What now for banks in the physical commodities sector?

By Theano Manolopoulou and Carol M. Burke

Banks play an important business role in the physical commodities sector by providing the much needed access to capital and related risk management, including through:

• extension of credit;
• project finance;
• market making and liquidity;
• risk management and hedging; and
• fostering competition.

These services are especially important to small and medium-sized companies that do not have the in-house cash flows, expertise or risk management capabilities of their larger competitors.

However, banks operate under a complex and more rigorous regulatory framework than companies that extract and refine natural resources and distribute energy. In the US, banks and financial holding companies (“FHCs”) are subject to oversight by: a) the Board of Governors of Federal Reserve System (the “Federal Reserve”); b) the Securities and Exchange Commission; c) the Commodities Futures Trading Commission; and d) most importantly, the “Court of Public Opinion”. The legal authority for banks and FHCs to engage in physical commodities activities that are “complementary to a financial activity” is derived from the Gramm-Leach-Bliley Act of 1999, which amended the U.S. Bank Holding Company Act of 1956 to expand the permissible business activities of FHCs.

Critics claim that physical commodities activities by FHCs pose a risk to the safety and soundness of depository institutions or the financial system generally. Recent catastrophic events have increased concerns on the ability of banks to shoulder the high costs and liabilities that result from major energy disasters such as Deepwater Horizon and the San Bruno, California pipeline explosion.

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Make Whole Provisions in Bankruptcy

This post was written by Sarah K. Kam.

Loan agreements and bond indentures often contain "make-whole" provisions, which provide yield protection to lenders and investors in the event of a repayment prior to maturity. They accomplish this by requiring the borrower to pay a premium for pre-payment of a loan. This allows lenders to lock-in a guaranteed rate of return when they agree to provide financing. Borrowers also benefit since the yield protection allows lenders to offer lower interest rates or fees than they would absent such protection.

As contractual provisions, lenders and investors expect make-whole provisions to be enforceable according to their terms. But, what happens if the borrower files a bankruptcy petition?

Recent Decisions

In the current low interest rate environment, the enforceability of make-whole provisions in bankruptcy has been the subject of litigation as debtors have sought to refinance higher-interest debt, and lenders and investors seek to maintain their contractual rates of return. This litigation has recently produced several decisions about the lender's entitlement to early termination premiums.

The basic issues regarding the enforceability of make-whole provisions were addressed by a Delaware bankruptcy judge applying New York law in In re School Specialty, Inc., No. 13-10125, 2013 WL 1838513 (Bankr. D. Del. Apr. 22, 2013). The court held that a make-whole provision was an enforceable liquidated damages provision which satisfied the reasonableness standard under Bankruptcy Code § 506(b), even though it amounted to 37% of the outstanding principal balance of the loan. The court also rejected an argument by the creditors' committee that the payment constituted unmatured interest, which would not be allowable under Bankruptcy Code § 502(b)(2). Critically, the loan agreement provided that the debtors were required to pay an "Early Payment Fee" upon either prepayment or acceleration of the loan.

Several subsequent decisions have found that acceleration-upon-default provisions did not trigger prepayment obligations.

In Bank of NY Mellon v. GC Merchandise Mart, LLC (In re Denver Merchandise Mart, Inc.), 740 F.3d 1052 (5th Cir. 2014), the Fifth Circuit ruled that, under Colorado law, acceleration of a note due to the borrower's pre-petition default did not trigger the prepayment obligation, since the note's plain language did not require the borrower to pay prepayment consideration absent actual prepayment and there was no language in the note equated acceleration with prepayment.

In In re AMR Corp., 730 F.3d 88, 98-105 (2d Cir. 2013), the Second Circuit, applying New York law, held that the Chapter 11 debtors' obligations under an indenture had been accelerated automatically as a result of their bankruptcy filing and, therefore, the repayment of the debt was in the nature of post-maturity-date repayment, rather prepayment. By the express terms of the indenture, the repayment did not trigger their obligation for a "make-whole" payment, even though the payment was made voluntarily so that the collateral could be released and pledged to a post-petition lender. More recently, a New York Bankruptcy Judge, following the Second Circuit's reasoning, observed that the credit documents must contain express language that clearly triggers a pre-payment premium upon acceleration. In re MPM Silicones, LLC, No. 14-22503 (Bankr. S.D.N.Y. Sept. 9, 2014) (bench ruling).


Bankruptcy law only requires that a make-whole provision be "reasonable." Aside from that overlay, bankruptcy courts will enforce make-whole provisions in accordance with the applicable state law; but, they will be strictly interpreted particularly if they do not clearly provide for consideration to be paid upon an acceleration of the debt. For example, New York provides that the parties can contract for a right of the borrower to prepay the debt in return for an agreed consideration which compensates the lender for the early termination of the stream of interest payments. Without that contractual option, the New York rule of perfect tender would preclude early payment. But, the lender forfeits the right to the pre-payment consideration if the lender accelerates the loan unless the loan documents contain "a clear and unambiguous clause" that requires the payment even in the event of acceleration. See In re MPM Silicones, LLC, supra.

Thus, the lender's right to its make-whole premium hinges on whether the relevant provisions of their notes or loan documents provide, with sufficient clarity, for the payment of such premium after the maturity of the notes has been accelerated. Drafters should ensure that make-whole provisions (i) have a clear trigger for the payment and (ii) expressly provide that it is payable upon any early payment, regardless of whether it is the result of acceleration or enforcement actions taken by the lender.

What's in a Name? Amendments to the Uniform Fraudulent Transfer Act

This post was written by Jonathan Korman and Laura Amato.

On July 16, 2014, the Uniform Law Commission (the “Commission”) approved a series of discrete amendments to the Uniform Fraudulent Transfer Act (the “UFTA”) and renamed it the Uniform Voidable Transactions Act (the “UVTA”). The UVTA is intended to address inconsistency in the courts, better harmonize with the Bankruptcy Code and the Uniform Commercial Code (the “UCC”), and provide litigants with greater certainty in its application to a fraudulent transfer action. While the amendments are not intended to completely overhaul the UFTA, there are three categories of noteworthy updates, each highlighted below.


Under the UFTA, a “fraudulent transfer” exists when a debtor transfers property to a third party with the intent to hinder, delay or defraud its creditors, or, if the debtor was insolvent at the time of the transfer, the debtor received less than reasonably equivalent value for such property. The UFTA, as adopted by the individual states, provides a remedy for creditors against such third-party transferees by allowing a fraudulent transfer to be “voided” and treated as if it never happened. Consequently, the value of the property is returned to the debtor or its estate.

Evidentiary Matters

One difficulty in applying the UFTA has been how a creditor proves that a debtor undertook a fraudulent transfer. Absent an admission of wrongdoing by the debtor, a creditor must prove either that the debtor intended to defraud creditors by demonstrating one or more so-called “badges of fraud” (e.g., that the transfer was made to a family member, the debtor actually retained control and enjoyment of the property, or that the debtor transferred substantially all of its assets) or, in the alternative, that the debtor was insolvent and did not receive reasonably equivalent value for the property transferred or benefit for the obligation undertaken. In contrast to what the UVTA’s former name might suggest, a showing of actual fraud under either of these circumstances is not required at all, nor was it ever intended to be. Nonetheless, the misnomer led to confusion in the courts, some of which have applied the higher “clear and convincing” evidentiary burden typically associated with civil actions based in fraud.

The UVTA addresses this confusion by providing greater clarity with respect to the evidentiary requirements for a voidable transaction claim. In addition to replacing the word “fraudulent” with the word “voidable”, the UVTA clarifies the standard of proof for a voidable transaction and the burden of rebutting the presumption of a debtor’s insolvency.

The UVTA now explicitly states that the creditor-claimant has the burden to establish the elements of its claim by a preponderance of the evidence, and not the higher clear and convincing standard. Furthermore, the Commission’s official comments warn that courts should not alter the allocation of the burdens or apply any non-statutory presumptions to avoid upsetting the uniformity of the UVTA.

While the burden of proof remains with the creditor, the UFTA has historically provided a rebuttable presumption that a debtor is insolvent if it fails to pay to debts as they come due. The UVTA refines this presumption in two meaningful ways. First, the UVTA clarifies that any nonpayment of debts that are the subject of a “bona fide dispute” are not presumptive of insolvency. This qualification is consistent with the intent of the original meaning of the UFTA as well as the Bankruptcy Code (11 U.S.C. § 303(h)(l)). Second, the UVTA expressly states that the burden to rebut this presumption falls on the debtor, conforming to the treatment of rebuttable presumptions in the Uniform Rules of Evidence. The Commission’s official comments indicate that this clarification is also consistent with the original intent of the UFTA.


The UFTA has historically protected transfers that resulted from the enforcement of a security interest in accordance with Article 9 of the UCC. However, the UVTA carves out “strict foreclosures” from this defense to a voidable transaction action. A “strict foreclosure” is one in which a debtor, post-default, consents to the secured party accepting collateral in full or partial satisfaction of the obligations secured by the collateral, without a public sale or judicial foreclosure. Strict foreclosures are attractive to secured creditors because of their lower transaction costs as compared to a judicial foreclosure or public sale.

Following the lead of California, Connecticut, and Pennsylvania versions of the UFTA, the drafters of the UVTA determined that, unlike other creditor remedies provided in Article 9 of the UCC, strict foreclosure operates as the functional equivalent of a voluntary transfer to a third party and should accordingly be voidable under the UVTA. Although strict foreclosures are no longer automatically protected under the UVTA, a creditor may still show that a foreclosure sale was conducted in good faith and in a commercially reasonable manner to shield its claim to the collateral from other creditors.

Choice of Law

The issue of which state’s law should apply is often an intensely litigated issue (even before the commencement of litigation of the substantive voidable transaction claim) because fraudulent transfer laws vary among the states in several respects. For example, California has a seven year statute of limitations for a fraudulent transfer claim (Cal. Civ. Code § 3439.09), while Delaware’s statute of limitations is four years (Del. Stat. Ann. § 1309), and Virginia has no statute of limitations whatsoever, instead relying only on the common law doctrine of laches to determine if claims are stale (See Bartl v. Ochsner (In re Ichiban, Inc.), No. 06-10316-SSM, 2007 WL 1075197 (Bankr. E.D. Va. 2007)). The UVTA dispenses with the choice of law issue by including a governing law rule that is largely consistent with that of Article 9 of the UCC, applying the law of the debtor’s residence at the time that the transfer was made (i.e., for individual debtors, the person’s state of residence, and for businesses, the state in which its business is conducted or, if business is conducted in more than one state, the place in which the business had its chief executive office) to claims under the UVTA. One important distinction between the UVTA and the UCC is that under the UCC, the location of a business that is a “registered organization” (as defined in the UCC) is always its state of organization, which may not be the state in which its business is conducted or the place of its chief executive office.


Overall, the UVTA harmonizes with the Bankruptcy Code, UCC, and the Uniform Rules of Evidence, should promote better uniformity across secured lending and bankruptcy practices, and provides better guidance to both the courts and litigants about how avoidance actions should be adjudicated. It is important to note, however, that the UVTA does not have an automatic effective date and each state’s legislature may (or may not) adopt the changes made by the UVTA, as desired. Currently, most states have adopted a version of the UFTA (including California, Delaware, the District of Columbia, and Pennsylvania), whereas some states (including New York and Maryland) still apply the Uniform Fraudulent Conveyances Act (the predecessor to the UFTA). While the UVTA’s revisions have the potential to meaningfully affect fraudulent transfer claims, the full impact of the UVTA will not be known until it is adopted and implemented.

What Happens to Your Collateral During a Bankruptcy?

This post was written by Michael J. Venditto and Sarah K. Kam.

Lenders and their attorneys are conditioned to believe that being over-secured is as good as life gets for a creditor.  Lenders want to secure repayment with collateral that is valuable and liquid, while their attorneys ensure that the security interest is properly perfected.  But, post-closing confidence in a job well done can quickly evaporate if the borrower files a bankruptcy case intending to sell the collateral. 

Is it true that a debtor can sell collateral without the lender’s consent?   Yes, under the Bankruptcy Code it can be done ‒ even if the collateral is sold for less than the amount of outstanding debt.  So, a secured creditor must be proactive if a distressed borrower tries to sell the collateral in a bankruptcy. 

How Can This Happen?
Section 363 of the Bankruptcy Code authorizes a bankrupt entity to sell all, or part, of its assets.  Sales in the ordinary course of business do not require bankruptcy court approval, while sales outside the ordinary course require both a hearing and court approval. 

To determine whether a transaction is in the ordinary course of business, bankruptcy judges usually apply one of two tests.  The first is an objective standard, sometimes called the horizontal test, which looks at the debtor’s industry to determine if the sale is the type of transaction conducted by other businesses in the ordinary course.  The other is a subjective test, sometimes called the vertical test, which looks at the expectations of creditors (i.e., whether the transaction subjects creditors to different economic risks from those which the creditor accepted and could reasonably anticipate) when extending credit.  For example, if the collateral is inventory, it can be sold in the ordinary course on customary terms, in which case the resulting proceeds of sale might constitute restricted cash collateral (but, that is an issue for a different article).  However, if the debtor proposes a bulk sale of a substantial portion of its inventory, that transaction would be outside the ordinary course of business.

On the other hand, asset sales that are outside of the ordinary course of business, including the sale of all or a significant portion of a debtor’s assets, require notice to interested parties and advance approval by the bankruptcy court.  In considering a proposed sale transaction, bankruptcy courts generally are concerned with (i) the process and (ii) the result.  If a debtor conducts a fair and impartial sale process, the courts usually defer to the debtor’s business judgment in deciding whether to approve a sale.  Once the sale is approved by the bankruptcy court, section 363(m) of the Bankruptcy Code provides that any reversal or modification of the sale approval will not affect the validity of the transfer.  This forces a creditor who wants to appeal the bankruptcy court’s decision to obtain a stay pending appeal.  If the sale approval is not stayed, any appeal from the bankruptcy court’s order will be moot.

Selling “Free and Clear” of Liens
One of the chief benefits of a bankruptcy sale is section 363(f) of the Bankruptcy Code, which gives the debtor the ability to strip liens from sale assets.  Debtors routinely use this statute to sell their property “free and clear” of liens.  Section 363(f) allows a debtor to sell property free and clear of any third-party’s interest in such property if one of five conditions can be satisfied:  (1) sale free and clear of the interest is permissible under nonbankruptcy law; (2) the creditor consents; (3) if the interest is a lien, the property is sold for a price greater than the aggregate amount of all liens; (4) the interest is in bona fide dispute; or (5) the third-party “could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.” 

Under this provision, the debtor is able to sell an asset free and clear of an undisputed lien only if the sale is at a price that exceeds the amount of the lien.  This provides lenders with relatively little protection, however, since the value of a lien cannot exceed the value of the collateral (in other words, if the claim is greater than the value of the perfected interest in the collateral, the excess portion of the claim is unsecured).  Unless the lender is able to demonstrate that the sale is at a price below asset value, the debtor should be able to sell the asset free and clear of the lender’s lien.

However, all is not lost since the Bankruptcy Code provides lenders with some tools to protect their interests, including the ability to “bid up” an inadequate sale price.

The Right to Credit Bid
To protect an interest in collateral that is offered for sale, the Bankruptcy Code gives a creditor the right to “credit bid” (i.e., bid debt rather than cash) up to the full amount of its claim. The threat of a lender’s credit bid is designed to keep prospective bidders honest: a low ball offer could induce the lender to enter into a bidding contest.  That assumes, of course, that the secured creditor prefers to acquire the collateral in exchange for cancellation of some, or all, of the debt.  The lender might prefer this to a short sale if the lender can achieve a greater return of value on the collateral than the debtor.  But, lenders ordinarily do not want to own the collateral.  The Bankruptcy Code does provide such lenders with an alternative means of protecting their interests, although the benefits are often illusory.

Requesting Adequate Protection
A secured creditor who is proactive can seek “adequate protection” of its collateral interest.  Adequate protection is a concept that is used, but not defined, in the Bankruptcy Code.  It is almost universally accepted to require that a debtor provide some economic protection for the secured creditor’s interest in the collateral, pending the resolution of the bankruptcy case.   Section 361 of the Bankruptcy Code provides some examples what forms of protection might be adequate.  In the context of a sale, one form of adequate protection might be granting the creditor a replacement lien on the sale proceeds.  This replacement lien must attach to the proceeds in the same order and priority as the pre-sale interest in the collateral to ensure that the lender receives the indubitable equivalent of its pre-sale interest in the collateral. This takes us full circle back to a free and clear sale under section 363(f) and the issue of valuation, which was mentioned above.

What is My Collateral Worth?
Valuation has been characterized by some judges as nothing more than “guesstimating.”  This is more than a tacit admission that litigating valuation issues in a bankruptcy case can be problematic for several reasons.  First, during the course of a bankruptcy, there may be different reasons to value an asset and the lender’s interest will vary, depending on the circumstances.  In fact, section 506(a) of the Bankruptcy Code acknowledges this vagary; it provides that value should be determined in light of several factors, one of which is the purpose of the valuation.   For example, a higher value may have the salutary effect of increasing the amount of a secured claim, while a lower value would better support a request for either adequate protection or relief from the automatic stay.

Whatever the purpose, bankruptcy courts are accustomed to adjudicating the value of assets.  Nevertheless, these issues arise in contexts that are overlain with input from competing constituencies that are distinct from the lender’s concerns.  Moreover, circumstances often require a valuation determination in a timeframe that makes it difficult to engage and prepare the needed valuation experts.

For all of these reasons, the outcome of a valuation litigation can be unpredictable.   One party will ask for a higher valuation, the other will seek a lower valuation, and each will offer evidence in support of its position.   As often as not, the court comes up with a third value based upon its own reasoning.   Simply put, valuation is unpredictable, imprecise and discretionary.  But as demonstrated above, it is vitally important to secured lenders, since it controls their rights in bankruptcy and ultimately will affect their prospects for recovery.

Your Take-Away
Bankruptcy is a frustrating experience for lenders, even when they are fully perfected.  When a borrower enters bankruptcy, the lender’s ability to realize the full benefit of the protections that are negotiated on the front-end of the transaction will be put to the test.  To avoid being swept along, the lender and its counsel must be diligent and actively engaged.

Distressed Over Eligible Assignees: Who's In, Who's Out in Meridian Sunrise Village

 This post was written by Jonathan Korman and Bart Cicuto.

A recent decision out of the U.S. District Court for the Western District of Washington will be of interest to both lenders and borrowers of loans that are expected to be traded. In Meridian Sunrise Village, LLC v. NB Distressed Debt Investment Fund Limited, hedge funds found themselves excluded from the definition of "Eligible Assignee" under a loan agreement when the Court narrowly interpreted the meaning of "financial institutions" to exclude a distress debt fund. The Court equated "financial institutions" with "entities that make loans" rather than any entity that manages money, such as a hedge fund, ultimately resulting in the fund’s inability to vote for a Reorganization Plan.

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A $1.8 million Drafting Lesson

This post was written by Svetlana Atestatova and Yvonne Pham.

In a typical case of distressed borrower where the lender was left holding the unpaid debt bag,  the Fifth Circuit Court of Appeals chimed in on the hotly debated and litigated prepayment premiums litigation. In re Denver Merchandise Mart, 740 F.3d 1052 (5th Cir. 2014).  The lender was secured, with the accelerated $24 million note and the alleged prepayment penalty of $1.8 million. Not outrageous considering it was 7.5% of the outstanding principal whereas other courts enforced a 37% prepayment premium in In re School Specialty, 2013 WL 183851, at *2 (Bankr. D. Del. April 22, 2013) So why did the court send the lender home without a prepayment penalty? and 25% in In re Financial Center Associates of East Meadow, L.P., 140 B.R. 829, 839 (Bankr. E.D.N.Y. 1992).

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Alternative Lenders - The Small Business Loan Landscape

This post was written by Angela Angelovska-Wilson

There is no shortage of reports that indicate that small business financing has been one of the hardest hit segments during the financial crisis.  Specifically, the Cleveland Fed noted that in the years between 2007 and 2012, small business lending declined 78%.

Obviously, there is a myriad of reasons for the extreme drop in small business lending during the Great Recession.  Even today, traditional bank lenders see small businesses as less attractive and more risky borrowers than they used to be prior to the financial crisis. Fewer small business owners have the cash flow, credit scores, or collateral that bank lenders are looking for.  This gap has opened up an opportunity for non-bank, online financial services companies commonly referred to as "Alternative Lenders" that are aggressively pursuing many of the small business customers traditionally served by banks. 

Alternative Lenders rely on technology for receiving and processing applications and are mining Yelp, Facebook, Twitter and other social-media data to help identify a borrower, to determine a borrower's creditworthiness and to quantify a borrower's propensity to repay.  Typically the application process and the decision have a very quick turnaround, from just a few hours to only few days.   


Industry analysts have estimated that about two dozen Alternative Lenders — including OnDeck Capital Inc., Kabbage Inc. and CAN Capital Inc.— lent about $3 billion collectively in 2013, double the 2012 total. 

Traditional bank lenders are taking note of this trend and are learning how to deploy technology in their own small business lending operations.  Even Fair Isaac Corp. has publicly stated that it is weighing possibilities for incorporating social media in credit scoring.  However the use of social media analytics is a trend that is raising serious concerns among consumer groups and regulators.    

The alternative lending space is certainly heating up, more players are entering the market, existing companies are growing fast and investors are placing their bets.  Many of these companies could be interesting acquisition targets for traditional banks.  Most importantly, let’s not forget that traditional lenders have a clear-cut competitive advantage over Alternative Lenders – much lower cost of capital.  Of course, even Alternative Lenders are not without competition, today’s small business owners can also turn to crowdfunding, peer-to-peer lending, microlending, and other options for financing of their operations and dreams. 

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.