Loan transfers Flashcards
Methods of loan transfers?
· Novation
· Assignment / LMA assignment
· Sub participation
· Risk participation
- Novation?
· The New Lender (NL) and the borrower accept new rights and obligations in respect of each other. Strictly speaking, the rights and obligations of Existing Lender (EL) and the borrower with respect to each other are cancelled, not transferred.
· Can do in part
- Formalities for novation?
· Whilst under common law a novation agreement is required to be executed by all the parties, the LMA Agreement overcomes this administrative burden by providing for the use of transfer certificates (see schedule 4). These are effectively short-form novation agreements which are effective on execution by the Agent, EL and NL only - the borrower’s signature is not required, as it will have agreed in the loan agreement to the use of transfer certificates instead of a full novation agreement. NB: The Agent is only obliged to execute the transfer certificate once it has completed all necessary ‘know your customer’ checks in respect of NL (see clause 30.6(b)).
· A copy of the executed transfer certificate will be sent to the borrower by the Agent as soon as reasonably practicable after execution (clause 30.8).
· A fee will be paid by the NL to the Agent to cover the administrative work which the Agent must undertake in connection with the novation (clause 30.4).
· The consent to the use of transfer certificates is NOT consent to the transfer to NL itself. Consent to the identity of NL as transferee is a separate consent which may still be required depending on the terms of the loan agreement and the identity of NL (second option in clause 30.2(a)).
· Since novation involves the cancellation of the existing loan agreement and its replacement with a new one, any existing security for the loan granted to EL will be discharged and new security will need to be granted to NL.
· This can cause problems for NL as it will rank below any prior granted security over the borrower’s assets and the time periods relating to when a liquidator or administrator may challenge the security as a transaction at an undervalue or preference under ss. 238 and 239 Insolvency Act 1986 or when a floating charge is avoided under s.245 Insolvency Act 1986 are restarted. These are known as security ‘hardening periods’.
· For this reason, any security will commonly be held by a security trustee for the benefit of all the lenders from time to time. When the loan is transferred by novation, the security trustee simply holds the security for the benefit of NL rather than EL, and no new security is needed as the existing security rights will transfer automatically to NL. However, this approach may not be effective when the secured assets are located in overseas jurisdictions which do not recognise the concept of a trust.
· 30.1 of LMA Agreement gives permission for novation
- Advantages of novation?
· Since novation involves the cancellation of the loan agreement between EL and the borrower, it results in the complete transfer of risk sometimes referred to as a ‘clean break’. All the terms to which EL is subject, both rights and obligations, are transferred to NL. Similarly, as the new agreement has the same terms and conditions as the old one, NL will have the benefit of all of the terms of the original loan agreement.
· EL no longer has any non-payment risk as NL will put EL in funds for the principal amount novated at the time of novation. However, the price paid by NL may not be the exact principal amount – instead it will be an amount agreed between the parties.
· As novation transfers obligations and rights, it will remove the loan (including any undrawn amounts) from EL’s balance sheet.
· Novation can be used to transfer all or part of a loan.
· Assuming the loan agreement provides for the use of transfer certificates (i.e. it reflects the LMA Agreement), novation is a very quick and cheap method of transfer.
· Provided a security trustee has been appointed, the benefit of security will be held by the security trustee for the benefit of the lenders from time to time and so will pass from EL to NL without the need for a separate agreement or any loss of priority or re-starting of hardening periods (THIS IS THERE WITH THE LMA).
- Disadvantages of novation?
· At common law, the consent of the borrower is required. The borrower may consent to novation in advance under the terms of the loan agreement, but this consent may be limited to certain specified circumstances.
· In the LMA Agreement, the borrower’s consent is given in advance to transfer by novation to existing lenders and their affiliates/related funds (an affiliate being defined as a bank in the same group of companies as EL). Therefore, consent is only required for a novation to transferees which are not existing syndicate lenders or affiliated to existing syndicate lenders (clause 30.2(a)(i)). Note also that the LMA Agreement provides at clause 30.2(a)(ii) that the consent of the borrower will not be required if an event of default is continuing at the time of the relevant transfer. Under clause 30.2(b) the borrower’s consent must not be unreasonably withheld or delayed and will be deemed given after 5 business days unless expressly refused within that time. NB: In some practice areas such as the leveraged loan market, a borrower will invariably control a transfer (to a greater or lesser extent).
NEED CONSENT
· The change of identity of the lender may trigger the tax gross-up or increased costs clauses in the loan agreement. The borrower will not want to be exposed to the risk of paying increased costs on a transfer and may refuse its consent to the identity of any NL which would entail an increase in its costs.
· However, the loan agreement may provide that the borrower will not be liable for any increased costs which arise because of the novation. This is the position taken in clause 30.3(e) (i) and (ii) of the LMA Agreement, which protects the borrower from paying increased costs or gross-up arising as a consequence of the novation, except if the novation occurs in the primary syndication of the loan.
· Primary syndication would include syndication before the loan agreement is signed or shortly thereafter (the secondary market is the sale of debt that occurs after primary syndication of the original loan has been completed).
· Where security for the loan consists of assets located overseas, the governing law of the security will usually be the law of the asset’s location. If the security trustee structure is not effective under the local law (of particular concern in civil law jurisdictions), the effect may be that novation discharges the security. New security can be created, but this is problematic since priority will be lost and hardening periods for insolvency purposes will be re-started – not to mention the costs and time involved in creating and perfecting the new security.
· EL will no longer be the lender of record. This may not be a problem, but if the main purpose of entering into the loan was to establish a relationship with the borrower, the relationship may potentially be adversely impacted. This is because it won’t be possible to achieve a transfer by novation without the borrower being aware where the borrower’s consent is required.
- Assignment?
· Rather than creating a new agreement an assignment involves the transfer of EL’s existing rights to the NL. Only EL’s rights will be transferred-obligations cannot be assigned.
· The LMA Agreement contractually circumvents the main disadvantage of assignment (namely that only the benefits and not the burdens can be assigned).
· At common law, only EL’s rights will be transferred – obligations cannot be assigned.
Formalities of Assignment?
· Only EL and NL need be party to the assignment agreement.
· At law consent of the borrower is not required for an assignment to take place, although the underlying agreement may include restrictions relating to assignment, such as need to get the borrower’s consent.
· The assignment will only be a legal assignment if the requirements of s.136(1) Law of Property Act 1925 are satisfied. These requirements are that the assignment must be: (1) absolute – this means that the assignment must be for the whole of EL’s part of the debt; (2) in writing and signed by EL; and (3) notified to the borrower (NB: only notice is required, not consent). A legal assignment will transfer full legal and beneficial title to the loan to the transferee.
· An assignment which does not satisfy all the requirements of s.136 will be an equitable as signment, under which only a beneficial interest passes.
· It is important for NL that notice is given to the borrower for there to be a legal assignment. If notice is not given, NL is exposed to increased risk as the borrower will be entitled to: (1) make payments to EL rather than NL; (2) set off amounts owed to it by EL against the payments which it owes to NL on the loan; and (3) amend the terms of the loan by agreement with EL, without requiring NL’s consent. In addition, assignments generally rank in priority in accordance with the date of notice to the borrower (by the rule in Dearle v Hall). In practice, giving notice of the assignment is more important than whether the assignment is legal or equitable (which often is simply a case of whether all or only part of the loan is being assigned).
· To transfer the benefit of any security a separate security assignment may need to be signed in addition to the assignment agreement. If security is located outside England and Wales local advice must be sought but it may be that, in civil jurisdictions, assignment avoids the problems related to security which we considered in relation to novation.
- Advantages of legal assignment?
· The NL will put the EL in funds for the drawn down amount that has been assigned. This will be the price that is agreed between the parties (whether the existing principal amount or a lower amount, for example, with a non-performing loan).
· A legal assignment, or an equitable assignment that is notified to the borrower, will generally remove the drawn down amounts from EL’s balance sheet and its capital adequacy requirements.
· The consent of the borrower is not usually needed and the assignment agreement need only be signed by EL and NL.
- Disadvantages of legal assignment
· At law, assignment transfers rights, not obligations. EL will therefore still be required to provide future funding to the borrower, e.g. under an RCF or a term loan that is not yet fully drawn. Assignment is therefore not an effective transfer method if there are outstanding lending obligations. This is the main reason why, in practice, loans are rarely transferred by legal assignment.
· Serious issues arise for NL if notice of the assignment is not given to the borrower - one key point is that if the borrower is not notified of the assignment, it is entitled to continue to make payments to EL. This means that NL is reliant on EL to pass on principal and interest to it, and so is taking a double credit risk on EL passing on the payments as well as on the borrower making them. It is only possible to avoid disclosing an assignment to the borrower if NL is prepared to accept these consequences. Note that notice is a separate requirement from borrower consent to the assignment and a requirement for consent (see above) would mean the borrower is aware of the assignment anyway.
- LMA assignment?
· Can do this in part unlike common law assignment
· The LMA Agreement provides a procedure for assignment (clause 30.7) which supplements the common law position. It provides a pro forma assignment agreement (Schedule 5) and contemplates the release and assumption of obligations as well as the assignment of rights, and in this way the main disadvantage of a legal assignment is avoided.
· Under the LMA Agreement the parties, in addition to assigning rights, make a contractual agreement that EL releases its obligations and the NL assumes equivalent obligations. For this reason an LMA Assignment is a hybrid which is more similar to a novation than a legal assignment.
· One important point to note regarding the formalities of execution of an LMA Assignment is that the LMA form of assignment agreement requires execution by EL and NL with the Agent counter-signing by way of confirmation. It needs to be addressed to the Agent and the Company (i.e. the borrower). As such the borrower will receive a copy of the executed assignment agreement(a copy will be sent to the borrower by the Agent as soon as reasonably practicable after execution – clause 30.8 of the LMA Agreement). Receipt of the assignment agreement will represent actual notice to the borrower of the assignment, meaning that NL will become ‘lender of record’ and avoid any double credit risk that may arise if payments ultimately due to it were to be made first to the EL.
· The common law position regarding consent is also varied under the LMA Agreement. Under the second option in clause 30.2(a)(i), the borrower’s consent is required for assignments to lenders which are not existing syndicate members or affiliated to existing syndicate members. This means that the same consent provisions apply on LMA Assignment as they do to LMA novation. As for novation, the LMA provides at clause 30.2(a)(ii) that the borrower’s right to veto an assignment to the NL will be overridden if an event of default is continuing at the time of the relevant assignment.
· A fee will be paid by the NL to the Agent to cover the administrative work which the Agent must undertake in connection with the assignment – see clause 30.4 of the LMA Agreement.
· Given that the LMA Assignment is more similar to a novation you may be wondering why an EL would ever opt to use an assignment agreement (Schedule 5) rather than a transfer certificate (Schedule 4). The answer to that question is that in the vast majority of transfers a novation will be used as the preferred method since it is more straightforward and does not require a separate security assignment. An assignment agreement will usually only be used where security has been granted over assets located in a civil jurisdiction which does not recognise the concept of a security trust. In this situation, local lawyers would need to be instructed to ensure that the LMA provisions whereby the NL assumes obligations would be enforceable under local law and of course to ensure that any local law formalities were followed in preparing and executing the separate security assignment.
· When the loan is assigned to another lender – the New Lender is one the one that deals with it
- Sub-participation?
· Sub-participation does not involve any transfer of rights or obligations from EL to NL. Instead, EL and NL enter into a separate agreement (a sub-participation agreement) creating new rights and obligations between EL and NL. The intention behind a sub-participation is to transfer the economic interest/risk associated with the loan, while leaving the relationship between the EL and the borrower unaffected. Sub-participations can be entered into on a funded or risk basis
· In a funded participation, the NL agrees to pay the EL the principal amount of the loan to be participated (which can be all or part of EL’s participation). The EL is then obliged to pass on payments of interest and principal relating to the participated part of the loan when EL receives those amounts from the borrower. The credit risk in relation to the loan therefore passes to the NL.
· What if the borrower needs to restructure the loan?
EL will not be under any obligation but will have a rescheduling risk
- Funded participation - formalities
· A sub-participation agreement between EL and NL is required. The borrower will not be a party to the agreement, and indeed may not even be aware that the sub-participation has taken place. The LMA produces a standard form of sub-participation agreement.
· If EL is required to provide future funding to the borrower (i.e. under an RCF or a term loan with tranches that have not yet been drawn down), a sub-participation agreement can provide for NL to place EL in funds as and when those further advances are made by EL.
· As EL remains the lender of record, it will remain entitled to the benefit of any security. It is not normal practice for EL to assign the security rights to NL. Instead, NL will rely upon EL exercising its rights under the security on its behalf.
· The LMA sub-participation agreement provides that EL must pay over to NL the relevant proportion of interest and principal pro rata to NL’s participation, including the proceeds from a realisation of security held by EL, which are received by EL from the borrower. This must be done ‘without material delay’, otherwise EL will be in breach of contract.
- Advantages of funded participation?
· As a matter of law, consent is generally not required for sub-participation, although it is possible for the loan agreement to vary this position and require the borrower’s consent to sub-participation.
· Unlike novation or assignment, with sub-participation EL remains the lender of record. There is no need for the borrower even to be informed that the sub-participation has taken place. This may be important if EL wishes to protect itself against the risk of the borrower not repaying, without damaging its relationship with the borrower.
· Once NL has paid the drawn down amounts to EL (putting EL ‘in funds’ for the drawn down amounts), EL’s risk is fully removed in respect of those drawn down amounts. As we saw above, if the borrower fails to pay any part of the principal or interest to EL, EL is excused from paying the unpaid agreed amount to NL.
· If EL still has a commitment to make further advances to the borrower under the terms of the original agreement, then EL still bears the risk of those future advances until they too are requested by the borrower and EL has been ‘put in funds’ by NL in respect of those further advances.
· Sub-participation removes risk in relation to drawn down amounts which will satisfy EL’s internal credit committee that the risk has been transferred. Risk relating to undrawn amounts will only be removed once EL is funded by NL.
· Until NL funds these undrawn amounts, EL takes a risk on NL which may or may not satisfy EL’s internal credit committee from an internal risk perspective.
- Disadvantages of funded participation
· Confidentiality. NL is unlikely to be willing to accept a sub-participation without being given detailed information about the borrower. As we saw above, EL will have given an express confidentiality undertaking to the borrower (LMA Agreement clause 43). However, clause 43.2(b)(ii) and (A) allows disclosure of information to potential sub-participants provided they enter into a confidentiality undertaking. EL should check that this clause appears in the loan agreement as otherwise, obtaining the borrower’s consent to sharing information will negate the benefit of not having to obtain the borrower’s consent to the sub-participation itself.
· Rescheduling risk. As there are two parties involved, provision needs to be made in the sub-participation agreement for which party will bear the rescheduling risk (i.e., EL having to deal with the borrower in financial difficulty after it has executed the loan transfer). Commonly, NL will bear the risk of the consequences of any rescheduling (although EL may well conduct the negotiations with the borrower as the borrower is likely to be unaware of the existence of the NL). However, if EL has sub-participated its entire interest in the loan, EL may agree not to make certain substantial changes to the loan agreement without NL’s consent. If EL does find itself in negotiations with the borrower and unable to agree to amendments without NL’s consent, the existence of the sub-participation may become apparent to the borrower, and this may have an impact on its relationship with EL.
· Because EL is relying on NL to put it in funds, it remains exposed to the risk of NL defaulting until it actually receives the funds. This is particularly an issue in relation to EL’s obligation to lend further amounts. Although EL can sub-participate this obligation by requiring NL to fund any future drawdown requested by the borrower, until actually put in funds, EL will remain exposed to NL for the amount of its undrawn commitments.
· As EL remains the lender of record, the benefit of the terms of the agreement are not transferred to NL. NL is not therefore entitled to benefit from the gross-up clause or the increased costs clause.
· NL is exposed to the double credit risk of both the borrower and EL. If either the borrower defaults and fails to pay EL, or EL defaults and fails to pass on the amount received, NL will not receive the full principal and interest due. NL has no contractual relationship with the borrower, and therefore, if there is a non-payment, NL must rely on EL to pursue the borrower on its’ behalf.
- Risk participation?
· As with funded participation, EL and NL enter into a separate agreement. However, in the case of risk participation, the agreement provides that NL will only pay EL to the extent that the borrower does not pay the amount it owes to EL in full.
· This works something like a guarantee or insurance, in the sense that NL agrees to make good any amount which the borrower fails to pay to EL. EL will pay NL a fee in return for entering into the agreement. This type of participation is sometimes commercially referred to as an unfunded participation.
