Lending Law Report : Corporate Finance Lawyer & Attorney : Reed Smith Law Firm : Lending Transactions, Secured Investments

This post was written by Svetlana Attestatova, a member of Reed Smith's financial industry practice group, addressing several intellectual property issues that have come up in our deals recently.  

Sometimes we get rather technical questions, and this post responds to one of those: if the collateral for your loan includes patents, trademarks or copyrights ("IP"), read on.

Searches.  In addition to regular lien searches, you may want to run specific IP searches on your borrower and guarantors, especially if valuable IP is part of your collateral.  A search will confirm who the owner of the IP is, and will reveal the existence of other liens.  If IP is central to your deal, beware of the timing gap issues discussed below and consider running some additional post-filing searches after the applicable time period lapses.

Disclosure Schedules.  Accurate schedules listing the IP are important -- and sometimes difficult to obtain.  The underlying representations in the credit and security agreements will determine what should be disclosed on the schedules.  Sometimes the list is limited to registered U.S. IP; other times, it is limited to material IP.  The schedules and your search results should be reconciled.

How to Perfect.  The steps required to perfect your security interest in IP vary for different types of IP.  We will spare you the extensive legal explanation here and just say that the preferred practice is to file a UCC-1 financing statement (as you typically would for most other collateral) and also to file a short-form security agreement with the U.S. Patent and Trademark Office for patents and trademarks, and with the U.S. Copyright Office for registered copyrights.  The short-form agreement is prepared solely for the purpose of making these filings and does not include the covenants and other detailed terms that would appear in the more comprehensive security agreement for the deal.  Even though a PTO filing may not be absolutely required for perfection of patents or trademarks, it is advisable in order to help protect your interests against a good faith purchaser of a patent or trademark.  However, please note that unlike patents and trademarks, a Copyright Office filing is required for perfection of your interest in registered copyrights.  As always, it is critical to get the collateral description, the IP identifying marks and other necessary  information right on these filings.

Timing Gap Issues. One potential timing gap issue arises when there is a discrepancy between the closing date and the date through which the searches have been run.  This is purely an issue of the PTO and Copyright Office records being up to date.  A longer gap in time here increases the likelihood of things being missing from the search results.  A second timing gap issue is the grace period provided by both the PTO and Copyright Office that permits an assignment that was signed before your security agreement filing but unrecorded at the timing of your filing to trump priority of your recorded filing, as long as the competing assignment is recorded within the grace period (even if recorded after your filing). This grace period is three months for patents and trademarks and one month for copyrights.  To help with this issue, the lender would usually receive representations from the borrower that  no competing assignments have been granted.  Post-closing searches should reveal the existence of any of these filings.

Other IP; Special Cases. “Intent-to-use” trademarks deserve a special mention.  Although a security interest can be taken in this type of IP, you should be aware that foreclosure may be problematic until the mark has been put to use in commerce and there is goodwill associated with it.  If the collateral includes mask works, you'll want to make both Copyright Office and UCC filings.  For trade secrets, UCC filings are advisable.  And, generally, if you have other unusual (and valuable) IP collateral -- for a company that develops software, or where software is embedded into machinery with accompanying accounts receivable, for example -- consult with counsel to be sure you are properly perfected.

After-Acquired IP. The credit or security agreement will usually require the borrower to deliver periodic updates listing any newly acquired or registered IP (including a requirement to inform the lender as soon as an unregistered copyright became registered).  UCC-1 filings can be structured to effectively cover after-acquired assets in the initial filing, but new filings with the PTO or the Copyright Office will be needed to cover each additional IP item.

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By now many of you will have heard about the recent decisions in the TOUSA (pdf) bankruptcy case.  There are several other write-ups out there that cover the many important elements of this case in detail, but here I wanted to just say a few words about one issue of significance to senior secured lenders.  The question of whether subsidiaries can properly guarantee a loan made to the parent company (without it being a fraudulent conveyance) sometimes comes up in loan transactions, and having an understanding of the issues here can be really helpful. 

You'll recall that the TOUSA case is about fraudulent conveyances.  As explained in our last post, in simple terms, a bankruptcy court can void (and claw back) payments made if the debtor was insolvent at the time of the transaction and if it received less than "reasonably equivalent value" for what it gave up in the deal.  Setting aside the question of solvency, then, here's our issue:

QUESTION:  If a subsidiary of the borrower guarantees the loan (and/or provides a lien or other support), do you have to show that the subsidiary received some of the proceeds of the loan in order to demonstrate that it got "reasonably equivalent value" in the transaction? 

SHORT ANSWER:  No.  Reasonably equivalent value can be received through intangible and indirect benefits as well as by direct benefits such as cash proceeds.  

The court in the TOUSA case explained that you can take a relatively broad view of what constitutes "value."   In TOUSA, the company's subsidiaries became co-borrowers on the loan and provided liens on their assets.  The loan proceeds were used to pay off a significant liability.  The court found that the subsidiaries had received value in exchange for this because they had received "indirect economic benefits" from the loan.  The benefits were, among other things, "the opportunity to avoid default, to facilitate the enterprise's rehabilitation, and to avoid bankruptcy, even if it proved to be short lived" (here, the companies ended up in bankruptcy anyway).  The court clarified that it is not just cash, but all kinds of interests in property -- including intangible things like "promises to act or forbear to act" and indirect or contingent benefits -- that can be considered.  

But was the value "reasonably equivalent" to the property rights that were transferred?  In this case, yes.  A "legitimate and reasonable" expectation that default could be avoided and the enterprise strengthened by the transaction can be enough value.  For the TOUSA subsidiaries, absent the loan transaction, there was a realistic risk that the companies would not have been able to continue to survive.  The value to the companies was their ongoing existence, and the court found that this met the standard for being reasonably equivalent to what they gave up in the deal.  It was not necessary to quantify the benefits and determine a precise dollar valuation in order to come to this conclusion. 

Of course, as with all things legal, the analysis can get rather complex and the conclusions will vary depending on the facts at hand (full disclaimers, no promises, your results may vary, don't try this at home, etc.).  A takeaway from the TOUSA case is that you can look at a lot of different things when considering if there was value received -- and showing that there was "reasonably equivalent value" may not be quite as difficult as it sometimes seems.

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This post, by my colleague Svetlana Attestatova, follows up on our last post on this topic.  Last time, we pointed out that it's often the case that a borrower can certify that it's not in default (and can borrow money) if the quarter has not yet ended and there is still enough time for the company's performance to improve.  This post describes the cautionary tale of a case that went the other way -- where the court found that the borrower should not have certified that it wasn't in default, even though the quarter had not yet ended.

In our last post, we talked about the borrower making "no default" representations in borrowing notices.  In this post, we would like to tell you a bit more about an important case on this topic -- The Chase Manhattan Bank v. Motorola, Inc. (pdf).  That case highlighted the factors and processes to be considered when deciding whether to certify to no default, and, because of some unusual circumstances, came to a different conclusion than might normally be reached.

First, a bit of background.   The borrower in this case had entered into an $800 million bridge facility with a syndicate of lenders.  The collateral package included the borrower's pledge of a Memorandum of Understanding ("MOU") that it had received from its former parent company.  (Several years earlier, the parent company had created this company and spun it off, but continued to maintain and operate a network for it.  Under the MOU, the former parent company agreed to provide up to $300 million to the borrower to support its loan obligations.)  The credit documentation executed in favor of the lenders required the former parent company to make the cash infusion required under the MOU upon the occurrence of a triggering event -- i.e., an event of default under the loan, or the failure of the borrower to achieve certain financial targets.  Conversely, the former parent company's obligations could be released and terminated if things were going well -- and if the borrower certified to the lenders that there was no default, that it had met certain requirements for its network systems, and that it had obtained committed funding to meet projected costs.  The borrower determined that these conditions had been met and delivered this certificate 17 days before the next test of the financial targets (the non-performance of which would have triggered a requirement for the former parent company’s performance of the MOU obligations).  The lenders accepted the certificate and agreed that the former parent company could be released from its obligations.  Seventeen days later, as of the financial covenant test date, the borrower failed to meet its financial covenants.  Indeed, the borrower's business continued to decline, and it filed for bankruptcy a few months later.

The lenders demanded reinstatement and performance of the former parent company's obligations, questioning the borrower's good faith in issuing the certificate and saying that they considered the certificate to be materially inaccurate.  The former parent company claimed that its obligations terminated when the lenders accepted the certificate from the borrower.  

The court sided with the lenders and emphasized several facts.

Impossibility.  First, the gap between the required revenues as of the financial covenant test date and the actual revenues for the borrower around the time the certificate was issued was 25 times.  With a gap like that, the court found that the borrower simply could not have achieved the required revenues.  In addition, the court found that the borrower could not have met the other requirements under the credit agreement to maintain its systems in line with projections (the needed equipment was substandard and unavailable, and the distribution channels were inadequate).  Unlike the situation we see more often, where there may still be a reasonable possibility of meeting the covenants by quarter end, the court found that conditions existing at the time this certificate was delivered would inevitably have become events of default under the loan agreement.

Lack of Good Faith.  Second, the court thought that management’s behavior was problematic. The court found that the borrower's CFO failed to perform significant due diligence to determine whether it could make the required representations, while knowing that the actual results were substantially below targets -- and to the court this showed lack of good faith.  

Voluntary Certification; Not a Borrowing Notice.  Third,  the court noted that the borrower was not obligated to issue the certificate, but merely exercised its right to do so in order to terminate the former parent company's obligations.  Arguably, this situation is somewhat different from a borrower that has to draw on a revolving line of credit to stay in business.

The lessons learned from this case are the three "D's": due diligence, documentation and disclosure.   This case serves as a reminder that if the borrower’s performance is substantially short of targets, significant due diligence should be done - and documented - to confirm the borrower’s ability to comply with its financial covenants at the future test date.   Due diligence and documentation are even more critical in the case where a borrowing notice is given after the quarter end but before the financial statements are delivered, because the covenants are tested as of the (earlier) quarter end date and the financial statements "speak" as of the quarter end.  In that case, the company should consider whether it would benefit from disclosing the possibility of default to the lenders.  From the lenders' perspective, of course, lenders would rather know about a potential default than be misled into thinking all is well.  From the company's perspective, in some cases disclosure can build goodwill with the lenders, and if the lenders are likely to grant a waiver, could be considered as a viable option.

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This post was written by guest blogger Svetlana Attestatova, one of my colleagues in the financial industry group here at Reed Smith.  She answers a question that often comes up at this time of year, when year-end financial statements are being prepared.   

Let’s talk about borrowing money under revolving lines of credit.  Sometimes it's not entirely clear whether the borrower is in default, and there's a question as to whether they can borrow money.  Here are our facts: 

1. The company needs to draw on its revolving line of credit, and it’s three weeks before the end of the fiscal quarter.
2. Based on the numbers in hand, the CFO thinks the company may go into default on its financial covenants at the end of the quarter.
3. The required “notice of borrowing” under the credit agreement requires the company to certify that there is no default at the time of the borrowing.

Can the company borrow the money?

The answer is an all too frequent “it depends.”   It would be helpful to know more.  What if the CFO learns that the company is expecting additional sales that will result in more revenue, and that revenue is expected to come in before the end of the quarter?  Once the revenue is in, the financial covenants would be met and there would be no default.  In that case, the answer is that it’s probably OK for the CFO to certify that there is no default.  If the quarter has not yet ended (assuming the financial covenants are tested only as of the last day of the fiscal quarter, as is typical for many corporate loan agreements), there is still time for the company's performance to improve, and the CFO's belief that there is no default would appear to be reasonable and in good faith.  

Now, let’s change our facts.  What if it’s three weeks after the quarter end.  The CFO has financial data for the quarter that indicates a default occurred at the quarter end, but the financial statements have not yet been completely finalized or delivered to the lenders.  The answer here is that the CFO probably can’t certify that there is no default, and the company probably can't borrow the funds.

A word of caution:  One court found the company to be in breach of its credit agreement when it certified to the lenders that there was no default even before the financial covenant test period ended (similar to our first set of facts).  This was in the "Motorola" case (The Chase Manhattan Bank v. Motorola, Inc., 184 F. Supp. 2d 384 (S.D.N.Y. 2002) (PDF)).  But, in that case the outlook for meeting the covenants was very bleak.  We'll talk about the rather unique Motorola facts in our next post.

And, of course, not every case is as clear as these sample fact patterns -- often, there are many factors that should be considered and weighed (i.e., call your lawyer).   Also, note that most financial covenants need to be tested monthly or quarterly (at the month-end or quarter-end date), rather than being tested on an ongoing basis.  A continuous requirement to comply with financial covenants would change the analysis.  

More on this next time.

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Are things going to get better in 2011?   Recent increases in corporate lending may give us a reason to start the new year feeling optimistic. 

Last week there was a positive article on the front page of the Wall Street Journal titled "Banks Open Loan Spigot".  In the article, Ruth Simon reported that after nearly two years of declines in corporate loan numbers, there was actually an increase in commercial lending in the fourth quarter of 2010.   Though the increase was small, and lending rates remain nowhere near the levels we saw in 2008, bankers from major institutions such as Wells Fargo, Bank of America, JPMorgan Chase, PNC and others are quoted as saying they expect corporate lending will continue to increase in 2011.  

Some of the growth may be expected in specialized areas such as asset-based lending and retail finance.  And, though some companies remain cash-rich, some small growth may appear in credit usage rates, which also rose toward the end of the year at some institutions.

What does this mean for all of us?  Certainly, we would all hope that the trend continues - and grows.  An increase in the volume of corporate loans can generate not only greater opportunities for the lenders and businesses involved, but also (eventually) opportunities for growth in the economy as a whole.  Here's hoping for a very happy 2011!

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Like the New York Giants, equity cures have made a comeback here in the fourth quarter -- even without the help of Eli Manning. 

Source

An equity cure right is a provision that's included in the loan agreement for a sponsor finance deal, giving the private equity sponsor that owns the borrower the right to put in additional cash to cure a default under a financial covenant.  So, for example, if the company breaches its leverage ratio for the quarter (either because it has too much debt or too little EBITDA), the sponsor can make a cash contribution to the company after the quarter-end, and that cash will be added to the company's EBITDA number for that quarter (as if it represented actual earnings), to put the company back into compliance with the covenant.  Once the cash is contributed, the financial covenant default is considered cured.

Back in the day (remember 2006, anyone?) an equity cure right might have contained relatively few limitations on the sponsor's ability to exercise it.  It was not unusual for there to be a very large cap (or sometimes none at all) on the amount that could be contributed, with relatively long periods of time in which to put in the money.  Though there were often restrictions on the number of cures that could be made (both in the aggregate and the number per year), these were often negotiated to permit very frequent cures.  We also sometimes saw permission to put the cash in as subordinated debt rather than equity, and other bells and whistles, depending on the size and type of the sponsor.  All of this was heavily negotiated.

When the credit markets tightened up, we didn't see equity cure provisions in new deals very often.  Now we're seeing them again all over the place -- but with somewhat more restraint in what's permitted.  Though there are a few outliers, it's often the case that the cash must be contributed as equity, within a few days of the quarter-end financials being produced.   There is almost always a cap on the number of cures permitted -- often one per fiscal year and/or three over the life of the deal.   There may sometimes even be a requirement that the cash be used to pay down the amounts outstanding under the loan, rather than just treating the cash as additional EBITDA and keeping it on the books.  Though there's definitely willingness to allow equity cures again, lenders seem to be a bit less eager to permit very broad rights.

I'd be interested to know if any of you are seeing even more flexibility in equity cure provisions these days, and whether you think we'll end up with similar terms to what we saw in 2005-2006.  Email me or post  a comment here with your thoughts. 

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I live in California, which (among many other things) is a state known for having some unusual laws.  One oddity that comes up from time to time when negotiating loans is the fact that jury trial waivers - which are standard in most corporate loan agreements - are generally unenforceable in California. 

This is old news to several of you, I know, but I received some questions about this recently, so I thought it might be helpful to offer up an explanation.  In a nutshell, what this means for you is that if your borrower is located in California, if California law is the governing law for your loan agreement, or, if neither of those things is true, but there is nonetheless some possibility that you could end up in a California court, you may want to choose an alternative to a straight-up jury trial waiver provision (unless, of course, you actually want a jury . . . ).

Back when this became law in California (because of the decision in Grafton Partners v. Superior Court (pdf), where the California Supreme Court determined that pre-dispute jury trial waivers violate the state's constitution) there was initially some confusion as to how best to get around the prohibition on these kinds of waivers.  But now, there are well-established practices for what to do.

Many lenders in California have chosen to use judicial reference provisions in their loan agreements.  Judicial reference is generally accepted as a valid alternative to jury trial waivers, using the Grafton case analysis (as is arbitration, under many circumstances).  Judicial reference is a special process established in the California Code of Civil Procedure (Section 638, et seq.), and, as a practical matter, it can be rather similar to arbitration.  It gets you out of the regular courtroom and into separate proceedings that don't involve a jury, where the case can be decided by a referee chosen by the parties.  The general rules for judicial reference are provided for directly in the California statute. 

Here's one example of how some lenders have added judicial reference to the waiver provisions in a loan agreement (there are certainly more complicated ways to do this too):

 To the extent the foregoing waiver of a jury trial is held to be unenforceable under applicable California law, the parties hereby agree to refer, for a complete and final adjudication, any and all issues of fact or law involved in any litigation or proceeding (including but not limited to all discovery and law and motion matters, pretrial motions, trial matters and post-trial motions), brought to resolve any dispute between the parties hereto (whether based on contract, tort or otherwise) arising out of or otherwise related to this Agreement or any other Loan Document to a judicial referee who shall be appointed under a general reference pursuant to California Code of Civil Procedure Section 638, which referee's decision will stand as the decision of the court.  Such judgment will be entered on the referee’s statement of judgment in the same manner as if the action had been tried by the court.  The parties shall select a single neutral referee, [who shall be a retired state or federal judge] [with at least five years of judicial experience in civil matters]; provided that in the event the parties cannot agree upon a referee, the referee will be appointed by the court.

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I'm delighted to announce the publication of my book Corporate Credit -- A CFO's Guide to Bank Debt and Loan Agreements.  

First of all, let me just say that after many months of preparation, it sure feels good to finally have it in print!   Becoming a published author was both more fun and more difficult than I thought it would be -- especially while working (more than) full time on other things, as those of you whose deals I worked on during the last year can attest.  (And if you're ever thinking of writing a book yourself, let me know, as I've got a whole lot of advice to offer on this topic now too.)

Anyway, if you enjoy reading this blog, you'll probably enjoy the book too.  In many ways, the book is an extension of the blog, covering some of the same kinds of topics in a different format.  

The book is intended to be a helpful guide for corporate borrowers and lenders alike, explaining in plain and easy-to-understand language what the terms of a corporate loan agreement mean.   There are chapters on things like representations and warranties, interest rates, financial covenants, events of default, reporting requirements, syndication, security interests, guarantees, and how to get ready for a closing.   Pretty much all the basics you'll need to know to understand your loan agreement and work your way through the loan process.

For those of you on the lender side, don't let the title throw you off -- this is not a how-to manual for CFO's to learn to beat up on lenders in tough negotiations!   (Sorry, CFO's.)  Instead, there are explanations about why certain provisions of a loan agreement are important for both sides, to help everyone have a better understanding of the terms and how to consider negotiating them.  Both lenders and borrowers will find this useful.

Corporate Credit was published on October 1, 2010 and is available for purchase on Amazon.com.

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Several of us spent some time at the annual ACG business conference in Los Angeles this week.   Having attended this conference for the past few years, it was nice to see a bit more optimism in the crowd this time than, say, last year and the year before.  

I was particularly interested to hear a panel of lenders talk about what they think the loan market will be like in the coming months.  Everybody agrees that we're not back to where things were in 2005-2007 (and in some ways, that could be a good thing).  Still, things definitely seem to be loosening up a bit, and there seems to be - for lack of a better term - cautious optimism about the future of the lending world.  We've been seeing it in our practice here, and so have the lenders on the panel. 

One of the panelists mentioned that more lenders are getting back in the game, particularly CLO's.  Another described the general trend of leverage levels moving slowly up, and pricing moving down.  There's also some loosening of terms and structure -- some of us are even seeing dividend recap deals again.  As usual, the middle market remains more active than the upper end.

Predicting the future is really tough, though.  Some economists think we're headed for a double-dip.  Others think we can ride it out.  Lenders see some opportunities in refinancing credit facilities that will mature in 2011 and 2012, and in expected (hoped for, anyway) expansion of the acquisition market.

What do you think the next few months will look like?

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What issues have you faced most often when trying to negotiate covenants in a loan agreement?  Do you find that many of your negotiations are about the tension between maintaining appropriate limits vs. providing sufficient flexibility for the business?  Do specific issues arise in setting baskets for other debt, liens and investments?    Permitting acquisitions?   Dealing with subsidiaries?   Agreeing on appropriate levels for financial covenants? 

For the borrower, it's often the case that a large part of the process involves thinking through what the company needs in order to maintain and grow its business.  This includes figuring out what the company will need during the entire life of the loan - looking ahead up to three or even five years and taking an educated guess. 

On the other side of the table, the lenders need to know that things at the company won't change in a way that adds an unacceptable level of risk - for example, that the company will maintain reasonable financial performance and won't get rid of revenue producing assets (well, at least without paying down the loan). 

If, for example, the borrower wants the ability to make significant acquisitions during the term of the loan, but the lenders think that for this company the acquisitions would create an unacceptable level of risk, these two differing viewpoints can lead to lengthy discussions.  If all goes well (as is often the case), these negotiations result in creative solutions being crafted that meet the needs of all the parties.  At the end of the day, there may be a few things can't be determined in advance that are set aside for later, with the lenders saying that the borrower should request consent if the anticipated event ever does occur.  But usually the parties try to keep as many items off this list as possible.

On October 6, I'll be speaking on the topic of negotiating covenants in this program.  Agreeing on the covenants is one of the most important - but also one of the most difficult - parts of a loan transaction.   If you let me know what issues you've faced, I'll try to cover those in the October 6 program and in future blog posts.  As always, you can post responses in the comments below or email me at salker@reedsmith.com.  Thanks for your input!

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Do you require a promissory note from the borrower when you make a loan under a syndicated credit facility? In syndicated deals, promissory notes -- like bell-bottom pants and polyester suits with wide lapels -- really seem to have gone out of style.

In a syndicated loan deal, the note is often just a very simple document with one or two paragraphs. It says what the amount of the lender's loan is and that it is payable by the borrower “as set forth in the loan agreement” -- meaning, go look at the loan agreement for all the actual deal terms, because you sure won't find any of them here.

Though this was not the case a few years ago, these days issuance of notes in a syndicated loan deal is almost always optional, at the request of the lenders. Some lenders still request notes for their records, but most lenders don't require them anymore. Instead, they rely on the loan agreement itself as sufficient evidence of the debt. Certainly, not having to keep track of notes (issuing new ones whenever new lenders come into the deal, making sure old ones are found and returned for cancellation, exchanging old for new when commitments are increased or decreased, etc.) is easier, saving time and money.

The role of a promissory note varies depending on what type of deal it is, though.

In smaller, simple deals, a promissory note itself might constitute the entire loan documentation, containing all of the deal terms. This is often the case with unsecured loans made by early-stage investors, and it's particularly common if the note is supposed to be freely transferable to others. Bank loans, by contrast, would rarely be documented with a promissory note alone. In a deal involving a bank or other institutional lender, there is almost always a loan agreement that contains covenants, events of default and other terms generally applicable to the loan, regardless of how small the loan amount may be.

On occasion, you’ll see a hybrid approach, with some of the loan terms stated in a loan agreement and some in an accompanying note. This is an alternative method for drafting loan documents that is sometimes used in deals involving a single lender, if the lender prefers this form of documentation. In this case, the loan agreement will contain the representations and warranties, covenants, and defaults, and other general terms relating to the borrower, and the note will contain the loan amount, borrowing and repayment terms, interest rate information, and other terms specifically relating to the loan itself.

But in syndicated deals, where the note contains nothing new that the loan agreement does not already say, promissory notes are uncommon.
 

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When you want to make a loan, you probably get copies of the borrower's recent financial statements, and you probably take a pretty close look at them as part of your credit process.  You might even ask for more information about certain items that you see on the financial statements.  But how often do you dig deeply behind the financial statements and conduct your own audit?  Probably never, right?

Unless you have reason to think otherwise, it's likely that you take the financial statements largely at face value and rely on representations from the borrower as to their accuracy.  Indeed, nearly every loan agreement contains a representation that the financial statements "fairly present, in all material respects, the financial position of the Borrower" as of the date of the statements and that the statements "were prepared in accordance with generally accepted accounting principles" (or words to that effect).  But what if the representation isn't true?  

In a case decided just yesterday in New York, the lenders alleged that the borrower's representations about its financial statements were false in many important respects.  At issue in the case was the question of whether the lenders should have looked behind the numbers, undertaking a review of the borrower's books and records to discover the alleged inaccuracies.  The court in this case said no.  Even though the court thought there were some "hints" that could have suggested that the financial condition of the borrower wasn't all that it appeared to be, and that the lenders might have been "put on their guard" by some of the facts, the court nonetheless found that the lenders had done enough to protect themselves by requiring the borrower to give representations and warranties as to the accuracy of the statements.  The court specifically stated that the lenders were not required to conduct their own audit or even engage in detailed questioning of the preparers, so long as they included appropriate representations in the loan agreement.  It's possible for inaccuracies in financial statements to be so obvious that the lenders really should question things further up front, but absent those kinds of facts, we wouldn't expect more to be required.

The Loan Syndications and Trading Association (LSTA) noted in a publication sent to its membership today that requiring lenders to conduct an independent examination of borrowers' financial statements could have resulted in a "material disruption" in the commercial lending market.   It's certainly nice to have avoided such an outcome.

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Here's an easy one for you:  How many of you (lenders) think that you should have to get consent from the borrower to sell a participation in a loan?  I'll take the safe bet and guess "none" -- since it's such standard practice for lenders to sell participations to other lenders without borrower consent.  Really, you'd be hard pressed to find a credit agreement that said otherwise.

With that in mind, let's take a quick look at a recent case from a federal court in Manhattan that said just the opposite.  The Cablevisión case, reported on by the Wall Street Journal last month, says that despite the fact that the loan agreement plainly stated that the lenders could sell participations without consent from the borrower, the lender did in fact need borrower consent and was prohibited from selling a participation without it.

How can this be?  On the surface, this decision is surprising and a bit disturbing, since it seems to cut against both the specific terms the parties agreed to and the common market practice in this area.  To be fair, though, the participation in this case was not an ordinary loan participation, and the court was heavily influenced by the facts.  Much can be said about this case, but let's just focus in on a couple of issues that are particularly important for us here.

First, it turns out that the would-be participant was a major competitor of the borrower.  This topic isn't often addressed in loan agreements, and I think that's because it isn't a practical concern in most cases.  Unless the borrower's competitors (or their affiliates, as in this case) are in the lending business, negotiating limits on assignments or participations to competitors won't be high on the borrower's issues list.  Also, the lenders themselves generally aren't interested in participating the loan to a competitor of the borrower, as in some cases this could undercut the borrower's business (and the lenders' ability to get repaid).  Because the borrower's confidential information can be freely shared with participants and lenders alike, allowing a competitor into this group could be a bit like inviting the fox into the henhouse.  We all need to know who we're dealing with -- and what each person's affiliations are.

Second, we learn from the court's comments in this case that the lender had originally planned to do a full assignment of the loan, and, as required under the loan agreement, had asked for the borrower's consent to the assignment.  (In contrast to participations, where the lender remains party to the loan agreement and the participants just share risk behind the scenes among themselves, an assignment substitutes a new party to the loan agreement in place of the original lender and typically requires borrower consent.)  Not surprisingly, the borrower declined to consent to this proposed assignment to its competitor.

The lender then decided to sell the competitor a participation, which didn't require consent.  It seems clear that the lender in this case thought and fully intended that its participation would comply with the terms of the loan agreement -- and indeed the participation appeared to do so.  This participation was a bit unusual, though, since it was for 90% of the loan amount.  Also, the participation agreement included some very favorable terms for the participant.  Two terms in particular -- automatic assignment of the entire loan to the participant upon an event of default, and a very broad right to demand that the lender obtain and deliver additional confidential information from the borrower -- led the court to believe that this participation was really intended to be an "end-run" around the consent requirements applicable to assignments.

As mentioned in a prior post, loan agreements in the United States include an implied covenant of "good faith and fair dealing" which is deemed to be part of the loan terms regardless of what the agreement actually says.  Since there was nothing stated in the loan agreement that would prohibit the participation, the court instead based its decision on this implied covenant of good faith and fair dealing.  The court thought the lender's actions were unfair and granted a preliminary injunction against the participation. 

Though the facts of this case are unusual, the outcome is instructive.  Similar to the increase in lender liabililty cases that we're already seeing, we may start to see more judges applying the doctrine of good faith and fair dealing with a broader brush, as here.  And, yes, there might be some participations that require consent.

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On Wednesday, I spoke at an international conference on microfinance.   The conference was a veritable United Nations, with representatives from the microfinance community around the world in attendance.   We even had those little earpieces for language translation.  My role at the conference was to discuss how loans and workouts are done in corporate finance, and whether there are differences in lending to microfinance institutions (covering just the institutional loans this time, not the microloans the institution makes to its individual clients).   I was surprised to find many similar issues, despite the sometimes vastly differing circumstances.  

Is there anything that we, in the corporate finance world, can learn from microfinance lending?  

1.  Use intercreditor agreements.   Workouts involving microfinance institutions highlight the  importance of using intercreditor agreements among lenders.   It's very common for a microfinance institution to have received loans from several different creditors, some domestic and some international, but all without any intercreditor arrangements in place.   One person I met was from a microfinance institution in Eastern Europe that is running into some financial issues.  She's trying to address those issues with ten lenders who each have differing views and approaches.  The lack of a common understanding among the lenders as to what to do in this situation creates problems for the lenders themselves, as well as for the borrower institution. 

2.  Use similar loan documents whenever possible.   When several lenders make loans to a single borrower, it becomes all the more vital that the terms of the loans match up.  Borrowers and senior secured lenders sometimes insist on this approach in corporate lending, but this hasn't happened much (yet) in microfinance.  Microfinance institutions often find themselves with loan documents that contain a wide variety of covenants and terms - each one different from the last.   Several institutional borrowers at the conference mentioned that keeping track of (and complying with) eight or ten different sets of reporting requirements takes up time and resources that would be better spent serving the institution's clients.  Trends toward standardization of loan documents and the increased use of syndicated loan structures may help with this issue over time.

3.  Defined legal structures make a big difference.  Microfinance loan workouts can be significantly complicated by absence of the legal structures that we take for granted in the US and Western Europe.  Several countries don't have Chapter 11-like procedures for bankruptcy -- or if they do, the process isn't always available to microfinance institutions, especially nonprofits.  In many places, it isn't legally possible to obtain a perfected security interest in accounts, which are the primary assets a microfinance institution is likely to have.  Even if you do have a security interest, your priority over other creditors isn't assured.   Also, the entire process can be affected in unexpected ways by local political events and regulatory changes.  Though we are occasionally surprised by bankruptcy court decisions in the US, we benefit from relative certainty as to who has priority and how the legal process will treat our claims.

Borrowers and creditors all over the world, in microfinance and in corporate finance, share many of the same concerns.   We have much to learn from each other.

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This week I am delighted to be in New York attending the WWB Microfinance and Capital Markets Conference. 

For those of us who normally spend our time on corporate lending and workouts, microfinance offers a rare opportunity to use our skills to improve the lives of people who are truly in need.  Micro loans have helped thousands of families around the world to build up small enterprises, move out of poverty, and be able to afford food, education and healthcare for their children.  Because these loans have a remarkably low default rate (often less than 2%), the funds provided to a microfinance institution are returned to be loaned out again and again -- to help even more people. 

Many institutions that make loans to the poor are backed by loans or other types of investments from other entities -- from commercial banks and financial institutions, microfinance investors, donors, and others.  Tomorrow I will be speaking on a panel of commercial lenders and microfinance institutions, discussing the issues that arise when a microfinance institution defaults on a loan.   As you can imagine, workouts in this context are quite different from those we usually see in corporate America.   There are some interesting lessons we can learn from this; I'll have more to say on this topic in my next post.

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In my last post, I gave some suggestions for reducing the risk of lender liability in a workout situation.  This time, let's talk some more about what to do when you're working through a workout, and focus on what happens when you're getting ready to seek remedies.  

As a general rule, it is a good idea to act "reasonably" in a default situation.  

There is usually an implied requirement of "good faith and fair dealing" in a contract-based relationship, whether under general state contract law or under the UCC.  Good faith and fair dealing essentially requires that you follow commercially reasonable standards of behavior and be fair to the borrower.  In some states it means that you have to act "honestly" (the definition varies).   This concept is applied to your agreement regardless of what the contract otherwise appears to say.   And this is true all the time, of course, not just after a default. 

Here's an example of how this plays out in a loan agreement.  Secured loan agreements usually say that any kind of default gives the lender the right to terminate the loan and foreclose on all the assets.  In practice, however, even though the agreement would appear to permit a lender to foreclose on assets if (for example) the borrower is just five days late in delivering its financial statements, it would be unusual for a lender to do so.  Indeed, many courts would find that type of action to violate the implied covenant of good faith and fair dealing, as the remedy would appear to the court to be out of proportion to the harm suffered by the lender.  That said, the law does respect your right to negotiate your own terms, and a judge won't normally rewrite the terms you agreed to.  You shouldn't be asked to do more than what you agreed to, but you will be required to do what you agreed to do fairly and in good faith. 

What else can you do to reduce the risk of lender liability when seeking remedies after a default?

• Give notice.  Even though notice may not be required under your loan agreement, in some situations it may be wise to give the borrower some notice before taking any action.  This is especially true if you are contemplating actions like foreclosure, that have harsh results.  Depending on the situation (and this does differ from case to case), giving notice may be fairly easy and may not do any harm to the lender's position -- and it may help demonstrate to a court later that the lender acted reasonably, giving the borrower a chance to explore alternatives.
   
•  Follow a consistent procedure.  It helps if you have established policies and procedures for seeking remedies and for the decision process to get there.  This seems like a good business practice generally, as it not only establishes consistency in dealing with borrowers, but it also helps to ensure that the options you want to have considered are actually considered -- and that a measured and appropriate response is given.  Also, be aware that if your normal practice is to ignore defaults of the type at issue and then you suddenly deviate from that practice and terminate the loan, some courts have found this behavior objectionable.
   
• Figure out what the assets are worth, and what you're likely to be paid.  If you have sufficient security and you are unlikely to lose anything if you forbear or take lesser steps against he borrower, you might want to consider these other options.  Some courts may find your exercise of remedies inappropriate if it can be shown that you would've had full recovery by forbearing on the default; similarly, your exercise of remedies can be called into question if you recover more than the loan agreement would've given you otherewise.   In these situations, you might do some clever thinking to see if you can get an appropriate result with less harm to the borrower.  For example, maybe forbearance makes sense, or maybe you can do things over a longer period of time, foreclose on only certain types of assets, or seek other types of remedies, while otherwise allowing the business (or portions of it) to continue.  Lots of options here.

There's no way to completely eliminate the risk of liability, but taking careful action can help mitigate this risk.  Applying principles of "good faith and fair dealing" will help.

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Tough times bring all sorts of things out of the woodwork.  Some of you will remember that back in the 80's and early 90's there was a flurry of "lender liability" lawsuits, with lenders being sued when they exercised remedies after a default on a loan.  There were a lot of these cases filed across the country during that time.  But by the mid 90's, these lawsuits appeared to have gone the way of the dinosaur.  Times were good and defaults were few.  Well, guess what . . . they're back.   We shouldn't be surprised, given the increase in the number of loan defaults.  In fact, we probably should expect to see more of these cases in the coming months.

How can you protect yourself against lender liability claims?  

One common basis for a lender liability lawsuit is what the lender did after the borrower defaulted on the loan.   If the lender behaves in a manner that later appears to have been unfair or inappropriate (perhaps "not in good faith", coercive, or in breach of a promise - more on this in future posts), a claim can result.   So, what types of things should you do after a default or in a workout situation?

• Engage in discussions.   When a borrower goes into default on a loan, what is your typical response?   With many lenders, the first thing that happens is a conversation with the borrower.  Sometimes this turns into a long series of discussions, followed by forbearances or partial waivers, as the lender and borrower attempt to sort things out and avoid a negative outcome.   And repeated defaults add pressure to subsequent discussions.   Regardless of how things go, it is often a good idea to engage in at least some discussion with the borrower.   For one thing, a discussion might actually result in the situation being "worked out" to a solution that's reasonably satisfactory to both parties.  Of course, this is usually the goal!   But even if the situation can't be worked out, engaging in negotiation and talking through the options can help you demonstrate later that your response to the default was reasonable and appropriate under the circumstances.
   
• Consider a prenegotiation agreement.   Not all defaults will require prenegotiation agreements, but in some cases you'll find it helpful to document what your understanding is before entering into workout discussions.   As discussions proceed, sometimes misunderstandings can result -- the borrower might think that the lender has promised something when that isn't the case, or may think the lender has agreed to waive the default when the lender thinks it hasn't.  Among other things, prenegotiation agreements help establish the scope of the discussions and what (if anything) can be agreed to orally vs. in a formal waiver document.   A prenegotiation agreement can also clarify who is authorized to make promises on behalf of the lender.   
   
• Speak carefully.  Sometimes lender liability cases arise from things the lender's representative said in the course of workout negotiations.  It can come down to just being careful not to speak in broad terms, avoiding over-promising or over-stating what you are actually willing to do.  In this regard, it is often helpful to establish (perhaps in a prenegotiation agreement) that nothing is considered agreed to or binding until it is in writing.   
   
• Write it down.  If you decide to forbear from exercising remedies for a period of time while trying to work things out, it's a good idea to put the forbearance in writing and include an express reservation of your rights in connection with the default.  Sometimes the argument is made that the lender gave tacit consent to ongoing defaults -- by ignoring them repeatedly, or by doing nothing about new defaults -- and that this action (or inaction) was effectively a waiver.  You can help avoid this by recognizing in writing the ongoing existence of defaults and stating that you're reserving all your rights under the loan documents.

These are just a few suggestions -- hardly an exhaustive list.  And, as we know, not every default can be worked out.  Next up, we'll explain more about lender liability cases and get into how to mitigate the risk when you've decided to accelerate the loan, foreclose or seek other remedies. 

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In our prior posts on this topic, we focused on what your loan agreements might say about how to deal with a defaulting lender.  In this post,  we'll talk about what happens when a member of your bank group goes into default because it is taken over by the FDIC.  Special rules apply in that case.

Automatic Stay.  The Federal Deposit Insurance Act  provides for an "automatic stay" whenever a lender is taken over by the FDIC.  In part, the statute says that no one may "exercise any right or power to terminate, accelerate, or declare a default under any contract" that the failed institution is a party to, for a period of 90 days after appointment of the FDIC as receiver (45 days, if it is a conservatorship).  

My colleagues Colleen McDonald and Nikki Kolhoff have explained (pdf) that this means you can't do anything that would affect the contractual rights of the defaulting lender, if such action is based solely on the insolvency or FDIC takeover.  So, for example, you can still amend your loan documents, but you have to invite the defaulting lender to vote, and the amendment can't affect the rights of the defaulting lender without that lender's consent.  According to McDonald, the bottom line here is "if you are going to amend your loan agreement, make sure you do it correctly."  She points out that both the "D'Oench Dhume doctrine" (D'Oench, Duhme & Co. v. FDIC, 315 U.S. 447 (1942)) and 12 U.S.C. Section 1823(e) impose specific requirements on modifications of loans involving financial institutions taken over by the FDIC.  Contracts that don't meet the requirements can be avoided altogether by the FDIC - so it's worth taking the time to make sure those requirements are met.

In addition, even if the loan agreement would otherwise permit you to stop sharing payments with a defaulting lender, if the lender is taken over by the FDIC, you'll still have to share all principal and interest payments with it -- at least, to the extent of the obligations it has previously funded.  (As discussed in our prior post, the loan documents should ordinarily prohibit the defaulting lender from sharing in principal and interest payments relating to advances it did not fund.) 

As a practical matter, the automatic stay can create significant problems for a bank group, particularly if the defaulting lender is the administrative agent for the credit facility.  Since the agent manages the funding and payment processes, and often holds the borrower's bank accounts and controls other collateral for the loan, an FDIC takeover could bring everything to a halt - at least temporarily.  

McDonald recommends that to help protect against these problems, the loan agreement should include the right to declare the lender in default early -- before FDIC takeover.  This would allow the bank group to take action before the automatic stay kicks in.  For example, if the agent in a syndicated loan goes into default (pre-FDIC takeover), its rights as agent could be terminated and assigned to a successor, and all the collateral could be transferred to the new agent -- thus permitting the credit facility to function pretty much as usual through the FDIC takeover.  McDonald suggests including a definition of  "Impaired Agent" in the loan agreement that would include an agent that fails to make payments or fund loans required under the loan documents, or that rescinds or repudiates a loan document.

Exceptions.  There are other sections of the Federal Deposit Insurance Act that provide exceptions to the automatic stay, including an exception for when the FDIC as conservator/receiver fails to comply with otherwise enforceable provisions in the loan agreement.  Sometimes these exceptions can provide relief for the bank group, though their full effect is as yet untested.   I have a feeling we'll get the chance to test some of these provisions over the next few months.

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The U.S. Department of Energy has a new program to guarantee loans to support the development of renewable energy projects.   Lenders who meet the DOE's requirements for eligibility have been invited to submit applications for partial guarantees from the DOE for the financing of projects that will generate electricity or thermal energy, using commercial technology.   The loans must be structured as traditional senior secured indebtedness, and the guaranteed amount will vary but is capped at 80% of the principal amount of the loan.   The guarantees offered by the DOE are expected to support up to as much as $4-8 billion in lending to eligible projects.   If you'd like to learn more about this program, my partners Ellen Bastier and Ferd Convery from Reed Smith's energy practice group have written a helpful summary of the program.   

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This post was written by Joel Schaider, a partner in the Financial Industry Group here at Reed Smith.

With failed financial institutions approaching record numbers, the Federal Deposit Insurance Corporation (“FDIC”) has been required to step in and seize the assets of these institutions.  The single largest categories of assets held by a failed financial institution are its performing and non-performing loans.  These loans are in the process of being sold to the public in bulk through a sealed bid process.

How to Find Information on Loan Sales  

The FDIC’s website contains information on current loans which are available for bid.  The loans of each failed institution are grouped into pools by loan type (e.g. commercial and industrial, consumer, residential, agriculture).  The website contains a list of offering announcements which are currently available for bid including the name of the financial institution which originally held the loans, the number of loans in each pool, a general description of the loan type, a description of the nature of the collateral securing the loans, the location of the collateral and the percentages of seasoned performing and non-performing loans in each group.  There are also key dates listed for the commencement of due diligence and the due date for the submission of a bid.

Additional information on loan sales may be obtained from two loan sales advisors (First Financial Network and DebtX) who the FDIC has retained to manage the sales process. The offering announcement for each loan sale will identify the sales advisor who has been assigned to manage the particular sale. 

How the Sale Process Works

• Purchaser Qualification.   The first step in the sale process to for the purchaser to become qualified.  First Financial and DebtX have established similar qualification requirements, however, it is advisable for the purchaser to qualify with both advisors.  Once the qualification requirements have been met, purchasers will be given passwords and access instructions to the loan due diligence and other information pertaining to a particular loan sale.
   
• Timing.  Generally, the period of time involved in bidding and purchasing a group of loans from the FDIC is approximately 6 to 8 weeks from the time the offering is first announced. The initial period of due diligence is typically 4 to 5 weeks in length with the bids to be submitted on a specified date after the expiration of the due diligence period. Generally, it takes two weeks for the bid to be awarded. The closing would then occur within a short period after the bid is awarded.
   
• Due Diligence.   The FDIC makes no representations or warranties in connection with the purchase of any loans and all of the risk of loss associated with the loans are passed to the purchaser upon closing.  The rights and remedies available to the purchaser are solely contained in the underlying loan documents and the associated collateral.  Therefore, a review of the loan files including the collateral is a critical element which must be completed prior to the submission of a bid. 
  
  The due diligence process may vary depending on the size and characteristic of the loans contained in each portfolio. Larger-sized commercial loans may require greater scrutiny than smaller consumer loans. However, a large number of consumer loans, for example, may contain defective terms which could affect the enforceability of all the loans in the portfolio. The loan files may be missing signed documents or important pieces of collateral. Experienced counsel needs to be involved in order to conduct due diligence in an efficient and effective manner.
  
  The due diligence files are obtained through the financial advisor assigned to the particular sale. The files are typically available on a secured website, on a separate hard drive (which may be purchased) or in a physical location.
   
• Bid Submission.  Upon completion of due diligence, an interested purchaser needs to submit a bid.  An initial deposit of $100,000 is required from each bidder to be sent by wire transfer at the time of bid submission.  The deposit is fully refundable, without interest, if the purchaser’s bid is not accepted.  If the purchaser’s bid is accepted, a final deposit equal to 10% of the purchase price of the loan portfolio, less the amount of the initial deposit, is required to be deposited within one business day following the bid award.
   
• Closing.  Closing occurs on a specified date within a short period of time after the bid is accepted by mail or in person at a place designated by the sales advisor.  The balance of the purchase price is due at the time of closing. All loan documentation such as notes, collateral documents and loan files will be delivered to the purchaser within a reasonable time after closing.

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Last week, our firm hosted a workshop at the annual conference for the Los Angeles chapter of the Association for Corporate Growth (ACG).  Our topic was “Finding Financing in a Difficult Market”.  No one in the room needed to be convinced that the market is indeed difficult these days. 

Our workshop was focused on trying to find the few bright spots in the market.  There was a senior lender on the panel, who indicated that the market for senior loans may not be quite as dead as people seem to think.  For example, the ABL market continues to be active and can be a good source of funding for underperforming companies that have valuable assets.  On the cash flow side of the house, there are some borrowers that the banks would like to loan money to, but many of those companies seem to be on the sidelines waiting for the market to change. 

Our experience in recent months has been that senior loans are still available in some situations, but for a number of companies this kind of financing can be hard (or impossible) to find.  Within this constricted market, we’re still seeing acquisitions and other types of deals getting done, but rather than relying solely on senior financing, most seem to involve a combination of sources of funds, including equity, mezzanine and sometimes various forms of second-lien/mezz hybrid financing. 

We’ve seen the role of mezz lenders in corporate acquisitions dramatically increase in the last few months.  In the workshop, I described a recent deal to acquire a middle market manufacturing company.  The private equity fund relied on a combination of equity financing, a structurally subordinated loan to the holding company, a small senior revolving loan for working capital, and a secured mezzanine loan that looked much like a second-lien loan. Piecing together financing from various sources –with some very complex intercreditor arrangements – got the deal done.

My corporate partner John Iino discussed a major trend that our mergers and acquisitions practice is seeing:  an increase in deals being done on an all-equity basis, without a debt component.  This is the only way to go when debt financing is unavailable.  Many of the acquisitions are strategic combinations.  And it's not uncommon to see the equity funding for companies (and transactions) come from foreign investors.

It will be interesting to see where the market takes us in the next few months.

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In the past year, we’ve seen many changes in how interest rates are calculated. Volatility in the quoted rates for LIBOR created problems for several lenders, who suddenly found that the interest rates they were earning on some of their outstanding loans didn’t cover their cost of funds.

There are many possible ways to remedy this problem, most of which I’m sure you’re all familiar with by now.   For example:

• You can set a rate floor for both LIBOR and base rate loans, to protect against significant decreases in the quoted rates. 
• You can require that the interest rate be based on “the higher of” LIBOR or the base rate. 
• You can use the rates quoted to a few carefully chosen reference banks as the basis for calculating LIBOR, rather than the typical published rates. 
• You can require one-month LIBOR rather than offering longer interest periods.
• For larger companies, you can calculate the margin based on the credit default swap rate for that company – or you can use a credit default swap index rate. 

There are deals out there containing all of these and more.  And these approaches work equally well in single-lender deals as in syndicated deals.

However, in a syndicated loan, there is additional tension between the need for each of the lenders to have its own cost of funds covered, and the problem that would be created for the borrower (and perhaps other lenders) if a situation affecting only one member of the bank group could be used to drive the interest rate up on the entire credit facility.   The “market disruption” clauses in a few older deals are not entirely clear on this point, but the current standard is to provide for some consensus that the problem affects many of the lenders in the group before taking action.  

One fairly common way to address this issue is to include a provision like the following, which appears in the Alliance Data Systems Corporation credit agreement.  This provision requires a majority of the lenders to share the problem before triggering a switch from LIBOR to the base rate.

Alternate Rate of Interest.  If before the beginning of any Interest Period for a Eurodollar Borrowing:
(i) the Administrative Agent determines (which determination shall be conclusive absent manifest error) that adequate and reasonable means do not exist for ascertaining the Adjusted LIBO Rate for such Interest Period; or
(ii) Lenders having 50% or more of the aggregate principal amount of the Loans to be included in such Borrowing advise the Administrative Agent that the Adjusted LIBO Rate for such Interest Period will not adequately and fairly reflect the cost to such Lenders of making or maintaining such Loans for such Interest Period;
the Administrative Agent shall promptly give notice thereof to the Borrower and the Lenders, and, until the Administrative Agent notifies the Borrower that the circumstances giving rise to such suspension no longer exist, (a) the obligations of the Lenders to make Eurodollar Loans, or to continue to convert outstanding Loans as or into Eurodollar Loans shall be suspended and (b) each outstanding Eurodollar Loan shall be converted into a Base Rate Loan on the last day of the then current Interest Period applicable thereto. Unless the Borrower notifies the Administrative Agent at least three Business Days before the date of any affected Borrowing for which a Notice of Borrowing has previously been given that it elects not to borrow on such date, such Borrowing shall instead be made as a Base Rate Borrowing.

The Alliance Data Systems agreement is from May of 2009; another recent example with similar provisions is the Tyson Foods credit agreement  from the first quarter of 2009 (and there are many more).  It can be helpful to include a provision like this in a syndicated loan agreement, so that the lenders in the bank group are protected from receiving yields below their cost of funds, in a way that makes sense for the entire group.

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At long last, the Huntsman case has settled.  As recently reported, the banks providing the commitment for the acquisition financing have agreed to pay $1.7 billion (in a combination of cash and debt) to end the litigation. 

This case provides a good reminder of the need to be careful when issuing commitment letters.  Even though your commitment is conditioned on many things, and even though there are significant events that would appear to trigger a condition that lets you out of the commitment, you can still find yourself out of pocket.

In the Huntsman case, the commitment letter provided by the lenders included a typical condition that the borrower not be insolvent at the time the loan was to be made.  When it came time to fund, the banks thought the borrower was in fact insolvent, and refused to fund.  Regardless, these lenders have now spent significant time in litigation over this matter, and ended up settling for a not inconsequential sum.

Lenders, like all contracting parties, should be able to rely on the language of their commitment letters.  If the commitment letter provides the lender a right to refuse to fund under certain circumstances, and those circumstances come to pass, that right should be given effect.  Conditions on the obligation to fund are a necessary part of a commitment, particularly in an acquisition financing where the letter is usually issued in the early stages of the deal - at a time when there are still many unknowns.  Including a very clearly worded set of conditions, with strong language that makes the lender's intentions plain, can help protect the lender.

Of course, most lenders understand that they need to take litigation risk into account, especially when providing commitments for significant acquisitions.  It's part of the cost of doing business.  And, any time a very large dollar amount is at stake, the risk of litigation will increase.  As the Huntsman case illustrates, nothing is ever certain when litigation is involved. There are costs associated with defending the case even if you ultimately win.  Even with a strong case, you may find it advantageous to settle - sometimes for a rather large sum.

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