This post was also written with assistance from Jordan Hook.
Foreign and international banks are increasingly presented with opportunities to lend to the U.S. subsidiaries of their foreign clients through their U.S. branches. These opportunities exist partially due to the fact that regulations abroad have constrained lending, and foreign parent companies are looking to the U.S. markets for financing the operations of their U.S. subsidiaries. In these “inbound loan” transactions, the U.S. branch of the bank will often be asked to make pricing and structural accommodations to these U.S. subsidiaries because of the strength of the foreign parent company and the banking relationship that it has with the bank abroad, either through the bank’s main office or a foreign branch. In this situation, both the U.S. branch and the foreign bank have to evaluate the risks associated with inbound loans, and structure satisfactory solutions.
Inbound Loans: How They Differ From Typical Loans
In a typical secured loan, the parent company of the borrower (if the borrower is not the ultimate parent company in the corporate chain) will guarantee the debt of the borrower and grant a pledge of its assets (including the equity it owns in the borrower) to the lender to secure that guaranty. The parent company will also submit to the various affirmative and negative covenants in the loan documents, including restrictions on debt and lien incurrence, investments, dividends, acquisitions, dispositions of assets and other restrictions on its business, to protect the value of the guarantee and the pledged security. Finally, the events of default will be triggered based on the actions of the parent, including a cross-default to other debt of the parent. In this typical structure, the loan facility provided will be the main source of financing for the entire corporate family, including the parent.
In an inbound loan, however, the loan facility will only finance the operations of the U.S. subsidiary, and the parent will have a separate (often larger) loan facility from the foreign bank. As the result, the parent will expect its involvement in the U.S. facility to be limited to an unsecured guaranty of the borrower’s debt under applicable foreign law. The parent will try to avoid making representations and warranties to the lender, will be hesitant to submit to any of the covenants that restrict its business, and will resist having the events of default be triggered based on its actions. This presents risks to the U.S. branch, including the potential diminishment of the value of the guarantee.
Structural Solutions for Inbound Loans
A U.S. lender in an inbound loan will need to weigh the risks against the larger relationship with the client in the foreign market to determine the “right” middle ground. Common compromises made in inbound loans, which accommodate the parent’s requests noted above but still protect the bank, include:
- The guarantee will be secured by a pledge of the parent’s equity interests in the U.S. borrower, but no other assets of the parent.
- The parent will make representations and warranties to the lender, with carveouts as appropriate to reflect its business.
- The parent will agree to most affirmative covenants, including: (i) delivery of financial and other information and notices; (ii) corporate existence; (iii) payment of taxes; (iv) maintenance of properties and insurance; (v) compliance with laws; (vi) maintenance of books and records; (vii) compliance with OFAC, etc.; (viii) payment of obligations; (ix) maintenance of material licenses; (x) environmental matters; (xi) employee benefit plans; and (xii) compliance with loan documents. However, many of these will be qualified by “Material Adverse Effect” which will be defined to consolidate the parent, the borrower and any other subsidiaries taken as a whole.
- The parent will agree to few negative covenants, limited typically to: (i) conduct of business; (ii) modification of loan documents; (iii) inconsistent agreements; and (iv) a negative pledge with respect to the equity interests pledged by the parent.
- A default may be triggered by some events concerning the parent, including: (i) failure to perform under the loan documents; (ii) breach of representations and warranties; (iii) a cross default to an agreed threshold of debt (which will typically be much higher than the threshold for the borrower’s cross default); (iv) insolvency and bankruptcy; and (v) denial of obligations under the loan documents.
While these structural solutions are common compromises in inbound loans, a U.S. lender will need to be mindful of the larger relationship and will need to explain the need for these provisions to the borrower, the foreign parent and its counterparts in the foreign bank.