priming of the junior lender’s liens by any debtor-in-possession financing provided by the senior lender) and plan support provisions (e.g., an agreement that the junior lender will not support a plan opposed by the senior lender), to name a few in a long list. 

Many of these provisions, in addition to being lengthy, are heavily negotiated.  So, it is appropriate to wonder if they actually work.  There are surprisingly few rulings analyzing these provisions and, to the extent that courts have ruled on their enforceability, the results are mixed.

Section 510(a) of the Bankruptcy Code provides that:

“[a] subordination agreement is enforceable in a case under this title to the same extent that such agreement is enforceable under applicable nonbankruptcy law.” 

Some courts have followed the plain language of the statute and enforced intercreditor agreements according to their terms.  Other courts interpret the statute more narrowly, viewing section 510(a) as applying only to a consensual alteration of the priority of payment amongst creditors but not allowing them to alter the parties’ rights under the bankruptcy laws.  This uncertainty has given second-lien lenders some leverage.  After agreeing to bankruptcy waivers in an intercreditor agreement, they challenge the enforceability of these provisions following the commencement of a chapter 11 case by the borrower.

The problem is illustrated by looking at decisions on bankruptcy voting provisions.  Is a provision that transfers the second-lien creditor’s right to vote to accept or reject a proposed reorganization plan enforceable?  In one heavily cited decision, In re 203 North LaSalle Street Partnership, 246 B.R. 325 (Bkrtcy. N.D. Ill. 2000), a bankruptcy judge said no, ruling that an intercreditor provision giving the senior lender the right to vote the subordinated lender’s claim was not enforceable on the reasoning that it was inconsistent with Bankruptcy Code § 1126(a), which governs class voting.  But, some more recent cases have given effect to these provisions.  In re Coastal Broadcasting Systems, Inc., 2012 WL 2803745 (Bkrtcy. D.N.J. July 6, 2012) held that the assignment of voting rights was unambiguous and its enforcement was “necessary to prevent junior creditors from receiving windfalls after having explicitly agreed to accept less lucrative payment arrangements.”   Using a different rationale, another court found that a voting provision was enforceable because the junior lender had made the senior lender its agent for purposes of voting (see, e.g.In re Aerosol Packaging, LLC, 362 B.R. 43, 47 (Bkrtcy. N.D. Ga 2006), holding that the right to vote any claim in the borrower’s bankruptcy had been assigned to the senior lender with the result that it could vote the claim and take other actions in support of its own interests even if they were potentially contrary to the wishes and immediate interests of the second-lien lender).

Is there a discernable trend toward giving effect to these bankruptcy-voting provisions?  Not really.  Some decisions evidence a sentiment that sophisticated parties should be held to pre-petition agreements that are intended to streamline a chapter 11 case.  See, e.g., Ion Media Networks, Inc. v. Cyrus Select Opportunities Master Fund, Ltd (In re Ion Media Networks, Inc.), 419 B.R. 585 (Bkrtcy. S.D.N.Y. 2009) (“plainly worded contracts establishing priorities and limiting obstructionist, destabilizing and wasteful behavior should be enforced and creditor expectations should be appropriately fulfilled.”).  However, bankruptcy courts are protective of the rights of all parties to be heard and will not enforce bankruptcy waivers unless they are clear.  In re Boston Generating LLC, 440 B.R. 302, 320 (Bankr. S.D.N.Y. 2010) (“Although I believe it goes against the spirit of the subordination scheme in the Intercreditor Agreement to allow the Second Lien Lenders to be heard and to attempt to block the disposition of the Collateral supported by the First Lien Agent, I am … constrained by the language of the Intercreditor Agreement. After extensive briefing and oral argument as well as detailed review of the Intercreditor Agreement, the Court finds no provision which can be read to reflect a waiver of the Second Lien Agent’s right to object ….”).

The case law on the enforceability of intercreditor provisions that go beyond mere lien and payment subordination remains unsettled.  Nevertheless, these provisions are an important element of intercreditor agreements and first-lien lenders will not, and should not, be willing to eliminate them.

Negotiating Forward-Looking MAC Clauses: Addressing Borrowers' and Lenders' Divergent Interests in the Inclusion of "Prospects"

This post was written by Lee Ann Dillon, Abbey Mansfield and Jordan Hook.

Material adverse change (“MAC”) or material adverse effect (“MAE”) clauses in Credit Agreements are used primarily as a condition precedent to closing and all borrowings, and the occurrence of a MAC or MAE may also constitute an event of default.  The MAC definition will also be used to qualify representations and warranties, covenants and other terms in the Credit Agreement.

Though MAC definitions will be negotiated, a typical definition would include: 

“a material adverse change in the business, assets, properties, liabilities (actual or contingent), operations, condition (financial or otherwise) or prospects, of the Borrower, individually, or the Borrower and its Subsidiaries taken as a whole.” 

However, there can be disagreement among parties about whether it is proper to include “prospects” in this context.

Borrowers’ and Lenders’ Divergent Views
From a Borrower’s perspective, the MAC determination should be based upon the business’ actual performance as of a certain date, rather than its projected performance (which may or may not come to fruition).  However, a Lender will want to be protected from prospective (and in some cases inevitable) financial and operational events that may affect the borrower’s ability to repay the loans, even though they have not yet resulted in measurable consequences.
Often, whether or not to include the term will come down to which party has more bargaining power in the deal.

Alternative Considerations for Lenders
When faced with a “powerful” Borrower who is able to negotiate out the word “prospects” from a MAC definition, a Lender may want to consider the following alternatives:

  • Revise the MAC clause to read that “there shall have occurred no event that could or would constitute a material adverse change.”  This language is commonly accepted by Borrowers and also covers the forward-looking idea that would otherwise be covered by “prospects”. 
  • If the loans have a strong enough guarantee (for example, by a strong parent company), a Lender may be comfortable simply relying on the guarantee to cover forward-looking risks.

More on Capital Call Facilities: The European Perspective

This post was written by Abbey Mansfield.

A few months ago we blogged about capital call facilities, including basics, challenges and opportunities from a U.S. law perspective.  As noted in that post, capital call (aka "subscription" or "equity bridge") facilities have garnered attention recently due to their strong performance in the wake of the financial crisis.

Today, we are happy to offer the European perspective on these facilities, provided by our London colleague Leon Stephenson.  In an article (which you can download here) which first appeared in the January edition of Butterworths Journal of International Banking & Financial Law, Leon highlights five key differences between capital call facilities and typical bilateral corporate facilities (based on the Loan Market Association (LMA) documentation).  Thanks for the great information, Leon!

Heads I Win, Tails You Lose? Bitcoin as Collateral is Not a Good Bet

This post was written by Jonathan W. Riley.

For lending lawyers and commercial lenders who have been wondering what the recent fuss over “Bitcoin” is all about, and what, if any, value Bitcoin has as collateral, today is the day you’ll get your answer. 

Bitcoin is an online medium of exchange which permits buyers and sellers to interact anonymously to facilitate instantaneous payments for goods and services, without the involvement of a third party. The Bitcoin currency network has a decentralized structure, subject to very little government oversight and free of the control of any particular entity or person.

Bitcoin is typically stored on a user’s personal computer or in cloud based accounts called “wallets.” However, Bitcoin wallets do not meet the UCC’s definition of a deposit account as they are not maintained with a bank. Further, Bitcoin wallets are not insured by the FDIC.

There are a handful of reasons why Bitcoin might be attractive to existing and potential commercial lending customers. Fees in connection with Bitcoin transactions are minimal in comparison to credit card fees. Bitcoin platforms do not allow chargebacks (i.e. Bitcoin transactions are irreversible). Bitcoin transactions are typically confirmed within an hour while payments made with credit cards can take 2-3 days to be credited to a merchant’s account.

Despite its appeal to customers, there are several reasons for lenders to be wary of accepting Bitcoin as collateral. Some primary concerns are as follows: 

  • Bitcoin’s value has been extremely volatile historically. The worth of a user’s Bitcoin holdings can decrease sharply and could even drop to zero;
  • Bitcoin wallets are subject to cyber-attacks; the entire contents of a wallet account can be wiped out by hackers;
  • Bitcoin’s anonymity makes it an appealing method of funding criminal activity (e.g. money laundering). Such activity could lead to law enforcement agencies closing exchange platforms and preventing access to and use of Bitcoin collateral;
  • Bitcoin investments may result in adverse tax consequences to users, such as value added tax or capital gains tax;
  • Bitcoin wallets, as mentioned above, are not deposit accounts under the UCC. This means Bitcoin collateral must be treated as a general intangible and perfected with a UCC-1 financing statement rather than through control. A control agreement is preferable to a UCC-1 because it evidences the prior agreement between the lender and the user’s bank to permit the lender to access and remove funds upon an event of default; and
  • Bitcoin’s future is uncertain. While there is currently little oversight, there have been calls for heavier restrictions or the elimination of virtual currencies like Bitcoin altogether.

The preceding concerns clearly indicate that any lender who accepts Bitcoin as collateral for a loan is taking a substantial risk that the value of this collateral will be lost or greatly diminished. However, given the rapid appreciation of the price of Bitcoin over the last several months, it might be difficult for lenders to simply refuse to take it as security. As such, it is important that lenders conduct client specific due diligence on Bitcoin assets in order to make the most informed credit decision possible.

Avoiding the Unintended Tax Consequences of Foreign Subsidiary Pledges and Guarantees: A Look at Deemed Dividends in U.S. Loan Transactions

This post was written by Carol Burke and Jordan Hook with assistance from Abbey Mansfield .

Overseas Shipping Group (“Overseas”) recently sued its former attorneys, a prominent New York-based law firm, for legal malpractice in drafting credit agreements that resulted in the company incurring an estimated $463 million in tax liability. The suit alleges that the tax liability arises from the fact that the credit agreement holds two foreign subsidiaries jointly liable with their American parent, Overseas. This suit raises an important question: under what circumstances will a foreign subsidiary’s income be subject to tax liability in the United States as a result of being a party to a credit agreement with their U.S. parent?

Section 956 of the Internal Revenue Code (“Section 956”) was enacted in 1962 to prevent a U.S. parent company from avoiding tax liability while implicitly receiving the benefit of the income of their controlled foreign subsidiaries (“controlled foreign corporations” or “CFCs”). Prior to the enactment of Section 956, a CFC’s profits and earning were only subject to taxation in the U.S. at the time they were repatriated as dividends to the U.S. parent. Under Section 956, however, investments made by CFCs in specified “United States property” are considered to be a constructive dividend and subject to U.S. taxation. A CFC’s earnings and profits are considered a constructive or deemed dividend subject to U.S. taxation if the subsidiary is the “pledgor or guarantor” of its U.S. parent’s debt obligations.

Section 956 in U.S. Loan Transactions:
A CFC is deemed to have made a taxable dividend in the context of a U.S. loan transaction if (i) its U.S. parent pledges two-thirds or more of the voting power of the CFC as security, (ii) the CFC provides an upstream guarantee of the obligations of its U.S. parent, (iii) the CFC grants or pledges its assets to secure the obligations of its U.S. parent or, as illustrated by the recent suit brought by Overseas, (iv) the CFC is jointly and severally liable for the obligations of its U.S. Parent (which will be deemed an “upstream guarantee” under Section 956). Given the general federal corporate income tax rate of 35%, this can have serious consequences for companies not planning to pay taxes on those deemed dividends.

Suggestions in dealing with a potential “deemed dividend” problem:
When negotiating a U.S. loan transaction, Borrowers and their counsel must consider issues raised by Section 956, and consider practical solutions to avoid paying taxes on deemed dividends, some of which are identified below:

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Commercial Restructuring and Bankruptcy Newsletter: Helpful Information for Lenders!

This post was written by Abbey Mansfield.

Reed Smith's Commercial Restructuring and Bankruptcy (CRAB) attorneys recently released their December 2013 newsletter covering issues in the restructuring and bankruptcy field, many of which are relevant to lenders (with one in particular noted  below).  The full newsletter is available here.

Included in the newsletter are the following topics:

  • Detroit Gets a Fresh Start and Pension Debt is at Risk
  • UK Supreme Court Finds Certain Pension Liabilities Are Not Entitled to Priority Treatment, in Nortel and Lehman Decisions
  • Amount of Credit Bid Must Be Included in Calculation of Quarterly Fee
  • Delaware Chancery Court Evaluates ‘Public, Commercially Reasonable’ Foreclosure Sale Under UCC
  • Parent Obligor Can Pledge Subsidiary’s Collateral with Subsidiary’s Knowledge and Consent
  • Lender’s Use of Debtor’s Valuation Judicially Estops Lender from Making Value Objection
  • Bondholders Bound by ‘No Action’ Clause in Unitranche Financing Documents

Secured lenders may be especially interested in the topic bolded above, in which Christopher Rivas discusses a recent Third Circuit case which held that, under the California UCC, a parent company can pledge as collateral the deposit account of one of its subsidiaries, with the subsidiary's knowledge and consent, even though the parent obligor pledging the collateral did not have legal title to the account.

Thanks to our CRAB colleagues for compiling this helpful information!