The International Comparative Legal Guide to:

Lending & Secured Finance 2014

2nd Edition

A practical cross-border insight into lending and secured finance

Published by Global Legal Group, with contributions from:

Adjuris DLA Piper McMillan LLP

Ali Budiardjo, Nugroho, Reksodiputro Drew & Napier LLC Milbank, Tweed, Hadley & McCloy LLP
Allen & Overy LLP Freshfields Bruckhaus Deringer LLP Miranda & Amado Abogados
Andreas Neocleous & Co LLC Hajji & Associés MJM Limited
Andrews Kurth LLP Ikeyi & Arifayan Morrison & Foerster LLP
Asia Pacific Loan Market Association J.D. Sellier + Co. Nchito & Nchito
Bhikha & Popat Advogados JŠK, advokátní kancelář, s.r.o. Orrick, Herrington & Sutcliffe LLP
Bingham McCutchen LLP KALO & ASSOCIATES Pestalozzi Attorneys at Law Ltd
Bonn & Schmitt Khan Corporate Law Rodner, Martínez & Asociados
Brian Kahn Inc. Attorneys KPP Law Offices Shearman & Sterling LLP
Bruun & Hjejle Kramer Levin Naftalis & Frankel LLP Simpson Thacher & Bartlett LLP
Chiomenti Studio Legale LawPlus Ltd. Skadden, Arps, Slate, Meagher & Flom LLP
Clayton Utz Lee & Ko SRS Advogados
Cleary Gottlieb Steen & Hamilton LLP Lee and Li, Attorneys-at-Law The Loan Syndications and Trading Association
Cordero & Cordero Abogados Loan Market Association TozziniFreire Advogados
Cornejo Méndez Gonzalez y Duarte S.C. Loyens & Loeff N.V. White & Case LLP
Criales, Urcullo & Antezana – Abogados Maples and Calder
Cuatrecasas, Gonçalves Pereira Marval, O’Farrell & Mairal
Dave & Girish & Co. Mayer Brown LLP
Davis Polk & Wardwell LLP McGuireWoods LLP
The International Comparative Legal Guide to: Lending & Secured Finance 2014
Editorial Chapters:
1 Loan Syndications and Trading: An Overview of the Syndicated Loan Market – Bridget Marsh &
Ted Basta, The Loan Syndications and Trading Association 1
2 Loan Market Association – An Overview – Nigel Houghton, Loan Market Association 7
3 Asia Pacific Loan Market Association – An Overview – Janet Field, Asia Pacific Loan Market Association 11
Contributing Editor
Thomas Mellor, General Chapters:
Bingham McCutchen LLP
4 An Introduction to Legal Risk and Structuring Cross-Border Lending Transactions – Thomas Mellor &
Account Managers Marc Rogers Jr., Bingham McCutchen LLP 15
Edmond Atta, Beth
Bassett, Antony Dine, 5 Global Trends in Leveraged Lending – Joshua W. Thompson & Caroline Leeds Ruby, Shearman &
Susan Glinska, Dror Levy, Sterling LLP 20
Maria Lopez, Florjan
Osmani, Paul Regan, 6 Recent Trends in U.S. Term Loan B – Meyer C. Dworkin & Monica Holland, Davis Polk & Wardwell LLP 26
Gordon Sambrooks, 7 Yankee Loans – Structural Considerations and Familiar Differences from Across the Pond to Consider –
Oliver Smith, Rory Smith
R. Jake Mincemoyer, White & Case LLP 31
Sales Support Manager
Toni Wyatt 8 Issues and Challenges in Structuring Asian Cross-Border Transactions – An Introduction – Roger Lui &
Elizabeth Leckie, Allen & Overy LLP 36
Sub Editors
Nicholas Catlin 9 Acquisition Financing in the United States: Outlook and Overview – Geoffrey Peck & Mark Wojciechowski,
Amy Hirst Morrison & Foerster LLP 41
Editors 10 A Comparative Overview of Transatlantic Intercreditor Agreements – Lauren Hanrahan & Suhrud Mehta,
Beatriz Arroyo Milbank, Tweed, Hadley & McCloy LLP 46
Gemma Bridge
11 Oil and Gas Reserve-Based Lending – Robert Rabalais & Matthew Einbinder, Simpson Thacher &
Senior Editor Bartlett LLP 52
Suzie Kidd
12 Lending to Health Care Providers in the United States: Key Collateral and Legal Issues – Art Gambill
Global Head of Sales
& Kent Walker, McGuireWoods LLP 56
Simon Lemos
Group Consulting Editor 13 A Comparison of Key Provisions in U.S. and European Leveraged Loan Agreements – Sarah M. Ward &
Alan Falach Mark L. Darley, Skadden, Arps, Slate, Meagher & Flom LLP 61

Group Publisher 14 Financing in Africa: A New Era – Nicholas George & Pascal Agboyibor, Orrick, Herrington & Sutcliffe LLP 67
Richard Firth
15 LSTA v. LMA: Comparing and Contrasting Loan Secondary Trading Documentation Used Across the
Published by Pond – Kenneth L. Rothenberg & Angelina M. Yearick, Andrews Kurth LLP 72
Global Legal Group Ltd.
59 Tanner Street 16 The Global Subscription Credit Facility Market – Key Trends and Emerging Developments –
London SE1 3PL, UK Michael C. Mascia & Kiel Bowen, Mayer Brown LLP 79
Tel: +44 20 7367 0720
17 Majority Rules: Credit Bidding Under a Syndicated Facility – Douglas H. Mannal & Thomas T. Janover,
Fax: +44 20 7407 5255
Email: [email protected] Kramer Levin Naftalis & Frankel LLP 83
URL: www.glgroup.co.uk
Country Question and Answer Chapters:
GLG Cover Design
F&F Studio Design 18 Albania KALO & ASSOCIATES: Nives Shtylla 87
GLG Cover Image Source 19 Angola SRS Advogados in cooperation with Adjuris: Carla Vieira Mesquita &
iStockphoto Gustavo Ordonhas Oliveira 94
Printed by 20 Argentina Marval, O’Farrell & Mairal: Juan M. Diehl Moreno & Diego A. Chighizola 101
Ashford Colour Press Ltd.
April 2014 21 Australia Clayton Utz: David Fagan 109
Copyright © 2014 22 Bermuda MJM Limited: Jeremy Leese & Timothy Frith 117
Global Legal Group Ltd.
All rights reserved 23 Bolivia Criales, Urcullo & Antezana - Abogados: Carlos Raúl Molina Antezana &
No photocopying Andrea Mariah Urcullo Pereira 127

ISBN 978-1-908070-95-1 24 Botswana Khan Corporate Law: Shakila Khan 134

ISSN 2050-9847
25 Brazil TozziniFreire Advogados: Antonio Felix de Araujo Cintra 141
Strategic Partners
26 British Virgin Islands Maples and Calder: Michael Gagie & Matthew Gilbert 147
27 Canada McMillan LLP: Jeff Rogers & Don Waters 154
28 Cayman Islands Maples and Calder: Alasdair Robertson & Tina Meigh 162
29 China DLA Piper: Robert Caldwell & Peter Li 169
30 Costa Rica Cordero & Cordero Abogados: Hernán Cordero Maduro & Ricardo Cordero Baltodano 177
31 Cyprus Andreas Neocleous & Co LLC: Elias Neocleous & George Chrysaphinis 184

Continued Overleaf

Further copies of this book and others in the series can be ordered from the publisher. Please call +44 20 7367 0720
Disclaimer
This publication is for general information purposes only. It does not purport to provide comprehensive full legal or other advice.
Global Legal Group Ltd. and the contributors accept no responsibility for losses that may arise from reliance upon information contained in this publication.
This publication is intended to give an indication of legal issues upon which you may need advice. Full legal advice should be taken from a qualified
professional when dealing with specific situations.

www.ICLG.co.uk
The International Comparative Legal Guide to: Lending & Secured Finance 2014

Country Question and Answer Chapters:

32 Czech Republic JŠK, advokátní kancelář, s.r.o.: Roman Šťastný & Patrik Müller 192
33 Denmark Bruun & Hjejle: Jakob Echwald Sevel & Peter-Andreas Bodilsen 198
34 England Skadden, Arps, Slate, Meagher & Flom LLP: Clive Wells & Paul Donnelly 205
35 France Freshfields Bruckhaus Deringer LLP: Emmanuel Ringeval & Cristina Radu 215
36 Germany Cleary Gottlieb Steen & Hamilton LLP: Dr. Werner Meier & Daniel Ludwig 224
37 Greece KPP Law Offices: George N. Kerameus & Panagiotis Moschonas 235
38 Hong Kong Bingham McCutchen LLP in association with Roome Puhar: Vincent Sum &
Naomi Moore 242
39 India Dave & Girish & Co.: Mona Bhide 253
40 Indonesia Ali Budiardjo, Nugroho, Reksodiputro: Theodoor Bakker & Ayik Candrawulan Gunadi 259
41 Italy Chiomenti Studio Legale: Francesco Ago & Gregorio Consoli 266
42 Japan Bingham Sakai Mimura Aizawa: Taro Awataguchi & Toshikazu Sakai 274
43 Korea Lee & Ko: Woo Young Jung & Yong Jae Chang 282
44 Kosovo KALO & ASSOCIATES: Vegim Kraja 289
45 Luxembourg Bonn & Schmitt: Alex Schmitt & Philipp Mössner 297
46 Mexico Cornejo Méndez Gonzalez y Duarte S.C.: José Luis Duarte Cabeza & Ana Laura
Méndez Burkart 303
47 Morocco Hajji & Associés: Amin Hajji 310
48 Mozambique SRS Advogados in association with Bhikha & Popat Advogados: Momede Popat &
Gonçalo dos Reis Martins 317
49 Netherlands Loyens & Loeff N.V.: Gianluca Kreuze & Sietske van ‘t Hooft 322
50 Nigeria Ikeyi & Arifayan: Nduka Ikeyi & Kenechi Ezezika 330
51 Peru Miranda & Amado Abogados: Juan Luis Avendaño C. & Jose Miguel Puiggros O. 337
52 Portugal SRS Advogados: William Smithson & Gonçalo dos Reis Martins 346
53 Russia White & Case LLP: Maxim Kobzev & Natalia Nikitina 352
54 Singapore Drew & Napier LLC: Valerie Kwok & Blossom Hing 359
55 South Africa Brian Kahn Inc. Attorneys: Brian Kahn & Michelle Steffenini 367
56 Spain Cuatrecasas, Gonçalves Pereira: Manuel Follía & Héctor Bros 373
57 Switzerland Pestalozzi Attorneys at Law Ltd: Oliver Widmer & Urs Klöti 381
58 Taiwan Lee and Li, Attorneys-at-Law: Abe Sung & Hsin-Lan Hsu 390
59 Thailand LawPlus Ltd.: Kowit Somwaiya & Naddaporn Suwanvajukkasikij 398
60 Trinidad & Tobago J.D. Sellier + Co.: William David Clarke & Donna-Marie Johnson 405
61 USA Bingham McCutchen LLP: Thomas Mellor & Rick Eisenbiegler 414
62 Venezuela Rodner, Martínez & Asociados: Jaime Martínez Estévez 425
63 Zambia Nchito & Nchito: Nchima Nchito SC & Ngosa Mulenga Simachela 430
 EDITORIAL

Welcome to the second edition of The International Comparative Legal Guide

to: Lending & Secured Finance.
This guide provides corporate counsel and international practitioners with a
comprehensive worldwide legal analysis of the laws and regulations of lending
and secured finance.
It is divided into three main sections:
Three editorial chapters. These chapters are overview chapters and have been
contributed by the LSTA, LMA and APLMA.
Fourteen general chapters. These chapters are designed to provide readers with
a comprehensive overview of key issues affecting lending and secured finance,
particularly from the perspective of a multi-jurisdictional transaction.
Country question and answer chapters. These provide a broad overview of
common issues in lending and secured finance laws and regulations in 46
jurisdictions.
All chapters are written by leading lending and secured finance lawyers and
industry specialists and we are extremely grateful for their excellent
contributions.
Special thanks are reserved for the contributing editor Thomas Mellor of
Bingham McCutchen LLP for his invaluable assistance.
Global Legal Group hopes that you find this guide practical and interesting.
The International Comparative Legal Guide series is also available online at
www.iclg.co.uk.

Alan Falach LL.M.

Group Consulting Editor
Global Legal Group
[email protected]
 PREFACE

Welcome to the 2014 edition of The International Comparative Legal Guide

to: Lending & Secured Finance. Bingham McCutchen LLP is delighted to
serve as the Guide's Contributing Editor, and I am honoured to have been
invited to write this preface.

Cross-border lending has increased dramatically over the last decades in terms
of volume of loans, number of transactions and number of market participants.
There are many reasons for this: the globalisation of business and development
of information technology; the rise of emerging economies that have a thirst
for capital in order to develop economies to their full potential; and the
development of global lending markets, which has led to a dramatic rise in the
number of market participants searching for the right mix of return and risk, a
search that often leads to cross-border lending opportunities. For these reasons
it is increasingly important to maintain an accurate and up-to-date guide
regarding relevant practices and laws in a variety of jurisdictions.

The Guide’s first edition established itself as one of the most comprehensive
guides in the practice of cross-border lending. Building on that success, this
second edition, with contributions from the LSTA, the LMA, the APLMA,
coverage of 46 jurisdictions and useful overview chapters exploring certain
topics in-depth, serves as an even more valuable, authoritative source of
reference material for lenders, global businesses leaders, in-house counsel and
international legal practitioners.

We hope you find the Guide useful and practical, and we encourage you to
contact us with suggestions to improve future editions.

Thomas Mellor
Bingham McCutchen LLP
Contributing Editor
The International Comparative Legal Guide to: Lending & Secured Finance 2014
[email protected]
Chapter 1

Loan Syndications and

Trading: An Overview of Bridget Marsh

the Syndicated Loan Market

The Loan Syndications and Trading Association Ted Basta

In the past 25 years, the art of corporate loan syndications, trading, formed, and its mission since inception has included the development
and investing has changed dramatically. There was a time when of best practices, market standards, and trading documentation. The
banks lent to their corporate borrowers and simply kept those loans LSTA has thus successfully spearheaded efforts to increase the
on their books, never contemplating that loans would be traded and transparency, liquidity, and efficiency of the loan market; in turn, this
managed by investors like stocks and bonds in a portfolio. In time, more standardised loan asset class has directly contributed to the
however, investors became drawn to the attractive features of loans growth of a robust, liquid secondary market.
– unlike bonds, loans were senior secured debt obligations with a The LSTA’s role has expanded to meet new market challenges.
floating rate of return – and, over the years, an institutional asset After the Global Financial Crisis of 2008, the LSTA assumed more
class emerged. Today, such loans are not only held by banks but are prominence in the loan market, regularly engaging with the U.S.
also typically sold to other banks, mutual funds, insurance government and its regulatory bodies on recent legislative and
companies, structured vehicles, pension funds, and hedge funds. regulatory initiatives. Policymaking in the wake of the financial
This broader investor base has brought a remarkable growth in the crisis had included sweeping changes to the financial industry,
volume of loans being originated in the primary market and including to the loan market, even though the regulatory impact on
subsequently traded in the secondary market. The syndicated loan the loan market was sometimes an unintended byproduct of reform
market represents one of today’s most innovative capital markets. legislation aimed somewhere else. The LSTA has, therefore,
In 2013, total corporate lending in the United States exceeded $2.1 dedicated substantial time and energy since the crisis to building
trillion – the highest volume recorded in the past 23 years.1 This awareness among regulators about the loan market and how it
figure encompasses all three subsectors of the syndicated loan market functions, seeking to distinguish it from other markets and, at times,
– the investment grade market, the leveraged loan market, and the persuading policymakers to exempt the loan market from particular
middle market. In the investment grade market total lending – or legislative measures. With most of the comment periods for those
issuance – stood at approximately $749 billion in 2013. Most lending regulatory changes having expired, the LSTA will move into a
in the investment grade market consists of revolving credit facilities second phase of its regulatory outreach program, where it plans to
to larger, more established companies. The leveraged loan market, maintain a dialogue about the loan market with regulators and to
where loans are made to companies with non-investment grade promote the many benefits of a vibrant leveraged loan market for
ratings (or with high levels of outstanding debt), represented $1.14 US companies.
trillion.2 Leveraged loans are typically made to companies seeking This chapter examines: (i) the history of the leveraged loan market,
to refinance existing debt, to finance acquisitions, leveraged buyouts, focusing on the growth and maturation of the secondary trading
or to fund projects and other corporate endeavours such as dividend market for leveraged loans; (ii) the role played by the LSTA in
recapitalisations. Although investment grade lending and leveraged fostering that growth through its efforts to standardise the practices
lending volumes are roughly comparable, leveraged loans comprise of, and documentation used by participants active in, the secondary
the overwhelming majority of loans that are traded in the secondary loan market to bring greater transparency to the loan asset class; and
market. Then there is the middle market. As traditionally defined, (iii) the regulatory challenges faced by the loan market in a post-
middle market lending includes loans of up to $500 million that are financial crisis environment, which our members believe is the
made to companies with annual revenues of under $500 million.3 For most important concern for the loan market.
these companies, the loan market is a primary source of funding. In
2013, middle market lending totaled more than $200 billion, with
$160 billion of that amount considered large middle market deals.4 Growth of the Secondary Market for Leveraged
Of these three market segments, it is the leveraged loan market that Loans
has evolved most dramatically over the past 25 years. Attracted by
The story of the leveraged loan market starts approximately 25
the higher returns of the loan asset class, the investor base has
years ago in the United States, with the first wave of loan market
expanded significantly and become more diverse. This, in turn, has
growth being driven by the corporate M&A activity of the late
fueled demand for loans, leading to a commensurate rise in loan
1980s. Although a form of loan market had existed prior to that
origination volumes in the primary market. For the loan market to
time, a more robust syndicated loan market did not emerge until the
grow successfully, for the loan asset class to mature, and to ease the
M&A deals of the 1980s and, in particular, those involving
process of trading and settlement, these new entrants to the market
leveraged buy-outs (LBOs), which required larger loans with higher
have needed uniform market practices and standardised trading
interest rates. This had two significant consequences for the loan
documentation. In 1995, in response to these needs, the Loan
market. First, because banks found it difficult to underwrite very
Syndications and Trading Association (“LSTA” or “Association”) was

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 The Loan Syndications and Trading Association Loan Syndications and Trading

large loans on their own, they formed groups of lenders – syndicates commercial loans – a need reflected in the LSTA’s creation in 1995.
– responsible for sharing the funding of such large corporate loans. (The LSTA and its role in the development of a more standardised
Syndication enabled the banks to satisfy market demand while loan market is discussed more fully below, under “The
limiting their own risk exposure to any single borrower. Second, Standardisation of a Market”.)
the higher interest rates associated with these large loans attracted Around the same time, the loan market acquired investment tools
non-bank lenders to the loan market, including traditional bond and similar to those used by participants in other mature markets, for
equity investors, thus creating a new demand stream for syndicated example, a pricing service, bank loan ratings, and other supporting
loans. Retail mutual funds also entered the market at this time and vendor services. In 1996, the LSTA established a monthly dealer
began to structure their funds for the sole purpose of investing in quote-based secondary mark-to-market process to value loans at a
bank loans. These loans generally were senior secured obligations price indicative of where those loans would most likely trade. This
with a floating interest rate. The resultant asset class had a enabled auditors and comptrollers of financial institutions that
favourable risk-adjusted return profile. Indeed, non-bank appetite participated in secondary trading to validate the prices used by
for syndicated leveraged loans would be the primary driver of traders to mark their loan positions to “market”. Within a few
demand that helped fuel the loan market’s growth.5 years, however, as leveraged lending topped $300 billion and
Although banks continued to dominate both the primary market secondary trading volume reached $80 billion, there was a need to
(where loans are originated) and the secondary market (where loans “mark-to-market” loan positions on a more frequent basis.7 In
are traded), the influx of the new lender groups in the mid-1990s 1999, this led to the LSTA and Thomson Reuters Loan Pricing
saw an inevitable change in market dynamics within the syndicated Corporation jointly forming the first secondary mark-to-market
loan market. In response to the demands of this new investor class, pricing service run by an independent third party to provide daily
the banks, which arranged syndicated loans, began modifying U.S. secondary market prices for loan market participants. Shortly
traditional deal structures, and, in particular, the features of the thereafter, two other important milestones were reached, both of
institutional tranche or term loan B, that portion of the deal which which facilitated greater liquidity and transparency – (i) the first
would typically be acquired by the institutional or non-bank loan index was created by the LSTA and Standard and Poor’s, and
lenders. The size of these tranches was increased to meet (or create) (ii) bank loan ratings became widely available to market
demand, their maturity dates were extended to suit the lenders’ participants.
investment goals, and their amortisation schedules tailored to Just as the market’s viability was on the rise, so was its visibility. In
provide for only small or nominal instalments to be made until the 2000, the Wall Street Journal began weekly coverage of the
final year when a large bullet payment was scheduled to be made by syndicated loan market and published the pricing service’s
the borrower. In return, term loan B lenders were paid a higher rate secondary market prices for the mostly widely quoted loans. All
of interest. All these structural changes contributed to a more these tools – the pricing service, the bank loan ratings, the loan
aggressive risk-return profile, which was necessary in order to index, and the coverage of secondary loan prices by a major
attract still more liquidity to the asset class. financial publication – were important building blocks for the loan
A true secondary market for leveraged loans in the United States market, positioning it for further successful growth.
emerged in the 1990s. During the recession of the early 1990s, At about this time, the scales tipped, and the leveraged loan market
default rates rose sharply, which severely limited the availability of shifted from a bank-led market to an institutional investor-led
financing, particularly in transactions involving financing from market comprised of finance and insurance companies, hedge, high-
regional and foreign banks. Interest rates to non-investment grade yield and distressed funds, loan mutual funds, and structured
borrowers thus increased dramatically. Previously, banks had vehicles like collateralised loan obligations or “CLOs”. Between
carried performing loans at par or face value on their balance sheets, 1995-2000, the number of loan investor groups managing bank
while valuations below par (expected sale prices) were only loans grew by approximately 130 percent and accounted for more
generally assigned to loans that were in or near default. During the than 50 percent of new deal allocations in leveraged lending. By
credit cycle of the early 1990s, however, a new practice developed the turn of the millennium, leveraged lending volume was
in the banking industry. As banks in the U.S. sought to reduce their approximately $310 billion and annual secondary loan trading
risk and strengthen their balance sheets, they chose to sell those volume exceeded $100 billion as illustrated in the chart below.
leveraged loans which had declined in value since their syndication, With these new institutional investors participating in the market,
rather than hold the loans until their maturity date as they had in the the syndicated loan market experienced a period of rapid
past. In so doing, a new distressed secondary market for leveraged development that allowed for impressive growth in both primary
loans emerged, consisting of both traditional (bank) and non- lending and secondary trading.
traditional (non-bank) buyers. Banks were not simply originators
Chart 1
of these loans but now were also loan traders, and thus, in their role
as market makers, began to provide liquidity for the market.
Although leveraged lending volume in the primary market had
reached approximately $100 billion by 1995, trading activity was
still relatively low, standing at approximately $40 billion.6 The
early bank loan trading desks at this time initially acted more as
brokers than traders, simply brokering or matching up buyers and
sellers of loans. As liquidity improved and the lender base
expanded, investors began to look to the secondary market as a
more effective platform from which to manage their risk exposure
to loans, and eventually active portfolio management through
secondary loan trading was born. With the advent of this new and
vibrant secondary loan market, there naturally was a greater need
for standard trading documents and market practices which could
service a fair, efficient, liquid, and professional trading market for

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The Loan Syndications and Trading Association Loan Syndications and Trading

Unfortunately, as the credit cycle turned and default rates increased secondary loan trading market to be even more liquid and
sharply in the early 2000s, there was a temporary lull in the transparent than it was before the financial crisis.
market’s growth, with secondary loan trading stalled for a number
of years. By 2003, however, leveraged lending (and trading)
volumes quickly rebounded as investor confidence was restored. The Standardisation of a Market
Even the most bullish of loan market participants could not have No regulatory authority directly oversees or sets standards for the
predicted the rate of expansion that would take place over the next trading of loans in the United States, although, of course, loan
four years, from 2003-2007. Once again, this growth was driven by market participants themselves are likely to be subject to other
M&A activity and large LBOs. Increasing by nearly 200 percent in governmental and regulatory oversight. Instead, the LSTA leads the
that four-year period, leveraged loan outstandings were more than loan market by developing policies, guidelines, and standard
half a trillion dollars and secondary trading volumes reached $520 documentation and promoting just and equitable market practices.
billion – a record that still stands today. Although hedge funds, loan The LSTA’s focus is attuned to the distinctive structural features of
mutual funds, insurance companies, and other investor groups the loan market which stem from the fact that corporate loans are
played a large part in this phase of the loan market’s expansion, the privately-negotiated debt obligations that are issued and traded
growth of the past three years had only been possible because of the subject to voluntary industry standards. Because the LSTA
emergence of CLOs; this type of structured finance vehicle changed represents the interests of both the sellers and buyers of leveraged
the face of the leveraged loan market and was responsible for its loans in the market, it serves as a central forum for the analysis and
revival after the Global Financial Crisis. discussion of market issues by these different market constituents
The Global Financial Crisis in 2008 led to a recession in the United and thus is uniquely placed to balance their needs and drive
States, a contraction of global supply and demand, and record levels consensus.
of default rates. Several years passed before leveraged lending Loan market participants have generally adopted the standardised
issuance was restored to pre-crisis levels, finally reaching $665 documents and best practices promulgated by the LSTA. Although
billion in 2012. And then in 2013, the market would enter into its the LSTA is active in the primary market, where agent banks
next phase of expansive growth. originate syndicated loans, it is most prominent in the secondary
In 2013, record levels of refinancing activity drove leveraged market, where loan traders buy and sell syndicated loans. Over the
lending volumes to an all-time high of $1.1 trillion – surpassing years, the Association has published a suite of standard trading
2012’s prior record by almost 50 percent. On the institutional side, documents: forms or “trade confirmations” are available to
lending reached $639 billion, surpassing 2012’s prior record by evidence oral loan trades made by parties and form agreements are
almost 90percent. Lenders also financed a substantial amount of available to document the terms and conditions upon which the
new loans in 2013, including a number of mega-sized deals such as parties can settle those trades. The adoption of the LSTA’s standard
Heinz and Dell. As a result, the size of the secondary loan market trading documents by the market has directly contributed to the
finally returned to its pre-crisis size, and by the end of June 2013, growth of a robust, liquid secondary market.
outstandings on the S&P/LSTA Leveraged Loan Index (LLI) It is customary for leveraged loans to be traded in an over-the-
equalled the previous record high of $595 billion set in late 2008. counter market, and, in most instances, a trade becomes legally
By year end 2013, the LLI had grown by a total of $133 billion to binding at the point the traders orally agree the material terms of the
a fresh record of $682 billion. These record levels of supply were trade. Those key terms are generally accepted as including the
funded by record levels of demand. Although CLOs still dominated borrower’s name, the name, facility type, and amount of the loan to
institutional lending activity in the primary leveraged loan market be sold, and the price to be paid for the loan. For commercial
by accounting for 53percent of non-bank institutional lending, also reasons, most U.S. borrowers choose New York law as the law
notable was the leap forward taken by retail loan funds, which governing their credit agreements, and for similar reasons, the
accounted for one-third of all non-bank institutional lending in LSTA has chosen New York as the governing law in their trading
4Q13, a three-fold increase in three years. In total, a record $144 documentation. Since 2002, loan trades agreed over the telephone,
billion of new loan demand came to market through CLOs and like agreements relating to derivatives contracts and certain other
retail fund in-flows. On the CLO side, new and old managers alike financial instruments, have benefited from an exemption from a
printed north of $81 billion in deals – about $14 billion ahead of the New York law which would otherwise require them to be set forth
previous two years combined. CLO “2.0s” now manage roughly in a signed writing to be enforceable. Because of the LSTA’s
half of the $300 billion in U.S. CLO assets under management lobbying efforts, the applicable New York law was changed in 2002
(AUM). On the retail side, investors contributed $63 billion to loan to facilitate telephone trading. Thus, provided both parties have
mutual funds in 2013 as they sought low duration, floating-rate traded together previously on LSTA standard documentation, even
assets. Loan fund AUM now exceeds $168 billion. if one party fails to sign a confirmation evidencing the terms of the
It was certainly a year for the record books but unfortunately trade, the loan trade will be legally binding and enforceable, if it can
secondary-trading volumes just missed their own entry. According be shown that the parties orally agreed the material trade terms.
to the LSTA’s 4th Quarter Secondary Trade Data Study, annual This was a critical legislative reform that contributed to legal
trade volumes had remained range-bound in the $400 billion certainty in the loan market and harmonised its status with that of
context for the past three years, seemingly the new normal. But in other asset classes.
2013, volumes reached $517 billion (2013’s figure represented a After agreeing the essential trade terms, loan market practice
post-recession high that was only $3 billion shy of 2007’s all-time requires that parties then execute a form of LSTA trade
record high of $520 billion). Although secondary trading activity confirmation (the legislative change discussed above merely makes
had been in steady decline since 2007, the asset classes’ investment it possible legally to enforce an oral trade even if a confirmation has
thesis (senior secured, floating rate, high risk-adjusted return) not been signed). Loans can be traded on what is referred to as par
coupled with all the investment tools put in place years earlier – an documentation or on distressed documentation. Two forms of trade
independent pricing service (LSTA/TRLPC Mark-to-Market confirmations are available for this purpose and the choice of which
Pricing), a standard benchmarking tool (the LLI), ratings, and the one to use is a business decision made at the time of trade.
standardisation of legal and market practices – have enabled today’s Performing loans, where the borrower is expected to pay in full and

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 The Loan Syndications and Trading Association Loan Syndications and Trading

on a timely basis, are typically traded on par documentation which loans on the open market or through a “Dutch Auction” procedure,
means that the parties evidence their binding oral trade by executing and guidelines regarding the borrower’s creation and updating of a
an LSTA Par Confirmation and then settling the trade by list of competitors it seeks to ban from joining the syndicate of
completing the form of Assignment Agreement provided in the lenders or acquiring participations in the loan (typically referred to
relevant credit agreement (the term par is used because performing as a “Disqualified Lender List”).
loans historically traded at or near par). Alternatively, where a
borrower is in, or is perceived to be in, financial distress or the
market is concerned about its ability to make all interest payments Regulatory Challenges
and repay the loan in full and on a timely basis, parties may opt to
The financial crisis and the myriad financial reform regulation it
trade the borrower’s loans on distressed documentation. In this
spawned has required the LSTA to be in frequent communication
case, the trade is documented on an LSTA Distressed Confirmation,
with regulators. The U.S. loan market faces regulatory pressure
and the parties settle the transaction by executing the relevant
directly on leveraged lending and also on one of its key demand
assignment agreement and a supplemental purchase and sale
streams, CLOs. CLOs represented 53 percent of the institutional
agreement. The LSTA has published a form agreement for this
loan market in 2013, and CLO formation could be impaired
purpose which has been refined over the years and is generally used
(indeed, possibly even shut down) by Dodd-Frank’s Risk Retention
by the market. This agreement includes, amongst other provisions,
and Volcker Rule. The elimination of CLOs would leave a
representations and warranties, covenants, and indemnities given
significant gap in the syndicated loan market – one not easily filled
by seller and buyer. The adoption of standard documents in this
by banks in light of the regulators’ “Guidance on Leveraged
regard, particularly for distressed debt trading, significantly
Lending” in effect as of May 2013 and the increased capital
contributed to a more liquid loan market, for market participants,
requirements to be implemented under Basel III and Dodd-Frank.
knowing that an asset is being traded repeatedly on standard
In addition, FATCA – the Foreign Account Tax Compliance Act –
documents, can then uniformly price the loan and more efficiently
poses additional challenges for the loan market.
settle the trade.
Dodd-Frank’s Volcker Rule has two components: (i) a ban on
When a loan is traded, the existing lender of record agrees to sell
proprietary trading; and (ii) a ban on banks owning or sponsoring
and assign all of its rights and obligations under the credit
private equity funds or hedge funds. The final rules implementing
agreement to the buyer.8 In turn, the buyer agrees to purchase and
the Volcker Rule were published in December 2013 – almost two
assume all of the lender’s rights and obligations under the credit
years after the proposed rules were first released and the LSTA
agreement. The parties must then submit their executed assignment
submitted its request for an exemption for CLOs. The final rules
agreement to the administrative agent which has been appointed by
have a number of wins for the loan market: (i) loans were exempted
the lenders under the credit agreement. The borrower’s and agent’s
from the proprietary trading restrictions imposed on banks for most
consent is typically required before the assignment can become
other assets; and (ii) a clear path was set out for a complete
effective. Once those consents are obtained, the agent updates the
exemption from the Volcker Rule for CLOs. However, in order to
register of lenders, and the buyer becomes a new lender of record
qualify for the exemption, CLOs may not hold any securities or
under the credit agreement and a member of the syndicate of
structured products other than short-term cash equivalents.
lenders.9
Moreover, if a CLO does not qualify for the exemption and is
If, for some reason, the borrower does not consent to the loan indeed a “covered fund” for purposes of the Volcker Rule, banks
transfer to the buyer, the parties’ trade is still legally binding under would be prohibited from holding its ownership interests. Because
the terms of the LSTA’s Confirmation and must be settled as a the final rules define ownership interest to include debt securities
participation.10 The LSTA has published standardised par that have “indicia of ownership”, such as the right to participate in
participation agreements and distressed participation agreements the removal or replacement of the investment manager of the
which may be used to settle par and distressed trades respectively covered fund, it may not be possible for banks – the traditional
where loan assignments are not permissible. Under this structure, owners – to hold CLO debt tranches. The LSTA has been actively
the seller sells a 100 percent participation interest in the loan to the campaigning for relief from the agencies, otherwise, banks will be
buyer and retains bare legal title of the loan. Although the seller required to divest or restructure these debt securities by July 21,
remains a lender of record under the credit agreement and the 2015.
borrower will not typically be aware that a participation interest in
The second threat to CLO formation is Risk Retention, which
the loan has been sold, the seller must pass all interest and principal
requires securitisers of these vehicles to retain five percent of the
payments to the buyer for so long as the participation is in place.
credit risk of securitised assets. Although Dodd-Frank identifies the
The transfer of a participation interest on LSTA standard documents
securitisers as those entities that initiate or originate an asset backed
is typically afforded sale accounting treatment under New York law.
security by “selling” or “transferring” assets, the reproposed risk
Thus, if the seller of the participation becomes a bankrupt entity, the
retention rules released in August 2013 actually target the CLO
participation is not part of the seller’s estate, and the seller’s estate
manager as the entity that selects loans to be purchased for
will have no claim to the participation or the interest and principal
inclusion in the CLO collateral pool and then manages the
payments related thereto.
securitised assets once deposited in the CLO structure. CLO
The LSTA continues to expand its suite of trading documents but managers would presumably be required to retain CLO securities
forecasts that it will play a more active role in the primary market equal to five percent of the fair value of the CLO on their balance
in 2014. Later this year, it will release new versions of its primary sheet for the life of the vehicle, without the ability to sell or hedge
documents, including an expanded publication of its Model Credit - an impossible requirement for all but a handful of CLO managers.
Agreement Provisions which will include language addressing Although the LSTA has urged an exemption for CLOs on the basis
refinancing mechanics, “amend and extends” whereby certain that there is actually no “securitiser” in an Open Market CLO
lenders may extend their loan’s maturity date in exchange for a because no one entity originates assets on its balance sheet and sells
higher margin (pursuant to this post-financial crisis credit or transfers them to an issuer, the LSTA has been working
agreement development, only those lenders participating in the extensively to craft an alternative retention scheme that would work
extension need consent to it), sponsor and borrower acquisitions of for CLOs and the agencies The LSTA’s proposal for a “Qualified

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The Loan Syndications and Trading Association Loan Syndications and Trading

CLO” would require a CLO to be subject to a number of restrictions market, FATCA poses additional specific compliance problems for
and protections, but for which a manager would only have to vintage CLOs, and the LSTA continues to engage with the IRS
purchase and retain five per cent of the equity, not of the fair value seeking permanent relief for vintage CLOs in further guidance.
of the deal. (For instance, $2.5 million of a new $500 million CLO,
not $25 million.) It remains to be seen whether the agencies will
adopt such a proposal in their final rules – expected this summer. Conclusion
Fortunately, CLOs would not be subject to risk retention until two
Today’s loan market certainly looks very different from that of
years after the final rules are written (1Q2016 at the earliest).
before the financial crisis and represents a new and more
Unfortunately, CLOs are not the only regulatory target – banks, too, challenging period for not only investors but also the LSTA. Loan
face new challenges. In addition to the increased capital prices are now said to be closely correlated to, and no longer
requirements to be implemented under Basel III and Dodd-Frank, shielded from, the daily price fluctuations of other asset classes.
the federal bank regulators’ issued final Interagency Guidance on Although the risk-adjusted returns of leveraged loans are still
Leveraged Lending in March 2013 – replacing Guidance from 2001 advantageous, today’s returns come with a higher level of volatility.
– which could materially impact banks’ ability to underwrite and In this environment, the LSTA remains committed to promoting a
hold certain types of leveraged loans. The Guidance allows banks fair, efficient, and liquid market for loans and maintaining its
to craft their own definitions of “leveraged lending” based on a position as the market’s principal advocate.
number of enumerated criteria, such as companies which engage in
an acquisition or recapitalisation transaction and companies with
total leverage greater than four times, or senior leverage greater Endnotes
than three times, debt/EBITDA. The Guidance seeks to address not
1 Thomson Reuters Loan Pricing Corporation.
only loans arranged by banks, but also loans held by banks and
takes a step further than the earlier guidance by addressing pipeline 2 “Leveraged” is normally defined by a bank loan rating by
Standard & Poor’s of BB+ and below (by Moody’s Investor
risk. Perhaps the most significant change in the Guidance is the
Service, Ba1 and below) or, for non-rated companies,
suggestion that a loan to a company that cannot show the ability to typically an interest rate spread of LIBOR + 125 basis points.
amortise from free cash flow all its senior debt or half its total debt
3 For a more detailed description on the loan market sectors,
within five to seven years will likely be criticised. The Guidance
see Peter C. Vaky, Introduction to the Syndicated Loan
also looks sceptically at loans to companies that would have Market, in THE HANDBOOK OF LOAN SYNDICATIONS
leverage levels of six times or more after planned asset sales and & TRADING, 39 (Allison Taylor and Alicia Sansone, eds.,
also loans which lack meaningful maintenance covenants. Based 2007); Steve Miller, Players in the Market, in THE
on the language in the Guidance, the number of criticised loans a HANDBOOK OF LOAN SYNDICATIONS & TRADING,
bank holds may significantly increase. Structured as guidance supra, 47.
rather than rules, but with a compliance date of May 21, 2013, 4 Thomson Reuters Loan Pricing Corporation.
banks are struggling to understand exactly how to interpret the 5 For a more detailed description of the history of the loan
Guidance and fully comply. It remains to be seen if, and to what market, see Allison A. Taylor and Ruth Yang, Evolution of
extent, the Guidance impacts banks’ ability to engage in the the Primary and Secondary Leveraged Loan Markets, in
leveraged lending business. THE HANDBOOK OF LOAN SYNDICATIONS &
Finally, FATCA, enacted in 2010, imposes a 30 percent withholding TRADING, supra, 21.
tax on U.S. source payments to any foreign financial institution, for 6 Thomson Reuters Loan Pricing Corporation.
example, a foreign bank, offshore fund or CLO, which does not sign 7 Thomson Reuters Loan Pricing Corporation.
an agreement with the IRS and agree to provide information on its 8 For a detailed comparison of assignments and participations,
U.S. accounts. The final regulations implementing FATCA were see Richard Wight with Warren Cooke & Richard Gray, THE
published on January 17, 2013, although a six-month extension of LSTA’S COMPLETE CREDIT AGREEMENT GUIDE,
some implementation dates was granted in July 2013. For loans, 507-508 (McGraw-Hill 2009).
FATCA means a potential 30 percent withholding on interest 9 For further information on the structure of assignments, see
payment, many fees, principal payments, and sales proceeds. id. at 508-522.
FATCA hits loans especially hard, because while loans issued 10 For further information on the structure of participations, see
before the grandfathering deadline of July 1, 2014 are not subject to id. at 522-527.
FATCA, loans are routinely amended and any material modification
of a loan, such as a 25 basis points spread change or a tenor
extension, is deemed a new loan for FATCA purposes and subject Acknowledgment
to FATCA withholding. Withholding on interest payments begins
The authors would like to acknowledge the assistance of their
in July 2014 and withholding on principal payments and gross sale
colleague Tess Virmani in the preparation of this chapter.
proceeds begins in January 2017. Unfortunately for the loan

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 The Loan Syndications and Trading Association Loan Syndications and Trading

Bridget Marsh Ted Basta

The Loan Syndications and Trading The Loan Syndications and Trading
Association Association
366 Madison Avenue, 15th Floor 366 Madison Avenue, 15th Floor
New York, NY 10017 New York, NY 10017
USA USA
Tel: +1 212 880 3000 Tel: +1 212 880 3000
Fax: +1 212 880 3040 Fax: +1 212 880 3040
Email: [email protected] Email: [email protected]
URL: www.lsta.org URL: www.lsta.org

Bridget Marsh is Executive Vice President and Deputy General Ted Basta is Senior Vice President of Market Data & Analysis for
Counsel of the Loan Syndications and Trading Association the LSTA, where he manages key strategic partnerships and
(LSTA). Bridget heads the LSTA’s Primary Market Committee products of the LSTA, including the LSTA’s trade and settlement
and Trade Practices and Forms Committee and leads the legal data initiatives, the LSTA/Thomson Reuters LPC Mark-to-Market
projects for the development and standardisation of the LSTA’s Pricing Service and the S&P/LSTA Leveraged Loan Index. In
documentation. She is responsible for responding to and addition, Ted manages the LSTA’s Market Data and Analysis
addressing secondary loan market trading disruptions and team which is responsible for the Association’s analytical and
ensuring that the LSTA’s primary market and trading reporting initiatives all of which enhance market visibility,
documentation reflects current market practices. Bridget transparency and liquidity. Those efforts include the continued
regularly speaks on the loan market at American Bar Association development, expansion and distribution to loan market
events. participants of market analytics and secondary trading and
Prior to joining the LSTA, Bridget practised as a corporate finance settlement data.
attorney at Milbank, New York, and as a lawyer in the Prior to joining the LSTA, Ted was Vice President and Director of
corporate/M&A department of Simmons & Simmons, London, and Global Pricing with Loan Pricing Corporation (LPC), where he
completed a judicial clerkship for The Honorable Justice managed the LSTA/LPC Mark-to-Market Pricing Service. Ted
Beaumont of the Federal Court of Australia. In 2013, she was received an M.B.A. from the Zicklin School of Business at Baruch
elected as a Fellow of the American College of Commercial College and a B.A. in Accounting from Long Island University.
Finance Lawyers and named to the Irish Legal 100.
Bridget Marsh received a B.A. magna cum laude from
Georgetown University, a law degree with first class honors from
Sydney Law School, University of Sydney, and a Masters in
Political Science from the University of New South Wales. She is
admitted as an attorney in New York, England & Wales, and New
South Wales, Australia.

Since 1995, the Loan Syndications and Trading Association has been dedicated to improving liquidity and transparency in the
floating rate corporate loan market. As the principal advocate for this asset class, we aim to foster fair and consistent market
practices to advance the interest of the marketplace as a whole and promote the highest degree of confidence for investors in
floating rate corporate loans. The LSTA undertakes a variety of activities to foster the development of policies and market
practices designed to promote just and equitable marketplace principles and to encourage coordination with firms facilitating
transactions in loans and related claims. For more information, please visit www.lsta.org.

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Chapter 2

Loan Market Association

– An Overview

Loan Market Association Nigel Houghton

Loan Market Association distressed debt, proposed standard settlement parameters and built
out a contributor-based trading volume survey. Based on the
Founded in 1996, the Loan Market Association (LMA) is the trade success of the Association’s secondary market initiatives, its remit
body for the syndicated loan market in Europe, the Middle East and was then broadened to cover primary, as well as secondary, loan
Africa (EMEA). market issues.
The LMA’s principal objective is to foster liquidity in the primary Just 2 years after it was founded, LMA membership had grown
and secondary loan markets, a goal which it seeks to achieve by from an initial 7 founding bank practitioners to over 100
promoting efficiency and transparency, by the establishment of institutions. Steady growth since then has seen the membership
widely accepted market practice and by the development of base expand to 513 in 2013, including banks, non-bank institutional
documentation standards. As the authoritative voice of the investors, law firms, ratings agencies and service providers from 52
syndicated loan market in EMEA, the LMA works with lenders, law countries.
firms, borrowers and regulators to educate the market about the The evolution of the market from the mid-90s to today and the
benefits of the syndicated loan product, and to remove barriers to requirements of its increasingly diverse membership have seen the
entry for new participants. LMA’s work become broadly subdivided into the following
The purpose of this chapter is to give the reader an insight into the categories:
background and development of the LMA, the scope of its work, Documentation.
and recent and current initiatives.
Market guidelines.
Advocacy and lobbying.
Background to the LMA Education and events.

Banks have bought and sold loans for decades but standard market An overview of each category, a brief market overview and outlook
practice is still relatively recent. summary are given below.

Growth in borrowing requirements in the 1970s had seen loan

facilities, traditionally provided on a bilateral basis, increasingly Documentation
replaced by larger credit lines from a club of lenders, and then by
loan facilities syndicated to the wider market. In the US in the
1980s, a more formal secondary market evolved in parallel with From secondary to primary
demand on banks’ balance sheets and into the 1990s also with the
proliferation of non-bank lenders hungry for assets. Proprietary Following widespread adoption of the LMA’s secondary trade
loan trading began to increase and crossed the Atlantic into Europe documentation as the European market standard, focus was turned
initially via London-based units of US banks. to primary documentation. A recommended form of primary
By the mid-90s, the secondary market in Europe had itself evolved documentation was developed by a working party which included
to become of increasing importance to banks looking to manage LMA representatives and those of the UK-based Association of
their loan book more actively, be it for single client exposure Corporate Treasurers (ACT), the British Bankers’ Association
reasons, return on equity or otherwise. Proprietary trading added to (BBA), as well as major City law firms, with documents first
its growing relevance. Despite this, it was evident to practitioners launched in 1999. Involvement of the ACT and BBA from the
that the market, as it was at the time, lacked any standard codes of outset played a major role in achieving broad acceptance of the
practice, was inefficient and opaque. In response, a group of banks LMA recommended forms among borrowers and lenders alike.
agreed to form a market association tasked with promoting This success was complemented by the subsequent addition of other
transparency, efficiency and liquidity and, in December 1996, the forms of primary documentation, including a mandate letter and
LMA was formed. term sheet.
Following the English law recommended forms in terms of format
and style, French law (2002) and German law (2007) versions of
Initial Focus and Development investment grade primary documentation were later developed,
further broadening general acceptance of LMA standards.
Within a few years of inception, the LMA had introduced standard
form secondary trade documentation for performing loan assets and

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 Loan Market Association Loan Market Association – An Overview

From corporate to leveraged and beyond include those covering the use of confidential information, a guide
to waivers and amendments and transparency guidelines.
The increasing importance of the European leveraged loan market As the market has evolved so has the investor base and with it the
in the early 2000s saw the Association also focus on the LMA’s role in the provision of market guidance. Where new
development of standardised leveraged loan documentation, with sources of liquidity are sought, the LMA can provide such guidance
recommended forms agreed in early 2004. and reassurance in a private and unregulated market.
All proposed forms of documentation produced by the LMA are to
be regarded as a starting point for negotiations, with the expectation
Advocacy and Lobbying
that the more complex the transaction, the more tailoring will be
required. This notwithstanding, the fact that all documents have The LMA seeks to maintain a dialogue with regulators and
been developed after extensive consultation with market government bodies wherever new or revised regulatory proposals
practitioners has led to the recommended documents being viewed may impact the loan market, whilst also proactively promoting the
as a robust framework upon which to base subsequent individual market as a core funding source in the corporate economy. Since
negotiations. This is particularly true of the leveraged document, the financial crisis of 2007, this area of the Association’s work has
where significant input was also sought from non-bank investors grown in importance as the number of new regulatory proposals has
within the membership via an institutional investor committee. dramatically increased. Policy decisions underlying the new
As the financial crisis of 2007 began to bite, work commenced on a proposals are largely to be supported, the overarching aim being a
recommended form of intercreditor agreement, a document more robust financial system better able to shoulder economic
generally bespoke to the structure of each transaction. Launched in shock and withstand periods of stress. The LMA’s lobbying focus
2009, the document met with market-wide acclaim again as a robust has been on the potentially negative implications of these proposals
framework and as the product of comprehensive discussion by for the loan market, both intentional and unintended, and the effects
market practitioners. on its members.
Historically, the LMA’s principal focus has been on documentation Clearly, with Basel III likely to come into legislative force in the
relating to corporate investment grade and leveraged loans, near term, there has been market-wide discussion of the potential
alongside a full suite of secondary loan trading documentation. impact of the new Liquidity Coverage Ratio (LCR) and Net Stable
However, in recent years, and in response to member demand, the Funding Ratio (NSFR) proposed by the Basel committee, with
association has significantly expanded its coverage. 2012 saw the banks’ balance sheets likely to be constrained by the restrictive
launch of a commercial real estate finance document for multi- regulation. Recent regulatory developments are manifold, however,
property investment, a facility agreement for developing markets and the LMA has sought to make representations on behalf of its
and a pre-export finance facility agreement. The LMA continued to membership on all relevant issues.
expand its suite of documentation in these areas in 2013, with the Over recent years, the LMA has actively lobbied regulators in the
launch of a single property development finance facility agreement, UK, EU and US on various proposals potentially impacting the loan
and four further facility agreements intended for use in developing market. Responses to regulatory bodies are too numerous to list.
markets transactions. Examples of activity in this field are submissions to the Internal
Back within the leveraged corporate market, Q4 2013 saw the Revenue Service in the US regarding certain provisions under the
launch of an intercreditor agreement and super senior revolving Foreign Account Tax Compliance Act (“FATCA”), also to the
credit facility for use in conjunction with a high yield bond. European Commission relating to the drafting and interpretation of
For 2014, a real estate finance intercreditor agreement is in the the Capital Requirements Directive IV and the Commission’s
pipeline, to sit alongside the multi-property investment agreement. In consultation on shadow banking. Proactive lobbying has led to
February 2014, the association published a guide to Schuldschein tangible results, including confirmation from the Securities
loans, the result of extensive collaborative work by a working party Exchange Commission and the Commodity Futures Trading
based in Germany. Appropriately the guide has been published in both Commission that US derivatives regulations under Dodd-Frank
German and English. The LMA has also announced its intention to were not intended to capture LMA-style participations, and
produce a standardised template for European private placements. confirmation from the European Banking Authority that risk
retention requirements in new Collateralised Loan Obligations are
to be kept at 5% (cf. Article 394 CRD IV, previously referred to as
Review and development Article 122a). Other notable dialogue includes a response to a
European Commission consultation to request that the list of
In response to member feedback, market developments, legislation eligible assets under Article 50 of the UCITS IV Directive be
and regulation, the LMA’s document library is constantly reviewed expanded to include certain types of loan. Also, following
and updated. Primary and secondary recommended forms have consultation with a working party comprising a cross-section of its
undergone several revisions and seen some significant membership, the LMA recently responded to a European
amendments, a notable example being the combination of Commission consultation on the need to overcome barriers to long-
secondary par and distressed trading documents in 2010, updated term financing and diversify the system of financial intermediation
once again in 2012. Continuing the theme, terms & conditions for for long-term investment in Europe.
secondary loan trading were subject to a full “Plain English” review
The LMA expects to continue to play a leading role in the dialogue
in 2013 with the goal of making these more navigable, particularly
with regulators going forward, from Basel III to risk retention, from
for those whose native language is not English.
FATCA legislation to UCITS.

Market Guidelines
Education and Events
LMA guidelines are widely regarded as defining good market
practice and typically address those aspects of loan market business As a core objective, the LMA seeks to educate members and others
not specifically documented between parties. Guidelines produced regarding documentation and legislative, regulatory, legal,

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Loan Market Association Loan Market Association – An Overview

accounting, tax and operational issues affecting the syndicated loan gives a practitioner’s overview and detailed reference guide. It goes
market in EMEA. As the industry’s official trade body, the LMA is without saying, however, that the crisis sparked by the US sub-
the ideal education and training resource for what has become an prime mortgage market had a significant impact. Fuelled by an
increasingly technical market. Relationships with the key players abundance of liquidity, particularly from institutional investors in
in the market afford the LMA access to some of the leading experts the leveraged market, primary volumes in EMEA soared in the
in their field and as such the credentials of contributors can be years building up to the crisis. The liquidity crunch saw primary
guaranteed. issuance fall dramatically by 2009 to barely one-third of the record
Evening seminars and documentation training days are regular $1,800BN seen in 2007. Volumes recovered some ground through
calendar events in the UK. Also, to reflect the multi-jurisdictional to 2011 but dipped again in 2012 against the backdrop of the
membership base, seminars and conferences are held in many other Eurozone sovereign debt crisis and the US “fiscal cliff”. In
financial centres, including Frankfurt, Paris, Milan, Stockholm, contrast, 2013 saw markets rebound and loan issuance increase
Moscow, Dubai, Nairobi, Lagos, Johannesburg and New York. substantially. Policy intervention and specifically the Outright
Monetary Transactions programme announced by the ECB in the
In September 2013, 800 delegates attended the LMA’s 6th annual
2nd half of 2012 was a significant driver of confidence. At just over
Syndicated Loans Conference in London, the largest loan market
$1,000BN, 2013 volumes in EMEA were up 30% year on year.
event in EMEA. In total, over 20,000 delegates have attended LMA
Issuance volumes in leveraged finance recovered particularly
events across EMEA in the last 6 years.
strongly, more than doubling levels seen the prior year.
In 2005, the inaugural LMA Certificate Course was held in London.
Demand for the leveraged loan product has spread across a broader
Consistently oversubscribed, the course is now entering its 9th year
investor base than seen prior to the 2007 financial crisis.
and will be run four times in 2014. Held over 5 days, the course
Institutional investors have also become more visible in other loan
covers the syndication process through to secondary trading,
asset classes, such as real estate and infrastructure finance. Several
including agency, portfolio management, pricing and mathematical
funds have more recently been set up to lend directly to small and
conventions, terms sheets and an introduction to documentation.
medium companies, particularly in the UK. Retrenchment by banks
The Syndicated Loans Course for Lawyers is a 2-day programme, post crisis opened the door to alternative sources of finance across
designed specifically for those working in the legal profession, the loan market and many institutions are now established
providing detailed tuition on all aspects of the primary and participants. A significant driver of institutional demand within
secondary loan markets. leveraged finance pre-crisis, the CLO returned to European markets
In 2011, the LMA published The Loan Book, a comprehensive in 2013 with new vehicle issuance volume of €7.4BN, compared
study of the loan market through the financial crisis, with with virtually zero since 2008.
contributions from 43 individual market practitioners. Over 10,000
copies of The Loan Book have been distributed to date since
publication. In 2013 the association published Developing Loan
The Way Forward
Markets, a volume dedicated to the analysis of various regional Results from a survey of LMA members at the end of 2013 suggest
developing markets, both from an economic and loan product that market participants expect overall growth to continue into
perspective. 2014. Some 60% of respondents expect loan market volumes
The first in a series of market guides, Regulation and the Loan across EMEA to increase by more than 10% year on year.
Market, published late 2012, also met with considerable interest Competitive pressure was cited as the single biggest influencing
from the membership. This publication has subsequently been factor on the syndicated loan market in the short term, replacing
updated to reflect ongoing regulatory developments. Other guides regulatory requirements which topped the poll the previous year.
in the series include Insolvency in the Loan Market, Using English As the final detail and implementation of regulatory measures
Law in Developing Markets and Guide to Syndicated Loans and become clearer and nearer, however, the LMA’s focus on lobbying
Leveraged Finance Transactions. and advocacy will continue unabated.
Other trends will also determine the focus of the LMA’s work into
Other Initiatives 2014 and beyond. With bank capital constraints in mind, we have
seen borrowers access funding sources on an increasingly global
Operational issues have long been raised by LMA members as an basis and the LMA will continue to work to promote further cross-
area of concern, particularly around administrative agency and the border liquidity. The institutional investor base will continue to
potential for significant settlement delays in the secondary market. grow and non-bank finance will increase in importance across loan
Syndicate size alone can lead to process overload when waivers and asset classes; the LMA will seek to give voice to investors in all
amendments are combined with transfer requests. The LMA is in market sectors. Developing markets will continue to grow and
dialogue with both agency and operations representatives from its more borrowers will begin to require funding from beyond
membership, along with commercial service providers, to scope the domestic boundaries; the LMA will continue and expand its work in
potential for increased automation. The LMA also continues to these markets to promote the acceptance of regional standards. In
work closely in this regard with its sister association in the US, the December 2013 the LMA announced the integration of the African
LSTA. LMA. By combining experience and resources, coverage of
markets across the African continent will increase significantly.
Through 2014 a series of events will be held in several African
Market Overview regions.
A detailed study of the development of the syndicated loan market The LMA’s principal objective some 17 years ago was to promote
in EMEA, particularly post the financial crisis of 2007, is beyond greater liquidity in the syndicated loan market, an objective which
the scope of this chapter. The Loan Book, as mentioned above, remains as, if not more, relevant today.

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 Loan Market Association Loan Market Association – An Overview

Nigel Houghton
Loan Market Association
10 Upper Bank Street
London, E14 5JJ
United Kingdom

Tel: +44 20 7006 1207

Fax: +44 20 7006 3423
Email: [email protected]
URL: www.lma.eu.com

Nigel joined the LMA as a Director in 2012. He has over 20 years’

experience in banking and finance with a focus on debt capital
markets. Nigel joined the LMA from GE Capital in London where
he was Head of Secondary Sales & Trading within Leveraged
Finance Capital Markets. During 10 years at Commerzbank AG,
Nigel was an LMA Board Member for several years and a
founding member of the bank’s London-based Structured
Finance & Loan Syndications team. Nigel began his career in
banking via a graduate programme at Deutsche Bank AG
following training at Coopers & Lybrand Deloitte. Nigel has a BA
(Hons) from the University of Durham.

The Loan Market Association (LMA) has as its key objective improving liquidity, efficiency and transparency in the primary and
secondary syndicated loan markets in Europe, the Middle East and Africa (EMEA). By establishing sound, widely accepted market
practice, the LMA seeks to promote the syndicated loan as one of the key debt products available to borrowers across the region.
As the authoritative voice of the syndicated loan market in EMEA, the LMA works with lenders, law firms, borrowers and regulators
to educate the market about the benefits of the syndicated loan product, and to remove barriers to entry for new participants.
Since the establishment of the LMA in 1996, the Association’s membership has grown steadily and now stands at 490
organisations covering 46 nationalities, comprising commercial and investment banks, institutional investors, law firms, service
providers and rating agencies.

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Chapter 3

Asia Pacific Loan

Market Association –
An Overview
Asia Pacific Loan Market Association Janet Field

About the APLMA practices with a view towards improving global loan market
liquidity. Through its close contact with the Loan Market
2014 marked the 15th anniversary of the Asia Pacific Loan Market Association (LMA) in London, the Loan Syndications and Trading
Association (APLMA). Founded in 1998, the APLMA is a pan- Association (LSTA) in New York, and other associations across
Asian not-for-profit industry association dedicated to promoting Asia, the APLMA monitors global market trends as part of its
growth and liquidity in the primary and secondary loan markets of efforts to more closely integrate the Asian loan markets into an
the Asia-Pacific region, and advocating best practices in the increasingly globalised loan market.
syndicated loan market.
The APLMA is headquartered in Hong Kong with branches in
Standard Documentation
Singapore and Australia. Due to the size and diversity of the Asia
Pacific region, the operations of the APLMA are decentralised. As Documentation has been a core focus of the APLMA since its
well as the branch network, the APLMA has a number of offshore inception and one of the association’s key missions is to standardise
committees in China, Taiwan, Malaysia, India and New Zealand, both primary and secondary documentation for syndicated loan
and we aim to continue to establish new chapters in the key markets transactions in the Asia Pacific markets. The APLMA documents
of the region, as well as forging working relationships with other have rapidly become the market standard for Asia.
associations in the region.
The first APLMA template, launched in 1999, was a par trade loan
The APLMA currently has 245 institutional members from Asia document substantially modelled on the template of the LMA in
Pacific, Europe, the US and the Middle East. Membership London. Since then, all APLMA templates have been modelled on
comprises commercial and investment banks, non-bank financial the LMA standards.
institutions, law firms, rating agencies, financial information
In 2000, the APLMA entered into an agreement to adapt the LMA’s
service providers and online trading platforms. There are also ten
standard primary loan documentation for use in the Asia Pacific
Honorary members comprising regional regulators and trade
region. A multicurrency term loan facility agreement was launched
associations.
in the same year based on the LMA primary document for
The APLMA represents the common interests of the many different investment grade corporates.
institutions active in the syndicated loan markets across Asia. The
This was followed by the launch of a suite of secondary par trading
Association’s key objectives are to:
documents in a joint initiative with the LMA. Following
provide leadership in the syndicated loan industry and act as consultation with its members, the APLMA elected to adopt the
the collective voice of the members;
LMA standard secondary documents, which were drafted in
promote growth and liquidity in Asia’s primary and consultation with the APLMA Documentation Committee. Whilst
secondary loan markets; used widely by the APLMA membership, these documents are
facilitate the standardisation of primary and secondary loan branded as LMA documents as they are identical to those used by
documentation; the LMA, unlike the primary market documents. The APLMA also
develop and promote standard trading, settlement and produced its own Trader Check List.
valuation procedures;
develop the secondary market for loan sales and trading;
Different Jurisdictions
promote prudent banking practices;
serve as a liaison between major loan market players and In addition to the English law and Hong Kong law documents, the
regional regulators; APLMA has produced Australian Law and Singapore Law standard
monitor legislative, regulatory and market changes for templates, and a Chinese translation (for reference purposes only).
impact on the syndicated loan market; The first Australian law document, launched in 2001, was produced
enhance industry education through seminars, conferences under the direction of the APLMA Australian Documentation
and training courses; and Committee. The documents have been adapted to reflect the unique
provide a dynamic professional pan-Asian networking features of Australian law and local market practices. This was
forum. followed by the launch of the S.128F loan note structure documents
The APLMA works together with its sister associations in Europe (multicurrency term and revolving facilities subscription agreement
and North America to advocate common market standards and and loan note deed poll).

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 Asia Pacific Loan Market Association APLMA – An Overview

A Singapore law single currency term and revolving facility Singapore law templates which are expected to be launched in
agreement followed to provide a standard template for the 2014.
Singaporean market. Other than revisions of the primary facility agreements, the
following document templates are also scheduled for roll-out in
2014:
Other Templates
i) English law and Hong Kong law mandate letters and term
As well as the primary facility agreements, the APLMA has sheets for “unsecured” and “secured” transactions
developed a number of templates to provide alternative wording for respectively;
use by members. ii) offshore RMB (CNH) facility provisions; and
A financial covenants template provides sample wording on iii) an updated Chinese translation of standard templates to
financial covenants commonly applicable to investment grade reflect recent template revisions.
borrowers. In the APLMA primary facility agreement, the financial
covenant section is left blank.
Agency Issues
The APLMA has also produced a sample Asia arbitration clause
with a litigation option for a hybrid dispute resolution process The APLMA Agency Committee was formed in 2012 as a sub-
(under such process both parties are required to submit all disputes committee of the Documentation Committee to review agency
to arbitration). The sample clause provides various options under provisions in the documentation, and to provide a forum for
which arbitration can be administered. discussion on issues relating to the agency function. It has since
A suite of standard confidentiality letters includes templates for become a separate Committee in its own right.
primary syndication and for sale/sub-participation/CDS under both Over the past year, the Agency Committee has drafted sample
English law and Hong Kong law. wording for a number of agency related provisions such as snooze
you lose, break costs, and interpolated rates for members’ reference
whenever any of these provisions is applicable. A number of
Documentation Updates Agency Notes were produced and passed to the Documentation
Committee for incorporation, where appropriate, into the APLMA
In 2011, the APLMA Documentation Committee produced revised
standard agreements.
primary and secondary confidentiality undertakings and jurisdiction
clause language for hybrid arbitration, and made a number of As the use of websites is now the norm in the loan market, the
revisions to the Hong Kong Law and English Law single currency Agency Committee has drafted a new note with suggested
agreements in line with LMA revisions and market changes. provisions on e-communications and the use of deal sites which will
be formally rolled out in 2014 to provide guidance on best market
These amendments were then cloned into the multicurrency term
practice and proper usage.
and revolving facilities agreements. A full set of English law
templates was rolled out including:
i) APLMA multiple borrower, multiple guarantor, single Regulatory Issues
currency term facility agreement (English Law);
ii) APLMA single borrower, single guarantor, single currency Regulatory issues continue to be at the forefront of the APLMA’s
term facility agreement (English Law); and remit. Regulators across the globe continue to introduce legislation
iii) APLMA multiple borrower, multiple guarantor, to bring further regulation to the financial markets. Some of these
multicurrency term and revolving facilities agreement are unique to individual jurisdictions, and some are being co-
(English Law). ordinated across the global markets. These will impact all areas of
banking products and services.
In 2013, all primary Hong Kong law and English law
documentation templates were further revised to reflect the The APLMA has been hosting a series of regulatory seminars across
additional changes to the LMA documents and market changes, the region to update members on how these regulatory changes will
including new wording on market disruption and Basel III and a impact on the loan market in Asia, with particular focus on the
new footnote on FATCA. ongoing development of the Basel III proposals and implementation
New Hong Kong law and Australian law secured facility agreement in Asia, extra territoriality issues embedded within European and
templates were also rolled out. The secured facility agreements are US legislation, and the introduction of taxes on banks’ businesses,
based on the APLMA multiple borrower, multiple guarantor, such as those levied under FATCA and how these will impact on
multicurrency term and revolving facilities agreement, but with Asian financial institutions and transactions.
additional provisions which are typically required if security is In 2013, the APLMA produced a new FATCA Guidance Note for
granted, and incorporate security agency provisions. Agents. The APLMA also recommends that members refer to the
The APLMA Australian Branch also produced a new AUD bilateral LMA FATCA riders (which are available to all members on the
term and revolving facilities agreement and new language in respect APLMA website) which were revised following the release of the
of the Personal Property Securities Act. final FATCA regulations issued by the US in January, 2013 and
further updated in July 2013 following the IRS update.

Major Projects 2014

CNH HIBOR Fixing
The APLMA is currently revising all primary documents to
incorporate the new “IBOR” definition and the change in LIBOR The APLMA China Working Group was formed to facilitate the
administrator from the British Bankers Association to ICE growth and development of the offshore RMB (CNH) syndicated
Benchmark Administration which was announced in February 2014. loan market. One of the key challenges identified by the Working
A new Singapore Documentation Committee was formed in 2013 Group was the requirement for a standard CNH HIBOR reference
and this committee is close to finalising a suite of updated rate. The committee held a number of consultations with the

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Asia Pacific Loan Market Association APLMA – An Overview

Treasury Markets Association (TMA) and in June 2013 the TMA Leaders’ series for members with less than five years’ experience,
announced the launch of a new CNH HIBOR fixing. This includes and the Women’s series aimed at providing mentoring and
tenors from overnight to 12 months and provides a formal professional development for women in the loan market.
benchmark for market participants to make reference to in pricing
CNH loans.
APLMA Awards
The next step, as the market develops, will be for the APLMA to
draft new standard CNH provisions to facilitate the ongoing A recent major development was the introduction of APLMA-
development of the market. sponsored Awards for the syndicated loan market as an independent
alternative to those organised by financial magazines.
Best Market Practices The APLMA Awards are voted on by industry professionals, they
are anonymous, and no one has to pitch. As an industry body,
The APLMA has drafted a set of non-binding recommendations on APLMA members, who are all active in the syndicated loan market,
best practice in the Asian cross-border syndicated loan market. In are ideally placed to decide who to vote for based on their own
establishing best practice, the APLMA aims to help to reduce discretionary criteria.
disputes between banks or users of the syndicated loan market in Banks and law firms are not allowed to vote for themselves in the
areas where best practice is unclear. Over the past year, a number bank and legal categories, but can vote for deals they participated
of new recommendations were drafted relating to the following in. The votes are then counted by an external independent
issues: accountancy firm in the interests of neutrality.
i) fee sharing among MLAs with different final holds; The APLMA Awards are not tied into any form of sponsorship, and
ii) listing of banks in communications such as tombstones, the names of the winners are a closely guarded secret, only revealed
information memoranda and cover pages of facility at the Awards Ceremony.
agreements;
iii) confidentiality undertakings; and
iv) amendments and waivers. Looking Ahead
In 2014, best practices will continue to form a key focus as the In mid-January, the APLMA chairman and two APLMA branch
APLMA looks to address some of the regulatory changes and how chairmen were asked to state their wish for the coming year.
they are impacting on our members.
APLMA Chairman Atul Sodhi said “Asia-Pacific loan volumes had
a record year in 2013 – Thomson Reuters figures show an annual
Education and Training increase of 50%. An important feature was the return of
underwriting, which was partially due to the lack of economic
As part of its commitment to enhancing industry education and shocks and greater predictability of the economic environment. My
providing a vibrant pan-Asian professional network, the APLMA wish is that the economic outlook remains positive to give
holds over 70 seminars, conferences, training courses and companies the confidence to invest and as a result borrow and, in
networking events each year in all the major financial centres, most turn, that banks have the confidence to grow their business and help
of which are free of charge. create strong deal flow”.
These include a programme of documentation training and Aditya Agarwal, Singapore Branch Chairman commented that
regulatory seminars across the region, as well as specialist seminars “loan markets have been quick off the block in 2014 – a slew of
on a range of issues including the secondary and distressed markets, launches in December have meant we were all busy playing catch
leveraged finance, project finance, Islamic finance and an up in January. However, upcoming elections in the two largest
institutional seminar. democracies in Asia (India, Indonesia) coupled with an uncertain
The two largest events of the year are the APLMA 3rd Annual political climate in Thailand threaten to dampen the enthusiasm of
Global Loan Market Summit, which this year was held in Hong borrowers and investors alike. Along with China, India and
Kong on 13 February in association with the LMA and the LSTA, Indonesia are the three largest markets for G3 loans in the region
and the APLMA 16th Annual Asia Pacific Syndicated Loan Market and a ‘sub-optimal’ political situation could derail the strong
Conference which will be held on 4-5 June in Macau. These momentum of the last few months”.
conferences tackle topical issues such as trends and developments Sean Sykes, Australian Branch Chairman added that “from the
in the regional and global loan markets, economic indicators, Australian perspective, the fourth quarter of 2013 saw a significant
leveraged finance, the secondary market, and the outlook for positive shift in confidence which unlocked greater intent and
growth. issuance. My wish is for this positive sentiment to prevail over
Each year, the APLMA also holds a series of 1-week Syndicated 2014 because if it can we will see a great year for the loan market,
Loan Certificate Courses. This hands-on workshop style course is with more event-driven activity, strong volumes and more demand
aimed at members new to the syndicated loan market and focuses for underwriting and arranging. More transactions will require
on how to structure, price and document syndicated loans. distribution onshore and, equally importantly, offshore to banks and
institutions in Asia”.
Other events include overseas conferences in China, Taiwan, India,
New Zealand, Indonesia and Malaysia, the APLMA Young

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 Asia Pacific Loan Market Association APLMA – An Overview

Janet Field
Asia Pacific Loan Market Association
32/F, Jardine House
One Connaught Place
Central
Hong Kong
Tel: +852 2826 3500
Fax: +852 2825 8800
Email: [email protected]
URL: www.aplma.com

Janet Field is the Managing Director of the Asia Pacific Loan

Market Association (APLMA). She is based in Hong Kong and
oversees the operations of the APLMA across Asia Pacific. She
heads up a team responsible for the development of standard
primary and secondary loan documentation for a number of
different jurisdictions, drafting recommendations on best market
practices, lobbying, and organising over 70 educational seminars,
conferences and networking events per year across the region.
The APLMA has a network of branches in Hong Kong, Australia
and Singapore, as well as offshore committees in China, Taiwan,
India, Malaysia and New Zealand.

Founded in 1998, the APLMA is a pan-Asian not-for-profit industry association dedicated to promoting growth and liquidity and
advocating best practices in the primary and secondary loan markets of the Asia-Pacific region. Its main tasks include:
providing standard loan documentation templates;
formulating guidelines on market practices;
organising seminars, trainings and networking events;
monitoring legislative, regulatory and market changes for impact on the syndicated loan market; and
serving as a liaison between major loan market players and regional regulators.
The APLMA is headquartered in Hong Kong. It has branches in Australia and Singapore and offshore committees in China, India,
Malaysia, New Zealand and Taiwan. Currently it has 245 institutional members from Asia Pacific, Europe, the US and the Middle
East. Membership comprises commercial and investment banks, non-bank financial institutions, law firms, rating agencies and
financial information service providers.

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Chapter 4

An Introduction to Legal
Risk and Structuring Thomas Mellor
Cross-Border Lending
Transactions
Bingham McCutchen LLP Marc Rogers Jr.

1. Introduction: The Rise of Cross-Border then the lender must rely on the pile of paper and the legal process,
Lending in order for the money to be returned. This notion helps drive the
point home that legal risk is primarily something that keeps lenders
Increase in Cross-Border Lending. For lenders and lawyers who (rather than borrowers) awake at night. While there is no settled
practice in the cross-border lending area, whether in the developed description of legal risk, it can be thought of as having a number of
economies or the emerging markets, this is a dynamic and exciting components, starting with documentation risk, which is mitigated
time. Cross-border lending has increased dramatically over the last by having competent counsel ensure that legal documentation
couple of decades in terms of volume of loans, number of correctly reflects the business arrangement and is in the proper
transactions and number of market participants. According to the form. In a cross-border lending context it is useful to think of legal
Bank for International Settlements, the amount of outstanding risk as having two additional related and sometimes overlapping
cross-border loans held by banks worldwide was approximately components: (1) enforcement risk and (2) the risk of law reform.
$6.85 trillion in 2013, an increase from $1.71 trillion in 1995. Enforcement Risk. Lenders want to enter a lending transaction
There are many reasons for this increase: the globalisation of knowing that a number of “enforcement components” are in place
business and development of information technology; the rise of to allow for enforcement of loan documentation (that pile of paper)
emerging economies that have a thirst for capital in order to develop and to resolve disputes and insolvency in a predictable way. These
their economies to their full potential; and the development of components include a well-developed body of commercial law, an
global lending markets, especially in the US, which has led to a independent judiciary and an expedient legal process. This reliance
dramatic rise in the number of market participants searching for the exists in the context of an unsecured loan, a secured loan or an
right mix of yield and risk in the loan markets, a search that often insolvency of the borrower, since as a general matter courts have
leads to cross-border lending opportunities. the power to adjudicate issues with respect to property of a
Challenges of Cross-Border Lending. In addition to understanding company located in their jurisdiction. Thus, in a cross-border
the creditworthiness of a potential borrower, the overlay of lending context, especially if a borrower’s primary assets are
exposure of a lender to a foreign jurisdiction entails analysis of a located in a foreign jurisdiction, there is typically some reliance by
myriad of additional factors, the weighting of which will vary from a lender on the laws, legal institutions and legal process of that
country to country, and many of which are overlapping. This mix foreign jurisdiction.
of political, economic and legal risks, bundled together, are referred For example, a US lender seeking to enforce a loan agreement
to collectively as country risk. Understanding country risk is against a foreign borrower could do so in one of two ways.
imperative for a lender to a cross-border loan and for investors to be Assuming the borrower has submitted to the jurisdiction of New
able to compare debt instruments of similarly-situated companies York courts, the lender could file suit in New York against the
located in different countries. borrower, obtain a judgment from a New York court, and then seek
Examination of Legal Risk. This first overview chapter of the to have that judgment enforced against the assets of the borrower in
Guide provides some observations on an element of country risk the borrower’s home country. In the alternative, the lender could
that is closest to the hearts of lawyers: legal risk. Together with tax seek to enforce the loan agreement directly in the courts of the
considerations, understanding legal risk can be important for foreign jurisdiction. In either case, there is reliance on the laws,
structuring cross-border loan transactions. But what exactly is legal institutions and legal process in the borrower’s home jurisdiction.
risk? Can legal risk be measured? What tools do lenders If the foreign jurisdiction’s local law is not consistent with
traditionally use to mitigate legal risk? Do these tools work? international norms, or its legal institutions are weak, corrupt or
Finally, we complete this chapter with some observations on how subject to undue political influence, then enforcement risk may be
conventional notions of legal risk are being challenged. considered high. It should be noted that enforcement risk may be
high even in a jurisdiction that has modernised its commercial laws
if legal institutions have not also matured (the latter taking more
2. Legal Risk in the Cross-Border Lending time to achieve).
Context
Law Reform Risk. Lenders also want to know that the laws they
What is Legal Risk? Young lending lawyers are taught that when are exposed to in connection with a loan to a borrower will not
a loan transaction closes, “the borrower walks away with a pile of arbitrarily change to the lender’s detriment. This aspect of legal
the lender’s money and the lender walks away with a pile of paper risk is closely associated with political risk. Law reform risk
and the legal risk”. If the borrower refuses to pay the money back, detrimental to lenders is at its highest when a country is undergoing

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 Bingham McCutchen LLP Legal Risk & Structuring Cross-Border Lending Transactions

some sort of systemic crisis. For example, in 2002 during prices provides a similar measure. As with sovereign ratings, this
Argentina’s financial crises, the government of Argentina passed a tool is useful to obtain a measure of potential systemic stress and
law that converted all obligations of Argentine banks in US dollars law reform risk but seems less useful in terms of measuring
to Argentine pesos. Given that pesos were only exchangeable at a enforcement risk of a borrower in that jurisdiction for the same
fixed rate that did not accurately reflect a true market rate, this reasons provided above.
change in law had the effect of immediately reducing the value of Recovery after Default Analysis. A type of analysis performed by
the lenders’ loans. ratings agencies that might be considered useful for measuring legal
Why Legal Risk Matters. If enforcement risk is high, this weakens risk from country to country is corporate default and recovery
a lender’s negotiating position in the case of a workout of a loan (as analysis. A reasonable hypothesis might be that the average
compared to a similarly situated borrower in a country where recovery for creditors after a borrower default would be higher
enforcement risk is low). If law reform risk is high, lenders risk a countries with low legal risk: stronger institutions means higher
multitude of unsettling possibilities, some examples of which are recoveries for creditors. But a review of the data suggests there is
described below. In each case, this increased risk should be little or no such correlation. Why is this? There are a few possible
reflected in increased pricing. In cases where the risk and/or pricing explanations: recovery rates depend on a variety of factors other
of a loan is considered too high, then a loan transaction may be than legal risk, including the severity of default and the makeup of
structured in order to attempt to mitigate the legal risk and/or reduce the individual borrowers subject to the analysis. It also is probable
pricing. Lenders have a number of tools at their disposal in order that lenders in a country with strong legal institutions (and low risk)
to mitigate legal risk. In this way, loan transactions that might may be more willing to make “riskier” loans (based on a portfolio
otherwise not get done, do get done. theory of investment) given they have confidence in the
jurisdiction’s strong legal institutions to resolve defaults and
insolvency in a predictable manner.
3. Can Legal Risk be Measured?
World Bank “Doing Business” Rankings. The World Bank
Before examining ways to mitigate legal risk, it is interesting to publishes an interesting study each year titled the Ease of Doing
examine the extent to which legal risk can be measured. Measuring Business Rankings. These rankings rate all economies in the world
legal risk certainly is not an exact science, though it nevertheless from 1 to 185 on the “ease of doing business” in that country, with
can be a useful exercise to consider yardsticks that might provide a 1 being the best score and 185th the worst (see
sense of one country’s legal risk relative to another’s. A threshold http://doingbusiness.org/rankings). Each country is rated across
challenge is that while there are many tools available to measure eleven categories, including an “enforcing contracts”, “resolving
country risk, as mentioned above legal risk is only one component insolvency” and “protecting investors” category. The rankings
of country risk. Nevertheless, there are some tools that may be provide a helpful tool for comparing one country to one another.
helpful. In terms of measuring legal risk, the conventional wisdom While there is not space to detail the methodologies of the rankings
is that developed economies have stronger legal institutions and less in this chapter, the methodologies can produce some strange results.
legal risk when compared to emerging market jurisdictions. For instance, in the 2013 rankings both Belarus and the Russian
Federation have a better “enforcing contracts” score than Australia.
The Usefulness and Limitations of Sovereign Ratings. Sovereign
Nevertheless, these rankings can be a useful benchmark and are
ratings measure the risk of default on a sovereign’s debt. These
worthy of mentioning.
ratings are useful to get a “systemic” view of how a country is doing
economically. A country that has a high sovereign debt rating is Subjectivity. Ultimately, in addition to the quantitative and
likely to be financially stable. A country that is financially stable is qualitative data described above, a lender’s perception of the legal
less likely to undergo systemic stress, at least in the short term, and risk of lending into a particular country will be driven by a number
therefore less likely to undergo law reform adverse to lenders of geographic, historical, political, cultural and commercial factors
(remember the link between systemic stress and law reform noted peculiar to the lender and the country in question. For example, as
above). a general matter, French lenders seem more comfortable than US
lenders when lending to borrowers in Africa, while US lenders
But does it follow that there is a correlation between a sovereign’s
seem generally more comfortable than French lenders lending to
rating and enforcement risk against private borrowers in the
borrowers in Latin America. (English lenders seem comfortable
sovereign’s jurisdiction? A sovereign’s risk of default on its debt
lending anywhere!) Lenders will measure legal risk differently
instruments may be low because the country has extensive state-
based on their institution’s experience and tools at hand to work out
owned oil production that fills the country’s coffers. This would not
a loan should it go bad.
necessarily indicate that a country’s legal institutions would fairly
and efficiently enforce a pile of loan documents against a borrower
in that jurisdiction – the legal institutions in such a country might 4. Tools Used to Mitigate Legal Risk
be as corrupt and/or inefficient as the day is long. While a quick
review of sovereign ratings does suggest that there is at least some The fact that a borrower is located in a jurisdiction with a high level
correlation between ratings and enforcement risk, there are also of legal risk does not mean that a loan transaction cannot be closed.
some outliers (for example, at the time of the writing of this article, Lenders have been closing deals with borrowers in far-off lands
Bermuda and China have similar sovereign ratings, though since the Venetians. Today, lenders use a number of tools to help
international lenders probably consider enforcement risk to be more mitigate legal risk, both in terms of structuring a transaction and
significant in China than in Bermuda). otherwise. These concepts are used in all sorts of financings, from
Sovereign Rate Spreads and Sovereign Credit Default Swap simple bilateral unsecured corporate loans to large, complicated
Prices. One of the simplest and most widely used methods to syndicated project financings with a variety of financing parties.
measure country risk is to examine the yields on bonds issued by Which of these tools will be available to a lender will depend on a
the country in question compared to a “risk free” bond yield (still variety of factors, especially the relative negotiating positions of the
usually considered the US, notwithstanding the recent credit borrower and lender for a particular type of transaction.
downgrade). A comparison of sovereign debt credit default swap Observations on the effectiveness of certain of these tools in
practice are provided in section 5.

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Bingham McCutchen LLP Legal Risk & Structuring Cross-Border Lending Transactions

Governing Law. As a starting point, the choice of governing law of valuable credit enhancement than customers affiliated with the
a loan agreement is important because it will determine whether a borrower and located in the same jurisdiction.
contract is valid and how to interpret the words of the contract c. Playing Defence and Offence. It should be noted that, in the case
should a dispute arise. The governing law of most loan agreements of a secured transaction, offshore collateral should not be viewed as
in international transactions has historically been either New York a substitute for the pledge of the borrower’s local assets. In such a
or English law. This is primarily because these laws are considered case, a pledge of local assets is also vitally important since, at least
sophisticated, stable and predictable, which lenders like. Also, theoretically, it preserves the value of the lender’s claim against
lenders generally prefer not to have a contract governed by the law those assets against third party creditors. To use a football analogy,
of a foreign borrower’s jurisdiction, since lawmakers friendly to the collateral can be thought of as having an “offensive” component
borrower could change the law in a way detrimental to the lender and a “defensive” component: the pledge of local assets to the
(law reform risk). As part of any cross-border transaction, lending lender is a “defensive” move because this keeps other creditors
lawyers spend time ensuring that the choice of governing law will from obtaining prior liens in these assets, while an equity pledge
be enforceable in the borrower’s jurisdiction, often getting coverage might be considered an “offensive” tool, allowing the lender to
of this in a legal opinion delivered at closing. foreclose and sell a borrower quickly and efficiently in order to
Recourse to Guarantors in a Risk-Free Jurisdiction. A lender to repay a loan with the proceeds.
a borrower in a jurisdiction with high legal risk may require a Partnering with Multilateral Lenders or Export Credit Agencies.
parent, subsidiary or other affiliate of the borrower in a “risk-free” A multilateral development bank is an institution (like the World
jurisdiction guarantee the loan. In this type of situation, the lender Bank) created by a group of countries that provides financing and
would want to ensure that the guaranty is one of “payment” and not advisory services for the purpose of development. An export credit
of “collection”, since the latter requires a lender to exhaust all agency (ECA) is usually a quasi-governmental institution that acts
remedies against a borrower before obligating the guarantor to pay. as an intermediary between national governments and exporters to
In a cross-border context, this could result in a lender being stuck provide export financing. Private lenders to borrowers in risky
for years in the quagmire of costly enforcement activity in a foreign jurisdictions are often comforted when these government lenders
and hostile court. While almost all New York and English law provide loans or other financing alongside the private lenders to the
guarantees are stated to be guarantees of payment, it is nevertheless same borrower, the theory being that the “governmental” nature of
always wise to confirm this is the case, and especially important if these institutions provides additional leverage to the lenders as a
the guarantee happens to be governed by the laws of another whole given these entities are considered to be more shielded from
jurisdiction. possible capriciousness of a host country’s legal and political
Collateral in a Risk-Free Jurisdiction. With secured loans, if the institutions.
legal risk of a borrower’s home country is high, lenders will often Reputation in the Capital Markets. A borrower or its shareholders
structure an “exit strategy” that can be enforced without reliance on may be concerned with their reputations in the capital markets in
the legal institutions of the borrower’s jurisdiction. This has been a connection with a long and contentious loan restructuring exercise.
classic tool of project finance lenders for decades and has This may be particularly true in the case of family-owned
contributed to the financing of projects in a variety of countries that conglomerates in emerging markets, especially if other parts of the
have high legal risk. business need to access international financing. If access to the
a. Offshore Share Pledge. For example, a lender often requires a capital markets is not considered to be important, they may be
share pledge of a holding company that ultimately owns the willing to weather the storm. See T. DeSieno & H. Pereira,
borrower. This type of share pledge may be structured to allow for Emerging Market Debt Restructurings: Lessons for the Future, 230
an entity organised in a risk-free jurisdiction to pledge the shares of N.Y.L.J. 39 (2003). In sovereign or quasi-sovereign situations, a
the holding company, also organised in a risk-free jurisdiction, government seeking foreign investment or striving to maintain good
under a pledge document governed by the laws of a risk-free relations with the international capital markets is less likely to be
jurisdiction. Such a pledge, properly structured and vetted with heavy-handed in a dispute with international investors. While
local counsel, is a powerful tool for a lender, allowing a lender to Argentina today probably does not fall into this category, in our
enforce the pledge and either sell the borrower as a going concern firm’s experience it has been the case in certain other emerging
to repay the loan or to force a replacement of management. In the market jurisdictions.
case of such a pledge, it is important to ensure that the borrower’s Personal Relationships. The value of personal relationships should
jurisdiction will recognise the change in ownership resulting from not be overlooked in mitigating legal risk. While personal
enforcement of such a pledge under its foreign ownership rules. relationships are important in both the developed and emerging
When preparing such a pledge, it is important to carefully examine markets, personal relationships play a particularly special role in
the enforcement procedures to ensure that the pledge can, to the those countries that do not have well-developed institutions and
maximum extent possible, be enforced without reliance on any processes to resolve disputes. Some institutions, when working out
cooperation or activity on the part of the borrower, its shareholders problem loans in emerging markets, often turn the loan over to
or directors. different personnel than those who originated the loan. In certain
b. Offshore Collateral Account. Another classic tool is to require a cases, it may be helpful to keep those with the key personal
borrower to maintain an “offshore collateral account” in a risk-free relationships with the borrower involved in these negotiations.
jurisdiction into which the borrower’s revenues are paid by its Political Risk Insurance and Credit Default Swaps. A lender may
customers. In project finance structures, lenders will often enter purchase “insurance” on a risky loan, in the form of political risk
into agreements with the borrower’s primary customers requiring insurance or a credit default swap. Rather than mitigating risk, this
that revenues be paid into such an account so long as the loans are instead shifts the risk to another party. As such, this is a good tool
outstanding. It is important to point out that these accounts will to have in the lender’s toolbox.
only be as valuable as the willingness of customers to pay revenues
Why Good Local Counsel is Important. Finally, the value of high-
into them. Creditworthy, offshore customers from jurisdictions
quality local counsel in a cross-border loan in a high-risk
where the rule of law is respected are likely to provide more

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 Bingham McCutchen LLP Legal Risk & Structuring Cross-Border Lending Transactions

jurisdiction cannot be overstated. This value comes in three forms: ownership should not be legally recognised, they may transfer
knowledge of local law and which legal instruments provide the assets to other affiliated companies in violation of contractual
most leverage to lenders in an enforcement situation; providing obligations, or engage in countless other activities unimaginable to
local intelligence on where other “leverage points” may be; and lenders when the loan was closed. This “hold-up” value effectively
finally, by being well-connected to the local corridors of power and gives the borrower and its shareholders leverage not available in
thereby being able to predict or “deflect” law reform in a manner risk-free jurisdictions, even when the equity is “out of the money”.
helpful to clients. For local counsel in high-risk jurisdiction, it’s Does Teaming Up With Government Lenders Help or Hurt
best not to be penny-wise. Private Lenders? As mentioned above, private lenders are often
comforted when government lenders co-lend to a borrower. Is this
5. Recent Developments and Anecdotes that comfort warranted? Government lenders may have motivations
during a workout that extend beyond recovery on debt to other
Both Support and Challenge the
goals. These goals may be maintaining good relationships with the
“Conventional Wisdom” foreign country in question, maintaining employment at home (in
The Sovereign Debt Crisis: Ireland and Greece. As mentioned the case of ECAs), or instituting environmental, anti-terrorism or
above, the conventional wisdom suggests that legal risk is higher in other policy goals. Experience with government lenders in
the emerging markets than in the developed economies. But restructuring exercises suggests that government lenders may be
consider what happened to creditors in Ireland and Greece recently. less willing to engage in difficult negotiations with foreign
In both cases, lawmakers in these countries changed the law in a borrowers and, in the eyes of at least some private investors in
manner that materially and adversely impacted the rights of certain restructuring exercises, their inclusion in a transaction has
creditors. In Ireland, Irish lawmakers changed the bank resolution led to decreased recoveries. While government lenders can
rules to favour equity over debt. In Greece, lawmakers changed certainly be helpful to a workout process under the right
Greek law in a way that allowed for collective active mechanics in circumstances, private lenders should be clear-sighted on the
a form that did not exist previously, effectively forcing minority benefits government lenders provide.
shareholders to be bound by a majority vote. See T. DeSieno & K. Challenges to New York and English Law? As transaction and
Dobson, Necessity Trumps Law: Lessons from Emerging Markets insolvency laws in emerging markets are modernised and become
for Stressed Developed Markets? (Int’l Ass’n of Restructuring, more uniform, and as legal and political institutions develop and
Insolvency and Bankruptcy Professionals, International Technical mature, many local borrowers may push harder for local law to
Series Issue No. 25, 2013). These and other examples make clear govern their loan agreements. At a recent syndicated lending
that even in the so-called developed economies law reform can be a conference focused on Latin America, local lenders in the region
risk to creditors, especially when economies are under systemic made clear they thought they had a competitive advantage over
stress. international lenders because they had an ability to make loans
Why New York or English Law is Still a Good Choice. In the under local law, something local corporate borrowers seemed to
Greek situation mentioned above, the majority of Greek bonds were value. The extent to which the market would soon see syndicated
issued under Greek law and some bonds were issued under English loans governed by local law was much discussed. While this
law. Bondholders holding English law governed bonds did not phenomenon likely may not occur on a significant scale in the near
suffer the same consequence of the change in Greek law (since term, it does seem that the choice of governing law may be one
Greek lawmakers could not change English law). In this instance at consideration that is increasingly in play when lenders are
least, the conventional wisdom held true. competing for lending mandates.

Why Local Law May Sometimes Be A Better Choice. In a recent

transaction in the emerging markets, lenders were provided with a 6. Final Thoughts
choice to have a guarantee governed by either New York law or
local law. Conventional wisdom would suggest the lenders should With the world becoming smaller, emerging markets developing
opt for New York law. However, on the advice a top local law firm, and lenders searching for yield, more lenders will seek
the lenders opted for the guarantee to be governed by local law. opportunities in cross-border lending. As a result, the question of
Why? Because after considerable weighing of risks and benefits legal risk will be one of increasing relevance, and local knowledge
(including the law reform risk associated with the choice of local will be of increasing importance.
law) it was determined the local law guarantee would provide Lenders have a number of useful tools available to help mitigate
considerably more leverage against the guarantor in the event of legal risk. Ultimately, it may not be possible to reduce risk to that
enforcement. It could be enforced more quickly and efficiently in of a “risk free” jurisdiction. Lenders should be careful to not
local courts than a New York law guarantee (used by other overestimate the comfort certain structural tools will ultimately
creditors under other facilities) thus potentially providing an provide. A borrower and its shareholders in a jurisdiction where
advantage to its beneficiaries. This notion of local law being better the rule of law is weak typically enjoy a significant advantage over
is probably more often going to be the exception rather than the a foreign lender in a debt restructuring exercise.
rule. Focus on structural tools should not overshadow perhaps the most
Are Offshore Share Pledges Really Risk-Free? Even in cases of important mitigant of all: the best protection against legal risk is to
offshore pledge agreements that are perfectly documented as make a good loan to a responsible borrower with “sound
described above, lenders who have tried to enforce these pledges commercial fundamentals”. In the case of a cross-border loan to a
have sometimes run into difficulties. In jurisdictions with high borrower in a high-risk jurisdiction, “sound commercial
legal risk, borrowers and their shareholders can prevent lenders fundamentals” goes beyond looking at a borrower’s financial
from being able to practically realise on the value of their collateral statements, projections and understanding its strategies. The most
in a number of ways: they may use the local legal system to their forward-thinking lenders will strive at the outset of a transaction to
advantage by making baseless arguments that the change of understand the full array of leverage points it may have against a

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Bingham McCutchen LLP Legal Risk & Structuring Cross-Border Lending Transactions

borrower and its shareholders, including the need for future Acknowledgment
financing and/or access to the capital markets, and of the
consequences of default for a borrower and its shareholders. The authors would like to thank Bingham partner Timothy DeSieno
for reviewing and providing helpful comments on this article.

Thomas Mellor Marc Rogers Jr.

Bingham McCutchen LLP Bingham McCutchen LLP
399 Park Avenue 399 Park Avenue
New York, NY 10022-4689 New York, NY 10022-4689
USA USA

Tel: +1 212 705 7425 Tel: +1 212 705 7434

Fax: +1 212 752 5378 Fax: +1 212 752 5378
Email: [email protected] Email: [email protected]
URL: www.bingham.com URL: www.bingham.com

Thomas Mellor is a partner in Bingham’s Banking and Leveraged Marc Rogers Jr. is an associate in Bingham’s Banking and
Finance Group, Project Finance Group and Financial Leveraged Finance Group, where he represents banks, other
Restructuring Group, and is co-chair of Bingham’s Latin America financial institutions and borrowers in a variety of corporate
Practice. Tom has extensive experience representing banks and lending matters.
other financial institutions in structuring and negotiating a variety
of debt finance transactions both in the United States and
globally, including syndicated, club and bilateral lending
transactions (investment grade and leveraged), as well as project
finance and restructuring transactions. Tom is particularly
experienced in cross-border financings (especially in Latin
America, Europe and Asia) as well as financings with structural or
other sorts of complexity. Tom is listed as a leading lawyer and/or
rising star in banking and finance in Chambers Global, Chambers
USA, Chambers Latin America, Legal 500 Latin America, IFLR
1000 and Latinvex. Tom is author of “China’s Investment in Latin
America: Themes, Challenges and Future Trends”, which
appeared in the Winter 2012 issue of Global Infrastructure.

Bingham’s market-leading practices are focused on global financial services firms and Fortune 100 companies. We have
approximately 900 lawyers in 14 offices in the US, Europe and Asia, including New York, London, Frankfurt, Beijing, Hong Kong
and Tokyo. We also have a significant East Coast/West Coast presence in the United States. Bingham has represented lenders
for over 100 years and is a leading law firm in the debt finance markets in the United States and globally. Our diverse practice
covers a wide range of debt financings, including syndicated lending, leveraged and investment grade financings, cash flow and
asset based financings, private note placements and multicurrency and cross-border financings.

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 Chapter 5

Global Trends in
Leveraged Lending Joshua W. Thompson

Shearman & Sterling LLP Caroline Leeds Ruby

Global trends in leveraged lending in 2013 have largely been driven remained necessary in 2013; e.g., a borrower needs to pay a premium
by substantial liquidity in US dollar markets, together with cautious of 101% or 102% if its first-lien loans are refinanced with loans with
investor optimism in the face of regulatory and political black a lower effective yield (based on margin and OID) within a specified
clouds on the horizon. In the face of continued Eurozone period after initial funding (ranging from six months to two years).
uncertainty, US fiscal policy ineffectiveness, US debt default The depth and breadth of liquidity in the US leveraged loan market,
posturing, and frothy asset markets with relatively anemic growth together with lower US pricing, provided cross-border financing
in maturing economies, the leveraged finance market has opportunities to both European and Asian borrowers that were
nonetheless remained relatively stable and a backbone to global unavailable in their home markets. A significant trend in 2013 was
economic stability in 2013. We discuss below specific trends in that European and Asian borrowers robustly accessed the US credit
leveraged lending from 2013. markets to borrow term loan B facilities and to enter the high yield
market. The Asia Pacific leveraged market remained relatively small
with about 18% of the volume of high yield issuance in the US
1. Market Ended Strongly (compared with Europe, which has about 60% of the volume in the
US), but is showing signs of growth.
Although the market faltered at times in the early part of 2013 and
the yield curve moved dramatically as a result of concerns that the
US Federal Reserve would rapidly taper monetary stimulus, the 2. The Reshaping of Liquidity and CLO
global leveraged markets recovered and finished on a positive note Issuance
at the end of 2013; we note, in particular, that this was despite the
European market being adversely impacted by the Cyprus Liquidity from the traditional bank market shrunk in 2013 as banks
restructuring and the US market being adversely impacted by the were affected by increased regulation. However, those banks that
temporary US federal government shut down. US primary issuance had repaired their balance sheets re-emerged in 2013 as
was USD $828 billion of leveraged loans, and issuance in the global underwriters of larger facilities and facilitated other liquidity
market exceeded USD $1 trillion. The 2013 leveraged finance solutions that have strengthened the leveraged loan market. For
market on both sides of the Atlantic proved to be surprisingly example, CLO issuances increased dramatically in 2013: USD $818
robust, driven by an increased appetite for leveraged products by billion of CLOs priced in 2013 compared with USD $54.3 billion in
investors hungry for yield while interest rates remain low. M&A 2012, and the CLO market shows continued strength in 2014. The
deal flow remained thin and, combined with an excess of credit resurgence of this form of securitisation reflects the continued
supply over demand, borrower-friendly terms, higher total leverage normalisation of the global credit markets in 2013 and a
and a reduction in pricing ensued. Dealogic reported that global stabilisation of the money supply.
average pricing decreased to 346bps in 2013. Frothiness in pricing Investors’ appetite for yield through leveraged exposure to the loan
was also matched by frothiness in deal structures; e.g., 2013 saw asset class coupled with managers’ desire to build assets under
significant issuance of PIK notes (including PIK toggle notes) and management in advance of the effective date for the risk retention
strong continued growth in second-lien financing to over USD $30 rules (e.g., rules that may effectively require managers to retain 5%
billion; this data supports, in part, a general trend that investors of the securities issued by the CLO) drove a significant demand for
have been willing to ease up on credit terms in the hunt for yield. CLO investments among managers and junior noteholders. The
The majority of transactions in 2013 were in the form of limiting factor currently seems to be a scarcity of AAA investors
opportunistic refinancings and repricings, although dividend recaps despite spreads in the AAA tranches of about 145-150 basis points
were also robust. Borrowers were keen to access the markets while over LIBOR. This scarcity was, in part, driven by a combination
interest rates remained low. New money deals were relatively of regulatory uncertainty and the effects of Basel III. For example,
modest in 2013, reflecting, in part, a subdued M&A market and the Volcker Rule prohibits banking entities from acquiring or
significant cash “on the sidelines” at large corporates. Less than retaining any “ownership interest” in covered funds. Since an
35% of 2013 leveraged loan volume represented new loan assets. actively managed CLO with a bond basket would be a covered
As a result of the large refinancing trend, the maturity profile of fund, and since the rights of senior noteholders to remove a CLO
institutional leveraged debt has been pushed out to 2017, and manager prior to an event of default could be viewed as a
portfolio churn has forced asset managers to work hard to maintain prohibited ownership interest, it is likely that some banks are
their leveraged loan assets under management. Soft call protection passing on CLO investments while the uncertainty persists. The
to compensate for early refinancing as part of a repricing transaction Volcker Rule exempts loan-only CLOs from the covered fund
definition, and it is likely that banks will show increased

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Global Trends in Leveraged Lending Shearman & Sterling LLP

willingness to invest in the senior tranche of such CLOs. The Basel quarterly-tested financial maintenance covenants, but many still
III treatment for securitisations is also still in flux, and although the retain incurrence-based financial covenants (i.e., compliance with a
most recent proposals decrease the capital requirement for certain fixed-charge coverage test or leverage test measured at the time
securitisation exposures compared to earlier proposals, the capital debt is incurred, investments made or dividends issued). In
requirement for other securitisation exposures has been increased. addition, some revolving credit facilities only contain a springing
The European risk-retention rules have a similar effect. Failure to financial covenant that is tested only while the RCF is drawn upon
satisfy the risk-retention requirements imposes higher capital or the outstanding borrowings thereunder exceed certain
charges on financial institutions investing in such non-conforming predetermined thresholds. Financial maintenance covenants in the
securitisations. Until recently, it seemed possible for certain third TLB market still remain relatively common where the TLB is
parties to retain the required risk, while newer guidance seems to structurally subordinated to an amortising term loan A or where the
retreat from that position and reintroduces uncertainty among structure is all senior with no subordinated debt.
European AAA investors, again with what is likely to be a
Borrowers with cov-lite terms effectively have a longer period of
dampening effect on demand among affected financial institutions.
time to deal with underperforming companies without having to
Basel III also introduced a new requirement: the Net Stable Funding negotiate with syndicate lenders, but at the cost of increased credit
Ratio. This is a metric designed to mitigate funding risk and which, risk to the lenders who are losing the early warning signs of
among other things, would require 5% of undrawn portions of deteriorating credit. Lenders also have to wait longer to reprice
committed credit facilities to be matched by stable funding (where cov-lite loans resulting in greater credit risk exposure and the
regulatory capital and deposits are regarded as the most stable type prospect of lower returns. Restructuring of a borrower of a cov-lite
of funding). In addition, this ratio, intended as a constraint against loan is likely to happen at a later stage of financial distress and in a
excess leverage and the gaming of risk-based capital requirements, more compressed time frame when fewer options may be available
does not involve a recognition of the risk exposure – reducing to preserve enterprise value. Senior bank lenders may no longer be
effects of any credit mitigation techniques (e.g., through guarantees, “at the table” negotiating with the borrower ahead of other
CDS, collateral or netting of loans and deposits). This is widely
creditors. However, it is interesting to note that recovery rates for
regarded as resulting in higher capital requirements for banks,
US borrowers of cov-lite loans do not seem to have been less than
which in turn has a dampening effect on loan asset growth.
for loans with maintenance financial covenants. There is little data
Alternative finance entities continued to emerge in 2013 as liquidity yet for Europe where bankruptcy laws are generally less creditor
providers and active market participants (e.g., insurance companies, friendly than Chapter 11 of the US Bankruptcy Code.
pensions, wealth funds, private equity funds, hedge funds and credit
Cov-lite issuance increased dramatically during 2013 and
funds). These non-bank entities were generally able to provide more
represented a majority of total issuance in the United States, and
flexible credit structures (e.g., unitranche financings) and take
Thomson Reuters LPC reports that the total issuance was USD
advantage of regulatory overhang in 2013. The emergence of
$381 billion versus the prior 2007 record of USD $108 billion.
business development companies (BDCs), being investment funds
There have been reports that CLOs have been increasing the
which lend to the middle-market in exchange for robust returns at
proportion they are permitted to invest in cov-lite loans from 30-
relatively low leverage levels, also presented a compelling alternative
for investors in 2013. Many of these alternative providers are not 40% to 50% and narrowing the definition of cov-lite for the
subject to the constraints of Basel III and are deemed to operate in the purposes of their investment guidelines to allow greater investment
shadows of the traditional banking sector; as such, they represent stiff in the asset class. The abundance of cov-lite loans was highlighted
competition for the regulated banks and traditional structured finance in a paradoxical statement by a senior analyst at Moody’s Investors
market. This is but another example of investors’ appetite for high Services, who noted that if one does come across a new transaction
yield and corresponding tolerance for higher risk. today with a full set of maintenance covenants, this may “suggest
other problems with the credit, maybe that it is new to the market or
exiting from bankruptcy”.
3. European and Asian Borrowers Accessing In the Interagency Guidance on Leveraged Lending, 78 Reg. 17766
the US Loan Financing Markets March 22, 2013 (the “Leveraged Guidance”), US regulators
expressed concerns regarding the additional risk cov-lite loans carry
There was continued appetite among European and Asian
compared to loans with financial maintenance covenants and
borrowers to raise dollar-denominated term loan B leveraged
indicated that they would review such loans as part of the overall
facilities in 2013, as such TLB loans were available with lower
credit evaluation of an institution. It is possible that increased
pricing than equivalent debt products in domestic European
regulation or a rise in the default rate may affect cov-lites in the next
currencies and often were “cov-lite”, meaning no financial
couple of years. US regulatory focus on counter-cyclical monetary
maintenance covenants applied. Cash-rich US investors facing a
policy in the leveraged finance market to control asset bubbles was
limited supply of deals warmed to foreign borrowers in 2013.
a notable and significant trend in 2013; it remains to be seen how
Nearly 30% more European companies raised dollar loans in the US
this new regulatory focus will play-out and the potentially new
institutional market last year than in 2012, the clear trend being that
competitive landscape that will evolve in response.
the TLB market is showing signs of becoming a global, rather than
regional, market. The structural currency risk presented by these
cross-border deals where a borrower does not have sufficient US 5. Amend and Extend Transactions
dollar cash flows for a natural hedge raises complexities that may
burden this market in the coming years. 2013 saw borrowers elect to negotiate an amendment and extension
of their facilities at lower pricing rather than incur the fees for a full
refinancing. Amendment fees were often between 50 and 100bps
4. Cov-lite Loans for a European amend-and-extend (“A&E”) transaction, which is
much cheaper than a refinancing. CLOs nearing the end of their
A significant proportion of sponsor TLB loans issued in the US reinvestment period also preferred A&E transactions as they locked
markets are cov-lite, and 2013 saw lower-rated corporate borrowers in yield for a longer period. In the US market, it is common for
seeking cov-lite terms. Cov-lite deals traditionally exclude A&E transactions to only require the consent of the majority of

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 Global Trends in Leveraged Lending Shearman & Sterling LLP

affected lenders. Recent changes have been made to the European 8. Dividend Recapitalisations
Loan Markets Association precedent facilities agreement to also
allow for structural changes with the consent of only the majority of Dividend recapitalisations remained an important part of the story
affected lenders and to allow non-pro rata debt buybacks by a in 2013, continuing a strong trend from 2012. Return of capital
modified Dutch auction. through dividends, in lieu of full exits, has remained attractive to
asset owners where exits are not optimal and the cost of debt
remains relatively modest on a WACC basis. Repeat “drive-by”
6. Accordion Facilities dividend recapitalisation deals have been received by the market
with mixed success, but have remained, while the market remains
US facilities often have an accordion feature allowing the
introduction of new tranches of debt by upsizing existing facilities highly liquid, reasonable and plausible deals to bring to market for
or allowing incremental equivalent debt in the form of a new term stronger stable credits. Certain credits that were on the cusp of exits
loan tranche or an increase in an existing revolving credit in 2012 were converted to dividend recap deals in late 2012 and
commitment or the issuance of second-lien or subordinated debt, early 2013 due to weakening sell-side conditions, but were able to
subject to certain terms and conditions. Generally such incremental exit completely in 2013 as sell-side stories improved; a heart-
loans (or, in certain instances, notes) are subject to a dollar cap warming story of dividends followed by very attractive P/E exits for
and/or the satisfaction of a leverage test alongside the requirement these sponsors. For those sponsors that have pushed the envelope
that existing loan financial covenants be complied with unless the on leverage and fixed charge coverage ratios, dividend recap deals
majority lenders agree to vary them. A new incremental tranche is have, occasionally, led down the less pleasant path of negative
almost always required to have a later maturity and a longer ratings actions, increased negative scrutiny by investors and a
weighted average life to maturity than the existing or initial scepticism when the credit returns to market for refinancing; this
tranche(s). US facilities usually also include a most favoured was particularly the case for credits where the equity investors had
nations (MFN) clause. If the effective total yield (including OID, already received a complete cash return of equity.
margins and floors) on new pari passu debt exceeds that on the
existing debt by an agreed amount (usually 50bps), then the margin
on the existing debt increases to reduce that differential to only 9. Downward Pricing Trends and Reverse Flex
50bps – thereby providing the existing lenders with interest rate
Strong credits took advantage of market conditions in 2013 to push
protection for the excess in the effective yield differential over
the envelope on pricing through so-called “reverse flex” during
50bps. Sponsors have sought, with mixed success in 2013, that the
syndication. In March 2013, approximately four times as many
MFN interest rate protection end, or “sunset”, after a period of time
deals saw pricing move down versus deals that were forced to
(usually 18 months). One of the primary reasons is that in a
increase pricing. In response to strong investor demand, issuers
situation where the original loan and incremental loan have
continue to push down pricing during syndication, tightening
identical terms but are issued for different prices that result in
spreads and accelerating commitment deadlines. However, explicit
different accruals of OID (or one loan having OID and the other
“reverse flex” provisions in commitment papers were rare in 2013
not), there is the question as to whether the loans are fungible from
and reserved only for the most creditworthy and sought-after
a tax perspective (bearing in mind that tax non-fungibility will
borrowers in bespoke circumstances.
impair liquidity and therefore potentially increase the all-in
effective cost to the borrower). In Europe, accordion facilities have
often been limited to uncommitted acquisition or capital 10. Convergence of Bank and Bond Terms
expenditure facilities but US style accordion features are appearing.
It is becoming more usual for European intercreditor agreements to There continues to be a convergence between high yield bonds and
provide for the introduction of new pari passu debt and the possible the TLB market, particularly as the same investors continue to
release and re-grant of security where this is the only route under invest in both products. Bond style features are now often seen in
local law for such security to secure the new existing debt. US facilities, and some are appearing in European and Asian term
facilities, particularly where a borrower already has US facilities.
7. Structural Adjustments These include:
(a) the ability to designate subsidiaries as “Unrestricted
Structural adjustment provisions are now often included in both US Subsidiaries” (which are ring fenced but to which many of
and European credit agreements. Introduction of a new tranche or the covenants and events of default do not apply);
increase or extension of an existing facility or an extension of a (b) the inclusion of builder baskets, being a percentage (usually
payment date or reduction in pricing requires only the consent of 50%) of cumulative consolidated net income (or retained
the affected lenders and the majority lenders (typically 50.1% of excess cash flow) plus new equity injected plus returns on
lenders in the US and 66 2/3% of lenders by commitment in investments, which can be used (in the absence of a default
Europe). These provisions have been used to allow borrowers to and subject to compliance with a leverage ratio test) to make
reprice or amend and extend without unanimous lender consent. investments, pay dividends, return capital or prepay junior
debt; and
English law schemes of an arrangement have been used
successfully by both English and non-English borrowers to cram (c) being subject to some negative covenants mirroring those of
high yield bonds; e.g.: debt may be permitted to be incurred
down dissenting senior lenders to achieve a restructuring of
subject to satisfaction of a pro forma leverage test (rather
facilities (such as the Icopal deal).
than a cap); liens to secure debt may be permitted subject to
As A&E transactions have become easier to do, forward start satisfaction of a tighter pro forma senior secured leverage
facilities have become less common. Forward start facilities are test or if such liens are silent junior liens, and, in each case,
facilities previously seen in the European market, which are subject to an agreed intercreditor agreement; and asset sales
negotiated 12 to 24 months before existing facilities mature, and may be permitted for fair market value where 75% of the
become available upon the maturity date of existing facilities. consideration is in cash and where proceeds are reinvested or
These facilities remove refinancing risk for the borrower but are used to prepay the term facilities.
more expensive than A&E transactions.

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The negative covenants in a European super senior RCF for a bank and no event of default will occur) if the company is sold to an
and bond financing are generally the same as those incurrence eligible sponsor or company with a similar business and subject to
covenants in the applicable bond indenture together with a restriction meeting certain conditions; e.g., these conditions usually define,
on purchasing notes over a threshold without reducing the super among other things, acceptable buyers, time constraints, minimum
senior revolving credit facility pari passu. European lenders equity contributions and pro forma leverage tests to be satisfied.
generally still require customary loan style affirmative undertakings, For example, the purchaser must be over a certain size/credit rating
a cross default, loan style insolvency event of default tailored for the and the transaction must occur within a maximum of 18 months and
jurisdictions concerned, a grace period for non-payment of three is subject to a minimum equity contribution requirement and
business days and breach of representation event of default and, for maximum debt incurrence test. The precap deal may also include a
term loan financings, an excess cash flow sweep. modest step-up in interest margins following the transaction or the
In the US market, traditional distinctions generally still exist for term payment of a fee in connection with it. This structure is beneficial
loan events of default and affirmative covenants from that contained for private equity buyers and sellers who are able to avoid a costly
in the high yield bond market. However, in a small number of recent refinancing. This feature is less popular with investors who are
deals in the US market, there has been a gradual move towards: (i) wary of losing control over those to whom they are lending.
events of default and affirmative covenants that are similar to those in Investor reservations mean that only top companies in a strong
the bond indenture (where a breach of a representation is not an event market and in a very strong transaction usually qualify for a pre-
of default); (ii) a longer grace period for a payment default (instead of cap. Even though some sponsors tried in 2013 to make this a
the usual three business days); (iii) a longer grace period for a permanent feature of the market, US bankers do not see pre-cap
covenant default (instead of no grace period); (iv) no annual excess becoming a widespread market norm (in contrast to cov-lite loans);
cash flow sweep (which is strongly resisted by lenders who are rather it will likely remain an exceptional provision to be used only
looking for a clear path to deleveraging); and (v) a cross acceleration in specific circumstances and subject to significant market testing
and cross payment default instead of the usual cross default provision. prior to deal launch.
Even though at this stage the convergence of bond-like events of While portability features are seen in high yield bonds issued by
default and affirmative covenants remains relatively small (and often European investors, the portability feature has not taken off in the
concentrated in certain segments of the market), it is not inconceivable European or Asian loan markets. It may also present regulatory
that this trend may strengthen in years to come. challenges.

11. Super Senior Revolving Credit Facilities 13. Unitranche Facilities

and “First Out” Facilities
Unitranche facilities remained popular in 2013 in both the European
“First out” RCFs have traditionally been relatively uncommon in and US mid-market and the trend was in increasing deal size in both
the US market but gained popularity in 2013 in middle-market markets. Unitranche facilities, which combine the senior and junior
financings and restructurings. In these deals, RCF lenders seek tranches into one unified layer of debt under a single credit facility,
additional protection as compensation for the low yield on these are often provided by alternative lenders such as credit funds and
types of facilities, which are typically only drawn when the private equity funds. They fall between senior and mezzanine debt
borrower comes under financial pressure. The RCF and term in terms of leverage pricing and risk. While unitranche facilities are
lenders share the same collateral on a pari passu basis, but the often fully “bought” deals (e.g., thereby carrying no market
proceeds of the collateral enforcement are paid first to the RCF syndication risk for the borrower), they do present additional
lenders under a waterfall usually included in the security documents complexity for borrowers as a result of the intercreditor agreement
or in an intercreditor agreement. The documentation will provide among the tranches (the so-called agreement among lenders
for class voting on changes affecting the first-out structure such as (AAL)). The borrower is not a party to an AAL so, unless otherwise
an increase in the RCF, and control on enforcement. Revolving regulated by other credit documents, the borrower will often not be
lenders’ ability to control enforcement remedies, as well as their aware of significant matters that may affect the credit (e.g., voting
rights in a bankruptcy, are often highly negotiated and frequently arrangements that may be decisive in a workout). However, with
depends on their leverage in any particular deal. Super senior RCFs fewer lenders (and, often, a single lender) providing the debt in
(“SSRCFs”) continue to be popular in Europe as the European connection with a unitranche structure, a borrower benefits from
borrowers continue to access the secured senior bond market. The more streamlined negotiations and much greater flexibility on
SSRCF has super priority with respect to recoveries from security terms. One material disadvantage is the uncertainty as to how
or distressed disposals of collateral and related claim releases. courts will treat this structure in a bankruptcy scenario –
However instructions of the bondholders with respect to unitranches have not yet been meaningfully tested in bankruptcy
enforcement will trump those of the SSRCF lenders for a certain courts (that being said, the absence of extensive caselaw suggests
period (usually six months) following an event of default if the that few sophisticated investors have been willing to invest the
SSRCF has not been discharged in full and in other specified resources to test the efficacy of the structure).
circumstances such as insolvency of the debtor. The SSRCF Unitranche facilities can be highly bespoke. They may have a
usually only has one or two financial covenants such as an interest bullet repayment, cash and PIK interest, call protection and
and/or a leverage financial covenant and has negative covenants
incurrence and maintenance covenants (or a mix of the two).
mirroring those in the bond. Financial covenants may only be
Typical unitranche lenders cannot usually provide working capital
tested when the RCF is drawn or before it is drawn.
or hedging facilities, so one or more banks usually have to provide
these and they will generally rank as super senior creditors being
12. Portability paid out first from recoveries but with no rights to block payments
on the unitranche facilities. Unlike in a super senior RCF in a bank
2013 saw a limited number of US facilities with a “pre-cap” or bond structure, the senior lenders do not have separate voting rights
“portability” feature. These provisions permit a change of control but will vote with the junior lender. However, it is common for the
to occur (and, therefore, no mandatory prepayment will be required unitranche structure to include certain additions to the list of matters

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 Global Trends in Leveraged Lending Shearman & Sterling LLP

requiring unanimous lender consent so that the senior lenders bases and cash dominion mechanisms, demonstrated very robust to
cannot be outvoted on these matters. The senior lenders may also total recoveries upon bankruptcy, according to a 2013 Fitch Ratings
have an independent right to enforce on the occurrence of certain report.
events of default after an agreed period or can take over
enforcement after 6-9 months.
16. Equity Cures

14. Syndicate Control In both the US and European markets, 2013 continued to see a
widespread acceptance of equity cure rights, but with continued
Given the wider variety of possible investors, 2013 saw sponsors discussions around permitted amounts, use in consecutive fiscal
and significant corporate borrowers continuing to seek more control quarters and the application of equity cure proceeds to repay debt.
over the identity of potential lenders including imposing white An equity cure right allows an injection of capital into the borrower
lists/black lists and enhanced consent rights. This reflects a trend group to stave off or ‘cure’ a financial covenant default. When
that certain investors have become more activist. lenders agree to include such provisions, they generally take
In the context of assignments, disqualified lender provisions comfort from the fact that, in exercising them, sponsors will inject
continued to be heavily negotiated in 2013, and sponsors came out further equity or subordinated debt into the group, providing both
of the gate recently asking for a blanket prohibition against additional funds and a show of commitment.
assignments to “competitors” (typically undefined and therefore
very broad in application) and certain affiliates thereof. Arrangers
17. Regulatory and Political Overhang
have generally been successful in limiting the competitor concept,
in many cases getting sponsors to agree that all disqualified Globally, the strong flow in the leveraged finance pipeline in 2013
institutions, including competitors and competitor affiliates, must occurred in an uncertain regulatory environment that cast a long
be expressly identified to the arrangers prior to the execution of the shadow on both lender and issuer behaviour. In the United States,
commitment letter. Federal Reserve actions around interest rates and QE tapering at the
end of 2013 contributed to heightened volatility in the high yield
bond market and periods of intermittent bond outflows. Risk
15. ABL Deals
retention, the yet-to-be finalised Basel III requirements, Federal
In 2013, ABL facilities allowed borrowers to obtain higher leverage Deposit Insurance Corp. assessments, the Volcker Rule and the
at a lower cost compared to cash-flow-based term debt, while also Leveraged Guidance are among current and pending regulatory
providing certainty of execution and a flexible covenant package. rules with which banks are now faced.
ABL deal flow was relatively weak in 2013 (e.g., approximately 320 On a positive note, 2013 ended with the passage by the US House
deals with a value of USD 75 billion; many of which were renewals of Representatives of a bipartisan, two-year budget agreement,
or upsizings). Asset-based lenders remained mired in a market indicating that more shutdowns or standoffs are unlikely. This is a
burdened by limited deal flow and few signs of any near-term sign that perhaps 2014 will bring more economic visibility and
pickup. certainty for corporate borrowers and investors alike, hopefully
Syndicated ABL tranches as part of leveraged deals were rare in alleviating some of the near-term political uncertainty that global
cross-border deals in Europe and Asia as more complex structuring financial markets have had to endure.
considerations arise; e.g., these deals often involve a sale of
receivables to an SPV to ensure satisfactory recoveries on a
Acknowledgment
bankruptcy under the less creditor-friendly bankruptcy laws in
certain European and Asian jurisdictions. These structures remain, The authors would like to acknowledge the assistance of their
generally, more expensive and time consuming to implement than colleagues, Bjorn Bjerke, Amy Gluckman and Azad Ali in the
US ABL structures. Conversely, US ABL structures, which often preparation of this chapter.
involve lending to opcos with monitored strictly defined borrowing

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Global Trends in Leveraged Lending Shearman & Sterling LLP

Joshua W. Thompson Caroline Leeds Ruby

Shearman & Sterling LLP Shearman & Sterling LLP
599 Lexington Avenue Broadgate West, 9 Appold Street
New York, NY, 10022 London, EC2A 2AP
USA United Kingdom

Tel: +1 212 848 8703 Tel: +44 20 7655 5944

Fax: +1 646 848 8703 Fax: +44 20 7655 5500
Email: [email protected] Email: [email protected]
URL: www.shearman.com URL: www.shearman.com

Joshua W. Thompson, Co-Head of the Global Finance Group and Caroline Leeds Ruby, a partner of the firm, is resident in the London
Co-Head of the Leveraged Finance Group, is resident in the New office. She represents banking and corporate clients and private
York office. He focuses his practice on complex financings, equity and fund investors in complex cross-border financings in
including acquisition financings and other leveraged lending developed and developing markets, including acquisition
(including leveraged buyouts, tender offers and other going private financings, leveraged lendings of all types (including going private
transactions), structured financings, second-lien financings and transactions, mezzanine and PIK loans), financings to funds,
mezzanine investments. In addition, he has extensive experience receivables financings, debt buy-backs, multinational restructuring
representing debtors, creditors, management and investors in transactions, work-outs, distressed purchases and defaulting loans.
complex restructurings, work-outs, bankruptcies and acquisitions of As counsel for lead arrangers and investors or corporate borrowers,
troubled companies. As counsel for lead arrangers and private she is involved in all aspects of deal structuring, transaction
equity sponsors, he is involved in all aspects of deal structuring, management, negotiation and documentation.
negotiation and documentation. Josh is recognised as a leading Caroline is ranked as a leading lawyer by Chambers UK 2013. “A
practitioner for bank lending by IFLR 1000 and Legal 500, which range of impressed clients note that Caroline Leeds Ruby is
notes that “clients are ‘happy to put trust and faith’ with the ‘excellent’ ‘really first-class,’ ‘stays cool under pressure’ and has ‘excellent
team head.” business acumen’.”
Josh also is the former general counsel of Jefferies Finance.

Shearman & Sterling’s Leveraged Finance Group is a leader in the high yield and leveraged bank market. Noted for their in-depth
understanding of the business and legal considerations involved in leveraged credits, their lawyers offer a combination of market
experience and a broad range of capabilities in the capital markets and the syndicated lending marketplace. They represent
commercial banks, investment banks, mezzanine and second-lien providers, private equity sponsors and corporate borrowers.
The team includes lawyers from the global Capital Markets and global Finance teams based in New York, London, Paris, Frankfurt,
Milan, Singapore, Hong Kong and Abu Dhabi, working in close collaboration with members of the Bankruptcy & Reorganization
and Project Development & Finance teams when needed. Shearman & Sterling’s Leveraged Finance team delivers sophisticated,
market-recognised advice and deal management for acquisition and other leveraged financings across a wide range of industries,
financial sectors and jurisdictions.

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 Chapter 6

Recent Trends in
Meyer C. Dworkin
U.S. Term Loan B

Davis Polk & Wardwell LLP Monica Holland

There has been much discussion recently in the United States relationship. They are often equally comfortable investing in HY
financial markets about the convergence of terms and features in term Bonds, where many of the protections traditionally found in the
loan B (“TLB”) with those typically found in high yield bonds (“HY commercial loan market are absent. Accordingly, these lenders
Bond”). Though typically described as a “convergence”, the changes focus on key economic terms, and are not as concerned about, and
are relatively one-sided, with the TLB gravitating toward features often are not set up to monitor, financial maintenance covenants.
long familiar to issuers and buyers of HY Bonds. This phenomenon The makeup of this lender base and the absence of the close
has been with us for years, but has accelerated recently. In 2013, a working relationship that characterises the commercial loan market
year dominated by strong investor demand and “best efforts” means that amendments are not as readily available and cannot be
refinancings and dividend recapitalisations, borrowers and sponsors credibly promised or relied upon in negotiating loan
predictably tested the market’s appetite for greater flexibility, which documentation. These investors are less focused on deleveraging
frequently meant borrowing even more technology from HY Bond over time and more willing to rely on less protective incurrence
documents. In this article, we consider some of the ways in which tests to guard against overleverage by the borrower and their
U.S. TLB terms have continued to move toward – and in some cases position in the capital structure. At the same time, financial buyers
exceed the flexibility found in – HY Bond terms, and examine the and other sophisticated borrowers have recognised this change, and
market and other forces driving that trend. have pushed incrementally for greater flexibility in initial terms.
TLB covenants and other terms have evolved in response, giving
lenders the economics they demand while increasingly providing
Changes in the U.S. TLB Market borrowers greater flexibility. Over time, this dynamic between
lender interests and borrower demands has had a profound impact
The U.S. TLB market has its origins in the commercial bank term
on U.S. TLB terms.
loan market. In the traditional bank loan model:
loans are made on a lend-and-hold basis with the expectation
that lenders would have ongoing exposure to, and a close Economic Terms
working relationship with, the borrower;
a highly leveraged borrower is typically expected to deliver
over time; Yield
financial maintenance covenants provide lenders with an
important monitoring tool and an early warning that a TLB are generally floating rate, and the built-in interest rate hedge
borrower is experiencing financial difficulty; and that this provides is an important distinguishing feature of the asset
the lender syndicate is a relatively discrete group of banks, class compared to (generally) fixed-rate HY Bonds. But it is
most of which have broader relationships with the borrower interesting to note that the advent of LIBOR and base rate “floors”
and can accommodate unexpected transactions or covenant has – during the extremely low interest rate environment of the past
breaches through amendments, often with a minimal fee. several years – caused TLB to be fixed-rate instruments accruing
Accordingly, in this model, upfront covenant flexibility is limited, interest at a rate equal to the floor plus the interest rate margin,
accommodating appropriate operational flexibility, but not major albeit with significant protection if LIBOR rises in the future. More
adjustments in capital structure or significant corporate events not significantly, during this period, original issue discount (“OID”),
anticipated at closing. Moreover, lenders in that market have which has long been a feature of HY Bonds, has become a standard
traditionally expected to share pro rata among themselves in the component of TLB pricing. In fact, in both initial syndications and
cash flow of the business and other prepayment events. This was secondary trading (including for purposes of “most-favored-nation”
the model many participants and practitioners in the term loan and “repricing” protections for incremental and refinancing
market grew up with, and is the model that continues today in many provisions), TLB pricing is now thought of in terms of overall
parts of the U.S. market and in other jurisdictions. “yield” (a terminology previously reserved for bonds), rather than
Practitioners active in today’s U.S. TLB market will scarcely simply a rate consisting of LIBOR plus an interest rate margin.
recognise this paradigm. The U.S. TLB market is now dominated
by non-traditional lenders: CLOs, hedge funds and institutional Call Protection and Prepayments
investors. These investors tend to view a term loan to a leveraged
borrower as a transaction – a prepayable, senior secured floating A second element of economic convergence is the widespread
rate investment – rather than one part of a broader institutional inclusion of “call protection” in TLB. In HY Bonds, call protection

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Davis Polk & Wardwell LLP Recent Trends in U.S. Term Loan B

is designed to preserve an investor’s income stream, by including a Financial Covenants

no-call period for the first years following issuance (often half the
life of the bond), followed by a “call period” subject to prepayment Perhaps the most conspicuous example of the “convergence” of
premiums that decline over time. In contrast, TLB call protection TLB toward HY Bonds is the continued presence and even
usually takes the form of a “soft call” – a prepayment premium of predominance in the U.S. TLB market of “covenant lite” structures.
typically 1% payable in connection with repricings of TLB Traditional term loans contained “maintenance” covenants –
occurring 6 to 12 months following the closing of the TLB. covenants, such as maximum leverage ratios and minimum
However, there are examples, particularly in the second lien TLB coverage ratios – that are tested either at all times or on a specified
market, of “hard calls” – a prepayment premium of typically 1% to periodic (typically quarterly) basis. In contrast, HY Bonds were
3% payable in connection with any voluntary and certain said to have an “incurrence-based” covenant package, because
mandatory prepayment of TLB within 1 to 3 years following the financial covenants were tested only upon, and as a condition to the
closing date, and in some cases these financings have incorporated permissibility of, specified actions (e.g. debt incurrence or making
no-call periods (often with “make-whole” calls permitted). A few restricted payments). In a covenant-lite TLB, maintenance
TLBs have even provided for special terms permitting prepayments covenants are replaced with incurrence covenants, which permit
with proceeds of an equity issuance – a so-called “equity claw” – borrowers to incur debt, make an investment or restricted payment
typically the sole province of HY Bonds. or take any other applicable action subject to complying with the
As the market’s focus has shifted from deleveraging over time, it applicable financial covenant test (and other applicable
has similarly reduced its focus on mandatory prepayment events, requirements). The deleveraging over time that financial covenants
including through the elimination of the “equity sweep” and the traditionally mandated has therefore been replaced with a model
dilution of the asset sale and excess cash flow (“ECF”) prepayment that permits major corporate transactions to proceed so long as the
requirements. Specifically, asset sale prepayment provisions often transaction does not cause the overall leverage to exceed an agreed
exclude a range of dispositions, include per-transaction and/or maximum.
aggregate materiality thresholds (below which the prepayment In determining compliance with such “incurrence” covenants, TLB
requirement does not apply) and are subject to permissive facilities have also adopted a number of other borrower-friendly
reinvestment rights during 12 to 18 month reinvestment periods. features from HY Bonds. These include defining “EBITDA” –
Significantly, as greater flexibility to incur secured indebtedness which is the denominator of any leverage ratio and numerator of
has been built into loan documentation, asset sale prepayment any coverage ratio – to include broad and often uncapped “add-
covenants now often permit the borrower to share asset sale backs” for items such as restructurings costs and projected cost
proceeds on a ratable basis with other pari passu secured debt. savings and synergies (including costs savings and synergies
Similarly, the calculation of the excess cash flow that is required to relating to initiatives with respect to which actions are only
be swept is subject to broad deductions, including for anticipated expected to be taken within 12 to 24 months) and determining
expenditures and investments, certain restricted payments and compliance with such covenants on a “pro forma” basis by, for
prepayment of other indebtedness. Importantly, the ECF sweep will example, calculating EBITDA in connection with an acquisition to
frequently be reduced dollar-for-dollar by voluntary prepayments or include the acquired entity (and its EBITDA) in the borrower’s
repurchases, even if made non-pro-rata among the TLB lenders. results throughout the relevant test period. In addition, many
This is in stark contrast to that traditional pillar of the commercial leverage covenants are now calculated on a “net” basis – reducing
bank market requiring pro-rata treatment across all lenders of a the debt in the numerator by the amount of unrestricted cash of the
particular class, as it effectively reallocates a borrower’s cash flow borrower (often without any cap).
to particular lenders at the expense of others. Finally, TLB often
afford lenders the right to reject mandatory payments, thereby
Asset Sales
making the prepayment requirement resemble more closely the
traditional “offer to repurchase” in a HY Bond.
TLB have largely eliminated fixed dollar limitations on a
borrower’s ability to divest its assets. Instead, assets sales are
Covenants generally permitted so long as the sale is made at fair market value,
75% of the sale consideration in “cash” (subject to a basket for
Occasionally a negative covenant package for a TLB will be designated non-cash consideration) and the net proceeds of such
indistinguishable from a related HY Bond, having been copied sale are applied to prepay outstanding loans (subject to the
directly from a concurrent or recent bond offering. More often, materiality thresholds, broad reinvestment rights and rejection
provisions that are the functional equivalent of the HY Bond terms rights referred to above). In effect, the TLB asset sale covenant has
are included in a more traditional-looking TLB package. Even the been converted from a negative covenant as it was in traditional
entities covered by the typical TLB package bear a striking credit facilities to the functional equivalent of a requirement to
resemblance to the typical HY Bond transaction. For example, a make an offer to prepay the loans if not applied first to other
TLB document typically no longer limits a borrower’s ability to permitted purposes, similar to what one would find in a HY Bond.
designate subsidiaries as “unrestricted subsidiaries” (thereby
excluding such subsidiaries from the covenants, collateral package
and EBITDA calculations under the TLB) to an overall dollar cap. Debt Incurrence
Rather many TLB, akin to the HY Bond structure, limit the ability
to so designate subsidiaries solely by reference to the borrower’s The typical 2013 TLB credit facility is crowded with flexibility
investment capacity and, in certain instances, pro forma compliance allowing the borrower to adjust its capital structure and incur
with an incurrence ratio, which is actually more borrower friendly incremental indebtedness. This flexibility comes in numerous
than HY Bonds, in which a fixed charge coverage ratio (“FCCR”) forms: refinancing facilities, incremental facilities, amend-and-
condition typically applies to all such designations. The following extend provisions, acquisition related debt, permitted ratio debt,
are certain other select areas of covenant convergence. basket debt and others, with additional variability among these
forms for incurring them on a first-lien, second-lien or unsecured

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 Davis Polk & Wardwell LLP Recent Trends in U.S. Term Loan B

basis, and inside or outside the credit facility itself. These various often include an “available amount” or “cumulative credit” basket
types of flexibility have developed independently and in different that builds based on excess cash flow and other components and
forms, and the combination of them has resulted, in many cases, in may only be used subject to satisfying certain leverage levels. More
overlapping or inconsistent standards within TLB agreements, and recently, however, the TLB cumulative credit concept has trended
little uniformity across the industry. However, they speak to the closer to the HY Bond standard by building based on 50% of CNI
ongoing trend of viewing credit facilities as flexible documents (or in a small number of deals, the greater of retained ECF and 50%
designed to survive significant corporate transactions, in this case of CNI) and replacing the leverage ratio condition with a coverage
debt incurrence, subject to maintaining a certain leverage profile. ratio.
There are three primary instances of flexibility that borrowers have Another common feature of TLB deals is that the leverage ratio
been able to achieve in some transactions that owe their origins to and/or absence of default conditions to the use of the builder basket
HY Bonds. is often limited to the making of equity payments (as opposed to
First, a limited number of TLB now permit debt incurrence subject investments), with the effect of establishing a more lenient set of
to satisfaction of a FCCR or interest coverage ratio (usually of conditions than HY Bonds, where the FCCR condition applies to all
2.00x or greater). While in a low interest rate environment this uses of the builder basket. Relatedly, some recent deals have also
creates significant flexibility, there are several mitigants that have seen the advent of an unlimited ability to make restricted payments
survived in the TLB market. First, even where a FCCR test for debt and investments and prepay junior secured debt, subject to the
incurrence applies, secured debt is only permitted subject to satisfaction of a leverage ratio. This may be driven, in part, by the
satisfaction of a leverage ratio. This can be contrasted with secured desire to hard-wire dividend recapitalisation capacity into TLB as
HY Bonds which frequently contain no ratio test for junior lien debt an alternative to a sale given the recent relatively anemic M&A
(although they do for pari passu or senior secured debt). Second, activity.
TLB typically still include more stringent parameters around the Finally, in most HY Bond issuances, the issuer is not limited in the
terms of pari passu/junior lien debt (including limitations on final amount of investments it can make in restricted subsidiaries
maturity, weighted average life, prepayments and, sometimes, more (whether or not guarantors), whereas TLB typically limit
restrictive terms), although it must be noted that many of these investments by the borrower and guarantors in non-guarantor
requirements are currently under pressure from borrowers. subsidiaries. However, in recent months, a few TLB deals have
Second, the ability to “reclassify” debt incurred under fixed dollar eliminated even this distinction, particularly where a U.S. borrower
baskets to ratio debt baskets is now included in a limited number of has significant non-U.S. operations or a non-U.S. growth strategy.
TLB. The rationales for resisting this are that a borrower that could This change has a number of important implications, including
not meet the ratio debt test at the time of incurrence should not be greatly facilitating acquisitions of entities that cannot or do not
“rewarded” for later improving performance. And, that lenders intend to become guarantors of the credit. From the borrower’s
should not be subject to what might be an unrepresentative “high- perspective, these features may seem essential to the realization of
water mark” of EBITDA performance over the life of the loan as the international strategies and increasingly complex global corporate
point for recharacterising basket debt as ratio debt, and resetting the structures that may evolve during the life of the loan. Limitations
starting point for using such fixed dollar baskets. But to a borrower, on cross-border transfers that are second-nature to a creditor may
these arguments contain echoes of a maintenance-covenant seem unduly constricting to a borrower.
construct: the debt is “stuck” in the basket under which it was
incurred. Borrowers argue (with varying degrees of success) that,
Flexibility to Make Acquisitions
with the market’s new, relatively relaxed attitude toward
deleveraging, if borrowers can satisfy the debt incurrence ratio at
One useful case study in the continuing march towards maximum
the time of reclassification, lenders are not harmed by such
flexibility in loan documentations is the trends in 2013 relating to
reclassification.
borrowers’ ability to make acquisitions. This is particularly driven
Third, another concept appearing occasionally in TLB is by sponsors who frequently view their portfolio companies if not as
“contribution indebtedness”, which allows the borrower to incur an acquisition platform, at least as a business that should be
debt equal to 100% (or occasionally up to 200%) of equity proceeds positioned to grow opportunistically over time. This manifests
it receives from investors. This originated as a HY Bond concept itself in several ways. First, it is now common to allow incremental
and is permitted on the theory that if investors are willing to further facilities to be utilised on a “funds certain” basis. Though it takes
capitalise an issuer on a 50% or 33% equity basis, bond lenders a number of forms, some more aggressive than others, the theme is
should be satisfied. consistent: if an incremental facility will be utilised to finance an
acquisition, then the conditions precedent to incurring such
Restricted Payments incremental indebtedness should match as closely as possible the
conditions precedent to a limited “SunGard” conditionality.
TLB covenants still tend to differentiate between investments, Second, negative covenants frequently permit indebtedness to be
equity payments (usually called restricted payments in that market) incurred to finance an acquisition subject to either satisfaction of an
and prepayments of junior debt, while HY Bonds treat these items agreed ratio or – borrowing from HY Bonds again – if the leverage
as part of a single “restricted payments” covenant. However, as ratio giving pro forma effect to the acquisition is not worse than it
available amount builder baskets and maximum ratio conditions in was immediately before. Third, call protection in TLB now often
TLB are increasingly applied across all three classes of payments or have an exception for material acquisitions, with the result that if
transactions, this distinction has become more form than substance, the borrower is forced to refinance its existing debt in order to
and has been eliminated in a minority of TLB deals. consummate an acquisition, it will not be penalised by having to
pay a prepayment premium to the existing lenders. HY Bonds are
In HY Bonds, restricted payments may be made in the amount of a
not so generous. Finally, permitted acquisition baskets are typically
builder basket equal to 50% of consolidated net income (“CNI”),
not only uncapped (except with respect to acquisitions of non-
100% of equity proceeds and certain other builder components,
guarantor entities) but also not subject to pro forma compliance
subject to compliance with FCCR greater than 2.00x. TLB more
with a leverage ratio. Taken together with negative covenant

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Davis Polk & Wardwell LLP Recent Trends in U.S. Term Loan B

baskets that grow as total assets or EBITDA grow and expansive borrowers realised that, unlike HY Bonds, their TLB did not
pro forma adjustments, these provisions ensure that borrowers can contemplate, and in many cases did not easily permit, them to take
enter into strategic transactions without seeking the consent of their advantage of depressed secondary trading prices to restructure their
bank group, or refinancing their existing debt, and without incurring balance sheet. Borrower and affiliates buyback provisions have
the associated costs of doing so. now become standard in TLB transactions, though they have
evolved in a way that is not identical to HY Bonds. There is usually
a cap on the aggregate holdings of such affiliates of 20-30% of the
Relationships among Lenders TLB and voting rights are limited to core economic issues directly
affecting their interests as lenders, with restrictions on receiving
In many respects, the changing makeup of the investors in TLB has
lender-only information and attending lender-only meetings. “Debt
been reflected in provisions that alter, in sometimes dramatic ways,
fund affiliates” of borrowers are typically not subject to the
the relationships between lenders and the “exit rights” that such
foregoing limits and may purchase loans in excess of the cap (but
lenders view as important to their investment decision.
are limited to constituting not more than 49.9% of lenders for
purposes of voting). In HY Bonds, affiliates of an issuer may
Assignments and “Secondary” Market purchase notes without cap, but the Trust Indenture Act (“TIA”) and
the terms of most HY Bonds even if not TIA-governed, provide that
One of the clearest remaining distinctions between the TLB and HY such affiliates have no voting rights. Thus, this is another area
Bond markets is that a borrower’s consent to assignments is still where the evolution of the TLB market has gone past the traditional
required in TLB. In contrast, free transferability is a hallmark of flexibility of HY Bonds, as affiliated lenders now have a greater
HY Bonds, subject to applicable securities law restrictions. It voice than affiliated noteholders.
should be noted, however, that a borrower’s consent in TLB is
usually subject to a “deemed consent” if the borrower fails to
respond within a specified period, which highlights the focus on Conclusion
liquidity of TLB.
As noted above, a principal driver of the evolution of the TLB
market toward that of HY Bonds has been the changes in the
Bilateral Changes relevant lender base. While commercial banks and other private-
side institutional investors were historically the principal holders of
The rights of lenders to deal individually with borrowers has bank loans, the TLB market is today largely driven by debt funds
continued to expand, akin to the “affected holder” standard in HY and other public-side investors. As a result, there has been a shift
Bonds. In today’s TLB, individual lenders frequently may modify in the TLB origination process from a “lend-and-hold” model, in
their economic rights (e.g., pricing and maturity) without majority which the arranging commercial banks made and held the bank
lender approval. Borrowers may also incur additional tranches of loans to maturity, to an “originate to sell” model, in which arranging
debt or fungible incremental debt under TLB. In addition, borrower banks syndicate the TLB to public-side investors and do not expect
buybacks are often permitted on an “open market” basis – non-pro- to hold those loans. Arranging banks have been under pressure,
rata and without offering to all lenders – as has always been true of particularly in the context of best efforts transactions which
HY Bonds. dominated the market in the last 12-to-18 months, to arrange loans
that provide maximum flexibility to the borrower while being
attractive to public-side investors. Given that these institutions
Affiliated Lenders
have long been comfortable with the covenant package and other
issuer-friendly features included in HY Bonds, it is no surprise that
In another change conforming to HY Bonds, affiliates of borrowers
these terms have increasingly found acceptance in the TLB they are
outside the consolidated group may buy TLB on the open market.
willing to buy.
This development arose following the financial crisis, as many

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 Davis Polk & Wardwell LLP Recent Trends in U.S. Term Loan B

Meyer C. Dworkin Monica Holland

Davis Polk & Wardwell LLP Davis Polk & Wardwell LLP
450 Lexington Ave 450 Lexington Ave
New York, New York 10017 New York, New York 10017
USA USA

Tel: +1 212 450 4382 Tel: +1 212 450 4307

Fax: +1 212 701 5382 Fax: +1 212 701 5307
Email: [email protected] Email: [email protected]
URL: www.davispolk.com URL: www.davispolk.com

Mr. Dworkin is a partner in Davis Polk’s Corporate Department, Ms. Holland is a partner in Davis Polk’s Corporate Department,
practising in the Credit Group. He advises financial institutions practicing in the Credit Group. She has extensive experience in
and borrowers on a variety of credit transactions, including the representation of senior lenders and borrowers in connection
acquisition financings, asset-based financings, debtor-in- with domestic and cross-border acquisition and leveraged buyout
possession financings and bankruptcy exit financings. In addition, financings, first- and second-lien financings, workouts, debt
Mr. Dworkin regularly represents hedge funds, investment banks restructurings and intercreditor issues.
and corporations in negotiating prime brokerage agreements,
ISDA and BMA standard agreements and other trading and
financing documentation and other complex structured financial
products.

The Firm
Davis Polk & Wardwell LLP is a global law firm with more than 900 lawyers in 10 offices worldwide. For more than 160 years, we
have advised industry-leading companies and global financial institutions on their most challenging legal and business matters.
We offer high levels of excellence and breadth across all our practices, including capital markets, mergers and acquisitions,
insolvency and restructuring, credit, litigation, private equity, tax, financial regulation, investment management, executive
compensation, intellectual property, real estate and trusts and estates.
The Credit Practice
We are among the world’s most experienced law firms in advising banks and other financial institutions and borrowers on LBOs
and other leveraged and investment-grade acquisition financings, structured financings, project financings, debt restructurings,
bridge loans, recapitalizations and many other types of transactions involving the use of credit. We are also the leading advisor
to banks providing debtor-in-possession, bankruptcy exit financings, rescue financings and other distressed or bankruptcy-related
financings in their various forms.

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Chapter 7

Yankee Loans – Structural

Considerations and Familiar
Differences from Across the
Pond to Consider
White & Case LLP R. Jake Mincemoyer

Introduction typically the intercreditor agreement – this is because placing a

company into formal European insolvency proceedings is often
The depth and liquidity of the investor base in the US institutional seen as the option of last resort as it limits the restructuring options
term loan market provides an attractive alternative for European (and likely value recovery) available to the senior lenders. Due to
borrowers in the leveraged finance market and has been a key this difference in expectation around how a restructuring is
source of financing liquidity, particularly in the last few years as expected to take place, the US and European leveraged finance
European markets have suffered from macroeconomic uncertainty markets start from very different places when it comes to
and regulatory constraints. The comparatively lower pricing of US structuring leveraged finance transactions. In the US, structures
dollar leveraged loans available in the US compared to that of typically assume a US Bankruptcy process, and in Europe
leveraged loans in the European market has also been an attraction structures typically assume a restructuring outside of a formal
for European borrowers, even once the cost of currency hedging has insolvency process, relying on contractual rights in an intercreditor
been factored in. agreement.
There are, however, a number of issues to consider in structuring so In the US, a restructuring implemented under Chapter 11 of the US
called “Yankee Loans” (US institutional term loans provided to Bankruptcy Code is a uniform, typically group-wide, court-led
European borrower groups governed by New York law credit process where the aim is to obtain the greatest return by delivering
documentation). These are driven primarily by differences in the restructured business out of bankruptcy as a going concern.
restructuring regimes in the US and Europe, and also by the needs Bankruptcy petitions filed under Chapter 11 invoke an automatic
(and expectations) of US institutional term loan investors. stay prohibiting any creditor (importantly this includes trade
There are also a number of features typical for the European creditors) from taking enforcement action which in terms of
leveraged loan market which, while familiar in the US leveraged practical effect has global application, as a violation of the stay may
loan market, are treated in very different ways in New York law lead to an order of contempt from the applicable US Bankruptcy
governed deals. In the context of Yankee Loans, many of these Court. The automatic stay protects the reorganisation process by
differing features or familiar differences need to be considered preventing any creditor from taking enforcement action that could
more carefully and amount to much more than e.g. a mere lead to a diminution in the value of the business. It is important to
difference between English and American spelling. This article note that a Chapter 11 case binds all creditors of the given debtor
considers firstly some of the key structuring considerations for (or group of debtors). US lenders retain control through this
Yankee Loans and then goes on to discuss some key familiar process as a result of their status as senior secured creditors holding
differences between the US and European leveraged finance senior secured claims on all (or substantially all) of the assets of a
markets, to be considered more carefully in the context of Yankee US borrower group.
Loans. By contrast, in Europe senior lenders traditionally rely on
contractual tools contained in an intercreditor agreement to retain
control of a restructuring process. These contractual tools found in
Structuring Considerations
a European intercreditor agreement include standstills applicable to
junior creditors party to the intercreditor agreement and release
provisions applicable upon a distressed disposal of the borrower
(Re)structuring is key
group. These allow for the group to be sold as a going concern
(typically following the enforcement of a share pledge at a holding
The primary focus of senior lenders in any leveraged finance
company level) and released from the claims of the creditors party
transaction is the ability to recover their investment in a default or
to the intercreditor agreement following the application of the
restructuring scenario. The optimal capital structure minimises
proceeds from such sale pursuant to an agreed waterfall. This
enforcement risk by ensuring the senior lenders have the ability to
practice has developed because, unlike the US Chapter 11
control the restructuring process, which is achieved differently in
framework, there is no equivalent single insolvency regime that
the US and Europe. In the US, a typical restructuring is a creature
may be implemented across Europe. While the EC Regulation on
of statute and is usually accomplished through a Chapter 11 case
Insolvency Proceedings provides a set of laws that promote the
under the US Bankruptcy code, where senior lenders’ status as such
orderly administration of a European debtor with assets and
is protected by well-established rights and processes. By contrast,
operations in multiple EU jurisdictions, such laws do not include a
in Europe, an effective restructuring for senior lenders in a
concept of a “group” insolvency filing and most European
leveraged finance transaction is typically a creature of contract –
insolvency regimes (with limited exceptions) do not provide for a

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 White & Case LLP Yankee Loans

stay on enforcement applicable to all creditors. Worth noting, done under NY documentation should include the contractual
however, is that while a Chapter 11 proceeding binds all of the “restructuring tools” typically found in a European-style
borrower’s creditors, the provisions of the intercreditor agreement intercreditor agreement, most notably a release or transfer of claims
are only binding on the parties thereto. Typically these would be upon a distressed disposal, and consideration should be given as to
the primary creditors to the group (such as senior bank lenders, whether to include a standstill on enforcement actions applicable to
mezzanine lenders and/or high yield bondholders), but would not junior creditors (which in many ways can be seen as a parallel to the
include trade and other non-finance creditors, nor (unless execution automatic stay under the US Bankruptcy Code) to protect against a
of an intercreditor agreement is required as a condition to such debt European borrower’s junior creditors accelerating their loans and
being permitted) third party creditors of permitted debt. forcing the borrower into insolvency. If that were to occur, the
In addition to the challenges arising as a result of multiple different likelihood of an effective restructuring of the business would be
European restructuring and insolvency laws, placing a company reduced as, not only would the senior creditors lose the ability to
into formal insolvency proceedings in many European jurisdictions effectively control enforcement of their security (for example,
is largely seen as the last option, as it will often impact the lenders’ arranging a pre-packaged sale of the business), but also, the equity
ability to sell the business as a going concern and therefore will in holders would lose the ability to negotiate exclusively with the
most instances reduce the value recovered (attitudes in Europe senior creditors for a period of time.
towards filing for formal insolvency proceedings are generally
negative, with vendors and customers typically viewing it as a Who/Where is your borrower and your guarantors?
precursor to the corporate collapse of the business).
Therefore, in order to obtain strategic control in an out-of-court Legal/structuring considerations
restructuring of a European borrower, it is important that senior In US leveraged loan transactions, the most common US state of
lenders are able to use their contractual rights to not only control the organisation of the borrower is Delaware, but the borrower could be
reorganisation of the borrower’s obligations (either by taking organised in any state in the US without giving rise to material
enforcement action, typically pursuant to a share pledge over the concerns to senior lenders. In Europe, however, there are a number
equity interests in a holding company of the borrower group, or by of considerations which are of material importance to senior lenders
leveraging those rights to renegotiate the terms of the financing) but when evaluating in which European jurisdiction a borrower should
also to prevent other creditors from pushing the borrower into a be organised. First, many European jurisdictions have regulatory
formal insolvency process. licensing requirements for lenders to borrowers organised in that
Historically, deals syndicated in the US leveraged loan market were jurisdiction. Second, withholding tax is payable in respect of
those where the business or assets of the borrower’s group were payments made by borrowers organised in many European
mainly in the US, albeit that some of the group may have been jurisdictions to lenders located outside of the same jurisdiction.
located in Europe or elsewhere, and these deals traditionally Finally, some European jurisdictions may impose limits on the
adopted the US approach to structuring: the loan documentation number of creditors of a particular nature a borrower organised in
was typically New York law governed and assumed any that jurisdiction may have.
restructuring would be effected in the US. Similarly, deals Similarly, the value of collateral and guarantees from US borrower
syndicated in the European leveraged loan market were historically group members in US leveraged loan transactions is generally not a
those where the business or assets of the group were mainly in source of material concern for senior lenders. The UCC provides for
Europe, and these deals traditionally adopted a European approach a relatively simple and inexpensive means of taking security over
to structuring: the loan documentation was typically English law substantially all of the non-real property assets of a US entity and,
governed, based on the LMA form of senior facilities agreement, save for well understood fraudulent conveyance risks, upstream,
and provided contractual tools for an out-of-court restructuring in cross stream and downstream guaranties from US entities do not
an intercreditor agreement (typically based on an LMA form). give rise to material concerns for senior lenders.
US institutional term loan investors are most familiar with, and However, the value of upstream and cross stream guarantees given
typically expect, NY law and market-style documentation. by companies in many European jurisdictions is frequently limited
Therefore, most Yankee Loans are done using NY documentation, as a matter of law. These limits can often mean that lenders do not
which includes provisions in contemplation of a US Bankruptcy in get the benefit of a guarantee for either the full amount of their debt
the event of a reorganisation (including, for example, an automatic or the full value of the assets of the relevant guarantor. There are
acceleration of loans and cancellation of commitments upon a US also very few European jurisdictions in which fully perfected
Bankruptcy filing due to the automatic stay applicable upon a US security interests can be taken over substantially all of a company’s
Bankruptcy filing). However, while a European borrower group non-real property assets with the ease or relative lack of expense
could elect to reorganise itself pursuant to a US Bankruptcy afforded by the UCC. In many jurisdictions it is not practically
proceeding (which would require only a minimum nexus with the possible to take security over certain types of assets, especially in
US), most European borrower group restructurings have favour of a syndicate of lenders which may change from time to
traditionally occurred outside of a formal insolvency process, as time (if not from day-to-day).
described above.
As a result, in structuring a Yankee Loan, significant consideration
It is therefore important that US lenders ensure that the structure should be given to the jurisdiction of the borrower, and guarantors
and documentation of the financing for a European borrower group within the group, in light of a number of issues that are not typically
provide the contractual tools necessary to allow the senior lenders relevant for a US leveraged loan transaction. In addition, as
to have control of the restructuring process before the borrower may discussed in more detail below, consideration should be given to the
be required to initiate a local insolvency filing (which in some fact that due to the limitations on upstream and cross stream
jurisdictions is an obligation binding on directors) or other creditors guarantees and the ability to include substantially all of an entity’s
take enforcement actions which may trigger a formal insolvency. assets as collateral, third party debt incurred at a subsidiary
To ensure senior lenders’ ability to drive the process in Europe and guarantor level may have claims that are pari passu with, or senior
protect their recoveries against competing creditors, a Yankee Loan to, the claims of the senior secured lenders who have lent to a

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White & Case LLP Yankee Loans

holding company of the guarantor, even if such third party debt is which provide permissions (for example to incur additional debt)
unsecured. subject to compliance with a specific financial covenant ratio which
In addition, to ensure that a European restructuring may be is tested at the time of the specific event, rather than a maintenance
accomplished through the use of the relevant intercreditor provisions, covenant which would require continual compliance at all times,
consideration should be given to determine an appropriate which traditionally has been required in bank loan covenants.
“enforcement point” in the group structure where a share pledge All of these features of the current US institutional term loan market
could be enforced to effect a sale of the group. The ease with which provide attractive flexibility for European borrowers, and are
such share pledge may be enforced (given the governing law of the frequently included in Yankee Loans, which adds to their appeal for
share pledge and the jurisdiction of the relevant entity whose shares European borrowers. Senior lenders should however consider these
are to be sold) should also be considered to ensure that the distressed features carefully, as they may have different impacts in a Yankee
disposal provisions in a European intercreditor agreement may be Loan provided to a European group compared to a loan made to a
fully taken advantage of if needed. US group.
Investor considerations Debt incurrence covenants in particular should be carefully
Many institutional investors in the US leveraged loan market considered in the context of a Yankee Loan. As noted above,
(CLOs in particular) have investment criteria which governs the guarantees provided by European group members may be subject to
loans that they may participate in. These criteria usually include the material legal limitations and the collateral provided by European
jurisdiction of the borrower of the relevant loans, with larger guarantors may be subject to material legal and/or practical
availability or “baskets” for US borrower loans, and smaller limitations resulting in security over much less than “all assets” of
“baskets” for non-US borrower loans. As a result, many recent the relevant guarantor. This may lead to an unexpected result for
Yankee Loans have included US co-borrowers in an effort to ensure senior lenders accustomed to guarantees and collateral provided by
that a maximum number of US institutional leveraged term loan US entities in the event of a restructuring consummated by means of
investors could participate in the financing. The addition of a US a Chapter 11 process. If permitted incremental or ratio debt is
co-borrower in any financing structure merits careful consideration incurred by a borrower that is also a guarantor of the main credit
of many of the issues noted above if the other co-borrower is facilities and such guarantee or collateral is subject to material
European. For example, the non US co-borrower may not legally limitations, the claims of the creditors of such incremental or ratio
be able to be fully liable for its US co-borrower’s obligations due to debt, even if unsecured, may be pari passu, or even effectively
cross-guarantee limitations. In addition, a US co-borrower may senior to the guarantee claims of the senior secured lenders of the
raise a number of tax structuring considerations, including a main credit facilities at that guarantor. In a Chapter 11 proceeding
potential impact on the deductibility of interest, which should be involving such a guarantor, the senior lenders will only have a senior
carefully considered. secured claim against that guarantor to the extent of their guarantee
claim and the value of any collateral provided by that guarantor.
In addition, in the event of a restructuring accomplished by means
Familiar Differences of a distressed disposal and release of claims utilising the
contractual provisions from a European intercreditor agreement, the
providers of incremental or ratio debt may not be subject to the
Covenant flexibility terms of the intercreditor agreement if they are not a party thereto.
As a result, they will not be subject to any standstills on
In addition to the well-known (if not fully understood or enforcement actions, or subject to any release provisions upon a
appreciated) difference in drafting style between NY leveraged loan distressed disposal, even if such debt is junior secured or unsecured
credit agreements and European LMA facility agreements, the in nature. This again may be an unexpected result for senior
substantive terms of loan documentation in the US and European lenders. While the contractual provisions in a European
markets have traditionally differed as well, with certain concepts intercreditor agreement in many ways emulate two of the key
moving across the Atlantic in either direction over time. Most features of a Chapter 11 proceeding – a standstill on enforcement
recently, we have seen increased flexibility for borrowers in a applicable to junior creditors, which is comparable to the Chapter
variety of forms moving slowly from the US market to Europe, but 11 automatic stay and the release of claims upon a distressed
many common US provisions have yet to gain broad market disposal, which is comparable to the release of claims which may
acceptance in the current European market, which adds to the be effected upon a US Bankruptcy Court confirming a plan of
attractiveness of Yankee Loans for European borrowers. reorganisation, these features only apply to creditors that are party
One aspect of the terms for US leveraged loan transactions which to the intercreditor agreement (as opposed to a Chapter 11
has not readily emerged on the European side of the Atlantic has proceeding, which generally binds all creditors to a given debtor).
been the trend in the US for “covenant-lite” facilities, in which It should be noted that these concerns apply to all third party debt
typically only the revolving facility benefits from a financial incurred by guarantors with limited guarantees and/or collateral
covenant (but not the term facilities). Financial covenants in US pursuant to general baskets or in respect of trade credit, but the risk
leveraged deals (whether or not “covenant-lite”) also routinely is heightened in relation to incremental or ratio debt that may be
include “equity cure” provisions which allow for an “EBITDA incurred pursuant to incurrence ratio baskets.
cure”, pursuant to which an equity contribution may be made to
“cure” a financial covenant breach, with the cure amount being Conditionality
deemed to be contributed to the EBITDA side of the leverage ratio
(i.e. the ratio of debt to EBITDA), rather than reducing debt (either Documentation Principles vs. Interim Facilities and “Full Docs”
through a deemed reduction or an actual repayment), as is typically
In acquisition financing, the risk that the purchaser in a leveraged
seen in European “equity cure” provisions.
buyout will not reach agreement with its lenders prior to the closing
The negative covenant package for “covenant-lite” facilities in the of the acquisition (sometimes referred to as “documentation risk”)
US also typically contains incurrence ratio baskets similar to what is generally not a material concern (or at least is a well understood
would commonly be found in a high yield bond covenant package, and seen to be manageable concern) of sellers in private US

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 White & Case LLP Yankee Loans

transactions. Under New York law, there is a general duty to appeared. In both cases, the guiding principle is that the conditions to
negotiate the terms of definitive documentation in good faith and the initial funding should be limited to those which are in the control
US leveraged finance commitment documents also typically of the bidder/borrower, but as expected there are some familiar
provide that the documents from an identified precedent transaction differences which are relevant to consider in the context of a Yankee
will be used as the basis for documenting the definitive credit Loan.
documentation, with changes specified in the agreed term sheet, The first key difference is that in the US, market lenders typically
together with other specified parameters. These agreed criteria are benefit from a condition that no material adverse effect with respect
generally referred to as “documentation principles” and give to the target group has occurred. However, the test for whether a
additional comfort to sellers in US transactions that the material adverse effect has occurred must match exactly to that
documentation risk is minimal. contained in the acquisition agreement. With this construct, the
In European deals, there is generally a much greater concern of lenders’ condition is the same as that of the buyer, however if the
sellers relating to documentation risk. This can be explained in part buyer did want to waive a breach of this condition the lenders
by the fact that there is no similar duty imposed to negotiate in good would typically need to consent to this. In European certain funds,
faith under English law, the typical governing law for European the lenders typically have no material adverse effect condition
leveraged financings (and under English law, an agreement to agree protection, although they usually would benefit from a consent right
is unenforceable). Therefore, to address seller concerns about to any material changes or waivers with respect to the acquisition
documentation risk in European deals, lenders typically agree with agreement (as would also be present in SunGard conditionality).
purchasers to enter into fully negotiated definitive credit Therefore, if a European buyer wished to waive a material adverse
documentation prior to the submission of bids, or to execute a short- effect condition that it had the benefit of in an acquisition
form interim facility agreement under which funding is guaranteed agreement, it is likely that this would be an action that European
to take place in the event that the lenders and the sponsor are unable “certain funds” lenders would need to consent to.
to agree on definitive credit documentation in time for closing, with The second key difference is that in the US, market lenders typically
the form of the interim facility pre-agreed and attached as an benefit from a condition that certain key “specified representations”
appendix to the commitment documents. made with respect to the target are true and correct (usually in all
In some recent Yankee Loans, sellers (or buyers sensitive to material respects). However, these must be consistent with the
European sellers’ concerns) have been pressing that the European representations made by the target in the acquisition agreement and
approach to solving documentation risk be followed, this condition is only violated if a breach of such specified
notwithstanding that the finance documentation will be governed by representations would give the buyer the ability to walk away from
New York law provided by US market investors. the transaction. In the European market, no representations with
Putting aside the difference in drafting style between NY leveraged respect to the target group generally need to be true and correct as a
loan agreements and European LMA facility agreements, and the condition to the lenders’ initial funding. The only representations
resultant impact on transaction costs and timing, which itself would which may provide a draw stop to the initial funding are typically
tend to support following US practice of commitment documents core representations with respect to the bidder. Similar to the material
containing documentation principles, the need to carefully consider adverse effect condition, while these appear different on their surface,
the structuring considerations discussed above would seem to in most European transactions if a representation made with respect
support the use of commitment documents containing to the target group in the acquisition agreement was not correct, and
documentation principles in lieu of full credit documentation or as a result the buyer had the ability to walk away from the transaction,
interim facility agreements in connection with bids where Yankee this would likely trigger a consent right for the lenders under a
Loans provided under NY law will finance the acquisition. European certain funds deal.
With time, we would expect European sellers (and their advisors) to Much like documentation principles compared to full documents
become comfortable with the use of documentation principles for (or an interim facility), SunGard conditionality compared to
New York law financings (as is customary for US sellers), given European “certain funds” show differing approaches to an issue
that the governing law of the finance documents, not the taken on each side of the Atlantic which result in similar substantive
jurisdiction of the seller, is the key factor in evaluating outcomes. Thus far, Yankee Loans have approached these issues on
documentation risk. However, until then consideration will need to a case-by-case basis, although with at least a slight majority
be given to the appropriate form of financing documentation and favouring the US approach to these issues.
the potential timing and cost implications resulting therefrom.
SunGard vs. Certain Funds Diligence – reliance or non-reliance
Certainty of funding for leveraged acquisitions is a familiar topic on
both sides of the Atlantic. It is customary for financing of private Lenders in US leveraged finance transactions will be accustomed to
companies in Europe to be provided on a private “certain funds” performing their own primary diligence with respect to a target
basis, which limits the conditions to funding or “draw stops” that group, and their counsel will perform primary legal diligence with
lenders may benefit from as conditions to the initial funding for the respect to the target group. Frequently this may include the review of
acquisition. Bidders and sellers alike want to ensure that, aside from diligence reports prepared by the bidder’s advisors and/or the seller’s
documentation risk, there are minimal (and manageable) conditions advisors, which will be provided on a non-reliance basis and primary
precedent to funding at closing (with varying degrees of focus by the review of information available in a data room or a data site.
bidder or seller dependent on whether the acquisition agreement Lenders in European leveraged finance transactions will also be
provides a “financing out” for the bidder – an ability to terminate the accustomed to performing their own diligence with respect to a target
acquisition if the financing is not provided to the bidder). group with the assistance of their counsel, which will also frequently
Similar concerns exist in the US market, which has developed a include the review of diligence reports prepared by advisors to the
comparable, although slightly different approach to “certain funds”. bidder and/or the seller. However, European lenders typically are
In the US market, these provisions are frequently referred to as provided with explicit reliance on these reports, which is also extended
“SunGard” provisions, named after the deal in which they first to lenders which become party to the financing in syndication.

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White & Case LLP Yankee Loans

In the context of a Yankee Loan, while the advisors to the bidder

and/or seller may be willing to provide reliance on their reports for R. Jake Mincemoyer
lenders, consideration will need to be given as to whether this is White & Case LLP
needed and/or desired. Lenders’ expectations may also diverge in 5 Old Broad Street
London EC2N 1DW
the context of a Yankee Loan which includes a revolving credit
United Kingdom
facility provided by European banks (likely relationship banks to
the borrower or target group) as opposed to the US banks initially Tel: +44 20 7532 1224
providing the term loan facilities. Fax: +44 20 7532 1001
Email: [email protected]
URL: www.whitecase.com

Conclusion
Jake Mincemoyer is a partner of White & Case’s Banking Practice
currently based in London. Jake was based in the firm’s New York
We expect Yankee Loans to be of continuing importance, at least in office from 2001-2010.
the near term. Ultimately, Yankee Loans can be seen as simply US Jake represents and advises clients in a broad range of finance
institutional term loan tranches provided to European groups. matters, with an emphasis representing lead arrangers,
However, while one may reasonably expect that many of the underwriters, borrowers and sponsors in leveraged finance
transactions under New York and English law, syndicated in both
“familiar differences” between the US and European leveraged loan
the New York and European markets.
markets would (and perhaps should) follow a US approach for what Jake has extensive experience in multi-jurisdictional cross-border
is ultimately a US product with US market investors, there are secured financings including bank and high yield bond debt,
fundamental differences to restructurings of US and European acquisition financings, refinancings and recapitalisations. Most
leveraged groups, as outlined above, which should be considered recently, Jake has utilised his unique experience in structuring
both US and European leveraged financings in connection with a
during the structuring of a Yankee Loan. number of transactions involving European groups and debt
facilities syndicated in the New York market. Jake is listed as a
Leading Lawyer in the International Financial Legal Review 1000
Acknowledgment (2014) and as a Leading Individual in the Legal 500 UK edition
(2013).
The author would like to thank Associates Shanan Dunstan and Ben
Wilkinson, who contributed to this chapter.

White & Case LLP is a leading global law firm with lawyers in 39 offices across 26 countries. Among the first US-based law firms
to establish a truly global presence, we provide counsel and representation in virtually every area of law that affects cross-border
business. Our clients value both the breadth of our global network and the depth of our US, English and local law capabilities in
each of our regions and rely on us for their complex cross-border transactions, as well as their representation in arbitration and
litigation proceedings.

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 Chapter 8

Issues and Challenges in

Structuring Asian Roger Lui
Cross-Border Transactions –
An Introduction
Allen & Overy LLP Elizabeth Leckie

An estimated US$758.9 billion of syndicated loans were reported in follow those in Europe, the US or somewhere else (this is not
the Asia Pacific market in 2013, up from US$747.9 billion in 2012. necessarily dictated by, but has a strong correlation to, the
This estimate excludes bilateral lending which, in some jurisdictions governing law of the documents);
such as the PRC, remains the predominant form of lending. There are how their security may be enforced and impediments that
significant loan capital inflows into Asia Pacific from Europe and the may stand in their way; and
US as well as intra-regionally, in the form of a vibrant cross-border any fetters on the borrower’s ability to service its debt.
syndicated loans market hubbed in Hong Kong and Singapore, some
recent big ticket multi-agency-led project financings (for example,
the US$20 billion limited-recourse financing for the Ichthys LNG 2. Documentation
project in Australia and the US$5 billion financing for the Nghi Son
refinery project in Vietnam) and a number of domestic markets with
deep pools of liquidity, such as South Korea, Japan, Taiwan, the PRC, 2.1 APLMA and LMA forms/governing law
Malaysia, the Philippines and Australia.
APLMA and LMA form and style loan agreements are widely used
There are legal and structural complexities in lending in the Asia
for English law loan transactions in Asia. The APLMA also
Pacific region. The jurisdictions in the region are derived from a
publishes template loan agreements governed by Hong Kong law,
wide range of legal traditions and jurisprudence, which prescribe
Singapore law and Australian law. Cross-border loan transactions
for relationships between creditors and debtors, ownership of assets
for Hong Kong, Singapore and Australian corporates, in particular
and rights (and how they may be secured), insolvency and capital
where such transactions are arranged by local lenders, are
movement differently and with varying degrees of legal certainty.
commonly governed by the respective local law, each of which is
This article investigates some of the legal issues that arise in cross- well accepted in the market given the common law basis of the
border financings in the region and how they may be dealt with. jurisdictions and similarity to English law. Domestic loan
The brevity of this article requires that we consider these many and transactions in jurisdictions where there are pools of large domestic
complex issues by way of examples; we do not attempt to carry out liquidity (for example, Malaysia, South Korea, and Taiwan) are
a survey across jurisdictions on each of the categories of issues we commonly governed by domestic law.
highlight below.
Certain market practice points are worth noting:
the threshold for majority lenders is usually set at 662/3 per
1. Diversity in the Region, and Factors to cent of lenders’ commitments and/or participations;
Consider representations are repeated on new extensions of credit and
on interest payment dates;
While Hong Kong, Singapore, Malaysia, Australia and New there is generally no automatic acceleration of loans upon
Zealand are common law jurisdictions, the balance of the insolvency;
economies in the region follow codified, civil law traditions. Some, it is not uncommon for lenders to be able to rely on legal or
such as the PRC and Vietnam, have socialist approaches in relation other due diligence reports issued by the borrower’s counsel
to, for example, ownership of land. The use of holding vehicles or other advisers; and
domiciled in offshore jurisdictions such as the British Virgin legal opinions in relation to enforceability of finance
Islands, the Cayman Islands and Bermuda is common throughout documents and capacity and authority of obligors to enter
the region, with some specific affinities between, for example, into finance documents are generally delivered by lenders’
Mauritian vehicles and Indian corporates, and Labuan vehicles and counsel.
Indonesian corporates. Some of the countries in the region also New York law transactions would, as expected, follow US style
impose varying degrees of capital and foreign exchange control. documentation. Historically, some Indonesian and Philippines
In structuring their cross-border lending in the region, lenders project financings, and some financings by US corporates or
therefore need to consider, amongst other things: sponsors in the region, have been documented under New York law.
the most appropriate governing law for their facility
agreements – preferably one that allows the parties to be able
2.2 US influence
to enforce the terms of the negotiated documents as they are
presented;
Notwithstanding the above, some aspects of US financing
whether the allocation of risks and general loan terms should

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Allen & Overy LLP Issues & Challenges in Structuring Asian Cross-Border Transactions

technology feature in some financings in Asia – especially if it is However, the position is different in a number of other Asian
hoped to syndicate a portion in the US (through a TLB or otherwise) jurisdictions. For example, in the PRC, it is practically impossible
or where strong US-based sponsors are borrowing. In addition, a to enforce a foreign judgment in the absence of a bilateral treaty on
number of Asian borrowers (particularly listed PRC real estate recognition and enforcement of judgments or without being able to
companies) have issued high yield bonds using standard New York establish the reciprocity principle (while the PRC has entered into
law style documentation. It is common for lenders and bondholders bilateral treaties with a number of jurisdictions, it has not yet
to be treated on a pari passu basis and such borrowers are entered into any such treaties with either the UK or the US). The
requesting that terms between the bonds and loans be aligned. This position is similar in Vietnam and Thailand. In Indonesia, there are
has caused certain US style provisions to be included in Asian loan no procedures for direct recognition and enforcement of foreign
transactions, resulting in some hybrid forms of documentation. judgments and a judgment creditor must commence a new action in
US regulations also have increasing influence on documentation the Indonesian courts, although the original judgment may serve as
requirements in certain Asian financing, for example: evidence of the relevant foreign law and underlying facts. Where a
foreign judgment cannot be enforced easily in the jurisdiction of
FATCA: Financial institutions generally require FATCA
provisions to be included in finance documents. This is incorporation of an Asian obligor or where its assets are located,
particularly relevant to Asian lenders based in jurisdictions lenders should consider whether arbitration would be a viable
where the relevant governments have not entered into alternative to litigation.
arrangements with the US and therefore are not FATCA That decision is often driven by whether or not the relevant
compliant. Provisions are based on LMA suggested jurisdiction is a signatory to the New York Convention, which
wording. There is no market standard on allocation of (among other things) requires courts of signatory states to recognise
FATCA risk although this is currently developing in line with
and enforce arbitration awards made in other signatory states,
the US approach and strong borrowers will ensure that the
risk is allocated to lenders. subject to public policy and certain other limited exceptions.
Australia, England, the PRC (and by extension Hong Kong),
Sanctions/Anti-corruption provisions: Financial institutions,
Indonesia, Japan, Singapore, Thailand, the US, Vietnam and India
in particular those headquartered or with a significant
presence in the US, increasingly require such provisions to are all signatories to the New York Convention. It is therefore not
be included in finance documents. uncommon for lenders to require disputes under cross-border loan
transactions in Asia to be subject to arbitration, usually seated in
Hong Kong, Singapore, London or New York.
3. Governing Law And Enforcement It is also possible for parties to provide for an optional dispute
resolution clause where, for example, disputes may be submitted to
arbitration but one party (usually the lender) retains an option to
3.1 Governing law of finance documents
litigate, or vice versa. However, local law advice should be taken
to ascertain whether the use of such option clauses may, in the local
The governing law of finance documents (and in particular the loan jurisdiction, jeopardise the enforceability of an arbitral award (for
agreement) is important as questions of legal validity and example, certain local jurisdictions would require a clear agreement
interpretation are determined by principles of the governing law. As between parties to resolve disputes by way of arbitration, which
noted, English law (and in some cases New York law) is favoured may be compromised by optionality).
as the governing law for cross-border loan transactions, with the
laws of certain common law based jurisdictions such as Hong
Kong, Singapore and Australia also widely used and accepted. 3.3 Local law for local security

Based on the general doctrine of lex situs, security over certain

3.2 Dispute resolution
assets (for example, land) should be taken using local law to avoid
conflicts of laws issues on enforcement of security. In addition,
Typically, disputes in loan transactions would be settled by the local laws in certain jurisdictions may require that security may
courts of the jurisdiction of the governing law of the underlying only be taken over assets located in that jurisdiction using local law,
finance documents, although the lenders would generally have the and this should be determined at an early stage in the transaction.
right to commence proceedings in other jurisdictions.
It is less common for disputes in loan transactions to be settled
through arbitration, which is generally seen to be less efficient and 4. How Security is Held
potentially more costly for claims for recovery of debt under loan
A loan syndicate would generally expect that, where possible,
agreements (which are usually viewed to be relatively
security assets are held by a security agent or trustee on behalf of
straightforward).
lenders, and (where registration is required) be registered in favour
In a cross-border lending transaction where the governing law of of the security agent or trustee. The agency or trust structure
the loan agreement is English or New York law, and the English or enables the security agent or trustee to enforce on behalf of the
New York courts have exclusive jurisdiction over disputes, the lenders as a group, including any new lenders who have joined the
lenders would in a default scenario obtain a judgment in the English syndicate by transfer or assignment, especially if the transfer may
or New York courts and seek to enforce such judgment against an be deemed under relevant law to be a discharge of the borrower’s
obligor in its jurisdiction of incorporation and/or jurisdictions in obligations towards the exiting lender.
which it has assets. This is generally not a significant issue of
Whether a security trust or agency is recognised in the jurisdiction
concern where obligors and security assets are located in common
of incorporation of the security grantor and where the security will
law based jurisdictions such as Hong Kong, Singapore and
need to be enforced and, where recognised, the degree of certainty
Australia, as such jurisdictions have established laws and
as to which of these concepts are enforceable, are therefore
procedures pursuant to which the local courts may recognise and
important questions.
enforce such judgments without re-examining the merits of the
original judgment.

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 Allen & Overy LLP Issues & Challenges in Structuring Asian Cross-Border Transactions

The security trust is recognised in the common law jurisdictions in for PRC entities borrowing on a cross-border basis. Cross-border
the region and other relevant common law jurisdictions such as the loan structures using an offshore company (often a special purpose
BVI and Cayman Islands. While the PRC has implemented trust vehicle) as the borrower have become prevalent.
laws to recognise trusts, these are recently enacted laws and have not
been rigorously tested in the relevant courts. As a result, security in
a syndicated loan in the PRC is more usually held by a security agent
as agent of the lenders. However, although this is common practice
in the PRC, we have come across instances where local registration
authorities have refused to register the security agent as beneficiary
and, instead, require that each lender is registered as the beneficiary
of the security and each new lender is also registered.
Security over assets in Thailand is granted to the lenders and any
other finance parties (e.g. the security agent) and perfected in A loan will be made to the offshore borrower which will in turn
favour of (in respect of a mortgage) each finance party separately or downstream the loan proceeds to the FIE either by way of a
(in respect of a pledge) the security agent for and on behalf of the shareholder loan (which would remain subject to the foreign debt
finance parties. It is also market practice for the finance parties to headroom) or equity injection.
appoint a security agent to act as agent of the lenders, to hold title
The offshore lenders would generally take security over all assets
deeds and to act on enforcement.
situated offshore, as well as equity in the FIE. This includes share
In Vietnam, a security agency could be used in certain security over the shares in the offshore borrower. In a default
circumstances. For example, the government may allow an onshore scenario, this would allow the offshore lenders to enforce the share
or offshore security agent to hold security over assets in Vietnam in security to either sell the offshore borrower as a going concern and
a BOT project. To avoid uncertainty relating to the use of a security apply the proceeds towards repayment of the loan, or force a
agent in Vietnam, each lender should be registered as a secured replacement of management.
creditor in Vietnam. In a syndicated loan with onshore lenders in
PRC foreign exchange control regulations do not allow PRC
Vietnam, an onshore security agent must be a bank licensed to
entities (whether an FIE or a domestic entity) to grant security in
operate in Vietnam.
favour of offshore lenders to secure debts owed by its offshore
parent (in this case, the offshore borrower) to offshore lenders. This
5. Foreign Exchange Controls (and a PRC means that the offshore lenders’ claims under the offshore loan
Example) would be structurally subordinated to the claims of creditors of
onshore members of the group. However, there are various ways to
enhance the credit of such structures, including the following:
5.1 General Personal guarantee: It is not uncommon for offshore lenders
to require the founder or majority shareholder to provide a
A number of Asian jurisdictions operate foreign exchange controls personal guarantee to guarantee offshore loan transactions of
to regulate and monitor the flow of cross-border funds and currency the group. There are potential drawbacks to this – in
particular, if the founder or majority shareholder is a PRC
conversion. This could have an impact on structuring cross-border
individual, there could be potential issues with enforcing
loan transactions, and in many situations is the underlying driver
such guarantee against the individual in the PRC and with
behind how cross-border loan transactions are structured. The repatriating any enforcement proceeds offshore.
impact can be illustrated by reference to PRC foreign exchange Notwithstanding this limitation, there is still merit from the
controls and how it impacts the structuring of PRC cross-border offshore lenders’ perspective to obtain a guarantee from such
loan transactions. individuals, who may have assets offshore. Even if such
Broadly speaking, PRC-incorporated entities can incur individuals do not have assets offshore, the offshore lenders’
ability in most cases to initiate bankruptcy proceedings
indebtedness from non-PRC persons (such indebtedness herein
against the individual has proven to be an effective lever for
referred to as foreign debt). However, where the direct
offshore lenders when negotiating with PRC enterprises in a
shareholders of the PRC-incorporated entity include one or more default or restructuring situation.
non-PRC persons (foreign invested enterprise or FIE), there are
Bank guarantees/Nei Bao Wai Dai structures: If a PRC
limits as to the level of foreign debt it may incur. “Domestic
enterprise has substantial unsecured assets onshore, it may
companies”, which refers to companies established under the laws consider enhancing the credit of an offshore loan made to the
of the PRC, the shareholders of which are PRC persons (and FIEs offshore borrower by arranging for a PRC bank to issue a
where the shareholding of non-PRC persons is less than 25 per guarantee to the offshore lenders, which will become payable
cent.), may only borrow loans from non-PRC persons if approval on demand by the offshore lenders (usually after occurrence
from the State Administration of Foreign Exchange (SAFE) is of a default and/or acceleration of the loan). In consideration
obtained. for the PRC bank’s agreement to issue such guarantee, an
onshore subsidiary will provide an indemnity to the PRC
Lending directly to an FIE or a domestic company on the basis
bank and, if required, security for such indemnity. The
above has one major advantage, in that the FIE or domestic offshore lenders are therefore relying on the credit of PRC
company would not be prohibited by PRC exchange control bank. This structure is commonly known as “Nei Bao Wai
regulations from granting security over certain of its assets to secure Dai” (which translates to an onshore guarantee for an
its own foreign debt. offshore loan), and is quite commonly seen as a structuring
tool.
5.2 The offshore holding vehicle structure A number of other issues must also be considered when structuring
such cross-border loans, including:
In practice, these issues create substantial constraints and obstacles Use of proceeds: It is important to ascertain how the
proceeds of the financing will be used, as PRC regulations

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Allen & Overy LLP Issues & Challenges in Structuring Asian Cross-Border Transactions

could provide obstacles to any repatriation of funds back to have laws or regulations which would restrict the taking of security
the PRC and/or conversion of any foreign currency into local over assets in regulated industries.
currency on repatriation. For example, under the existing
A number of jurisdictions require local law security documents to
SAFE regime, it is not permissible to convert a cross-border
USD loan into RMB for the purpose of refinancing RMB be in the local language (in certain jurisdictions, there is no hard
debt onshore. rule that agreements must be in the local language but, in practice,
only local language agreements will be accepted for registration).
Debt service: The offshore borrower’s ability to service the
loan will be dependent on the ability of the group to For example, PRC law governed pledges over equity in a PRC
repatriate cash outside of the PRC. Cash may be up- wholly foreign-owned enterprise must be in the Chinese language;
streamed by PRC subsidiaries to their offshore parent English versions are sometimes signed concurrently but the Chinese
companies either through repayment of shareholder loans or versions would generally prevail. Certain jurisdictions may allow
dividend payments, although each of these avenues is subject English versions to prevail or have equal standing.
to specific regulations.

6.2 Floating charges and general security interests

5.3 Others
The universal floating charge over all assets, which is generally
Another example of a jurisdiction with foreign exchange recognised in common law jurisdictions, is generally not available
restrictions is Thailand where, in general, all outward remittances of in civil law based jurisdictions in Asia. However, in certain
foreign currency must either, depending on the type of transaction, jurisdictions, certain techniques may be used to achieve a similar
be transacted through authorised local banks or approved by the result.
Bank of Thailand (the BOT). Local banks are authorised to transact In Indonesia for example, in a document creating security over a
without prior BOT approval (a permitted transaction), provided specific asset, there will be provisions that allow the object of the
that all necessary documents are submitted to the local bank. This security to be updated in order to capture future assets of the same
includes the repayment of offshore loans and the payment of kind.
interest on them, but excludes the outward remittance of proceeds
In Vietnam, Vietnamese law allows the creation of security over all
from the enforcement of security outside the court proceedings or
existing and future assets with a general description of those assets,
payments under a guarantee.
registrable in Vietnam. However, registration of security must be
For a non-permitted transaction, although the BOT approval is not updated when a future asset comes into existence or when the
required until the payment is made, it has become increasingly construction of a building is completed or acquired. An update of
common for lenders in larger transactions to require an “in- security is not required for security over stocks in trade and it is
principle” approval from the BOT for the outward remittance of possible to take security over all goods stored in a warehouse.
enforcement proceeds by the security provider in the event that
security is enforced or a guarantee is called. This in-principle
approval provides some comfort to the lenders by reducing the 6.3 Grace period prior to enforcement/methods of
uncertainty normally associated with the obtaining of a government enforcement
approval and, if granted, it will also usually reduce the time the
BOT will take to consider the actual application. Note, however, It is not always possible for lenders to enforce security immediately
that BOT approval will not be given in all cases. on the occurrence of an event of default by a borrower. For
example, in Indonesia and Thailand, lenders must generally serve
demand letters before taking enforcement action.
6. Security – What is Available, and Other Issues Other jurisdictional differences affect the timing and procedures for
to Look Out For the enforcement of remedies. Whilst the laws of common law
jurisdictions would generally allow for out-of-court enforcement
remedies, the laws of certain jurisdictions may require that security
6.1 Security over specific assets – availability and is enforced through the local courts.
specific requirements
For example, in Thailand, enforcement of a mortgage generally
Security over certain types of assets may not be available in certain requires a judicial order and sale by public auction, while
Asian jurisdictions. For example, Thai law does not recognise any enforcement of a pledge does not require a judicial order but the
security interest over (among other things) bank accounts, sale must be made by public auction or, in the case of publicly listed
receivables and insurances (although it is not uncommon for lenders shares, via the Stock Exchange of Thailand.
to take collateral through absolute assignments (usually just for In our experience with enforcement of security in Indonesia,
payment streams) and conditional assignments). Foreign lenders notwithstanding the agreement of the parties in the security
may not take security interests over land use rights and assets documents, a court order or decision may be required for the
attached to land in Vietnam, as all land in Vietnam is owned by the enforcement of a security interest created under such documents. A
state (although onshore lenders (including foreign banks in law passed several years ago requires agreements involving
Vietnam) may take security interests over land use rights). Indonesian entities to be made in the Indonesia language. There are
Where security over specific assets is available, it is important for many uncertainties surrounding this law and further clarification,
lenders to obtain local law advice to ascertain at the outset whether by implementation of regulations, is needed.
there are any specific requirements in respect of taking such Vietnamese law allows the enforcement of security without being
security. These would usually include specific approvals from, subject to any court hearing. However, the absence of an effective
and/or registration with, specific authorities. It is also important to enforcement mechanism allows the grantor of security to frustrate
ascertain whether there are any restrictions in respect of taking the enforcement by refusing to physically hand over assets in its
security over specific assets. For example, certain jurisdictions may possession, resulting in a potential delay of several months as the
secured creditor goes to a Vietnamese court to sue for possession.

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 Allen & Overy LLP Issues & Challenges in Structuring Asian Cross-Border Transactions

7. Final Words with well-recognised structuring and documentation conventions,

cross-border deals often require careful structuring to achieve the
While there is much opportunity for cross-border lending within allocation and mitigation of risks in a manner which is familiar to
Asia, and an active and growing market in many jurisdictions, it is participants in the North American and European markets.
not as unified a market as it may seem from the outside. While some
jurisdictions have a well-developed domestic syndicated market

Roger Lui Elizabeth Leckie

Allen & Overy Allen & Overy LLP
9th Floor, Three Exchange Square 1221 Avenue of the Americas
Central New York
Hong Kong NY 10020
China and Hong Kong USA

Tel: +852 2974 7236 Tel: +1 212 610 6317

Email: [email protected] Email: [email protected]
URL: www.allenovery.com URL: www.allenovery.com

Roger has experience in advising on a wide range of finance Elizabeth specialises in US finance and restructuring with over 20
transactions, including corporate loans, pre-IPO financing, equity- years of experience on a broad range of finance transactions for
backed financing, structured and acquisition financing, real estate financial institutions and corporations through all phases from
financing and project financing. He is a respected authority in the origination through workout, restructuring and bankruptcy. Her
structured and project finance field with experience with power experience covers syndicated secured and unsecured lending,
projects in jurisdictions as diverse as Korea, Hong Kong, the asset-based lending, acquisition finance, subordinated debt,
PRC, Vietnam, Laos and the Philippines. Being fluent in English, structured finance, letters of credit and other bank finance
Cantonese and Mandarin, he is recognised by clients for his transactions. She has experience with a number of industries and
knowledge of the markets across the region and the diversity of specialises in cross-border issues.
his practice.
He is a member of the Asia Pacific Loan Markets Association’s
(APLMA) Documentation Committee and China Working Group.

With over 1,000 lawyers worldwide, including in all major financial centres, Allen & Overy has one of the largest and most
international teams of banking and finance lawyers of any global law firm. Few practices can match our top tier position across the
full range of financial products. With such a deep team and global reach, international and industry-leading ‘first-of-a-kind’
transactions are our hallmark. We have been instrumental in nearly all the major developments in the modern financial markets.
The past few years have been the most challenging in the history of the international financial markets and have required fresh
thinking as the markets adjust to continually changing economic, political and regulatory conditions. Renowned for our intellectual
rigor, our banking and finance lawyers draw on deep product expertise and regularly work alongside our regulatory, litigation,
restructuring and other specialists – particularly important in light of recent market conditions – to develop innovative solutions for
our clients, often incorporating complex financing techniques that lead the industry.
That is why over 800 corporate and financial institution participants in the financial markets entrust us with the full range of their
domestic and cross-border transactions.
In this document, Allen & Overy means Allen & Overy LLP and/or its affiliated undertakings. The term partner is used to refer to
a member of Allen & Overy LLP or an employee or consultant with equivalent standing and qualifications or an individual with
equivalent status in one of Allen & Overy LLP’s affiliated undertakings. For further information see www.allenovery.com.

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Chapter 9

Acquisition Financing in
the United States: Geoffrey Peck

Outlook and Overview

Morrison & Foerster LLP Mark Wojciechowski

2014 Expected to be a Stronger Year for Mergers Delaware corporate law can have a wide impact on M&A
and Acquisitions in the United States transactions. New Section 251(h) of the Delaware General
Corporation Law (DGCL) allows, in certain circumstances, for the
In 2014, the United States is expected to see an increased level of parties to a two-step acquisition to agree that the back-end merger
mergers and acquisitions activity, especially in the middle market. can be closed without shareholder approval if the purchaser
The market for M&A activity is an important consideration for acquires a sufficient number of outstanding shares in the tender
participants in acquisition financings because the relative volatility offer to approve the back-end merger. This is often a simple
or stability of the market can impact the terms of the financing and majority of shares unless the certificate of incorporation requires a
dictate whether the terms are more favourable to lenders or super-majority. Previously, a purchaser was required to obtain at
borrowers. least 90% of the outstanding shares before it could complete a
Although M&A activity in 2013 did not live up to predictions, total merger without shareholder vote. New Section 251(h) will
dollar value of M&A deals was up, largely because of a few “mega streamline third party acquisition financings for two-step
deals”, including the $28 billion buyout of Heinz by Berkshire acquisitions because the tender offer and the back-end merger can
Hathaway, the $25 billion buyout of Dell, Verizon’s $130 billion be closed at virtually the same time, eliminating the risks that
agreement to buy Vodafone, and the $20 billion purchase by Japan’s lenders face with extended periods of time between the closing of
Softbank of 70% of Sprint. The technology sector saw the largest the two transactions. Given that Section 251(h) is in its infancy, it
volume of deals in 2013, which in the U.S. included Cisco’s $2.7 remains to be seen whether this form of merger will be a preferred
billion acquisition of Sourcefire and the acquisition of BMC structure and, when used, whether the financings will reflect
Software for $6.9 billion by a private equity consortium. The reduced fees or other changes to standard terms because of the
momentum in technology M&A continued at the start of 2014 with associated efficiencies.
the announcement of Lenovo’s purchase of IBM’s server business As M&A activity increases in 2014, so will the need for acquisition
and Motorola Mobility from Google, for a combined $5.21 billion, financing. It is important to review the fundamentals of U.S.
as well as Google’s $3.2 billion purchase of Nest and VMWare’s acquisition financing using secured loans and monitor trends in this
$1.175 billion acquisition of AirWatch. regularly changing area of loan financing.
M&A activity in 2014 is also expected to heat up in health care,
biotechnology and life sciences. In January, GE announced the The Commitment Letter is Key
$1.06 billion purchase of a medical equipment business from
Thermo Fisher Scientific and Forest Laboratories announced the The commitment letter for a financing sets forth the material terms
purchase of Aptalis Pharma for $2.9 billion. These deals, among of the lenders’ obligations to fund the loans and the conditions
others, are indicative of a strong start to the year for M&A activity, precedent to such obligations. Obtaining a suitable commitment
albeit non-leveraged. letter from one or more lenders is of particular importance to
The middle market is expected to dominate M&A activity in 2014. acquisition financing and can be the deciding factor as to whether a
In a recent survey by KPMG, 77% of U.S. CEOs responded that seller will sign an acquisition agreement with a particular buyer
they expect to close M&A deals this year under $250 million, where the buyer cannot otherwise prove itself able to fund the
followed by 12% who expect deals between $250 and $499 million, acquisition from its own funds. As in all committed financings, the
and 5% who expect to close deals of between $500 and $999 borrower wants an enforceable commitment from its lenders which
million. obligates the lenders to extend the loans, subject to certain
The increase may be for a variety of reasons, including pent-up conditions that have been mutually agreed upon. In acquisition
demand and continued low interest rates. In addition, many financing, where the proceeds of the loans will be used by the
corporate balance sheets continue to be flush with cash and private borrower to pay the purchase price for the target company, in whole
equity funds have both deep pockets of uncalled capital and the or in part, the seller will also be concerned that the buyer has strong
need to sell portfolio companies that, but for the financial crisis and funding commitments from its lenders. If the buyer’s lenders do not
long recovery, would have been sold earlier. Parties are poised to fund the loans, a failed acquisition could result.
pursue the pipeline of deals that did not close in previous years. In a typical timeline of an acquisition, especially one involving
A 2013 change in Delaware corporate law may also fuel the public companies, the buyer and seller execute the definitive
increase in M&A activity. Since Delaware is one of the most agreement for the acquisition weeks, if not months, in advance of
common U.S. jurisdictions of corporate organisation, changes in the acquisition. Following execution, the buyer and seller work to

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 Morrison & Foerster LLP Acquisition Financing in the United States

obtain regulatory approvals and other third-party consents that may Documentation Conditions
be needed to consummate the acquisition, execute a tender offer if
required, complete remaining due diligence, finalise the financing Commitment letters for general financings often contain vague and
documentation and take other required actions. Signing an partial lists of documents and conditions that the lenders will
acquisition agreement often results in the seller not pursuing other require before funding the loans. Phrases like “customary
potential buyers for a period of time while the parties work to conditions precedent” are often seen. In contrast, a commitment
complete the items noted in the prior sentence. For example, letter for an acquisition financing typically has an explicit, detailed
acquisition agreements often contain covenants forbidding the and often lengthy list of conditions.
seller from soliciting or otherwise facilitating other bids and If the lenders are permitted to require satisfaction of conditions
requiring the parties to work diligently towards closing. Further, precedent to funding that are not expressly set forth in the signed
many acquisition agreements either do not give the buyer a right to commitment letter (whether customary conditions or not), this
terminate the agreement if its financing falls through (known as a increases the risk to the borrower that these additional conditions
“financing-out” provision), or require a substantial penalty payment cannot be met. It is common in an acquisition financing to see an
to be made by the buyer if the transaction fails to proceed, including express statement from the lenders that the list of conditions
as a result of the financing falling through (known as a “break-up precedent in the commitment letter are the only conditions that will
fee”). Accordingly, at the signing of the acquisition agreement, and be required for funding. In some cases the list of conditions
as consideration for the buyer’s efforts and costs to close the precedent in commitment letters for acquisition finance are so
acquisition, the buyer will want the lenders to have strong detailed that they are copied directly into the final forms of loan
contractual obligations to fund the loans needed to close the agreements.
acquisition.
Similarly, vague references to “customary covenants” and
“customary events of default” in a commitment letter add risk that
Who Drafts the Commitment Letter? the lenders will require that the loan agreement include
unreasonable provisions which could not be met by the borrower.
Private equity funds (also known as sponsors) are some of the most To limit this risk, commitment letters for acquisition financings
active participants in M&A transactions and related financings. often include fully negotiated covenant and default packages
With their sizable volumes of business that can be offered to banks, (which may include pages of detailed definitions to be used in
sponsors often have greater leverage in negotiations with lenders calculation of any financial covenants).
than non-sponsor-owned companies. Sponsors and their advisors
Some sponsors even require that the form of the loan agreement be
monitor acquisition financings in the market and insist that their
consistent with “sponsor precedent”, meaning that the loan
deals have the same, if not better, terms. As economic tides shift,
documentation from the sponsor’s prior acquisition financing will be
the sponsors’ ability to leverage their large books of banking
used as a model for the new financing. Agreeing to use or be guided
business grows and wanes, and the favourability for sponsors of
by “sponsor precedent” limits the risk to the sponsor that the financing
acquisition financing terms shift as well.
will be delayed or not close because the lender and its counsel produce
Who drafts the commitment papers is one area where sponsors are a draft loan agreement with unexpected terms and provisions.
often treated more favourably than other borrowers. While lenders
in most cases want to draft commitment papers, the larger sponsors
are now regularly preparing their own forms of commitment papers Representations and Warranties
and requiring the lenders to use them. From the sponsors’
perspective, controlling the drafts can result in standardised Loan agreements typically require that the included representations
commitment letters across deals and a more efficient and quick and warranties be accurate as a condition of the funding. Lenders
process to finalise commitment letters. To get the best terms, the financing the acquisition also want the representations with respect
sponsors often simultaneously negotiate with separate potential to the target in the acquisition agreement to be accurate. This is
lenders and then award the lead role in an acquisition financing to reasonable because after consummation of the acquisition, the
the lender willing to accept the most sponsor-favourable terms. target is likely to be obligated on the loans (either as the borrower
or a guarantor) and thus part of the credit against which the lenders
are funding.
Conditionality “SunGard” (named for an acquisition financing that included these
terms) or “certain funds” provisions are now common in
The buyer’s need for certainty of funds to pay the purchase price
commitment letters for acquisition financings. These clauses are
puts sharp focus on the conditions that must be met before the
relevant to several provisions in a typical commitment letter. With
lenders are contractually obligated to fund the loans. As a result, a
respect to representations and warranties, these clauses provide that
buyer has a strong preference to limit the number of conditions
on the closing date of the loan, as a condition of the lenders’ funding
precedent in a commitment letter, and to make sure that the
obligations, only certain representations need to be accurate.
commitment letter is explicit as to the included conditions, in order
Strong sponsors even negotiate the precise meaning of the term
to lessen funding uncertainty. The buyer and seller want to avoid a
“accurate”. The representations required to be accurate as a
scenario where the conditions precedent to the buyer’s obligation to
condition of the lenders’ funding obligation in a typical SunGard
close the acquisition has been met but the lenders’ obligation to
clause include the following:
fund the loans has not. Particularly in the scenario where no
financing-out clause is included in the acquisition agreement, if the Only those representations in the acquisition agreement
acquisition financing falls through because the buyer cannot satisfy relating to the target that, were they untrue, would be
material to the lenders and for which the buyer has a right
the conditions in the commitment letter, the buyer may not be able
under the acquisition agreement to decline to close the
to close the acquisition and could be required to pay the seller acquisition must be accurate. While providing certainty of
sizable contractual breakup fees and be subject to lawsuits from the funding, this standard avoids a scenario where the loan
seller. Certain conditions discussed below are commonly subject to agreement has different representations with respect to the
heavy negotiation in an acquisition financing. target from the acquisition agreement.

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Only certain representations with respect to the borrower set either interest rate, fees or both) within pre-agreed limits or make
forth in the loan agreement must be accurate (the “specified other pre-agreed changes to the structure of the loans (such as call
representations”). These can include those with respect to protections, shorter maturities, etc.). While these changes provide
corporate existence, power and authority to enter into the some comfort to committed lenders in gradually deteriorating
financing, enforceability of the loan documents, margin financial markets, they may not be as helpful in a dramatic
regulations, no conflicts with law or other contracts,
downturn where there is little to no market for loans on any terms.
solvency, status of liens (but see below regarding this topic)
and certain anti-terrorism and money laundering laws. A Just after the financial crisis, not surprisingly, flex clauses often
financial covenant could also be included as a specified became broader in scope and gave lenders greater flexibility to
representation in some deals. What are included as specified change key terms of a financing. The types of provisions that can
representations change with changing economic conditions be subject to flex include interest margin, negative covenant
and relative bargaining strength of companies and sponsors. baskets, financial covenant ratios, the allocation of credit between
As financial markets have improved and the leverage of first lien, second lien and high yield bonds and the amount and type
sponsors has increased, the typical list of specified
of fees. As markets continue to improve, sponsors are using their
representations has shrunk and may well continue to weaken,
benefiting sponsors. leverage to limit flex provisions, including the financing terms
subject to the flex provisions, and to require greater limits on the
These are the only representations applicable as conditions scope of the changes that can be made without their consent.
precedent to the initial funding of the loans. Even if the other
representations in the loan agreement could not be truthfully made Some sponsors have even turned the tables on their lenders and
at the time of the initial funding, the lenders nonetheless are required “reverse flex” arrangements. These require the lenders to
contractually obligated to fund the loans. amend the financing terms under the commitment letters to be more
favourable to the borrower if syndication of the loans is so
successful that there are more potential lenders than available loans.
Company MAC
Perfection of Liens
Company material adverse change (MAC) is a type of
representation included in some acquisition agreements and loan
agreements. This is a representation that no material adverse As in all secured financings, lenders in an acquisition financing
change in the business of the target has occurred. Inability to make need evidence that their liens on the borrower’s assets are perfected
the representations in the acquisition agreement typically permits and enforceable, preferably as a condition precedent to the initial
the buyer to terminate the acquisition agreement and in the loan funding under the loan agreement. However, ensuring perfection of
agreement it excuses the lenders from their funding obligations. A the liens is often highly technical and can be a time-consuming
customary MAC definition in an acquisition agreement differs from process depending on the nature and location of the borrower’s
that in a loan agreement. Acquisition agreement MAC clauses are assets and the specific legal requirements for perfection. The
often more limited in scope and time frame covered, and have more technical nature of lien perfection raises the risk that lenders will
exceptions (including for general market and economic conditions withhold funding for the loans because insufficient steps were taken
impacting the target). Like other representations, buyers and sellers to perfect the liens, and in an acquisition financing timing and
often require that the MAC definition in loan agreements mirror the certainty are at a premium.
definition in acquisition agreements, but solely for purposes of the Typical SunGard provisions limit this risk by requiring delivery at
initial funding of the acquisition loans (and not for ongoing draws funding of only (i) Uniform Commercial Code financing statements
under a working capital revolver, for instance). which perfect a security interest in personal property that can be
perfected by filing, and (ii) original stock certificates for any
pledged shares. Perfecting a security interest in other asset classes
Market MAC and Flex
is required on a post-funding basis by a covenant detailing what
perfection steps are required. The sorts of collateral perfected on a
Market MAC is another type of MAC representation in some
post-closing basis can include real estate, deposit and securities
commitment letters. Seen more in economic down-cycles, these
accounts, intellectual property, foreign assets and other more
clauses allow the lenders to terminate their commitments if there
esoteric collateral requiring more complicated efforts.
has been a material adverse change in the loan and syndication
markets generally. Strong borrowers and sponsors have had success As financial markets continue to improve, sponsors are likely to
negotiating these clauses out of their commitment letters over the continue pushing lenders to increase the time frames to complete
last several years as the economy has continued to improve. post-closing collateral deliverables, give the administrative agent
greater flexibility to extend these time frames without lender
As discussed above, the time between signing the commitment
consent and limit efforts by lenders to increase the collateral
letter, on one hand, and closing the acquisition and funding the
deliverables required at closing.
loans, on the other, is often a significant period. Lenders whose
commitment letters do not have a market MAC, especially those
lenders who fully underwrite the commitments, are subject to The Acquisition Agreement Matters
deteriorating financial markets during the syndication of the
commitments and the risk that they will not be able to sell down the Delivery of the executed acquisition agreement is a condition
commitments to other lenders. “Flex” provisions limit this risk and precedent to the lenders’ obligation to fund the loans. As discussed in
allow for amendments to the terms of the financing without the more detail below, as a fallback, lenders sometimes accept a near final
borrower’s consent when necessary to allow the lenders arranging draft of the acquisition agreement, coupled with a covenant from the
the loan to sell down their commitments. buyer that there will be no material changes. The terms of the
acquisition agreement are important to lenders in a number of respects
If during syndication there is no market for the loans at a certain
beyond understanding the structure and business of the borrower after
price or with certain terms, the committed lenders are permitted to
consummation of the acquisition. Lenders also regularly require
exercise these flex clauses and increase the pricing (with respect to
inclusion of certain provisions in acquisition agreements.

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Structure of the Acquisition lenders’ concerns. Many terminated acquisitions result in

accusations of wrongdoing and bad faith by the parties. Litigation
The structure of the acquisition is important to the lenders as it will is not uncommon. Lenders want to make sure that any litigation
dictate a number of issues for the financing, including collateral brought by the seller does not look to the lenders for damages.
perfection, identity of the guarantors and borrowers and timing of the Xerox provisions (named for a financing with Xerox where these
acquisition (i.e., how long the lenders need to have their clauses were seen) give lenders this protection in the form of an
commitments outstanding). There are a number of common acknowledgment by the seller in the acquisition agreement that the
acquisition structures. While the specifics of those structures are seller’s sole remedy against the buyer and its lenders for
beyond the scope of this chapter, these include stock purchases (with termination of the acquisition is the breakup fee specified in the
or without a tender offer), mergers (including forward, forward acquisition agreement. If the acquisition terminates because the
triangular and reverse triangular mergers) and asset purchases. Each lenders fail to fund their commitments, the lenders may be subject
has its own unique structuring issues for the lenders. to a breach of contract suit brought by the buyer. But the lenders in
any termination scenario often seek to restrict suits brought against
Representations and Company MAC them by the seller. Conversely, the sellers’ focus on certainty of the
financing has caused some sellers to push back on inclusion of these
As described above, the lenders often rely on the representations provisions. Some sellers with strong leverage even negotiate for
and warranties in the acquisition agreement, including the the right to enforce remedies (or cause the buyer to enforce
definition of material adverse change, and incorporate those terms remedies) against the lenders under a commitment letter.
into the loan agreement. Since the lenders are not party to the acquisition agreement,
applicable law creates hurdles for the lenders to enforce the Xerox
provisions. To address these hurdles, lenders seek to be expressly
Obligation to Continue Operating
named as third-party beneficiaries of the Xerox provisions. In the
event the lenders have claims against the seller for breach of the
Lenders often review whether the seller is contractually obligated in
Xerox provisions, lenders will have customary concerns about the
the acquisition agreement to continue operating the business in the
venue and forum of any claims brought by the lenders under the
ordinary course and not to make material changes to the business.
acquisition agreement. Like in loan agreements, lenders often seek
Again, the target is a part of the lenders’ credit and the lenders do
to have New York as the exclusive location for these suits and seek
not want to discover after consummation of the acquisition that the
jury trial waivers in the acquisition agreement.
target has been restructured in a way that results in its business
being different from the lenders’ understanding.
Efforts to Obtain the Financing
Indemnity
Lenders will consider provisions in the acquisition agreement
regarding the buyer’s obligations to obtain financing. Typically,
Lenders also typically consider the indemnities provided by the seller
buyers agree to use “reasonable best efforts” or “commercially
in the acquisition agreement. If, after the acquisition is consummated,
reasonable efforts” to obtain the financing in the commitment letter.
it is discovered that the seller made a misrepresentation or, worse,
These provisions may include a requirement to maintain the
committed fraud or other wrongdoing as part of the acquisition, those
commitment letter, not to permit any modification to the terms of
indemnities could affect the buyer’s ability to recover against the
commitment letter without the seller’s consent (with some
seller. If the misrepresentation or wrongdoing results in the lenders
exceptions), to give notice to the seller upon the occurrence of
foreclosing on the assets of the borrower, the indemnities could be
certain events under the commitment letter, and obtain alternative
inherited by the lenders if the rights of the borrower under the
financing, if necessary. As noted above, acquisition agreements
acquisition agreement are part of the collateral. Acquisition
may also contain provisions obligating the buyer to enforce its
agreements typically contain anti-assignment and transfer provisions.
rights against the lender under the commitment letter, or even
It is important that those provisions expressly permit the lenders to
pursue litigation against the lender. Buyers with strong leverage
take a lien on the acquisition agreement.
will want to limit provisions in the acquisition agreement requiring
specific actions against the lenders.
Purchase Price Adjustments and Earn-Outs
Cooperation with the Financing
Any payments to be made to the seller by the buyer after
consummation of the acquisition are important to the lenders.
As discussed above, the lenders have an interest in understanding
Many loan agreements define these payments, whether based on
the acquisition and the nature of the target’s business. Further, the
performance of the target or other factors, as debt and their payment
conditions precedent will require deliverables from the target and
needs to be specifically permitted by the loan agreement. Beyond
the lenders’ regulatory, credit and legal requirements demand that
technically drafting the loan agreement to permit payment of these
they receive certain diligence information about the target and its
amounts, these payments should be viewed as assets of the buyer
business. None of this can be accomplished if the seller does not
that are not available to the lenders to repay the loans and this may
agree to assist the buyer and its lenders. Lenders often require that
impact the credit review of the loan facility.
the acquisition agreement include a clause that the seller will
cooperate with the lenders’ diligence and other requirements
Xerox Provisions relating to the acquisition financing.

When a proposed acquisition terminates, the commitment letters for

Amendments to the Acquisition Agreement
the acquisition financing typically state that the lenders’
commitments also terminate. That is not always the end of the
Lenders usually have the opportunity to review the acquisition

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Morrison & Foerster LLP Acquisition Financing in the United States

agreement, or at least a near final version, prior to executing their consent rights for any material change in the acquisition agreement.
commitment letters. The buyer and seller will want the lenders to Lenders often seek to negotiate express provisions that would be
acknowledge that the final agreement or draft is acceptable. The deemed material or adverse, including some of the above clauses
lenders, on the other hand, will want to receive notice of any that were included in the acquisition agreement at the requirement
amendments to the acquisition agreement and ensure they do not of the lenders. Some lenders with strong negotiating leverage even
adversely impact the financing. To avoid the lenders’ refusal to negotiate for a clause in the acquisition agreement that any
fund the loans because of an amendment to the acquisition amendments will require the lenders’ consent.
agreement, buyers and sellers are often careful to ensure that no
amendments to the acquisition agreement will be required. Some
amendments are unavoidable and commitment letters often contain Conclusion
express provisions as to the nature of those amendments that need
Leveraged acquisitions in the United States raise unique structuring
lender approval. If lender approval is not needed, then the lenders
issues and techniques, only some of which are discussed here. As
cannot use the amendment as a reason to refuse funding.
global financial markets continue to improve, expect to see greater
Negotiations of the “no-amendment” condition focus on the volumes of acquisition financings and sponsors exercising greater
materiality of the amendments and whether the change has to be leverage over their lenders to loosen acquisition financing terms.
adverse or materially adverse, with some lenders negotiating

Geoffrey R. Peck Mark S. Wojciechowski

Morrison & Foerster LLP Morrison & Foerster LLP
250 West 55th Street 250 West 55th Street
New York, NY 10019-5201 New York, NY 10019-5201
USA USA

Tel: +1 212 336 4183 Tel: +1 212 468 8079

Fax: +1 212 468 7900 Fax: +1 212 468 7900
Email: [email protected] Email: [email protected]
URL: www.mofo.com URL: www.mofo.com

Geoffrey Peck is a Partner in Morrison & Foerster’s New York Mark Wojciechowski is a partner at Morrison & Foerster LLP. Mr.
office. Mr. Peck specialises in financial transactions and Wojciechowski focuses on leveraged and acquisition finance,
restructurings, representing banks, funds, issuers and borrowers mergers and acquisitions and hybrid transactions involving
in a broad spectrum of financings, including syndicated and structured debt and equity investments. His clients include major
asset-based loans, acquisition, subscription-backed, debtor-in foreign and domestic commercial banks and investment banks,
possession, mezzanine, structured commodity and project as well as public and private corporations and investment funds.
financings, and secondary market trading. His practice is both Mr. Wojciechowski routinely advises these clients on both
domestic and cross-border. Mr. Peck received his B.A. and B.S. transactional and regulatory matters. Mr. Wojciechowski is
from Boston University and his J.D. from the University of recognised as a leading lawyer by Chambers USA 2013 for
Pennsylvania. excellence in the field of M&A/Corporate work.

Morrison & Foerster is a global firm of exceptional credentials and clients, including some of the most successful financial
institutions, asset managers, investment funds and companies. With over 1,000 lawyers in 17 offices in the world’s key financial
and business centres, MoFo handles some of the world’s largest and most complex domestic and cross-border financial,
restructuring, acquisition and corporate transactions. MoFo is committed to provide the best customer service to our clients, while
providing innovative and business-minded results. Chambers Global named MoFo its 2013 USA Law Firm of the Year. Visit us
at www.mofo.com.

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 Chapter 10

A Comparative Overview
of Transatlantic Lauren Hanrahan

Intercreditor Agreements
Milbank, Tweed, Hadley & McCloy LLP Suhrud Mehta

Introduction mezzanine financings are always second lien secured financings

(unlike in the U.S. where “mezzanine financing” often connotes a
Intercreditor terms, or at least the accepted frameworks applicable senior unsecured or senior subordinated financing). Although first
to a given financing structure in a particular market, are often fairly lien/second lien financings and senior/mezzanine financings are
settled, but where cultures collide, for example, in a U.S. syndicated very similar, as highlighted above, the key terms of U.S. second lien
bank loan financing for European borrowers, or other financings and European mezzanine intercreditors have been constructed
involving practitioners and business people in different parts of the based on very different assumptions which therefore results in
world, deal parties may have very different expectations as to the significant differences.
key intercreditor terms that ought to apply.
European mezzanine intercreditor agreements typically combine
In this article, we will compare and contrast the key terms in U.S. claim subordination, payment blockages, lien subordination, broad
second lien and European mezzanine intercreditors and discuss the enforcement standstill provisions restricting the junior lien
blended approach taken in some recent intercreditor agreements for creditors’ ability to take enforcement action (on debt and guarantee
financings of European companies in the U.S. syndicated bank loan
claims as well as collateral) and extensive release mechanics. U.S.
markets. Similar dynamics may also be involved when documenting
second lien intercreditors establish lien subordination, which
intercreditor agreements involving other non-U.S. jurisdictions, but
regulates the rights of the U.S. second lien creditors with respect to
for ease of reference we will refer to these intercreditor agreements as
collateral only, and includes an enforcement standstill with respect
“Transatlantic Intercreditor Agreements”.
to actions against collateral only. U.S. second lien intercreditors do
not generally include payment subordination of the junior facility
Assumptions and they rely heavily on waivers of the junior lien creditors’ rights
as secured creditors under Chapter 11.
U.S. second lien intercreditors are predicated on two key
assumptions: first, that the business will be reorganised pursuant to Within regions, the forms of intercreditor agreement can vary
Chapter 11 of the United States Bankruptcy Code (Chapter 11); and significantly. European mezzanine intercreditors are often based on
second, that the first lien lenders will receive the benefits of a the form promulgated by the Loan Market Association (the
comprehensive guarantee and collateral package (including shares, “LMA”), but are negotiated on a deal-by-deal basis. By contrast,
cash, receivables and tangible assets) pursuant to secured there is no market standard first lien/second lien intercreditor
transactions laws that effectively provide creditors with the ability agreement in the U.S. (The Commercial Finance Committee of the
to take a security interest in “all assets” of the borrower and American Bar Association did publish a model form of intercreditor
guarantors. European mezzanine intercreditors, in contrast, assume agreement in 2010, but it is not widely used.) As discussed below,
that (i) in all likelihood, not all assets of the borrower and recent intercreditors for financings of European companies in the
guarantors will be subject to the liens of the first lien and second U.S. syndicated bank loan markets vary even more significantly.
lien secured parties, and (ii) it is unlikely that the borrower and
guarantors will be reorganised in an orderly court-approved process
and more likely, since there is no pan-European insolvency regime Key Terms of U.S. Second Lien Intercreditor
(and so there is not a pan-European automatic stay on enforcement Agreements and European Mezzanine
of claims), the intercreditor terms will have to work in the context Intercreditor Agreements
of potentially multiple and disparate insolvency proceedings (and
ideally avoid insolvency proceedings altogether). As a result one of
the key goals that European mezzanine intercreditors seek to 1. Parties to the Intercreditor Agreement
facilitate instead is a swift out-of-court, out-of-bankruptcy,
enforcement sale (or “pre-pack”) resulting in a financial U.S. second lien intercreditors are generally executed by the first lien
restructuring where “out of the money” junior creditors’ claims are agent and the second lien agent and executed or acknowledged by the
removed from the financing structure by releasing or disposing of borrower and, sometimes, the guarantors. Depending on the
the liens and guarantees of the “out of the money” junior creditors. flexibility negotiated by the borrower in the first lien credit agreement
and second lien credit agreement, the intercreditor agreement may
Overview also allow for other future classes of first lien and second lien debt
permitted by the credit agreements to accede to the intercreditor
The first lien/second lien relationship in the U.S. most closely agreement. U.S. second lien intercreditors also typically allow for
resembles the senior/mezzanine relationship in Europe, where refinancings of the first lien and second lien debt.

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Milbank, Tweed, Hadley & McCloy LLP Transatlantic Intercreditor Agreements

By contrast, the parties to European mezzanine intercreditors The collateral agent under European mezzanine intercreditors,
generally include a longer list of signatories. In addition to the first however, takes instructions from 66 2/3% of the sum of (i) the
lien agent and lenders, the second lien agent and lenders and the drawn and undrawn amounts under the senior credit agreement, and
obligors, the obligors’ hedge providers, cash management (ii) any actual exposure (plus any mark to market value if the senior
providers, ancillary facility lenders, the lenders of intra-group credit agreement has been discharged) under any outstanding
loans, the lenders of shareholder loans and the security agent will hedging arrangements.
execute a European-style intercreditor agreement. The longer list of b. Enforcement Standstill Periods
parties to European mezzanine intercreditors is largely driven by
U.S. second lien financings involve lien subordination as opposed
the senior creditors’ need to ensure that after giving effect to the
to payment (also referred to as debt or claim) subordination. The
senior lenders’ enforcement, the borrower group is free and clear of
result of lien subordination is that only the proceeds of shared
all claims (both secured and unsecured) against the borrower and
guarantors and a desire to ensure that any enforcement action by collateral subject to the liens for the benefit of both the first lien
creditors is choreographed in a manner which maximises recoveries secured parties and second lien secured parties are applied to
for the senior secured creditors (and thus indirectly for all repayment in full of the first lien obligations before the second lien
creditors). European mezzanine intercreditors do not typically secured parties may receive any distribution on the proceeds of the
expressly permit refinancings and traditionally did not include shared collateral, but the second lien secured parties may receive
additional classes of first lien or second lien debt. (The LMA form other payments (such as payments of principal and interest and
of senior/mezzanine intercreditor agreement now includes a payments from other sources, e.g., unencumbered property) prior to
concept of “Qualifying Senior Facilities Refinancings”, but this the first lien obligations being paid in full. In the context of U.S.
option in the form is not currently selected frequently because its obligors, in practice, it is unlikely that there would be substantial
utility is limited by the mezzanine facility’s maturity date, typically property that is unencumbered since the security granted would
expiring 12 months after the maturity date of the senior credit likely pick up most assets – in contrast to certain European obligors
facilities. This maturity date effectively limits the maturity date of whose unencumbered assets may be significant due to local law
the new senior credit facilities, thereby necessitating the consent of limitations.
the mezzanine creditors to refinance the senior facility.) Payment subordination requires the junior lien creditors to turnover
Hedge obligations are generally included as first lien obligations to the first lien secured parties all proceeds of enforcement received
(and sometimes also as second lien obligations) under U.S. second from any source (including the proceeds of any unencumbered
lien intercreditors, but hedge counterparties are not directly party to property) until the first lien obligations are paid in full.
U.S. second lien intercreditors. By accepting the benefits of the Consequently, the difference in recoveries between lien
first priority lien of the first lien agent, the hedge counterparties subordination and payment subordination could be significant in a
receive the benefits of the first priority lien granted to the first lien financing where material assets are left unencumbered, as is likely
agent on behalf of all first lien secured parties (including the hedge in a financing in which much of the credit support is outside of the
counterparties) and the hedge counterparties are deemed to agree U.S.
that the first lien security interests are regulated by the intercreditor U.S. second lien intercreditors prevent the second lien agent from
agreement and other loan documents. The hedge counterparties exercising any of its rights or remedies with respect to the shared
under U.S. second lien intercreditors in syndicated bank financings collateral until expiration of the period ending 90 to 180 days after
generally do not have the ability to direct enforcement actions and notice delivered by the second lien agent to the first lien agent after
do not have the right to vote their outstanding claims (including any a second lien event of default or, in some cases, if earlier, second
votes in respect of enforcement decisions). lien acceleration. The standstill period becomes permanent to the
Cash management obligations (e.g., treasury, depository, overdraft, extent the first lien agent is diligently pursuing in good faith an
credit or debit card, electronic funds transfer and other cash enforcement action against a material portion of the shared
management arrangements) are often included as first lien collateral. An exercise of collateral remedies generally includes
obligations under U.S. second lien intercreditors on terms similar to any action (including commencing legal proceedings) to foreclose
the terms relating to the hedge obligations. By contrast, European on the lien of such person in any shared collateral, to take
mezzanine intercreditors do not typically expressly contemplate possession of or sell any shared collateral or to exercise any right of
cash management obligations. In European financings, the cash setoff with respect to any shared collateral, but the acceleration of
management providers would typically provide the cash credit facility obligations is generally not an exercise of collateral
management services through ancillary facilities – bilateral remedies.
facilities provided by a lender in place of all or part of that lender’s
European mezzanine intercreditors typically contain a much
unutilised revolving facility commitment. Ancillary facilities are
broader enforcement standstill provision than the U.S. second lien
not a common feature of U.S. credit facilities. The lenders of the
intercreditors. The scope of the enforcement actions is negotiated,
ancillary facilities would generally become direct signatories of a
European mezzanine intercreditor. but typically prohibits any acceleration of the second lien debt, any
enforcement of payment of, or action to collect, the second lien
debt, and any commencement or joining in with others to
2. Enforcement commence any insolvency proceeding, any commencement by the
second lien agent or second lien creditors of any judicial
a. Enforcement Instructions enforcement of any of the rights and remedies, whether as a secured
The first lien agent under U.S. second lien intercreditors takes or unsecured creditor, under the second lien documents or
instructions from a majority of the loans and unfunded applicable law. The enforcement standstill period typically runs for
commitments under the senior credit agreement, which follows the (i) a period of 90 days (in most cases) following notice of payment
standard formulation of required lenders in U.S. senior credit default under the senior credit agreement, (ii) a period of 120 days
agreements. (Note, however, that the vote required to confirm a (in most cases) following notice of financial covenant default under
plan of reorganisation in a Chapter 11 proceeding is a higher the senior credit agreement, and (iii) a period of 150 days (in most
threshold – at least two-thirds in amount and more than one-half in cases) following notice of any other event of default under the
number of the claims voting on the plan.) senior credit agreement, plus (in some cases) 120 days if the senior

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lien agent is taking enforcement action. In European mezzanine connection with enforcement by the senior creditors (or a
intercreditors, the senior creditors firmly control enforcement. In “distressed disposal”), the junior security and debt and guarantee
addition, the senior agent can override the junior agent’s claims can be released (or disposed of) subject to negotiated
instructions to the security agent, leaving the mezzanine lenders conditions. Market practice continues to evolve but the fair sale
only able to influence the timing of enforcement action after the provisions are increasingly common, i.e., public auction/sale
standstill period. process or independent fair value opinion. The LMA form
Because the enforcement standstill in U.S. second lien intercreditor agreement requires the security agent to take
intercreditors is limited to enforcement against shared collateral, reasonable care to obtain a fair market price/value and permits the
U.S. second lien lenders, unlike their European counterparts, retain sale of group entities and release of debt and guarantee claims, plus
during the standstill period the right to accelerate their second lien the sale of mezzanine debt claims. Recent changes to the LMA
loans and to demand payment from the borrower and guarantors. intercreditor agreement provide that the security agent’s duties will
However, in the event any second lien agent or any other second be discharged when (although this list is not exhaustive): (i) the sale
lien creditor becomes a judgment lien creditor in respect of the is made under the direction/control of an insolvency officer; (ii) the
shared collateral as a result of enforcement of its rights as an sale is made pursuant to an auction/competitive sales process
unsecured creditor (such as the ability to sue for payment), the (which does not exclude mezzanine creditors from participating
judgment lien would typically be subordinated to the liens securing unless adverse to the sales process); (iii) the sale is made as part of
the first lien obligations on the same basis as the other liens a court supervised/approved process; or (iv) a “fairness opinion”
securing the second lien obligations under the U.S. second lien has been obtained. Any additional parameters/conditions to the
intercreditor agreement. This judgment lien provision effectively above will be hotly negotiated, particularly in deals where specialist
limits the effectiveness of the junior lien creditors’ efforts to sue for mezzanine funds are anchoring the mezzanine facility. Typical
payment, since the junior lien creditors ultimately will not be able points for discussion will be: (i) the circumstances in
to enforce against shared collateral, although the junior lien which/whether the senior creditors can instruct a sale in reliance on
creditors could still obtain rights against any previously a fair sale opinion rather than a public auction; (ii) terms of any
unencumbered assets of the borrower and guarantors. public auction (i.e. how conducted, on whose advice, who can
participate, who can credit bid); (iii) any cash requirements; and
(iv) any information/consultation rights.
3. Payment Blockages
In addition to the release provisions, European mezzanine
intercreditors typically allow (subject to the fair sale provisions
U.S. second lien intercreditors do not generally subordinate the
discussed above) the security agent to transfer the junior lien debt,
junior lien obligations in right of payment to the first lien
intragroup liabilities and/or shareholder loans to the purchasers of
obligations.
the assets in an enforcement situation. The disposal of liabilities
European mezzanine intercreditors do subordinate the junior lien option will be, in many cases, more tax efficient than cancelling the
obligations in right of payment to the senior lien obligations and subordinated debt in connection with enforcement.
include a payment blockage period that is typically permanent
Many of these conditions with respect to sales of collateral are
during a payment default under the senior credit agreement and 120
absent in U.S. second lien intercreditors because meaningful
days during each year during any other event of default under the
protections are afforded by the Uniform Commercial Code
senior credit agreement. The mezzanine creditors may negotiate for
requirement for a sale of collateral to be made in a commercially
exceptions to the payment blockage periods, e.g., payment of a pre-
reasonable manner and, in the case of a 363 sale process, by a court-
agreed amount of expenses related to the restructuring or a
approved sale in Chapter 11, as discussed more fully below.
valuation of the borrower group (other than expenses related to
disputing any aspect of a distressed disposal or sale of liabilities). In addition, the release provisions in U.S. second lien intercreditors
In addition, separate payment blockage rules typically apply to are also premised on the first lien and second lien security interests
hedge obligations, shareholder loan obligations and intragroup being separately held by the first lien collateral agent and the
liabilities in European mezzanine intercreditors. second lien collateral agent and documented in separate, but
substantially similar, documents that are meant to cover identical
pools of collateral. In European mezzanine intercreditors, the
4. Releases of Collateral and Guarantees release provisions assume that one set of security interests are held
by one security agent on behalf of all of the creditors (senior and
In order to ensure that the junior lien creditors cannot interfere with mezzanine).
a sale of the shared collateral, both U.S. second lien intercreditors
and European mezzanine intercreditors contain release provisions
in which the junior lenders agree that their lien on any shared 5. Limitation on First Lien Obligations
collateral is automatically released if the first lien creditors release
their lien in connection with a disposition permitted under both the U.S. second lien financings include a “first lien debt cap” to limit
first lien credit agreement and the second lien credit agreement and, the amount of first lien obligations that will be senior to the second
more importantly, in connection with enforcement by the first lien lien obligations. The analogous provision in European mezzanine
creditors. intercreditors is referred to as “senior headroom”. Any amounts
that exceed the “first lien debt cap” or “senior headroom” do not
While important in U.S. second lien intercreditors, the release
benefit from the lien priority provisions in the intercreditor
provisions are arguably the most important provision of European
agreement. The “cushion” under the first lien debt cap or
mezzanine intercreditors.
“headroom” is meant to allow for additional cash needs of the
U.S. second lien and European intercreditors permit, in the ordinary borrower group as part of a loan workout or otherwise.
course, the guarantees and collateral to be released in respect of any
The “first lien debt cap” in U.S. second lien financings is typically
asset or any member of the group if the asset sale is permitted under
110% to 120% of the principal amount of loans and commitments
both the first lien credit agreement and second lien credit
under the first lien facilities on the closing date plus 100% to 120%
agreement. However, under European intercreditor agreements, in

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Milbank, Tweed, Hadley & McCloy LLP Transatlantic Intercreditor Agreements

of the principal amount of any incremental facilities permitted vary. The trigger events generally include acceleration of the first
under the first lien credit agreement on the closing date. The first lien obligations in accordance with the first lien credit agreement
lien debt cap is sometimes reduced by the amounts of certain and the commencement of an insolvency proceeding. Other
reductions to the first lien commitments and funded loans (other potential trigger events include any payment default under the first
than refinancings), e.g., mandatory prepayments. The first lien debt lien credit agreement that remains uncured or not waived for a
cap does not apply to hedging obligations and cash management period of time and a release of liens in connection with enforcement
obligations, which are generally included as first lien priority on common collateral. The triggering event for the European
obligations without limitation. In addition, interest, fees, expenses, version of the purchase option also varies and may include
premiums and other amounts related to the principal amount of the acceleration/enforcement by the senior, the imposition of a
first lien obligations permitted by the first lien debt cap are first lien standstill period on mezzanine enforcement action or the imposition
priority obligations, but are generally not limited by the cap itself. of a payment block.
The trend in U.S. second lien financings is to allow for larger “first
lien debt caps”; some borrower-friendly U.S. second lien financings
8. Common U.S. Bankruptcy Waivers
even allow for unlimited first lien obligations (subject of course to
any covenants restricting debt in the applicable credit agreements
First lien secured parties in the U.S. try to ensure that the first lien
and other debt documents, including the second lien credit
secured parties control the course of the Chapter 11 proceeding to
agreement). Additional capacity is often also permitted in the case
the maximum extent possible by seeking advanced waivers from
of DIP financings in the U.S. (as discussed below).
the second lien secured parties of their bankruptcy rights as secured
“Senior headroom” is typically set at 110% of senior term debt plus creditors (and in some cases, unsecured creditors) that effectively
revolving commitments in European mezzanine intercreditors. render the second lien secured parties “silent seconds”. These
Ancillary facilities that would be provided in European deals in lieu waivers are often hotly negotiated. However, U.S. second lien
of external cash management arrangements would be naturally intercreditors routinely contain waivers from the second lien
limited by the amount of the revolving commitments since they are secured parties of rights to object during the course of a Chapter 11
made available by revolving credit facility lenders in place of their proceeding to a debtor-in-possession facility (or “DIP facility”), a
revolving commitments. Hedging obligations can be limited (by sale by the debtor of its assets free of liens and liabilities outside of
imposing maximum limits on the notional amounts hedged under the ordinary course of business during Chapter 11 proceedings, with
the hedging transactions entered into) or otherwise can be left the approval of the bankruptcy court (a section 363 sale) and relief
unlimited but naturally constrained to a degree by the fact that most from the automatic stay, which automatically stops substantially all
credit agreements will restrict the borrower group from doing acts and proceedings against the debtor and its property
speculative trades. immediately upon filing of the bankruptcy petition.
The enforceability of the non-subordination related provisions in
6. Amendment Restrictions U.S. second lien intercreditors is uncertain because there is little
(and conflicting) case law in this area. However, subordination-
In both U.S. second lien intercreditors and European mezzanine related provisions are regularly enforced by U.S. bankruptcy courts
intercreditors, first lien lenders and second lien lenders typically to the same extent that they are enforceable under applicable non-
specify in the intercreditor agreement the extent to which certain bankruptcy law pursuant to section 510(a) of the Bankruptcy Code.
terms of the first lien credit agreement and second lien credit The second lien creditors in U.S. second lien intercreditors provide
agreement cannot be amended without the other lien’s consent. their advanced consent to DIP facilities whereby, subject to certain
Amendment restrictions are negotiated on a deal-by-deal basis and conditions, the second lien creditors agree not to object to the
may include limitations on increasing pricing, limitations on borrower or any other obligor obtaining financing (including on a
modifications of maturity date and additions of events of default priming basis) after the commencement of a Chapter 11 process,
and covenants. The trend in U.S. second lien intercreditors, in whether from the first lien creditors or any other third party
particular in financings of borrowers owned by private equity financing source, if the first lien agent desires to permit such
sponsors, is for few (or no) amendment restrictions; the inclusion of financing (or to permit the use of cash collateral on which the first
amendment restrictions in European intercreditors is reasonably lien agent or any other creditor of the borrower or any other obligor
well-settled at this point. has a lien).
In the U.S., second lien claimholders expressly reserve the right to
7. Purchase Options exercise rights and remedies as unsecured creditors against any
borrower or guarantor in accordance with the terms of the second
Both U.S. second lien intercreditors and European mezzanine lien credit documents and applicable law, except as would
intercreditors contain similar provisions whereby the second lien otherwise be in contravention of, or inconsistent with, the express
creditors can purchase the first lien obligations in full at par, plus terms of the intercreditor agreement. This type of provision, for the
accrued interest, unpaid fees, expenses and other amounts owing to reasons articulated above, does not have a counterpart in European
the first lien lenders at the time of the purchase. A purchase option mezzanine intercreditors.
gives the second lien creditors a viable alternative to sitting aside
during an enforcement action controlled by the first lien creditors
9. Non-cash Consideration / Credit Bidding
by allowing the second lien creditors to purchase the first lien
obligations in full and thereby enabling the second lien creditors to
Recent changes to the LMA intercreditor agreement include explicit
control the enforcement proceedings themselves.
provisions dealing with the application of non-cash consideration
The European version of the purchase option includes a buyout of (or “credit bidding”) during the enforcement of security. Credit
the hedging obligations, which may or may not be included (or bidding facilitates debt-for-equity exchanges by allowing the
clearly included) in U.S. second lien intercreditors. security agent, at the instruction of the senior creditors, to distribute
The triggering events for the purchase option in U.S. intercreditors equity to senior creditors as payment of the senior debt or to

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 Milbank, Tweed, Hadley & McCloy LLP Transatlantic Intercreditor Agreements

consummate a pre-pack where the senior debt is rolled into a newco documented using the opposite approach – by using a form of
vehicle. intercreditor agreement based on the LMA form of
In the U.S., the term “credit bidding” refers to the right of a secured senior/mezzanine intercreditor agreement; and still other similar
creditor to offset, or bid, its secured allowed claim against the financings have sought to blend the two approaches or to draft the
purchase price in a sale of its collateral under section 363(b) of the intercreditor agreement in the alternative by providing for different
Bankruptcy Code, thereby allowing a secured creditor to acquire terms (in particular different release provisions) depending on
the assets that are subject to its lien in exchange for a full or partial whether a U.S. or non-U.S. restructuring will be pursued. Given all
cancellation of the debt. In U.S. second lien intercreditors, the of these various considerations, Transatlantic Intercreditor
second lien creditors consent to a sale or other disposition of any Agreements are often quite à la carte. We have highlighted below
shared collateral free and clear of their liens or other claims under some of the more interesting points:
section 363 of the Bankruptcy Code if the first lien creditors have the parties typically have included the holders of intra-group
consented to such sale or disposition of such assets. However, the liabilities and shareholder loans, following the European
second lien creditors often also expressly retain the ability to credit approach, and have embedded restrictions on payment of the
bid their second lien debt for the assets of the borrower and intra-group liabilities and shareholder loans in certain
circumstances;
guarantors so long as the sale proceeds are used to repay the first
lien obligations in full. In European intercreditor agreements, the the enforcement instructions typically have come from a
second lien creditors would not typically have the right to credit bid majority of first lien creditors (vs 66 2/3%) in the U.S.-style
but the loans and unfunded commitments under the senior
their second lien debt.
credit agreement and the actual exposures of hedge
counterparties (plus mark to market positions post-credit
10. The Holders of Shareholder Obligations and agreement discharge) have been taken into account in
Intragoup Obligations calculating that majority in the European-style;
the European-style release provisions discussed above
In addition to direct equity contributions, shareholder loans are generally have been included either as the primary method of
often used in European capital structures. Shareholder loans are release or as an alternative method in the event that a U.S.
less common in U.S. capital structures and if present in the capital bankruptcy process is not pursued;
structure, shareholder loans would likely be subordinated to the in certain deals, enforcement standstill and turnover
credit agreement obligations under a separately documented provisions have been extended to cover all enforcement
subordination agreement (i.e., not included as part of the typical actions and recoveries (broadly defined), not just relating to
collateral enforcement actions;
U.S. second lien intercreditor agreement). Similarly, holders of
intragroup liabilities would also not be included in U.S. second lien payment subordination of the second lien facility typically
intercreditor agreements. However, the treatment of intragroup has not been included; and
liabilities is often negotiated by the borrower and arrangers in U.S. the full suite of U.S. bankruptcy waivers from the second lien
syndicated credit agreements and results differ, but often the creditors generally have been included.
intragroup liabilities are required to be documented by an In addition, other provisions appear in Transatlantic Intercreditor
intercompany note and subject to an intercompany subordination Agreements that will not be familiar to those accustomed to the
agreement. The intercompany subordination agreement would typical U.S. second lien intercreditors, such as parallel debt
subordinate the intragroup liabilities to be paid by the loan parties provisions (a construct necessary in certain non-U.S. jurisdictions
to the credit facility obligations and would generally include a in which a security interest cannot be easily granted to a fluctuating
payment blockage of amounts to be paid by each intragroup payor group of lenders), agency provisions for the benefit of the security
that is a borrower or guarantor under the credit facilities during the agent and special provisions necessitated by specific local laws to
continuation of an event of default. be encountered (or avoided) during the enforcement process (e.g.,
French sauvegarde provisions and compliance with U.S. FATCA
regulations).
Blended Approach Taken in Recent Transatlantic
Intercreditor Agreements
Conclusion
Recent intercreditor agreements for financings involving primarily
non-U.S. companies in U.S. syndicated bank loan financings, and As the number of financings that touch both sides of the Atlantic
using NY-law governed loan documents, have taken different continues to rise and the complexity of such financings increases,
approaches to the intercreditor terms, which seem to be determined the intercreditor arrangements for multi-jurisdictional financings
on a deal-by-deal basis depending on several considerations: (1) will continue to be important and interesting. Although trends are
the portion of the borrower group’s business located in the U.S.; (2) emerging, it is too soon to say that there is a standard or uniform
the jurisdiction of the organisation of the borrower; (3) the approach to documenting such intercreditor terms. Indeed, as was
likelihood of the borrower group filing for U.S. bankruptcy the case with European mezzanine intercreditor agreements, this is
protection; and (4) the relative negotiation strength of the junior unlikely to occur until the new forms of Transatlantic Intercreditor
lien creditors and the borrower, who will be inclined to favour Agreement are stress tested in cross-border restructurings – which,
future flexibility and lower upfront legal costs. For these and other thankfully, seem a remote prospect at present.
reasons, seemingly similar financings have taken very different For further information, please contact Lauren Hanrahan by email
approaches. Some intercreditor agreements ignore the complexities at [email protected] or by telephone at +1 212 530 5339 or
of restructuring outside of the U.S. and simply use a U.S.-style Suhrud Mehta by email at [email protected] or by telephone at
intercreditor agreement; other similar financings have been +44 20 7615 3046.

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Milbank, Tweed, Hadley & McCloy LLP Transatlantic Intercreditor Agreements

Lauren Hanrahan Suhrud Mehta

Milbank, Tweed, Hadley & McCloy LLP Milbank, Tweed, Hadley & McCloy LLP
1 Chase Manhattan Plaza 10 Gresham Street
New York, NY 10005 London, EC2V 7JD
USA United Kingdom

Tel: +1 212 530 5339 Tel: +44 20 7615 3046

Fax: +1 212 822 5339 Fax: +44 20 7615 3100
Email: [email protected] Email: [email protected]
URL: www.milbank.com URL: www.milbank.com

Lauren Hanrahan is a partner in the New York office of Milbank, Suhrud Mehta is a partner in the London office, leads the firm’s
Tweed, Hadley & McCloy and a member of the firm’s Leveraged European Leveraged Finance Group and is also a member of the
Finance Group. A partner since 2010, Ms. Hanrahan’s practice Financial Restructuring Group. Suhrud focuses mainly on
focuses on representing banks and other financial institutions in leveraged finance and restructuring transactions. He has advised
senior lending transactions. She has significant experience in on some of the most significant cross-border, public to private,
representing lenders in acquisition financings, including leveraged, infrastructure and investment grade financings in the
leveraged buyouts, tender offers and other going private London/European market. His leveraged and restructuring
transactions, recapitalisations, bridge and mezzanine financings, expertise focuses on multi-tiered capital structures: bank and
debtor-in-possession and exit facilities and special situation bond and bank and mezzanine, in particular. Suhrud has been
financings. She has a broad range of financing experience in recognised as a leader in his field by a number of journals, among
both US and international transactions. She also devotes a them: Chambers UK (which designated him among the 1st tier of
portion of her practice to acting as agents’ counsel or lead banking lawyers in London), Chambers Global, Legal 500, Who’s
investors’ counsel in connection with amending and restructuring Who Legal, Super Lawyers and Legal Business (where he was
troubled loans and negotiating workouts. Recognised as a named as one of the leading finance lawyers/rainmakers in
leading lawyer for bank lending and finance in Legal 500 & IFLR, London). He is the author of a number of articles published in the
Ms. Hanrahan has handled major transactions for financial International Financial Law Review and regularly speaks at
institutions such as Goldman Sachs, Credit Suisse, UBS AG, The conferences.
Royal Bank of Scotland plc, Canadian Imperial Bank of
Commerce and various hedge funds.

Milbank, Tweed, Hadley & McCloy LLP is a leading international law firm providing innovative legal solutions to clients throughout
the world for more than 140 years. Milbank is headquartered in New York and has offices in Beijing, Frankfurt, Hong Kong,
London, Los Angeles, Munich, São Paulo, Singapore, Tokyo and Washington, DC.
With one of the largest and most experienced teams in this field, Milbank’s Banking and Leveraged Finance group assists clients
on some of the most advanced and complicated leveraged finance transactions in the world. They represent underwriters, lenders,
private equity sponsors, strategic investors, issuers and borrowers on a broad array of financings, including:
First and second lien loans, bridge loans, secured and unsecured high-yield bonds and mezzanine financing.
Leveraged buyouts, other acquisition financings, leveraged recapitalisations and going-private transactions.
Working capital and letter of credit facilities.
Financings for investment-grade and sub-investment-grade borrowers.
Debtor-in-possession financings and exit financings.
Restructurings.
Vendor financings.
Structured financings.
Asset-based lending and securitisation.

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 Chapter 11

Oil and Gas

Reserve-Based Lending Robert Rabalais

Simpson Thacher & Bartlett LLP Matthew Einbinder

Relative to other major industries, the oil and gas exploration and sales prices for the hydrocarbons being produced, net of identified
production (E&P) industry is a highly capital intensive industry. costs of production. Future sales prices will be based on a “bank
Not surprisingly, E&P companies utilise various financing tools to price deck” that will typically provide for prices for the relevant
satisfy their capital demands, which vary based on numerous commodities that are below the then current market forward price
factors, including the credit quality of the borrower, the quality and curve to mitigate commodity price volatility. Where this price
maturity of oil and gas reserves and the physical location of such volatility is addressed through commodity price hedging
reserves. These tools include mezzanine debt, second lien term agreements, lenders will use prices established in those hedging
loans, unsecured high-yield bonds and synthetic lending structures, agreements in place of this bank price deck with respect to the
such as volumetric production payments and prepaid forward sales. hedged volumes. The amount of recoverable reserves and
The most common financing tool utilised by E&P borrowers, production rates will be provided in an engineering report or
however, and the tool that is the subject of this paper, are “reserve- “reserve report”, which is a technical report prepared by a
based loans” (RBLs) as understood in the US market. petroleum engineer.
Within the reserve report, proved reserves will be classified as
Reserve-Based Loans and the Borrowing Base “proved developed producing” reserves (PDP), “proved developed
non-producing” reserves (PDNP) and “proved undeveloped”
RBLs typically take the form of a borrowing base revolving credit reserves (PUD). The present value of these three categories of
facility whereby lenders extend credit that is secured by liens on oil proved reserves will then be given varying degrees of credit
and gas mineral interests and related assets and rely, primarily, on towards the overall borrowing base. For example, PDPs, the
the cash flow produced by the sale of hydrocarbons and, category of reserves with the highest certainty of recoverability,
secondarily, on the sale of the underlying mineral interests for may be given borrowing base credit for 65% of their present value,
repayment. The most important feature of these facilities is the while PDNPs and PUDs, may only be given borrowing base credit
borrowing base, which represents the amount of credit that lenders for as little as 25% and 10%, respectively, of their present value. A
will extend based on a subset of the borrower’s oil and gas assets, lender may further impose limitations on the amount of the
subject to a maximum commitment amount. borrowing base that PDNP and PUD reserves represent so that the
concentration of borrowing base value attributable to PDNPs and
What that subset of assets excludes is as important as what that
PUDs is capped. Finally, it should be noted that other factors, such
subset includes. For example, an E&P company may have an oil
as the existence of other debt and its relative tenor and interest rate,
and gas acreage position for which it only has limited geological
can affect the amounts advanced. Consequently, given the various
information. This “raw” acreage may represent a significant
factors utilised in assessing the loan value of a pool of oil and gas
investment by the borrower, but will have no “borrowing base”
assets, two borrowers with similar PVs but dissimilar assets may
value in a customary RBL, which only gives credit for “proved”
have very different borrowing bases. Likewise, two borrowers with
reserves. Similarly, oil and gas reserves that are classified as
similar PVs and similar assets, but different balance sheets, will
“probable” or “possible” to reflect a diminished likelihood that oil
likely have different borrowing bases.
or gas will be economically produced from these reserves are also
given no “borrowing base” value. Within the universe of “proved” Some RBLs may also contain an “over-advance”, “stretch” or “non-
reserves, the customary RBL will risk adjust the various conforming” component to the borrowing base. This component
subcategories of “proved” reserves to limit advance rates, as represents an amount that exceeds the borrowing base value of the
described below, based on a number of variables assessed on a case- oil and gas properties that would result from the application of
by-case basis. These variables include lease operating costs, traditional underwriting processes. The stretch component may be
reserve life and decline rates, the geographic location and diversity justified as a decision to extend credit at a rate higher than
of the reserves and the quality of the hydrocarbon produced. ordinarily done on PDNPs or PUDs, provide credit for probable
Finally, equipment or personal property typically is given little, if reserves, permit PDNPs or PUDs to constitute a larger share of the
any, borrowing base value. borrowing base than is typical or value other factors specific to the
borrower such as there being collateral, other than reserves, that has
As a general matter, a lender will assess the “present value” (or PV)
significant value. The stretch component is typically documented
of the future net revenue from the borrower’s interests in identified
as a separate tranche of debt within the RBL (with availability
oil and gas properties using a 9% or 10% discount rate over the
typically terminating within the earlier of (a) an interim period of
reserve life of such property. Future revenue will be based upon
six to eighteen months, or (b) an agreed upon event, such as the
estimates of recoverable reserves, future production rates and future
issuance of certain unsecured indebtedness) that is subject to higher

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Simpson Thacher & Bartlett LLP Oil and Gas Reserve-Based Lending

pricing. In any event, it is commonly designed to be interim capital most states and is rarely required even where available. Finally,
for the borrower, and the borrower is often subject to more surveys of the surface estate related to the mineral estate are
restrictions during the period that the non-conforming borrowing typically not relevant to the lender’s analysis and are not required.
base is outstanding. Another nuance of RBL lending is that, analogous to the turnover
Finally, certain credit facilities will opt for a more transparent, of inventory and accounts receivable, a borrower’s portfolio of oil
formula-based calculation that utilises predetermined pricing and gas assets will be constantly changing, whether by means of
assumptions promulgated by the SEC or forward price curves based acquisitions, divestitures, depletion of old reserves, discovery of
upon NYMEX futures prices. Such formula-based borrowing base new reserves or revised reserve engineering. As a result, a lender
calculations are most often seen in the context of term loan facilities will need to assess whether incremental title diligence is warranted
with institutional investors who have fewer internal technical and on those new assets.
engineering resources and may be more passive than traditional
commercial bank lenders.
Notable RBL Structural Protections

RBL Collateral and Title Diligence The dynamic nature of the asset pool in RBLs requires that the
lenders take a more active role in managing the loan credit than they
In the US, state laws treat oil and gas mineral interests in place prior might take for other types of facilities. As the portfolio changes, the
to extraction or severance of the mineral from the ground as real reserve report and other engineering reports which the lenders
property. And, like any real estate, a mortgage or deed of trust is the initially analysed in making their credit assessment must be updated
instrument that is used to create a state law mortgage lien on such and re-evaluated at periodic intervals. These periodic reevaluations
mineral interests. After extraction, the mineral and the related called “redeterminations” are done on a semi-annual schedule,
account receivable generated from its sale at the wellhead is causing some practitioners to refer to RBLs as “six-month deals”.
transformed into a category of personal property governed by the In addition to these scheduled redeterminations, it is also typical for
Uniform Commercial Code (UCC) known as “as extracted the borrower or the lenders to have the ability to request
collateral”. As-extracted collateral is the combination of the redeterminations on an interim or “wildcard” basis or in connection
hydrocarbon molecule extracted and the account receivable with a significant event such as a major acquisition. Occasionally,
generated by its sale at the wellhead. Analogous to a “fixture”, in cases where a borrower is rapidly acquiring and developing
however, while this type of personal property asset falls under the proved reserves, a borrower may also be able to request quarterly
ambit of Article 9, non-possessory security interests attaching to as- redeterminations to reflect its development activities and make
extracted collateral must be perfected by filing a UCC-1 financing incremental capital available more quickly. At least one of the
statement affecting as-extracted collateral in the county where the scheduled redeterminations in each annual period will require an
wellhead is located. A UCC-1 financing statement filed with a independent approved petroleum engineer to prepare or audit the
Secretary of State of the relevant State (or other appropriate filing reserve reports. Increases to the borrowing base in connection with
office) will not be effective to perfect the security interest created in a redetermination will require the consent of all or nearly all of the
the as-extracted collateral. lenders and decreases to, or the maintaining of, the borrowing base
As oil and gas mineral interests are a species of real estate, RBL traditionally will require the consent of two-thirds of the lenders. A
lending raises title concerns that are analogous to those raised in borrowing base may also be “adjusted” (distinguished from a
typical real estate lending. However, where a typical real estate redetermination by the absence of new reserve and other
loan may relate to a single property or relatively discreet pool of engineering reports) to exclude assets which are sold or which have
properties upon which diligence efforts need to be focused, because title deficiencies, or to reflect the monetisation of a favourable
of the highly concentrated risk of title failure, reserve-based lenders commodity price hedging arrangement.
can be more flexible in their diligence efforts depending on the If, at any time, the total credit exposure under the RBL exceeds the
relative concentration of value in their collateral pool and the borrowing base then in effect a “borrowing base deficiency” results.
corresponding effect of such concentration on the risk of title The existence of a borrowing base deficiency will typically trigger
failure. As an example, consider an E&P company that owns a certain covenant limitations on the borrower and certain limited
portfolio of oil and gas leases that numbers into the thousands, with lender rights and remedies. The main ramification, however, will
no single well or lease representing a statistically significant be mandatory prepayments in an amount equal to the borrowing
percentage of the entire portfolio value. Given that title failure is base deficiency. Typically, this prepayment is not immediate, but
rarely catastrophic (i.e. a total loss), the risk of simultaneous due in one or more installments over a period ranging from 90 to
catastrophic title failure across this large portfolio of assets would 180 days (so that any borrowing base deficiency has been cured
be low and further mitigated if the assets have been producing prior to the next scheduled redetermination of the borrowing base).
without a title dispute for a long period of time. As a result, the This period enables the borrower to reduce its capital budget and
cost-benefit analysis of undertaking a review of title of such a large use production proceeds to reduce the deficiency and/or pursue an
number of properties may not be considered cost-beneficial. orderly liquidation of assets to generate cash proceeds to repay the
Accordingly, the procedure for diligence in lending to such a deficiency. Some RBLs will also offer the borrower the opportunity
company might be an “audit” of the borrower’s lease or well files to cure a deficiency by supplying engineering reports on previously
for a number of high value assets and some other randomly chosen unevaluated assets so that credit can be given to those assets to
lesser value ones, recognising that the borrower’s interest in supplement the borrowing base asset pool.
ensuring that it has good title are aligned with the lenders’ interests.
However, where significant concentration of value exists and a
higher risk of title failure is presented, reserve-based lenders may Hedging Covenants
require additional diligence in the form of county level title
Given that E&P companies are subject to commodity price
searches and even updated title opinions from an oil and gas title
volatility, it is not surprising that RBLs may include affirmative
attorney. With respect to oil and gas mineral interests, owner’s or
covenants requiring the borrower to enter into various commodity
mortgagee’s title insurance, however, is not commonly available in

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 Simpson Thacher & Bartlett LLP Oil and Gas Reserve-Based Lending

price swap agreements or utilise other hedging techniques to reduce volume to which it is contractually entitled. Similarly, the borrower
exposure to this volatility. A typical hedging covenant will require typically represents that it is not party to any contract such as a
the borrower, either as a condition to closing or within a short time “ship or pay” contract or volume or throughput guarantee (in favour
period thereafter, to enter into commodity price hedging of midstream assets such as a pipeline or processing facility)
arrangements for an agreed upon minimum percentage of its requiring the borrower to utilise and pay for capacity on the pipeline
projected production over an agreed period. Both the minimum or at the facility, whether or not hydrocarbons are actually
volume and tenor will be based upon the incremental amount of physically transported or processed. In general, these
borrowing base credit the borrower desires, or on a credit analysis representations may be viewed as diligence mechanisms designed
of the borrower’s “base case” cash flow for both debt service and to help lenders understand arrangements that would impact their
budgeted expenses, including its forecasted drilling costs. These determination of the borrowing base. Negative covenants
commodity swaps are typically entered into with the RBL lenders restricting the borrower from entering into marketing contracts or
themselves and rank pari passu with the principal of the loans and engaging in marketing activities in respect of hydrocarbons
are secured by liens on the same oil and gas properties constituting produced by third parties, or from entering into contracts for the
collateral for the loans. Hedging with RBL lenders is beneficial to purchase and/or sale of hydrocarbons of third parties where the
the borrower and the lenders because it avoids the need to provide producer takes commodity price risk on volumes to which it is not
separate collateral to secure hedging exposure and reduces the itself producing are also common and meant to give the lenders
borrower’s liquidity needs. It also provides the lenders with comfort about the nature of the borrower’s business activities. A
knowledge of the credit profile of the hedge counterparties. In RBL will also contain affirmative covenants that require the
addition to minimum affirmative hedging requirements, RBLs borrower to deliver certain types of information relating to its oil
typically feature negative hedging covenants limiting the maximum and gas assets to assure the lenders that the collateral is being
volume a borrower may hedge and a maximum tenor for those adequately maintained and to assist in the regular evaluations
hedges. The goal of these limitations is to avoid speculative hedges conducted in the context of the reserve report. These covenants
and the adverse effect of having commodity hedges with notional include delivery of production information on a periodic basis,
volumes in excess of actual physical production. lease operating statements, reserve reports in connection with the
semiannual redeterminations, title information in connection with
the delivery of reserve reports and lists of buyers who purchase
Specific Oil and Gas Representations, hydrocarbons from the borrower. Additionally, a borrower will be
Warranties and Covenants subject to affirmative covenants which require it to operate and
maintain its oil and gas properties in accordance with typical
Along with those provisions which practitioners expect in any
industry standards.
credit facility, RBLs contain several other oil and gas specific
provisions. The representations and warranties tend to focus on
items related to oil and gas properties, with the borrower Conclusion
representing that it has good title to the properties evaluated in the
reserve report, that all wells are drilled in compliance with any RBLs continue to be the predominant senior capital funding tool for
governmental requirements and that the properties are free of any E&P companies. The flexibility that this tool provides to both the
material environmental issues. Another common representation is borrowers and the lenders creates an instrument conducive to the
that the borrower has no material gas imbalances, which are various risks inherent in the oil and gas industry and the use of oil
discrepancies that result from a difference between the amount of and gas reserves as collateral.
natural gas being taken by one working interest owner over the

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Simpson Thacher & Bartlett LLP Oil and Gas Reserve-Based Lending

Robert Rabalais Matthew Einbinder

Simpson Thacher & Bartlett LLP Simpson Thacher & Bartlett LLP
909 Fannin, Suite 1475 909 Fannin, Suite 1475
Houston, TX 77010 Houston, TX 77010
USA USA

Tel: +1 713 821 5610 Tel: +1 713 821 5620

Fax: +1 713 821 5602 Fax: +1 713 821 5602
Email: [email protected] Email: [email protected]
URL: www.stblaw.com URL: www.stblaw.com

Robert Rabalais is a Partner in the Houston office of Simpson Matthew Einbinder is a senior associate in the Houston office of
Thacher and is a member of the firm’s Banking and Credit Group Simpson Thacher and is a member of the firm’s Banking and
and Energy and Infrastructure Group. Robert’s practice focuses Credit Group and Energy and Infrastructure Group. Matthew’s
on a range of lending and capital markets transactions in the oil practice focuses on leveraged acquisition financings, energy and
and gas exploration and production, midstream and related oil and gas related financings and project financings.
service sectors. He represents corporate borrowers and issuers, Matthew recently represented Templar Energy, a First Reserve
commercial banks and mezzanine lenders, institutional investors portfolio company, in connection with its $300 million revolving
and insurance companies. borrowing base facility and its $700 million second lien facility to
Robert has been identified as “one of the country’s top energy finance its acquisition of oil and gas assets. In addition, he
financing lawyers” by Law360 and named 2012 Houston Lawyer represented JPMorgan Chase Bank, N.A., in connection with a
of the Year for Banking and Finance Law by Best Lawyers. $2.0 billion revolving borrowing base facility for Exco Resources,
Robert received his J.D. from Louisiana State University Law Inc. in connection with its acquisition of oil and gas assets.
Center and his B.S. from Louisiana State University. Matthew received his J.D. from University of Virginia School of
Law in 2005, and was on the Editorial Board of the Virginia Law
Review, and his B.S. from Columbia University in 2000 in applied
mathematics.

Our Houston office offers clients a compelling combination of industry knowledge, deep transactional experience and exceptional
talent. Opened in 2011, the office is a natural consequence of Simpson Thacher’s century-old energy practice. In particular, we
enhance the Firm’s services on matters involving exploration, production, midstream, refining and petrochemicals, oil field service
and power companies. Our team advises transactions that span corporate disciplines, including:
mergers and acquisitions;
joint ventures;
private equity investments;
syndicated loans;
equity and debt offerings, including master limited partnerships; and
project financing and infrastructure development, derivatives and structured financings.
Clients rely on the support of our team of energy-focused attorneys who have been a part of the local fabric for many years. Our
Houston team is augmented by a dedicated group of in-house certified professional and registered land title professionals, who
help satisfy the critical diligence role often required to successfully and efficiently complete our clients’ energy transactions.

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 Chapter 12

Lending to Health Care

Providers in the United Art Gambill

States: Key Collateral

and Legal Issues
McGuireWoods LLP Kent Walker

I. Introduction II. Collateral Issues

Health care spending currently constitutes approximately 17 Accounts receivable are the most common asset of a provider that
percent of the gross domestic product of the United States each can serve as collateral for a loan facility. Many providers do not
year. While the rate of growth in health care spending has slowed own the real property where they practise or the equipment used in
somewhat since the 2008 recession, and politicians and the provision of services, and trusts and endowments that often
stakeholders continue to search for the magic policy bullet that will support hospitals and other health care facilities are customarily
permanently contain this growth, the massive share of the United restricted and cannot be used for collateral. For providers that do
States economy devoted to health care is a simple fact of economic not qualify for cash flow based financing, accounts receivable are
and political life for the foreseeable future. Consequently, it should often the only type of viable collateral for a secured loan facility.
come as no surprise that lenders continue to view the health care And even in a leveraged or cash flow based financing, where
industry with keen interest. liquidation of accounts receivables is not the primary anticipated
At the same time, the United States health care industry is remedy after default, a health care lender must understand the third-
exceptional in ways that are unrelated to its size. The industry is party payor programs and resulting receivables of the provider
thoroughly regulated at the federal, state and local levels of borrower.
government, and government regulations and reimbursement Government health care receivables and private insurance
programs are in a constant state of flux. Most significantly, the
receivables are the two most common types of health care
provision of health care services to patients is distinguished by a
receivables that are financed by health care lenders. Other
pervasive third-party payor system. The majority of health care
receivables, such as self-pay receivables (those owing by an
costs in the United States are not paid by the patient receiving
uninsured or underinsured patient) and capitation payments (those
services, but by third party private or government insurance
owing under managed care relationships), are often excluded from
programs. With increased enrollment in Medicaid and private
borrowing base consideration because of the unpredictable or
insurance under the Affordable Care Act, the share of health care
questionable nature and collectability of the payment obligation.
costs paid by third parties is expected to grow even larger. No other
industry has a payment structure that approaches this level of This chapter, therefore, focuses on the principal collateral issues
disconnect in interests between consumers of services and the arising when taking a security interest in government health care
entities paying for those services. For governmental payors and receivables and private insurance receivables.
many private insurance payors, the question is not whether the
payor will be able to pay (the concern in traditional secured A. Government Receivables
lending), but how much of a given receivable will be paid and when
such payment will occur. 1. Nature of Payments
This chapter will address several collateral and legal issues that are Medicare and Medicaid are the two principal government health
unique to secured lending transactions with United States borrowers care programs in the United States. Medicare is the health
who provide medical services (“providers”) in exchange for insurance program for persons aged 65 or over as well as
expected future payments from governmental programs or other individuals who are disabled. Medicare is funded by the federal
third-party payors. This reliance by providers on volatile government and administered by the Centers for Medicaid and
government payment programs can impair the cash flow and Medicare Services (“CMS”). Medicaid is the health insurance
liquidity of such borrowers. As a result, cash flow based loan program for eligible low income individuals that is funded by the
facilities are not an option for many providers, who must turn
states and by federal matching funds, and is administered by the
instead to asset-based loans predicated on the value of receivables
states subject to guidelines established by the CMS. Certain
owing to the provider by third-party payors. Regardless of whether
providers are heavily dependent on Medicare and Medicaid
a secured lender is lending on an asset-based model or cash flow
receivables. Typically, half of a hospital’s revenue, and up to 80%
model, however, the secured lender must understand its provider’s
of a skilled nursing facility’s revenue, comes from the Medicare and
third-party payor programs, how receivables under those programs
Medicaid programs.
are originated and valued and how security interests in such
receivables are created, perfected and enforced. Unlike a traditional secured loan facility, the principal issue with
Medicare and Medicaid receivables is not whether the payor (the
United States or a state government) will have the ability to pay.

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Rather, the principal issue is whether the governmental payor will payments must be initially paid to a deposit account with respect to
pay an amount less than what was estimated or predicted by the which only the provider can give instructions. Consequently, this
provider. The Medicare and Medicaid programs are notoriously initial deposit account cannot be subject to a customary UCC three-
complex, and reimbursement rates are subject to change with little party “control agreement” whereby the depositary bank agrees to
notice. Further, most Medicare and Medicaid payments that a give the lender the right to direct the disposition of funds in the
provider receives are provisional, pending final confirmation by deposit account (even if such right is only exercised after default).
audit. If an audit indicates that a provider was overpaid, the Thus, the lender cannot perfect a direct security interest in such a
Medicare or Medicaid payor may offset such overpayments against deposit account through the use of a control agreement. It is
future payments (against which a secured lender may have already important to note that, assuming the lender has taken appropriate
advanced). Lenders mitigate overpayment risk by examining steps under the UCC to perfect its security interest in all of a
historical reimbursements and monitoring the provider’s claims provider’s Medicare and Medicaid accounts receivable, the lender
preparation process to ensure that it is consistent with customary will continue to have an indirect security interest in any amounts on
practice. And while any asset-based receivables financing facility deposit in such a deposit account that constitute identifiable
is going to give some discretion to the lender to determine proceeds of the Medicare and Medicaid receivables themselves.
eligibility of receivables, it is not uncommon in a health care loan Nevertheless, a lender’s recourse against such proceeds of
facility for the lender to have substantial (or even unlimited) Medicare and Medicaid receivables is severely limited until such
flexibility to modify advance rates, set reserves (often called funds are moved out of the provider’s initial deposit account.
“liquidity factors”) and otherwise adjust availability with respect to Where the lender itself is also the depositary bank that maintains the
government receivables. In the context of a cash flow loan, the provider’s deposit account into which Medicare and Medicaid
secured lender is also keenly interested in the provider’s historical payments are made, CMS regulations require that the bank lender
billing and collections practices and results as a predictor of future agree in the loan agreement to waive its offset rights with respect to
cash flow. such deposit accounts. And as part of the Medicare enrollment
2. So-Called “Anti-Assignment” Issues process, providers are required to obtain offset waiver
The Medicare and Medicaid statutes contain broadly misunderstood confirmations from their bank lenders for deposit accounts
language commonly referred to as the “anti-assignment” maintained with the bank lender that will directly receive Medicare
provisions. The Medicare and Medicaid statutes, and their or Medicaid payments. As a result, until those payments are moved
implementing regulations, generally prohibit payments from being to a different deposit account at the direction of the provider, bank
made to any party other than the provider in connection with an lenders are unable to sweep or offset such payments unilaterally.
“assignment” of a claim by the provider. Although the statutes and Health care lenders mitigate the risk of not having “control” over
regulations do not prohibit “assignments” of claims under the the initial deposit account into which Medicare and Medicaid
Medicare and Medicaid programs (rather, only payments made to a payments are made by utilising a structure known as a “double
party other than the provider are prohibited), there is a stubbornly lockbox” arrangement. The goal is to move Medicare and Medicaid
persistent misconception that a lender cannot take an effective payments as quickly as possible from the first “tainted” deposit
security interest in Medicare and Medicaid accounts receivable account and into a second deposit account that is not subject to the
under Article 9 of the Uniform Commercial Code (“UCC”). CMS restrictions on a non-provider having “control”.
However, federal case law, U.S. Congressional legislative Under the “double lockbox” arrangement, the provider instructs CMS
commentary and the Medicare and Medicaid statutes and and all other applicable governmental payors (but not insurance
regulations themselves clearly permit the assignment or grant of a payors) to make payment to a dedicated “government receivables
security interest in Medicare and Medicaid receivables so long as deposit account”. The government receivables deposit account
payments of such receivables are made only to the provider itself. should be subject to a modified three-party agreement that resembles
3. Remedies and Lockbox Issues a traditional deposit account control agreement in all ways except that
While a secured lender can take an effective security interest in the provider retains all rights to direct disposition of funds in the
Medicare and Medicaid receivables, there are important limitations account (in order to comply with the CMS regulations). This three-
on such a security interest that need to be thoroughly understood by party account agreement should also provide that the depositary bank
lenders. For example, under Article 9 of the UCC, a secured party waives its rights of setoff other than for customary account charges
with a security interest in accounts receivable generally has several and returned items (so that the lender is not competing against the
remedies that it may pursue after default: the secured party may (1) depositary bank for priority in amounts on deposit in the deposit
notify account debtors to make payment directly to the secured account). And finally, the three-party account agreement should also
party, (2) enforce the rights of the borrower directly against the provide that the provider voluntarily instructs the depositary bank to
account debtor, and (3) compromise and settle the accounts sweep the government receivables deposit account on a daily basis to
receivable in a commercially reasonable manner. However, a a second deposit account over which the lender has control through a
secured party with a security interest in Medicare and Medicaid traditional control agreement.
receivables generally cannot exercise any of the foregoing While the provider must retain the right to rescind the daily sweep
remedies, because the Medicare and Medicaid statutes and the instructions to the second lockbox at any time in order to comply
Federal Assignment of Claims Act (which ordinarily cannot be with the CMS regulations, the loan agreement should provide that
complied with for Medicare and Medicaid receivables) expressly exercising such rescission constitutes an immediate event of
prohibit the exercise of these remedies. A secured lender should default. The lender should be able to determine whether such
understand that its ability to direct the liquidation of Medicare and unauthorised redirection has occurred by monitoring cash flow in
Medicaid receivables is substantially constrained. both of the two deposit accounts (note that the CMS regulations do
Further, CMS takes seriously the statutory prohibition on making not prohibit a provider from giving a lender electronic access to
payments to any entity other than the provider and has adopted review deposit account balances). If a provider were to breach its
regulations and guidelines designed to prevent a lender from obligations under the loan agreement and stop the automatic daily
effectively inserting itself between the governmental payor and the sweep of funds to the second deposit account, only a few days of
provider. CMS regulations require that all Medicare and Medicaid collections should be impacted before the lender would discover the

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 McGuireWoods LLP Lending to Health Care Providers in the United States

breach and be able to call a default and stop funding additional III. Legal Issues
loans (and presumably enter into workout discussions with the
provider or exercise remedies against the provider). CMS has A comprehensive summary of legal and regulatory issues facing
approved the double lockbox arrangement in policy statements and health care providers, and thus affecting their secured lenders, is
private decisions. outside the limited scope of this chapter. However, consistent with
In a scenario where the lender is also the depositary bank for the the preceding focus on government receivables (the single largest
provider, a modified form of the double lockbox arrangement is source of payment for most providers), the following summary of
recommended, without the need for three-party agreements. Under three major United States federal health care regulatory programs
this arrangement, Medicare and Medicaid payors are again instructed focuses on legal and regulatory risks that potentially impact a
to make a payment to a dedicated deposit account with respect to provider’s payments under Medicare and Medicaid, because any
which the depositary bank has waived its rights of offset, and the liabilities owing in connection with such regulatory noncompliance
provider gives revocable instructions to the depositary bank to sweep can be directly offset against such payments. This summary does
funds out of the dedicated deposit account on a daily basis to a second not address commercial payor or state law issues, both of which can
deposit account over which the depositary bank has retained its rights also be significant sources of provider liability (and can thus trigger
of offset. Again, a lender’s remedies with respect to Medicare and corresponding repayment or recoupment issues).
Medicaid payments are not restricted in any way once those funds are
moved by the provider from the original government receivables A. Physician Self-Referral Law (A/K/A Stark Act)
deposit account and into a second deposit account.
The Ethics in Patient Referrals Act of 1989 (or “Stark Act”) was
B. Private Insurance Receivables enacted for the purpose of prohibiting physicians from referring
Medicare patients to clinical laboratories in which the physicians
Prior to the 1999 amendments to Article 9 of the UCC, it was (or members of their immediate family) have a financial interest.
unclear whether accounts receivable owing by a health insurance The Stark Act was amended in 1993 to (1) expand the referral
company were within the scope of the UCC because the UCC prohibitions to apply more broadly to certain “designated health
generally does not apply to security interests in claims under services” (“DHS”), and (2) extend the anti-referral provisions to
insurance policies. Case law was split regarding whether the UCC Medicaid patients. DHS include clinical laboratory services,
governed security interests in payment obligations owing by health imaging and radiology services, inpatient and outpatient hospital
insurance companies under their policies. This uncertainty caused services, occupational therapy services, physical therapy services
substantial discomfort for lenders and arrangers of loans and and provision of durable medical equipment and supplies.
securitisation facilities secured by receivables owing by private The Stark Act rules and regulations are complex and contain
health insurance companies. As a result, practitioners documenting detailed standards for determining whether a direct or indirect
such transactions often undertook the cumbersome task of creating ownership, investment or compensation arrangement exists, as well
a lien under common law, which generally involves executing an as exceptions and “safe-harbors” to the referral prohibition. These
assignment agreement and requesting written acknowledgment rules must be carefully analysed (along with a review of applicable
thereof from each insurance company. case law and CMS guidance) in determining whether a potential
The 1999 amendments to Article 9 of the UCC put this issue to rest violation exists. A secured lender, as part of its due diligence, will
and created a new type of account called a “health-care-insurance scrutinise potential Stark violations based upon the relationship of
receivable” which is expressly within the scope of the UCC. Thus, physicians (or members of their immediate family) with DHS
as a preliminary matter, it is now clear that a lender can obtain a providers. A violation of the Stark Act may result in a denial of
perfected security interest in health-care-insurance receivables in Medicare or Medicaid reimbursements, required refunds of
the same manner as applicable to any other receivable. However, Medicare/Medicaid amounts collected in violation of the statute,
the UCC does contain several limitations or qualifications that civil penalties, and possibly exclusion from participation in the
apply to health-care-insurance receivables. For example, the Medicare or Medicaid programs altogether. Because such refunds
general rule that a secured party can send notice to an account and penalties can be directly offset against future Medicare or
debtor to pay the account (and thereby create a situation where the Medicaid payments, a lender must be aware of issues that could
account debtor can no longer discharge its obligation by making arise from the physician relationships of its provider borrower.
payment to the borrower) does not apply to health-care-insurance Note that even if the Stark Act does not apply because the referred
receivables. The UCC also provides that a secured party with a
service does not constitute a DHS, the federal Anti-Kickback
security interest in health-care-insurance receivables cannot enforce
Statute may apply if a person solicits or receives any remuneration
that claim directly against the insurance company and cannot
(including any kickback, bribe or rebate) (1) in return for referring
require that the insurance company pay the secured party directly.
an individual for any service for which payment may be made under
In short, a lender with a security interest in private health-care-
any federal health care program, or (2) in return for purchasing,
insurance receivables ends up in much the same position as it does
leasing or ordering any good, facility, service or item for which
with Medicare and Medicaid receivables with regards to remedies
payment may be made under a federal health care program.
(although payments can at least be made to a deposit account over
Accordingly, lenders need to be aware that the payment or receipt
which the lender has “control”).
of any kind of remuneration by a borrower that is directly or
To mitigate these limitations, a lender could obtain a power of indirectly tied to referrals could implicate the federal Anti-Kickback
attorney authorising the lender to enforce claims held by a borrower Statute. Fortunately, CMS has adopted several safe harbors that
against such insurance companies, but the enforceability of such a provide protection (including civil and criminal immunity) for
power of attorney is outside the scope of the UCC. Theoretically, a conduct otherwise prohibited under the statute. Many financial
lender could also obtain the insurance company’s consent to the arrangements will not fit one of these narrow safe harbors, and as a
assignment and agreement to pay the lender directly after default, result must be analysed using a highly fact-specific approach.
but this is not realistic in most situations because private health
insurance companies typically are not willing to sign such consents.

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McGuireWoods LLP Lending to Health Care Providers in the United States

B. HIPAA claim submitted in violation of Stark or the Anti-Kickback Statute

into a false claim.
The Health Insurance Portability and Accountability Act of 1996 The False Claims Act contains a “qui tam” provision whereby
(“HIPAA”), as modified by the Health Information Technology for private citizens (known as “relators” or, more colloquially, as
Economic and Clinical Health Act (the “HITECH Act”), is a federal “whistle blowers”) are permitted to sue on the federal government’s
statute with two primary purposes: (1) to provide for administrative behalf. The False Claims Act provides for financial incentives,
simplification of certain health care information through the through damages, to encourage private citizens and their counsel to
development of standards and requirements for the electronic bring such actions. In order to validly pursue a false claims action,
transmission of health care information, and (2) to provide federal the relator must file a complaint in U.S. District Court under seal.
protection for the privacy and security of such information. After an investigation by the Department of Justice (“DOJ”), the
HIPAA primarily applies to providers and health plans, which are DOJ decides whether or not it will pursue (or “intervene” in) the
referred to as “covered entities”. As discussed more fully below, case. The DOJ has the option whether to intervene, and less than
HIPAA also applies to “business associates” of covered entities. half of qui tam false claims suits result in intervention by the DOJ.
Under HIPAA, the United States Department of Health and Human If the DOJ declines to intervene, the relator may still prosecute the
Services has established detailed privacy standards (the “Privacy action on behalf of the United States, and, in such case, the United
Rules”) to protect certain personal health information stored and States will not be a party to the proceedings (apart from its right to
transmitted in electronic form. The Privacy Rules regulate the use any recovery). Several states also have adopted similar statutes for
and disclosure by covered entities of “protected health information” Medicaid claims.
(“PHI”), which is individually identifiable health information The False Claims Act provides for treble damages and a $5,500 to
maintained in a system of records by a covered entity. The Privacy $11,000 penalty for each violation. A provider’s improper billing of
Rules provide that a covered entity may not use or disclose PHI to its Medicare claims over an extended period of time can easily give
anyone other than to the individual patient to which such rise to thousands of separate violations. Successful qui tam actions
information relates, except for purposes of treatment, payment or are regularly brought against providers resulting in significant
health care operations as permitted under the applicable rules. payments of aggregated penalties and forfeitures by those providers
Violations of HIPAA by a provider may result in civil fines and and the collection of significant payments by the government and
criminal penalties, which could be offset against Medicare and the relators in those cases. Penalties for False Claims Act violations
Medicaid payments owing to the provider. can quickly add up to an amount that exceeds the outstanding
The Privacy Rules are of particular concern to a secured lender Medicare and Medicaid receivables owing to a provider, and
whose primary collateral consists of the provider’s Medicare and consequently a lender should review billing procedures and policies
Medicaid accounts receivable, because the fine details regarding before entering into, and during the continuance of, a loan
such accounts receivable almost certainly contain PHI. HIPAA transaction with a provider. Practically speaking, there is no
does permit disclosure by a covered entity of PHI to third-party quicker way for a provider to find itself in bankruptcy proceedings
“business associates” in connection with treatment, payment, or than through the prosecution of a large successful qui tam suit,
health care operations. Some lenders conclude that they may be though it is common for the DOJ to enter into a settlement
deemed “business associates” as a result of their lending agreement with a provider for the payment over time of obligations
relationship and choose to enter into a written business associate arising from False Claims Act violations, particularly if the provider
agreement with the provider to formalise the relationship. serves a geographic or other market niche that needs to be preserved
However, there is little regulatory guidance regarding whether a for policy reasons. Nevertheless, meaningful False Claims Act
secured lender should in fact be treated as a business associate. violations by a provider have the potential to materially reduce or
Regardless, because a health care lender could have direct or expunge the value and collectability of the primary collateral for a
indirect liability under HIPAA with respect to any PHI that it secured lender.
receives (knowingly or otherwise), lenders should never request
PHI and should carefully outline what collateral reporting will be
IV. Conclusion
required from the provider in a manner that expressly precludes the
reporting of any PHI. Many health care lenders adopt internal Notwithstanding the issues discussed above with respect to
policies to ensure that they do not receive PHI and to establish steps collateral and legal concerns in the health care space, lending
to seek legal advice regarding its obligations under HIPAA if activity remains robust and competitive. Because of the premium
disclosure of PHI is inadvertently made to the lender. placed on expertise and experience with these collateral and legal
issues, most lenders have dedicated departments and personnel
C. False Claims Act (particularly workout specialists) who work exclusively with
borrowers in the health care industry. Managed appropriately, loan
The False Claims Act is a federal statute that applies to any person transactions with health care providers can provide robust collateral
who knowingly (1) presents a fraudulent claim for money or coverage and borrower performance.
property against the United States, or (2) makes or causes to be
made a false statement to obtain payment or approval of a false
Acknowledgment
claim paid. The most common example of a violation in the health
care context is a provider who intentionally overcharges the federal The authors would like to thank McGuireWoods health care partner
government for Medicare reimbursement. Notably, Stark Act and Barton C. Walker for reviewing and providing valuable comments
Anti-Kickback Statute violations can serve as the basis for a cause to this article.
of action under the False Claims Act, effectively transforming each

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 McGuireWoods LLP Lending to Health Care Providers in the United States

Art Gambill Kent Walker

McGuireWoods LLP McGuireWoods LLP
1230 Peachtree Street, Suite 2100 201 North Tryon Street, Suite 3000
Atlanta, Georgia 30309 Charlotte, NC 28202
USA USA

Tel: +1 404 443 5741 Tel: +1 704 373 8961

Fax: +1 404 443 5691 Fax: +1 704 444 8801
Email: [email protected] Email: [email protected]
URL: www.mcguirewoods.com URL: www.mcguirewoods.com

Art represents major financial institutions in loan transactions to Kent’s practice focuses primarily on corporate lending, including
the healthcare and life science industries, including asset-based syndicated, club and bilateral debt financings and related capital
lending and cash-flow lending. He has extensive experience in raising transactions. He has extensive experience in all phases
second-lien and mezzanine financing; real estate financing; of complex credit facilities, from structuring and documentation to
acquisition financing; debtor-in-possession financing and post- distribution and syndicate management. His experience
confirmation financing; equity enhancements of debt financings; encompasses cash-flow, leveraged recapitalization, asset-based,
and negotiation of complex intercreditor and debt subordination and acquisition financings, as well as first lien and second lien
relationships. Art has particular experience in financing and and mezzanine financings, and includes transactions ranging
acquisition transactions for skilled nursing facilities (both from large corporate lending to middle market and commercial
operators and owners), physician groups, long-term acute care lending. Kent has represented the administrative agent and
hospitals, early-stage life science companies, pharmaceutical participant banks in a variety of leveraged and investment grade
manufacturers and distributers, and hospital and other provider syndicated, club and single-bank loan transactions.
organisations. Kent received his law degree cum laude from Harvard Law
Art is active in bar organisations relative to the Uniform School and an undergraduate degree in Business Administration
Commercial Code. He currently serves as chair of the UCC with highest distinction from the University of North Carolina at
Committee of the Business Law Section of the State Bar of Chapel Hill, where he was a Morehead Scholar and a member of
Georgia. He received his B.A. from Yale University and his J.D. the business school honor society Beta Gamma Sigma. He was
from UCLA School of Law. a clerk on the U.S. Court of Appeals for the Eleventh Circuit in
Atlanta.

McGuireWoods LLP is an international firm with more than 900 lawyers and 19 offices in the United States, United Kingdom and
Belgium. Serving public, private, government and non-profit clients, the firm continues a legacy of experience and excellence.
McGuireWoods is widely recognised as an elite law firm in syndicated finance and general corporate lending, with over 70 lawyers
regularly serving as lead counsel to major global financial institutions in arranging and administering a broad range of syndicated
and bilateral loan transactions.
McGuireWoods consistently ranks among the top firms in syndicated loans by volume of credit exposure and number of deals. In
2013, the firm was ranked sixth in the U.S. in dollar volume of transactions and third in number of deals closed for the year by Loan
Pricing Corporation’s Law Firm League Table. In these transactions, the firm represented lead arrangers, administrative agents
and bookrunners in syndicated debt financings.

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Chapter 13

A Comparison of Key
Provisions in U.S. and Sarah M. Ward

European Leveraged Loan

Agreements
Skadden, Arps, Slate, Meagher & Flom LLP Mark L. Darley

While there are many broad similarities in the approach taken in investment grade loan transactions, leveraged acquisition finance
European and U.S. leveraged loan transactions, there are also a transactions and real estate finance transactions.
number of significant differences in respect of commercial terms Market practice in Europe invariably anticipates that parties will
and general market practice. The importance of having a general adopt the LMA recommended form documents as a starting point
understanding of these differences has been highlighted in recent for syndicated loans (and the practice of individual law firms or
years as an increasing number of European borrowers, suffering banks using their own form of loan document has largely
from macroeconomic uncertainty and regulatory constraints at disappeared). An important reason for starting with the LMA
home, have looked to the highly liquid U.S. syndicated leveraged standard forms is familiarity of the European investor market with
loan market as an attractive alternative source of funding. the documents, hopefully adding to the efficiency of review and
This chapter will focus only on certain key differences between comprehension not just by those negotiating the documents but also
practice in the United States and Europe that may be encountered in by those who may be considering participating in the loan. The
a typical leveraged loan transaction. References throughout this LMA recommended forms are only a starting point, however, and
article to “U.S. loan agreements” and “European loan agreements” whilst typically, the “back-end” LMA recommended language for
should be taken to mean New York-law governed and English-law boilerplate and other non-contentious provisions of the loan
governed leveraged loan agreements, respectively. agreement will be only lightly negotiated (if at all), the provisions
This chapter is intended as an overview and a primer for that have more commercial effect on the parties (such as mandatory
practitioners. It is divided into three parts: Part A will focus on prepayments, business undertakings, representations and
differences in documentation and facility types, Part B will focus on warranties, conditions to drawdown, etc.) remain as bespoke to the
covenants and undertakings and Part C will consider differences in specific transaction as ever.
syndicate management. Similar to the LMA in Europe, the Loan Syndications and Trading
Association (the “LSTA”) in the United States (an organisation of
banks, funds, law firms and other financial institutions) was formed
Part A – Documentation and Facility Types to develop standard procedures and practices in the trading market
for corporate loans. One of the main practical differences from the
LMA, however, is that although the LSTA has developed
Form Documentation recommended standard documentation for loan agreements, those
forms are rarely used as a starting draft for negotiation. Instead,
In both the European and U.S. leveraged loan markets, the standard U.S. documentation practice has historically been based on the form
forms used as a starting point for negotiation and documentation of the lead bank or agent, albeit that many banks’ forms incorporate
greatly influence the final terms. In Europe, both lenders and LSTA recommended language.
borrowers, through conduct adopted over a number of years, have
typically become accustomed to and comfortable with using an Increasingly, however, in both Europe and the United States, strong
“industry standard form” as a starting point for documentation. sponsors succeed in negotiating from an agreed borrower-friendly
However, in the United States, such practice has not emerged and sponsor precedent drafted by the borrower’s counsel. Even if the
the form on which the loan documentation will be based (as well as lead lender’s counsel is responsible for drafting, sponsors often
who “holds the pen” for drafting the documentation) – which may negotiate a specific precedent or form on which the loan
greatly influence the final outcome – will be the subject of documentation will be based.
negotiation at an early stage.
Market practice in Europe has evolved through the influence of the Facility Types
Loan Market Association (or the “LMA”) and the widespread
membership it attracts from those involved in the financial sector: The basic facility types in both U.S. and European loan agreements
the LMA is comprised of more than 500 member organisations, are very similar. Each may typically provide for one or more term
including commercial and investment banks, institutional investors, loans (ranking equally but with different maturity dates,
law firms, service providers and rating agencies. While the LMA amortisation profiles (if amortising) and interest rates) and a pari-
originated with the objective of standardising secondary loan passu ranking revolving credit facility. Of course, depending on the
trading documentation, it now plays an essential role in the primary nature of the borrower’s business, there could be other specific,
loan market by producing recommended forms of English law standalone facilities, such as facilities for acquisitions, working
documents suitable for a variety of circumstances, including for capital and letters of credit.

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 Skadden, Arps, Slate, Meagher & Flom LLP U.S. & European Leveraged Loan Agreements

In the United States, as in Europe, revolving and term loan facilities made by the borrower and the delivery of certain types of collateral
typically share the same security package (or liens in U.S. loan required by the lenders on the closing date of the loan.
market parlance) and priority. However, in the United States, some
revolving loan facilities may be structured as “first-out-revolvers”
to make such loans more attractive to potential investors. First-out- Part B – Covenants and Undertakings
revolvers are secured by the same liens granted to all pari-passu
Many of the most significant differences between U.S. and
creditors but provide for payment priority to the first-out-revolvers
European loan agreements lie in the treatment and documentation
in respect of collateral proceeds.
of covenants (as such provisions are termed in U.S. loan
Mezzanine finance has historically been common in the European agreements) and undertakings (as such provisions are termed in
market. Despite sharing the same name, “mezzanine” finance terms European loan agreements). This Part B explores the differences in
in Europe are more akin to U.S. second lien term loans than some of the more intensively negotiated covenants/undertakings,
“mezzanine” financing in the United States. European mezzanine recognising that the flexibility afforded to borrowers in these
loans largely follow the same form as the senior loan agreement, provisions depends on the financial strength of the borrower, the
though with higher pricing, a longer final maturity, more relaxed influence of a sponsor and market conditions.
financial covenants, and secured on a subordinated basis to the
Notwithstanding the various differences (outlined below), U.S. and
senior loan (and, typically, containing call protection provisions).
European loan agreements utilise a broadly similar credit “ring
U.S. Term B loans are typically made by U.S. based institutional fencing” concept, which underpins the construction of their
investors (historically, there has not been much European investor respective covenants/undertakings. In U.S. loan agreements,
appetite for this type of debt) and provide a higher interest rate and borrowers and guarantors are known as “loan parties”, while their
a lower rate of amortisation during the life of the loan than Term A European equivalents are known as “obligors”. In each case, loan
loans, which are syndicated in the United States to traditional parties/obligors are generally free to deal between themselves on
banking institutions. Compared to European mezzanine loans, U.S. the basis they are all within the credit group and are bound under
Term B loans contain broadly more relaxed covenants, with a clear the terms of the loan agreement. However, to minimise the risk of
market trend emerging of the convergence of certain key terms with credit leakage, loan agreements will invariably restrict dealings
those found in the high yield debt market. While in Europe, some between loan parties/obligors and other members of the borrower
very strong sponsors and borrowers have been able to negotiate group that are not loan parties/obligors, as well as third parties
similarly relaxed terms for some time in their European loan generally. In U.S. loan agreements there is usually an ability to
agreements, for certain other European sponsors and borrowers, designate members of the borrower’s group as “unrestricted
U.S. Term B loans (and/or the U.S. high yield bond market) have subsidiaries” so that they are not restricted under the loan
provided an increasingly popular alternative means of achieving a agreement. However, the loan agreement will then limit dealings
similar outcome. between members of the restricted and unrestricted group.

Certainty of Funds Restrictions on Indebtedness

Another key difference between the U.S. and European loan U.S. and European loan agreements will almost always include an
markets relates to the issue of certainty of funds in an acquisition “indebtedness covenant” (in U.S. loan agreements) or a “restriction
finance context. In the United Kingdom, when financing an on financial indebtedness” undertaking (in European loan
acquisition of a U.K. incorporated public company involving a cash agreements) which prohibits the borrower (and usually, its
element, the City Code on Takeovers and Mergers requires subsidiaries) from incurring indebtedness outside of the amounts
purchasers to have “certain funds” prior to the public announcement drawn under the particular loan facility. Typically, “indebtedness”
of any bid. The bidder’s financial advisor is required to confirm the will be broadly defined in the loan agreement to include borrowed
availability of the funds and, if it does not diligence this money and other obligations such as notes, letters of credit,
appropriately, may be liable to provide the funds itself should the contingent obligations, guaranties and guaranties of indebtedness.
bidder’s funding not be forthcoming. Understandably, both the
In U.S. loan agreements, the indebtedness covenant prohibits all
bidder and its financial advisor need to ensure the highest certainty
indebtedness, then allows for certain customary exceptions (such as
of funding.
the incurrence of intercompany debt, certain acquisition debt,
In practice, this requires the full negotiation and execution of loan certain types of indebtedness incurred in the ordinary course of
documentation and completion of conditions precedent (other than business or purchase money debt), as well as a specific list of
those conditions that are also conditions to the bid itself) at the bid exceptions tailored to the business of the borrower. The
stage of an acquisition financing. The concept of “certain funds” indebtedness covenant will also typically include an exception for a
has also permeated the private buyout market in Europe, so that the general “basket” of debt, which can take the form of a fixed amount
lenders in a private acquisition finance transaction are, in effect, or a formula based on a ratio, an incurrence test or a combination
required to confirm satisfaction of all of their financing conditions such as the greater of a fixed amount and a ratio formula.
at the signing of the loan agreement and dis-applying any drawstop Reclassification provisions (allowing the borrower to utilise one
events (subject to limited exceptions) until after completion of the type of permitted debt exception and then reclassify the incurred
acquisition. permitted debt under another exception) are also becoming more
In the United States, however, there is no regulatory certain fund common in the United States.
requirement as in the United Kingdom. In U.S. acquisition The restriction on financial indebtedness undertaking typically
financing, commitment papers, rather than loan documents, are found in European loan agreements is broadly similar to its U.S.
typically executed simultaneously with the purchase agreement. covenant counterpart and usually follows the same construct of a
Ordinarily, while such commitment papers are conditioned on the general prohibition on all indebtedness, followed by certain
negotiation of definitive loan documentation, they contain “permitted debt” exceptions (both customary ordinary course type
“SunGard” clauses that limit the representations and warranties exceptions as well as specifically tailored exceptions requested by

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Skadden, Arps, Slate, Meagher & Flom LLP U.S. & European Leveraged Loan Agreements

the borrower). However, unlike in the United States, ratio debt covenant (such as a leverage covenant), the borrower may also be
exceptions and reclassification provisions are not yet commonly required to satisfy a tighter leverage ratio to utilise the builder
seen in European leveraged loan agreements. basket for an investment or restricted payment. Some sponsors
have also negotiated loan documents that allow the borrower to
switch between different builder basket formulations for added
Restrictions on Granting Security / Liens
flexibility.
U.S. loan agreements will also invariably restrict the ability of the European loan agreements will typically contain stand-alone
borrower (and usually, its subsidiaries) to incur liens. A typical U.S. undertakings restricting the making of loans, acquisitions, joint
loan agreement will define “lien” broadly to include any charge, ventures and other investment activity by the borrower (and other
pledge, claim, mortgage, hypothecation or otherwise any obligors). While the use of builder baskets is still unusual in
arrangement to provide a priority or preference on a claim to the European loan agreements, often acquisitions will be permitted if
borrower’s property. This lien covenant prohibits the incurrence of funded from certain sources, such as retained excess cash flow.
all liens but provides for certain typical exceptions, such as liens Exceptions by reference to ratio tests alone are not commonly seen
securing any permitted indebtedness, purchase money liens, in European loan agreements, although they frequently form one
statutory liens and other liens that arise in the ordinary course of element of the tests that need to be met to allow investments such
business. as permitted acquisitions.
In the European context, the restriction on liens is known as a
“negative pledge”. Rather than the “lien” concept, European loan Restricted Payments
agreements will generally prohibit a borrower (and obligors under
the loan agreement) from providing “security”, where security is U.S. loan agreements will typically restrict borrowers from making
broadly defined to include mortgages, charges and pledges, but may payments on equity, including repurchases of equity, payments of
also include other preferential arrangements. As with U.S. loan dividends and other distributions, as well as payments on
agreements, the prohibition on providing security is subject to a list subordinated debts. As with the covenants outlined above, there are
of customary and specifically negotiated “permitted security” typical exceptions for restricted payments not materially adverse to
exceptions. Importantly, most European loan agreements will the lenders, such as payments on equity solely in shares of stock, or
specifically prohibit “quasi-security” in the negative pledge (where payments of the borrower’s share of taxes paid by a parent entity of
quasi-security includes such things as sale and leaseback a consolidated group.
arrangements, retention of title arrangements and certain set-off In European loan agreements, such payments are typically
arrangements) in circumstances where the arrangement or restricted under separate specific undertakings relating to dividends
transaction is entered into primarily to raise financial indebtedness and share redemptions or the making of certain types of payments,
or to finance the acquisition of an asset. Borrowers are also such as management and advisory fees, or the repayment of certain
typically able to negotiate a “general basket” to permit the securing types of subordinated debt. As usual, borrowers will be able to
of a certain fixed amount of general indebtedness, although a negotiate specific carve-outs (usually hard capped amounts) for
general carve-out for security securing any permitted indebtedness particular “permitted payments” or “permitted distributions” as
is rare. Of course, borrowers may be able to negotiate specific required (for example, to permit certain advisory and other
“permitted security” exceptions depending on their payments to the sponsor), in addition to the customary ordinary
creditworthiness and specific business requirements. course exceptions.
In U.S. loan agreements, a borrower may use its “builder basket” or
Restriction on Investments “Available Amount” (see above) for restricted payments,
investments and prepayments of debt, subject to annual baskets
A restriction on the borrower’s ability to make investments is consisting of either a fixed-dollar amount or a certain financial ratio
commonly found in U.S. loan agreements. “Investments” include test. In some recent large cap and sponsored middle market deals in
loans, advances, equity purchases and other asset acquisitions. the United States, borrowers have been permitted to make restricted
Historically, investments by loan parties in non-loan parties have payments subject only to being in pro forma compliance with a
been capped at modest amounts. In some recent large cap deals, specific leverage ratio, rather than meeting an annual cap or basket
loan parties have been permitted to invest uncapped amounts in any test.
of their subsidiaries, including foreign subsidiaries who are not European loan agreements typically do not provide this broad
guarantors under the loan documents. Other generally permitted flexibility. However, some strong sponsors have been able to
investments include short term securities or other low-risk liquid negotiate provisions permitting payments or distributions from
investments, loans to employees and subsidiaries, and investment in retained excess cash flow, subject (typically) to satisfying a certain
other assets which may be useful to the borrower’s business. In leverage ratio.
addition to the specific list of exceptions, U.S. loan agreements also
include a general basket, sometimes in a fixed amount, but
increasingly based on a flexible “builder basket” growth concept. Call Protection
This “builder basket” concept, typically defined as a “Cumulative
In both European and U.S. loan agreements, borrowers are
Credit” or an “Available Amount”, represents an amount the
commonly permitted to voluntarily prepay loans in whole or in part
borrower can utilise for investments, restricted payments (as
at any time. However, some U.S. loan agreements do include call
discussed below), debt prepayments or other purposes. Typically,
protection for lenders, requiring the borrower pay a premium if
the builder basket begins with a fixed-dollar amount and “builds” as
loans are repaid within a certain period of time. While “hard call”
retained excess cash flow (or in some agreements, consolidated net
premiums (where term loan lenders receive the premium in the call
income) accumulates. Some loan agreements may require a
period for any prepayment, regardless of the source of funds or
borrower to meet a pro forma financial test to use the builder
other circumstances) are rare, “soft call” premiums (typically 1%)
basket. If the loan agreement also contains a financial maintenance
on prepayments made within the first year, or increasingly, the first

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 Skadden, Arps, Slate, Meagher & Flom LLP U.S. & European Leveraged Loan Agreements

six months, and made as a part of a refinancing or re-pricing of In the United States, “covenant-lite” loan agreements containing no
loans are common in the U.S. loan market. maintenance or ongoing financial covenants are increasingly
While call protection is relatively rare in the European market for common in large cap deals and have found their way into many
senior debt, soft call protections have been introduced in certain middle market deals. In certain transactions, the loan agreement
European loans which have been structured to be sold or syndicated might be “quasi-covenant-lite” meaning that it contains only one
in the U.S. market. Call protection provisions are more commonly maintenance financial covenant (usually a leverage covenant)
seen in the second lien tranche of European loans and mezzanine which is applicable only to the revolver and only when a certain
facilities (typically containing a gradual step down in the percentage of revolving loans are outstanding (15-25% is fairly
prepayment premium from 2% in the first year, 1% in the second typical, but has been as high as 37.5%). Covenant-lite (or quasi-
year, and no call protection thereafter). covenant-lite) loan agreements may nonetheless contain financial
ratio incurrence tests – such tests are used merely as a condition to
incurring debt, making restricted payments or entering into other
Voluntary Prepayments and Debt Buybacks specified transactions. Unlike maintenance covenants, incurrence
based covenants are not tested regularly and a failure to maintain
During the financial crisis, many U.S. borrowers amended existing the specified levels would not, in itself, trigger a default under the
loan agreements to allow for non-pro rata discounted voluntary loan agreement.
prepayments of loans that traded below par on the secondary
European loan agreements invariably include on-going financial
market. Although debt buybacks are much less frequent in the
maintenance covenants with a quarterly leverage ratio test being the
current strong syndicated loan market, the provisions allowing for
most common. Despite the trend of covenant-lite deals in the U.S.
such prepayments have become standard in U.S. loan agreements.
market, it is fair to say that they are currently less prevalent in the
U.S. loan agreements typically require the borrower to offer to European market although becoming more so, especially where it is
repurchase loans ratably from all lenders, in the form of a reverse intended that the loan will be syndicated in the U.S. market in
“Dutch auction” or similar procedure. Participating lenders are addition to the European market.
repaid at the price specified in the offer and the buyback is
In the United States, the leverage covenant historically measured all
documented as a prepayment or an assignment. Loan buybacks
consolidated debt of all subsidiaries of the borrower. Today,
may also take the form of a purchase by a sponsor or an affiliate
leverage covenants in U.S. loan agreements frequently apply only
through non-pro rata open market purchases. These purchases are
to the debt of restricted subsidiaries (those subsidiaries designated
negotiated directly with individual lenders and executed through a
by the borrower to be subject to financial and negative covenants).
form of assignment. Unlike loans repurchased by the borrower and
Moreover, leverage covenants sometimes only test a portion of
then cancelled, loans assigned to sponsors or affiliates may remain
consolidated debt – sometimes only senior debt or only secured
outstanding. Lenders often cap the amount that sponsors and
debt (and in large cap deals of top tier sponsors sometimes only first
affiliates may hold and also restrict the right of such sponsors or
lien debt). Lenders are understandably concerned about this
affiliates in voting the loans repurchased.
approach as the covenant may not accurately reflect overall debt
Similarly, in European loan agreements, “Debt Purchase service costs. Rather, it may permit the borrower to incur unsecured
Transaction” provisions have been included in LMA recommended senior or subordinated debt and still remain in compliance with the
form documentation since late 2008. The LMA standard forms leverage covenant. This is not a trend that has yet found its way
contain two alternative debt purchase transaction provisions – one over to Europe.
that prohibits debt buybacks by a borrower (and its subsidiaries),
In the event a U.S. loan agreement contains a leverage covenant, it
and a second alternative that permits such debt buybacks, but only
invariably uses a “net debt” test by reducing the total indebtedness
in certain specific conditions (for example, no default continuing,
(or portion of debt tested) by the borrower’s unrestricted cash and
the purchase is only in relation to a term loan tranche and the
cash equivalents. Lenders sometimes cap the amount of cash a
purchase is made for consideration of less than par).
borrower may net out to discourage both over-levering and
Where the loan agreement permits the borrower to make a debt hoarding cash (though the trend in U.S. loan agreements is towards
purchase transaction, to ensure that all members of the lending uncapped netting).
syndicate have an opportunity to participate in the sale, it must do
In Europe, the total net debt test is tested on a consolidated group
so either by a “solicitation process” (where the parent of the
basis, with the total net debt calculation usually including the debt
borrower or a financial institution on its behalf approaches each
of all subsidiaries (but obviously excluding intra-group debt).
term loan lender to enable that lender to offer to sell to the borrower
Unlike the cap on netted cash and cash equivalents in some U.S.
an amount of its participation) or an “open order process” (where
loan agreements, European borrowers net out all cash in calculating
the parent of the borrower or financial institution on its behalf
compliance with the covenant.
places an open order to purchase participations in the term loan up
to a set aggregate amount at a set price by notifying all lenders at With strong sponsor backing, borrowers have increasingly eased the
the same time). restriction of financial covenants by increasing the amount of add-
backs included in the borrower’s EBITDA calculation. Both U.S.
Both LMA alternatives permit debt purchase transactions by the
and European loan documents now include broader and more
sponsor (and its affiliates), but such purchasers are subject to the
numerous add-backs including transaction costs and expenses,
disenfranchisement of the sponsor (or its affiliate) in respect the
restructuring charges, payments to sponsors and certain
purchased portion of the loan.
extraordinary events. Recently many borrowers have negotiated
add-backs (generally to the extent reasonably identifiable and
Financial Covenants factually supportable) for projected and as-yet unrealised cost
savings and synergies. While lenders have accommodated savings
Historically, U.S. and European leveraged loan agreements and synergies add-backs, increasingly such add-backs are capped at
contained at least two maintenance financial covenants: total a fixed amount or certain percentage of EBITDA (15% in the
leverage; and interest coverage, typically tested at the end of each United States, 5-20% in Europe).
quarter.

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Equity Cures of Financial Covenants waiver requiring the unanimous consent of lenders, if the “required
lenders” (typically more than 50% of lenders by commitment) have
For a majority of sponsor deals in the United States, loan consented. Other reasons a borrower may exercise “yank-a-bank”
agreements that contain a financial maintenance covenants also provisions are when a lender has a loss of creditworthiness, has
contain the ability for the sponsor to provide an “equity cure” for defaulted on its obligations to fund a borrowing or has demanded
non-compliance. The proceeds of such equity infusion are usually certain increased cost or tax payments. In such circumstances, the
limited to the amount necessary to cure the applicable default, and borrower may facilitate the sale of the lender’s commitment to
are added as a capital contribution (and deemed added to EBTIDA another lender or other eligible assignee. In most European loan
or other applicable financial definition) for this this purpose. agreements, yank-a-bank provisions are also routinely included
Because financial covenants are meant to regularly test the financial (described as such or as “Defaulting Lender” provisions) and are
strength of a borrower independent of its sponsor, U.S. loan similar in mechanism. However, the threshold vote for “required
agreements increasingly place restrictions on the frequency (usually lenders” is typically defined as at least 66.67% of lenders by
no more than two fiscal quarters out of four) and absolute number commitment.
(usually no more than five times over the term of the credit facility)
of equity cures. Snooze-You-Lose
In Europe, equity cure rights have been extremely common over the
last few years. As in the United States, the key issues for In addition to provisions governing the required votes of lenders,
negotiation relate to the treatment of the additional equity, for most European loan agreements will also contain “snooze-you-
example, whether it should be applied to increase cash flow or lose” provisions, which favour the borrower when lenders fail to
earnings, or otherwise reduce indebtedness. Similar restrictions respond to a request for an amendment, consent or waiver. Where
apply to equity cure rights in European loan documents as they do a lender does not respond within a specific time frame, such
in the United States in respect of the frequency and absolute number lender’s vote or applicable percentage is discounted from the total
of times an equity cure right may be utilised – however, in Europe when calculating whether the requisite vote percentage have
the frequency is typically lower (and usually, an equity cure cannot approved the requested modification. Similar provisions are rare in
be used in consecutive periods) and is subject to a lower overall cap U.S. loan agreements.
(usually, no more than two or three times over the term of the
facility). From a documentation perspective, it is also important to
note that there is no LMA recommended equity cure language.
Transfers and Assignments

In European loan agreements, lenders may assign their rights or

Part C – Syndicate Management otherwise transfer by novation their rights and obligations under the
loan agreement to another lender. Typically, lenders will seek to
rely on the transfer mechanism, utilising the standard forms of
Voting Thresholds transfer certificates which are typically scheduled to the loan
agreement. However, in some cases, an assignment may be
In U.S. loan agreements, for matters requiring a vote of syndicate necessary to avoid issues in some European jurisdictions which
lenders holding loans or commitments, most votes of “required would be caused by a novation under the transfer mechanic
lenders” require only a simple majority of lenders (that is, more (particularly in the context of a secured deal utilising an English-
than 50% of lenders by commitment size) for all non-unanimous law security trust, which may not be recognised in some European
issues. In European loan agreements, most votes require 66.67% jurisdictions).
or more affirmative vote of lenders by commitment size. In some, Generally, most sub-investment grade European deals will provide
but not all, European loan agreements, certain votes that would that lenders are free to assign or transfer their commitments to other
otherwise require unanimity may instead require only a “super- existing lenders (or an affiliate of such a lender) without consulting
majority” vote, ranging between 85-90% of lenders by the borrower, or free to assign or transfer their commitments to a
commitment size. Such super majority matters typically relate to pre-approved list of lenders (a white list), or not to a predetermined
releases of transaction security or guarantees, or an increase in the list of lenders (a blacklist). For stronger borrowers in both Europe
facilities. and the United States, the lenders must usually obtain the consent
“Unanimous” decisions in U.S. loan agreements are limited to of the borrower prior to any transfer or assignment to a lender that
fundamental matters and require the consent only of affected is not an existing lender (or affiliate).
lenders (and are not, therefore, truly unanimous), while in European In the United States, the LSTA has recommended “deemed consent”
loan agreements (except where they may be designated as a super of a borrower where a borrower does not object to proposed
majority matter), decisions covering extensions to payment dates assignments within five business days. Similar to stronger
and reductions in amounts payable (even certain mandatory European borrowers and sponsors who are able to negotiate a
prepayment circumstances), changes to currencies and “blacklist”, stronger borrowers in the United States, or borrowers
commitments, transfer provisions and rights between lenders all with strong sponsors, often negotiate a “DQ List” of excluded
require the unanimous consent of lenders (not just those affected by (disqualified) assignees. Recently in the United States, large cap
the proposed changes). borrowers have pushed for expansive DQ lists and the ability to
update the list post-closing (a development not seen in European
Yank-a-Bank loan agreements). In both the European and US contexts, the DQ
List or blacklist helps the borrower avoid assignments to lenders
U.S. loan agreements often contain provisions allowing the with difficult reputations.
borrower to remove one or more lenders from the syndicate in In the U.S. market, exclusion of competitors and their affiliates is
certain circumstances. A borrower may, for example remove a also negotiated in the DQ List. In European loan agreements, the
lender where such lender refuses to agree to an amendment or LMA recommended form assignment and transfer language

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 Skadden, Arps, Slate, Meagher & Flom LLP U.S. & European Leveraged Loan Agreements

provides that existing lenders may assign or transfer their