Loan agreements

Question 1

Key clauses in loan agreements?

Answer 1

• Facility
• Purpose
• Conditions Precedent
• Governing Law and Enforcement
• Interest and Interest Periods
• Fees
• Withholding tax and tax gross up
• Increased Costs provision
• Representations
• Undertakings
• Financial Covenants
• Events of Default

Question 2

• Purpose clause (clause 3)?

Answer 2

• The purpose behind the loan shapes the transaction. It needs to be consistent with each lending bank’s policy. It also focuses the lender’s mind as to what the documentation must contain in order to protect its position. This clause also restricts the borrower to ensure the funds are used for agreed purposes only.
• If there is an obvious violation of the purpose clause, the borrower will be in default and may hold the monies subject to a resulting trust in favour of the lender. This gives the lender an advantage in the event that insolvency follows default, because the money may be deemed to be held on trust for the lender and not to form part of the assets of the borrower on a winding-up (Barclays Bank Ltd. v. Quistclose Investments Ltd [1970] AC 567, HL_)._
• In practice it is usual for the purpose clause to include a general statement relating to the purpose, for example that the funds must be used ‘towards the borrower’s working capital requirements’ or ‘towards general corporate purposes’.
• If the lender knows a facility is for an unlawful purpose, e.g. it will breach government-imposed sanctions, then English law will treat the facility as void and unenforceable and will disallow any action to recover the funds advanced. Subsequent illegality of an initially lawful agreement, however, is treated differently and the lender can recover the funds by calling a mandatory prepayment event for illegality in the loan agreement (see clause 12.1 of the LMA Agreement).

Question 3

• Facility clause (clause 2)?

Answer 3

• Generally, a term loan can be drawn down during a relatively short period of time after the loan agreement is signed (called the ‘commitment’ or ‘availability’ period). If the borrower does not draw down the funds in that period, the lender’s obligation to lend ceases. Compare this to the position with an overdraft or a revolving credit facility (‘RCF’) that can generally be drawn on at any time during the term of the loan, up to the specified loan amount.
• In some transactions, the lender will agree to make the money available in a number of separate facilities or tranches (i.e. portions) all in the same loan agreement. Each facility and/or tranche may have different characteristics relating to maturity dates, availability, interest periods and repayment terms.
• The existence of more than one facility and/or tranche in the loan agreement will be reflected in the mechanical provisions of the agreement such as the drawdown, repayment and interest provisions. The remaining terms of the agreement, such as representations, undertakings and the events of default, will apply to the agreement as a whole, irrespective of the different facilities and/or tranches.

Question 4

What are lender’s obligations in syndicated loans?

Answer 4

several and not joint. As a result, syndicate members are responsible for their commitment only. This means syndicate members do not guarantee that the other lenders will provide their share of the loan. Conversely, the failure of one syndicate member to satisfy its obligations does not allow the others to back out.
· Each lender has a separate right of enforcement (clause 2.4(c)). However, in practice this right is subject to the decision of the Majority Lenders to accelerate the loan (clauses 29.20) and to the syndicate members’ obligation to share any amounts received under the pro rata sharing clause (clause 35).

Legally, each lender agrees to make a separate loan to the borrower up to the maximum amount it has agreed to lend (its commitment).

Question 5

What are conditions precedent?

Answer 5

• Conditions Precedent (or ‘CPs’) are conditions that a borrower has to fulfil before a lender becomes obliged to lend. A borrower is therefore unable to draw down any funds from a loan until the CPs are either a) satisfied or b) waived by the lender / agent (if a syndicated loan).

Question 6

drawstops?

Answer 6

an event that gives the lender the right to refuse to fund the facility. These include limited events (other than failure to deliver CPs) such as illegality or events of default.

Question 7

Repeating representations?

Answer 7

• It will be a condition to each new advance that certain of the representations (i.e. statements of fact) made on the original signing date are true and correct.

Question 8

• CPs vary according to the circumstances of the borrower and should be altered for each transaction. The following are examples of common CPs:

Answer 8

· constitutional documents (e.g. the company’s articles);
· legal opinion(s);
· insurance policies;
· financial information and auditors’ reports;
· any licences/consents relevant to that borrower;
· board resolutions or other corporate authorisations;
· compliance with KYC (‘know your client’) requirements (although this is normally dealt with internally by the lender’s compliance team); and
· evidence that all fees have been paid.
* Depending on the circumstances of the particular deal there may also be deal-specific CPs, for example in a real estate finance deal (where a property purchase is being financed) there will be property related CPs such as valuation reports, reports on title and environmental reports.

Question 9

• What is a legal opinion?

Answer 9

• Broadly, a legal opinion is a letter confirming the corporate capacity of the borrower (and, if relevant, any guarantor or security provider) and that the finance documents (i.e. the loan agreement and, where relevant, any security agreement or guarantee) are legally valid, binding and enforceable. It is another way for the bank to reduce the risk of non-payment.

Question 10

Who are usually asked to give a legal opinion?

Answer 10

• It is usually the bank’s (lender’s) solicitors who will be asked to give the opinion but it may, on occasion, be the borrower’s solicitors. In a bilateral loan the opinion will be addressed to the bank whereas in a syndicated loan it will be addressed to the agent (where the agent is the agent of the syndicate) and may also be addressed to the original syndicate lenders.

Question 11

What does a legal opinion apply to?

Answer 11

• The opinion will only apply to matters of law and not of fact. The statements of opinion will often reflect the kind of legal representations given by the borrower in the loan agreement, e.g. that the documents associated with the loan are legally valid and enforceable.
• An opinion does not give the bank any assurance that the borrower will be able to service the loan (i.e. pay the interest payments) or repay the loan (capital). It merely offers another level of comfort for the bank by confirming the further legal due diligence carried out on the borrower. It also provides the bank with an alternative course of action if the opinion is incorrect (i.e. against its lawyers).

Question 12

• Two situations where legal opinions are invariably required:

Answer 12

· Secured lending: Banks will usually want an opinion to confirm the enforceability of the security, and to outline any risks associated with the security.
· Overseas jurisdictions: If the bank is lending to a borrower incorporated in a foreign jurisdiction or is taking security over assets in a foreign jurisdiction (e.g. the assets of a foreign subsidiary of the borrower), the bank will require a legal opinion from local lawyers. This opinion will generally cover the corporate capacity of the company in that jurisdiction and the enforceability, legality and priority of the documents which that company is entering into.

Question 13

• When drafting or reviewing the CPs, remember to check:

Answer 13

· Timing- Although no contractual time limits, will it be possible to satisfy the relevant CP in the time available before the funds need to be drawn down?
· Approval- Who will decide if a CP is met - and are they to act reasonably? This is usually at the lender’s or its agent’s discretion: for example, “in form and substance satisfactory to the agent, acting reasonably”.
· Control If third parties are involved (e.g. report providers), what control can be exercised over such parties to get the required information/documents delivered on time?

Question 14

Is legal opinion needed when the lender is lending to a borrower incorporated in a foreign jhurisdiction?

Answer 14

• If the lender is lending to a borrower incorporated in a foreign jurisdiction or a foreign subsidiary of the borrower is granting security over its assets, the lender will require a legal opinion from local lawyers. This opinion will generally cover the corporate capacity of the company in that jurisdiction and the validity of its choice of English law to govern any English law documents it enters into and (to the extent any of the documents entered into by the company are governed by the local law of its country of incorporation) the enforceability of any documents governed by the relevant local law.**

Question 15

Fee clauses?

Answer 15

• The fees to be paid by the borrower are set out in a fee clause (and, for syndicated loans, separate fee letter(s)) and usually comprise:
• Commitment fee: This fee reflects the cost to the lenders of having set aside money to lend (rather than actually having handed over the money) during the availability period of the loan.
• Arrangement fee/participation fee: Only relevant for syndicated loans. The arranger will charge a one-off fee, sometimes referred to as a front end fee, for its role as arranger of the loan. Although the loan agreement specifies that the arranger is to receive a fee, the actual amount of the arrangement fee is set out in a separate fee letter addressed to the arranger so it is kept confidential from the syndicate members
  · The arranger will decide, as part of the syndication strategy, how much of this fee to share amongst the lenders and how much to keep for itself. The amount each of the other lenders receives, often known as a participation fee, will usually depend on the amount of money that lender has committed to lending. These amounts are set out in the invitation letter sent out by the arranger to solicit banks to join the syndicate.

Question 16

• Agent’s fee?

Answer 16

Only relevant for syndicated loans. This is the fee paid to the agent for its administrative services. It is normally paid annually but may be paid quarterly in some cases. Similarly to the arranger’s fee, the loan agreement specifies that the agent is to receive a fee and that it is for its own account. The actual amount of the agency fee is not disclosed in the loan agreement, but is set out in a separate fee letter addressed to the agent for the purpose of confidentiality. Note that even though the agent is appointed on behalf of the syndicate lenders it is the borrower that is responsible for paying this fee.

Question 17

• Underwriting fee?

Answer 17

Only relevant for syndicated loans. This fee is paid to the arranger (and co-arrangers, if any) if a loan is underwritten. As seen previously, underwriting a loan means that the arranger (and co-arrangers, if any) will guarantee to provide the total loan amount to the borrower if it is/they are unable to fully syndicate the loan. This will be paid in addition to the arrangement fee. Again, it will be set out in a separate fee letter between the arranger and the borrower

Question 18

• Security Trustee fee?

Answer 18

This will be paid by the borrower to the security trustee (or security agent) on a secured deal. Like the agent’s fee, it will be set out in a separate fee letter.

Question 19

What are representations?

Answer 19

• Representations are statements of fact about the borrower and its business – they are based on the day of signing and certified as true by the borrower as at that date.
• Representations constitute the contractual basis on which a lender makes and continues to make a loan available.

Question 20

Do representations and warranties differ?

Answer 20

• ‘Representations’ and ‘warranties’ are interchangeable terms in respect of loan agreements. These are treated in the same way since the loan agreement provides a contractual remedy for both under what would be a misrepresentation at common law.
• The difference between representations and warranties at common law is very important where common law and/or statutory remedies are relied on, but this is only rarely the case under a loan agreement. Under a loan agreement, a breach of any of the representations and warranties is an event of default which has specific contractual remedies.

Question 21

• What if the borrower cannot make the representation as it is untrue?

Answer 21

• If a borrower is unable at the outset of the loan to make a certain representation (namely because it is untrue), it will need to qualify the drafting of the representation in the loan agreement itself. Sometimes a borrower will disclose a problem to the lender in a disclosure letter prior to signing the loan agreement, but this is less common.
• As a misrepresentation will trigger an event of default, the borrower will want to limit the scope of the representations.

Question 22

How are representations repeated?

Answer 22

• The lender will want some or all of the representations to be repeated at regular intervals (given that there is an ongoing relationship between the lender and the borrower through the loan agreement).
• Typically, the representations are made on the date of the signing of the loan agreement, and they are then usually repeated: on the date of each request for a loan (a utilisation request); and on the first day of each Interest Period
• There will be a balancing exercise between the lender wanting as many representations repeated as possible; and the borrower seeking to limit the number of representations being repeated (for both practical and factual reasons).
• In relation to repetition of representations, the borrower will commonly argue that:
  · certain matters cannot or are unlikely to change (e.g. that it is validly incorporated);
  · some statements are only relevant upon signing, such as information contained within original financial statements;
  · the content of the representation is covered under a separate undertaking;
  · and/or the lender is afforded protection by an indemnity (particularly relevant in the case of withholding of tax, whereby if the law is changed, leading to a deduction – the lender is protected through a ‘gross-up’ provision within the loan agreement).

Question 23

How to represenations benefit the lender?

Answer 23

• For the lender, a representation helps to reduce the risk of entering into the loan. It forces the borrower to disclose certain information about itself under the representation (and this is done ahead of signing the loan agreement).
• The lender also gains control here as a breach of any representation leads to an event of default.
• The borrower’s inability to repeat any representation also triggers a drawstop event which leads to the borrower being suspended from any further borrowing under the loan agreement (see clause 4.2(b)).

Question 24

Why should borrowers be careful about representations?

Answer 24

• A borrower should try to resist repetition as much as possible. It should always refuse to repeat the representation that there is no ‘potential event of default’ (note that a ‘Default’ in the LMA Agreement includes both an actual event of default and a potential event of default). An inability to say there is no potential event of default will then amount to an actual event of default for misrepresentation
• A borrower should also be wary of making absolute statements – as it will not want an immaterial inaccuracy to be a misrepresentation.
• Any borrower with a significant number of subsidiaries will need to ensure that, if required to make the same representations about these subsidiaries, that they are able to establish adequate reporting lines and to carry out the required due diligence.
• An objection may arise from the borrower to make a representation on behalf of minor or irrelevant group companies. A compromise, in those circumstances, is to limit the representation to only specific subsidiaries or ‘Material Subsidiaries’.
• The borrower then has less administrative obligations to monitor all subsidiaries.
• The lender does, however, still gain comfort that the more important subsidiaries comply with the representation.
• ‘Material Subsidiaries’ are often defined as the Obligors and any company that constitutes a certain percentage of the group’s turnover, profit or asset value (each of these being specific to the deal).
• A common response from the borrower is to also attempt to limit its representations and warranties with a knowledge qualification (i.e., such as stating that each representation is ‘to the best of its knowledge and belief’ or best endeavours or due inquiry – this makes the borrower have an obligation to gain knowledge which is better for the lender).
• A lender is often reluctant to accept this, other than in very specific situations. This is because it undermines the very object of representations; the borrower should accept the risk and monitor both itself and any subsidiaries to ensure that it stays roughly the same entity throughout the loan period (therefore keeping the lender comfortable).

Question 25

What are undertakings?

Answer 25

• Undertakings are promises made by the borrower to either do or not do something.

Question 26

• There are normally three categories of undertakings within a loan agreement:

Answer 26

· information undertakings (clause 26), financial covenants (clause 27) and
- require the borrower to provide certain specified information to the lender / its agent.
· general undertakings (clause 28).
- the remainder of the undertakings within a loan agreement, and which do not constitute financial covenants or information undertakings.
· Financial covenants are promises made by the borrower to meet certain financial targets set by the lender.

Question 27

What do information undertakings involve?

Answer 27

· These involve the borrower providing information such as:
- supplying audited accounts within a specified time period (such as within 120 days from the end of the borrower’s financial year);
- supplying details of any litigation started (or threatened) against the borrower or any member of the borrower’s group;
- supplying any documents sent by the borrower to its shareholders;
- Notify lender/agent of any Default.

Question 28

What do general undertakings involve?

Answer 28

• The Borrower promises to (for example):
  · maintain appropriate insurance;
  · not to dispose of its assets;
  · not to grant security for any other loan or other types of debts (known as a ‘negative pledge’) or incur additional financial indebtedness; and
  · keep its assets in good repair.

Question 29

Common Financial Covenants?

Answer 29

· Common covenants being:
- minimum net worth; leverage ratio; gearing; and interest cover.

Question 30

• Undertakings: Lender’s perspective?

Answer 30

· Undertakings offer the lender control over how the borrower is run and allows a lender to monitor the borrower through regular information supplied to it by the borrower.
· As due diligence is conducted by the lender at the start of the loan, this creates a standard which the lender will monitor the borrower against – the borrower should ensure that it remains materially the same throughout the life of the loan.
· If the lender believes that an undertaking has been breached, then it can take steps to call an event of default.
· A lender needs to understand the business and specific circumstances of the borrower before it exercises its rights and remedies in respect of an event of default.
· A lender should ensure that it does not become too involved in the business of the borrower (such as being an active part of its decision making) to be deemed as a shadow director (particularly if the borrower experiences financial difficulty and the lender steps up its level of control).
· Such involvement could constitute exerting ‘material influence’ over a borrower, triggering government scrutiny under the National Security and Investments Act 2021
· Also, with such involvement a lender could risk liability for the borrower’s defined benefits pension scheme, and it may trigger registration requirements under the PSC regime.

Question 31

• Undertakings: Borrower’s perspective?

Answer 31

· A borrower should ensure that it keeps the lender informed of any (material) changes to its business and that it manages its business in such a way as to avoid a breach of any undertaking.
· Undertakings should be both realistic and consistent across any loans entered into by a borrower.
- For example, any financial thresholds (such as a de minimis threshold for no disposals) should be the same across different loans of the borrower. This will allow a borrower to manage any disposals without having to check every loan agreement.
· The lender will often require the borrower to ensure that its subsidiaries (as defined under Companies Act 2006) will comply with the undertakings. The borrower is able to do so as it is the majority shareholder in its subsidiaries and therefore exercises control as a shareholder over them. Again, the borrower may be concerned, if it has a significant number of subsidiaries, about its ability to ensure they all comply with the undertakings, especially if there are subsidiaries that are relatively insignificant in the context of the group as a whole or a large number of overseas subsidiaries. The same point in relation to Material Subsidiaries, mentioned in the context of representations, would also apply here.
· A borrower can also argue that the undertakings should be drafted to exclude any breaches which would have an immaterial effect on its ability to 1) repay the loan and/or 2) comply with its other obligations under the finance documents within the deal.

Question 32

What do financial covenants do?

Answer 32

• Financial covenants (if they are to be included in the loan agreement - this won’t always be the case) are focused on the financial condition of the borrower. Their function is to protect the lender if the business of the borrower declines financially. A lender is able to call an event of default if a financial covenant is breached.
• Financial covenants give a clear and objective indication of the borrower’s financial health and performance. These form the base of the financial parameters of the borrower at the outset of the loan. They also set the level of deterioration in the borrower’s financial position that would constitute a material change to the lender.
• The figures included in the annual audited accounts of the borrower will be used by the lender to test the financial covenants it has set for the borrower. In addition, the figures in the unaudited quarterly accounts (and sometimes from monthly management accounts) will also be used to ensure financial covenants are tested with sufficient frequency.

Question 33

• Examples of financial covenants:

Answer 33

• Minimum net worth
  · This is to ensure that the total assets of a borrower do not outweigh its liabilities by a set amount (for example by not less than £10 million).
• Leverage ratio
  · This monitors the ratio of the amount of debt a borrower has compared to the amount of its profit – this reassures the lender that the borrower is able to pay its debt obligations.
• Gearing
  · This monitors the ratio of the amount of debt of a borrower to its shareholder funds – this is normally expressed as a maximum percentage (for example that gearing to not exceed 50%).
• Interest cover
  · This monitors the ratio of a borrower’s operating profits to its cost of borrowing. This helps to indicate how solvent a borrower is. It also helps to control a borrower’s external borrowing as it cannot exceed the limits of the interest cover ratio.

Question 34

• Financial covenants: Lender’s perspective

Answer 34

• A lender will give careful consideration as to which ratios are relevant to the borrower’s particular business. Which particular financial indicators are most likely to reveal problems within the borrower’s business and its ability to service the loan?
• The lender should be practical in setting the level of financial covenants to ensure that they are triggered at a point which is early enough to enable a lender to take steps to work with the borrower to turnaround its financial position but also such that it is not always reacting to premature and inconsequential breaches.
• The lender should aim to be in a position where it can monitor the ability of the borrower to maintain a specified level of financial performance (which may be based on predictions in the borrower’s business plan).

Question 35

• Financial covenants: Borrower’s perspective

Answer 35

• A borrower should ensure that the financial covenants are appropriate and achievable.
• A borrower will want to ensure that financial covenants are not easy to trigger, especially where a borrower is not likely to default on any payments or be in any financial difficulty.
• A borrower should ensure that financial covenants do not restrict its ability to run its business efficiently.
• Financial covenants require an agreement between a borrower and the lender to ensure that these work throughout the lifetime of the loan.
• Carve-outs make undertakings not apply

Question 36

Fixed rate of interest?

Answer 36

• A fixed rate is a rate of interest that is unchanging for the life of the loan. It will provide the lender (and the borrower) with certainty. However, this certainty comes at a cost. If the base rate of interest rises, the lender may find that its own cost of funds increases meaning the cost to the lender exceeds the amount of interest it is receiving from the borrower. To offset this risk, a fixed rate of interest tends to be higher than the floating rate available to the borrower at the time the loan agreement is entered into and is therefore, less attractive to the borrower. Therefore, fixed rate interest is rare in corporate lending.

Question 37

Floating interest rate?

Answer 37

• Most corporate loans will bear interest at a floating rate. At the simplest level, banks, like any other business, make their profit on the difference between the price of the product they sell and the cost of making that product available. Applying this concept to loans, the “cost” of the loan is the lender’s cost of borrowing the money (known as its ‘cost of funds’).
• The interest rate charged by a lender on a loan will generally be a benchmark rate” plus the ‘margin’ as will be discussed below. This means the interest rate will vary throughout the life of the loan to broadly reflect the fluctuating cost to the lender of providing the finance to the borrower. Benchmarks are calculated by independent bodies, so create an element of standardisation and transparency in the market.

Question 38

LIBOR - floating interest rates?

Answer 38

• Until recently, LIBOR (which stands for the London Interbank Offered Rate) was the main interest benchmark rate used around the world for corporate lending.
• Set in London, LIBOR is a screen rate derived by the LIBOR administrator (ICE Benchmark Association, which is supervised by the FCA) from panel banks submitting daily their own internal rates for lending in one of the five LIBOR currencies (sterling, US dollars, the euro, the Swiss franc and the Japanese yen) for each of seven interest periods (overnight, one week, one month, two months, three months, six months and twelve months).
• As a result of the LIBOR manipulation scandal, and the fact that changes in the interbank market have meant that many LIBOR settings are not grounded in sufficient transactional data (because there is so little trading for certain currencies), confidence in the reliability and robustness of existing interbank benchmark interest rates was undermined. As a result, the Financial Stability Board recommended in 2014 that stakeholders around the world should identify Risk Free Rates (‘RFRs’) that might be used as alternative benchmark interest rates to LIBOR.

Question 39

• Floating rate interest benchmark: relevant RFR –SONIA

Answer 39

• The replacement to LIBOR is the relevant risk-free rate (‘RFR’).
• The relevant RFR for sterling loans is the Sterling Overnight Index Average (‘SONIA’). This is what we will use for the purposes of this Workstream. Other currencies have different RFRs (e.g. US dollar loans have the Secured Overnight Financing Rate (‘SOFR’), while Euro loans have the Euro Short-Term Rate (‘€STR’), though EURIBOR continues to be used as an alternative benchmark to LIBOR for euro loans).
• The dates for the discontinuation of LIBOR differs depending on the currency, but sterling LIBOR ceased to be published from 31 December 2021 on its original basis.
• SONIA is administered by the Bank of England and broadly reflects the average of the actual interest rates the banks have paid to borrow sterling overnight, on an unsecured basis, from other financial institutions in circumstances where credit, liquidity and other risks are minimal.
• Unlike LIBOR, the RFRs are only produced as overnight backward-looking rates.
• SONIA for a given London business day is published by the Bank of England at 9 am on the following London business day.

Question 40

• Floating rate interest benchmark: relevant RFR

Answer 40

• At a very basic level, the lender (or agent in a syndicated loan) will work out the relevant RFR at the end of each interest period and will notify the borrower of the amount of interest to be paid (which will be the RFR plus margin (see below)).
• A lender may use its own base rate as the cost of funds as an alternative to the relevant RFR. The lender’s base rate will vary as it will usually track whatever theBank of England’s base interest rate is. The borrower will still have to pay a specified margin above this (see below). However, it is rare for base rates to be used in corporate lending.

Question 41

Interest rate components?

Answer 41

RFR
floating rate
Margin

Question 42

RFR?

Answer 42

• The costs of funding by a lender fluctuate and so an element of the interest that is to be paid will float (in that it will be calculated for a set interest period);
• The lender (or the agent in a syndicated loan) will work out the relevant RFR at the end of each interest period and notify the borrower of the amount of interest to be paid.
• The amount of interest will be the RFR combined with the margin.

Question 43

Margin?

Answer 43

• This is broadly the profit made by the lenders. The margin will usually be a fixed rate on top of the relevant RFR (or the base rate). The level of the margin will depend on the risk associated with the particular borrower/transaction as well as general market conditions.
• The margin is usually expressed as a percentage per annum based on the lender’s quote which is usually in basis points per annum. You need to be able to translate between the two (100 basis points = 1%, so a margin rate of 1.9% per cent per annum = 190 basis points).

Question 44

What is default interest?

Answer 44

• Default interest is a specific rate of interest which protects the lender against any late or non-payment of interest (or, as applicable, capital).

Question 45

How is the default rate usually expressed?

Answer 45

• The default rate is usually expressed as a fixed rate above the normal contractual rate: e.g., 1% above the interest rate payable on the loan. This is a higher rate of interest as - upon late or non-payment - a borrower becomes a higher credit risk and so the lender requires compensation.

Question 46

What does default interest cover?

Answer 46

• Default interest covers any additional borrowing costs of a lender and reflects the change in the credit risk of the borrower.

Question 47

What happens if a default interest is challenged?

Answer 47

, if the default interest clause is challenged, the court may judge it to be unenforceable as a penalty. Whether a clause is held by a court to be unenforceable would depend on whether the level of interest would be out of all proportion to any ‘legitimate interest’ of the lender.

Question 48

What are the main threats to lenders margin?

Answer 48

• The main ‘threats’ to a lenders margin include withholding tax and increased costs.

Question 49

Why have margin protection provisions?

Answer 49

• Margin protection provisions within a loan agreement are those which aim to protect a lender against such events which could erode their margin and thereby ensure the lender is not out of pocket.

Question 50

How are magin provisions implemented?

Answer 50

• This will be achieved by including in the loan agreement margin protection provisions, namely a ‘tax gross-up’ clause to deal with the imposition of withholding tax and an ‘increased costs’ clause to deal with the imposition of increased costs.

Question 51

Witholding tax?

Answer 51

• A payment of UK source interest is subject to UK ‘withholding tax’ unless the lender falls within one of a number of exceptions.
• ‘Withholding tax’ is a mechanism for tax authorities to collect tax at source, so the corporation tax liability of the lender will be deducted (or withheld) at source by the borrower and paid directly to HMRC.
• The lender would then receive its interest payment net of (i.e. reduced by) the withholding tax.
• Subject to specific conditions being met, an exemption may be available where the lender is a UK bank, or where the lender is a UK corporate. If an exemption applies, the lender will be able to receive interest from the borrower gross of any tax (i.e. the borrower will not have to withhold tax).
• The LMA Agreement refers to a ‘Qualifying Lender’, which includes UK banks and UK corporates subject to the exemption mentioned above, and lenders in jurisdictions with which the UK has a double tax treaty, referred to as a ‘Treaty Lender’.

Question 52

Purpose of a tax gross-up clause (clause 19.2(a)-(d))?

Answer 52

• The commercial terms agreed between a UK bank lender and borrower will usually assume that the full amount of interest will be paid to the bank (without any withholding). Borrower make good of the income tax that they owe to the lender – making good for the money withheld.
• However, the ‘Tax Gross Up’ clause protects the lender in a scenario whereby tax is deducted, for example if the borrower ceases to be exempt from its withholding tax obligation, or if there is a change in law.
• The ‘Tax Gross Up’ clause usually makes the borrower responsible for the cost of any withholding tax, by requiring the borrower to ‘gross up’ (i.e. increase) the amount of any interest paid so that, after tax has been deducted, the lender receives the original amount which it would have received if the deduction had not been made. Therefore, the lender is not out of pocket.

Question 53

• Purpose of increased costs clause (clause 20)

Answer 53

• This clause protects a lender in a situation where its underlying costs relating to a loan facility increase because of a change in law. In such a scenario, the borrower will be required under the increased costs clause to compensate the lender for the increase.
• Where any costs associated with the loans do rise unexpectedly, this will have a knock-on effect on margin. This, in turn, could lead to the profits of the lender suffering.

Question 54

• What kind of costs would not be recoverable from the borrower in an increased costs clause?

Answer 54

· Costs arising from non-compliance/breach of any law or regulation the bank is subject to.
· Costs arising from changes in tax law. The lender would be protected by the tax gross-up provisions.

Question 55

• Protections for the borrower

Answer 55

• If the borrower is obliged to pay additional amounts under either the gross-up clause or the increased costs clause, there may be certain protections available to it in the loan agreement.
• The Borrower may have the right to repay the affected lender if withholding tax would be required to be paid in respect of that lender and the borrower would have to gross-up its interest payment to that lender or if increased costs were payable by the borrower (clause 12.6(a)). Note, under clause 2.3 a borrower can request that another lender takes on the amounts that would otherwise be cancelled under clause 12.6(a).
• For gross-up only, the borrower may be entitled to receive from the lender the amount paid to HMRC if the lender receives an equivalent amount in the form of a tax credit and can attribute that tax credit to the amount the borrower paid (clause 19.4).
• There are certain circumstances where loans are transferred between lenders in which the tax gross-up clause or increased costs clause will not be triggered.
• Finally, clause 22 (‘Mitigation’) sets out a duty on the lender to act so as to minimise any application of the tax gross up and increased costs clauses. This is designed to give a borrower some comfort that a lender will not rely on the open-ended protection which those clauses afford and make no attempt to minimise or avoid the increased tax or other costs.

Question 56

Subordination?

Answer 56

• a problem that arises when there is a group of companies and there are loans at different levels of the group. This is known as structural subordination.

Question 57

Structural subordination?

Answer 57

• It is very common for companies to operate under a group structure where a holding company has 100% shareholdings in subsidiaries. These subsidiaries may be operating companies, running businesses and owning assets or themselves intermediate holding companies of operating companies. Lenders may lend to the holding company which then filters the money down to the subsidiary(y/ies).
• This can cause problems for the lender which lends to the holding company if the subsidiaries have existing loans or later take out loans. This is because of the statutory order of repayment of creditors on the winding-up of a company.

Question 58

• The repayment of creditors on a winding-up is made in the following order (note: this is a deliberately simplified list):

Answer 58

· fixed chargeholders;
· preferential creditors;
· payments out of the ring-fenced fund;
· floating chargeholders;
· unsecured creditors; and finally
· shareholders.

Question 59

• Contractual Subordination?

Answer 59

• Where there are different lenders either in a group structure (as above) or within a transaction (e.g. there may be a loan from a syndicate as well as a separate loan being given by a shareholder or the directors) then these lenders can decide amongst themselves the order in which they will be paid by a defaulting borrower.
• The document which governs this arrangement is invariably either called a subordination agreement, an intercreditor deed or a deed of priorities.

Question 60

o The Events of Default (‘EoD’) clause is included in a loan agreement to set out clearly a lender’s remedies if

Answer 60

• (i) a borrower breaches a clause in the loan agreement or
• (ii) any of the set events contained in the EoD clauses occur.

Question 61

• Common EoD clauses include the following:

Answer 61

o Non-payment (clause 29.1)
o Breach of Financial Covenants (clause 29.2)
o Breach of other obligations in the loan agreement (clause 29.3)
o Misrepresentation (clause 29.4)
o Cross-default (clause 29.5)
o Insolvency (clause 29.6)
o Insolvency Proceedings (clause 29.7)
o Creditors’ Process (clause 29.8)
o Unlawfulness (clause 29.9)
o Material Adverse Change (clause 22.19)

Question 62

• Cross default?

Answer 62

o Bargaining tool to make borrower tell bank issues – but if you have event of default in earlier agreement it will apply to the next agree,enmt
* NEED TO MAKE SURE THE AGREEMENTS ARE CONSISTENT AND LOOK AT PREVIOUS LOANS TO SEE HOW THEY MATCH UP

Question 63

• A lender’s rights under an (unamended) LMA style cross default EoD can arise in one of three situations:

Answer 63

o Where the borrower or any of its subsidiaries fails to pay any Financial Indebtedness when it is due (or after any relevant grace period has ended) – see clause 23.5(a).
o When any creditor of the borrower or any of its subsidiaries:
* declares any Financial Indebtedness is due and payable before the date originally agreed or it becomes otherwise due and payable; or
* cancels or suspends any outstanding commitment to lend,
* and the creditor’s right to do so arises because the borrower (or any of its subsidiaries) has committed an EoD under the agreement creating Financial Indebtedness with that creditor – see clauses 22.5(b) and(c).
o When any creditor of the borrower or any of its subsidiaries becomes entitled to declare any Financial Indebtedness due and payable before the date originally agreed because of an EoD under the agreement creating Financial Indebtedness between the creditor and the borrower (or any of its subsidiaries) – see clause 22.5(d).

Question 64

• Cross default – possible amendments

Answer 64

o Limiting ‘Financial Indebtedness’:
* A borrower may try to limit the impact of a cross default clause by limiting the clause to default under documents that provide for ‘financial indebtedness’ only (for example: documents such as loan agreements; bonds; or hire purchase agreements). In these circumstances, the definition of ‘Financial Indebtedness’ in a loan agreement is key and the LMA Agreement definition is already limited in this way.
o ‘De Minimis Basket’:
* A common borrower ‘tool’ is to include a ‘de minimis basket’ which - in practical terms - means the inclusion of wording to allow insignificant defaults to not trigger a cross default clause. Typically, the wording stipulates that individual defaults under a certain amount (for example, £50k) and the overall total of any default do not go over a threshold (such as £250k) – in such cases, neither would trigger the general cross default clause.

Question 65

Insolvency as an event in default?

Answer 65

o If a borrower (or any of its subsidiary entities) is declared ‘insolvent’ this will trigger an EoD.
o ‘Insolvency’ is where an entity cannot pay its debts as they fall due, though the definition in clause 23.6 is broader. In such a scenario, the borrower will be unable to pay back both the principal and interest payments under a loan agreement.
o There is no availability for any amendments or a grace period if insolvency is declared.

Question 66

• Insolvency Proceedings and Creditors’ Process: Amendments/grace periods?

Answer 66

o Limiting the enforcement of any security: A borrower might seek carve-outs for an agreed threshold value relating to the potential enforcement of security over any of its assets which will be enforced as a result of the Insolvency Proceedings EoD (see clause 23.7(d)).
o Limitation surrounding the seizing of any assets: A similar carve-out can also be seen in clause 23.8 to ‘Creditors’ process’ where the assets seized must have an aggregate threshold value for the clause to be triggered and/or a grace period is given to discharge the creditor’s process.
o Protection against similar proceedings: Analogous (or similar) proceedings could be brought if a borrower deals overseas and has overseas creditors. Here a lender will want to protect its own ability to call the ‘Insolvency Proceedings’ EoD against these analogous proceedings and so will include language such as the last line of clause 23.7 to do try to do so.

Question 67

Unlawfulness as an event of default?

Answer 67

o It is important to distinguish unlawfulness (where it is unlawful for the borrower or any guarantor to perform their obligations) from illegality (where it is illegal for the lender to perform its obligations).
o Unlawfulness will always be an EoD and a lender will not agree to make unlawfulness a mandatory prepayment event (see below). A borrower can argue that it being unlawful for the borrower to perform its obligations could be something which is outside the control of the borrower and so it is unfair that it could trigger cross default. A lender’s response to this would be that this is an issue of risk allocation – the risk must stay with a borrower in such a situation and so unlawfulness for the borrower will remain as an EoD (under clause 23.9).

Question 68

• Material Adverse Change (‘MAC’)?

Answer 68

o Despite a solicitor’s best efforts, it is impossible to pre-empt every circumstance or event that could lead to a significant effect on a borrower’s ability to comply with its payment obligations under a loan agreement.
o To counteract such an event happening, a lender will require the inclusion of a catch-all provision in a loan agreement. A ‘MAC’ EoD is also a requirement of most lenders’ internal credit committees – no lending will be allowed unless this EoD clause is included in a loan agreement.
o A lender rarely uses its rights under the ‘Acceleration’ clause to call an EoD and demand immediate repayment based solely on a MAC. It is generally difficult to prove that they were justified in doing so - I.e; that a MAC had definitely occurred.

Question 69

• Mandatory Prepayment Events?

Answer 69

o As there are certain events which are outside the control of a borrower, it will not want such events to be treated as events of default because then something not within the borrower’s control could be an EoD and could trigger a cross-default in the borrower’s other loan agreements.
o A lender will still require the ability to cancel its commitment under a loan agreement to make further funds available to a borrower and will instead require prepayment of all money currently borrowed if any of these certain events occur.
o This is achieved by stipulating certain events as ‘mandatory prepayment events’ in the loan agreement.

Question 70

o The following events are most commonly (but not always) deemed as mandatory prepayment events.

Answer 70

• Illegality: Where it becomes illegal for the lender to continue lending to the borrower (see clause 12.1 of the LMA Agreement).
• Change of control: For example, a scenario where a borrower company has no control over its parent shareholder selling its shares (see clause 13.1(b)(ii) of the LMA Agreement). In some loans this may instead be treated as an event of default.

Question 71

• What are a lender’s options following an EoD?

Answer 71

o Acceleration (clause 23.12): This clause provides a lender with the following remedies:
* Cancel its obligations to make any further loans to a borrower (this will be relevant where there are numerous tranches of a loan or if the loan is a revolving credit facility; see clause 23.12(a)).
* Demanding immediate repayment of some or all of its outstanding loans including any outstanding interest and fees; see clause 22.16(b). This is what is meant in practice by ‘accelerating’ a loan.
* Place all of the remaining outstanding loans on demand meaning that these will now be payable on demand; see clause 23.12(c).
o ‘Drawstop’ (clause 4.2): If a lender is obliged under the loan agreement to lend further money to the borrower, it can also call a drawstop. This will be a temporary measure taken by the lender until the EoD is rectified. Under a drawstop, a lender suspends further tranches of the loan being drawn down until the relevant situation is rectified. This is different to cancellation of a loan; cancellation is permanent whereas a drawstop is temporary.

Question 72

Enforcement of security?

Answer 72

o By the Lender or (in a syndicated deal) by the Security Agent/Security Trustee under the terms of the relevant security document

Question 73

• The Agent’s role in a ‘Default’ situation?

Answer 73

o In a syndicated loan, the agent has duties (clauses 33.3(e) and (f) of the LMA Agreement) to notify the syndicate lenders promptly if it receives a notice of a Default under the loan and also to notify the syndicate lenders promptly if it is aware of any non-payment under the loan (remember non-payment is an EoD).
o Under clause 29.20 of the LMA Agreement, in an EoD situation the agent has the power to exercise any of the remedies under the ‘Acceleration’ provisions of the EoD clause and the obligation to do so if instructed by the ‘Majority Lenders’.
o The borrower will be keen to ensure the Agent can only exercise the remedies under the ‘Acceleration’ clause in respect of an EoD ‘which is continuing’.

Question 74

o A potential EoD is a situation which would be an EoD but for the fact:

Answer 74

• the EoD has a contractual grace period which the borrower is currently in; or
• the EoD clause requires the giving of a notice or making of a determination which has not happened yet.

Question 75

A borrower intends on entering into a loan agreement for a £35,000,000 syndicated five-year term loan which is to be secured over the assets of the borrower. The loan is to be used by the borrower for working capital purposes and the arranger has agreed to arrange the loan on a best efforts basis. The parties have agreed that the loan will follow the LMA form. The fees to be paid by the borrower in connection with the loan will be set out in separate fee letters.

In addition to the commitment fee, arrangement fee and agency fee, which of the following fees will be payable by the borrower?

Underwriting fee and security trustee fee.

Security trustee fee.

Participation fee, underwriting fee and security trustee fee.

Underwriting fee.

Answer 75

Security trustee fee.

Correct.
The facts indicate that the loan will be syndicated and will be secured, which will therefore require a fee to be paid to the security trustee.
Participation and arrangement fees are interchangeable terms and therefore no separate participation fee will be required in addition to the arrangement fee.
No underwriting fee will be payable, since the facts indicate that the agent will not be underwriting the loan; it is being arranged on a best efforts basis.

Question 76

A company is seeking a £4,000,000 syndicate secured term loan to be arranged by its relationship bank. The arranger and the borrower are currently negotiating the representations clause.

The company currently owns 3 subsidiaries, all of which contribute to the turnover of the group. Subsidiary A accounts for 63% of the group’s turnover and has some key supply contracts which benefit the group. Subsidiary B accounts for 36% of the group’s turnover and holds some of the group’s key assets which are required for production of its products. Subsidiary C is a minor subsidiary which holds few assets and currently contributes 1% to the group’s turnover. The borrower does not anticipate any significant change in the structure of its business.

Which of the following is the most likely conclusion when negotiating the representations clause?

The borrower will be required to provide representations on behalf of itself and its ‘Material Subsidiaries’, with such a definition covering subsidiaries A and B.

The borrower will be required to provide representations on behalf of itself which should be repeated, but representations on behalf of its ‘Material Subsidiaries’ (to cover subsidiaries A and B) should not repeat.

The borrower will be required to provide representations, but the representations should not cover the subsidiaries as they are not borrowing and are therefore less of a concern to the syndicate.

The borrower will be required to provide representations on behalf of itself and all of its subsidiaries

Answer 76

The borrower will be required to provide representations on behalf of itself and its ‘Material Subsidiaries’, with such a definition covering subsidiaries A and B.

This appears to be the most likely compromise position. Borrowers will typically be required to not only represent in respect of themselves, but also in respect of any ‘Material Subsidiaries’, since any key subsidiaries contributing to the group’s turnover or asset pool are likely to be relevant in the eyes of the syndicate. The threshold at which this is set will usually be commercially agreed, but the facts indicate that subsidiaries A and B not only contribute significantly to the group’s turnover but hold some key assets too. Less significant subsidiaries, such as subsidiary C, will likely be carved out of the definition to avoid overly burdensome requirements on the borrower. Whether the representations repeat or not will be a separate discussion, but the categorisation of subsidiaries as ‘Material Subsidiaries’ will not automatically carve them out of the repeating representations.

Question 77

A company (the ‘Company’) is seeking a six-year syndicated term loan in order to incorporate a new subsidiary to specifically operate the consultancy part of its business. The company already wholly owns three subsidiaries which are operating companies within the group and generate the majority of the group’s profits. The Company does not have significant assets of its own, except for the shares it owns in its subsidiaries. One of the Company’s subsidiaries entered into an unsecured four-year term loan six months ago with another lender.

Which of the following is correct in relation to addressing any concerns the syndicate might have?

A subordination agreement between the syndicate and the existing subsidiary lender will help to protect the syndicate’s position.

Including protective drafting, such as a no financial indebtedness undertaking and negative pledge in the subsidiary’s loan will protect the syndicate’s position.

The syndicate should not be concerned, since the subsidiary’s loan is unsecured.

Obtaining a guarantee or security from the Company will give syndicate direct recourse against the Company and improve the syndicate’s position with regards to the subsidiary lender

Answer 77

A subordination agreement between the syndicate and the existing subsidiary lender will help to protect the syndicate’s position.

Correct.
The syndicate lenders will be structurally subordinated to the lender at subsidiary level. The fact that this loan is unsecured is irrelevant, since the existence of the lending is the cause of the problem. Whilst obtaining a guarantee and/or security can improve the syndicate’s position, it would need to take any such guarantee and/or security from the subsidiary, not from the Company. By including protective drafting in the Company’s loan agreement (not the subsidiary’s loan agreement), the syndicate can also mitigate the risk

Question 78

A borrower has a fully drawn term loan with a bank, the terms of which are based on the LMA. There are grace periods in the non-payment, insolvency proceedings and creditors’ process events of default only. The loan agreement has an undertaking not to dispose of assets and there is a de minimis exception to this of £10,000 in aggregate. The borrower has received an offer to buy one of its warehouses for £500,000 which the borrower is considering accepting.

What action is the bank entitled to take under the loan agreement if the borrower sells the warehouse?

The bank will be entitled to call an event of default for breach of other obligations.

The bank will be entitled to call a potential event of default.

The bank will be entitled to call for mandatory prepayment

The bank will be entitled to exercise drawstop.

Answer 78

The bank will be entitled to call an event of default for breach of other obligations.

Correct
Correct. The breach of the no disposals undertaking, if the borrower sells the warehouse, would trigger the other obligations event of default.
The bank will not be entitled to exercise drawstop because, on the facts, the loan is a fully drawn term loan and there are no outstanding drawdowns to temporarily suspend.
The bank will not be entitled to call for mandatory prepayment on these facts – mandatory prepayment events are things such as change of control of the borrower or illegality of the lender to lend and they are not relevant on these facts.
The bank will not be entitled to call a potential event of default. A potential event of default is where an event of default has been triggered but it contains a grace period which is running. On the facts, the relevant event of default does not contain a grace period (even if it did, arguably this breach would not be capable of remedy) so a potential event of default is not relevant on these facts.

Question 79

A borrower has a £2 million term loan agreement with a bank, the second tranche of which is due to be drawn down in a few days’ time. The loan agreement is based on the LMA and contains a repeating representation that there is no litigation over £200,000. The borrower has just been served with a claim form indicating it is being sued for £1 million for patent infringement.

Which event of default will be triggered under the borrower’s loan agreement and when?

The non-payment event of default will be triggered if the borrower does not pay the £1 million being claimed.

The misrepresentation event of default will be triggered when the no litigation over £200,000 representation is repeated in a few days’ time.

The creditors’ process event of default has been triggered by the service of the claim form suing the borrower for £1 million.

The cross-default event of default has been triggered by the service of the claim form suing the borrower for £1 million.

Answer 79

The misrepresentation event of default will be triggered when the no litigation over £200,000 representation is repeated in a few days’ time.

Correct. The repeating representation that there is no litigation over £200,000 will be repeated when the second tranche of the loan is drawn down. As the representation will be incorrect, a misrepresentation event of default will be triggered on its repetition.
The non-payment event of default will not be triggered because the borrower, on the facts, has not missed a payment to the bank. The £1 million being claimed is not money due to the bank under the loan agreement.
The cross-default event of default will not be triggered because, on the facts, the borrower had not got an event of default under another of its loan agreements. The £1 million claim is in relation to patent infringement, it has nothing to do with the borrower breaching another of its loan agreements.
The creditors’ process event of default will not be triggered because, on the facts, no remedy is being exercised by a creditor over an asset of the borrower (e.g. there is no execution of a judgment debt here). The serving of a claim form does not fall within creditors’ process.

Question 80

A borrower has an RCF loan agreement with a bank, the terms of which are based on the LMA. The borrower sent its latest interest payment to the bank on the due date yesterday but, unknown to the borrower, the payment failed to go through due to a computer glitch.

What action can the bank take today?

The bank can call a non-payment event of default and cancel the loan

The bank can call a potential event of default and exercise drawstop.

The bank can call a non-payment event of default and accelerate the loan.

The bank can call a potential event of default and put the loan on demand

Answer 80

The bank can call a potential event of default and exercise drawstop.

Correct. The non-payment event of default usually has a 2 or 3 day grace period for non-payments caused by technical errors such as on these facts. Whilst the grace period is running the borrower is in a potential event of default and the only remedy available to the bank is drawstop (relevant on these facts as the loan is an RCF).
The bank cannot call an event of default as this situation would only be a potential event of default. The bank is also limited, in the options available to it, in a potential event of default situation.