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

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.

• Email This
• Print
• Comments (3)
• Trackbacks
• Share Link

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!

• Email This
• Print
• Comments
• Trackbacks
• Share Link

I was talking with a client the other day, and a good question came up.  Since this question has been raised a few times recently, I thought I'd share it with you here.   This is the story:  The lender wants to refinance a loan made by another bank, and the other bank has provided an interest rate swap to the borrower.  The problem is that the swap is "out of the money" -- meaning that, in this case, the borrower would owe the bank about $20 million if the swap were terminated today.  As is typical, termination of the credit facility will cause the swap agreement to terminate too, so, unless we can come up with another option, the swap will terminate and the $20 million will be owed on the day the loan is refinanced. 

If the dollar amount owed is small, or the borrower is a very large company easily able to pay the amount, this isn't a problem.  But what can we do if the borrower can't afford to pay the termination amount?

Here are some options you might consider for how to deal with a swap when terminating a loan agreement:

1.  Novate the swap, so that the new lender replaces the old lender as the swap provider and can keep the existing swap open in support of the new loan.  My partner Andrew Cross, who specializes in dealing with all kinds of unusual issues that come up the derivatives world, says that this is legally possible but has found that it's not practical in many situations.  If the swap is out of the money, as in our case, the existing lender is still going to insist (rightfully) on being covered for the losses in connection with the novation -- so somebody still has to come up with $20 million.  As a practical matter, this option is best reserved for swaps on which nothing (or very little) is owed at the time.

2.  Give the existing lender some collateral, and ask them to agree to waive the termination event and keep the swap open.   This requires the existing lender to agree to preserve the existence of the swap, which isn't always possible if they aren't continuing to be the lender for the company.  It also requires the borrower to come up with sufficient collateral to cover the loss amount, which would require both that the borrower has enough assets to do this and that the new lender(s) agree that those assets can be carved out of their own collateral pool and given to that institution for that single purpose.  If there's a lot of money involved, it is unlikely that the borrower will have sufficient assets available to put up the required collateral, and even if they do, the new lender(s) may not want to permit it.

3.  Bring the lender into the new deal.  If the existing lender agrees to join in as a lender in the new loan, the swap can continue to be supported by a lien on all the borrower's assets, and there will be no need to make the $20 million termination payment or provide separate collateral.  It is standard for the security agreement in a syndicated loan deal to say that any swaps or hedges provided by the lenders and their affiliates are also  "secured obligations" and are covered by the collateral in exactly the same way as the loans.  

Option 3 might offer the best outcome for all involved, If the existing lender can be convinced to participate in the new deal.  Under Option 3, the original lender remains fully protected by a security interest in all the borrower's assets, the borrower's resources don't have to be applied to pay for (or collateralize) temporary losses that might have been nothing more than the result of a market shift (that might later shift back again), the borrower doesn't have to try to get a new interest rate swap in connection with the new loan, and the new lenders are able to close their refinancing. 

These are options that I've seen work in the past, but I'd be interested to know if any of you have seen any other options work successfully when a swap is out of the money.  Let me know! 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

With the increase in corporate bankruptcy filings over the past year, there have been some interesting bankruptcy court decisions that affect those of us on the front end in corporate lending.  One recent case took up the question of whether a second lien is truly second -- and whether it is safe to expect that the terms of your intercreditor agreement will be enforced.  

In an intercreditor agreement, the senior lender will usually require that the junior lender waive several of its rights, including

• the right to challenge the validity or priority of the senior lender's liens, and
• the right to oppose a plan of reorganization supported by the senior lender. 

The intercreditor agreement in the ION Media case, as is common for an agreement of this type, included a broad waiver of these and other rights.  In the agreement, the junior creditor agreed that its rights to the company's assets would be junior, and the relative priorities of the lenders' claims would not be affected or impaired by "any nonperfection of any lien purportedly securing" any of the senior obligations.  However, in the bankruptcy case, the junior creditor took issue with these terms, and argued that some of the assets weren't "collateral" as defined in the intercreditor agreement -- so the waiver should not apply.  The bankruptcy court disagreed, deciding instead to enforce the waiver as written. 

When we draft these kinds of waivers in intercreditor agreements, this is exactly the type of situation we are trying to address:  if it turns out that there's a problem with the senior lender's lien (perhaps liens as to some of the collateral don't appear to have been properly perfected, for example), the junior lender is still supposed to remain in the junior position.  These terms help  ensure that the senior lender actually receives the benefit of its senior position.  And this agreed-upon allocation of risk affects many other elements of the lending relationship for both creditors -- including loan pricing.  Junior creditors typically receive significantly higher rates of return than senior lenders, due to the higher level of risk they take on.

Until now, we were pretty sure that all these provisions worked, but we didn't have the benefit of a published case on point.  It is helpful for both junior and senior creditors to have more certainty here.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

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.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

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. 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

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.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

One question we hear a lot these days is whether a syndicated loan agreement can be amended to do certain things without consent of all of the lenders. 

Several kinds of changes that may be made to a loan agreement, such as reducing the principal amount, decreasing the interest rate, postponing payment dates and the like, typically will require all of the lenders affected by the change to approve.  With more borrowers in financial trouble, it has become increasingly important - and sometimes necessary for the borrower’s survival - to get amendments passed quickly.  But it can be difficult, if not impossible, to get all of the lenders to agree.

This is part one of a series of posts about what to do when this issue comes up.

When the borrower asks for relief on some of its obligations, and the agent and majority lenders are willing to agree to what the borrower has requested, in many deals there will be strong incentive to take a narrow view of the other lenders’ voting rights in order to get the amendment passed.  Agents are analyzing amendment provisions very carefully to determine precisely what is and is not required in terms of lender voting.  If there are ways to get the amendment passed without triggering the other lenders’ voting rights, then that can end up being the desired course.

For example, we know we can’t extend an interest payment date without a 100% vote, but there is no such prohibition on amending events of default.  So, the agent and majority lenders may start thinking about whether they can lengthen the cure period for payment defaults by a few days, which could have the effect of permitting the borrower to pay later without changing the date the payment is due.  This type of amendment would have other consequences, of course, and it may not be a good idea for a number of reasons.  Whether changes like this can even be considered will depend on the circumstances, and on the terms of the loan agreement.

In any event, these situations call for some clever thinking on the part of the agent and its counsel.  And they call for careful consideration of how the non-consenting lenders will view the amendment.  Elevating form over substance (i.e. “we know we can’t amend section 2.04 without consent, so we’ll add a new section 2.05”) is likely to result in objections from the non-consenting lenders – and rightfully so.  Finding alternative types of amendments that can properly be made, and other substantive provisions to amend, is a safer course.

• Email This
• Print
• Comments
• Trackbacks
• Share Link