International Loan Documentation

International LoanDocumentation

Sue Wright

I N T E R N AT I O N A L L O A N D O C U M E N TAT I O N

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SUE WRIGHT

International LoanDocumentation

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© Sue Wright 2006

All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission.

No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP.

Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages.

The author has asserted her right to be identified as the author of this work in accordance with the Copyright,Designs and Patents Act 1988.

First published in 2006 byPALGRAVE MACMILLANHoundmills, Basingstoke, Hampshire RG21 6XS and175 Fifth Avenue, New York, N.Y. 10010Companies and representatives throughout the world.

PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin’s Press, LLC and of Palgrave Macmillan Ltd.Macmillan® is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries.

ISBN-13: 978–1–4039–4279–1ISBN-10: 1–4039–4279–X

This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources.

A catalogue record for this book is available from the British Library.

Library of Congress Cataloging-in-Publication Data

Wright, Sue, solicitor.International loan documentation / Sue Wright.

p. cm. — (Finance and capital markets series)Includes bibliographical references and index.ISBN 1–4039–4279–X (cloth)1. Loans, Foreign – Law and legislation. 2. Commercial loans – Law and

legislation. 3. Loans, Foreign – Law and legislation – Great Britain.4. Commercial loans – Law and legislation – Great Britain. I. Title. II. Series.

K1094.3.W75 2005658.15�242—dc22 2005044651

10 9 8 7 6 5 4 3 2 115 14 13 12 11 10 09 08 07 06

Printed and bound in Great Britain byAntony Rowe Ltd, Chippenham and Eastbourne

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For Dave, Amy, Leo, Hilary and Claude

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vii

List of Statutes, Regulations, Directives and Conventions xi

List of Cases xiv

Acknowledgements xvi

Introduction 1

General Introduction 1Section 1: Principal Types of Loans 3Section 2: Loan Agreement Overview 7Section 3: LIBOR-Based Lending 13Section 4: Scope of the Loan Agreement 17Section 5: Asset and Project Finance 24Section 6: Quasi Security and Financial Indebtedness 28

PART I Administrative Provisions

1 Interpretation 35

Clause 1: Definitions and Interpretation—Section 1—An Introduction 35Section 2—The LMA Definitions 38

2 The Facility 56

Clause 2: The Facility 56Clause 3: Purpose 59Clause 4: Conditions of Utilization 60

Contents

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3 Utilization 67

Clause 5: Utilization 67Clause 6: Optional Currencies 70

4 Repayment, Prepayment, and Cancellation 74

Clause 7: Repayment 74Clause 8: Prepayment and Cancellation 74

5 Costs of Utilization 80

Clause 9: Calculation of Interest 80Clause 10: Interest Periods 83Clause 11: Changes to Calculation of Interest 87Clause 12: Fees 91

6 Additional Payment Obligations 93

Clause 13: Tax Gross-up and Indemnities—Introduction 93Clause 13: Tax Gross-up and Indemnities 94Clause 14: Increased Costs 100Clause 15: Indemnities 104Clause 16: Mitigation 105Clause 17: Costs and Expenses 105

PART II Guarantee, Representations, Undertakings, and Events of Default

7 Guarantee 109

Clause 18: Guarantee and Indemnity 109

8 Representations, Undertakings, and Events of Default 117

Clause 19: RepresentationsSection 1—An Introduction 117Section 2 —The LMATerm Loan Representations 124

Clause 20: Information Undertakings 137Clause 21: Financial Covenants 141Clause 22: General Undertakings

Section 1—The LMA Undertakings 147Section 2—Other Common Undertakings 158

Clause 23: Events of DefaultSection 1—Introduction 165Section 2—The LMA Events of Default 168

C O N T E N T Sviii

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C O N T E N T S ix

Part III Boilerplate and schedules

9 Changes to Parties 187

Clause 24: Changes to LendersSection 1—Methods of Transfer 187Section 2—Transfers of Secured Loan 196Section 3—The LMA Term Loan 201

Clause 25: Changes to the Obligors 206

10 The Finance Parties 210

Clause 26: Role of the Agent and the Arranger 210Clause 27: Conduct of Business by

the Finance Parties 217Clause 28: Sharing among Finance Parties 217

11 Administration 221

Clause 29: Payment Mechanics 221Clause 30: Set Off 224Clause 31: Notices 224Clause 32: Calculations and Certificates 225Clause 33: Partial Invalidity 227Clause 34: Remedies and Waivers 227Clause 35: Amendments and Waivers 228Clause 36: Counterparts 229

12 Governing Law and Enforcement 230

Clause 37: Governing Law 230Clause 38: Enforcement 230

13 Schedules 233

Schedule 1: Parties 233Schedule 2: Conditions Precedent 233Schedule 3: Requests 241Schedule 4: Mandatory Cost Formula 241Schedule 5: Form of Transfer Certificate 242Schedule 6: Accession Letter 243Schedule 7: Form of Resignation Letter 244Schedule 8: Form of Compliance Certificate 245Schedule 9: Existing Security 246Schedule 10: Form of Confidentiality Undertaking 246Schedule 11: Timetables 246Schedule 12: Legal Opinions 247

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x

Appendix 1 Some English Law Concepts 259

Section 1: Some Basic Concepts 261Section 2: Security 271Section 3: Guarantees 281

Appendix 2 Glossary of Terms Used in International Lending 286

Bibliography 308

Index 310

C O N T E N T S

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xi

ENGLISH PROVISIONS

1856Mercantile Law Amendment Act 1856s5 285

1878–82Bills of Sale Acts 1878 and 1882 276

1890Partnership Act 1890s3 48

1925Law of Property Act 1925s94 280s94(2) 281s136 275

1967Misrepresentation Act 1967s3 268

1971Powers of Attorney Act 1971s1 267

1977Unfair Contract Terms Act 1977s2(2) 268s3 268s27 268

List of Statutes,Regulations, Directives

and Conventions

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L I S T O F S TAT U T E Sxii

1979Capital Gains Tax Act 1979s86 157

1985Companies Act 1985s35(A) 234s150 294s151 295s396(1) 276s409 277s427 157s741(2) 304

1986Insolvency Act 1986 286s123 284 and 297s214 307s238 284s239 300Insolvency Rules 1986Rule 12.3(2A) 48

1988Income and Corporation Taxes Act 1988s209 48

1989Law of Property (Miscellaneous Provisions) Act 1989s1(2) 267

1999Contracts (Rights of Third Parties) Act 1999 55 and 191s2 55

2000Finance Act 2000 48

2002Enterprise Act 2002s252 273

2003Financial Collateral Arrangements (No 2) Regulations 2003 278

EC PROVISIONS

EC Regulation on Insolvency Proceedings—Regulation 1346/2000 236

EC Insurance Mediation Directive (2002/92/EC) 251

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INTERNATIONAL CONVENTIONS

Brussels Convention of 1926 relating to Maritime Liens and Mortgages 279Geneva Convention of 1948 on International Recognition of Rights in

Aircraft 2791958 United Nations Convention on the Recognition and Enforcement

of Foreign Arbitral Awards (the New York Convention) 231Rome Convention on the Law Applicable to Contractual Obligations 1980 301Cape Town Convention on International Interests in

Mobile Equipment 2001 279

L I S T O F S TAT U T E S xiii

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Abu Dhabi National Tanker co v Product Star Shipping (No 2) (1993) 1 Lloyds Rep 397 258

Argo Fund Ltd. (The) v. Essar Steel Ltd (2005) EWHC 600 189Ashborder BV v Green Gas Power Ltd (2004) EWHC 1517 153, 156 and 274

Badeley v Consolidated Bank (1888) LR 38 Ch D 238 48Bank of Credit and Commerce International SA (In liquidation)

No 8 (also known as Morris v Agrichemicals Ltd) (1998) AC 214 279BNP Paribas SA v Yukos Oil Co (2005) EWHC 1321 180British Waggon Co v Lea & Co (1879–80) LR 5 QBD 149 191

Carlill v Carbolic Smoke Ball Company (1892) 2 QB 484 189Central London Property Trust Ltd v High Trees House Ltd (1947) KB 130 293Charge Card Services Re (1987) Ch 150 279Chemco Leasing SpA v Rediffusion (1987) 1 FTLR 201 283China and South Seas Bank Ltd. v Tan (1990) 1 AC 536 112Clayton’s Case See Devagnes v NobleConcord Trust v The Law Debenture Corp plc (2005) 1 WLR 1591 180 and 258Cosslett (Contractors) Ltd Re (1998) Ch 495 273 and 274Customs & Excise Commissioners v Broomco (1984) Ltd formerly

Anchor Foods Ltd (2000) BTC 8035 176

Dearle v Hall (1828) 3 Russ 1 276Devagnes v Noble (1816) 1 Mer 572 (Clayton’s Case) 110Director General of Fair Trading v First National Bank Plc (2002) 1 AC 481 82Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd (1915) AC 79 300

Esso Petroleum Co Ltd v Hall Russell & Co Ltd (the Esso Bernicia) (1989) AC 643 285

xiv

List of Cases

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Fallon (Morgan’s Executors) v Fellows (Inspector of Taxes) 2001 BTC 438 157

General Produce Co v United Bank Ltd (1979) 2 Lloyds Rep 255 282Goldsoll v Goldman (1915) 1 Ch 292 227 and 253Griffith v Tower Publishing (1897) 1 Ch 21 191

Heald v O’Connor (1971) 1WLR 282

Holme v Brunskill (1877–78) LR 3 QBD 495 112

Illingworth v Houldsworth see Yorkshire Woolcombers

Kelly v Cooper (1993) AC 205 211Kleinwort Benson Ltd v Malaysian Mining Corp (1989) 1 AER 785 283

Lonergan ex p Shell Re (1876–77) LR 4 Ch D 789 48Lordsvale Finance plc v Bank of Zambia (1996) QB 752 83Ludgate Insurances Co Ltd v Citibank (1998) Lloyds Rep 221 258

Manning v AIG Europe Ltd (2004) EWHC Ch 1760 114Morris v Agrichemicals See Bank of Credit and CommerceMytravel Group Re (2004) EWHC 2741 157

Polak v Everett (1875–76) LR 1 QBD 669 112

Rolled Steel Products (Holdings) Ltd v British Steel Corp &others (1986) Ch 246 284

Shierson v Vlieland-Boddy (2004) EWHC 2752 (Ch) 236Slavenburg’s Bank NV v Intercontinental Natural Resources Ltd (1980)

1AER 955 277Spectrum Plus Ltd (2005) 3 W.L.R. 58 274Sumitomo Bank Ltd v Banque Bruxelles Lambert SA (1997)

1 Lloyds Law Report 487 210Swire v Redman (1875–76) LR 1 QBD 536 112

Thomas v Thomas (1842) 2 QB 851 266Tolhurst v Associated Portland Cement Manufactures (1900) Ltd.

(1903) AC 414 191Triodos Bank NV v Dobbs (2005) EWCA Civ 630 112

Wulff v Jay (1871–72) LR 7 QB 756 112

Yorkshire Woolcombers Association Re (also known as Illingworth vHouldsworth) (1903) 2 Ch 284 and (1904) AC 355 274

L I S T O F C A S E S xv

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This book was inspired by the questions and comments of the many delegates whohave attended my loan documentation courses over the years. Their questions,often difficult and insightful, and based on their widely differing backgrounds andareas of expertise, have been indispensable in helping to widen my own perspectiveon the documentation, and in highlighting issues of concern. My thanks to thosemany delegates who have inspired me to investigate those issues which are dis-cussed in this book.

My thanks also go to the partners, staff and clients at Norton Rose, where Iobtained my practical experience of international finance, without which this bookwould have been impossible.

Thanks are also due to those who have been kind enough to spare their valuabletime to review parts of the manuscript of this book at its various stages of develop-ment, and to provide comments and suggestions. In particular I would like to thankStaffan Avenius (Nordea Bank), Anne-Marie Godfrey (Deacons), Kenneth Gray(Norton Rose) Alexey Ievlev (ING Bank), Jonathan Porteous (Stevens and BoltonLLP), Richard Powell (Mundays) and Paul Rogerson (ABN Amro) for their kindassistance. The comments, information and support provided have been enor-mously helpful in getting this book from conception to completion.

Finally, of course, I would like to thank the Loan Market Association for theirpermission to use their primary form documents in this text, and the Dutch BankersAssociation, for consenting to the use of their ‘parallel debt’ wording.

Sue Wright 15th October 2005.PS To Leo, thanks too for your comments, which will be included if a humorous

version of this book is ever commissioned.

xvi

Acknowledgements

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GENERAL INTRODUCTION

How to use this book

A word of caution is necessary at the outset. This book seeks to give readers thetools to enable them to negotiate loan agreements efficiently (i.e. with minimumexpense in terms of time and money) and effectively (i.e. to result in a documentwhich closely suits their corporate needs, whether they are borrower or lender). Forthis book to succeed in its aim it must be used appropriately—that is, as an aid to,and not as a substitute for, proper understanding of the commercial position of theparties. Readers need to keep in mind that loan agreements are used in widelydiffering commercial situations. Some examples (among the innumerablepossibilities) are

� secured loans made to start-up companies owned by entrepreneurs;

� structured loans to special purpose companies, designed to achieve a particulartax effect or for the purpose of a particular project;

� loans to investment grade corporates designed to provide them with liquidity.

The basic precedent for all these situations will be remarkably similar, but thechanges to that precedent which are appropriate in each case will vary enormously.Comments which are made in this book will only be appropriate in some (usually aminority) of the circumstances in which a loan agreement will be used. One sizedoes not fit all. Moreover, there will be many comments which ought to be made inspecific transactions which are not made in this book. The comments included arenot intended to be (nor can they be) exhaustive. The comments in the book areintended to give the reader a better understanding of what the loan agreement does

1

Introduction

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and does not say, and to provide readers with a full set of tools with which to ensurethat the final agreement meets their commercial objectives.

However, the most important commercial objective of the parties to a loantransaction is to reach an agreement on the documents quickly (time is money) andin a way which gives all involved confidence in their ongoing relationship (anddoes not result in disproportionate legal fees). If this is to be achieved, parties mustidentify the points they wish to make with care, and only make comments which arecommercially significant in the context of the particular transaction. Failure to dothis will backfire as the counterparty will quickly lose patience, probably resultingin a negotiation which fails to achieve the parties’ real commercial objectives.

Readers are therefore urged to ensure that they do not lose sight of the ultimatecommercial objectives, and that they use this book only as an aid to better under-standing of the agreements, not as a ‘checklist’ of comments—a purpose for whichthis book was not designed and is not appropriate.

What should I be looking for in this loan agreement? Why does it have to be so long?

This introduction sets the scene for the discussion of the loan agreement by

� describing the main categories of loans (in section 1);

� providing an overview of the loan agreement (in section 2);

� looking at LIBOR-based lending (in section 3);

� discussing the scope of the agreement, including who can be affected by it, andwhose activities can have an effect under it (in section 4);

� providing a brief overview of asset and project finance (in section 5);

� describing (in section 6) various commercial arrangements which, while notamounting to borrowing or giving security in a legal sense, amount to thecommercial equivalent and therefore have to be treated in a similar manner forthe purposes of the loan agreement.

This book uses the loan agreements that are published by the Loan MarketAssociation (‘LMA’)1 as the starting point for its discussions. In general, the LMArecommended form for a term loan is used as the basis for discussion, and isreferred to in this book as the ‘LMA Term Loan’. The book follows the structure andclause numbering of the LMA Term Loan, and references to clauses, unless statedotherwise, are to clauses of the LMA Term Loan. The text also comments on situa-tions and documents which differ from the LMA Term Loan. Such comments arehighlighted by shaded text.

G E N E R A L I N T R O D U C T I O N2

1 This association exists to promote the trading of interests in loans. See further paragraph 1 of section 2of this introduction on p. 8.

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SECTION 1: PRINCIPAL TYPES OF LOANS

Loans can be classified with reference to a number of characteristics. The principalcategories are discussed here.

1 Classification on the basis of availability

Perhaps the main characteristic for categorizing loans is the issue of availability.

1.1 Term loan

A term loan is a loan which is made available to the borrower on the basis that it willbe repaid by specified instalments over a set period of time. Once repaid it cannotbe redrawn. It is generally used for a specific financing requirement such as an assetpurchase. It is a long-term debt on the borrower’s balance sheet.

1.2 Demand loan

A facility which the lenders make available but which the lenders are able to cancelor require repayment of at any time (or ‘on demand’) may be called an ‘uncommit-ted facility’ (because the lenders are not committed to maintain its availability) or a‘demand facility’. Facilities of this type do not require lengthy documentation asthere is no need for undertakings or Events of Default, the lenders being free to ter-minate the facility at will. The lack of a commitment by the lenders is a significantdisadvantage to a borrower. On the other hand, the capital adequacy treatment(Box 0.1) of such facilities, while they are not drawn down (as well as committedfacilities with a maximum duration not exceeding 364 days) may result in thembeing cheaper for a borrower than committed facilities of a longer duration.

P R I N C I PA L T Y P E S O F L O A N S 3

2 This will not be the case under Basel II (see Box 1.35 on p. 102) which gives a risk weighting to theundrawn portion of uncommitted facilities although the risk weighting will remain lower than that whichapplies to the drawn portion of a committed facility.

BOX 0.1

Under the Basel Accord (see Box 0.11 on p. 16), banks’ capital must equal at least 8% of risk-weighted assets. Different types of facility have different risk weightings. Theundrawn portion of an uncommitted facility (and of a committed facility of less than364 days’ duration) currently have no risk weighting2 and are therefore cheaper toborrowers than longer committed facilities.

1.3 Overdraft facility

An overdraft facility is a facility that the borrower may draw on, repay and thendraw again. This is as distinct from a term loan which, once the borrower hasrepaid, cannot be reborrowed. An overdraft facility is used for situations where the

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borrower has fluctuating financing requirements (e.g. for working capital). Byhaving the ability to repay and reborrow, the borrower is able to ensure that levelsof borrowing at any time do not exceed the financial requirements of the borrowerat that time. An overdraft facility may be committed or uncommitted. In a commit-ted facility, the lenders would commit to lend up to a specified sum for a givenperiod, for example, 12 months. The borrower could draw up to the limit at anytime, repay as it wished and have the comfort of being able to draw again, up to thelimit, at any time within the committed period.3 If the facility is uncommitted or ifthe period of the commitment is short then the facility will be a current liability onthe borrower’s balance sheet, with the implications that it carries for the borrower’sliquidity. Given its short-term (and in some cases, uncommitted) nature, lengthydocumentation will not be required.

1.4 Revolving credit

A revolving credit is a committed facility which operates in a similar way to anoverdraft (in that it may be repaid and reborrowed) but is of longer term. It is a long-term debt on the borrower’s balance sheet. The documentation will be very similarto that for a term loan. The maximum amount available may remain the samethroughout the facility period or it may reduce over time.

2 Classification on the basis of the lenders’ credit decision

The second key characteristic of a loan is the question of the type of credit risk whichthe loan represents for the lenders. That is, what are they relying on in their assess-ment of the borrower’s ability to repay the loan? Borrowers repay loans either byselling assets; by using income generated from a particular asset or project; or out oftheir general corporate resources. While this is a very broad generalization, theseare the distinctions which underlie the classification of loans as ‘corporate finance’,‘asset finance’ and ‘project finance’.

2.1 Corporate finance

A corporate finance transaction (when the expression is used in this context, not in itswider meaning which encompasses corporate financings based on the capital mar-kets) is one in which there is neither a specific asset nor a specific stream of incomeon which the lenders, credit decision is based, but rather they are relying on the gen-eral financial position of the borrower. This is also known as ‘balance sheet lending’.

2.2 Asset finance

An asset finance transaction is one in which the future value of the asset concernedis a key factor in the lenders’ credit risk. This, of course, has major implications forthe security and the documentation, as discussed in section 5 of this introduction.

I N T R O D U C T I O N S E C T I O N I4

3 However, the borrower will need to pay a commitment fee to the lenders for any part of the facility,which the borrower is not using at any time, and which the lenders remain committed to lend.

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3 Classification on the basis of the purpose of the loan

The third major attribute of a loan for classification purposes is the question of itspurpose. While there are as many purposes as there are borrowers there are certaincategories which are commonly used to describe loans.

3.1 Acquisition finance

Acquisition finance is finance used to acquire something, usually a company.

3.2 Bridge finance

Bridge finance is finance made available to bridge a gap. For example, a companymay require financing for a corporate acquisition. It may intend to raise the bulk of

P R I N C I PA L T Y P E S O F L O A N S 5

2.3 Project finance

A project finance transaction is one in which the income generated by the project isa key factor in the lenders’ credit decision. It is described in more detail in section 5of this introduction.

In the context of asset and project financing, it should be noted that the lendersare often taking a mixture of asset risk, project risk, and corporate risk. For example,lenders providing ship finance (which is regarded as asset finance) will not onlyassess the future value of the ship. They will often also look at the operator’sbalance sheet and financial ratios and at the likely income which the ship willgenerate. In other words, the lenders will take asset, project, and corporate riskwithin a facility which is traditionally regarded as an asset finance transaction.

2.4 Limited recourse financing

Some transactions (most commonly project finance) are put together on a ‘limitedrecourse’ basis. This involves the lenders accepting that they will only be repaid outof specified assets. This may be done by having a contractual limitation on recourse(see Box 0.2).

Alternatively, it may be done structurally, by establishing a special purposeentity which will only own the assets (e.g. project assets and income) to which thelenders are intended to have recourse, with the lenders lending to that entity.

BOX 0.2

Under a contractual limitation on recourse, the lenders agree with the borrower only topursue certain assets, such as income from the project in question, and that if theincome in question is insufficient, the lenders will suffer a loss and will not be able toclaim further repayment from the borrower.

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that finance through issuing bonds on the capital markets but need interim financeto cover the period during which circulars are issued to the public, etc. A bridgefinance loan (which is usually high margin, short-term debt provided by the rela-tionship bank) could bridge the gap.

3.3 Mezzanine finance or venture capital

Mezzanine finance or venture capital is finance used where traditional finance isnot available in sufficient amounts to meet the borrower’s needs. Generally compa-nies meet their financing requirements by a mixture of debt (borrowing from thirdparties) and equity (the company’s own money, either as invested by shareholdersor as profits which would otherwise be available to shareholders). Where the level ofdebt is high compared to the amount of equity, the company is described as ‘highlyleveraged’ or ‘highly geared’. Where equity plus the amounts available from tradi-tional lenders will be insufficient to meet the need, borrowers may approachmezzanine financiers to make up the difference. These financiers specialize in pro-viding funds for a particular project, such as a management buy out or a majoracquisition, which supplement moneys available from traditional lenders for thatproject. The finance they provide will be subordinate to the traditional loan. It willcarry more risk and therefore the margin will be higher. Generally the mezzaninefinancier will also require some form of ‘equity kicker’—that is, in addition tothe margin they will require a share in any profits from the transaction. The financemay be provided by way of subordinated debt or by way of preference shares.

3.4 Refinancing

Refinancing is finance made available to repay existing debt. This may be done toachieve less onerous covenants or more favourable margins, to reflect new corpo-rate structures, to increase leverage, as part of a restructuring following a default, orfor numerous other reasons.

3.5 Mismatch facilities

These are facilities which seek to match the difference between what is available toa borrower from a given source and what the borrower needs. For example, in asecuritization a borrower may require a mismatch facility to bridge the gap betweendates of payment of receivables and due dates on commercial paper issued.

3.6 Swingline facilities

Swingline facilities are facilities which are available to meet short-term liquidityneeds (such as to replace funds which, but for a market disruption, would havebeen available to a borrower by the issue of commercial paper). They will be avail-able with minimum (same day) notice and only to cover short-term needs. Theyoften have a maximum period for advances to be outstanding of 3–5 days.

I N T R O D U C T I O N S E C T I O N I6

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4 Classification on the basis of the number of lenders

4.1 Syndicated loans

Syndicated loans are made available by a number of lenders who all join togetherto make the loan. With the exception of certain fees, which are for the benefit ofindividual lenders in the syndicate, the lenders have equal rights (or rather, rightsproportionate to the amount each has lent—i.e. pro rata) against the borrowerunder a single loan agreement.

4.2 Club loans

These are syndicated loans where there are few syndicate members. The lenders,who are called a club and who will participate in the loan, are known from the out-set and there will be no need to market the facility to the wider banking communityas with a large syndicate.

4.3 Bilateral facilities

Bilateral facilities are made by a single lender to a single borrower.

5 Miscellaneous categories

5.1 Sovereign debt

This is debt made available to a sovereign entity.

5.2 Export credit

Export credit is debt that is supported in some way (e.g. by some form of guaranteeof payment) by a government in order to encourage exports from their country.

5.3 Acceptance credit facility

Under an acceptance credit facility, instead of the lenders agreeing to lend moneyto the borrower, they agree to accept bills of exchange on behalf of the borrower. Theterms of the facility document will be similar to the term loan with changes reflect-ing the mechanical differences in the forms of financial support.

SECTION 2: LOAN AGREEMENT OVERVIEW

The loan agreement is generally produced by the lenders’ lawyer. Its purpose is toensure that the lenders have all the rights and powers they require, bearing inmind that, at least in a simple, single drawdown, term loan the lenders will havehanded over a large sum of money and received in exchange, this document (plusperhaps security). Therefore, by custom, the lenders have what is a major negotiat-ing advantage—the right to produce the first draft of the agreement.

L O A N A G R E E M E N T O V E R V I E W 7

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1 The Loan Market Association recommended forms

In London, LMA4 has produced recommended forms for unsecured, corporate riskterm loans and revolvers.5 These are now widely accepted as a common negotiatingplatform, albeit often with variations reflecting a law firm’s own preferences.

The first LMA documents were introduced in 1999 with a number of aims,including, in particular, the aim of promoting efficiency in the original negotiationof the loan, and, subsequently, on its transfer, to facilitate review of the agreementby proposed investors. The recommended forms were negotiated and agreed byrepresentatives of borrowers, lenders, and law firms, with the aim of producingdocuments which were not overly favourable to any party. To a large extent, thesedocuments have been successful in their aims and it has become market practice touse these documents as a basis for loan documentation in the London market andbeyond. The LMA recognized on launch of the recommended forms that some pro-visions would need to be negotiated on a case-by-case basis. They therefore dividedthe loan into ‘hard’ and ‘soft’ provisions, with the soft provisions (representations,undertakings, financial covenants, events of default, transferability, and conditionsprecedent) being put forward simply as a starting point, which would neednegotiation on a case-by-case basis. The remainder of the agreement (the ‘hard’provisions) was expected not to require adjustment in most cases.

A number of adjustments to the ‘soft’ provisions of the recommended form willneed to be made in any given transaction.

� Some parts of the recommended form have been left blank as there is no standardmarket practice for these provisions. Such provisions need to be negotiated on aone-off basis. Examples are the financial covenants and the material adversechange clause.

� If the loan is to be secured then a number of the provisions may be drawn moretightly than for the LMA Term Loan which assumes an unsecured loan.

� The document will need tailoring to reflect the credit decision—that is, additionalrepresentations, undertakings, and events of default are likely to be necessary,reflecting specific concerns relating to the borrower’s business. In particular, if thelenders are taking any project or asset risk in the transaction, substantial additionswill be needed as discussed in section 5 of this introduction.

� The lenders may have certain policy requirements, for example, as to transfer-ability which they wish to have incorporated.

� The borrower may have certain policy requirements, for example, as to agreeingcross acceleration clauses only, which they have agreed with the lenders.

I N T R O D U C T I O N S E C T I O N 28

4 The LMA was established in 1996 as a forum for dealing with issues relating to the syndicated loanmarket.

5 The forms available are for multicurrency term, revolving, or combined term and revolving, facilities.There are also options, discussed at the end of clause 5, for a swingline (Dollars or Euros) and for a letterof credit option.

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2 Loan agreement structure

2.1 Function of the clauses

Each provision of the agreement is of one of three types:

� first, there are the administrative provisions—dealing with calculation ofinterest, mechanics of advances, repayment, and the like;6

� second are the business critical provisions (Box 0.3) such as representations,undertakings, and events of default;7

� third, there are the boilerplate clauses dealing with important issues such asindemnities, notices, jurisdiction, changes in circumstances (such as increasedcosts), and the relationship between the lenders (such as the agency clause).8


6 In the LMA Term Loan, these provisions are in clauses 1–17.7 In the LMA Term Loan, these provisions are in clauses 18–23.8 In the LMA Term Loan, these provisions are in clauses 24–38.

BOX 0.3

It is in the business critical provisions that most negotiation should usually focus sincethis is the part of the agreement which will have a significant ongoing effect on how theborrower conducts its business, and how much power the lenders can wield.

BOX 0.4

In other words, the borrower is being asked to state that certain facts are true (in therepresentations), to prove that they are true (in the conditions precedent), and thelenders are also checking that they are true (in the due diligence).

2.2 Stages of the transaction

The business critical provisions of the agreement seek to protect the lenders at threedifferent stages of the transaction.

(a) Before drawing. First, the document protects the lenders, before any money islent, through those provisions which operate to release the lenders from their obligationsto advance funds. At this stage, the lenders have three types of protection operating atthe same time: the due diligence (which the lender and their lawyer will conduct prior tosignature of the loan agreement), the borrower’s representations (in clause 19 of theLMA Term Loan), and the conditions precedent (in clause 4 of the LMA Term Loan).

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This triple layer of protection is designed to minimize the risk of error. As apractical issue it means that the conditions precedent, representations, and legalopinions duplicate each other to a large extent, so that if adjustments are made toone area in a loan agreement, it will often be necessary to make correspondingadjustments to the other areas.

(b) After drawing. Second, the document protects the lenders after the money hasbeen lent and while it is outstanding. This is the remit of the undertakings (or covenants).Their role is to ensure that the status quo (or something near to that) is maintained duringthe life of the loan and that the lenders are given the information they need (Box 0.5).

(c) Termination. Third, the document sets out the circumstances which the lendersregard as changing the position so completely that they require the right to be repaidimmediately. These are the Events of Default10—which give the lenders the right to accel-erate the loan. In practice, often the result of an Event of Default is a renegotiation notacceleration, but it is the existence of the right to accelerate which gives the lenders thenecessary leverage to renegotiate.

3 Key concerns

3.1 Borrower’s concerns

A borrower’s key concerns in reviewing the documents are:

(a) control

� to what extent do they remain free to conduct their business as they see fitand to what extent do they require consent for their activities?

� if they need consent (see Box 0.6) for some acts—what level of consent isneeded (e.g. Majority Lenders’ consent or unanimous consent of all lenders)and might any requirement for consent impose unacceptable delays in theiraction (e.g. do they need freedom to act if there is no response to a requestwithin a specified period of days)?

� what companies within their group are restricted?11


BOX 0.5

Except in limited recourse transactions such as some project finance, it makes littledifference whether any particular issue is dealt with as an undertaking or as an Eventof Default since a breach of undertaking is an Event of Default.9 The tradition is toinclude as undertakings those things which the borrower can promise (e.g. not to grantsecurity) and as Events of Default those which it cannot (e.g. material adverse change).

9 There are often grace periods before breaches of undertakings become Events of Default, but thesecould equally be built directly into the Events of Default.

10 Or compulsory prepayment events—see clause 8.2.11 See discussion on the scope of the agreement at section 4 of this Introduction at pp. 17–24.

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(b) certainty of funds

� in what circumstances might the loan cease to be available?

� are all those circumstances within the borrower’s control (e.g. change ofownership of the borrower12)?

� are all those circumstances objectively tested or are some matters of opinion,and, if so, by what standards can an opinion be tested? For example,‘material’ or ‘reasonable’;13

� should some of those events more properly result in a change in margin ratherthan a right to accelerate, for example, minor breach of a financial ratio.14

3.2 Lenders’ concerns

Lenders’ key concerns in reviewing the agreement are:

� equality with other creditors (this is one of the reasons for the pari passu clause(clause 19.12), the negative pledge (clause 22.3), and the cross default clause(clause 23.5) in an unsecured facility);

� ensuring they are provided with sufficient information, in good time (clause 20);

� protection of their profit (by the ability to pass on changes in costs such aschanges in capital adequacy cost—clause 14);

� certainty as to the effect of the agreement (hence the importance of the choice oflaw and jurisdiction clauses at clauses 37 and 38);


BOX 0.6

At some point in the negotiations, the lender may make the point that the borrowershould not be too concerned about giving the lenders rights to object to certain things,because the lenders will only use their rights when it is sensible to do so. Nevertheless,borrowers should treat this argument with caution and seek to negotiate an agreementwhich will enable them to conduct their business with minimum need to makerequests for consents or waivers because

� requests for consent will involve the borrowers in spending time and money (and,in some cases, the lenders charge a fee for consents);

� if consent is required, the lenders may take the opportunity to raise other issues ofconcern to them and link those to the issue of consent;

� there may be a change in personnel or policies at the lenders’ office which mayresult in a different approach to the granting of waivers and consents;

� wherever the lenders have the right to accelerate their loan then other lenders willhave the same right under their cross default clauses.

12 See discussion of clause 8.2 and see also section 1 of the discussion of clause 23.13 See section 1 of the discussion of clause 23.14 See discussion of clause 21.

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� ability to withdraw (i.e. right to accelerate) if there is a change in circumstanceswhich may affect the lenders’ view of the credit risk involved (clause 23);

� maintenance of the borrower’s assets and income—hence financial ratios atclause 21 and asset or project specific covenants.

4 Hazards in reviewing a loan agreement

Four principal difficulties arise in reviewing a loan agreement, which are worthhighlighting here. These are the difficulty of spotting what is not there, the potentialfor conflict between different parts of the agreement, the significance of the precisewording of the definitions; and appreciating the impact of repeating representa-tions. These issues are discussed in turn in the following paragraphs.

4.1 Spotting what is not there

It is easy to see and comment on what is there, but harder to spot what is not there.In order to see the wood for the trees it is often helpful to summarize the key issuesbefore reading the draft agreement. This will help the reader to spot what is notthere and minimize the risk of being drawn into making minor comments on whatis there while failing to spot the bigger picture.

4.2 Potential conflict between provisions

Potential conflicts arise because, as discussed at para 2.2 on p. 9, the agreement pro-tects the lenders at three different stages.15 Any particular issue is therefore touchedon in a number of different places in the agreement, some of which may conflictwith others (Box 0.7).

It is therefore sensible, as well as reading the agreement from start to finish, tocheck, in relation to each key issue, how it is dealt with at each point of the agree-ment (conditions precedent, representations, repeated representations, covenants,and events of default) to get a complete picture and also to ensure that any conflictsbetween the provisions are ironed out. This is worth doing on later drafts as well asinitially, because changes negotiated in one area of the document are often inadver-tently missed in corresponding parts of the agreement.


BOX 0.7

For example, to find out in what circumstances litigation against the borrower canimpact on the loan, it will be necessary to look at the representations; conditions prece-dent; repeated representations; undertakings; and the events of default.

15 The provisions of the representations and conditions precedent, and the wording of any attachedlegal opinion, are also inter-related.

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4.3 Definitions

Loan agreements contain detailed definitions. There are a number of reasons forthis. One reason is to keep the complexities out of the body of the agreement.Another is to avoid ambiguity. The difficulty for the reader is that it is hard to com-ment on (or to fully appreciate the implications of) any particular definition out ofcontext. It is sensible to start reviewing any loan agreement, not at the definitions,but, instead, at the operative clauses (those which operate to actually do somethingas opposed to the definitions clause which simply describes things). When a definedterm (usually signified by capital letters, but see para 1.1 on p. 36) is encountered,return to review its definition. This will make it easier to appreciate the detail of thedefinition.

4.4 Repeated representations

A final word of caution relates to the repeated representations. As we will see inrelation to clause 19 of the LMA Term Loan, certain representations may be repeatedduring the life of the loan. After full drawdown on a term loan, the result of this isthat, if a repeated representation becomes untrue, the lenders will be entitled toaccelerate the loan. The same result would have been achieved by phrasing theissue as an undertaking (if it is something which the borrower can promise) or anEvent of Default (if not). By using a repeated representation instead, the possibilityof conflict between different parts of the document has been increased.16

SECTION 3: LIBOR-BASED LENDING

1 Interbank markets

Most lenders17 borrow money in order to lend. They may borrow in the capitalmarkets (e.g. by issuing bonds or commercial paper) or they may borrow in aninterbank market. For the purpose of international lending, most (not all) loans areLIBOR based—and are written on the assumption that the lenders are fundingthemselves by raising money in an interbank market. This may be a domestic cur-rency market (e.g. borrowing Sterling in London) or a Eurocurrency18 market (e.g.borrowing Dollars in Tokyo) (Box 0.8 on p. 14). Market practices (e.g. periodrequired for notice of drawing, what constitutes a banking day, conventions fornumber of days in a year for calculating annualized payments, and the like) are dif-ferent as between the domestic and international markets.

Whether the lenders are funding themselves in a domestic or international mar-ket, if a payment falls due in the relevant currency, then, in order to get value for a

L I B O R - B A S E D L E N D I N G 13

16 See further section 1 of the commentary on clause 19.17 Unless raising money from taxes or other contributions.18 ‘Eurocurrency’ is used here in its traditional sense of meaning a currency being traded outside its

home country. It does not necessarily involve Europe.

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payment made in that currency (and not continue to be charged interest on it) thelenders’ correspondent banks need to be open for business in the principal financialcentre for the currency concerned. So, for example, to make a payment in Yen, Tokyomust be open.19

2 Cost-plus lending

LIBOR-based lending is a ‘cost-plus’ basis of lending (as opposed to an inclusivebasis).

An inclusive basis is where the lender charges a single rate, such as its base rate,which encompasses all its costs of funding and some profit. This rate will be set at alevel which allows a fair degree of variation in the lenders’ costs to be absorbedwithout its having to change its base rate. The base rate will be changed from timeto time when there are step changes in the lender’s funding costs. Any such changein base rate will take effect immediately under the loan agreement. The rate whichthe lender will charge to the borrower will usually be higher than the base rate, withthe amount of uplift reflecting the perceived credit risk of the borrower.

The cost-plus basis of charging interest, on the other hand, involves the lender inagreeing a fixed level of profit (the Margin) with the borrower and charging theborrower interest at the lender’s actual costs plus the agreed Margin.

2.1 LIBOR

Typically, interest under a Eurocurrency loan agreement, where the lender is fund-ing itself in London, will be charged at LIBOR (Box 0.9 on p. 15) plus Margin.

LIBOR means the London Interbank Offered Rate. It is the rate of interest atwhich a bank offers to place deposits with another bank in a specified amount of aspecified currency on a specified date, for a specified period, in the LondonInterbank Market (Box 0.10 on p. 15).

The practice in the London market is that a lender wishing to fund itself in theinterbank market enters into a commitment to borrow two business days before themoney is required and the rate of LIBOR will be settled at the time the commitmentis made. The moneys are borrowed for the specified period (typically one, three, or


BOX 0.8

This explains the distinction between Euribor (which is the domestic interbank interestrate for borrowing Euros in one of its home countries) and Euro Libor (which is theinternational interbank interest rate for borrowing Euros in London).

19 See Ross Cranston Principles of Banking Law, chapter 2—‘Interbank networks’ for a review of themechanisms for interbank payments. Also Goode Commercial Law chapter 17.

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six months, although other periods are available, possibly at a premium reflectingthe unusual nature of the period) and repaid, together with interest, at the end ofthat period.21

2.2 Yield protection

The risks of all eventualities which may result in the lender incurring additionalcosts are passed on to the borrower through the ‘yield protection’ clauses.22 Thetypes of costs which these clauses protect the lender against are the costs ofcomplying with capital adequacy requirements (see Box 0.11 on p. 16); the cost ofcomplying with mandatory liquid asset requirements (see Box 0.11 on p. 16); thecost incurred if there is a withholding tax (see clause 13); and the cost of funding indifferent markets if the relevant interbank markets are disrupted (see clause 11.2).

L I B O R - B A S E D L E N D I N G 15

BOX 0.9

The first letter of ‘LIBOR’ stands for London, and will be different if the lender isfunding itself in a different market, for example, where the lender is funding itself inTokyo, the reference will be to TIBOR. Nevertheless, in some markets, the practice is torefer to LIBOR despite the fact that the lender funds itself in a different market, withLIBOR being used simply as a benchmark rate and with the lender recognizing that itwill not always accurately reflect its cost of funds.

BOX 0.10

Hence simply to say LIBOR is meaningless. The expression only has a meaning inrelation to

� a given amount� a specified currency and� a set duration.

For example, six-month $ LIBOR on $10 million or three-month Euro LIBOR on 10 millionEuros.

It is also necessary to define whether the intention is to refer to a Screen Rate or to aparticular bank’s actual rate of LIBOR.20

20 See commentary on LIBOR in clause 1.21 See commentary on definition of LIBOR in clause 1 for a further discussion of LIBOR.22 The increased cost clause (clause 14), the market disruption clause (clause 11.2), and the gross up

clause (clause 13.2(c)).

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BOX 0.11

There are two main types of regulatory costs which a lender may seek to pass on to aborrower under a loan agreement in which interest is calculated on a ‘cost-plus’ basis.These are

� costs of compliance with capital adequacy requirements, and� costs (known as ‘mandatory costs’ and previously referred to in the London

Interbank Market as ‘mandatory liquid asset costs’) of maintaining any requiredlevel of liquid assets with the central bank and of any fees payable to the bankingregulator.

CAPITAL ADEQUACY

Banking regulators require internationally active banks to maintain a minimum levelof capital to support their activity. The amount of capital required is dependent on thetypes of business conducted by the banks, with different types of transaction having adifferent effect. For example, loans which are guaranteed by International FinanceCorporation carry a lower risk weighting, and therefore require a lower level of capital,than loans without such a guarantee.23

Any changes in the level of capital required in relation to any given transaction willhave an impact on the bank’s profit for that transaction, and any additional costsresulting from such changes are therefore generally passed on to the borrower for thattransaction. See further clause 14.

MANDATORY COSTS

Central banks in many jurisdictions require banks which are active in those jurisdic-tions to place interest free deposits with the central bank. The income from thesedeposits is used to help fund the regulatory activity of the central bank. In England, therequirement is for banks and other regulated institutions to pay fees to the FinancialServices Authority (‘FSA’) for its supervisory role. These fees are based on the amountof the lender’s “eligible liabilities” (including the interest it will be required to pay ondeposits obtained to fund LIBOR-based loans). Any changes in the level of feesor deposits required will have an impact on the lender’s profits from those types oftransactions which are taken into account in calculating the amount of those fees ordeposits. Any additional costs resulting from such changes are therefore generallypassed on to borrowers of those types of facility.

23 The regulations for internationally active banks are currently based on the Basel Accord of 1988, atwhich the Group of 10 countries (G10) adopted the 1987 proposals of the Basel Committee. After muchdiscussion, revisions to the Basel Accord have been agreed and are due to be implemented by the end of2006. The main effect of Basel II is discussed in Box 1.35 on p. 102.

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17

SECTION 4: SCOPE OF THE LOAN AGREEMENT

In every loan agreement, some fundamental issues relating to the scope of theagreement need to be addressed,

� Who can make use of the facility?

� Who are the lenders, the Agent, and the Security Trustee?

� Who can be called on to repay?

� Whose activities can cause difficulty for the borrower under the loan agreement?

See Box 0.12 for a description of the concepts used in the LMA Term Loan to addresssome of these issues discussed in the paragraphs below.

S C O P E O F T H E L O A N A G R E E M E N T

BOX 0.12

THE LMA STRUCTURE

The LMA Term Loan describes the various categories of persons affected by theagreement by the following definitions:

‘Original Borrowers’ These are the companies in the group which are initially entitledto borrow as specified in a schedule to the agreement.

‘Original Guarantors’ These are the companies specified in a schedule to theagreement which are initially required to guarantee the loan.

‘Company’ This is the ultimate holding company of the group or sub-group (whichmay or may not also be a borrower or guarantor).

‘Borrowers’ These are the members of the group which, at any particular time, haveborrowed or remain entitled to borrow moneys under the facility. This will be theOriginal Borrowers plus any other company in the group which has been acceptedby the lenders as a borrower but excluding any who are no longer entitled toborrow under the agreement.

Guarantors These are the members of the group which, at any particular time, areliable under guarantees of the loan. This will be the Original Guarantors plus anyadditional group companies which have guaranteed the loan but excluding anywhose guarantees have been released.

Obligors These are the borrowers and the guarantors.Group This is the Company and all its Subsidiaries24 at any given time.

24 See definition of ‘Subsidiary’ in clause 1.1 at p. 51.

1 Who can make use of the facility?

In many loan agreements this is limited to certain specified persons. In other cases(including the LMA Term Loan) additional group companies may make use of thefacility subject to certain conditions. Those additional companies will become party

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to the loan agreement at a future date by a mechanism agreed at the start.25

Borrowers will wish to ensure that this process is a mechanical one, as far as possi-ble, and that the conditions precedent do not effectively make the extension of theloan to new group members discretionary on the part of the lenders.

2 Who are the lenders?

Most commonly there will be a syndicate with the identity of lenders changing fromtime to time and new lenders becoming party to the agreement at a future date, bya mechanism agreed at the start.26 Borrowers will wish to be sure that any changesin lenders or change in lending office do not cause any adverse consequences, suchas additional costs under the gross-up clause,27 for the borrower. The original Agentand Security Trustee will be specified, but there may be provisions allowing theseroles to be passed on to others over time.

3 Who can be called on to repay?

Often there will be specified guarantors in addition to the borrowers. The LMATerm Loan also contains a mechanism for guarantors to change28 (subject toapproval of the lenders) allowing flexibility, for example, if the holding companywishes to dispose of a group member which is a guarantor or to release it from thoserequirements of the agreement which relate to guarantors.

4 Whose activities can cause difficulties for the borrowers under the loan agreement?

What is the scope of the loan agreement in relation to the group?For example, do financial ratios relate to the consolidated position of the group as awhole? Are there negative covenants relating to companies in the group which arenot borrowers? (See Box 0.13 on p. 20 for a diagram of the position under the LMATerm Loan).

This issue is of particular importance to all parties.

� Lenders need to ensure that the agreement provides them with sufficient powersin relation to all those issues which are relevant to their credit decision, whichmay well extend to issues involving members of the group which are neitherborrowers nor guarantors.

� Borrowers will be concerned to insulate themselves as far as possible from problemswhich may arise in other parts of the group. They will also want to avoid the possi-bility that activities of other group members, particularly those over which theborrowers have no control, may result in the withdrawal of the borrowers’ funding.


25 See clause 25.26 See clause 24.27 See clause 13.28 See clause 25.

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� The ultimate holding company will want to maintain the flexibility to restructurethe group and, if appropriate, sell parts of it, without interference by the variouslenders to group members under their different financing arrangements.

The parties therefore need to consider the following questions, considered inturn here.

� Is consent of lenders required to sale of a group member or acquisition of a newgroup member?29

� Should certain companies be excluded from the covenants altogether?30

� Which (if any) provisions should relate to group companies which are neitherborrowers nor guarantors?31

� Do the lenders have different concerns in relation to different members of thegroup?32 So, for example,

– Should some provisions be tested on a groupwide, as opposed to an individualcompany, basis?

– Should some provisions allow transactions between different group members?

4.1 Is consent of the lenders required to sale or acquisition of a group member?Some loan agreements restrict the borrowers from forming subsidiaries33 andrestrict group members from being sold out of the group. A common way to achievethis is to attach a group structure chart to the agreement and require the borrowersto undertake to make no changes to the group structure from that indicated in thechart.

Other loan agreements prevent sale of a subsidiary less explicitly, as they includeundertakings relating to specific named group companies or companies which aremembers of the group on the day of the loan agreement’s signature. The result is thatsuch companies cannot be sold out of the group, since, if they were, the continuedcompliance with the relevant provisions would be outside the control of the group.See Box 0.14 on p. 21 for a description of the position under the LMA Term Loan.

4.2 Should certain companies be excluded from the covenants entirely?Two types of companies are often excluded from the covenants in the loan agree-ment, being insignificant companies and non-recourse companies.

S C O P E O F T H E L O A N A G R E E M E N T 19

29 See paragraph 4.1.30 See paragraph 4.2.31 See paragraph 4.3 on p. 22.32 See paragraph 4.4 on p. 23.33 Indeed, in a loan to a single borrower which has no subsidiaries it is usually sensible to either include

potential future subsidiaries in the undertakings or to include an undertaking against forming sub-sidiaries to ensure that the purpose of the negative undertakings cannot be avoided through activities ofunregulated subsidiaries.

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BOX 0.13

IMPACT OF LMA TERM LOAN ON SPECIMEN GROUP STRUCTURE

Note 1. The ‘Company’ administers the facility. It assumes miscellaneous paymentand other obligations. The loan must be prepaid if there is a change of control of theCompany.

Note 2. Guarantors must remain in the Group, unless they resign as guarantors,which they can do with the consent of all Lenders. They are bound by the covenantsrelating to ‘Obligors’.

Note 3. Borrowers must remain in the Group unless they resign as borrowers.They may resign as borrowers if they repay those advances which were made to themand if there is no Default at the time of their resignation. They are bound by thecovenants relating to ‘Obligors’.

Note 4. Members of the Group are bound only by the ‘Group’ covenants (summa-rized in Box 0.17), which are less extensive than the ‘Obligor’ covenants. They need notremain in the Group. They may become Borrowers or Guarantors subject to certainconditions, including delivery of a satisfactory legal opinion.

Note 5. If this company is effectively controlled by a Group member it may be a‘Subsidiary Undertaking’, and, if such companies are included in the definition of‘Subsidiary’, it will be affected by the Loan Agreement in the same way as other Groupcompanies.

Parent

CompanyGROUP

Guarantor

Note 1

Note 5

Note 4

Note 4

Note 2

Note 3

Borrower

Member?

Guarantor

Member Subsidiaryundertaking

Borrower/guarantor

49%

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Insignificant companies. Borrowers will often ask for insignificant companies to beexempted from the covenants. Often the test of significance for this purpose looks at theTangible Net Worth of the company concerned and exempts it if that represents a minor(e.g. less than 5%) part of the Tangible Net Worth of the group. This is often calculatedwith reference to the latest audited accounts at the relevant time.

Non-recourse companies. The second type of company which is commonly exemptedis a company which is established for the purpose of a particular non-recourse transac-tion. These companies are established as vehicles for particular projects. The argument


BOX 0.14

The LMA Term Loan requires Obligors to remain members of the group,34 but allowsother group members to be sold and allows new companies to become part of thegroup. Change in the ultimate control of the group gives lenders the right to require tobe prepaid.35 By virtue of the provisions allowing Obligors to cease to be Obligors,36

even Borrowers can be sold out of the group as long as they first repay any loan theyhave borrowed. Guarantors can only be released from their obligations (and hencebecome free to be sold) with consent of all lenders.

34 See clause 23.9.35 See clause 8.2.36 See clause 25.

BOX 0.15

An example might assist. Assume that a loan agreement includes a negative pledgeclause saying ‘The Company shall ensure that no … [Material Subsidiary] shall … permit tosubsist any Security.’ Assume that

(a) the company grants security at a time when it is not a Material Subsidiary; and(b) the value of the company increases relative to that of the Group and it becomes a

Material Subsidiary.

Unless the security falls within one of the exceptions to the negative pledge clause, thecompany will need to discharge the security before it becomes a Material Subsidiary inorder to avoid being in breach, as the covenant is not to ‘permit Security to subsist’.

Comment Borrowers need to be cautious with this approach as a company which wasonce exempt may be caught at a later point if its relative importance in the Groupchanges. This may even result in an Event of Default by virtue of things done whilethe company was exempt. If this type of exception has been agreed, the group needsto keep a check on whether exempt companies might cross the threshold and ceaseto be exempt (Box 0.15).

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for excluding them from the provisions of the loan agreement is that difficulties with theproject vehicle are usually not the responsibility of the group and therefore should notimpact on the group’s commercial borrowing. (If excluded from the covenants, theywould also then be excluded for all purposes, including, e.g. financial ratios.) Hence adefinition of ‘Non-Recourse Company’ is often inserted (Box 0.16).

4.3 Which provisions should be extended to relate to group companies which are not Obligors?Borrowers, as noted earlier, want the covenants and other provisions to apply onlyto Obligors and not to be extended to any other company in the group. There arethree main reasons for this.

� The result of extending the provisions to a company which is not an Obligor willusually be that a downturn in that other company’s financial fortunes will causea potential problem for the borrower.

� The borrower may not be in a position to control the activities of that othercompany, and so to prevent that other company from doing things which causean Event of Default under the borrower’s loan.

� The group may wish to maintain flexibility as to company sales and purchases.37

Given that lenders have no claim against group companies which are not Obligors(and, in the LMA Term Loan, such companies may be sold without consent of thelenders) it may be questioned why, for example, the negative pledge or the nodisposals covenant extend to those companies. Often the lenders will justify this onthe basis that, whatever the legal situation, if a subsidiary were to have financialdifficulties (such as that caused by cross default,38 or which may be heralded by


BOX 0.16

‘ “Non Recourse Company” means, at any relevant time, a company which, at such time, hasno Financial Indebtedness other than Non Recourse Indebtedness.

“Non Recourse Indebtedness” means Financial Indebtedness incurred by a company (the“Project Company”) for the purposes of financing a particular project where

(i) the principal assets and business of the Project Company are constituted by thatproject; and

(ii) the provider of the Financial Indebtedness has no recourse against any member of the Groupor its assets except the assets of the Project Company comprised in the project.’

37 See paragraph 4.1 on p. 19.38 See clause 23.5.

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asset stripping39 or a breach of the negative pledge40) the ultimate holding companymay well find itself bound up with the financial difficulties of its subsidiary, even ifnot legally bound to support it. The solution needs to be agreed on a case-by-casebasis and usually on a clause-by-clause basis, taking account of the credit decision.The result (as in the LMA Term Loan—see Box 0.17) may well be that some clauseswill apply to all group members and others to Obligors only. However, any exten-sion of any clause to companies which are not Obligors needs very careful consid-eration by the borrower, as to whether it is justified, and acceptable, in the contextof the particular group.41

4.4 Do the lenders have different concerns about different members of the group?In agreeing which clauses should extend to group members and which should belimited to Obligors, the parties also need to consider whether the lenders mayhave specific concerns in relation to individual group members or whether they arelooking at the overall financial position of the group. For example, are the lenders


39 See clause 22.4.40 See clause 22.3.41 If the eventual agreed position is that some provisions extend beyond the Obligors, the borrower may

seek to mitigate this by providing for extended grace periods for Events of Default which relate tocompanies that are not Obligors.

BOX 0.17

The LMA Term Loan provides for the following covenants to relate to group compa-nies (as opposed to Obligors).

The items marked * in particular need careful consideration by the borrower (asdoes clause 19.13, if it is included in the definition of ‘Repeated Representations’) astheir effect is to tie the borrower’s financing to the fortunes of other group members.

� Representation (clause 19.13) as to no litigation.� Financial information (clause 20.1 requiring consolidated financial statements for

the Company).� Information generally (clause 20.4).� Negative pledge (clause 22.3)*.� No disposals (clause 22.4)*.� No merger (clause 22.5)*.� No change of business (of the group, not individual members)—clause 22.6.� Cross default (clause 23.5)*.� Insolvency (clauses 23.6 and 23.7)*.� Execution of judgments (clause 23.8)*.

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concerned to ensure that value is maintained in those parts of the group (theObligors) against which they have a direct claim, or are they content that the valueis maintained in the group as a whole? The answer will impact (among other things)on the following questions:

� whether any relevant limits, such as the effect which is to be treated as materialfor the purpose of the definition of ‘Material Adverse Change’42 or the thresholdamount for the negative pledge,43 or the test of change of business,44 is set on acompany-by-company basis (and then, whether it is set with reference to anyObligor or with reference to any group member) or with reference to the positionof the group as a whole.

� negative covenants—the borrowers may request that these relate to the group asa whole and that transactions between group members should be excluded from,for example, the no disposals clause. The lenders, on the other hand, may behappy to permit such transactions as between Obligors, but not between othergroup members. See Box 0.18.

� at which levels the financial ratios are tested. The lenders may require ratios to betested both at a consolidated level (probably excluding any companies such asnon-recourse companies which have been excluded from the undertakings), andalso for particular Obligors. If certain companies have been excluded from thefinancial covenants, the lenders may well want to restrict certain transactions,such as making loans or giving security, which benefit those companies.

SECTION 5: ASSET AND PROJECT FINANCE

1 Asset finance

Asset finance is financing of an asset (often a moveable asset) where the lenderregards the value of the asset being financed as a significant factor in its credit


BOX 0.18

For example, in relation to the no disposals undertaking at clause 22.4, the borrowermay request the ability to transfer assets between group members without the restric-tions of that clause. The lenders, on the other hand, may be concerned to ensure thatspecific assets remain within a company to which the lenders have direct access, inwhich case they may agree the exception, but only in relation to transactions betweenObligors.

42 See definition of ‘Material Adverse Change’ in Box 1.15 on p. 49.43 See clause 22.3(c)(viii).44 See clause 22.6.

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assessment. The expression is commonly used for ship finance, aircraft finance,financing of rolling stock, satellites, containers, and other major assets.

Key issues in asset finance, which need to be addressed by the documents45 andby due diligence, include:

� conflict of law (e.g. the law chosen for the loan agreement, the law applicable tothe security, and the law in the place where the asset is at the time any securitycomes to be enforced);

� whether to structure the transaction as a mortgage financing or as a title financing;46

� liabilities of a financier (such as the issue of whether the financier will be exposedto environmental liabilities, either simply as a result of taking security over theasset, or as a result of ownership of it in a title finance arrangement, or as a resultof enforcement of security over the asset);

� detention rights of third parties relating to the asset, if it is a moveable asset. Theissue here is to identify what parties may be entitled to detain the asset and preventits profitable use. Examples are the lien which a repairer has on an asset until therepair bill is paid and the right of port states to detain vessels for safety reasons;

� maintenance of the asset—the lenders will want to be sure that the asset isproperly maintained and, perhaps, that funds are set aside for this purpose;

� preservation of value of the asset generally, including loan to value ratios,47

� insurance—the lenders will want to have security over the asset’s insurance sothat, if there is damage to it, the lenders have replacement security. They will alsowant to be satisfied as to the insurance for potential liabilities to third partiesarising in respect of the use of the asset;

� impact of insolvency—are there risks that enforcement of security on the assetmay be impeded as a result of insolvency proceedings such as administration inEngland, or that transactions such as guarantees may be vulnerable to beunwound in the event of an insolvency;

� registration—where does the asset and any security on it need to be registeredand what are the consequences of non-registration;

� ability to sell the asset free of liens and other interests—and can the lender exerciseself-help remedies, or will any sale have to be effected by a court?

2 Project finance

Project finance involves lending against the income of a project. It usually involves:

� the development or exploitation of a right, natural resource or other asset;

A S S E T A N D P R O J E C T F I N A N C E 25

45 See, for example, the comments on clause 4.1 in an asset finance transaction, on p. 62, and section 2 ofthe commentary or clause 22.

46 See section 6 of this Introduction.47 See commentary on clause 21.

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� limited recourse lending;

� income capture with the debt being repaid out of the revenue generated by theproject.

In relation to the loan agreement, key characteristics will be:

� strict undertakings in relation to the key contracts in the project, (see Box 0.19 foran illustration of some common key contracts) for example, undertakings not toamend them, assignments of these contracts to the lenders, and direct agree-ments between lenders and the counterparties to those contracts—allowing thelenders step in rights (i.e. the right to step in and perform the contract on behalfof the borrower);


Government

Sponsors

Shareholdersagreement

Buildingcontract

Loanagreement

Supplyagreement

Offtakeagreement

Operatingagreement

Insuranceagreement

Concessionagreement/

license

Offtaker

Insurer

Operator

Leaders

Supplier

Constructioncompany

SPC

BOX 0.19

TYPICAL PROJECT FINANCE CONTRACTS

� the availability of funds from the lenders will be dependent on ratable contribu-tion from other lenders and/or sponsors;

� extensive information provision for the lenders;

� detailed project forecasts and budgets agreed in a financial model before the loanagreement is signed, with variations from the base case having numerousconsequences, such as restricting drawings of the loan; restricting payment ofdividends; changing the Margin; setting the amounts of repayments; andultimately, triggering an Event of Default;

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� long drawdown period during construction, with interest possibly being capital-ized, and drawings paid to a disbursement account;

� detailed expert evidence required as to state of the project at various pointsduring the drawdown period, as conditions precedent to further drawing;

� ‘waterfall’ for payment (see Box 0.20) of project income;

A S S E T A N D P R O J E C T F I N A N C E 27

48 See section 2 of the commentary on clause 22 - General undertakings.

BOX 0.20

The ‘waterfall’ is the expression commonly used to describe the series of accounts usedto hold income generated in a project finance transaction. Typically these include:

� The revenue account, into which income is paid.� The operating account, which is used to hold up to an agreed sum for ordinary

operating expenses.� The debt service account, which is used to hold sufficient funds to cover debt

service for an agreed period.� The debt service reserves account, which builds up an agreed cushion for future

debt service.� The maintenance reserves account, which builds up an agreed cushion for major

maintenance costs.� The distribution account—available to pay dividends to sponsors, subject to certain

conditions.

� often, release of certain security (e.g. completion guarantee) once evidence ofcompletion of the construction phase is provided;

� special purpose company undertakings—restricting the ability of the borrowerto undertake other activities;48

� security over all project assets;

� limited recourse to sponsors (shareholders in the project company);

� extensive insurance covenants;

� additional events of default if:

– remaining development cost exceeds available funding;

– ratios are not met;

– insurance becomes voidable;

– any relevant consent or license is altered;

– any physical damage occurs to project assets;

– the project is abandoned;

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– force majeure occurs under a project document in excess of a specified period;

– the project is expropriated;

– completion is delayed or

– any project document is terminated.

SECTION 6: QUASI SECURITY AND FINANCIAL INDEBTEDNESS

1 Quasi security49

Quasi security means arrangements which have the same commercial effect assecurity. It comprises both title financing and other arrangements.

Title financing. This is using title (or ownership to property) instead of security,such as is done in finance leases or hire purchase agreements (as discussed here). Mosttitle financing arrangements involve the separation of legal ownership (or title) to anasset from the economic ownership of the asset (or the commercial risks and rewardswhich go with ownership such as the risk or reward of a loss or gain in value of theasset). There are many different reasons for using title finance. In some cases, a tax oraccounting advantage is sought. In others, the structure is used as an alternative tosecurity because of unavailability of satisfactory security in the relevant jurisdiction.Whatever the purpose of the arrangements, their commercial effect is equivalent tothe effect of security (but see also Box 0.21). Therefore any provisions in a loan agree-ment which deal with security must also deal with these arrangements.

Other arrangements. Other arrangements, such as rights of set off, do notamount to title financing but can also have a similar impact to security and thereforeare discussed together with title financing in this section 6.

Examples of title financing include the following.

1.1 Finance or capital leases (as opposed to operating leases)

Finance leases are leases in which the lessor (or owner) is simply a financier and thelessee has the commercial risks and benefits of ownership. The lessor funds the pur-chase of the asset and receives rent through the lease sufficient to pay off the fund-ing cost plus interest. Once paid, the lease may continue at a nominal rent or theasset may be sold, with proceeds payable to the lessee. The effect is as thoughthe lessor had lent the funds to the lessee and the lessee had given security over theasset. Hire purchase is simply an example of a finance lease in which, once rent hasbeen paid sufficient to pay the funding cost plus interest, the lessee acquires title tothe asset for no significant further payment.

1.2 Title retention

If a seller gives credit to the purchaser of an asset and retains title to the asset untilpaid, the commercial effect is as if the purchaser had given security over the asset


49 See generally Goode ‘Legal Problems of Credit and Security’, pp. 1-16–1-38.

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for the amount of the credit.51 Another example is an instalment sale agreement, ora conditional sale agreement under which title only passes on payment of the finalpurchase installment or fulfillment of other conditions.

1.3 Selling receivables but keeping the associated risk (as in some securitizations)

A distinction needs to be drawn between situations where the receivables are soldtogether with the risk52 and where they are sold but the risk is retained by the seller.

For example, compare the situation where

� debts with a face value of $10 million are sold for $8 million and

� the same debts are sold at the same price but the seller keeps the risk (e.g. bygiving a guarantee to the buyer of the payment of the debts).

Assume the debtors pay only $6 million. In the first case, that is of no concern to theseller. In the second, the seller must compensate the buyer. The commercial effect ofthe second case is as though the seller had borrowed $8 million from the buyer andgiven security over the receivables.

1.4 Forward sale

This may be illustrated by an example. Let us assume that a manufacturer ofwatches, in order to raise finance, agrees with a ‘lender’ in January, for a price paidby the ‘lender’ at that time, that the next 500 watches produced will belong to the

Q U A S I S E C U R I T Y A N D F I N A N C I A L I N D E B T E D N E S S 29

BOX 0.21

Title financing is often used as an alternative to security but careful due diligence isnecessary, not only as to the legal effect but also as to the tax, accounting, and regula-tory effect. The person who is treated as the ‘owner’ of the asset for accounting pur-poses may be different from the ‘owner’ for tax purposes; the ‘owner’ for regulatorypurposes;50 and the owner for other legal purposes. In some countries, the structurewill not be treated, for legal purposes, in accordance with its apparent effect, but willbe ‘recharacterized’ in accordance with its substantive effect. This may lead to arequirement that such arrangements be registered as though they were security (as inNew York) or to the arrangements not being effective at all.

50 For example, is a temporary owner of shares under a repo treated as the owner for regulatorypurposes such as duty to disclose major shareholdings?

51 In some countries, the seller is automatically given a security interest for unpaid purchase moneys sothat title retention would be unnecessary.

52 Often referred to as a “true sale”, and, depending on the purpose of the securitization, the require-ment of a true sale may be key to its effectiveness.

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‘lender’. In other words, the ‘lender’ will purchase the watches in advance of theirmanufacture.53 The ‘lender’ may then appoint the manufacturer as his agent to sellthe watches with a requirement that a certain part of the sale proceeds be paid overto the ‘lender’ and with the manufacturer guaranteeing to make up any shortfallbetween the proceeds of sale recovered by the ‘lender’ and the advance price origi-nally paid by the ‘lender’ plus ‘interest’. The commercial effect is as though themanufacturer had given security over the watches to raise a loan.

1.5 Forward purchase (as in repos)

This is an arrangement where a company owns an asset, such as shares, and, inorder to raise finance, sells those shares to a financier for, say, $5 million, and agreesto repurchase them in six months time for $6 million. The commercial effect is as ifthe company had borrowed $5 million and given the shares as security.

1.6 Set off

Set off is a procedural rule which allows a party which owes money to another to reducethe amount he pays to that other by an amount which that other party owes to him.

The availability of this right of set off is a matter of law in the courts in which itis asserted. It may have the same commercial effect as security in some cases. Forexample, if a borrower of a loan of $10 million has a bank account with its lenderwith $5 million deposited, and the lender, if unpaid, can set off the amount in thebank account (leaving it with no obligation to pay over the deposit and withthe amount of its loan reduced to $5 million), the commercial effect is as though thelender had security over the bank account.54

1.7 Cash deposits

Depositing money with a party could have the same commercial effect as securityeither because of the set off rights which will arise or because of formal or informalarrangements allowing that other party to forfeit the sums deposited in certaincircumstances or because those sums are part of a payment mechanism.55

1.8 Trust arrangements

If a company holds an asset on trust for others then that asset is, just as it would beif security had been given over it, not available to that company’s creditors gener-ally in the insolvency of the company. A trust can therefore have the same commer-cial effect as security.56


53 To be effective, the relevant jurisdiction would need to recognize agreements to sell future propertyas being binding.

54 But a right of set off is not as good as security in all cases (and may even be better than security insome instances). See para 4.6 of section 2 of Appendix 1 on p. 279.

55 See Goode ‘Legal Problems of Credit and Security’, para 1-38.56 In fact, it may amount to a registrable security interest—see Goode ‘Legal Problems of Credit and

Security’ para 1-53 and compare para 1-38.

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2 Financial indebtedness

In considering quasi security it is also useful to look at the breadth of arrangementsby which finance can be raised and which can have the same commercial effect asborrowing money. Examples of such arrangements are described here.

2.1 Acceptance credit facility

This is an agreement by a lender to accept (or become liable for) bills of exchangeissued by the company. The effect is that the lender agrees to make payment to athird party under the bill of exchange on behalf of the company. The effect is as ifthe lender lent the equivalent amount to the company.

2.2 Bonds (like notes or commercial paper)

Bonds are simply promises to pay, which are traded in the capital markets. A com-pany will issue a bond (or note, or paper) which will be purchased in the capitalmarkets and then traded. The purchase price will be paid to the company. The com-pany has effectively borrowed the amount paid to it.

2.3 Note purchase facility

This is a facility under which a financier agrees to buy promissory notes issued bythe company.

2.4 Loan stock

Money borrowed from investors and represented by certificates which can be soldby the investors in whole or in part. Loan stock may be secured, in which case it isknown as debenture loan stock. It may be convertible into shares on terms specifiedin the stock, in which case it is known as convertible loan stock.

2.5 Seller’s credit

Where a seller sells goods but agrees to delayed payment.

2.6 Forward sale

Selling assets which are not owned yet may amount to borrowing money. For exam-ple, assume a furniture store sells furniture and requires payment in advance of thepurchase of that furniture by the store. The store has effectively borrowed moneyfrom its customers.

2.7 Other title financing

Other methods of title financing discussed above amount to borrowing on a securedbasis, being finance leasing; forward purchase (e.g. repos) and selling receivables onrecourse terms.

Q U A S I S E C U R I T Y A N D F I N A N C I A L I N D E B T E D N E S S 31

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This Part deals with those parts of a loan agreement which are mechanical in nature: thedefinitions, procedures for drawdown, calculation of interest, and the like. These provisionsare contained in clauses 1–17 of the LMA Term Loan.

P A R T I

Administrative Provisions

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CLAUSE 1: DEFINITIONS AND INTERPRETATION—SECTION 1—AN INTRODUCTION

1 Introduction

Loan agreements contain detailed definitions. This helps:

� to ensure consistency between different provisions of the document;

� to avoid ambiguity;

� to keep the complexities out of the body of the agreement (see Box 1.1).

35

C H A P T E R 1

Interpretation

BOX 1.1

For example, in the operative provisions, a simple statement can be made suchas, ‘The Borrower shall not create any Encumbrances other than Permitted Encumbrances.’The general purpose of this provision is easily understood, while its application, andtherefore its impact on the borrower, is only understood by reviewing the detail in thedefinitions.

There are traps for the unwary in using definitions. Principally these are:

� reading (or not reading) the definitions in context;

� appreciating (or failing to appreciate) that the definitions may need differentmeanings in different contexts;

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� avoiding circular definitions; and

� avoiding including operative provisions.1

We look at each of these issues here.

1.1 Definitions out of context

It is hard to comment on, or to fully appreciate the implications of, any particulardefinition out of context (see Box 1.2).

I N T E R P R E TAT I O N36

BOX 1.2

For example, appreciating whether the definition of ‘Financial Indebtedness’ should orshould not include derivative transactions depends on the reader knowing where thedefinition will be used and with what purpose.2

1 Provisions which ‘operate’ or actually do something as opposed to the provisions of the definitions inclause 1 which are merely descriptive.

2 See comments on clause 23.5 (a) for a discussion on the inclusion of derivatives in this definition.3 See comments on clause 1.2(d).

BOX 1.3

For example, assume clause 23.13 is drafted to say ‘On, and at any time after, the occurrenceof an Event of Default which is continuing, the Agent may … [accelerate the Loan]’.

On its own, this appears clear. However, it needs to be read in the context of clause1.2(d) which defines the word ‘continuing’3. When that meaning is taken into account,the reader will appreciate that clause 23.13 has a somewhat different meaning thanwould have been understood from reading clause 23.13 alone.

It may therefore be sensible to skip the definitions clause and start reading fromthe operative clauses starting at clause 2 (or, rather, at clause 1.2, for reasons dis-cussed here). When a defined term is encountered, its definition can then bereviewed in context. This makes it easier to appreciate the detail of the definition.

The suggestion is to commence reading at clause 1.2, so as to be aware of anywords which have been defined by that clause without that fact being flagged bythe use of capital letters.

Clause 1.2 is intended to deal with references to concepts (such as a person) asopposed to specific words (such as ‘Encumbrance’). In this interpretation clause,concepts are broadened without their being given capital letters. This can lead to theexistence of the wider meaning which has been given to the concept being over-looked. It is therefore sensible to read the interpretation clause (clause 1.2) beforereviewing the operative clauses and to make special note of the words and conceptswhich have been defined without being capitalized (Box 1.3).

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1.2 Different meanings in different contexts

While the definitions help to ensure consistency throughout the document it may bethat consistency is not required in some cases.

Borrowers frequently request that adjustments be made to a definition which, onconsideration, the lenders may wish to make in some instances (e.g. the negativepledge) but not others (e.g. the conditions precedent) (Box 1.4).

C L A U S E 1 : D E F I N I T I O N S S E C T I O N 1 37

BOX 1.4

For example, the borrowers may request a definition of ‘Permitted Encumbrances’which allows creation of a wide variety of security interests over the company’s prop-erty. The lenders may be willing to agree to this request in the context of the negativepledge but may want to be more restrictive as to the security interests which may existat the date of the first advance of the loan. In that case changing the operative clauseswould be a better option than changing the definition.

BOX 1.5

An example of a meaningless definition is, ‘Outstanding Indebtedness’ means all moneysoutstanding under the Security Documents’ while ‘ “Security Documents” means alldocuments executed as security for the Outstanding Indebtedness’.

It is therefore advisable to leave the definitions alone and make changes asappropriate in the operative clauses. Similarly, when reviewing the definitions, itis important to review them in each context in which they are used, as the defini-tion may be appropriate in some circumstances but may require adjustment inothers.

1.3 Circularity

It is not unusual to find that a defined term itself refers to another definedterm. This, if carried to extremes, can make the definitions very difficult for read-ers to understand. In some cases, it might make the definitions meaningless(Box 1.5).

1.4 Operative provisions

The definitions are there to explain what particular expressions mean. Theyshould not include any operative provisions, such as positive or negative undertak-ings or conditions. The main hazard of including operative provisions in thedefinitions is that they are harder to find there. At the extreme they may also beineffective.

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CLAUSE 1: DEFINITIONS AND INTERPRETATION—SECTION 2—THE LMA DEFINITIONS

Clause 1.1 Some definitions

The following definitions in the LMA Term Loan deserve particular attention.

Base Currency Amount

‘Base Currency Amount’ means, in relation to a Loan, the amount specified in theUtilisation Request delivered by a Borrower for that Loan (or, if the amount requested isnot denominated in the Base Currency, that amount converted into the Base Currency atthe Agent’s Spot Rate of Exchange on the date which is three Business Days before theUtilisation Date or, if later, on the date the Agent receives the Utilisation Request)adjusted to reflect any repayment (other than a repayment arising from a change ofcurrency), prepayment, consolidation or division of the Loan.

This definition is used in a multicurrency facility as a reference point for the lendersto determine from time to time what the amount of the loan would have been had italways been drawn in a single currency and remained in that currency.4

Break Costs

‘Break Costs’ means the amount (if any) by which:(a) the interest which a Lender should have received for the period from the date of receipt

of all or any part of its participation in a Loan or Unpaid Sum to the last day of thecurrent Interest Period in respect of that Loan or Unpaid Sum, had the principalamount or Unpaid Sum received been paid on the last day of that Interest Period;

exceeds:(b) the amount which that Lender would be able to obtain by placing an amount equal

to the principal amount or Unpaid Sum received by it on deposit with a leading bankin the Relevant Interbank Market for a period starting on the Business Day follow-ing receipt or recovery and ending on the last day of the current Interest Period.

Floating rate loans are generally drafted on the basis that the borrower will have theability to choose the interest periods from time to time5 but that the borrower musttake the reinvestment risk6 if any payment is made by the borrower in the middle ofan interest period. This is achieved by clause 11.4 which requires the borrower topay the lenders’ ‘Break Costs’ if payments are made in the middle of an interestperiod.


4 See the commentary on clause 6.5 See commentary on clause 10.6 The reinvestment risk is the risk that the amount which the lenders can earn on moneys received may

be less than the rate which the lenders are obliged to pay (or would have been obliged to pay if they hadmatch funded as discussed in the commentary on clause 10.1) on that sum for the remainder of the InterestPeriod.

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BOX 1.6

For example, assume a prepayment of $12 million is received one month after the startof a six-month Interest Period relating to that $12 million. Assume that the interest ratepayable by the borrower for the six-month period is 5% while LIBOR at the date ofreceipt of the $12 million is 4%.

Break Costs, in accordance with the definition would be the amount by which:

(a) the interest which the lenders would have received for the rest of the InterestPeriod (i.e. $12 million � 5% � 5/128 � $250,000); exceeds

(b) the amount the lenders can recover by investing the sum received for the balanceof the Interest Period (i.e. $12 million � 4% � 5/12 �$200,000).

That is Break Costs would be $50,000. However, the lenders will not suffer the loss of $50,000 until the end of the six months,since that is when it will receive interest on the sum reinvested and would havereceived interest from the borrower had the $12 million not been paid early. Therefore,a payment of $50,000 on the date of prepayment of the $12 million will over compen-sate the lenders by the amount of interest which will be earned on that sum during therest of the Interest Period. This can be corrected by requiring payment of the netpresent value of the relevant sum.

Lenders may argue that the inclusion of the Margin is correct since the borrowershould compensate them for the fact that Margins generally available at thetime of prepayment may be lower than that charged to the borrower10 and that

7 See Appendix 2, p. 299.8 In the interests of simplicity, this calculation simply calculates five months of interest as equalling

five-twelfths of one year’s interest, rather than calculating on the basis of the number of days elapsed anda 360-day year as would happen in practice.

9 Note the definition assumes moneys received will not be reinvested until the day following receipt.10 See also commentary on clause 11.4.

Comment In the context of large loans, some borrowers may request that the definitionbe adjusted to reflect the time value of money and hence ask that it is the net pres-ent value7 (the issue then being at what interest rate to make this calculation) of theamount set out in this definition which should be paid. (Box 1.6).

Comment The definition as stated in the LMA Term Loan looks at the total interest(including Margin) which the lenders would have received had the relevantpayment not been made and compares that with interest (LIBOR) which can beearned on the payment received.9 In this way, the calculation compensatesthe lenders not only for the cost of breaking their funding but also requires the bor-rower to pay the lenders’ Margin for the balance of the Interest Period. The bor-rower may wish to resist on the basis that the Margin for the rest of the InterestPeriod is not an expense suffered by the lenders, but a lost profit.

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compensation for lost Margin for the balance of the Interest Period is thecompromise position required for charging no prepayment fee.

Business Day

‘Business Day’ means a day (other than a Saturday or Sunday) on which banks are openfor general business in London and [];11 and:(a) (in relation to any date for payment or purchase of a currency other than euro) the

principal financial centre of the country of that currency; or(b) (in relation to any date for payment or purchase of euro) any TARGET Day.

There are often a number of different definitions addressing the concept of BusinessDay. A distinction needs to be drawn between business days for the purpose of

� making payments and calculating periods such as grace periods relating topayments;

� determining the effectiveness of notices and calculating periods such as graceperiods in relation to matters which do not involve payments.

Where no payments are involved, paragraphs (a) and (b) of the definition are notrelevant.

For the purpose of payments, the principal financial centre for the relevantcurrency12 will need to be open as well. This is addressed by paragraphs (a) and(b) of the definition in the LMA Term Loan.

The LMA Term Loan does not explicitly state whether references to a number ofBusiness Days is intended to mean ‘clear’ days, that is, excluding the first and lastday, or periods of 24 hours (Box 1.7). In view of the definition of Business Daysthe 24-hour interpretation is probably incorrect and it should be assumed that theintention is to refer to clear days.


BOX 1.7

For example, if three Business Days’ notice of drawdown is required and notice isgiven on Monday at 10 a.m. when will that notice expire? If the intention is to refer to‘clear’ days, it will expire on Thursday at midnight (so that drawing will be availableon Friday). If it is to periods of 24 hours then it will expire at 10 a.m. on Thursday (sothat drawing will be available on Thursday). This example assumes that Monday toFriday are all Business Days.

11 Beware of unnecessarily increasing the cities which need to be open for business for a day to count asa Business Day and thereby potentially having significantly extended notice perods. It should normallybe sufficient if the Agent’s and borrower’s places of business are open since the loan is structured so thatcommunications and payments can be made through the Agent.

12 For this purpose, see the commentary on TARGET days in the discussion of the definition of‘Quotation Day’ on p. 50.

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Compliance Certificate

‘Compliance Certificate’ means a certificate [substantially in the form set out in Schedule 8(Form of Compliance Certificate)] [in form and substance satisfactory to the Agent].

Generally, financial covenants are tested by requiring periodic certificates confirmingcompliance.

The precedent gives the draftsperson a choice here of attaching the form orreferring to a form satisfactory to the Agent. Attaching the form is preferable forboth parties (and syndicate members) for the certainty it gives as to precisely whatwill be required. Some flexibility is introduced by saying the document is to be‘substantially’ in the form attached, allowing for minor modifications which mayprove to be necessary between the date of signing the loan agreement and the dateof production of the relevant document.

A third alternative which is sometimes used is to require the document to besubstantially in ‘agreed form’ and define ‘agreed form’ as referring to the forms of doc-uments attached to a particular letter, for example. This has the advantage of keep-ing the loan agreement itself shorter, and is particularly useful for items which willonly be required to be produced once at the start of the loan period.

Default

‘Default’ means an Event of Default or any event or circumstance specified in Clause 23(Events of Default) which would (with the expiry of a grace period, the giving of notice,the making of any determination under the Finance Documents or any combination ofany of the foregoing) be an Event of Default.

The term Default is used to mean the occurrence of any event which might matureinto an Event of Default. An example is a breach of covenant which, if not remediedwithin any applicable grace period, would become an Event of Default. The breachof covenant would be a ‘Default’.

Some loan agreements use the concept of ‘Potential Event of Default’ to describethis. The concept is used throughout the agreement and in the security documents.It is not the same as an Event of Default, in that occurrence of a Default does not givethe lenders the ability to accelerate the loan. However, the existence of a Defaultcauses concern for the lenders and therefore the borrower’s rights after a Defaultand before an Event of Default will be more restricted than they were previously.For example, a lender will usually require that its commitment to lend new money(in a term loan) or to increase the amount outstanding (in a revolving credit) is sus-pended while there is a Default. It will also often place restrictions on things whichwould otherwise be permitted (e.g. payment of dividends, or application of insur-ance moneys or earnings may be prevented after a Default and before an Event ofDefault). See Box 1.8 on p. 42.

It is important to look carefully at the words in brackets in the definition. TheLMA Term Loan provides for three possibilities: expiry of grace periods; makingdeterminations; and giving of notice, or any combination of these.


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� Expiry of grace periods This part of the definition is to cover circumstances (e.g. abreach of certain covenants) which will become Events of Default if thosecircumstances still exist when a grace period expires.

� Making a determination This is to cover those circumstances that will become anEvent of Default if a party makes an adverse decision. An example is where it isan Event of Default if circumstances occur which, in the opinion of the MajorityLenders, are material. While they consider materiality there is a Default.


BOX 1.8

DEFAULTS AND EVENTS OF DEFAULT

Default = Breach of covenantor similar occurence

Term loan—no obligation to advance new money

Revolringcredit - no obligation to advance loans which are not Rollover Loans*

Event of Default = Default which remains unremediedon expiry of grace period (or similar)

no obligation to advancenew money

Entitled to demand immediaterepayment of outstanding sums

Note: * See comment on clause 4.2(a)(i) in a revolving credit on p. 63

13 See section 1 of the discussion of clause 23.

Comment The question might arise as to whether an event which is about to be reme-died is a ‘Default’ as defined in the LMA Term Loan (see Box 1.9 on p. 43).

Comment As discussed in relation to the Events of Default,13 one issue of concern to theborrower is to avoid subjective Events of Default as far as possible. If Events ofDefault are included which are to be determined in the opinion of some or all of thelenders, the impact of this definition should be considered. Payments (such as fur-ther drawings) are generally frozen on a Default and lenders may well be more will-ing to exercise their rights to freeze drawings than to exercise their rights ofacceleration. By virtue of the definition of ‘Default’ their right to freeze drawingswould arise whenever circumstances occur which might fall within the Event of

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� Giving of notice This wording is to cover any Events of Default that are triggeredby the giving of notice. It is unusual for Events of Default to be triggered bynotice alone, but often notice is required in addition to the expiry of a graceperiod or the making of a determination. For example, some breaches ofcovenant (in the LMA Term Loan, those specified at clause 23.3(b)14) may only beEvents of Default if a certain period of time expires after the lenders give noticeto the borrower of the existence of a breach. The definition of ‘Default’ thereforeincludes the three issues outlined here and any combination of them.


BOX 1.9

For example, assume that a particular loan agreement states that it is an Event ofDefault if there is a judgement against the borrower in an amount in excess of $1 millionand that judgement is not satisfied within 30 days. Assume also that a judgement hasbeen made against the borrower in an amount of $2 million, and the borrower is mak-ing arrangements to pay it. It will take the borrower 10 days to access the necessaryfunds. Until the payment has been made, the intention behind the drafting of the LMATerm Loan is that these events should constitute a ‘Default’. The borrower might arguethat in these circumstances there is no ‘Default’ because a Default is defined as an eventthat ‘would’ on expiry of a grace period, constitute an Event of Default. The judgementwill not result in an Event of Default because it will be paid.

Given that, if the borrower’s argument succeeded, it would render the definition of‘Default’ meaningless, it is reasonably clear that Defaults which are about to be remediedremain Defaults until they have actually been remedied.

BOX 1.10

For example, there may be an Event of Default if there is ‘litigation against the Borrowerwhich, in the opinion of the Majority Lenders, would have a Material Adverse Effect’. Theword ‘would’ in that Event of Default makes it very difficult for the lenders to use theEvent of Default because a high degree of certainty is necessary. Nevertheless, if litiga-tion arises which might have a Material Adverse Effect, by virtue of the definition of‘Default,’ the lenders will be entitled to freeze drawings while they consider whetheror not the circumstances fall within the wording of the Event of Default.

14 ‘23.3(b) No Event of Default … will occur if the failure to comply is capable of remedy and is remediedwithin … in relation to [Clause ] [ ] Business Days … of the Agent giving notice to the Compay … of the failure tocomply.’

Default, even if, on consideration, it would not do so. However strongly the word-ing of the Event of Default may be drafted, the ability to freeze future drawings isslightly more easily triggered because of the definition of ‘Default’ (see Box 1.10).

Some definitions of ‘Default’ or ‘Potential Event of Default’ include words suchas ‘or any other occurrence’. This should be resisted as too broad. It could, forexample, include the occurrence of a breach of covenant.

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Euribor

This definition will be necessary if the loan is to be available in Euros and thoseEuros are to be funded in the domestic market15 for Euros (or treated as beingfunded there for the purpose of the calculation of interest). If they are not to befunded in the domestic market for Euros, but in London instead, the relevant ratewill be Euro LIBOR. The choice as to whether Euros are to be funded (or treated asfunded) in their domestic market or in London will depend on the wishes of thelenders (or most of them) at the time of negotiating the agreement.

Facility Office

‘Facility Office’ means the office or offices notified by a Lender to the Agent in writing onor before the date it becomes a Lender (or, following that date, by not less than fiveBusiness Days’ written notice) as the office or offices through which it will perform itsobligations under this Agreement.

The plural is deliberate so as to allow any lender to service loans from differentFacility Offices.16

Finance Document

‘Finance Document’ means this Agreement, any Fee Letter, any Accession Letter, anyResignation Letter and any other document designated as such by the Agent and theCompany.

Many of the borrower’s covenants and representations relate to the FinanceDocuments. These should not be extended to include lenders’ documents such asany document used to transfer interests in the loan to new lenders. Such documentsare solely a concern for the lenders and, for example, the obligation of the borrowerto pay any stamp duty in relation to the Finance Documents should not extend tothese transfer documents.

Financial Indebtedness

‘Financial Indebtedness’ means any indebtedness for or in respect of:(a) moneys borrowed;(b) any amount raised by acceptance under any acceptance credit facility or

dematerialised equivalent;(c) any amount raised pursuant to any note purchase facility or the issue of bonds, notes,

debentures, loan stock or any similar instrument;


15 See para 1 of section 3 of the Introduction on p. 13.16 The borrower is concerned to ensure it does not have to gross-up payments. Given the the gross-up

obligation only applies to the extent that any advance is funded by a ‘Qualifying Lender’ (see Box 1.34 on p. 96)the ability of the lenders to specify different Facility Offices does not cause an issue for the borrower aslong as those Qualifying Lender provisions are retained.

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(d) the amount of any liability in respect of any lease or hire purchase contract whichwould, in accordance with GAAP, be treated as a finance or capital lease;

(e) receivables sold or discounted (other than any receivables to the extent they are soldon a non-recourse basis);

(f ) any amount raised under any other transaction (including any forward sale orpurchase agreement) having the commercial effect of a borrowing;

(g) any derivative transaction entered into in connection with protection against or ben-efit from fluctuation in any rate or price (and, when calculating the value of anyderivative transaction, only the marked to market value shall be taken into account);

(h) any counter-indemnity obligation in respect of a guarantee, indemnity, bond,standby or documentary letter of credit or any other instrument issued by a bank orfinancial institution; and

(i) the amount of any liability in respect of any guarantee or indemnity for any of theitems referred to in paragraphs (a) to (h) above.

The purpose of this definition is to distinguish between ordinary trade debts(e.g. debts to suppliers and employees) and debts in the nature of a financing. Thedefinition needs to be broad to pick up activities having the commercial effect ofborrowing such as repos or selling receivables on recourse terms.17

The definition is used in the negative pledge (clause 22.3) and in the cross defaultclause (clause 23.5) in the LMA Term Loan and may be used elsewhere in any givenloan agreement. In the negative pledge the definition is used to distinguish betweenpermitted and prohibited transactions.18 In the cross default clause only defaultsunder arrangements that constitute Financial Indebtedness are Events of Default.19

The LMA Term Loan does not include a covenant to incur no FinancialIndebtedness although the relative level of Financial Indebtedness may well beregulated by the financial ratios.

The definition is occasionally used in the financial ratios, but in this case,derivatives should probably be excluded from that calculation (because they do notactually represent a borrowing) and the parties would need to consider whethercounterindemnities and guarantees should be included.


17 See section 6 of the introduction (p. 28 et seq.) for a discussion of transactions having the commercialeffect of borrowing.

18 See commentary on clause 22.3(b).19 See commentary on clause 23.5(a).20 Which is not a limited recourse company excluded from the provisions of the loan agreement as

discussed at para 4.2 of section 4 of the Introduction on p. 19.

Comment Lenders may wish to extend the definition to include deferred payment forgoods or services acquired, but if this is done, borrowers may seek further excep-tions to the negative pledge.

Comment Borrowers may wish to exclude Non-Recourse Indebtedness if any company inthe group20 has or is likely to have any limited recourse indebtedness, since failure topay such debt should not trigger the cross default clause and security over the proj-ect assets for such indebtedness should not cause a breach of the negative pledge.

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GAAP

‘GAAP’ means generally accepted accounting principles in [].

Obligors in different countries may have to comply with different accountingprinciples. For the purpose of compliance with financial ratios, a single set of prin-ciples will need to be agreed. This will usually be the principles which have to becomplied with by the top company in the group to which the lenders have access. Insome cases these principles will not be acceptable to lenders if they are not familiarwith accounting principles in the relevant jurisdiction.

LIBOR

‘LIBOR’ means, in relation to any Loan:(a) the applicable Screen Rate; or(b) (if no Screen Rate is available for the currency or Interest Period of that Loan) the arith-

metic mean of the rates (rounded upwards to four decimal places) as supplied to the Agentat its request quoted by the Reference Banks to leading banks in the London interbankmarket, as of the Specified Time on the Quotation Day for the offering of deposits in thecurrency of that Loan and for a period comparable to the Interest Period for that Loan.

In the case of both LIBOR and Euribor the rate is defined as the applicable ScreenRate or, if none, the rate supplied by the Reference Banks, in each case at theSpecified Time on the Quotation Day for the relevant amounts. (See Box 1.11 for analternative to Screen Rate).


BOX 1.11

An alternative definition not involving screen rate is:

‘LIBOR’ means, in relation to a particular period, the arithmetic mean (expressed as a percentagerounded upwards if necessary to four decimal places) of the rates quoted by the Reference Banksto the Agent at the request of the Agent as the rate determined by each Reference Bank to be thatat which deposits of the currency in question for a period equal to the relevant period were beingoffered by such Reference Bank to leading banks in the London Interbank Market at or about11 am on the Quotation Date for such period.’

21 The rate for Euros is provided by a panel of 57 banks reflecting their evaluation of the market for Eurodeposits between prime banks. For LIBOR it is the rate (also known as ‘BBA LIBOR’) calculated fromquotes provided by 16 prime banks with the highest and lowest four quotes being ignored.

22 See commentary on clause 11.1 for the position where a Reference Bank does not provide a quotation.

The Screen Rate is defined as the relevant rate specified on the Telerate orReuters screen. Rates are specified on those screens for different currencies for themost common Interest Periods. The rates quoted reflect the rates available fromprime banks in the Interbank Market at the relevant time.21

The Reference Banks are to be used as a fall back if there is no published ScreenRate. This is important to provide quotes for periods that are not commonly avail-able and hence, for which no rate may be quoted on the screen.22 The rate which the

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Reference Banks are to quote, is the rate at which they offer deposits to ‘leadingbanks’ (since the rate offered depends on the credit position of the offerree).

The definitions of Specified Time and Quotation Day allow for the definitions tomatch the different market practices for different currencies and markets. TheSpecified Time is set out in Schedule 11 to the LMA Term Loan.

Borrowers (but not necessarily lenders—see Box 1.12) prefer a Screen Ratedefinition rather than have a definition which reflects the lenders’ actual cost of fundsfor two main reasons. First, it is transparent.23 Second (subject to the comments madeon clause 11.2 at p. 88) it protects them from having to pay a higher interest rate sim-ply because a lender cannot obtain funds at as fine a rate as a prime bank.


BOX 1. 12

There are of course risks for the lenders in agreeing to a screen rate, since this does notaccurately reflect their own cost of funds. If, as happened with many Japanese banks inthe early 1990s, the lenders’ costs of funds increase substantially, the result may(subject to the issues discussed on p. 88 in the context of clause 11.2(b)) be that the ratethey are able to charge the borrower (Screen Rate plus Margin) is less than their actualcosts. In order to avoid the continuing losses involved, the lenders may need to selltheir interest in the loan.

23 That is, borrower is able to check the rate by looking at published sources. This is not the case with apersonal rate of LIBOR.

24 See also the commentary on this definition in the context of a combined term loan and revolvingcredit at the end of clause 1.1 on p. 52.

Majority Lenders

‘Majority Lenders’ means:(a) if there are no Loans then outstanding, a Lender or Lenders whose Commitments

aggregate more than [662⁄3]% of the Total Commitments (or, if the Total Commitmentshave been reduced to zero, aggregated more than [662⁄3]% of the Total Commitmentsimmediately prior to the reduction); or

(b) at any other time, a Lender or Lenders whose participations in the Loans thenoutstanding aggregate more than [662⁄3]% of all the Loans then outstanding.

One of the basic principles of a syndicated loan is that the lenders will be treatedequally and that the syndicate will act in accordance with the wishes of a ‘Majority’.The lenders need to decide what they mean by a Majority. Commonly, the level is set at66.66% of the loan by contribution. A different level may be appropriate in a club deal,particularly if the usual level would give one lender (e.g. the Agent) a blocking vote.24

Margin

‘Margin’ means [] per cent per annum.

If the Margin is adjusted with reference to the performance of the borrower (e.g. asmay be common in a start-up venture, or a workout facility) there may be an

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Material adverse change/effect

Commonly loan agreements have an Event of Default relating to Material AdverseChange. This concept may also be used as a qualifier to certain representationsor covenants28 (see also Box 1.14).


BOX 1.13

s3 Partnership Act 189026 states ‘In the event of any person to whom money has been advancedby way of loan upon such a contract as is mentioned in the last foregoing section’

[this reference is to s2(3)(d) Partnership Act which reads ‘the advance of money byway of loan to a person engaged … in any business on a contract with that person thatthe lender shall receive a rate of interest varying with the profits … arising from carry-ing on that business’]

‘being adjudged bankcrupt … the lender of the loan shall not be entitled to recover anything inrespect of his loan … until the claims of the other creditors of the borrower … have been satisfied’.

This English provision does not, however, affect a lender’s right to recover underany security held for the loan.27

25 Under English law, entitlement to a share in the profits is not conclusive as to existence of apartnership—s2 Partnership Act 1890.

26 This section of the Partnership Act probably applies to companies as well as to persons by virtue ofRule 12.3(2A) Insolvency Rules 1986. The Law Commission (in its paper No 283 on partnership law, issuedin November 2003) has recommended repeal of this section of the Partnership Act.

27 Re Lonergan, ex p Shell (1876–77) LR 4 Ch D 789 and Badeley v Consolidated Bank (1888) LR 38 Ch D 238.28 Some draftspersons prefer to use a concept of ‘Material Adverse Effect’ for use as a qualifier to

representations. There is no need for a separate concept to be used for this purpose. The single concept ofmaterial adverse change may be used both for the Event of Dafault and for the qualifier to representation.However, if two separate concepts are used, they should mirror each other. For adverse effect should read

‘Material Adverse Effect’ means a material adverse effect ona) the business, condition (financial or otherwise), operations, performance, prospects or properties of any

Obligor [or any Group member] [or of the Group taken as a whole]b) the rights and remedies of the Lender; orc) the ability of the Borrower to perform its [payment] obligations under this Agreement.

BOX 1.14

For example the agreement may say that it will be an Event of Default if

‘circumstances arise which may give rise to a Material Adverse Change’.

There may also be a representation that

‘there is no litigation which may give rise to a Material Adverse Change’.

implication that the lender is a partner in the business.25 In addition, in many coun-tries, there may be tax issues to consider (eg in England, s209 Income andCorporation Taxes Act 1988 as amended by the Finance Act 2000) and/or issues asto the priority of the loan in an insolvency of the borrower (see Box 1.13). These willbe issues for due diligence in the country or countries in which the borrower con-ducts business and in which an insolvency of the borrower may occur.

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The LMA Term Loan contains no definition of Material Adverse Change. Thefollowing is an example29 (Box 1.15).

Month

‘Month’ means a period starting on one day in a calendar month and ending on thenumerically corresponding day in the next calendar month, except that:(a) [(subject to paragraph (c) below)] if the numerically corresponding day is not a

Business Day, that period shall end on the next Business Day in that calendar monthin which that period is to end if there is one, or if there is not, on the immediatelypreceding Business Day;

(b) if there is no numerically corresponding day in the calendar month in which thatperiod is to end, that period shall end on the last Business Day in that calendarmonth; and

(c) [if an Interest Period begins on the last Business Day of a calendar month, thatInterest Period shall end on the last Business Day in the calendar month in whichthat Interest Period is to end.]

The above rules will only apply to the last Month of any period.

This definition is intended to reflect the practice in the Interbank Markets. The nor-mal practice in the London markets is for rates which are quoted on the last day ofa month to end on the last day of the month in which they end. So, a two-monthperiod starting on 28 February will end on 30 April, not 28 April. If the document isto reflect that market practice, paragraph (c) should be included.


BOX 1.15

‘Material Adverse Change’ means any material adverse change in

(a) the business, condition (financial or otherwise), operations, performance, prospects orproperties of any Obligor [or any Group member] [or of the Group taken as a whole]30

(b) the rights and remedies of the Lender; or

(c) the ability of any Obligor to perform its [payment] obligations under this Agreement.

29 See the commentary on clause 23.12 for further discussion of the Material Adverse Change Event ofDefault.

30 See para 4.3 of section 4 of the Introduction at p. 22.

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Optional Currency

‘Optional Currency’ means a currency (other than the Base Currency) which complieswith the conditions set out in Clause 4.3 (Conditions relating to Optional Currencies).

In the LMA Term Loan every new currency not agreed in the original loan agree-ment must be approved by every lender.

Original Financial Statements

‘Original Financial Statements’ means:(a) in relation to the Company, the audited consolidated financial statements of the

Group for the financial year ended [ ]; and(b) in relation to each Original Obligor other than the Company, its audited financial

statements for its financial year ended …

Consolidated statements are required from the Company as the ultimate holdingcompany. Given that the lenders are structurally subordinate31 in relation to assetswhich are in group members which are not Obligors, it may be that financialcovenants will be tested with reference to the Obligors as opposed to (or as well as)the entire group.32 In this case the lenders will need a method to assess the financialposition of each Obligor, in addition to that of the group as a whole. For this reason(and also because lender policy generally requires this) audited statements are usu-ally required from each Obligor in addition to the consolidated statements.

Quotation Day

‘Quotation Day’ means, in relation to any period for which an interest rate is to bedetermined:(a) (if the currency is sterling) the first day of that period;(b) (if the currency is euro) two TARGET Days before the first day of that period; or(c) (for any other currency) two Business Days before the first day of that period,

unless market practice differs in the Relevant Interbank Market for a currency, inwhich case the Quotation Day for that currency will be determined by the Agent inaccordance with market practice in the Relevant Interbank Market (and if quotationswould normally be given by leading banks in the Relevant Interbank Market on morethan one day, the Quotation Day will be the last of those days).

The Quotation Day for each currency takes into account the amount of noticerequired to book funds in that currency. Where the currencies are to be funded in theLondon Interbank Market, two days’ notice is required and each of those days mustbe a business day in the principal financial centre for that currency. In the case ofEuros, two days’ notice is required and each such day must be a TARGET Day


31 See para 4.7 of section 1 of Appendix 1 at p. 269.32 See discussion on scope of the agreement in para 4.4 of section 4 of the Introduction (pp. 23–24).

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(a day when the Trans-European Automated Real-time Gross Settlement ExpressTransfer payment system is open for payments of euro.

The general wording at the end of the definition prevents the definition fromhaving the effect of requiring places to be open for business that are not relevant forrate fixing for the relevant currency.

Reference Banks

The Reference Banks are used to determine LIBOR if a screen rate is unavailable,for example, because the period requested is an unusual one not listed on thescreen.


33 See commentary on clause 19.

BOX 1.16

A is a subsidiary undertaking of B if, effectively, B has the right to exercise, or actuallyexercises, a dominant influence or control over it, or the right to remove or appoint amajority of the board of directors or if it may exercise the majority of the voting rights,or if the two companies are managed on a unified basis, regardless of the fact that itmay not own the majority of the shares in B.

Clause 1 in the LMA recommended form for a combined facility for a term loan and revolving credit

The following comments relate to the form of documents recommended by theLMA for use in transactions where the lenders are to provide both a term loanand a revolving credit facility under a single facility agreement.

Comment A borrower may require the Reference Banks to be first class banks to get thebest rate. They do not need to be members of the syndicate.

Repeated Representations

It is important that the Repeated Representations should consist only of those whichare not already covered by a covenant or an Event of Default.33

Subsidiary

‘Subsidiary’ means [a subsidiary within the meaning of section 736 of the Companies Act1985] [a subsidiary undertaking within the meaning of section 258 of the CompaniesAct 1985]/ [].

The draftsperson may choose whether this definition should be to subsidiaryundertakings or to subsidiaries (see Box 1.16).

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34 This will, of course, need to be reflected in the Events of Default clause and in the conditionsprecedent.

Available Commitment

Because the LMA recommended form allows the term loan (Facility A) and therevolving credit (Facility B) to be syndicated separately, the AvailableCommitment of any given lender may be different for each facility.

Base Currency

The document assumes the Base Currency is the same for both facilities.

Majority Lenders

Because the LMA recommended form allows the facilities to be syndicated sepa-rately care is needed in considering voting rights of syndicate members. It maybe appropriate to have two separate definitions for a majority of Facility Alenders and a majority of Facility B lenders and, in certain circumstances, torequire consent of a majority relating to each facility.

Areas which are likely to need consideration include:

� amendments and waivers (can provisions for one facility be amended withoutconsent of a majority for that facility, and/or can a Default be waived for thepurpose of allowing a drawing under one facility, or preventing accelerationof it, without the consent of the majority of that facility’s providers34);

� prepayments and cancellations (do these need to be made pro rata betweenfacilities);

� pro rata sharing (should the facilities be treated separately or should any sur-plus recoveries by one lender be shared among lenders to both facilities);

� the partial payments clause (clause 29.5), which allows the order of paymentsto be varied by the Majority Lenders. Should this require a majority in relationto each facility?

Rollover Loan

The concept of ‘Rollover Loan’ is used to describe advances in a revolving creditfacility which simply replace existing advances (as opposed to advances whichresult in an increase in the amount outstanding). This is discussed further in thecontext of clause 4.2 (conditions precedent) and 19 (representations).

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Clause 1.2 Construction

Clauses 1.2(a)(i) to (vi)

1.2 Construction35

(a) Unless a contrary indication appears, any reference in this Agreement to:(i) the ‘Agent’, the ‘Arranger’, any ‘Finance Party’, any ‘Lender’, any ‘Obligor’ or

any ‘Party’ shall be construed so as to include its successors in title, permittedassigns and permitted transferees;

(ii) ‘assets’ includes present and future properties, revenues and rights of everydescription;

(iii) a ‘Finance Document’ or any other agreement or instrument is a reference tothat Finance Document or other agreement or instrument as amended ornovated;

(iv) ‘indebtedness’ includes any obligation (whether incurred as principal or assurety) for the payment or repayment of money, whether present or future,actual or contingent;

(v) a ‘person’ includes any person, firm, company, corporation, government, stateor agency of a state or any association, trust or partnership (whether or not hav-ing separate legal personality) or two or more of the foregoing;

(vi) a ‘regulation’ includes any regulation, rule, official directive, request or guide-line (whether or not having the force of law) of any governmental, intergovern-mental or supranational body, agency, department or regulatory, self-regulatoryor other authority or organisation.

Note the very broad definition of the word ‘regulation’. This is principally due tothe use of that word in the increased cost clause (clause 14) and in the context of cap-ital adequacy rules.36


35 See para 1.1 on p. 36.36 See Box 0.11 on page 16.

Comment Some like to add the words ‘but compliance with which is customary’ afterthe words ‘whether or not having the force of law’, so as to introduce some level ofobjectivity.

Clause 1.2(a)(vii)

(vii) a provision of law is a reference to that provision as amended or re-enacted; and

This rule in (vii) needs to be considered whenever a reference to a statute or otherlegal reference is made in the agreement since it may not be appropriate in eachcase to have the reference treated as a reference to the statute as amended from timeto time. For example, a reference to a particular tax provision would often beintended to refer to that particular provision, not that provision as it may changefrom time to time.

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Clauses 1.2(a)(viii), (b), (c), and (d)

(viii) a time of day is a reference to London time.(b) Section, Clause and Schedule headings are for ease of reference only.(c) Unless a contrary indication appears, a term used in any other Finance Document or

in any notice given under or in connection with any Finance Document has the samemeaning in that Finance Document or notice as in this Agreement.

(d) A Default (other than an Event of Default) is ‘continuing’ if it has not been remediedor waived and an Event of Default is ‘continuing’ if it has not been [remedied orwaived]/[waived].

Particularly important is the definition given to the word ‘continuing’. A Defaultcontinues until remedied or waived. An Event of Default may (if the person draft-ing the Loan Agreement selects the second of the two alternatives) continue unlesswaived (i.e. the remedy of it will not prevent it from continuing). The reason somelenders require this is that they take the view that the Default should have beenremedied while it was a Default and before it became an Event of Default.Moreover, if the borrower could unilaterally cure Events of Default it would reducethe borrower’s incentive to inform the lender of them (see Box 1.17).


BOX 1.17

For example, assume that the loan agreement provides that the existence of a potentialenvironmental liability against the borrower is an Event of Default. Assume that sucha liability arises. The borrower may feel that, if they can deal with the issue (e.g. byarranging for the clean up or whatever else is necessary to discharge the liability) thebest course for them would be not to notify the lenders, but simply to satisfy the liabil-ity, thereby remedying the Event of Default.

If this clause provides that an Event of Default is continuing unless ‘waived’(as opposed to saying that it is continuing unless ‘remedied or waived’) then if the bor-rower were to pursue their proposed course of action in this case, they would run therisk that the lenders subsequently might discover what had happened, and, since theEvent of Default had not been ‘waived’, the intention is that the lenders would be enti-tled to accelerate the loan even though the Event of Default had been remedied. Inother words, if the clause specifies that an Event of Default is continuing unlesswaived, this gives the borrower an incentive to advise the lenders of Events of Defaultso as to obtain waivers.

Clause 1.3 Third Party Rights

1.3 Third Party Rights[A person who is not a Party has no right under the Contracts (Rights of Third Parties)Act 1999 to enforce or to enjoy the benefit of any term of this Agreement.](a) [Unless expressly provided to the contrary in a Finance Document a person who

is not a Party has no right under the Contracts (Rights of Third Parties) Act 1999

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(the ‘Third Parties Act’) to enforce or to enjoy the benefit of any term of thisAgreement.

(b) Notwithstanding any term of any Finance Document, the consent of any person whois not a Party is not required to rescind or vary this Agreement at any time.]

Clause 1.3 is intended to clarify the intention of the parties in relation to the rightsthat third parties may acquire as a result of the agreement, as envisaged by theContracts (Rights of Third Parties) Act 1999. There are two options. First, the partiesmay elect that no third parties37 are intended to have enforceable rights under theagreement. Alternatively, they may select that enforceable rights will arise wherespecifically stated—this choice will be made if it is preferred to have the Act regu-late the position in relation to the exclusion clause in clause 26.9, rather than rely onthe common law (see Box 1.18).


BOX 1.18

The Contracts (Rights of Third Parties) Act 1999 was introduced to remove some of thedifficulties which the common law doctrine of privity of contract had given rise to.That doctrine has the effect that no person is entitled to enforce a contract or to take abenefit under it unless that person is a party to the contract. There are a number ofexceptions to the doctrine, notably the law relating to assignments of contracts and thelaw in relation to the taking of the benefit of exclusion clauses.38 The Act did not abol-ish the doctrine of privity but it did supplement it, allowing third parties to enforceterms of a contract and to take the benefit of those terms if the contract intended(expressly or by its proper construction) that those third parties should have the bene-fit of the relevant terms of the contract. The Act expressly preserved the rights of per-sons who could take the benefit of exceptions to the privity rule (such as assignees)under the common law. However, the Act did not specify how the common law andthe Act would interrelate in such circumstances.39 Given this uncertainty, some preferto provide that no third parties (other than assignees and transferees, who will become‘Lenders’ as defined in the agreement when the assignment or transfer is effected) areintended to take the benefit of the contract. Others prefer to specifically provide thatemployees may take the benefit of the exclusion clause in clause 26.9 in accordancewith the Act (rather than under an exception to the privity rule), in order to avoid thecomplexities of the common law in this area.40

37 (Meaning, in the context of the LMA Term Loan, by virtue of the definition of ‘parties’ inclause 1.2(a)(i), persons who are not assignees or transferees—see Box 1.18.)

38 Treitel ‘The Law of Contract’, 11th edition at p. 626 et seq.39 There are important differences between the common law and the Act. See ‘Selected Legal Issues for

Finance Lawyers’ by Martin Hughes at Chapter 12.40 If any third party is intended to have the benefit of any provision of the contract, the Act (s2) also

allows that third party to prevent amendment of the contract to their detriment in certain circumstances.This right is subject to any express term of the contract to the contrary. This is the reasoning behind clause1.3(b)—to ensure that third parties cannot object to amendment of the loan agreement.

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41 For a discussion of the difference between several, joint, and joint and several obligations, see para 3.5of section I of Appendix 1 on p. 264.

CLAUSE 2: THE FACILITY

Clause 2.1 The facility

Clause 2.1 contains the lenders’ agreement to provide the facility.

Clause 2.2 Finance Parties’ rights and obligations

Clause 2.2(a)

2.2 Finance Parties’ rights and obligations(a) The obligations of each Finance Party under the Finance Documents are several.

Failure by a Finance Party to perform its obligations under the Finance Documentsdoes not affect the obligations of any other Party under the Finance Documents. NoFinance Party is responsible for the obligations of any other Finance Party under theFinance Documents.

Clause 2.2(a) provides that the rights and obligations of the lenders are several.41

The lenders are not underwriting each other and, if one lender fails to advancefunds when due, the others are not responsible. This is so even if, at the time thesyndicate was being put together, one or more lenders underwrote the syndication.That underwriting related to the syndication process only—that is the abilityto obtain sufficient take up of the loan—and not to the creditworthiness of theparticipants.

56

C H A P T E R 2

The Facility

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The borrower is not, of course, at the complete mercy of the Arranger in terms ofthe identity of lenders to be invited into the syndicate (and therefore, whose creditrisk the borrower will be exposed to). The borrower and Arranger will have agreedprinciples relating to the syndication process and the types of lenders who can beinvited to join the syndicate, at an early stage in the syndication process.

C L A U S E 2 : T H E F A C I L I T Y 57

42 It would often also limit the amount which they would be prepared to underwrite in the first place.

Comment If the borrower wants to avoid taking credit risk on persons other than the orig-inal underwriting bank(s) there are a number of options, including the following:

� In a term loan with a short drawdown period, the borrower may request that theloan be advanced by the underwriters and only syndicated after full drawdown.This would, however, limit the amount that could be financed,42 and would notbe possible at all in a revolving credit.

� A borrower may request some comfort in this clause that if a lender does default,the other lenders will consider making additional funds available, short of a legalobligation to do so.

� More unusually, a legal obligation by one or more lenders to stand in for adefaulting lender may be negotiated but this would involve payment of a com-mitment fee for this additional facility.

� The borrower may request that, if one or more of the non-defaulting lenderswould have had undrawn commitments still available to the borrower after thedate of the drawing in which another lender defaulted those other lendersshould commit in advance to permit their undrawn commitments to be used tofund the defaulted sum.

Clause 2.2(b) and (c)

(b) The rights of each Finance Party under or in connection with the FinanceDocuments are separate and independent rights and any debt arising under theFinance Documents to a Finance Party from an Obligor shall be a separate andindependent debt.

(c) A Finance Party may, except as otherwise stated in the Finance Documents,separately enforce its rights under the Finance Documents.

Clauses 2.2(b) and (c) provide that the rights of the lenders are separate and theymay take independent action to enforce their rights (subject as otherwise stated)(see Box 1.19 on p. 58).

This may seem an unusual provision, inconsistent with two basic concepts in asyndicated loan:

� that all lenders are equal and will achieve equal levels of return (subject to fees etc);

� that the syndicate will be run in accordance with the wishes of the ‘Majority’.

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Clause 2.2(c) represents one of the limits on these concepts of joint action in a syn-dicated term loan.43 Its effect in a fully drawn term loan is that, even thoughMajority Lender approval is needed for acceleration of the loan and enforcement ofsecurity, and even though it is not possible for a single lender to accelerate its por-tion of the loan independently of the rest; nevertheless there will come a time whenthe loan advanced by each lender will fall due, regardless of the views of the rest ofthe syndicate. If the borrower fails to pay any amount which has fallen due thisclause ensures that each lender has the same rights as any other unsecured creditorin relation to its share in that instalment.

This can be an important right in a workout if some lenders do not want to goahead with a rescheduling which the Majority are pursuing, but would prefer toenforce their rights. Clause 2.2(c) gives the individual lenders significant leverage inthat situation (but see Box 1.20).

T H E F A C I L I T Y58

43 See below for revolving credits.44 This is achieved by clause 28.5 of the LMA Term Loan.45 This is achieved by clause 35.2 of the LMA Term Loan.

BOX 1.19

Generally, the loan agreement will state that acceleration and enforcement of securitygiven for the loan require Majority Lender consent. Those rights therefore cannot beexercised independently as envisaged by this clause. The most likely enforcementaction available to be exercised independently pursuant to this clause is the ultimatesanction which unsecured creditors generally have, which is to petition for winding upof the company.

BOX 1.20

For this right to be effective, lenders must ensure that

� any recovery they make is not required to be shared with the syndicate underclause 28 (pro rata sharing);44 and

� the due date for payments cannot be altered by the Majority Lenders.45

In the case of a term loan which is not fully drawn (or a revolving credit), clause2.2(c) gives little comfort to lenders because, although an individual lender can takeaction to enforce amounts due, they can also be forced by the Majority Lenders toadvance further funds, despite the existence of a Default or an Event of Default. Seecommentary on clause 4.2(a)(i).

Comment In some circumstances the borrower or the lenders may wish to negotiateamendment of this clause precisely to protect themselves against being held toransom by individual ‘rogue’ lenders.

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In this case deletion of clause 2.2(c) may not be sufficient. It would be sensible toexpressly exclude individual lenders’ rights to petition to wind up the borrower as,in the absence of clause 2.2(c), it is likely in many jurisdictions that courts wouldinterpret the loan agreement as establishing several (as opposed to joint) debts duefrom the borrower to each lender. The result would be that each lender would haveits own right to take action against the borrower (principally the right to petition forwinding up) for its own portion of the debt even if the agreement did not specifi-cally provide for this.

CLAUSE 3: PURPOSE

Clause 3.1 Purpose

3.1 PurposeEach Borrower shall apply all amounts borrowed by it under the Facility towards [ ].

The borrower undertakes to use the loan for the specified purpose. This does not, ofitself, provide a great deal of protection for the lenders for three reasons:

� first, the borrower may disregard the clause, using the money for unauthorizedpurposes (and putting the lenders in the position of, at best, having assumed adifferent credit risk from that intended);

� second, the loan may be used for the purpose intended (e.g. general corporatepurposes), but its availability results in other moneys being able to be diverted toa purpose which the lenders would not have funded; and

� third, the purpose stated is often quite vague, for example, ‘general corporatepurposes’, leaving a lot of room for interpretation.

Nevertheless, the purpose clause is of some value. It may assist in good faith argu-ments by the lenders (e.g. to demonstrate their lack of awareness of any illegal useor use in contravention of a regulation, such as a use contrary to US margin stockregulations46). It will, in most cases, be likely to trigger discussions about intendeduse of the facility, which may then be more specifically detailed. It can, in the worstcases, assist in establishing a claim in fraud if the borrower uses the funds for anunauthorized purpose.

Some lenders use the clause to specify prohibited uses, for example, to say thatit is not available for any purpose which would constitute (illegal) financialassistance in England.47

C L A U S E 3 : P U R P O S E 59

46 The US margin stock regulations limit the amount of loans which can be made for the purpose of pur-chasing, and which are secured on, margin stock; being US traded equity securities as well as some othershares and debt obligations. Loans made in breach of these limits may be void. However, a lender can relyon the borrower’s statement as to proposed use of the loan.

47 If it were to be used for such a purpose, the clause would not protect the lenders from the conse-quences, so this is no substitute for proper due diligence including investigating any debt which is to berefinanced.

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Clause 3.2 Monitoring

Clause 3.2 provides that the lenders are not required to verify the application ofmoneys lent under the agreement.

CLAUSE 4: CONDITIONS OF UTILIZATION

Clause 4.1 Initial conditions precedent

4.1 Initial conditions precedentNo Borrower may deliver a Utilisation Request unless the Agent has received all of thedocuments and other evidence listed in Part I of Schedule 2 (Conditions precedent) inform and substance satisfactory to the Agent. The Agent shall notify the Company andthe Lenders promptly upon being so satisfied.

Before the loan can be advanced, the borrower must provide certain documentaryconditions precedent as listed in Schedule 2 of the LMA Term Loan and discussed inrelation to that schedule. Satisfaction of these conditions precedent supplements thelenders’ own due diligence procedures and the borrower’s representations set outin clause 19, so that, before the loan is advanced, the lenders have three independ-ent checks on each important issue: the borrower’s statement in the representations;the lenders’ independent review (encapsulated, in the case of legal issues, in itslawyer’s legal opinion); and the evidence presented in satisfaction of the conditionsprecedent. As a drafting matter, changes negotiated in any one of these areas of thedocument may need to be reflected in the others.

One issue here is whether the conditions precedent should be met to the satisfac-tion of the Agent, or to the satisfaction of all the lenders, or perhaps of the MajorityLenders.48 In practice it will be the Agent who attends the closing meeting.Nevertheless, many lenders will want all conditions precedent satisfied unless theyconsent otherwise—particularly in relation to issues around establishment of anysecurity.


48 Borrowers, of course, would prefer to satisfy the Majority Lenders rather than all lenders, so as not tobe effectively regulated by the most cautious lender.

Clause 3.1 in other commercial circumstances

In an asset finance transaction (or indeed a corporate loan in some instances suchas a refinancing), the loan agreement will provide that advances will be made toa specified account (e.g. the account of the seller of the asset or the lender to berefinanced) and that that will be treated as an advance to the borrower. In a proj-ect finance transaction, the agreement will provide for the loan to be advanced toa disbursement account (charged to the lenders) with provisions for drawings onthat account against invoices and/or other certification.

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The precise requirement as to the level of consent needed depends on the inter-play between the facts and the provisions of clause 4.1 (Initial conditions precedent)and clause 35 (Amendments and waivers).

Clause 4.1 requires the conditions precedent to be met to the satisfaction of theAgent, while clause 35 requires the consent of the Majority Lenders (or, in the caseof matters covered by clause 35.2, all the lenders) for waivers and amendments.The distinction between the two clauses is a fine one. It requires a differentiation tobe made between the Agent:

� making a decision as to whether a particular document does or does not satisfythe condition precedent (which is a decision which, under clause 4.1, is delegatedto the Agent49); and

� deciding that a particular document does not satisfy the condition precedent butdeciding to waive that condition precedent (which, because of clause 35.1,50 theAgent can only do with the consent of the Majority Lenders, or, if the effect ofthe waiver is to change those entrenched provisions listed in clause 35.2,51 withthe consent of all the lenders) (see Box 1.21).

C L A U S E 4 : C O N D I T I O N S O F U T I L I Z AT I O N 61

49 In making its decision on this issue, the Agent will rely on advice from its lawyers and, if there is anydoubt, in practice will be likely to seek the views of the syndicate, partly because the distinction betweenapproving a document and waiving a condition is often unclear, and partly to minimize its potentialliability in relation to breach of fiduciary duty.

50 ‘35.1(a) Subject to Clause 35.2 (Exceptions) any term of the Finance Documents may be amended or waivedonly with the consent of the Majority Lenders …’

51 Such as the Margin, and which, in a secured loan, is often extended to include the existence of thesecurity.

BOX 1.21

For example, assume that it is a condition precedent that the borrower delivers speci-men signatures of all directors of the borrower. Assume the document delivered onlyincludes specimen signatures for some of the directors. If the Agent decided to acceptthe document delivered, would this be something which amounted to a waiver (gov-erned by clause 35.1), and therefore required consent of the Majority Lenders, or wouldit be an exercise of the Agent’s discretion under clause 4.1, not requiring approval ofany other lender, since all the Agent is doing is accepting that a slightly deficientdocument is sufficient to satisfy the condition? The answer is unclear and will dependon the precise wording of the particular condition precedent as set out in Schedule 2.

This distinction between a waiver under clause 35 and an approval of a conditionprecedent under clause 4.1 is a necessary consequence of having the Agentapprove the conditions precedent as opposed to requiring all lenders to approvethem. The lenders will need to ensure that clause 35.2 includes key conditionsprecedent (such as those relating to security) as items which all lenders need toconsent to a waiver of.

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Clause 4.2 Further conditions precedent

4.2 Further conditions precedent(a) The Lenders will only be obliged to comply with Clause 5.4 (Lenders’ participation)

if on the date of the Utilisation Request and on the proposed Utilisation Date:(i) no Default is continuing or would result from the proposed Loan; and


52 See Box 3.22 on p. 240.

Clause 4.1 in other commercial circumstances

The following commentary looks at clause 4.1 in certain situations not covered bythe LMA Term Loan.

Asset finance transactions

For transactions where the loan is to finance the purchase of an asset and securityis to be taken over that asset, the conditions precedent will fall into two cate-gories: those required before notice of drawdown can be given; and those (theconditions related to the establishment of the security) which are required ondrawdown. There will be practical difficulties in satisfying the conditions prece-dent to drawdown.52 In particular, given that the lenders will have arranged theirfunding in advance, but will need to be advised of satisfaction of conditionsprecedent in order to actually advance funds, the agreement should specify atime of day by which the conditions precedent need to be satisfied, so as toensure that the Agent is in a position to notify lenders of satisfaction of condi-tions precedent in sufficient time for payments to be effected.

Multiple drawdown facilities

The conditions precedent in clause 4.1 will require adjustment where there is aterm loan with multiple drawdowns (and possibly an extended drawdownperiod). There will be different conditions precedent for the first drawdown fromthose which apply to subsequent drawings.

Documentary conditions precedent to subsequent drawdowns clearly need toreflect the purpose of the drawdown. So, for example, a loan for construction ofa given project, such as an airport, may provide for drawdowns matching stagesof construction—in which case the conditions precedent will relate to evidence ofachievement of the relevant stage of the project. Often the lenders are also con-cerned that the ratio of debt to equity is maintained and will therefore requireevidence that the relevant amount of equity has been injected.

Revolving credit

In a revolving credit facility, it would be unusual to require additional documen-tary conditions precedent on each drawdown.

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(ii) the Repeating Representations to be made by each Obligor are true in all materialrespects.

Clause 4.2 requires certain factual conditions precedent to be satisfied in additionto the documentary conditions precedent referred to in clause 4.1. These are arequirement that there be no ‘Default’53 and a requirement that the RepeatingRepresentations are true.

Clause 4.2(a)(i)

The reason for the requirement that there should be no ‘Default’ is that, if circum-stances exist which may mature into an Event of Default, the lenders should not beobliged to advance additional money (even though, of course, the lenders wouldnot yet be entitled to require immediate repayment of money already advanced, asthat right would not arise unless the relevant circumstances did, in fact, mature intoan Event of Default).

The condition is that no Default is ‘continuing’. This requirement should be readtogether with clause 1.2(d) (which defines ‘continuing’) and clause 34 (which setsout the level of consent required to grant a waiver of a Default). The result is that,for most Defaults, it is a decision for the Majority Lenders as to whether or not toadvance the loan, despite the existence of a Default. In certain cases (see, e.g. theoptions in relation to clause 8.2 relating to change of control) this decision not toadvance funds can be taken by individual lenders, independently of the Majority.See also the discussion on clause 1.2(d).


53 See commentary on the definition of ‘Default’ in Clause 1 on p. 41.

Clause 4.2(a)(i) in a revolving credit

The concept of ‘Default’ involves drawing a distinction between the lenders’ rightto require repayment of moneys already advanced (which arises on an Event ofDefault) and their right to be relieved of their obligation to lend new money(which arises on a Default). This distinction is more difficult to make in a revolv-ing credit facility. The mechanics of a revolving credit facility are that a loan isadvanced for a relatively short period, for example, three months. It is repaid infull at the end of that period and the borrower may then redraw whatever avail-able amount it requires for a new period. The new advance on a rollover maytechnically be regarded as ‘new money’, but in commercial terms, it is only anyadditional money over and above the amount outstanding immediately prior tothe rollover, which is really new.

For this reason, clause 4.2 of the LMA recommended form for revolving cred-its specifies that, in relation to ‘Rollover Loans’ (where the amount of the newloan does not exceed the old loan and the new loan is in the same currency as theold loan) the condition precedent is that no ‘Event of Default’ exists. For loanswhich are not ‘Rollover Loans’ the condition precedent is that no ‘Default’ exists(see Box 1.22 on p. 64).

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Clause 4.2(a)(ii)

In addition, clause 4.2(a)(ii) requires all Repeating Representations to be true (andthis applies to all advances of a term loan and to all rollovers of a revolving credit—whether or not they are simply ‘Rollover Loans’). The reason is to ensure that cer-tain very basic issues (such as ability to borrow the loan) remain as they originallywere. It is up to the draftsperson to specify which of the representations are to be‘Repeating Representations’ and are therefore to be conditions precedent toadvances. This is a complex area, discussed in detail in para 2 of section 1 of thecommentary on clause 19 (Representations).

Clause 4.3 Conditions relating to optional currencies

Clause 4.3 sets out additional conditions for drawing in a currency other than theBase Currency. These include a requirement that the currency has been approved, isfreely convertible to the Base Currency, and is readily available in the amountrequired. Once a currency is agreed the Agent must notify minimum drawingamounts.

Clause 4.4 Maximum number of loans

Clause 4.4 limits the number of loans that may be outstanding. This limits theadministrative requirements in servicing the loan for the lenders. In the case of a


BOX 1.22

CLAUSE 4.2 IN THE LMA RECOMMENDED FORM FOR A REVOLVING CREDIT

‘4.2 Further conditions precedent

The Lenders will only be obliged to comply with Clause 5.4 (Lenders’ participation) if onthe date of the Utilisation Request and on the proposed Utilisation Date:(a) in the case of a Rollover Loan, no Event of Default is continuing or would result from

the proposed Loan and, in the case of any other Loan, no Default is continuing orwould result from the proposed Loan; and

(b) the Repeating Representations to be made by each Obligor are true in all materialrespects.’

‘ “Rollover Loan” means one or more Loans:

(a) made or to be made on the same day that a maturing loan is to be repaid;

(b) the aggregate amount of which is equal to or less than the maturing loan;

(c) in the same currency as the maturing Loan (unless it arose as a result of the operation ofClause 6.2 (unavailability of a currency)); and

(d) made or to be made to the same Borrower for the purpose of refinancing a maturing Loan.’

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loan such as the LMA Term Loan, which allows for different loans to different groupmembers, the number of loans allowed must of course be sufficient for the antici-pated number of borrowers.


54 See section 2 of the commentary on clause 22 and the commentary on Schedule 2.

BOX 1.23

So, for example, assume that a revolving credit facility for $50 million provides thatonly one loan at a time is available under it. Assume that the borrower has borrowed aloan of $20 million for a six-month Interest Period under the facility. The result is that,during that six-month period, the borrower will be paying commitment fee on theunused facility ($30 million) but will be unable to draw any of that commitment.Clearly, a limit of one loan at a time is therefore too restrictive in a revolving credit.

Where the loan is to a single borrower, a number of different loans or tranchesmay also be desirable to enable the borrower to divide the loan into differentparts with different interest periods. This will enable the borrower to use the loanto manage its interest rate exposure.

In a revolving credit, clause 4.4 raises different concerns for the borrower asthe maximum number of loans needs to be set at a high enough number to ensurethat the borrower is not effectively unable to borrow any balance of the commit-ment (while still paying commitment fee on it) until the end of the then currentInterest Period (see Box 1.23).

Other conditions precedent

There is often an additional clause permitting the lenders to request such furtherfavourable certificates as the lenders may reasonably request. This is intended tocover things which subsequent events show to be advisable. Borrowers oftenobject to this clause, particularly in a revolving credit facility or a term loan witha long availability period, as giving too much discretion to the lenders and toolittle certainty to the borrower.

Conditions precedent relating to any other items which were important to thecredit decision need to be added. These might include conditions precedent as toexecution and registration of security and guarantees and conditions precedentas to key assets and contracts.54

Some loans are intended to be a backstop only—it is not intended that they bedrawn except in exceptional circumstances. For these, unless the conditionsprecedent are satisfied before the loan agreement is signed (in which case no con-dition precedent clause is necessary) it will be sensible to have key conditions

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precedent (such as board resolutions and legal opinions) satisfied as acondition precedent to the lenders’ commitment to lend (as opposed to beinga condition precedent to the actual advance of funds, as would normally be thecase) and perhaps to require those conditions precedent to be satisfied within afairly short period after signing the facility. There may then be a separate clausewith any other conditions precedent required for an advance to be made (such as,perhaps, a condition precedent that there is no Default).

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CLAUSE 5: UTILIZATION

Clause 5.1 Delivery of a Utilization Request

5. UTILISATION5.1 Delivery of a Utilisation RequestA Borrower may utilise the Facility by delivery to the Agent of a duly completedUtilisation Request not later than the Specified Time.

5.2 Completion of a Utilisation Request(a) Each Utilisation Request is irrevocable and will not be regarded as having been duly

completed unless: … the proposed Utilisation Date is a Business Day within theAvailability Period; …

(b) Only one Loan may be requested in each Utilisation Request.

Clause 5.1 requires a drawdown notice to be given at a ‘Specified Time’. The preciseperiod of time required for notice of drawdown depends on the currency and on themarket in which the loan is being funded and is set out in a schedule. The draw-down must be made within the Availability Period. This prevents an open-endedcommitment arising.

There are requirements as to the minimum amounts of any drawdown. This is bothfor administrative convenience of the lenders and also to prevent any lender havingto fund small amounts, such that the Screen Rate of LIBOR is not available for thoseamounts. Sometimes, there will be requirements as to frequency of drawdowns.

In the LMA Term Loan there are no restrictions on how many utilizations may bemade on the same day (hence a number of currencies may be drawn).

67

C H A P T E R 3

Utilization

Comment Lenders may wish to impose not only a minimum amount on the drawingbut also to require drawings to be in integral multiples of a given figure to prevent

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Clause 5.2 Completion of a utilization request

Clause 5.2 requires the borrower to deliver a utilization request specifyingthe amount required, the date on which it is required, and the Interest Period, forany loan.

Clause 5.3 Currency and amount

Clause 5.3 specifies the minimum amounts in which drawings must be made.

Clause 5.4 Lenders’ participation

5.4 Lenders’ participation(a) If the conditions set out in this Agreement have been met, each Lender shall make its

participation in each Loan available by the Utilisation Date through its FacilityOffice.

Clause 5.4 requires the lenders to lend through their Facility Office.56

U T I L I Z AT I O N68

55 See Ross Cranston, Principles of Banking Law, p. 39 et seq for a discussion of correspondent banking.56 See however the definition of ‘Facility Office’ discussed on p. 44.

themselves from being required to fund odd amounts which may not be readilyavailable in the market.

Comment Lenders may want to include an additional restriction in this clause or in theutilization request itself, to the effect that the borrower can only require moneys tobe paid to an account in the principal financial centre for the currency concerned, soas to ensure that the borrower is the party which needs to take insolvency risk on itsown bank’s correspondent bank in the relevant country.55

Clause 5 in other commercial circumstances

The LMA recommended forms include additional options, which may be addedto facilities that include a revolving credit. These are the swingline option (Eurosor Dollars) and the letter of credit option.

Swingline facility

This is a facility available in immediately available funds (the LMA form providesfor Dollars or Euros) to support the borrower’s liquidity see Box 1.24 on p. 69.

Drawings under the facility may only be made for a period of five daysat most and cannot be applied in repayment of another swingline facility (re-emphasizing the role of the facility as a backstop).

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C L A U S E 5 : U T I L I Z AT I O N 69

57 Although with less practical problems given the backstop nature and short duration of Swinglineloans.

BOX 1.24

A swingline may be used for general liquidity purposes and/or to support a commercialpaper programme. It can assist with rating of the commercial paper, as it will give themarket and the rating agencies comfort that the swingline will be available to be drawnon if the commercial paper cannot be repaid on the due date as a result of a failure(caused by a market disruption) to raise new finance by the issue of new commercialpaper.

One key characteristic of a swingline facility is that the lenders make availableimmediately available funds—unlike other facilities, one or two days’ notice ofdrawing cannot be given, as the facility is designed to cover short-term liquidityissues, of which notice is not possible (e.g. there will be no advance notice of aproblem in refinancing existing commercial paper). The questions then are:

j which lenders should fund the facility (not all will have access to immediatelyavailable funds); and

j which lenders should share in the risk.

As to funding, under the LMA recommended forms, the facility may be providedby all lenders of the revolving credit or by a sub-group of those lenders (or, in thecase of any lender, through an Affiliate of that lender), with utilizations under itreducing the amounts of their commitments to the revolving credit.

As to the risk, either the risk lies only with the lenders which fund theSwingline (in which case the issues relating to the definition of ‘MajorityLenders’ discussed on p. 52 in the context of the term and revolving credit facil-ity will apply57) or, alternatively, there is an option for loss sharing by all revolv-ing credit lenders on losses suffered by Swingline lenders.

Letter of credit option

The borrower may request the facility to be made available by issue of letters ofcredit. The LMA recommended forms provide for these to be issued by a singlelender relying on indemnities from all lenders who participate in the revolvingcredit. Unlike the swingline option, it is not contemplated that lenders’ sharing ofthe risk in this option might be any different from their shares in the revolvingcredit facility.

The standard form contemplates that letters of credit may be issued in acurrency other than the Base Currency, in which event there are provisions forvaluation from time to time in the Base Currency.

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CLAUSE 6: OPTIONAL CURRENCIES

All companies need to ensure, as part of their normal financial management, thatthe currencies in which their income is denominated matches the currencies inwhich their liabilities are denominated or that they have resources available to man-age any exposure which they have, resulting from a mismatch. The currencieswhich borrowers decide to borrow in will therefore normally (but not necessarily—e.g. see Box 1.25) be chosen to match the currencies in which they generate income.


BOX 1.25

The borrower may also own assets which have a worldwide market and which aregenerally bought and sold in a specific currency. Examples are ships and aircraft,which are normally traded in Dollars. Here, the borrower, or the lenders, may wish tosee the loan denominated in the currency in which the assets are normally bought andsold (even if income is earned in a different currency), so as to ensure the relative valueof the security is maintained.

Multicurrency loans may be drawn in one or more specified currencies, orswitched from one specified currency to another after drawdown. This ability todraw in and convert into different currencies assists the borrower in matchingincome and liabilities (particularly in a revolving credit), and can also be used as atool to access the interest rate applicable for borrowings in different currencies.

Whatever the borrower’s reason for wanting to have the ability to switch curren-cies, it needs to consider also the questions of how its repayment obligations will becalculated and how the amount of the available facility will be calculated. Theyneed to consider, for example, whether it is better for them to have

� a Dollar based loan which is available for drawing in, or conversion into, Euro or Yen;

� a Euro based loan which is available for drawing in, or conversion into, Dollarsor Yen; or

� three separate facilities, one in Dollars, one in Euros, and one in Yen.

Any payment made by the Agent under the letter of credit is immediatelyrefundable by the borrower. If an Event of Default occurs prior to the expiry ofthe letter of credit, the borrower is required to provide cash security to the Agentin an amount equal to the potential liability of the Agent under the letter of credit.

From the perspective of the lender which issues the letters of credit, it is relyingon the borrower’s credit risk, to the extent of that lender’s participation in the let-ter of credit facility, but, to the extent that other lenders have committed to sharethe risks in the facility, the lender is relying on the credit risk of those otherlenders—that is, will they make payment when due under their indemnities?

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The first two examples would normally be described as multicurrency loans and themechanisms for providing such facilities are included in the LMA recommendedforms for multicurrency loans. The third example is not normally described as amulticurrency loan.

The different impact of the three options depends on whether the facility inquestion is a term loan or a revolving credit facility.

Revolving credit

The key differences between the three examples, in the case of a revolving credit,relates to calculation of how much remains for drawing. If the borrower had threeseparate facilities in different currencies, it has the security that those facilities willremain available, in their specified amounts, regardless of exchange rates. If, on theother hand, the borrower relied on a Dollar-based loan to finance its need for Euros,it would be exposed to the possibility that the available Euros would be reduceddue to their appreciation against the Dollar—because the amount available at agiven drawdown date would be fixed at a Dollar sum. If that sum afforded fewerEuros than at the start, that risk is for the borrower.

Term loan

In the case of a term loan, the principal difference relates to calculation of repay-ments. In the first example (a Dollar-based loan), repayment will be required to bemade in amounts which keep the value of the loan, in Dollar terms, in line with aschedule fixed at the start of the loan (see Box 1.26). If income is in a currency otherthan Dollars, the risk is that exchange rates will move such that there will be insuf-ficient income to fund the repayment installments. In the second case (a Euro-basedloan), fixed Euro repayments will be required. Again, the borrower will take the

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BOX 1.26

Taking a simple example. Assume a multicurrency loan of $10 million is available inDollars or Euros and has a Base Currency of Dollars. It is repayable by 20 equal instal-ments, one every six months. It is drawn in Euros at a time when exchange rates are1 : 1. Hence, 10 million Euros are drawn. On the first repayment date, the exchange ratehas moved to 1 : 1.5. The borrower must repay 10 million Euros and redraw the thenequivalent of $9.5 million (the ‘Base Currency Amount’ at that time, that is, the amountwhich would have been outstanding if the loan had always been denominated inDollars). The amount the borrower can redraw is therefore 9.5 � 1.5 (the currentexchange rate) � 14.25 million Euros. The borrower repays 10 million Euros andredraws 14.25 million Euros. On the next repayment date, exchange rates havereturned to 1 : 1. The borrower must now repay 14.25 million Euros and can redraw thethen equivalent of $9 million (the Base Currency Amount at that time). The then equiv-alent of $9 million is 9 � 1 � 9 million Euros. The borrower repays 14.25 million Eurosand redraws 9 million Euros. The agreement may include provisions allowing theseamounts to be netted so that only the difference between the two amounts is paid.

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exchange rate risk in relation to the currency outstanding. In the third case,repayment of every facility will be in its outstanding currency, regardless of anymovement of exchange rates relating to that currency.

Multicurrency facilities can give numerous different options, for example, as towhich currencies are permitted (in the case of the LMA Term Loan, those currencieswill be specified in the agreement and may only be added to if all lenders agree) andwhether more than one currency is available at any one time.

Clause 6.1 Selection of currency

6.1 Selection of currency(a) A Borrower (or the Company on behalf of a Borrower) shall select the currency of a

Loan:(i) (in the case of an initial Utilisation) in a Utilisation Request; and(ii) (afterwards in relation to a Loan made to it) in a Selection Notice.

Each loan under the LMA Term Loan must be in a single currency. However,borrowers may request more that one loan at the same time, each of which may bein different currencies.

There are provisions (clause 6.1(c)) dealing with what happens if a borrower asksto convert the loan from one currency to another on a day which is not a BusinessDay for both currencies concerned (the loan remains in the existing currency and isrolled over on a daily basis until a day which is a Business Day for both currencies).There are also provisions (clause 6.2) dealing with the situation where some syndi-cate members are unable to fund in the requested currency (they are required tofund in the Base Currency).

Clause 6.3 Change of currency

6.3 Change of currency(a) If a Loan is to be denominated in different currencies during two successive Interest

Periods:(i) if the currency for the second Interest Period is an Optional Currency, the

amount of the Loan in that Optional Currency will be calculated by the Agentas the amount of that Optional Currency equal to the Base Currency Amount ofthe Loan at the Agent’s Spot Rate of Exchange at the Specified Time;

(ii) if the currency for the second Interest Period is the Base Currency, the amountof the Loan will be equal to the Base Currency Amount;

(iii) (unless the Agent and the Borrower agree otherwise in accordance with para-graph (b) below) the Borrower that has borrowed the Loan shall repay it on thelast day of the first Interest Period in the currency in which it was denominatedfor that Interest Period; and

(iv) (subject to Clause 4.2 (Further conditions precedent)) the Lenders shallre-advance the Loan in the new currency in accordance with Clause 6.5 (Agent’scalculations).


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A multicurrency facility has a Base Currency, with reference to which the amount ofthe loan available in any given currency will be calculated. This is the concept of the‘Base Currency Amount’ in the LMA Term Loan. It is the amount that would havebeen outstanding in the Base Currency if the loan had always been denominated inthat currency. The loan may be drawn in a different currency—in which case theamount advanced will be the equivalent of the Base Currency Amount on the draw-down date. Clause 6.3 of the LMA Term Loan provides that, if a loan is to changecurrency, then, at the end of the Interest Period when that change is to occur, theamount drawn, in the currency originally drawn, will be repaid in full. The bor-rower will redraw (in whatever permitted currency is permitted) the Base CurrencyAmount (or its then equivalent in the new relevant currency).

Clause 6.4

Clause 6.4 applies a similar procedure (without the repayment and re-advance) forinterest periods where there is no change of currency (see Box 1.26 on p. 71).

There are often provisions (clause 6.4(b) of the LMA Term Loan) that if there is nochange of currency and the difference between the amount due to be repaid and theamount due to be re-advanced is minimal then no adjustment will be needed.

These mechanics mean that the lenders may be required to advance furtherfunds even when the loan is being repaid.58

The mechanics of repayment and re-advance of the loan can cause difficultieswith secured loans as it may inadvertently have the effect of repaying the loanwhich the security secures.59

C L A U S E 6 : O P T I O N A L C U R R E N C I E S 73

58 This has implications for the method of transfer of a multicurrency loan—see para 2.3 of section 1 ofthe commentary on clause 24 on p. 192.

59 See further para 5 of section 2 of Appendix 1.

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CLAUSE 7: REPAYMENT

Clause 7.1 Repayment of loans

This clause specifies (in a term loan) the repayment schedule.

Clause 7.2 Reborrowing

This clause states that moneys repaid are not available for reborrowing.

74

C H A P T E R 4

Repayment, Prepayment,and Cancellation

Clause 7 in different commercial circumstances

Revolving Credit

7.1 Each Borrower which has drawn a Loan shall repay that Loan on the last day of itsInterest Period.

A revolving credit involves the advance of a loan for a chosen Interest Period,with the loan being repaid in full at the end of its Interest Period. Subject to clause4.4, (limiting the number of loans), additional loans may be advanced from timeto time. In a revolving credit, if the amount of the lenders’ commitment to lendreduces over time, clause 7.2 (Reduction of facility) will be included and will spec-ify the applicable limits on the facility during its term.

CLAUSE 8: PREPAYMENT AND CANCELLATION

Clause 8 deals with prepayment and cancellation. It falls into 3 sections:compulsory prepayment (clauses 8.1 and 8.2 dealing with illegality and change of

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control); voluntary cancellation and/or prepayment (clauses 8.3 and 8.4); andvoluntary prepayment of a single lender (clause 8.5).

Clause 8.1 Illegality

8.1 IllegalityIf it becomes unlawful in any jurisdiction for a Lender to perform any of its obligations ascontemplated by this Agreement or to fund or maintain its participation in any Loan:(a) that Lender shall promptly notify the Agent upon becoming aware of that event;(b) upon the Agent notifying the Company, the Commitment of that Lender will be

immediately cancelled; and(c) each Borrower shall repay that Lender’s participation in the Loans made to

that Borrower on the last day of the Interest Period for each Loan occurring after theAgent has notified the Company or, if earlier, the date specified by the Lender inthe notice delivered to the Agent (being no earlier than the last day of any applicablegrace period permitted by law).

Clause 8.1 requires compulsory prepayment and termination of the commitment inrelation to a single lender if it becomes illegal for that lender to continue to fund theloan (see Box 1.27). This covers not only illegality due to political events but also ille-gality due to imposition of exchange control regulations (for example). This clause isintended to deal with situations such as the Iranian crisis, the Falklands war, and theIraq wars and to allow a mechanism for the lenders to comply with any relevant law.While it may be wishful thinking to expect the participation in the loan to be prepaidin these circumstances, the right not to advance new moneys will be effective.

C L A U S E 8 : P R E PA Y M E N T A N D C A N C E L L AT I O N 75

60 The nearest English law gets is the concept of frustration which is quite different.

BOX 1.27

There is no force majeure clause and force majeure is not a concept which English Lawwill read into a contract which is silent on the subject.60 Therefore, the borrower willnot be relieved of its obligations if, for example, strike or exchange control restrictionsprevent it from making payments (but see clause 23.1).

Comment A borrower may, in certain circumstances, argue that

� the obligation to fund the loan should be suspended during the period of theillegality, but not cancelled;

� the obligation to prepay should not arise if the situation is capable of remedy,for example, by obtaining necessary licences or exemptions; and/or

� the relevant lender should have an obligation to try to obtain any permits etc.which may be available to cure the problem.

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Clause 8.2 Change of control

8.2 Change of control(a) If [[ ] ceases to control the Company]/[any person or group of persons acting in

concert gains control of the Company]:(i) the Company shall promptly notify the Agent upon becoming aware of that

event;(ii) [a Lender shall not be obliged to fund a Utilisation;](iii) if [the Majority Lenders so require]/[a Lender so requires and notifies the Agent

within [] days of the Company notifying the Agent of the event], the Agent shall,by not less than [_] days notice to the Company, cancel the [TotalCommitments]/[Commitment of that Lender] and declare [the participation of thatLender in] all outstanding Loans, together with accrued interest, and all otheramounts accrued under the Finance Documents immediately due and payable,whereupon the [Total Commitments]/[Commitment of that Lender] will be can-celled and all such outstanding amounts will become immediately due and payable.

(b) For the purpose of paragraph (a) above ‘control’ means …(c) [For the purpose of paragraph (a) above ‘acting in concert’ means …

Clause 8.2 requires compulsory prepayment of the whole loan and release of alllenders from their obligation to fund if there is a change of control in relation to theborrower and the Majority Lenders require prepayment. The argument is that theyhave relied on continuity of ownership and management in their credit decision.The commercial effect of this is the equivalent of an Event of Default but it is framedas a compulsory prepayment to avoid triggering cross default clauses.61

There is an option for compulsory prepayment of individual lenders in para-graph (iii). Many lenders will require this option, enabling them to require prepay-ment regardless of the views of the Majority in those cases where the identity of theshareholder is critical to their lending decision, even though a guarantee may nothave been sought from the shareholder.

The clause allows the right to require prepayment (governed by paragraph (iii))to be exercised independently from the right not to lend new money (governed byparagraph (ii)). It may be that lenders will be reluctant to call for prepayment ofmoneys already advanced but will want to stop future drawings.

R E PA Y M E N T, P R E PA Y M E N T, A N D C A N C E L L AT I O N76

61 See commentary on clause 23.5 at p. 175 “Compulsory prepayment events.”

Some loans contain other circumstances in which a compulsory prepayment isrequired. These may include cash sweeps if results for a given period are betterthan expected, prepayment with the proceeds of permitted disposals, or prepay-ment out of insurance proceeds in an asset finance, or out of post-completionprice adjustments, in an acquisition finance.

Comment The borrower may wish to ask for compulsory negotiation and/or a graceperiod.

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Clause 8.3 Voluntary cancellation

8.3 Voluntary cancellationThe Company may, if it gives the Agent not less than [_] Business Days (or such shorterperiod as the Majority Lenders may agree) prior notice, cancel the whole or any part(being a minimum amount of [ ]) of the Available Facility. Any cancellation under thisClause 8.3 shall reduce the Commitments of the Lenders rateably.

Clause 8.3 gives the borrower the right to reduce the amount of the facility. Thisright to reduce the commitment is a useful additional right to the right to prepay,particularly in a revolving credit or a term loan with a long drawdown period, as inthese cases the commitment fee will be payable during the whole drawdownperiod and cancellation allows the borrower a method to bring these fees to an end.

Lenders often require the minimum amount for cancellation to be significant.They may also require (both in this clause and the voluntary prepayment clause)that the right be exercised in relation to integral multiples of the specified amount toensure that lenders are not left with odd amounts to fund in the markets.


62 Without this express right, the borrower would probably not be entitled to prepay.

Comment Borrowers may wish to have prepayments applied pro rata against repay-ment instalments in certain circumstances so as to see immediate benefit from anyprepayment. This would be particularly important in an asset finance where theprepayment was made from sale of an asset which would otherwise have generatedpart of the income required for the loan repayment.

Comment The notice period for cancellation should be short so as to bring thecommitment fee to an end as soon as possible.

Clause 8.4 Voluntary prepayment of loans

8.4 Voluntary prepayment of Loans(a) A Borrower to which a Loan has been made may, if it gives the Agent not less than [ ]

Business Days’ (or such shorter period as the Majority Lenders may agree) priornotice, prepay the whole or any part of any Loan (but, if in part, being an amount thatreduces the Base Currency Amount of the Loan by a minimum amount of []).

(b) A Loan may only be prepaid after the last day of the Availability Period (or, if earlier,the day on which the Available Facility is zero).

(c) Any prepayment under this Clause 8.4 shall satisfy the obligations under Clause 7.1(Repayment of Loans) in [] order.

Clause 8.4 gives the borrower the right to prepay the loan.62 Prepayment must be inminimum amounts. Generally, the prepayment will be applied against the lastinstalments of the loan—to reduce its life. The lenders prefer this, not least as it iseasier to assess risk over the shorter term.

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Clause 8.5 Right of repayment and cancellation in relation to a single lender

8.5 Right of repayment and cancellation in relation to a single Lender(a) If:

(i) any sum payable to any Lender by an Obligor is required to be increased underparagraph (c) of Clause 13.2 (Tax gross-up); or

(ii) any Lender claims indemnification from the Company under Clause 13.3 (Taxindemnity) or Clause 14.1 (Increased costs); the Company may, whilst the circumstance giving rise to the requirement forindemnification continues, give the Agent notice of cancellation of theCommitment of that Lender and its intention to procure the repayment of thatLender’s participation in the Loans.

(b) On receipt of a notice referred to in paragraph (a) above, the Commitment of thatLender shall immediately be reduced to zero.

(c) On the last day of each Interest Period which ends after the Company has givennotice under paragraph (a) above (or, if earlier, the date specified by the Company inthat notice), each Borrower to which a Loan is outstanding shall repay that Lender’sparticipation in that Loan.

Clause 8.5 allows voluntary prepayment of an individual lender in circum-stances where it is costing the borrower additional moneys to fund that lender.

R E PA Y M E N T, P R E PA Y M E N T, A N D C A N C E L L AT I O N78

63 See the discussion in clause 1 on p. 38 on the definition of Break Costs.

Sometimes lenders will impose a prepayment fee. This is uncommon in unse-cured loans but becomes more common in more complex transactions or in localmarkets. In particular, many tax driven transactions need to remain in place dur-ing the early years for the tax benefits to be achieved so that prepayment duringthose years will sometimes be at a fee, or will require compensation from the ulti-mate beneficiary of the transaction, for lost tax benefits. If a prepayment fee isprovided for, then the borrower should consider whether that fee is appropriatein circumstances where there is a compulsory prepayment or a voluntary pre-payment of part of the loan under clause 8.5. The case for a prepayment fee is, ofcourse, different from the arguments relating to Break Costs. The fee is to com-pensate for lost profit while Break Costs represent an expense.63

Some agreements provide that prepayment may only be made on the last dayof an Interest Period. Provided the borrower agrees to pay Break Costs, there isno need for this limitation on prepayment.

In a revolving credit, given that the loan period is relatively short and any pre-payment would result in broken funding, the right of prepayment is often notincluded.

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The circumstances in which this is allowed are:

(a) where a gross-up applies to that lender;

(b) where that lender is entitled to payment under the increased cost clause.


In a project finance or a structured or other complex financing, the option ofprepayment by the borrower is often impractical and other solutions may need tobe negotiated if additional costs arise.

Clause 8.6 Restrictions

Clause 8.6 provides for notice of cancellation and prepayment to be irrevocable andfor payment to be accompanied by payment of interest and broken funding costs.

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CLAUSE 9: CALCULATION OF INTEREST

Clause 9.1 Calculation of interest

9.1 Calculation of interestThe rate of interest on each Loan for each Interest Period is the percentage rate per annumwhich is the aggregate of the applicable:(a) Margin;(b) LIBOR [or, in relation to any Loan in euro, EURIBOR] and(c) Mandatory Cost, if any.

Clause 9.1 provides for the borrower to pay interest at LIBOR64 plus Margin plus theMandatory Cost. The Mandatory Cost is the cost to the lenders of complying withmandatory liquid asset requirements applicable to them or other mandatory fees,insofar as that cost is attributable to their participation in the loan.65 The cost dependson the nationality and lending office of each lender. The Agent is required to calculatethe total cost for all lenders and this is the amount the borrower is required to pay.

In some markets, the practice is not to charge the Mandatory Cost in addition tothe Margin.

The reference to Euribor in paragraph (b) is optional. If the loan is to be out-standing in Euros at any time, the lenders may fund that in London, in which casethey will fund at Euro LIBOR and the reference to Euribor will not be necessary, orthey may fund in the domestic markets for the Euro, in which case the correct refer-ence will be to Euribor.66

80

C H A P T E R 5

Costs of Utilization

64 See the discussion of ‘LIBOR’ in clause 1 on p. 46.65 See Box 0.11 on page 16.66 See the discussion of ‘Euribor’ in clause 1 on p. 44.

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Clause 9.2 Payment of interest

9.2 Payment of interestThe Borrower to which a Loan has been made shall pay accrued interest on that Loan onthe last day of each Interest Period (and, if the Interest Period is longer than six Months,on the dates falling at six monthly intervals after the first day of the Interest Period).

Clause 9.2 deals with the timing of payment of interest. As a general principle,interest is required to be paid on the same dates (the last day of each Interest Period)as interest would be due on the lenders’ underlying funding assuming the lenderscompletely match funded.67 However, as a credit issue, the lenders normally requireregular interest payment and therefore will not want to allow interest to accrue forlonger periods than six months. This is the reason for the provision in the LMA TermLoan requiring six monthly interest payments when longer Interest Periods arechosen.

C L A U S E 9 : C A L C U L AT I O N O F I N T E R E S T 81

67 See clause 10.1 for further discussion of Interest Periods and match funding.

Comment Some borrowers may request that interest earned by the lenders on thisinterim payment until the last day of the Interest Period should be for the account ofthe borrower. As this would be a windfall profit, many lenders concede this point.

Clause 9.3 Default interest

9.3 Default interest(a) If an Obligor fails to pay any amount payable by it under a Finance Document on its

due date, interest shall accrue on the overdue amount from the due date up to the dateof actual payment (both before and after judgment) at a rate which, subject to para-graph (b) below, is [] per cent higher than the rate which would have been payable ifthe overdue amount had, during the period of non-payment, constituted a Loan in thecurrency of the overdue amount for successive Interest Periods, each of a durationselected by the Agent (acting reasonably). Any interest accruing under this Clause 9.3shall be immediately payable by the Obligor on demand by the Agent.

Clause 9.3 provides that if any amount is not paid on its due date, the rate of inter-est applicable to it will be increased to a default rate. This is usually LIBOR plusMargin (plus any Mandatory Costs) plus an uplift. This is intended partly to givethe borrower an incentive to pay in full and on time and partly to compensate thelenders for the additional credit risk and for the additional management timeinvolved in lending to a borrower which is in default. The increase in the interestrate must be such that the overall default interest rate is higher than the rate a bor-rower could normally expect to have to pay if their financial fortune reversed andobtaining funds was difficult, so as to make non-payment an unattractive form offinancing in those circumstances.

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The obligation to pay default interest arises whenever a payment is overdue,regardless of whether or not that non-payment constitutes an Event of Default. So,for example, if (as in the LMA Term Loan) the agreement provides that failure to payprincipal is not an Event of Default if caused by technical error and remediedwithin a given period of time, nevertheless, default interest will start to accrue onthe date of non-payment. Default interest is normally68 only charged when paymentis overdue. Hence, if there is an Event of Default other than as a result of non-payment, default interest will only start to accrue if the loan is accelerated.

Clause 9.3(a)

Clause 9.3(a) provides for the default interest to be paid both before and after judge-ment. This is because many jurisdictions specify a statutory rate of interest to applyto amounts that the court has determined to be due and issued a judgement for.That rate would apply from the date of the judgement until the judgement had beenenforced, but often only applies if no other rate has been agreed. Given that thestatutory rate is not regularly updated, the lenders prefer to know that, during thatperiod, default interest will still be LIBOR-based.69

C O S T S O F U T I L I Z AT I O N82

68 In some cases, lenders choose to require the loan agreement to allow them to charge default intereston the occurrence of any Event of Default, even if there are no moneys overdue, as an added encourage-ment to the borrower to avoid Events of Default, particularly those which are minor where the lendersmay be thought unlikely to exercise their right to accelerate.

69 A contractual choice of interest rate post-judgement is effective under English law. See DirectorGeneral of Fair Trading v First National Bank Plc 2002 1 AC 481. Such a provision may not be effective inthe place of enforcement of a judgement.

70 See also commentary on clause 11.4 (break costs).

Comment The wording of clause 9.3 allows the lenders to choose their funding periodsfor overdue amounts (and the interest will be compounded at the end of each suchfunding period).70

Comment Some borrowers will ask that, if the borrower fails to make a payment on itsdue date, the lenders fix daily Interest Periods for the overdue sums. This is in thebelief that any such failure to pay will quickly be remedied and choice of short inter-est periods will minimize broken funding costs.

Default interest is one of the areas that can cause difficulty in a number of jurisdic-tions. In some jurisdictions there is a limit on the duration for which such interestcan be charged, or secured. In some there is a limit on the amount which can becharged, or secured. In others, compound interest (charging interest on interest) isnot permitted. In England the provision will be void and unenforceable if it is apenalty. A ‘penalty’ is a provision that seeks to penalize (or punish) someone forbeing in default under an agreement, as opposed to a provision that seeks to com-pensate the other party for the consequences of the default. If the provision is a gen-uine pre-estimate of loss then it is interpreted as being compensatory and not penalin nature. The lenders’ argument is that the additional 1 or 2% is compensatory in

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nature and is not intended as a punishment, since it costs the lenders more tomanage a loan which is in default than one which is not.71

Clause 9.3(b)

9.3(b) If any overdue amount consists of all or part of a Loan which became due on a daywhich was not the last day of an Interest Period relating to that Loan:(i) the first Interest Period for that overdue amount shall have a duration equal to the

unexpired portion of the current Interest Period relating to that Loan; and(ii) the rate of interest applying to the overdue amount during that first Interest Period

shall be [] per cent higher than the rate which would have applied if the overdueamount had not become due.

Clause 9.3 draws a distinction between principal and other sums.Sums that are not already being funded by the lender (e.g. overdue interest or

principal unpaid at the end of the Interest Period relating to it) are dealt with underclause 9.3(a) which provides for the lender to charge interest at LIBOR on the duedate plus the Margin and additional percentage.

Clause 9.3(b) deals with overdue principal, where the principal in question fallsdue during an Interest Period—for example, as a result of an Event of Default orcompulsory prepayment. It provides for the Margin plus additional percentage tobe added to the LIBOR already applying to that payment of principal—that is, theLIBOR applicable to the then current Interest Period. This is because the lender isalready funding these sums at that rate and committed to carrying on doing so untilthe end of the current Interest Period.

Clause 9.4 Notification of rates of interest

This clause provides for the Agent to notify all parties of interest rates when they aredetermined.

CLAUSE 10: INTEREST PERIODS

Clause 10.1 Selection of Interest Periods

10.1 Selection of Interest Periods(a) A Borrower (or the Company on behalf of a Borrower) may select an Interest Period

for a Loan in the Utilisation Request for that Loan or (if the Loan has already beenborrowed) in a Selection Notice.

(b) Each Selection Notice for a Loan is irrevocable and must be delivered to the Agent bythe Borrower (or the Company on behalf of a Borrower) to which that Loan was madenot later than the Specified Time.

C L A U S E 1 0 : I N T E R E S T P E R I O D S 83

71 Lordsvale Finance plc v Bank of Zambia (1996) QB 752 considered an increase of 1% on a default andfound it enforcable in the circumstances of the case.

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(c) If a Borrower (or the Company) fails to deliver a Selection Notice to the Agent inaccordance with paragraph (b) above, the relevant Interest Period will, subject toClause 10.2 (Changes to Interest Periods), be [one] Month.

(d) Subject to this Clause 10, a Borrower (or the Company) may select an Interest Periodof [], [] or [] Months or any other period agreed between the Company and the Agent(acting on the instructions of all the Lenders). [In addition a Borrower (or theCompany on its behalf) may select an Interest Period of a period of less than [one]Month, if necessary to ensure that there are sufficient Loans (with an aggregate BaseCurrency Amount equal to or greater than the Repayment Instalment) which havean Interest Period ending on a Repayment Date for the Borrowers to make theRepayment Instalment due on that date].

(e) An Interest Period for a Loan shall not extend beyond the Termination Date.(f ) Each Interest Period for a Loan shall start on the Utilisation Date or (if already made)

on the last day of its preceding Interest Period.

Clause 10.1 gives the borrower the option during the course of the loan to choosethe period for which LIBOR is quoted (and thus charged to the borrower) withincertain limits set down by the clause. This is to give the borrower the ability to usethe choice of Interest Periods as a way to manage its interest rate exposure. (Both theduration of funding and the timing of funding will impact on the rate of LIBOR.)The borrower will choose the duration of the first Interest Period prior to draw-down and, for each subsequent Interest Period, shortly before it is due to start.Hence, in a floating rate loan based on LIBOR, the interest rate is effectively fixed atthe start of each Interest Period and paid at the end of it,72 with a new interest ratebeing fixed for a new period each time an Interest Period comes to an end.

It is normal to give the borrower the choice between one, three, and six monthperiods, sometimes also allowing 12 months, as these maturities are readilyavailable in the markets. Other durations are available but at a premium or withdifficulty. Under the LMA Term Loan, the Agent may only agree to periods otherthan those specified if all lenders agree.


72 Subject to clause 9.2.73 See the discussion of ‘Break Costs’ in clause 1.

In some markets, such as aircraft finance, and with some lenders such assupranational agencies, or lenders in local markets, the practice is not to give bor-rowers this flexibility. In such cases, Interest Periods are often set in advance tocoincide with repayment dates (e.g. to be three-monthly) and are not changeable.This gives the borrower less flexibility to use its choice of Interest Periods as away of managing its interest rate exposure as it will be unable to influence thetiming of approaches to the market to fix LIBOR.

The optional part of Clause 10.1(d) may be included to allow the borrower tochoose Interest Periods of unusual durations so as to coincide with repayment datesand avoid broken funding costs.73 This option may not be necessary because the

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LMA Term Loan allows a number of loans to be advanced. In these circumstances itmay well be reasonable to expect the borrowing group to organize the borrowingssuch that there is always a large enough loan expiring on a repayment date to avoidincurring break costs.

C L A U S E 1 0 : I N T E R E S T P E R I O D S 85

74 See discussion of ‘Break Costs’ in clause 1 on p. 38.75 Most governmental or supranational lenders (e.g. IFC) use the concept of LIBOR in this way.76 See also commentary on clause 11.2(b)(ii).

BOX 1.28

An example of appropriate wording follows

‘Where an Interest Period would otherwise overrun one or more Repayment Dates, the Loanwill be split into parts, with one part in the amount of each Repayment Instalment falling dueduring that Interest Period and another part in an amount equal to the balance of the Loan.Each such part shall have a separate Interest Period ending, in the case of each amounts equalto a Repayment Instalment, on the Repayment Date for that Repayment Instalment, and, inthe case of the balance of the Loan, on the date complying with the other requirements of thisclause [].’

Clause 10.1(e) provides that an Interest Period shall not extend beyond theTermination Date. This is sensible to ensure that repayment and the lenders’ fund-ing go hand in hand and so as to avoid any reinvestment risk74 arising.

While many lenders will actually fund themselves for the loan in the interbankmarket specified in the loan agreement and for the Interest Periods stated or chosen;(i.e. they ‘match fund’), many do not.

Some will fund in the specified Interbank Market but not necessarily for theInterest Periods chosen by the borrower, thus taking their own interest rate risk inrelation to the mismatch. Nevertheless, for those lenders, provisions for calculationof interest will remain drafted on the assumption that the lenders match fund.

Other lenders75 will instead use LIBOR as a commercially acceptable representa-tion of what is generally available in the market, while fully accepting that theirown cost of funds will be somewhat different.76 In this case lenders will not be ableto give borrowers the flexibility to choose Interest Periods as discussed above, butwill, instead, normally specify the length of Interest Periods which will remain thesame throughout the loan’s duration.

Clause 10.1 In a Revolving Credit Facility

10.1 Selection of Interest Periods(a) A Borrower (or the Company on behalf of a Borrower) may select an Interest

Period for a Loan in the Utilisation Request for that Loan

Where the agreement provides for a small number of loans, or there is a singleloan, borrowers will usually want the ability to split the loan into parts with dif-ferent interest periods, to ensure that they are not restricted in their choice ofinterest periods with reference to repayment dates (see Box 1.28).

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77 See clause 4.4.78 See clause 3.1.

(b) Subject to this Clause 10, a Borrower (or the Company) may select an Interest Periodof [], [] or [] Months or any other period agreed between the Company and the Agent(acting on the instructions of all the Lenders). [In addition a Borrower (or theCompany on its behalf) may select an Interest Period of a period of less than [one]Month, if necessary to ensure that [when aggregated with the Available Facility]there are sufficient Loans (with an aggregate Base Currency Amount equal to orgreater than the Reduction Instalment) which have an Interest Period ending on aReduction Date for the scheduled reduction to occur].

(c) An Interest Period for a Loan shall not extend beyond the Termination Date.(d) Each Interest Period for a Loan shall start on the Utilisation Date.(e) A Loan has one Interest Period only.

The principle relating to Interest Periods is the same whether the loan is a termloan or a revolving credit. The mechanics are different. In a revolving creditwhich is based on LIBOR, the borrower will request an advance, specify anInterest Period, and become obliged to repay the advance on expiry of thatInterest Period. A couple of days before expiry it will request a new advance(which it will use to repay the old one) and specify the Interest Period for thatnew advance. As a result, the borrower cannot alter the amount outstanding on adaily basis, but only at intervals corresponding to Interest Periods. In otherwords, if, on drawdown, the borrower wishes to take advantage of six monthLIBOR, by doing that, it loses its ability (subject to any rights of prepayment itmay have) to reduce the amount of the loan during that six-month period.

Hence in a revolving credit it is important for the borrower to have the right todraw further loans while a loan is outstanding so as to be able to access theundrawn commitment.77

Clause 10.1 In a Loan Advanced by Instalments

In loans advanced by instalments lenders will require the amounts of instalmentsto be significant to avoid administrative inconvenience, if necessary havingdrawdowns to a disbursement account to achieve this.78 Generally, the lenderswill also require Interest Periods for the advances to ‘consolidate’. In otherwords, they will require that any Interest Period for a second or third or lateradvance should end on the same day as the Interest Period for the first advance,rather than giving the borrower full choice of Interest Periods for each advanceseparately. This is simply a matter of administrative convenience for the lenderswho can therefore minimize their need to have discussions with the borrower asto the length of Interest Periods. In very large loans the borrower may wish tohave the ability to have the loan outstanding in separate ‘Tranches’ with differentInterest Periods (and/or currencies) applying to the different tranches.

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Clause 10.2 Changes to Interest Periods

Clause 10.2 allows the Agent to shorten Interest Periods to coincide with repaymentdates and so avoid broken funding costs.

Clause 10.3 Non-business days

Clause 10.3 deals with the position if an Interest Period ends on a non-business day.

Clause 10.4 Consolidation and division of loans

Clause 10.4 allows loans to be consolidated if they are in the same currency, with thesame maturity and to the same borrower. It also allows loans to be split into partson the borrower’s request.

CLAUSE 11: CHANGES TO CALCULATION OF INTEREST

11.1 Absence of quotations

Clause 11.1 provides that if any Reference Bank does not provide a quote for LIBORwhen needed, the calculation will be made on the basis of the quotes of the otherReference Banks.

Clause 11.2 Market disruption

11.2 Market disruption(a) If a Market Disruption Event occurs in relation to a Loan for any Interest Period,

then the rate of interest on each Lender’s share of that Loan for the Interest Periodshall be the rate per annum which is the sum of:(i) the Margin;

(ii) the rate notified to the Agent by that Lender as soon as practicable and in anyevent before interest is due to be paid in respect of that Interest Period, to be thatwhich expresses as a percentage rate per annum the cost to that Lender of fundingits participation in that Loan from whatever source it may reasonably select; and

(iii) the Mandatory Cost, if any, applicable to that Lender’s participation in theLoan.

(b) In this Agreement ‘Market Disruption Event’ means:(i) at or about noon on the Quotation Day for the relevant Interest Period the

Screen Rate is not available and none or only one of the Reference Banks sup-plies a rate to the Agent to determine LIBOR [or, if applicable, EURIBOR] forthe relevant currency and Interest Period; or

(ii) before close of business in London on the Quotation Day for the relevant InterestPeriod, the Agent receives notifications from a Lender or Lenders (whose partic-ipations in a Loan exceed [] per cent. of that Loan) that the cost to it of obtaining

C L A U S E 1 1 : C H A N G E S T O C A L C U L AT I O N O F I N T E R E S T 87

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matching deposits in the Relevant Interbank Market would be in excess ofLIBOR [or, if applicable, EURIBOR].

Clause 11.2 requires the borrower to compensate the lenders for their actual cost offunds in the event of ‘market disruption.’ The borrower does, of course, have theright to prepay an affected lender if these circumstances arise—see clause 8.5.79

This clause was originally introduced out of concerns that the Eurodollar mar-kets may be interrupted and lenders in general may be unable to fund in those mar-kets. It retains this function as defined in clause 11.2(b)(i). No LIBOR rate will beavailable in those circumstances.

Clause 11.2(b)(ii) extends the function of the clause so that it will also applywhere the cost of funds to the lenders (or to a specified proportion of the lenders)exceeds LIBOR (i.e. the Screen Rate). This protects the lenders against a differentialarising between the Screen Rate and their actual funding costs (see Box 1.29).


79 Exercise of that right should in these circumstances require minimum notice and be without any feewhich would otherwise apply.

80 See discussion of ‘LIBOR’ in clause 1 at p. 46 .

BOX 1.29

During the 1990s, this issue caused difficulties for Japanese banks which had numer-ous loans on which they were charging a Screen rate of LIBOR plus a Margin. The def-inition of Market Disruption at that time was limited to the circumstances set out inclause 11.2(b)(i). Unfortunately the fall in credit standing of the Japanese banks at thattime resulted in an increase in their costs of funding themselves in the LondonInterbank Market, such that their LIBOR exceeded their return from their loans. Theyhad no option but to sell the loans (at a loss) to banks which were still able to fund at arate at or near to the Screen rate. If the current wording of this clause from the LMATerm Loan had been included in their loans, they may have succeeded in charging theadditional cost to the borrower, leaving the borrower with the burden of arranging arefinancing.

If this clause were agreed in a bilateral facility, the effect would be to remove one ofthe main advantages to the borrower of having the interest rate determined withreference to a Screen rate of LIBOR.80 This highlights the fact that, depending on thelevel agreed as to the proportion of the lenders which need to be affected in orderfor the clause to operate, its effect is to pass on to the borrower any increase in costof funds to a lender caused by that lender’s own credit position. In practice, if thiswere to occur, the borrower would be likely to exercise its right to prepay andarrange a refinancing by lenders which continued to be able to finance at the ScreenRate of LIBOR. Nevertheless, the result would be that the borrower would have to

� pay the additional rate of interest until the prepayment occurred;

� incur further time and expense in arranging the refinancing, and

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� bear the risk of not being able to obtain the same Margin at that time as appliedto the original loan.

All of these would be due to a change in the lender’s credit position.

C L A U S E 1 1 : C H A N G E S T O C A L C U L AT I O N O F I N T E R E S T 89

Comment A borrower will therefore often request that a significant proportion of thesyndicate need to be affected in order for the clause to be triggered so as to ensurethat the circumstances do indeed amount to a market problem in general ratherthan a credit problem with individual lenders.

Clause 11.3 Alternative basis of interest or funding

11.3 Alternative basis of interest or funding(a) If a Market Disruption Event occurs and the Agent or the Company so requires, the

Agent and the Company shall enter into negotiations (for a period of not more thanthirty days) with a view to agreeing a substitute basis for determining the rate ofinterest.

(b) Any alternative basis agreed pursuant to paragraph (a) above shall, with the priorconsent of all the Lenders and the Company, be binding on all Parties.

Clause 11.3 requires the Agent and borrower to try to agree a substitute rate of inter-est if a Market Disruption Event occurs (but the borrower will continue to have topay the cost of funds until a substitute basis is agreed). Any substitute rate must beagreed by all the lenders under clause 11.3(b). This forces the borrower in effect tocater to the demands of the weakest member of the syndicate.

81 A syndicate which involves a small number of lenders.

Comment Some borrowers may be keen to require as much transparency as possible,for example, a certificate from the relevant lender confirming that it has taken simi-lar action in other loans and certifying the disruption and attempted solutions.

Clause 16 requires the lenders to try to avoid additional costs under this clause (andother similar clauses).

In a club deal81 the borrower may argue that clause 11.2(b)(ii) should be deletedcompletely. If the cost of funds to an individual lender exceeds the Screen Ratefor credit reasons—the argument would be that it should not be up to the bor-rower to refinance but rather up to the lender to sell its interest in the loan to alender which could continue to fund at LIBOR.

The borrower may also argue that clause 11.2(b)(ii) should be deleted com-pletely in those cases where LIBOR is used as a benchmark for a commerciallyacceptable rate and the lenders are not funding themselves in the LondonInterbank Market at all. In such cases, the borrower may argue that it is implicit inthe arrangements that the lenders take the risk of being unable to fund at LIBOR.

Some lenders will argue however that they are only able to offer LIBOR basedfunding at all because of the protection afforded them by this clause.

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Clause 11.4 Break Costs

The borrower agrees to pay to each lender ‘its Break Costs attributable to all or any partof a Loan or Unpaid Sum being paid … . on a day other than the last day of an InterestPeriod for that Loan or Unpaid Sum’.

Clause 11.4 is the obligation to pay broken funding costs. The obligation ariseswherever a sum is paid on a date other than the last day of the relevant InterestPeriod for the sum in question. So this obligation may arise on prepayment or if arepayment date falls during an Interest Period.

In the LMA Term Loan this requirement and (almost) all other requirements tomake payments other than principal and interest are expressed to be payable withinthree Banking Days of demand. Hence, no further grace period is appropriate in theEvents of Default.

The obligation is to pay a specified amount in respect of Break Costs as opposedto an indemnity. This protects the lenders in the event that they do not in fact matchfund but charge interest on a match fund basis.

Broken funding may also be incurred as a result of failure to draw on the speci-fied date. This is because the practice in the London Interbank Market is for thelenders to commit to borrow two days before the funds are drawn. If the funds arenot advanced on the date anticipated, the lenders will need to reinvest the moneysborrowed and will face a reinvestment risk. The loan agreement includes an indem-nity (in clause 15.2) from the borrower for these costs (see Box 1.30).


82 See Appendix 2, p. 299

BOX 1.30

This is the reason the loan agreement needs to be signed and drawdown notice givenbefore the lenders fix their funding. In some instances administrative convenience maysuggest that the agreement should be signed at the same time as funds are advanced(e.g. to avoid two lengthy meetings of people coming from different parts of theworld). One issue which will need to be dealt with in such a case is to ensure that avalid indemnity is given (with consideration) by the borrower, in respect of any brokenfunding costs, before the funding is booked in the market.

Comment It may be that interest rates have moved such that the lenders will make aprofit on moneys paid in the middle of a funding period. The borrower may ask thelenders to agree to pay any broken funding profits to the borrower.

The provisions of clause 11.4 dealing with Break Costs are appropriate only for afloating rate loan. In the case of long term fixed rate funding, the practice is that ifthe loan is repaid early, the borrower must also pay the marked to market value82 ofthe loan at the date of prepayment.

Box 1.31 on p. 91 briefly summarises the principal ways in which fixed rate fund-ing may be made available to borrowers.

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CLAUSE 12: FEES

12.1 Commitment fee(a) The Company shall pay to the Agent (for the account of each Lender) a fee [in the

Base Currency] computed at the rate of [] per cent per annum on that Lender’sAvailable Commitment for the Availability Period.

(b) The accrued commitment fee is payable on the last day of each successive period ofthree Months which ends during the Availability Period, on the last day of theAvailability Period and, if cancelled in full, on the cancelled amount of the relevantLender’s Commitment at the time the cancellation is effective.

12.2 Arrangement feeThe Company shall pay to the Arranger an arrangement fee in the amount and at thetimes agreed in a Fee Letter.

12.3 Agency feeThe Company shall pay to the Agent (for its own account) an agency fee in the amountand at the times agreed in a Fee Letter.

This clause provides for a commitment fee, an arrangement fee and an agency fee.The commitment fee is payable to all lenders in relation to the amount the lendersare committed to lend but which has not been drawn. It is calculated on a daily basisand payable at regular intervals during the drawdown period. The LMA Term Loansuggests that the fee should only start to accrue once the loan agreement is signedand the lenders are legally committed. Some lenders (particularly in club deals) willcharge this fee from the date of the offer letter acceptance. Some borrowers request

C L A U S E 1 2 : F E E S 91

BOX 1.31

There are many different methods by which fixed rate funding may be made availableto a borrower. The basic options are:

� the lenders fund themselves on a fixed rate basis (e.g. by issue of commercial paper)and pass the costs (including any early termination costs, usually calculated on amarked to market basis) on to the borrower;

� the lenders fund themselves on a floating rate basis but enter into a swap (usually asingle swap effected by the Agent on behalf of the syndicate) under which theyswap fixed interest due from the borrower under the loan agreement for the float-ing rate required for the lenders’ funding. Again, termination costs relating to theswap will be passed through to the borrower. Difficulties may also arise in thisstructure if the Agent becomes insolvent—causing termination of the swap.

� The lenders fund themselves on a floating rate basis and lend moneys to theborrower on the same basis, leaving the borrower to effect a swap.

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it should only start to accrue once the conditions precedent are satisfied.83 This is anissue for the offer letter.

The agency fee and arrangement fee are stated to be as specified in a fees letter.The amount of these fees is confidential to the Agent/Arranger. Their existenceneeds to be disclosed to ensure that the obligation to pay them is secured by anysecurity, that non-payment would constitute an Event of Default, and to ensure thatthe Agent/Arranger is under no obligation to share those fees with participants onthe basis that they are undisclosed profits.


83 This argument might be made if there are conditions to the lender’s commitment, as opposed to thedrawing (and the amount of the loan is sufficiently high to justify the point). See commentary on ‘otherconditions precedent’ in clause 4 at pp. 65 and 66.

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CLAUSE 13: TAX GROSS-UP AND INDEMNITIES—INTRODUCTION

Many countries (including England) require that, if a payment of interest (or otherpayments, such as rent under a lease, or payments of royalties) is paid by a residentof that country, the resident must, in certain circumstances, first deduct tax fromthat payment and account for that tax to the appropriate tax authorities. Anyobligation to deduct tax in this way is generally referred to as ‘withholding tax’. Thetax is a tax on the recipient and the payer of interest is, in effect, acting as a taxcollector on behalf of the tax authority.

The result of the imposition of a withholding tax in relation to a cross border pay-ment may be that the recipient is taxed twice on the same income: once in the coun-try of the source of the income and again in the country of the recipient. This may beavoided if the recipient is a resident of a country with which the payer’s country hasa double tax treaty. Such treaties may either remove or reduce the requirement towithhold tax on payments to residents of the country concerned (see Box 1.32 on p. 94).It may also be the case that, if tax is deducted at source, the country of the recipientwill grant a tax credit in respect of tax paid in the country where tax has beendeducted.

In the context of withholding tax, the provisions of clause 13(c) of the LMA TermLoan are highly jurisdiction specific. The standard provisions include wording (e.g.in the definition of ‘Qualifying Lender’), which reflect the requirements of the UKtax authorities relating to withholding tax. They assume that, as at signing, alllenders are eligible to receive interest without tax deduction, or, if not, that the bor-rower will not be obliged to gross-up. They may require amendments to be made toreflect the provisions of any relevant double tax treaty.

Significant changes will be needed dependent on the tax residence of the borrowersand the lenders, the provisions of any relevant double tax treaty, and the risk allocation

93

C H A P T E R 6

Additional PaymentObligations

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as between the parties. Therefore, this discussion does not look at the wording in detailbut, rather, highlights the general principles which the clause seeks to address andwhich will need to be dealt with, whatever jurisdictions are involved.

CLAUSE 13: TAX GROSS-UP AND INDEMNITIES

Clause 13.1 Definitions

Clause 13.1 sets out some definitions used in the tax gross-up clause.

Clause 13.2 Tax gross-up

Clause 13.2 is the clause dealing with tax gross-up.

Clause 13.2(a) and (b)

Clause 13.2(a) and (b) oblige the borrower to advise the Agent if it becomes obligedto make tax deductions from payments and to make payments free of suchdeductions unless it is obliged to make deductions by law.

Clause 13.2(c)

Clause 13.2(c) is the gross-up clause.

13.2(c) If a Tax Deduction is required by law to be made by an Obligor, the amount of thepayment due from that Obligor shall be increased to an amount which (after making anyTax Deduction) leaves an amount equal to the payment which would have been due if noTax Deduction had been required.

A D D I T I O N A L PA Y M E N T O B L I G AT I O N S94

84 It is sensible to consider both the place of the Facility Office and also the country of incorporation.85 Nevertheless, there may be tax consequences in the country of the agent simply as collecting and/or

distributing agent.86 See Appendix 2, p. 305.

BOX 1.32

Usually, in deciding which double tax treaties might be relevant, the countriesconcerned are that in which the interest is earned—being the relevant place of businessof the borrower (which is not necessarily the same as its place of incorporation) and thecountry of residence84 of the lender which is beneficially entitled to the interest—thatis, entitled to use it as its own money and not simply as an agent for someone else.85

Often there are administrative requirements which need to be complied with to get thebenefit of the treaty. There are often anti-avoidance provisions to prevent parties fromusing the treaties to export moneys which would otherwise have been taxable in thepaying jurisdiction (e.g. rules relating to thin capitalization86).

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‘Tax Deduction’ means a deduction or withholding for or on account of Tax from a pay-ment under a Finance Document.

Lenders need to receive their full interest without deduction, not least in order tofund their payment obligations in respect of their corresponding cost of funds(LIBOR).87 Clause 13.2(c) therefore states that if any withholding tax has to be paidin relation to payments under the loan, the amount of the payment will be increasedto whatever amount as, after deduction of the withholding tax, will leave the lenderwith the amount of interest originally due. This is often referred to as grossing-up. Insome countries88 there are doubts as to the enforceability of this clause on the basisthat an agreement by one person to pay another person’s tax is unenforceable andthis is a mandatory principle of public policy which cannot be avoided by a choiceof law.89 This is an issue for due diligence (see Box 1.33).

C L A U S E 1 3 : TA X G R O S S - U P A N D I N D E M N I T I E S 95

87 Nevertheless, in some circumstances it may be appropriate for each lender to bear the risk of a with-holding in respect of ordinary income tax which that lender would have had to bear in the jurisdiction ofthe withholding resulting from its having some connection with that jurisdiction apart from its involve-ment in the loan in question. The concept of ‘Indemnified tax’ is often used to describe the taxes which theborrower compensates for.

88 France is, apparently, an example.89 Enforcement of judgements which included payments of another’s tax may also therefore be affected.

BOX 1.33

If a gross-up clause is unenforceable then, if there is an actual withholding tax issue oncommencement of the transaction, the Margin will need to be higher to enable thetransaction to proceed.

The grossing-up clause is generally included in the loan agreement even wherethere is no withholding tax obligation on payments between the relevant parties—so as to ensure that, if withholding tax is subsequently imposed, the lenders will beprotected. The borrower’s escape route in this event is the right to prepay theaffected lender (see clause 8.5).

Clause 13.2(d) Limitations on the gross-up obligation

13.2(d) An Obligor is not required to make an increased payment to a Lender underparagraph (c) above for a Tax Deduction in respect of tax imposed by the United Kingdomfrom a payment of interest on a Loan, if on the date on which the payment falls due:(i) the payment could have been made to the relevant Lender without a Tax Deduction if

it was a Qualifying Lender (see Box 1.34 on p. 96) but on that date that Lender isnot or has ceased to be a Qualifying Lender other than as a result of any change afterthe date it became a Lender under this Agreement in (or in the interpretation, admin-istration, or application of ) any law or Treaty, or any published practice or conces-sion of any relevant taxing authority or

(ii) (A) the relevant Lender is a Qualifying Lender solely under sub paragraph (i)(B) ofthe definition of Qualifying Lender; and

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(B) the Board of the Inland Revenue has given (and not revoked) a direction (a‘Direction’) under section 349C of the Taxes Act (as that provision has effect onthe date on which the relevant Lender became a Party) which relates to that pay-ment and that Lender has received from that Obligor or the Company a certifiedcopy of that Direction; and

(C) the payment could have been made to the Lender without any Tax Deduction inthe absence of that Direction; or

(iii) the relevant Lender is a Qualifying Lender solely under sub paragraph (i)(B) of thedefinition of Qualifying Lender and it has not, other than by reason of any changeafter the date of this Agreement in (or in the interpretation, administration or appli-cation of ) any law, or any published practice or concession of any relevant taxingauthority, given a Tax Confirmation (see Box 1.34) to the Company] or


BOX 1.34

‘Qualifying Lender’ means

(i) a Lender (other than a Lender within sub—paragraph (ii) below) which is beneficially entitledto interest payable to that Lender in respect of an advance under a Finance Document and is:A. a Lender:

(1) which is a bank (as defined for the purpose of section 349 of the Taxes Act) makingan advance under a Finance Document; or(2) in respect of an advance made under a Finance Document by a person that was abank (as defined for the purpose of section 349 of the Taxes Act) at the time thatadvance was made;

and which is within the charge to United Kingdom corporation tax as respects any pay-ments of interest made in respect of that advance; orB. a Lender which is:

1. a company resident in the United Kingdom for United Kingdom tax purposes;2. a partnership each member of which is:

a) a company so resident in the United Kingdom; orb) a company not so resident in the United Kingdom which carries on a trade in the

United Kingdom through a permanent establishment and which brings intoaccount in computing its chargeable profits (for the purposes of section 11(2) ofthe Taxes Act) the whole of any share of interest payable in respect of thatadvance that falls to it by reason of sections 114 and 115 of the Taxes Act

3. a company not so resident in the United Kingdom which carries on a trade in theUnited Kingdom through a permanent establishment and which brings into accountinterest payable in respect of that advance in computing the chargeable profits (forthe purposes of section 11(2) of the Taxes Act) of that company

C. … or(ii) … .

‘Tax Confirmation’ means a confirmation by a Lender that the person beneficially entitled tointerest payable to that Lender in respect of an advance under a Finance Document is either:

[wording follows wording of (i)(B) of Qualifying Lender]

‘Treaty Lender’ means a Lender which:i. is treated as a resident of a Treaty State for the purposes of the Treaty;ii. does not carry on a business in the United Kingdom through a permanent establishment

with which that Lender’s participation in the Loan is effectively connected[; andiii ].

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(iv) the relevant Lender is a Treaty Lender (see Box 1.34 on p. 96) and the Obligor mak-ing the payment is able to demonstrate that the payment could have been made to theLender without the Tax Deduction had that Lender complied with its obligationsunder paragraph (g) below.

13.2(g) A Treaty Lender and each Obligor which makes a payment to which that TreatyLender is entitled shall co-operate in completing any procedural formalities necessary forthat Obligor to obtain authorisation to make that payment without a Tax Deduction.

For the borrower, the obligation to gross-up clearly makes a significant difference tothe cost of the loan. The borrower will therefore wish to limit its gross up obliga-tions. As far as practical they will wish to ensure that they do not borrow moneyfrom lenders in respect of whom there would be an obligation to withhold. This willbe achieved by agreement with the Arranger on the types of lenders to be invitedinto the syndicate in the first place, and by clause 24.2(f), discussed on p. 204, whichlimits the borrower’s gross-up obligations in the event of a change in Facility Officeor a change in lender. In addition, clause 13.2(d) sets out some other common limi-tations on the gross-up obligation.


Comment The limitations set out in clause 13.2(d) only apply to United Kingdom with-holding tax. If any likely Obligor is resident outside the UK and may be required topay withholding tax in a different jurisdiction, the parties will need to considerwhether there should be similar restrictions on the gross up obligations of thatObligor in addition to the provisions of clause 13.2(d). In other words, whereObligors may be from different tax jurisdictions, there may need to be a number ofclauses dealing with withholdings imposed by different countries. In the case of theLMA Term Loan, the group needs to consider not only the jurisdictions of the orig-inal Obligors, but also of any likely future Obligors.

The limitations in clause 13.2(d) can be roughly summarized as follows. There is nogross-up obligation if:

(a) (by virtue of clause 13.2(d)(i)) the lender is not a ‘Qualifying Lender’ in the firstplace. ‘Qualifying Lender’ is defined with reference to the circumstances inwhich the UK tax authorities will allow payments without withholding.

Comment If the borrower is borrowing from non-Qualifying Lenders in the firstinstance, those Lenders may well expect to receive a grossed-up payment and willtherefore need to alter this provision.

(b) (by virtue of clause 13.2(d)(i)) the lender ceased to be a lender to which paymentcould be made without deduction (otherwise than as a result of a change of lawor similar). In other words, if a change of facts (e.g. tax residence of the lender)results in a change of its status for the purpose of withholding tax this will notfall to the borrower.

(c) (by virtue of clauses 13.2(d)(ii)) the tax authorities have required payment to bemade subject to deduction of tax where the lender is resident or taxable in theUnited Kingdom but not a bank.

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(d) (by virtue of clause 13.2(d)(iii) and (iv)) payment could have been made withoutdeduction to the lender if it had complied with certain necessary administrativerequirements.


Comment Many loan agreements include a covenant by the lenders to comply with therelevant administrative procedures but no consequences if the lenders fail to do so.The approach of the LMA Term Loan, to the effect that the gross-up obligation willnot apply in these circumstances, is preferable.

Comment Some borrowers may request removal of the words ‘which that ProtectedParty determines’ to make this covenant less one sided.

Clause 13.2(f ) Evidence of tax payment

Clause 13.2(f ) Within thirty days of making either a Tax Deduction or any paymentrequired in connection with that Tax Deduction, the Obligor making that Tax Deductionshall deliver to the Agent for the Finance Party entitled to the payment evidence reason-ably satisfactory to that Finance Party that the Tax Deduction has been made or (as appli-cable) any appropriate payment paid to the relevant taxing authority.

Clause 13.3 General Tax Indemnity

Clause 13.3(a) Tax Indemnity

13.3 Tax Indemnity(a) The Company shall (within three Business Days of demand by the Agent) pay to a

Protected Party an amount equal to the loss, liability or cost which that ProtectedParty determines will be or has been (directly or indirectly) suffered for or on accountof Tax by that Protected Party in respect of a Finance Document.

Clause 13.3(b) Exceptions

(b) Paragraph (a) above shall not apply(i) with respect to any Tax assessed on a Finance Party:

(A) under the law of the jurisdiction in which that Finance Party is incorporatedor, if different, the jurisdiction (or jurisdictions) in which that Finance Partyis treated as resident for tax purposes; or

(B) under the law of the jurisdiction in which that Finance Party’s Facility Officeis located in respect of amounts received or receivable in that jurisdiction,

if that Tax is imposed on or calculated by reference to the net income received orreceivable (but not any sum deemed to be received or receivable) by that FinanceParty; or

(ii) to the extent a loss, liability or cost:(A) is compensated for by an increased payment under Clause 13.2 (Tax gross

up); or

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(B) would have been compensated for by an increased payment under Clause 13.2(Tax gross up) but was not so compensated solely because one of the exclu-sions in paragraph (d) of Clause 13.2 (Tax gross up) applied.

This exception effectively ensures that the borrower does not compensate thelenders for ordinary income tax on their profits in their countries of normal taxresidence.

Clause 13.4 Tax Credit

13.4 Tax CreditIf an Obligor makes a Tax Payment and the relevant Finance Party determines that:(a) a Tax Credit is attributable either to an increased payment of which that Tax Payment

forms part, or to that Tax Payment; and(b) that Finance Party has obtained, utilised and retained that Tax Credit,the Finance Party shall pay an amount to the Obligor which that Finance Party deter-mines will leave it (after that payment) in the same after-Tax position as it would havebeen in had the Tax Payment not been made by the Obligor.

This clause needs to be read together with clause 27 below.

27. CONDUCT OF BUSINESS BY THE FINANCE PARTIESNo provision of this Agreement will:(a) interfere with the right of any Finance Party to arrange its affairs (tax or otherwise)

in whatever manner it thinks fit;(b) oblige any Finance Party to investigate or claim any credit, relief, remission or repay-

ment available to it or the extent, order and manner of any claim; or(c) oblige any Finance Party to disclose any information relating to its affairs (tax or

otherwise) or any computations in respect of Tax.

Clause 13.4 provides that, if a lender receives a tax credit as a result of the tax with-held, the benefit of this tax credit will be passed back to the borrower. This is com-monly referred to as the ‘clawback clause’. This clause should be read in conjunctionwith clause 27 which provides that the lenders can arrange their tax affairs as theysee fit; they are not obliged to investigate or claim any relevant tax reliefs; and theyare not obliged to disclose their financial affairs or tax computations to the borrower.

The existence of a tax credit and a clawback clause is of limited value to the bor-rower because:

� the timing of any payment under clause 13.4 will probably be some years afterthe gross-up payment was made. It will take some time for the financial year toend and then for the tax position for that financial year to be finally settled;

� the amount of the credit available may well be far less than the amount withheld(as the withholding is calculated as a percentage of the interest payment whereas


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the credit is often limited to a percentage of the lender’s profit (i.e. Margin only)from a particular jurisdiction;

� a tax credit is not usually specifically attributed to any particular loan;

� clause 13.2 itself only applies if the lender decides that there has been an applica-ble tax benefit;

� the lender must have used and retained the benefit (i.e. it depends on the lenderbeing profitable); and

� the clause provides that the borrower will be given whatever amount the lenderdecides will result in the lender being in the same after tax position as if there hadbeen no gross-up.

Despite these limitations there is little improvement that a borrower can realisticallyhope to achieve through negotiation in most cases. Lenders cannot permit borrow-ers to get involved in the lenders’ tax affairs. Nevertheless, where the parties enterinto the loan knowing that a gross-up will apply and perhaps that the effects of thatwill be lessened by an applicable double tax treaty, these standard provisions willnot necessarily be applicable and the document will need to be adjusted to reflecteach party’s responsibilities in relation to claiming, and making use of, whateverrelief is available.

CLAUSE 14: INCREASED COSTS

14.1 Increased costs(a) Subject to Clause 14.3 (Exceptions) the Company shall, within three Business Days

of a demand by the Agent, pay for the account of a Finance Party the amount of anyIncreased Costs incurred by that Finance Party or any of its Affiliates as a result of(i) the introduction of or any change in (or in the interpretation, administration orapplication of ) any law or regulation or (ii) compliance with any law or regulationmade after the date of this Agreement.

(b) In this Agreement ‘Increased Costs’ means:(i) a reduction in the rate of return from the Facility or on a Finance Party’s (or its

Affiliate’s) overall capital;(ii) an additional or increased cost; or(iii) a reduction of any amount due and payable under any Finance Document,which is incurred or suffered by a Finance Party or any of its Affiliates to the extentthat it is attributable to that Finance Party having entered into its Commitment orfunding or performing its obligations under any Finance Document.

Clause 14.1 is one of the ‘yield protection’ clauses in a LIBOR-based loan designedto ensure that the lenders pass on to the borrower all their costs attributable to theloan and recover a pre-agreed level of pre-tax profit (the Margin) on top of theircosts incurred in providing the loan. The main costs which a lender incurs inproviding a loan are its funding cost (LIBOR) and the cost of complying with the


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capital adequacy and liquidity requirements applicable to the loan. The documentthen treats existing (known) costs differently from future (changed) costs.

� Generally lenders are expected to fix their Margin at a rate that covers them forthe cost of complying with existing capital adequacy requirements.90

� The practice with existing liquidity and regulatory requirements91 differs betweendifferent markets and lenders. The LMA Term Loan provides for the borrower topay Mandatory Costs (i.e. cost of compliance with existing, known, liquidity andregulatory requirements) in addition to LIBOR plus Margin (see clause 9.1 on p. 80).In some markets, the practice is to absorb these costs within the Margin.

� Clause 14.1 deals with the possibility of a regulatory change, after the date of signing,in these capital adequacy, liquidity, and regulatory costs and of any other costs andpasses these on to the borrower (which also has the right to prepay affected lenders).

Under this clause the borrower agrees to compensate the lenders for any additionalcosts or lost profits (for any lender or any member of a lender’s group of companies)attributable to the loan, resulting from changes in the regulatory92 environment. Theclause applies to increased costs arising as a result of regulations made after the loanagreement is signed and also as a result of existing regulations where a changeoccurs (such as a change in interpretation or a compliance date) after the loan agree-ment is signed. Given the changes to the capital adequacy regime which Basel II(see Box 1.35 on p. 102) will put into effect, some lenders may decide to excludeBasel II costs from the effect of this clause altogether, and deal with such costs byother means, such as adjustments to the Margin—see commentary on clause 14.3(a).

C L A U S E 1 4 : I N C R E A S E D C O S T S 101

90 See Box 0.11 on page 16.91 See Box 0.11 on page 16.92 The word ‘regulation’ in this context needs to be read in the light of clause 1.2(a)(vi).

Comment Borrowers may object to the lack of transparency in this clause—they are effec-tively forced to rely on the lender’s statement as to the existence and amount of thesecosts. Indeed, for those lenders that choose to use their internal credit process as thebasis of their capital adequacy requirements in accordance with the new capital ade-quacy rules which Basel II will bring into effect (see Box 1.35) the level of costs whichthe lender is being compensated for will also be decided by the lender itself. Some bor-rowers object to this self-certification.

Nevertheless, the clause may prove difficult for lenders to implement in relation toBasel II for two reasons.

� the lenders will only the able to claim compersation from the bossower if theadditional cost results from the introduction of Basel II. Proving this causationmay be difficult—what amount of capital has been allocated as a result of thenew regulation, and what amount as a result of prudent banking practice?

� the clause only requires the borrower to pay additional costs resulting from achange in regulation (or its interpretation). Once Basel II becomes effective, costs

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may change not only as a result of change in regulation and interpretation, butalso as a result of changes in a lender’s risk assessment procedures or changes infacts. Whether those fall within the wording of the clause or not is arguable.


93 Within the European Union it will apply to investment firms as well as to banks.94 The effect of the introduction of Basel II in some cases will be to reduce compliance costs.

BOX 1.35

Basel II is the new capital adequacy regime agreed in 2004 and intended to come intoeffect by the end of 2006.93 One main purpose of the new rules was to make the regu-latory requirements for capital reflect market perception of risk more accurately. Theprevious system was recognized as a blunt instrument that required more capital thangenerally thought necessary for some risks and less than necessary for others. The newsystem relies on three elements (known as the three ‘pillars’).

Pillar 1 is similar to existing rules in that it requires banks’ capital to be at least 8%of risk-weighted assets. The main differences are that the weighting system willchange and that additional risks will need to be taken into account. For the first time,banks will need to allocate capital for operating risk (the risk of mistakes and wrong-doing) as well as for credit risk and market risk. In measuring credit risk, weightingsare more detailed than in Basel I, and banks have an option to use their own internalmethods of risk assessment as the basis of the weighting.

Pillar 2 of the new framework allows national regulators the discretion to adjust therequirements to avoid anomalies and inconsistencies which might arise from the uni-form application of Pillar 1 to reflect the different track record of different banks inrecovering losses.

Pillar 3 requires greater disclosure of the risks to banks’ profitability so as to exposethem to the discipline of market reaction.

Comment While this clause allows lenders to pass on any additional costs, it does notrequire them to make an adjustment if the relevant costs decrease94—there is no‘Decreased Cost’ clause unless borrowers negotiate one!

Clause 14.2 Increased cost claims

Clause 14.2 provides for the affected lender to notify the Agent, which will thennotify the borrower, before making a claim.

This clause will, of course, not be appropriate in a loan agreement based on aninclusive rate of interest such as the base rate or prime rate. It is also not alwaysappropriate in a LIBOR-based loan—in certain more complex transactions whereallocation of all risks needs to be agreed it may be appropriate for the lenders totake the risks of future regulatory change or perhaps of regulatory change in agiven jurisdiction.

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Clause 14.3 Exceptions

14.3 Exceptions(a) Clause 14.1 (Increased Costs) does not apply to the extent any Increased Cost is:

(i) attributable to a Tax Deduction required by law to be made by an Obligor(ii) compensated for by Clause 13.3 (Tax indemnity) (or would have been compen-

sated for under Clause 13.3 (Tax indemnity) but was not so compensated solelybecause any of the exclusions in paragraph (b) of Clause 13.3 (tax indemnity)applied); or

(iii) compensated for by the payment of Mandatory Costs; or(iv) attributable to the wilful breach by the relevant Finance Party or its Affiliates of

any law or regulation.

The Increased Cost clause does not deal solely with capital adequacy rules: itcompensates the lenders for any reduction in their anticipated profits resulting froma change in regulation. Clause 14.3 cuts back the scope of the clause to ensure that itdoes not compensate the lenders for ordinary tax on their profits (clause 14.3(a)(ii))or for issues such as withholding tax and Mandatory Costs which are coveredelsewhere in the agreement.

In addition, as indicated carlier, some lenders and borrowers may wish toexclude Basel II costs from this clause entirely and to use a different method to dealwith such changing costs. This avoids some of the issues noted above in the com-mentary on the clause—such as the self certification issue, the proof of causationissue, and the issue (in loan agreements signed after Basel II is in effect) of changesresulting from changes in fact as opposed to change in regulation. The LMA TermLoan includes the following footnote on the issue.

‘Lenders may wish to consider the effect of Basel II in relation to their transaction in thecoulext of (i) the credit standing of the borrower (ii) the likely capital cost to be incurredby Lenders in respect of the Facility as a result of Basel II, and (ii) alternative means ifany, by which any Basel II costs may be addressed (for example through a margin ratchetor inclusion of a negotiation provision to address what happens if the Borrower’s riskweighting changes after the date of the Facility Agreement). If it is appropriate to excludeBasel II from the increased costs clause the following provision may be inserted at the endof this clause 14.3(a):‘(e) attributable to the implementation or application of or compliance with the

‘International Convergence of Capital Measurement and Capital Standards, aRevised Framework’ published by the Basel Committee on Banking Supervision inJune 2004 in the form existing on the date of this Agreement (‘Basel II’) or any otherlaw or regulation which implements Basel II (whether such implementation, applica-tion or compliance is by a government, regulator, Finance Party or any of itsAffiliates)’.

If Lenders determine that it is appropriate to exclude Basel II in this way, it isanticipated the exclusion provision will be included in a Facility Agreement bothprior to and following the implementation of Basel II’.

C L A U S E 1 4 : I N C R E A S E D C O S T S 103

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CLAUSE 15: INDEMNITIES

Clause 15.1 Currency indemnity

15.1 Currency indemnity(a) If any sum due from an Obligor under the Finance Documents (a ‘Sum’), or any

order, judgment or award given or made in relation to a Sum, has to be convertedfrom the currency (the ‘First Currency’) in which that Sum is payable into anothercurrency (the ‘Second Currency’) for the purpose of:(i) making or filing a claim or proof against that Obligor;(ii) obtaining or enforcing an order, judgment or award in relation to any litigation

or arbitration proceedings,that Obligor shall as an independent obligation, within three Business Days ofdemand, indemnify each Finance Party to whom that Sum is due against any cost,loss or liability arising out of or as a result of the conversion including any discrep-ancy between (A) the rate of exchange used to convert that Sum from the FirstCurrency into the Second Currency and (B) the rate or rates of exchange available tothat person at the time of its receipt of that Sum.

Clause 15.1 is the judgement currency indemnity. This deals with the situationwhich may arise if, in order to make a claim against the borrower or any of its assetsin a particular country, the claim needs to be denominated in the local currency. Inthis event, the final judgement will be for an amount which, when converted backto the currency of the debt, will give a profit or a loss. This clause provides for theborrower to indemnify the lenders for any loss in this situation. This provision maynot be enforceable in some countries and is an area for due diligence.

Clause 15.2 Other indemnities

15.2 Other indemnitiesThe Company shall (or shall procure that an Obligor will), within three Business Days ofdemand, indemnify each Finance Party against any cost, loss or liability incurred by thatFinance Party as a result of:(a) the occurrence of any Event of Default;(b) a failure by an Obligor to pay any amount due under a Finance Document on its due

date, including without limitation, any cost, loss or liability arising as a result ofClause 28 (Sharing among the Finance Parties);

(c) funding, or making arrangements to fund, its participation in a Loan requested by aBorrower in a Utilisation Request but not made by reason of the operation of any oneor more of the provisions of this Agreement (other than by reason of default ornegligence by that Finance Party alone); or

(d) a Loan (or part of a Loan) not being prepaid in accordance with a notice ofprepayment given by a Borrower or the Company.


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Clause 15.2 is a general indemnity to the lenders in respect of the occurrence of anyEvent of Default and in respect of funding costs. This indemnity applies whether ornot the lenders exercise their right to accelerate. Note also that clause 15.3 indemni-fies the Agent for expenses incurred in investigating a Default.

CLAUSE 16: MITIGATION

16.1 Mitigation(a) Each Finance Party shall, in consultation with the Company, take all reasonable

steps to mitigate any circumstances which arise and which would result in anyamount becoming payable under or pursuant to, or cancelled pursuant to, any ofClause 8.1 (Illegality), Clause 13 (Tax gross-up and indemnities), Clause 14(Increased costs) or paragraph 3 of Schedule 4 (Mandatory Cost formulae) including(but not limited to) transferring its rights and obligations under the FinanceDocuments to another Affiliate or Facility Office.

(b) Paragraph (a) above does not in any way limit the obligations of any Obligor underthe Finance Documents.

To some extent, the increased cost clause is a blank cheque in favour of the lenders—the borrower cannot be clear in advance as to how much it may become liable to payunder the clause. Its effect is mitigated by this clause 16.1 (and, of course, by the bor-rower’s right to prepay the lender in question in these circumstances95).

Under this clause 16.1 the lenders agree to try to minimise any additional costs tothe borrower under the illegality, gross up and increased costs clauses and underthe provisions dealing with mandatory costs. They need not, however, take stepswhich, in their opinion acting reasonably, might be prejudicial to them. One possi-ble way of mitigating these additional costs and other difficulties might, in certaincircumstances, be to lend through a different branch.96

CLAUSE 17: COSTS AND EXPENSES

17.1 Transaction expensesThe Company shall promptly on demand pay the Agent and the Arranger the amount ofall costs and expenses (including legal fees) reasonably incurred by any of them in con-nection with the negotiation, preparation, printing, execution and syndication of:(a) this Agreement and any other documents referred to in this Agreement; and(b) any other Finance Documents executed after the date of this Agreement.

C L A U S E 1 7 : C O S T S A N D E X P E N S E S 105

95 See commentary on clause 8.5.96 See commentary on clause 24.2(f).

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17.2 Amendment costsIf (a) an Obligor requests an amendment, waiver or consent or (b) an amendment isrequired pursuant to Clause 29.9 (Change of currency), the Company shall, within threeBusiness Days of demand, reimburse the Agent for the amount of all costs and expenses(including legal fees) reasonably incurred by the Agent in responding to, evaluating,negotiating or complying with that request or requirement.

17.3 Enforcement costsThe Company shall, within three Business Days of demand, pay to each Finance Partythe amount of all costs and expenses (including legal fees) incurred by that FinanceParty in connection with the enforcement of, or the preservation of any rights under, anyFinance Document.

Clause 17 deals with costs of putting the transaction together, costs of amendments,and cost of enforcement. In the first two cases, the borrower pays only the costs ofthe Agent and the Arranger, while in the case of enforcement expenses, the expensesof all lenders are to be covered. At the enforcement stage, lenders may well wish tohave independent advice and even to take independent action;97 whereas at thetransaction stage, lenders are largely content to rely on the advice given to the Agentsupplemented by the individual participant lenders’ in-house lawyer’s views,since, at this point, the interests of all the lenders are (almost) identical. This is oftennot the case on enforcement.

A number of comments may be made on this clause.


97 See commentary on clause 2.2.

Comment Commonly borrowers ask for a cap on transaction expenses. It is unlikelythat lenders would agree to any such cap or other restriction in relation to enforce-ment expense in most cases. However, perhaps in a workout loan, a borrower mayargue that they should only pay the expenses of the Agent in relation to any enforce-ment. The argument would be that the risk of multiple actions by different lenderscould be reduced if only the Agent’s legal expenses were covered, and that thiswould effectively help protect all parties from ‘rogue lenders’.

Comment In relation to clause 17.2 lenders may argue that all lenders’ expenses shouldbe covered, not just the Agent’s as they may wish to be advised separately from theother lenders. On the other hand the borrower may want to delete clause 17.2entirely to prevent unnecessary reference to lawyers.

Comment The requirement in clause 17.1 is to pay ‘promptly’; while in most other cases(including clauses 17.2 and 17.3) payment is required within three Banking Days ofdemand. A borrower may wish to clarify the timing of the obligation in clause 17.1 toensure they have a reasonable period to consider, and if appropriate, challenge, anyparticular expense before default interest starts to be chargeable. Lenders may alsoprefer greater certainty on the timing of this obligation.

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This Part deals with the guarantee (if there is one, and if it is included in the loanagreement); representations; undertakings; and Events of Default. These provisions are inclauses 18–23 of the LMA Term Loan. This is the part of the agreement that regulates theworking relationship between the lenders and the borrower, and hence is often the mostheavily negotiated part of the document.

P A R T I I

Guarantee,Representations,

Undertakings, and Events of Default

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CLAUSE 18: GUARANTEE AND INDEMNITY

Clause 18.1 Guarantee and indemnity1

Clause 18.1(a)

18.1 Guarantee and indemnityEach Guarantor irrevocably and unconditionally jointly and severally:2

(a) guarantees to each Finance Party punctual performance by each Borrower of all thatBorrower’s obligations under the Finance Documents;

A guarantee may be an ‘all moneys’ guarantee—guaranteeing whatever the bor-rower owes the lenders from time to time; or it may relate to a specific transaction.In the context of major financings, all moneys guarantees are unusual.

Clause 18.1(b) and (c)

(b) undertakes with each Finance Party that whenever a Borrower does not pay anyamount when due under or in connection with any Finance Document, thatGuarantor shall immediately on demand pay that amount as if it was the principalobligor; and

(c) indemnifies each Finance Party immediately on demand against any cost, loss orliability suffered by that Finance Party if any obligation guaranteed by it is or becomesunenforceable, invalid or illegal. The amount of the cost, loss or liability shall be equalto the amount which that Finance Party would otherwise have been entitled to recover.

109

C H A P T E R 7

Guarantee

1 See section 3 of Appendix 1 for a brief commentary on some important aspects of English law onguarantees.

2 See para 3.5 of section 1 of Appendix 1.

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Clause 18.1(b) constitutes a primary obligation3 on the guarantor to pay sums underthe loan agreement if unpaid by the borrower. The intention is to ensure that anydifficulties with the underlying debt (e.g. invalidity) do not affect the guarantor’sliability. However, money would have to be due under the loan agreement in orderfor a claim to be made under clause 18.1(b)—because it only applies if ‘a Borrowerdoes not pay any amount when due under … any Finance Document’. Hence, clause 18.1(c)is also necessary—an indemnity for loss resulting from there being no sums duebecause of invalidity, illegality, or unenforceability.

Clause 18.2 Continuing guarantee4

18.2 Continuing guaranteeThis guarantee is a continuing guarantee and will extend to the ultimate balance of sumspayable by any Obligor under the Finance Documents, regardless of any intermediatepayment or discharge in whole or in part.

Clause 18.2 is particularly important in a revolving credit, but is often also necessaryin a term loan if, for example in a multicurrency loan, it is treated as being repaid infull and readvanced from time to time.5 The intention is to clarify that the guaranteerelates not only to the original loan (which may well have been repaid6) but also tothe readvanced loans from time to time.

Clause 18.3 Reinstatement

18.3 ReinstatementIf any payment by an Obligor or any discharge given by a Finance Party (whetherin respect of the obligations of any Obligor or any security for those obligations or other-wise) is avoided or reduced as a result of insolvency or any similar event:(a) the liability of each Obligor shall continue as if the payment, discharge, avoidance or

reduction had not occurred; and(b) each Finance Party shall be entitled to recover the value or amount of that security or

payment from each Obligor, as if the payment, discharge, avoidance or reduction hadnot occurred.

Clause 18.3 deals with the possibility of clawbacks. Most jurisdictions allow forcertain transactions,7 which a company has entered into, to be ‘clawed back’ orreversed, if the company becomes insolvent within a certain period (commonlyreferred to as the ‘hardening period’) after the transaction occurred, subject to

G U A R A N T E E110

3 See para 1.1 of section 3 of Appendix 1 on p. 281.4 See para 1.4 of section 3 of Appendix 1 on p. 283.5 See comments on clause 6.3.6 Or treated as repaid by virtue of the rule in Clayton’s case (Devagnes v Noble 1816 1 Mer 572).7 Under English law, these include preferences, transactions at an undervalue and floating charges.

In some countries, set offs exercised shortly before winding up may also be clawed back.

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various criteria. Clause 18.3 provides that if the loan is repaid, but the lenderssubsequently have to reimburse that payment because it is clawed back in an insol-vency, the liability of the borrowers and guarantors shall remain in place as thoughthere had been no repayment of the loan in the first place.

C L A U S E 1 8 : G U A R A N T E E A N D I N D E M N I T Y 111

8 This clearly depends on the relevant jurisdiction of potential insolvency. If proof of solvency is a solu-tion, it should not be sought lightly. It would be time consuming and expensive on any given date to provesolvency.

BOX 2.1

It can be hard to find a compromise between the position of the lenders and theguarantor on this point. Ideally, the likelihood of a clawback occurring might need tobe assessed and, if the lenders perceive this as a real risk, provisions may need to beincluded in the original documents to the effect that security will only be released ifevidence is provided, at the time of the repayment and requested release of the securityfor the guarantee, that there is no risk of clawback given the law in relevant jurisdic-tions (e.g. because the person making payment of the loan is not insolvent therefore noquestion of clawback arises).8

Clause 18.4 Waiver of Defences

18.4 Waiver of DefencesThe obligations of each Guarantor under this Clause 18 will not be affected by an act,omission, matter or thing which, but for this Clause, would reduce, release or prejudiceany of its obligations under this Clause 18 (without limitation and whether or not knownto it or any Finance Party) including:(a) any time, waiver or consent granted to, or composition with, any Obligor or other

person;(b) the release of any other Obligor or any other person under the terms of any composi-

tion or arrangement with any creditor of any member of the Group;(c) the taking, variation, compromise, exchange, renewal or release of, or refusal or

neglect to perfect, take up or enforce, any rights against, or security over assets of,any Obligor or other person or any non-presentation or non-observance of any

Comment This issue is not too contentious in an unsecured guarantee. However,if the guarantor has given security for their guarantee obligations, and thatsecurity had been discharged on repayment of the loan, such a provisionwould not be effective to reinstate the security. Therefore, secured guaran-tees often allow the lenders to retain the security for a period (matching thelongest hardening period) after repayment of the loan. This, of course, can becommercially difficult for a guarantor. They are likely to want to be sure that,when the loan is repaid, any security they have given for the guarantee willbe released. Any right to retain the security may have the effect of prevent-ing a refinancing (see Box 2.1).

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formality or other requirement in respect of any instrument or any failure to realisethe full value of any security;

(d) any incapacity or lack of power, authority or legal personality of or dissolution orchange in the members or status of an Obligor or any other person;

(e) any amendment (however fundamental) or replacement of a Finance Document or anyother document or security;

(f) any unenforceability, illegality or invalidity of any obligation of any person underany Finance Document or any other document or security; or

(g) any insolvency or similar proceedings.

Under English law, guarantors can raise numerous defences to a claim under theguarantee. The rationale for most of these defences comes from the guarantor’sright of subrogation. This is the right of the guarantor, when they have paid underthe guarantee, to stand in the shoes of the lenders and take over their rights againstthe borrower. If lenders alter their rights and thereby change the rights which theguarantor will obtain through subrogation, in certain cases, unless the guarantorhas agreed otherwise, this will be a good defence for the guarantor for a claim forpayment under the guarantee. In some cases it will completely release the guaran-tor from liability, while in others it will reduce their liability (see Box 2.2).


9 Swire v Redman (1875–76) LR 1QBD 536.10 Polak v Everett (1875–76) LR 1QB 669 and Holme v Brunskill (1877–78) LR 3 QBD 495.11 Wulff v Jay (1871–72) LR 7 QB 756.12 Although (in the absence of bad faith) there is no positive duty to maximize the price obtained. See

comments in China & South Seas Bank Ltd. v Tan (1990) 1 AC 536.13 As to the effectiveness of these clauses see Dr James O’Donovan and Dr John Phillips, The Modern

Contract of Guarantee at paras 8–29 et seq and pp. 8–92–8–101. See also Triodos Bank NV v Dobbs (2005)EWCA Civ 630.

BOX 2.2

Cases include where

� the lenders give time to pay;9

� the lenders alter or release their rights against, or any security given by, the debtor;10

� the lenders negligently fail to protect the value of their security, for example, bynon-registration;11

� the lenders sell their security without taking proper care to obtain the currentmarket value.12

This is the reason for clause 18.4, which provides that the guarantors’ liability willremain unaffected. In practice and as a matter of risk avoidance, lenders should notrely on this clause to be effective. There is always a risk that, on the facts of thecase, what has happened is construed as not falling within the clause (e.g. a variationof the loan may be held to be so substantial as to result in a new loan, not the subjectof the original guarantee).13 Therefore, in practice, whenever amending a guaranteed

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loan (or one where any party other than the borrower has given security, where thesame principles apply) consent of the guarantor and third party security providersshould be sought, together with their written confirmation, before the change ismade, that the guarantee and security will remain effective following the change.

Clause 18.5 Immediate recourse

18.5 Immediate recourseEach Guarantor waives any right it may have of first requiring any Finance Party (orany trustee or agent on its behalf ) to proceed against or enforce any other rights or secu-rity or claim payment from any person before claiming from that Guarantor under thisClause 18. This waiver applies irrespective of any law or any provision of a FinanceDocument to the contrary.

Clause 18.5 allows the lenders to claim against the guarantor without first having totake action against any other party. It is, in any event, the case under English lawthat claims against a borrower do not need to be exhausted before a claim can bemade on a guarantor, but this express clause clarifies that position.

Clause 18.6 Appropriations

18.6 AppropriationsUntil all amounts which may be or become payable by the Obligors under or in connec-tion with the Finance Documents have been irrevocably paid in full, each Finance Party(or any trustee or agent on its behalf) may:(a) refrain from applying or enforcing any other moneys, security or rights held or

received by that Finance Party (or any trustee or agent on its behalf) in respect ofthose amounts, or apply and enforce the same in such manner and order as it sees fit(whether against those amounts or otherwise) and no Guarantor shall be entitled tothe benefit of the same.

Clause 18.6(a)

Clause 18.6(a) allows the lenders to apply all proceeds they have available for theloan in whatever order they choose. This freedom can significantly affect recoveries.

Clause 18.6(b)

(b) hold in an interest-bearing suspense account any moneys received from anyGuarantor or on account of any Guarantor’s liability under this Clause 18.

Clause 18.6(b) allows the lenders to recover money from the guarantor and notapply it in reduction of the debt. Instead the money can be placed in an interestbearing account, allowing the lenders to claim in the insolvency of the borrower forthe full debt and only apply the guarantee proceeds after the winding up has been


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completed. This will benefit the lender if the payment from the guarantor is lessthan the debt outstanding. In those circumstances, after payment under the guaran-tee, the lender is left with a claim against the borrower. The ability to put the guar-antee payment in a suspense account increases the amount the lenders can claim forin an insolvency, which, in turn, increases their recovery in the insolvency.

Clause 18.7 Deferral of Guarantors’ rights

18.7 Deferral of Guarantors’ rightsUntil all amounts which may be or become payable by the Obligors under or in connec-tion with the Finance Documents have been irrevocably paid in full and unless the Agentotherwise directs, no Guarantor will exercise any rights which it may have by reason ofperformance by it of its obligations under the Finance Documents:(a) to be indemnified by an Obligor; to claim any contribution from any other guarantor

of any Obligor’s obligations under the Finance Documents; and/or(b) to take the benefit (in whole or in part and whether by way of subrogation or

otherwise) of any rights of the Finance Parties under the Finance Documents or ofany other guarantee or security taken pursuant to, or in connection with, the FinanceDocuments by any Finance Party.

Clause 18.7 provides that the guarantor will not exercise its rights of subrogationand reimbursement until the lenders have been paid in full because lenders do notwish to have to share their security, or face competing claims with the guarantor inthe insolvency of the borrower, or of any other guarantor, if the lenders have notbeen paid in full.

There are three separate rights that are being deferred here:

� first, the right of subrogation;

� second, the right of reimbursement; and

� third, the right of contribution from other guarantors.

Lenders are concerned to ensure that, until they are repaid, guarantors do not com-pete with them, whether in the insolvency of the borrower or in the insolvency ofother guarantors, to the extent that guarantors have a claim in any insolvency aris-ing by virtue of payment under the guarantee.14


14 As to the effectiveness of these clauses see Dr James O’Donovan and Dr John Phillips, The ModernContract of Guarantee at paras 12–14 et seq, 12–128 et seq, and 12–260 et seq and Manning v AIG Europe UKLimited (2004) EWHC Ch 1760.

Subordination

Some guarantees go considerably further than clause 18.7. An example follows(Box 2.3 on p. 115).

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BOX 2.3

‘Until all the Guaranteed Liabilities have been paid, discharged or satisfied in full … theGuarantor agrees that it will not

a) exercise its rights of subrogation, reimbursement and indemnity against any Obligor;b) demand or accept repayment in whole or in part of any Indebtedness due to the Guarantor

from any Obligor …;c) claim any set off or counterclaim against any Obligor or prove in competition with the

Lender in the liquidation of any Obligor … but so that, if so directed by the Lender, it willprove for the whole or part of its claim in such liquidation and hold all recoveries in trust forthe Lender …’

Subordination before winding up

In this (fairly common) example, the guarantor is being asked to agree to makeno claim whatsoever against the borrower (or any other guarantor) until the loan isrepaid. All sums due to the guarantor from time to time are being subordinatedto the loan. This clearly depends on the commercial position and what cash flowsexist within the group. In many cases the guarantor and borrower (and otherObligors) have trading relationships which require inter-company payments tobe made and should not therefore agree to such a broad subordination. It maywell be that free flow of moneys between the debtor and the guarantor should bepermitted prior to winding up.

Subordination on winding up

A separate issue is subordination on a winding up. This is achieved by clause (c)in the example. This prohibits the guarantor from putting in a claim in the insol-vency of the borrower (or other Obligor such as a co-guarantor) in competitionwith the lenders. Alternatively, if the lenders direct, they may require the guar-antor to claim in the insolvency and hold the proceeds on trust for the lenders.The argument for inclusion of this provision is that the guarantor should be sup-porting the borrower and not doing anything that would reduce the lenders’recovery. If the guarantor does not claim in insolvency, or holds its claim in trustfor the lenders, the lenders’ recovery will be greater.

Guarantors should be wary of agreeing such a clause. The difficulty is that theguarantor cannot agree two such clauses in different guarantees with differentlenders to the same borrower. One lender may direct them to make no claim in theinsolvency while the other directs them to hold the claim in trust for them. The guar-antor cannot comply with both directions. In most cases therefore, the agreement ofthe guarantor not to claim in the insolvency either of the borrower or of any otherObligor should apply only (as in the LMA Term Loan) to any claim which the guar-antor has which arises from payment under the guarantee in question.

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Interest15

The question sometimes arises as to how interest should be dealt with to ensure thatthe lenders do not recover interest twice—once on moneys claimed but not yet paidunder the guarantee, and again by making an additional demand under the guar-antee for interest which is continuing to accrue under the loan agreement. For thisreason, interest should not accrue on claims made under the guarantee.

Similarly, when moneys have been paid under the guarantee and not appliedagainst the debt (in accordance with clause 18.6(b)) the guarantee should providefor that money to be placed in an interest bearing account (see Box 2.4).


15 See The Modern Contract of Guarantee at 5–50 et seq.

BOX 2.4

Some guarantors, where the amounts at stake are high, may wish to specify in theguarantee that where moneys are placed on deposit as envisaged by clause 18.6(b), anyadditional claim for interest accruing under the loan will be limited to an amount equalto the interest accruing on the suspense account. This would be most likely to be anissue in cases where a guarantor provides a guarantee for less than the full amount ofthe loan. If the guarantor guarantees the whole loan, the suspense account issue willnot arise since, assuming the guarantor pays in full, there will be no need for money tobe applied otherwise than in immediate satisfaction of the debt.

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CLAUSE 19: REPRESENTATIONS—SECTION 1—AN INTRODUCTION

1 Purpose

The loan agreement contains representations which are required to be made on thedate of the agreement. It also often contains representations which are required to bemade on other dates (typically, on each drawing and on the first day of each InterestPeriod). The purpose of the representations is,

� in the case of representations required to be made on the date of the agreement,to trigger disclosure of information; and

� in all cases, to give the lenders the contractual right not to advance additionalmonies (i.e. to act as a drawstop) and/or to accelerate the loan if the specifiedstatements are untrue on the date they are made.

There may also be liability in misrepresentation (as opposed to liability in contract)for the borrower if the statement is untrue.

We look at each of these functions of the representations in more detail here.

1.1 Disclosure

The representations form a checklist of basic propositions which the lenders expectto be true. The borrower and their lawyer, in commenting on the draft agreement,

117

C H A P T E R 8

Representations,Undertakings, and Events of Default

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will read through the representations and disclose further information on anywhich are not accurate. They form part of the three sets of checks which the lendersmake before advancing the loan (representations, due diligence, and conditionsprecedent16).

1.2 Drawstop/acceleration

The representations ensure that the lenders have a remedy against the borrower(drawstop and/or acceleration) if any of the stated facts are untrue when the repre-sentation was made. They ensure that it is the borrower, not the lenders, who takethe risk of any of them being untrue on that date (see Box 2.5).

R E P S , U N D E R TA K I N G S , A N D E V E N T S O F D E F A U LT118

16 See commentary on clause 4.1.17 There are a number of other clauses in relation to which a similar point could be made including

clause 19.6 (Governing law) and 19.8 (no filing), leading some borrowers to make a broad objection thatthey should not be required to make representations on matters of law.

BOX 2.5

Take, for example, the representation at clause 19.12 which states:

‘Its payment obligations under the Finance Documents rank at least pari passu with theclaims of all its other unsecured and unsubordinated creditors, except for obligations manda-torily preferred by law applying to companies generally.’

The borrower may not know whether this statement is true or not, and may object tobeing asked to make it, on the grounds that it is not something which the borrowershould be expected to know and, in any event, the lenders should rely on advice fromtheir lawyers on this point.17 Nevertheless, in most cases, the representation should beretained (but see Box 2.6) to ensure that, if the statement is not true and the loan doesnot rank pari passu, the lenders have the right not to advance the funds.

BOX 2.6

The answer to the question will depend (as always) on the nature of the transaction. Instraightforward situations, the borrower is expected to take all risks including the riskthat the initial legal situation is not as it had been expected. In complex cases, for exam-ple where the transaction is structured to take advantage of particular tax, accounting,or regulatory rules in different jurisdictions, it is not necessarily the case that the borrower should take risks relating to the existing or future legal position. In thesecases certain representations on matters of law may need to be deleted to reflect theagreed risk allocation.

It is therefore important to focus on the risk allocation role of the representationsin any negotiation of them, and to focus on the question ‘Should the lenders havethe right not to advance the loan if this statement is not true?’ and not on thequestion ‘Is it reasonable to ask the borrower to represent that?’ (see Box 2.6).

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1.3 Liability in misrepresentation

The contractual rights which the agreement contains (the right not to lend if anyrepresentation is untrue, and the right to demand early repayment of the loan) arein addition to the remedies for misrepresentation and breach of warranty given byEnglish law (see Box 2.7).

C L A U S E 1 9 : R E P R E S E N TAT I O N S — S E C T I O N 1 119

18 See Goode Commercial Law, p. 80 et seq and Treitel The Law of Contract, p. 330 et seq.19 See comments on clause 19.10.

BOX 2.7

Under English law, a person may be liable if he makes a statement which another relieson and which induces that other to enter into a contract.18 That statement may bewritten or verbal and liability may arise even if the person making the statement wassimply negligent in doing so. So, statements made by the borrower during negotiationof the loan could give rise to subsequent liability for the borrower, independently ofany claim under the loan agreement itself. The lender will need to show, among otherthings, that the lender relied on the representation in deciding to advance the funds.19

The lenders may be able to make an independent claim for misrepresentation inrelation to the representations contained in the agreement. However, in many casesthere will be little point in doing so. If any of the representations are untrue, therewill often be no need to make a claim in misrepresentation as the contractual reme-dies (acceleration, default interest, and the indemnity in clause 15.2(a)) shouldnormally be sufficient.

The most likely circumstances in which these contractual claims will be insuffi-cient is where, for some reason, they are unenforceable against the borrower. Thismay arise either because the entire agreement is not binding (e.g. because of a prob-lem with due authorization of it), or because a particular provision (e.g. the provi-sion for compound interest) is unenforceable. In these circumstances, the lendersmay be tempted to make a claim in misrepresentation in relation to the borrower’sstatement that the agreement is valid and binding. In the circumstances where theproblem arises in relation to a particular provision, as opposed to the agreement asa whole, this can be a useful additional remedy. However, if the problem relates toinvalidity of the agreement as a whole, it is likely that, if the agreement is not validlyauthorized, neither is the representation.

Hence, although it is possible that the representations could give rise to anindependent claim in misrepresentation, in many cases this will be of little benefit.

2 Repetition of representations

Many loan agreements require certain of the representations to be repeated afterthe date of the agreement. This is usually required as a condition precedent to

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drawdown (clause 4.2(a)(ii) of the LMA Term Loan, often also confirmed in thedrawdown notice itself) and at the beginning of Interest Periods (clause 19.14 ofthe LMA Term Loan). The LMA Term Loan also requires repetition as a condition tothe addition of a new Obligor.

2.1 Introduction—purpose of repetition

19.14 RepetitionThe Repeating Representations are deemed to be made by each Obligor by reference to thefacts and circumstances then existing on:(a) the date of each Utilisation Request and the first day of each Interest Period; and(b) in the case of an Additional Obligor, the day on which the company becomes (or it is

proposed that the company becomes) an Additional Obligor.

Clause 19.14 states that the ‘Repeating Representations’ are deemed repeated on(among other dates) the date of each new drawing and the first day of each InterestPeriod. The purpose of this is to ensure that, if any of the Repeating Representationsbecomes untrue, the lenders may refuse to advance new money and demandimmediate repayment of moneys already advanced. The LMA Term Loan does notdefine ‘Repeated Representations’ and there may be much negotiation over whichrepresentations should fall into this category.

2.2 Hazards of repetition of representations

The effect of repeating representations is far reaching, particularly when consideredin conjunction with other provisions of the agreement. The main problems whichthis simple clause creates are:

(a) it makes it hard to avoid inconsistencies in the document which will lead touncertainty in its application; and

(b) it makes it difficult (particularly for the principals involved) to understand theprecise implications of the document.

Given these drawbacks, the simplest solution, for the person reading the loan agree-ment, is to avoid repetition of representations (at least after the first drawdown) andto deal with the relevant issues by specific conditions precedent, undertakings,compulsory prepayment events, and events of default, as discussed in the summaryto this introduction at para 3. Nevertheless, it is often not possible, or worthwhile interms of legal fees, to make such a change to the structure of the agreement, so allconcerned need to be alive to the difficulties which repeated representations createand take extra care in reviewing these provisions. These main difficulties withrepeating representations are therefore discussed in more detail here.

2.2(a) InconsistenciesWhat the lenders want to achieve by the repetition is to ensure that if one of thespecified representations is no longer true on one of the specified dates, then the


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lenders will be entitled to accelerate the loan. However, if a Repeated Representationcovers a topic which is also covered by an undertaking or an Event of Default, anydifference in the wording of the provisions will create uncertainty (see Box 2.8).


20 See Box 0.6 on p. 11.

BOX 2.8

An example may illuminate the problem. Assume that a loan agreement includes thefollowing event of default:

‘[It is an Event of Default if] the Borrower defaults under any material contract by which itis bound and such default could reasonably be expected to result in a MaterialAdverse Change.’

Assume the agreement also contains a representation, which is repeated on the firstday of each Interest Period, as follows:

‘The Borrower is not in default under any material agreement by which it is bound’

Given that it is invariably expressed to be an event of default if a representation isuntrue when made or repeated, the effect of repeating that particular representationwould be to remove the Material Adverse Change carve out which had been negoti-ated into the event of default.

In practice, were the borrower to default under a material contract in circumstanceswhere the result was unlikely to be a Material Adverse Change the borrower would belikely to contest the right of the lenders to demand immediate repayment of the loanbecause the event of default and the repeated representation are in conflict.

It is important to ensure that the agreement does not contain conflicting provi-sions. Some of the practical difficulties which such inconsistencies give rise to are:

� Neither party will be certain as to the real intention. Did the parties really intend,in the above example, to have the right to accelerate the loan even if the defaultin question clearly would not give rise to a material adverse effect?

� The Agent may feel that the inconsistency is unintentional and that there is sim-ply a ‘technical’ event of default but not one which any of the lenders reallyintended to amount to a real Event of Default. However, if the Agent is to avoidpotential liability for breach of fiduciary duty, it will need to advise the syndicatenevertheless and obtain instructions.

� As a result, unnecessary time and expense will be incurred in debating the issue.

� The need to obtain consent is something better avoided as if circumstances havechanged (including change in market conditions generally or change in lender’spolicies), the lenders may have incentives to withhold consent, or they may wantto link consent to other issues.20

� The syndicate may be influenced by concerns about the reaction of other lendersto the borrower. Assuming that other loans include a cross default clause, otherlenders will have the right to accelerate their loans as a result of the fact that the

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syndicate has the right to accelerate this loan (whether or not that right wasincluded intentionally).

The simplest way to avoid inconsistencies between the Repeated Representationsand other parts of the agreement, and the problems which such inconsistenciescause, is to ensure that those representations which deal with issues which are com-mercially significant (e.g. default under other contracts, or litigation) are notrepeated, but that the relevant issue is dealt with instead by the undertakings andevents of default. This will usually result in those representations which relate tomatters of law being the ones which will be repeated (see commentary on the indi-vidual representations in section 2 of the commentary on clause 19).

However, in different markets where there is a significant cross border elementsuch as in structured or project finance, it may not always be appropriate that achange in law which results in representations becoming untrue should result inan Event of Default. It may be better for them to result in a positive obligation onsome party (perhaps a lender) to seek necessary consents or licences to cure theproblem, and, if not curable, it may result in compulsory prepayment. The sim-plest way to achieve these objectives is not to repeat the representations, butinstead, to ensure that the covenants, conditions precedent, events of default andcompulsory prepayment events deal with all issues as necessary.

2.2(b) ComprehensibilityAs might be apparent from the discussion on this topic, another difficulty with repeat-ing representations is that it makes the document hard to understand (and to draft cor-rectly). Extra care must be taken in reviewing the Repeated Representations and it isoften not immediately obvious to the Borrower what the effect of the repetition is. Forexample, will repeating a given representation detract from what has been discussedin relation to the Events of Default? Or will it result in a difference in relation to theopportunity which the Borrower has to cure the problem? (In the LMA Term Loan, theborrower has no ability to remedy an event of default which is triggered by a misrep-resentation while it may be given the possibility of curing other events of default.21)

3 Summary

If any representations are to be repeated on dates after the first advance of the loan,some guidelines may help to reduce the difficulties that this concept can give rise to.Some suggested guidelines (bearing in mind that there is no consensus on thisissue) are

� Whichever representations are to be repeated, they should be the same ones forthe purpose of drawdown and for Interest Periods (see Box 2.9 on p. 123).


21 See clause 23.4.

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� No representation should be repeated if it covers a topic which has been dealtwith in the undertakings or the events of default, or if it deals with a commer-cially significant issue which should more appropriately be dealt with by theundertakings or events of default.

� A representation should not be repeated if the risk which that representationaddresses should not fall on the borrower or should not constitute an event ofdefault (e.g. if the risk of change of law should fall on the lender or if the relevantissue should give rise to a compulsory prepayment event instead of an event ofdefault).

� Consider grace periods in relation to the misrepresentation event of default—seeclause 23.4.

� If commercially justified, avoid repetition of representations entirely, and recastas direct covenants, Events of Default, compulsory prepayment events, and/orconditions precedent.


22 This is the approach taken with a ‘Default’. Existence of a Default allows lenders not to advance fundsbut does not give rise to the right to accelerate.

BOX 2.9

Some argue that certain representations should be repeated in relation to new moneyadvanced by the lender but not at any other time because the circumstances in whichthe lenders are relieved of their obligations to advance new money should be morestringent than the circumstances in which they are entitled to demand immediaterepayment of moneys already advanced. This objective cannot be achieved by statingthat Repeating Representations are only to be repeated on dates on which new draw-ings are to be made and not at any other time (e.g. by requiring repetition on draw-down dates but not on the first day of all Interest Periods). This is because, if on suchrepetition on a proposed drawdown date, the representation were to be untrue, itwould result not only in a right not to advance additional money, but also in a right toaccelerate the outstanding debt. A rather peculiar situation would result in which thelenders would be entitled to accelerate outstanding sums if certain circumstances (thefacts specified in a Repeated Representation being untrue) happened to coincide withan attempted drawdown, but not if the same circumstances occurred at any other time.

If lenders do want to draw a distinction between the obligation to advance addi-tional funds and the right to accelerate existing moneys, this can be done by includinga condition precedent that the Repeating Representations are true, but without actuallyrequiring them to be repeated in clause 19.14.22 However in many cases lenders willnot want to find themselves in a position where they are not obliged to advance furtherfunds but cannot demand repayment of sums already advanced. They will usuallyprefer to have a complete exit route if problems arise.

For this reason it is unusual to draw a distinction between the representationswhich are required to be true for the purpose of the lenders’ obligation to advancefunds and those which are required to be true for the purpose of giving rise to theirright to accelerate.

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CLAUSE 19: REPRESENTATIONS—SECTION 2 —THE LMA TERM LOAN REPRESENTATIONS

19. REPRESENTATIONSEach Obligor makes the representations and warranties set out in this Clause 19 to eachFinance Party on the date of this Agreement (see Box 2.10).


23 See section 2 of the commentary on clause 22.

BOX 2.10

There is a technical difference between a representation and a warranty. The remediesfor breach of the two types of provision are different and there are different require-ments before a claim for breach can be founded. For most practical purposes, if any ofthe statements listed in this clause is untrue, the lenders will rely on their contractualrights (not to lend and/or to accelerate) which arise as a result. These rights are thesame for a misrepresentation as for a breach of warranty.

Turning then to the content of the representations. The LMA Term Loan containscertain fairly standard representations relating to legal issues such as the power andauthority of the borrower. It also contains a few representations relating to theborrower’s business. It is likely that these business related representations will needto be supplemented in many cases by additional representations relating to thebusiness issues of concern to the lenders.23

This section reviews each representation in turn, first with reference to the state-ment required to be made on the date of the loan agreement, and second in thecontext of its potential inclusion in the definition of ‘Repeated Representation’.

Clause 19.1 Status

19.1 Status(a) It is a corporation, duly incorporated and validly existing under the law of its juris-

diction of incorporation.(b) It and each of its Subsidiaries has the power to own its assets and carry on its business

as it is being conducted.

Sometimes the words ‘in goodstanding’ are added in clause 19.1(a). This will berelevant when the borrower is incorporated in a jurisdiction which requiresannual payments or filings to maintain goodstanding, lack of which may resultin fines or restrictions on business activities.

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Should clause 19.1 repeat?

It is possible (if not likely in most cases) that the borrower could cease to be duly incor-porated, validly existing, or to have power to carry on its business. Licenses to con-duct the relevant business may be withdrawn or taxes unpaid may lead to thecompany being struck off the register. If it did so, the lenders would wish to have theright to accelerate the loan. Given the unlikelihood of this occurrence, any potentialconflict with other provisions of the agreement is usually commercially insignificant.Therefore, if the concept of repeating representations after the first drawdown is to beused at all, this representation is one which can be repeated in normal circumstances.


24 Apart from the argument that disclosure might perhaps make it easier for borrowers to argue thatthere was no ‘reliance’ as required for a claim in misrepresentation, because the lenders relied on the legalopinion, not on the borrower’s representations, when deciding to advance funds. However, see commentsin para 1.3 on p. 119.

BOX 2.11

There is an issue here as to whether the lenders’ legal opinion should be disclosed tothe borrower. The main argument24 against disclosure is that disclosure will highlightany areas of perceived legal risk, which the borrower may take advantage of at a laterdate. This is most likely to be a real issue for the lenders in circumstances where theopinions in question would not readily be apparent to the borrower or their advisers.This may be the case in innovative transactions involving legal issues on whichlawyers may have differing opinions. It is less likely to be a significant issue in astraightforward unsecured loan.

This limitation on the representations is necessary because, of course, there are cir-cumstances (administration or a Chapter 11 for example) which would freeze

In a more complex transaction, if the risk of change of law is not to fall simplyon the borrower, it might be appropriate to recast this (or at least to ensure thatthe Event of Default relating to misrepresentations is not an automatic Event ofDefault but allows a period for remedy as discussed in the context of clause 23.4)to give appropriate possibilities to the borrower to remedy the situation.

Clause 19.2 Binding obligations

9.2 Binding obligationsThe obligations expressed to be assumed by it in each Finance Document are, subject toany general principles of law limiting its obligations which are specifically referred to inany legal opinion delivered pursuant to Clause 4 (Conditions of Utilisation) or Clause 25(Changes to the Obligors), legal, valid, binding and enforceable obligations.

The borrower’s statement in this clause, to the effect that the agreements are valid,binding and enforceable obligations are stated to be subject to principles of law specif-ically referred to in the legal opinion (see Box 2.11).

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enforceability. Any such issues should have been addressed in the legal opinion andaccepted by the lenders.


It is possible (if not likely in most cases) that the borrower’s obligations under theloan agreement could cease to be binding and enforceable. There may be achange of law which has this effect. The same arguments apply as in relation toclause 19.1.25 Therefore, again, if any representations are to be repeated after firstdrawdown, this is one which can be repeated in normal situations.


25 I.e. (a) if these events occurred the lenders should be entitled to accelerate and (b) commercialinsignificance of this issue.

26 Or at least to ensure that the Event of Default relating to misrepresentations is not an automatic Eventof Default but allows a period for remedy as discussed in the context of clause 23.4.

27 See comments on clause 3.1.

In a more complex transaction, if the risk of change of law is not to fall simply onthe borrower it might be appropriate to recast this26 to give appropriate possibil-ities to the borrower to remedy the situation.

Clause 19.3 Non-conflict with other obligations

19.3 Non-conflict with other obligationsThe entry into and performance by it of, and the transactions contemplated by, theFinance Documents do not and will not conflict with:(a) any law or regulation applicable to it;(b) its or any of its Subsidiaries’ constitutional documents; or(c) any agreement or instrument binding upon it or any of its Subsidiaries or any of its

or any of its Subsidiaries’ assets.

Borrowers may be restricted in their activities by law or regulation (e.g. if theybelong to a regulated industry such as banking or insurance, or if they are publicbodies), or by virtue of a general regulation affecting particular types of borrowingsuch as the US margin stock regulations.27 Clause 19.3(a) is designed to addressthese issues.

Clause 19.3(b) is intended to address the question of whether the borrower haspower (capacity) to borrow the loan—some companies have limited borrowingpowers in their constitutional documents.

Clause 19.3(c) will confirm that this borrowing is not in breach of contractualprovisions, such as a restriction on borrowing, or a negative pledge, given in a dif-ferent loan agreement. The terms of these prior agreements (unlike the borrower’sconstitutional documents, which are often a matter of public record) are not gener-ally available for inspection by the lenders on any public register, so there is littleindependent due diligence which the lenders can do to ensure that clause 19.3(c) iscorrect. Including this representation can assist in a good faith defence by the

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lenders to any claim by a third party, for example, that this loan agreement caused abreach of their existing contract and that the lenders were guilty of the tort ofinducing a breach of contract.


It is possible that regulations may be introduced after the date of the agreementwhich would be breached by continued performance of the borrower’s obligationsunder the loan agreement or associated transaction. If this occurred, the lenderswould want the right to accelerate the loan and, given the commercial unlikelihoodof such an event, then, if representations are to be repeated after the first drawdownat all, this is one which can be repeated in normal circumstances.



29 I.e. (a) if these events occurred the lenders should be entitled to accelerate and (b) commercialinsignificance of this issue.


In a more complex transaction, if the risk of change of law is not to fall sim-ply on the borrower it might be appropriate to recast this28 (at least in the case ofclause 19.3(a)) to give appropriate possibilities to the borrower to remedy thesituation.

Clause 19.4 Power and authority

19.4 Power and authorityIt has the power to enter into, perform and deliver, and has taken all necessary action toauthorise its entry into, performance and delivery of, the Finance Documents to which itis a party and the transactions contemplated by those Finance Documents.

This question is a mixture of fact and law. The borrower may make the commentthat they should not be required to give representations on matters of law (asdiscussed at para 1.2 of the introduction to this clause on p. 118) to the extent thatthe representation is one of law.


It is not inconceivable that continued performance of the borrower’s obligationsunder the loan agreement could subsequently become subject to some additionalauthorization. The same comments apply as in relation to clause 19.1.29 Therefore, ifany representation is to be repeated after first drawing, this is one which can berepeated in normal circumstances.

In a more complex transaction, if the risk of change of law is not to fall simplyon the borrower it might be appropriate to recast this30 to give appropriate possi-bilities to the borrower to remedy the situation.

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Clause 19.5 Validity and admissibility in evidence

19.5 Validity and admissibility in evidenceAll Authorisations required or desirable:(a) to enable it lawfully to enter into, exercise its rights and comply with its obligations

in the Finance Documents to which it is a party; and(b) to make the Finance Documents to which it is a party admissible in evidence in its

jurisdiction of incorporation,have been obtained or effected and are in full force and effect.

This representation refers not only to corporate authorizations but also consents(such as exchange control consent) licences, notarizations, and registrations.31

This representation is one which the borrower might object to, on the basis that itis a matter of law as to which they have no expertise.32 Nevertheless, it should nor-mally be retained to ensure that, if untrue, the lenders have the right to accelerateand/or not lend if relevant authorizations are not in place. Of course, the lenderswill also be taking advice from their lawyers on this issue and on the other mattersof law referred to in the representations.


It is possible that further authorizations may become necessary for the loan agree-ment to continue to be performed and admissible in evidence in the borrower’scountry of incorporation. The same comments apply as in relation to clause 19.1.33

Therefore, if any representation is to be repeated after first drawing, this is onewhich can be repeated in normal circumstances.


31 If any filings are required it may be appropriate to cross refer to clause 19.8.32 See comments under ‘drawstop’ above on p. 118.33 I.e. (a) if these events occurred the lenders should be entitled to accelerate and (b) commercial

insignificance of this issue.34 Or at least to ensure that the Event of Default relating to misrepresentations is not an automatic Event

of Default but allows a period for remedy as discussed in the context of clause 23.4.


Clause 19.6 Governing law and enforcement

19.6 Governing law and enforcement(a) The choice of English law as the governing law of the Finance Documents will be

recognised and enforced in its jurisdiction of incorporation.(b) Any judgment obtained in England in relation to a Finance Document will be recog-

nised and enforced in its jurisdiction of incorporation.

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Once again,35 this representation should be retained to ensure the lenders have thecontractual rights they need if the statement is untrue. It is also a key point for thelenders’ due diligence.


It is possible that the borrower’s jurisdiction of incorporation will cease to recognizejudgements obtained in the law of the country chosen to have jurisdiction. The samecomments apply as in relation to clause 19.1.36 Therefore, if any representation isto be repeated after first drawing, this is one which can be repeated in normalcircumstances.


35 See comments on clause 19.5.36 I.e. (a) if these events occurred the lenders should be entitled to accelerate and (b) commercial

insignificance of this issue.

BOX 2.12

Nevertheless, in many cases there is a withholding tax at the outset, or there would be,but for an exemption which the lenders may have agreed to obtain. It is important toreflect the commercial position in this clause and, in particular, to ensure that anyfailure by the lender to obtain any necessary permissions does not result in a misrep-resentation and therefore an Event of Default.


It is possible that a withholding tax will be imposed which did not exist on the daythe loan agreement was signed. However, in this case, the lenders will not need theright to accelerate the loan. They have the protection of the gross-up clause (clause13.2(c)). Therefore this representation should not be repeated.

In a more complex transaction, if the risk of change of law is not to fall simplyon the borrower it might be appropriate to recast this to give appropriate possi-bilities to the borrower to remedy the situation.

Clause 19.7 Deduction of Tax

19.7 Deduction of TaxIt is not required to make any deduction for or on account of Tax from any payment it maymake under any Finance Document.

While the lenders are protected by the grossing-up clause they will, assuming thatthe transaction has been put together on the understanding that there will be nowithholding tax, want the comfort of this representation because that will be thebasis on which the credit assessment will have been made (but see Box 2.12).

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Clause 19.8 No filing or stamp taxes

19.8 No filing or stamp taxesUnder the law of its jurisdiction of incorporation it is not necessary that the FinanceDocuments be filed, recorded or enrolled with any court or other authority in that juris-diction or that any stamp, registration or similar tax be paid on or in relation to theFinance Documents or the transactions contemplated by the Finance Documents.37

Clearly this clause needs to be amended (and corresponding conditions inserted torequire the relevant filing etc. to take place) if it is incorrect.

This clause is another area where the borrower may argue that it should not berequired to make statements on matters of law.38


It is possible that a filing requirement may arise in the future. The same commentsapply as in relation to clause 19.1.39 Therefore, if any representation is to be repeatedafter first drawing, this is one which can be repeated in normal circumstances.


37 See comment on clause 19.5.38 See comments on ‘drawstop’ on p. 118.39 I.e. (a) if these events occurred the lenders should be entitled to accelerate and (b) commercial

insignificance of this issue.40 See discussion on p. 131 for issues which arise if this representation is repeated.

In a more complex transaction, however, it may be appropriate to recast this togive the borrower the opportunity to effect the relevant filing etc. without its giv-ing rise to an Event of Default.

Clause 19.9 No default

19.9 No default(a) No Event of Default is continuing or might reasonably be expected to result from the

making of any Utilisation.(b) No other event or circumstance is outstanding which constitutes a default under any

other agreement or instrument which is binding on it or any of its Subsidiaries or towhich its (or its Subsidiaries’) assets are subject which might have a Material AdverseEffect.

This representation refers to all group members, not only Obligors. The impact ofthe representation depends on the definition of ‘Material Adverse Effect’ and in par-ticular on whether that definition looks on the effect on the group as a whole, or onindividual Obligors, or on individual group companies.

Assuming for the moment that the representation is not a ‘RepeatedRepresentation’,40 borrowers’ comments on it will be made in the light of the cir-cumstances which exist at or about the time the representation is being negotiated.In these circumstances, the word ‘might’ in clause 19.9(b), even though it would be

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objectionable in the material adverse change event of default,41 may well be areasonable standard for the lenders to insist on—they want to be advised of alladverse possibilities before becoming obliged to lend.


Clause 19.9(a) is a representation that there is no Event of Default. Whether this isrepeated or not is immaterial since, if there is an Event of Default at the time the rep-resentation is repeated, the statement will be untrue, but this will not give thelenders any extra rights over and above those they had arising from the existingEvent of Default.

Clause 19.9(b) is different. This is a representation that there is no default42 underany agreement which might have a Material Adverse Effect. There is a hazard inrepeating this representation, which is that there is a danger of a conflict between thisand the cross default clause.43 The cross default clause (clause 23.5 of the LMA TermLoan) deals with the circumstances where, if the borrower is in breach of a contractwith a third party, that should give rise to a right for these lenders to accelerate. Iflenders wish to provide that default under an agreement which does not relate toFinancial Indebtedness should be an Event of Default in certain circumstances44 thenthe simplest way to deal with that clearly and without risking a conflict betweenRepeated Representations and the Events of Default is to deal with the issue directlyas an Event of Default and not to repeat this representation (see Box 2.8 on p. 121).

Clause 19.10 No misleading information

19.10 No misleading information(a) Any factual information provided by any member of the Group for the purposes of the

Information Memorandum was true and accurate in all material respects as at thedate it was provided or as at the date (if any) at which it is stated.

(b) The financial projections contained in the Information Memorandum have been pre-pared on the basis of recent historical information and on the basis of reasonableassumptions.

(c) Nothing has occurred or been omitted from the Information Memorandum and noinformation has been given or withheld that results in the information contained inthe Information Memorandum being untrue or misleading in any material respect.

This representation updates to the date of signing the loan agreement, the informa-tion which was provided to the lenders in negotiation of the loan. This serves twopurposes:

� first, there is the obvious purpose of triggering provision of information if therehas been a change; and


41 See comments on clause 23.12.42 Note this is not the same as a representation that there is no ‘Default’ which is dealt with at clause 4.2.43 See the example referred to in Box 2.8 (on p. 121).44 As to which, see the commentary on clause 23.

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� second, this updating helps support the argument that the lenders had, in fact,relied on this information (one of the requirements to establish a claim inmisrepresentation) in their decision to lend.


This clause should not be repeated. It simply states that previous statements (in theinformation memorandum) were true when made and that nothing has happenedwhich makes that document misleading. Once the lenders have signed the loanagreement they no longer rely on the information memorandum for their informa-tion (but rather on the updates from the borrower from time to time) nor do theyexpect that the facts stated in it will not change from time to time. Therefore, it is notintended that any changes from the position set out in the information memoran-dum which occur after the date of the agreement should give rise to an event ofdefault. Therefore, this representation should not be repeated.

Clause 19.11 Financial statements

19.11 Financial statements(a) Its Original Financial Statements were prepared in accordance with GAAP consis-

tently applied [unless expressly disclosed to the Agent in writing to the contrarybefore the date of this Agreement].

(b) Its Original Financial Statements fairly represent its financial condition and opera-tions (consolidated in the case of the Company) during the relevant financial year[unless expressly disclosed to the Agent in writing to the contrary before the date ofthis Agreement].

(c) There has been no material adverse change in its business or financial condition (orthe business or consolidated financial condition of the Group, in the case of theCompany) since [ ] 45.

Clauses 19.10 (c) and 19.11(c) are intended to update the Information Memorandumand financial statements to the date on which the representation is made. The date onwhich these representations are made should be the date of signing the agreement.

The representation in clause 19.11(c) is set with reference to the consolidatedfinancial position of the Group as a whole and also with reference to each Obligor.46


The comments made on clause 19.10 apply equally here. This representation simplyupdates the financial information provided up to the date of signing. Lenders donot expect that information not to change after signing. This representation shouldtherefore not be repeated.


45 The last day of the financial period to which the latest audited financial statements relate.46 See the discussion on clause 21 and on the scope of the agreement at section 4 of the Introduction

(pp. 17–24).

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Clause 19.12 Pari passu ranking

19.12 Pari passu rankingIts payment obligations under the Finance Documents rank at least pari passu with theclaims of all its other unsecured and unsubordinated creditors, except for obligationsmandatorily preferred by law applying to companies generally.47

Clause 19.12 is one of three clauses (with the negative pledge (clause 22.3) andcross default clause (clause 23.5)) which are important to an unsecured lender toensure that they are equal with other lenders to the borrower outside the syndicate.The intention is to ensure that the syndicate of lenders for this loan is at least equalwith all other unsecured creditors, or, if not, that they know what creditors havepriority.

The pari passu clause simply requires this loan to be of at least equal rankingwith other unsecured debts (see Box 2.13).


47 The lenders might like to consider what obligations are mandatorily preferred by law.48 See Philip Wood, ‘Pari Passu Clauses—What Do They Mean?’ Journal of International Banking and

Financial Law, 2003, 10, p. 371 for an interesting article commenting on recent cases which suggest that theclause may have a wider meaning than that which is asserted here. See also the report of the FinancialMarket Law Committee on pari passu clauses in sovereign debt obligations, issued in March 2005 andavailable from their web site www.fmlc.org

49 Although, to an extent, the cross default clause has this effect, in relation to covenants, if not inrelation to fees and Margin. See discussion on clause 23.5.

BOX 2.13

In other words, it requires that, on a winding up, to the extent that the lenders have anunsecured claim, the borrower confirms that they will share the assets which are avail-able to unsecured creditors, pro rata with such other creditors, subject to the exceptionsset out in the clause.

It does not48 prevent the borrower from

� paying other debts before making payment on the loan—if lenders want toachieve this, a covenant not to prepay those other debts will be necessary;

� giving security for other debts—that is, the purpose of the negative pledge;

� agreeing different, more favourable, terms in any loan agreements with othercreditors—again, a specific covenant is needed to achieve this.49

The clause itself, on investigation, might look puzzling. It states that the obligationsunder the loan are at least pari passu with other creditors except (a) secured

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creditors; (b) subordinated creditors; and (c) creditors preferred by law applying tocompanies generally.

In most countries these three specified circumstances are the main ways in whichone claim may have a different priority to others and therefore it might be thoughtthat the clause was unnecessary as it simply states the obvious truth. However, theclause is included because, although those are the three main ways in which twodebts may have different priority in insolvency, there are sometimes other, excep-tional ways, which the lenders wish to be advised of (and not to be obliged to lend,if the position is that their loan will be junior to other, ordinary creditors withoutsecurity).

For example, it may be that the law in the borrower’s country,

� allows one claim to be preferred over another without giving security and with-out consent of the creditor who is effectively subordinated;50

� provides that loans with certain attributes will be subordinate to others—as inthe case of the English position on loans where the return to the lender varieswith the profits of the borrower.51

The representation is helpful, therefore, in ensuring that the lawyers involvedconsider whether any such subordination may be applicable.

However, the pari passu clause gives the lenders little comfort unless they alsoknow what claims may be preferred by operation of law applying to companiesgenerally. Common examples are tax and employee payments as well as, some-times, payments to certain companies such as public utility companies. This is anarea for the lenders’ due diligence. Having established what claims may havepriority by operation of law, the lenders may want to include covenants by theborrower not to allow indebtedness to those creditors to exceed a given amount.


It is possible for the loan to cease to be pari passu with other creditors, for example,if there were a change in the law of the relevant jurisdiction. Therefore, if any repre-sentation is to be repeated after first drawing, this is one which can be repeated innormal circumstances.


50 As in some Spanish law based jurisdictions, where execution of a debt instrument as an ‘escriturapublica’ gives this priority.

51 See discussion on the definition of ‘Margin’ in clause 1 on p. 47.52 Or at least to ensure that the Event of Default relating to misrepresentations is not an automatic Event

of Default but allows a period for remedy as discussed in the context of clause 23.4.


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Clause 19.13 No proceedings pending or threatened

19.13 No proceedings pending or threatenedNo litigation, arbitration or administrative proceedings of or before any court, arbitralbody or agency which, if adversely determined, might reasonably be expected to have aMaterial Adverse Effect have (to the best of its knowledge and belief) been started orthreatened against it or any of its Subsidiaries.

The reference to administrative proceedings is intended to pick up references tocompetition authorities and the like.


53 See para 4.3 of the discussion of the scope of the agreement at section 4 of the Introduction at pp. 22–23.

Comment This clause relates not only to Obligors but also to other group members. Itsimpact depends on whether the definition of ‘Material Adverse Effect’ relates to theeffect on the group as a whole, or on any individual Obligor, or on any individualmember of the group. In the third case, borrowers may want to restrict the repre-sentation so that litigation against group members which are not borrowers is notrelevant, since the lenders are not taking credit risks against those companies.53

Assuming for the moment that this representation is not a ‘RepeatedRepresentation’, borrowers’ comments on it will be made in the light of circum-stances which exist at or about the time the representation is being discussed.

Comment The borrower may wish to request removal of the words ‘if adversely deter-mined’ (or the addition of the words ‘is reasonably likely to be adversely deter-mined and which’) particularly if the representation is to be repeated after the initialdrawdown. These words have the effect that any proceedings taking place thatcould have a Material Adverse Effect could trigger the clause and prevent drawing(or worse, result in acceleration) even though the proceedings in question are highlyunlikely to have that result because the case in question is unlikely to succeedagainst the borrower.

Comment This representation has an important caveat—only litigation which mightreasonably be expected to have a Material Adverse Effect (if adversely determined)is relevant. The lenders may wish, in certain circumstances, to remove this carve outat least for the initial representation, to ensure it has full details of all litigation at thetime the loan agreement is signed.


There is a hazard in repeating this representation, which is that there is a danger of aconflict arising between this Repeated Representation and any Events of Defaultdealing with litigation or judgements. There is no Event of Default relating to litiga-tion in the LMA Term Loan. The nearest there is is clause 23.8, dealing with executionof judgements. This may lead the borrower to assume that litigation against it will

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not give rise to an Event of Default unless the circumstances in clause 23.8 occur. Iflenders intend litigation to give rise to an Event of Default in circumstances whichfall short of those referred to in clause 23.8 then the clearest way to achieve this is toinclude an Event of Default to this effect and not to repeat this representation.


54 See section 2 of the comments on clause 22.

Comment The borrower should not repeat a representation that no Default hasoccurred. The effect of this is that, if a Default has occurred (but it is not yet an Eventof Default as, for example, the grace period is running) then the representation isuntrue. Making an untrue representation is itself an Event of Default (without agrace period generally). The result of repeating a representation that no Defaultexists is therefore to potentially lose the benefit of the grace periods. Note this is dif-ferent from having a condition precedent that there is no Default. In that case, ifthere is a Default, it is not a misrepresentation and therefore not an event of default.Instead it simply relieves the lenders of the obligation to lend.

Clause 19.14 Repetition

19.14 The Repeating Representations are deemed to be made by each Obligor by referenceto the facts and circumstances then existing on(a) the date of each Utilisation Request and the first day of each Interest Period and(b) in the case of an Additional Obligor, the day on which the company becomes (or it is

proposed that the company becomes) an Additional Obligor.

For comments on clause 19.14 see section 1 of the commentary on clause 19 andsee also the commentary on each individual representation in section 2 of thecommentary on clause 19.

Representations in different circumstances

The representations as to validity and admissibility in evidence (clause 19.5(b)),governing law and enforcement (clause 19.6), withholding tax (clause 19.7), andno filing or stamp tax (clause 19.8) are not usually required of an English bor-rower in a straightforward unsecured loan, since, in those circumstances, theseissues are a matter of English law on which the lenders, by common practice, arecontent to rely on their own lawyers.

The LMA Term Loan includes only very basic representations which will beapplicable in all cases, covering issues such as power and authority. Additionalrepresentations will be necessary to reflect the specific transaction and therequirements of the lenders’ credit decision.54

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CLAUSE 20: INFORMATION UNDERTAKINGS

Introduction

The purposes of the undertakings are to ensure the lenders have the informationthey need; to ensure good housekeeping by the borrower; to give the lenders’ lever-age; and to protect the borrower’s assets.

The undertakings in the LMA Term Loan cover

� provision of information (clause 20);

� financial covenants (clause 21); and

� positive and negative covenants relating to protection of assets (clause 22).

Other undertakings are likely to be required in any given case as discussed insection 2 of the comments on clause 22.

20. INFORMATION UNDERTAKINGSThe undertakings in this Clause 20 remain in force from the date of this Agreement for solong as any amount is outstanding under the Finance Documents or any Commitment isin force.

The covenants are expressed to cease to be effective once there is no longer any loanoutstanding.55

Clause 20.1 Financial statements

20.1 Financial statementsThe Company shall supply to the Agent in sufficient copies for all the Lenders:(a) as soon as the same become available, but in any event within [ ] days after the end of

each of its financial years:(i) its audited consolidated financial statements for that financial year; and(ii) the audited financial statements of each Obligor for that financial year; and

(b) as soon as the same become available, but in any event within [ ] days after the end ofeach half of each of its financial years:(i) its consolidated financial statements for that financial half year; [and(ii) the financial statements of each Obligor for that financial half year].

There are a number of issues here.

(a) Which companies should the accounts relate to? This needs to reflect the creditdecision and the basis on which financial ratios are tested.56 The LMA Term

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55 It is important to be clear that other provisions such as indemnities and undertakings to reimbursethe lenders are not limited in this way. A claim under these other clauses may need to be made after theloan has been fully repaid, or before it is advanced.

56 See discussion of financial ratios at clause 21.

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Loan requires consolidated statements for the Company (the highest level in thegroup to which the lenders have recourse, which thus gives financial informa-tion for the whole of the group below the Company) and individual statementsfor each Obligor (thus ensuring that the lenders have financial informationrelating to those companies against which they have direct claims).

(b) How much time is allowed for preparation of the statements?

(c) Which types of financial statements are required? Normally, the lenders requireannual audited statements plus half yearly unaudited statements. This is whatthe LMA Term Loan provides for. In the case of sub-investment grade borrow-ers, lenders not uncommonly require additional financial statements such asmonthly management accounts. Public company borrowers may wish to restrictinformation provided to that which is available to the public generally, so as toreduce the risk of inadvertently creating possibilities for insider dealing.

Clause 20.2 Compliance Certificate

20.2 Compliance Certificate(a) [The Company shall supply to the Agent, with each set of financial statements

delivered pursuant to paragraph (a)(i) or (b)(i) of Clause 20.1 (Financial statements),a Compliance Certificate setting out (in reasonable detail) computations as tocompliance with Clause 21 (Financial covenants) as at the date as at which thosefinancial statements were drawn up.

(b) Each Compliance Certificate shall be signed by two directors of the Company [and, ifrequired to be delivered with the financial statements delivered pursuant to para-graph (a)(i) of Clause 20.1 (Financial statements), [shall be reported on by theCompany’s auditors in the form agreed by the Company and all the Lenders beforethe date of this Agreement]/[ by the Company’s auditors.]]

Clause 20.2 provides, as an option, for an auditor’s certificate to be produced withthe audited annual statements confirming compliance with the financial ratios.Their willingness to do this needs their prior approval.

Clause 20.3 Requirements as to financial statements

20.3 Requirements as to financial statements(a) Each set of financial statements delivered by the Company pursuant to Clause 20.1

(Financial statements) shall be certified by a director of the Company as fairly repre-senting its financial condition as at the date as at which those financial statementswere drawn up.

(b) [The Company shall procure that each set of financial statements delivered pursuantto Clause 20.1 (Financial statements) is prepared using GAAP.]

(c) [The Company shall procure that each set of financial statements of an Obligor deliv-ered pursuant to Clause 20.1 (Financial statements) is prepared using GAAP,


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accounting practices and financial reference periods consistent with those applied inthe preparation of the Original Financial Statements for that Obligor unless, in rela-tion to any set of financial statements, it notifies the Agent that there has been achange in GAAP, the accounting practices or reference periods and its auditors (or, ifappropriate, the auditors of the Obligor) deliver to the Agent:(i) a description of any change necessary for those financial statements to reflect the

GAAP, accounting practices and reference periods upon which that Obligor’sOriginal Financial Statements were prepared; and

(ii) sufficient information, in form and substance as may be reasonably requiredby the Agent, to enable the Lenders to determine whether Clause 21 (Financialcovenants) has been complied with and make an accurate comparison betweenthe financial position indicated in those financial statements and that Obligor’sOriginal Financial Statements.

Any reference in this Agreement to those financial statements shall be construed as areference to those financial statements as adjusted to reflect the basis upon which theOriginal Financial Statements were prepared.]

Clause 20.3 gives the draftsperson two choices. Either the accounts are prepared inaccordance with the relevant GAAP as it changes from time to time (clause 20.3(b))or with the original GAAP (clause 20.3(c)). The second is known as a ‘frozen GAAP’provision. The second option facilitates the working and testing of financialcovenants.

Clause 20.4 Information: miscellaneous

20.4 Information: miscellaneousThe Company shall supply to the Agent (in sufficient copies for all the Lenders, if theAgent so requests):(a) all documents dispatched by the Company to its shareholders (or any class of them)

or its creditors generally at the same time as they are dispatched;

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Comment Paragraph (a) is intended to ensure that those events that are significantenough to be notified to shareholders and/or creditors are, at the same time,notified to the lenders. However, in the case of private companies, it may beappropriate to limit the requirement to apply only to information which theborrower delivers to creditors or is required by law to deliver to its shareholders,since shareholders of private companies are often intimately involved in the day-to-day management and may receive more information than would be appropriatefor a lender.

(b) promptly upon becoming aware of them, the details of any litigation, arbitration oradministrative proceedings which are current, threatened or pending against anymember of the Group, and which might, if adversely determined, have a MaterialAdverse Effect; and

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(c) promptly, such further information regarding the financial condition, business andoperations of any member of the Group as any Finance Party (through the Agent)may reasonably request.


57 Such as any removal of the presumption that litigation will be adversely determined, and any restric-tion of the scope of the clause e.g. to relate to Obligors only.

58 See further commentary on clause 23.8.59 See the discussion of the scope of the agreement in section 4 of the Introduction (pp. 17–23) .60 Although they already have the benefit of the word ‘reasonably’.61 Since the lenders have no more rights if there are two Defaults than if there is only one.

Comment This clause ought to reflect any changes agreed to in clause 19.13.57

Comment If (as suggested in relation to clause 19.13 on p. 135) clause 19.13 is notrepeated then, under the LMA Term Loan, the lenders will be entitled to be advisedof litigation which falls within this clause but will not have any rights to take actionas a result of such litigation unless the circumstances also constitute an Event ofDefault under, for example, the material adverse change Event of Default or the crossdefault clause. Lenders may wish to consider whether they want significant litiga-tion to be an Event of Default58 and, if not, whether they wish to be advised of it.

Comment The borrower may want to restrict clause 20.4(c) to exclude certain Groupmembers or to include only Obligors.59 They may also want to restrict the general-ity of the clause60 so as to discourage frequent unwarranted requests, particularly asthe clause relates to the requirements of ‘any Finance Party’ so exposing the bor-rower to the requirements of every lender. Nevertheless, borrowers should bear inmind that provision of information to lenders is often as much in the interests of theborrowers as the lenders, because it facilitates well-informed decisions by lenders.

Clause 20.5 Notification of default

20.5 Notification of default(a) Each Obligor shall notify the Agent of any Default (and the steps, if any, being taken

to remedy it) promptly upon becoming aware of its occurrence (unless that Obligoris aware that a notification has already been provided by another Obligor).

(b) Promptly upon a request by the Agent, the Company shall supply to the Agent acertificate signed by two of its directors or senior officers on its behalf certifying thatno Default is continuing (or if a Default is continuing, specifying the Default and thesteps, if any, being taken to remedy it).

Clause 20.5 requires the borrower to notify the lenders of a Default. One mightquery what incentive there is for the borrower to comply with this undertakingsince, if there is a Default, then failure to notify the lenders of that fact will consti-tute another Default but will not make the borrower’s legal position any worse.61

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For this reason, it is important that the drafting ensures that failure to notify of aDefault does indeed make the borrower’s position worse. This is achieved by ensur-ing (in clause 23.3) that this undertaking either has no grace period or has only avery short grace period before it becomes an Event of Default. As a result, breach ofthis undertaking results in an Event of Default (not just a Default) even though thegrace period for the underlying Default may not have expired (see Box 2.14).

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BOX 2.14

So, for example, the borrower may be in breach of the undertaking in clause 22.1to maintain all necessary authorizations for performance of its obligations. Underclause 23.3(b), assume that a grace period of ten days has been given for this particularundertaking. Once the borrower realizes that a necessary authorization is missing, thatis a Default but not an Event of Default. If the borrower fails to notify the lenders‘promptly’ of the fact that an authorization is missing, that failure to notify is a breachof clause 20.5 and a Default in its own right. As long as no grace period has been givenin relation to clause 20.5, it is also an immediate Event of Default, so failure to notifyhas the result of depriving the borrower of the grace period they would otherwise havehad in respect of the original Default.

Comment Lenders may prefer to replace the word ‘promptly’ with a specific timeperiod.

Clause 20.6 Use of websites

Clause 20.6 contains provisions which allow for communication by the Companyby posting information on their website, but only in relation to those syndicatemembers who have agreed to that form of communication and with a requirementto inform the syndicate if information which is required under the Loan Agreementis posted onto the website.

Clause 20.7 ‘Know your customer’ checks

This clause contains provisions requiring delivery of information as necessary toallow the Agent and the Lenders to comply with any applicable ‘know yourcustomer’ regulations.

CLAUSE 21: FINANCIAL COVENANTS

The main points which need to be considered in relation to the ratios are:

� which aspects of the borrower’s financial condition to test;

� at which level of the Group to run the tests;

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� in respect of what periods to run the tests; and

� what the consequences of breach of a ratio should be.

What ratios to test

The financial covenants measure such things as:

(a) Tangible Net Worth;

(b) Borrowings to Tangible Net Worth (leverage or gearing);

(c) Current assets to current liabilities (liquidity);

(d) Debt service (or total outgoings) to EBITDA62 (interest cover or cash flow).

Which ratios to set will clearly depend on the particular business and the stressfactors within it.

Tangible Net Worth

This test simply looks at the value of the company, that is, the value of its assets lessthe amount of its liabilities. For this purpose, lenders generally exclude the value ofintangible assets such as goodwill, looking instead at the value of tangible assetswhich can be sold. The company’s assets are represented in its balance sheet by thefigure shown in respect of ‘shareholders funds’, and therefore the starting point ofthe definition is the amount of shareholders funds less items such as goodwill,which are intangible.

Gearing ratio

This ratio is intended to ensure that the borrower has the ability to pay its debts(including servicing the loan) as they fall due.

The gearing ratio looks at the amount borrowed and compares it with the bal-ance sheet value of the company to see if the company has overborrowed against itsassets. For this purpose, borrowings will include the various items (other thanderivatives, and with liabilities under guarantees being a debatable item) includedin the definition of Financial Indebtedness so as to catch transactions having thesame commercial effect as borrowings. Subordinated debt will be an item for dis-cussion with its treatment depending on the level of subordination.63

Liquidity ratio

The gearing ratio however will not highlight any cash flow problems the borrowermay have. This is the role of the liquidity ratio. This compares current assets (cashand assets which the company can convert into cash shortly) with current liabilities


62 Earnings before interest, tax, depreciation, and amortization.63 See discussion of subordination in para 4.7 of section 1 of Appendix 1 at p. 269.

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(liabilities falling due within 12 months). However, current assets include stock intrade—lenders may wish to exclude these from current assets for the purpose of theratio as stock may not be saleable at the price included in the balance sheet.

Interest cover

Lenders are also concerned with the question of how easily the company can serv-ice its debts out of profits. This is the role of the interest cover ratio, which comparesEBITDA with the interest expense in a given period. Another alternative is toinclude a ‘fixed charge cover ratio’. This, for any given period, compares EBITDA withtotal outgoings (not just interest) during the period.

Lenders may also want to restrict expenditure in which case they may impose alimit on the amount of capital expenditure in any given period.

At which level of the group to run the tests

This clearly needs to reflect the credit decision. Lenders may be concerned with thefinancial condition of the group as a whole and/or with the condition of specificcompanies (most likely the Obligors) within the group.64 They may therefore wishto impose certain financial covenants on the Obligors in addition to any covenantsfor the group as a whole. If any specific companies (such as subsidiary undertakingsor non-recourse companies65) have been excluded from the definition of ‘Group’then the lenders will probably want to have the ratios tested against the financialposition of the group excluding those companies.66

In respect of what periods to run the tests

One drawback with financial ratios is that there is often a mismatch between the tim-ing of any problem and the occurrence of the Event of Default. By the time a breachbecomes apparent, the accounting period in which it occurred will have come to anend and the particular issue may have been resolved.67 On the other hand, it may beevident that there is a problem and that once the accounts for the relevant period areproduced, they will show a breach, but until the accounts are produced, there is noth-ing the lenders can do about it. It is for this reason that lenders often require to havean event of default relating to material adverse change in financial condition notwith-standing the existence of financial ratios. See comments on clause 23.12 (p. 182) on theinterrelation of the material adverse change clause and the financial ratios.68


64 See the discussion of the scope of the agreement in section 4 of the Introduction.65 See para 4.4 of section 4 of the Introduction (p. 23).66 With corresponding adjustment needed to the undertaking in clause 20 to provide financial

information.67 Nevertheless, the Event of Default will have occurred and will not be capable of being cured (if

properly drafted—see clause 23.2).68 Lenders might also seek to make the tests predictive as well as historic, based on the predictions

within the company’s management accounts.

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Consequences of breach

These ratios are particularly important because, unlike many of the other covenantsand events of default, breach of them does not necessarily mean there is a problem,simply that the credit risk has changed somewhat. They give advance warning ofchanges and are able to be graded subtly as opposed to the black or white nature ofother provisions. For this reason, breach of a financial ratio need not be drafted tohave the effect of an Event of Default. It is possible (and not uncommon) to providethat, within certain limits (breach of which will be an Event of Default) failure tomeet a particular ratio simply affects the Margin.


69 The reason for this is twofold. First, the borrower is more likely to have financial difficulties at a time ofeconomic turmoil generally, when asset prices are also likely to have fallen; and second, the markets willoften be aware that the sale is a distressed sale, which will always result in lower prices than a voluntary sale.

Comment Finance directors in established companies need to be sure that the numbersspecified in the ratios are reasonable and will not give rise to an Event of Default tooreadily. The borrowers’ argument is that, assuming the borrower is a reasonablywell-established company, they need a robust loan agreement which will see themnot only through good times but also through downturns. All companies have upsand downs, so setting ambitious ratios, or even ratios reflecting the current situation,if breach of those ratios is an Event of Default, leads to a fragile position in which anydeterioration in the borrower’s condition will give the lenders the right to accelerate.This, in turn (through the cross default clauses), will result in its other lenders havingthe same right. The threat to their liquidity which this may cause (regardless of theoverall financial stability of the company) could be sufficient to precipitate its col-lapse. If breach resulted in a change in Margin, this risk would disappear.

Financial covenants in an asset finance transaction

An asset finance transaction will often include a security cover ratio (see Box 2.15on p. 145).

This will specify that the value of the security must always equal at least agiven percentage of the loan outstanding. The percentage varies between 120%and over 200%. The excess over 100% is designed to give the lenders a cushion for,

� interest which will accrue between commencement of proceedings and real-ization of proceeds of security;

� expenses which will be incurred by the lenders in realizing the security;

� the fact that values of assets tend to fall precisely when the lender requiresaccess to them;69 and

� currency fluctuations, if the loan is a multicurrency loan or if the value of thesecurity may be affected by the value of currencies other than the currency ofthe loan.

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70 If the loan is a multicurrency loan, the ratio will generally be tested with reference to the BaseCurrency Amount of the loan (see definition of ‘Base Currency Amount’). However, this exposes thelenders to an exchange rate risk in between the dates (usually the start of each Interest Period) when theloan needs to be readjusted to match the Base Currency Amount, as discussed in relation to clause 6. So, ifthe loan may be outstanding in a currency which is not the same as the currency in which the security islikely to be sold (the ‘Security Currency’), the lenders may require the ability to test the SecurityRequirement from time to time during Interest Periods, with reference to the amount of the loan at its thencurrent exchange rate as against the Security Currency.

BOX 2.15

EXAMPLE SECURITY COVER RATIO

‘If at any time the Security Value is less than the Security Requirement then the Borrower shall,within 10 Business Days, either(a) prepay the Loan in such amount as shall be required to ensure that, after such prepayment,

the Security Value is not less than the Security Requirement; or

(b) provide additional security for the Loan having a value, as determined by the MajorityLenders in their absolute discretion, equal to the difference between the Security Value andthe Security Requirement.’

‘Security Requirement’ means, at any relevant time, an amount equal to one hundred and fiftypercent of the amount of the Loan70 at that time;

‘Security Value’ means, at any relevant time, the value of the Security at such time as deter-mined by the latest valuation delivered to the Lenders pursuant to Clause {}’.

If the ratio is breached at any time, the borrower generally has the option of pro-viding additional security or prepaying the loan to the extent necessary to bringthe ratio back into line.

There are a number of issues that often arise in negotiation of this covenant.

1 When and how is the security valued? As to when, lenders frequently wish tohave the ability to obtain valuations more often than annually. The issue oftenboils down to one of expense, with the borrower obtaining annual valuationsbut with a right for the Agent to obtain interim valuations at its own expense.As to how, there are many options, including:

� each of the Agent and the borrower appoint a valuer, and the value is theaverage of the two;

� the borrower appoints a valuer but the Agent is able to challenge the valu-ation and, if it does so, the Agent’s valuer’s determination is the value;

� each of the Agent and the borrower appoints a valuer and the valuation isthe average of the two but the Agent has the ability to appoint a third if hedisputes the borrower’s valuation. The value will then be the average of thethree (or of the Agent’s two); and

� as above but the valuations can only be made by a valuer which is on a listof pre-agreed approved valuers.

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71 See para 4.4 of section 2 of Appendix 1 at p. 278.72 See Appendix 2.

BOX 2.16

For example, assume the loan is $10 million and the security cover ratio is 150%. If thesecurity (excluding cash) is valued at $12 million, there is a shortfall of $3 million in therequired Security Value. To cure this, the borrower would need to provide cash secu-rity of $3 million. If the borrower succeeds in its argument discussed here, however,then the cash security required will be only $2 million. This is because that $2 millionwill be counted against the $10 million loan on a Dollar for Dollar basis. That brings theamount of the loan which is not covered by cash security down from $10 million to$8 million. Security cover of 150% is required for that $8 million, resulting in a require-ment that the value of non-cash security is at least $12 million and the existing non-cash security covers that requirement.

2 Should there be any restriction on the types of assets that the lenders mustaccept as additional security? Often the lenders will limit additional securityto assets which have a public market for example, stocks and bonds. If otherassets may be permitted, lenders often require complete discretion as to howto value them, so as to protect themselves from

� being offered assets of a type which they would not have accepted at thecommencement of the loan; and

� the possibility that there may be legal difficulties in relevant countries increating valid security (such as security over moveable property71) or thatany security created may be clawed back in an insolvency, for example,because it is a preference.72

3 Lenders may wish to consider whether the requirements as to valuation ofadditional security should be determined by all the lenders or by a Majority.Individual lenders may not want to be required to accept security based on theviews of the rest of the syndicate. However, the borrower will be likely toobject to a requirement that the value should be agreed by all lenders as itexposes the borrower to the views of the most cautious lender.

4 If cash is part of the security (e.g. perhaps where moneys are blocked in anaccount where there is a restriction on distribution of those moneys) then theborrower may request that the Security Requirement should be the relevantpercentage of the loan minus the amount of cash cover. The effect of this requestis to reduce the Security Requirement by more than the cash held, on the basisthat the cash should count Dollar for Dollar against the loan. The argument isthat, because cash is readily accessible, the justifications discussed above forrequiring the Security Value to exceed the amount of the loan do not apply(see Box 2.16).

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CLAUSE 22: GENERAL UNDERTAKINGS—SECTION 1—THE LMA UNDERTAKINGS

The general positive covenants in the LMA Term Loan are minimal—to maintainconsents and comply with laws affecting the loan.

The negative covenants in the LMA Term Loan consist of the negative pledgeclause, a no disposals clause, and a clause prohibiting merger or change of business.

Clause 22.1 Authorization

22.1 AuthorisationsEach Obligor shall promptly:(a) obtain, comply with and do all that is necessary to maintain in full force and

effect; and(b) supply certified copies to the Agent of,any Authorisation required under any law or regulation of its jurisdiction of incorpora-tion to enable it to perform its obligations under the Finance Documents and to ensurethe legality, validity, enforceability or admissibility in evidence in its jurisdiction ofincorporation of any Finance Document.

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Comment This covenant relates to corporate authorities and other consents, licenses,filings, and registrations required under the laws in the place of incorporation ofObligors. It is somewhat less broad that the corresponding representation in clause19.5, which, unlike this clause 22.1, is not limited to Authorizations from theObligors’ jurisdiction of incorporation. The two clauses should be reviewedtogether.

Clause 22.2 Compliance with laws

22.2 Compliance with lawsEach Obligor shall comply in all respects with all laws to which it may be subject, iffailure so to comply would materially impair its ability to perform its obligations underthe Finance Documents.

This undertaking is self-explanatory.

5 The borrower often requests that if, after additional security has been given,the point comes when the ratio would be satisfied without taking into accountthe value of the additional security, the lenders should release that additionalsecurity.

Borrowers may also ask that the clause should not operate if, between the time ofthe shortfall and the date on which the clause would otherwise require prepay-ment or additional security, a repayment falls due which will have the effect ofbringing the loan down to a figure such that there is no longer any shortfall.

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Clause 22.3 Negative pledge

The negative pledge clause prohibits the borrower from giving security unless thatsecurity falls within one of the exceptions to the clause. There are many differentreasons for inclusion of a negative pledge and its significance varies from transac-tion to transaction.

Purpose. In an unsecured loan, it is one of the three clauses (pari passu, negativepledge, and cross default) which the unsecured creditor will regard as particularlyimportant as they ensure his equality with other creditors. Its role here is

� to preserve equality—as a general requirement that lenders to the borrower(except, perhaps, in special cases such as asset or project financings), lend on thesame (unsecured) basis; and/or

� to provide advance warning of a change in financial condition—if the borrowerneeds to borrow significant amounts on a secured basis this may reflect a changein its condition; and/or

� to protect the lenders’ leverage in the event of the borrower’s insolvency—thelenders may wish to ensure that there are no secured lenders for fear that asecured lender may be more prepared to take proceedings against a borrowerthan an unsecured lender; and/or

� to protect the pool of assets which the borrower has at the start of the transaction,from being dissipated.


73 See Box A1.12 at p. 273.

In a secured transaction lenders may be equally concerned as in an unsecuredtransaction to:

� protect their leverage in insolvency and hence prevent existence of any othersecured creditors; and

� protect the initial pool of assets from being dissipated.

In addition, if the lenders are taking security over substantially all the company’sassets they will want the negative pledge so as to:

� facilitate the lenders’ control of the company;

� enable the lenders to sell the company as a going concern should an Event ofDefault occur;

� reduce the likelihood of other creditors taking action against the company;

� bolster a floating charge;73 and

� simply as part of the range of covenants designed to ensure the company doesnot undertake any other business, if the company is a single purpose company.

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Consequences of breach. One problem with the negative pledge clause relates tothe consequences of breach. The clause aims to ensure that if the lenders need toenforce their rights against the borrower, all its assets will be shared equally. However,if the borrower breaches the clause, the lenders’ remedy is to accelerate. If they doaccelerate, they will then be in the situation which the clause was intended to avoid—that is, of having to enforce but not having equal access to the borrower’s assets. Inother words, the clause does not in fact protect the lenders against a borrower whichbreaches the clause. The position may be different if the person taking security knew,or should have known, that that security was given in breach of the negative pledge.74


74 This is one reason for the representation at clause 19.3—to help ensure that if anything done underthis loan arrangement is a breach of prior agreements, the lenders can point to the representation andshow that they were unaware of the breach.

75 See comments below on clause 22.3(b).76 See comments on clause 22.3(c)(iii). 77 ‘Security’ is defined to mean ‘a mortgage, charge, pledge, lien or other security interest securing any

obligation of any person or any other agreement or arrangement having a similar effect’.78 See the discussion on clause 22.3(c)(iii).

One variation on the negative pledge permits security to be given but only ifthe lenders are equally and rateably secured. This may be difficult to give effectto, given the fluctuating value of security and of the debt concerned, unless therewere a formal security sharing agreement.

Content. Generally, it is in all parties’ interests to ensure that the clause permits theborrower’s day-to-day activities and that it does not have the result of forcing the bor-rower to regularly request consent under it. The scope of the clause (e.g. does it pro-hibit title retention75) and of any exceptions (e.g. does the operation of law exceptiondepend on the relevant security also arising in the ordinary course of trading76) needsto be reviewed in the context of the borrower’s business and country of operations.

The negative pledge clause in the LMA Term Loan falls into three sections.

� First clause 22.3(a) prevents the creation or existence of ‘Security’77;

� Second clause 22.3(b) outlaws quasi security if that takes the form of one of theitems specified in the clause;

� Third clause 22.3(c) sets out the exceptions.

Clause 22.3(a) Prohibition on security

22.3 Negative pledge(a) No Obligor shall (and the Company shall ensure that no other member of the Group

will) create or permit to subsist any Security over any of its assets.

Clause 22.3(a) prevents the creation or existence of ‘Security’ (see Box 2.17 on p. 150).The clause does not only prohibit the borrower from creating Security but also saysthe borrower must not ‘permit [Security] to subsist’. This outlaws those securityinterests which arise at law such as liens.78 It also has an impact on Security created

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by companies which initially were not restricted but become restricted at a laterstage.80


79 See commentary on clause 22.3(b).80 See Box 0.15 on p. 21.81 See para 4.3 of section 4 of the Introduction on p. 22.

BOX 2.17

In this clause 22.3(a) (unlike section (b) relating to certain forms of quasi security) allmanner of Security is prohibited, whether or not it is created as security for FinancialIndebtedness.79 For example, security arising in the context of a litigation, such asjudgement liens, will be prohibited under clause 22.3(a)—subject to any relevantexceptions in clause 22.3.

Comment The prohibition in this clause relates to all members of the group. The bor-rower may want to limit the prohibition to Obligors on the basis that lenders haveno recourse against members of the group which are not Obligors and thereforeshould be unconcerned with their assets.81

Clause 22.3(b) Prohibition on quasi security

(b) No Obligor shall (and the Company shall ensure that no other member of theGroup will):(i) sell, transfer or otherwise dispose of any of its assets on terms whereby they are or

may be leased to or re-acquired by an Obligor [or any other member of the Group](ii) sell, transfer or otherwise dispose of any of its receivables on recourse terms;(iii) enter into any arrangement under which money or the benefit of a bank or other

account may be applied, set-off or made subject to a combination of accounts; or(iv) enter into any other preferential arrangement having a similar effect,

in circumstances where the arrangement or transaction is entered into primarily asa method of raising Financial Indebtedness or of financing the acquisition of anasset.

Clause 22.3(b) outlaws quasi security if that takes the form of one of the itemsspecified in the clause. This prohibition on quasi security only applies where itoccurs primarily for the purpose of raising Financial Indebtedness. The purpose, ofcourse, is to ensure that, no matter the legal structure, if the commercial effect isequivalent to security, it is prohibited. The qualification relating to FinancialIndebtedness is intended to distinguish between quasi security and arrangementswhich do not amount to raising finance.

The specific forms of quasi security prohibited by this clause are

� sale and repurchase or leaseback;

� selling receivables but keeping the risk; and

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� set off or similar arrangements with cash.

There is also a provision (clause 22.3(b)(iv)) stating that similar arrangements arealso prohibited (see Box 2.18).


82 See section 6 of the Introduction on pp. 28 et seq.83 See commentary on clause 22.3(c)(iv) and (v).84 With the possible exception of para (vii) depending on its drafting.

BOX 2.18

Certain other common forms of quasi security (finance leases, title retention, forwardsale and/or trust arrangements82) are not specifically excluded. It is therefore open toargument as to whether they are intended to be permitted or intended to be covered byclause 22.3(b)(iv) (the general provision for transactions having a similar effect) or bythe general wording in the definition of ‘Security’. An argument that finance leasing, atleast, is intentionally not prohibited can be made because clause 22.3(b)(i) expresslydeals with sale and leaseback but not simple finance leasing. The thrust of clause 22.3(b)seems to be towards only a sub category of quasi security—that is, the category whichinvolves effectively giving security over property already owned but not over new prop-erty. Thus (if this view were correct) hire purchase, title retention, and finance leasingare deliberately not prohibited. This fits with one common purpose of the negativepledge—to protect an existing pool of assets83—but if lenders’ requirements go beyondthat, they should review whether these additional forms of quasi security need to beexpressly prohibited.

Clause 22.3(c) Exceptions to negative pledge

The exceptions are as follows.

Comment Lenders and/or borrowers may wish to clarify precisely what forms of quasisecurity are intended to be prohibited by this clause, with particular reference tofinance leases and title retention—see Box 2.18.

Comment Of the exceptions, only para (ii) (ordinary banking arrangements) and para(iii) (operation of law) relate to quasi security. The other exceptions84 are to para-graph (a) only as they only permit ‘Security’ as defined. There is no reason forSecurity and quasi security to be treated differently for the purpose of these clauses,and a borrower should seek to adjust this and ensure that all exceptions apply notonly to ‘Security’, and hence to clause 22.3(a) only, but also to quasi security as pro-hibited by clause 22.3(b).

Clause 22.3(c)(i) Existing security(c) Paragraphs (a) and (b) above do not apply to:

(i) any Security listed in Schedule 9 (Existing Security) except to the extent theprincipal amount secured by that Security exceeds the amount stated in thatSchedule.

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This allows security already in place but only to the extent of the amount advancedto date.


BOX 2.19

Examples of security which arises by operation of law or in the ordinary course oftrading may include

� security over an asset as security for a debt arising from a transaction relating tothat asset—for example, in England, if equipment is delivered to a repairer therepairer will be entitled to hold onto the equipment (and will have security over it)until paid;

� security arising by statute—for example, in some countries, the tax authorities havesecurity over a company’s property for any tax owing; or environmental agencieshave security over a company’s property for clean up costs of environmentalincidents caused by the company;

� security arising under standard terms of banking arrangements—for example,under such arrangements, banks may have security over property deposited withthem for safe keeping;

� security in favour of unpaid sellers (in some countries, unpaid sellers automaticallyhave security in the assets sold until they have been paid for them);

� Security given or arising automatically in the context of litigation, while proceed-ings are pursued.

Comment Borrowers sometimes ask that this exception be extended to allow any refi-nancing of existing secured debt as long as the amount of the debt and the extent ofthe security are not increased. Some lenders will not agree as they are only happy toallow existing security on the basis that, over time, it will be paid off.

Clause 22.3(c)(ii) Netting or set off in the course of ordinary banking arrangements

(ii) any netting or set-off arrangement entered into by any member of the Group in theordinary course of its banking arrangements for the purpose of netting debit andcredit balances;

Thus ordinary banking set off or swap netting is not prohibited.

Clause 22.3(c)(iii) Operation of law(iii) any lien arising by operation of law and in the ordinary course of trading;

Many security interests arise without being deliberately created by the borrowerand, subject to the exceptions in this clause 22.3(c), existence of these forms of secu-rity is prohibited, regardless of the fact that they were not created on purpose andthey do not secure borrowings. They will be permitted if they arise both by opera-tion of law and in the ordinary course of trading (see Box 2.19).

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The exception is cumulative. It requires the security to arise both by operation oflaw and in the ordinary course of trading. So, only some of the examples listed inbox 2.19 will be permitted by this exception. For example, security for clean up costsin some circumstances would not be permitted because, although the security arisesby operation of law, the environmental incident may well not have occurred ‘in theordinary course of trading’. Security under standard banking terms does not nor-mally arise by operation of law, even though it is in the ordinary course of trading.To the extent that the relevant security is not permitted under this clause, it wouldbe counted towards the threshold amount in clause 22.3(c)(viii).


BOX 2.20

The ‘ordinary course of trading’ is a more restrictive expression than the‘ordinary course of business.’85 It will include activities which the business does,and expects to do, as part of its trading (meaning buying and selling). Nevertheless,there is no clear definition of the expression, which should therefore be used withcaution.

Comment Sometimes borrowers ask for the exceptions in paragraph (iii) to be independ-ent; not cumulative; so that liens arising by operation of law are permitted (e.g. inrespect of taxes) and liens arising in the ordinary course of trading are also permitted.Lenders prefer the cumulative requirement as, without it, the borrower’s ability todeliberately create security in the ordinary course of trading is unlimited (see Box 2.20).

Clause 22.3(c)(iv) and (v) After acquired property/companies(iv) any Security over or affecting any asset acquired by a member of the Group after the

date of this Agreement if:(A) the Security was not created in contemplation of the acquisition of that asset by

a member of the Group;(B) the principal amount secured has not been increased in contemplation of, or

since the acquisition of that asset by a member of the Group; and(C) the Security is removed or discharged within [_] months of the date of acquisi-

tion of such asset;(v) any Security over or affecting any asset of any company which becomes a member of

the Group after the date of this Agreement, where the Security is created prior to thedate on which that company becomes a member of the Group, if:(A) the Security was not created in contemplation of the acquisition of that company;(B) the principal amount secured has not increased in contemplation of or since the

acquisition of that company; and(C) the Security is removed or discharged within [ ] months of that company

becoming a member of the Group;

85 A recent case (Ashborder BV v Green Gas Power Ltd (2004) EWHC 1517) considered the meaning ofthe expression ‘ordinary course of business’ and held that, in certain circumstances, even an unprece-dented or exceptional transaction could be in the ordinary course of business. See also ‘Defining the“Ordinary Course of Business” ’, Journal of International Banking Law and Regulation, 2004, 19(12), p. 513.

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These clauses allow the borrower to purchase assets or companies which alreadyhave security on them provided that security is discharged within a specifiedperiod after the acquisition.


86 See introduction to clause 22.3.87 See para 4.2 of section 4 of the Introduction at p. 19.88 See Goode Commercial Law, p. 622 for details of security interests which may arise in the course of

litigation in England.

Comment The requirement in clauses 22.3(c)(iv)(C) and (v)(C) that the security must bedischarged within a period after the acquisition is one which a borrower might seekto resist. Existence of that security does not contain any adverse implications as tothe borrower’s financial position and retention of these restrictions may makeacquisitions more difficult. If the lenders view the purpose of the negative pledge asbeing to protect the borrower’s existing pool of assets, this requirement is unneces-sary. If, on the other hand, lenders are concerned simply to ensure equality andleverage on a winding up,86 they will require these provisions to remain as drafted.

Clause 22.3(c)(vi) Under the finance documents(vi) any Security entered into pursuant to any Finance Document;

Clause 22.3(c)(vii) OtherOther common exceptions are,

� Security created by limited recourse subsidiaries (unless limited recourse sub-sidiaries have been excluded from the ambit of the loan altogether)87 and secu-rity created (even if created by a company which is not a non-recoursecompany) for non-recourse debt. The argument is that this cannot harm thegroup except to the extent of the assets to which recourse is available for thelimited recourse finance. As long as those assets are disregarded for the pur-pose of this loan (e.g. excluded in calculations of financial ratios) then existenceof limited recourse debts and security for such debts should not concern thelenders.

� Security over property acquired after the loan agreement is signed, where thesecurity is given to secure financing for purchase of that property. Some lendersmay agree to this exception on the basis that giving security in these circum-stances is not to the detriment of the existing pool of assets, provided the prop-erty being acquired does not replace an asset from the existing pool. On the otherhand, lenders may not agree to this exception if they are concerned that the factthat the borrower is raising money on a secured basis might indicate somechange in its financial status, or if they want to ensure equality with otherlenders.

� Liens in the context of litigation.88 It may well be (depending on the type of busi-ness the borrower runs and the litigation in question) that any litigation would

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not be in the ordinary course of trading and therefore these security interests, ifpermitted at all, would only be permitted if they fell within the threshold set inclause 22.3(c)(viii). This could result in a large difference between the negotiatedposition in relation to litigation89 and the position in practice. Nevertheless,lenders may justifiably argue that the circumstances in which they are content tosee litigation occur will differ depending on whether that litigation involves thecreation of security or not.

� Security given in order to access a particular (advantageous) source of funds onlyavailable on secured terms, such as export credit.

� Cash transfers under a credit support arrangement for standard ISDAagreements.90

Clause 22.3(c)(viii) Threshold(viii) any Security securing indebtedness the principal amount of which (when aggre-

gated with the principal amount of any other indebtedness which has the benefit ofSecurity given by any member of the Group other than any permitted under para-graphs (i) to (vii) above) does not exceed [] (or its equivalent in another currency orcurrencies).


89 See clause 23.8.90 These require transfers to a designated account when potential losses exceed a certain threshold.

When the loss decreases, the funds are returned.91 See discussion on financial ratios at clause 21.92 See Box 0.6 on p. 11.

Comment Some borrowers ask for an annual figure to be allowed with carry forward ofunused amounts.

Comment Another option is to set an aggregate figure at a percentage of Tangible NetWorth.

Comment In negotiating the threshold amount, the parties need to ensure that it is flex-ible enough to protect the lenders interest as well as accommodating the likely com-mercial needs of the borrower. As with financial ratios,91 the borrower needs toensure that the agreement will be robust enough to see it through downturns, up toa point. If on the downturn only minimal secured lending is permitted, the effect ofthis clause may be to accelerate the downturn which might otherwise have beenavoided.

Lenders often argue that a lower threshhold is appropriate because they will giveconsent under it whenever withholding consent would be detrimental to the bor-rower’s interest. This argument should be treated with caution.92

Comment The amount of the threshold also needs to be set with the other terms of theclause in mind. If title retention is prohibited, the amount of the threshold needs tobe higher. Similarly if there were two separate exceptions: one for security arisingby operation of law; and a second for security arising in the ordinary course of trad-ing, the threshold could be lower.

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Clause 22.4 No disposals

22.4 Disposals(a) No Obligor shall [(and the Company shall ensure that no other member of the Group

will)], enter into a single transaction or a series of transactions (whether related ornot) and whether voluntary or involuntary to sell, lease, transfer or otherwise disposeof any asset.

The lenders may wish to restrict major disposals (even if they are at market value93)as they may affect the ability of the borrower to earn income to service the debt; orthey may indicate a cash flow problem; or a change in business strategy. In the LMATerm Loan, the clause is not only designed solely to ensure that value is maintainedin the Company (that would be the role of any Tangible Net Worth covenant and/or restriction on distributions to shareholders), but also to prevent changes in thecomposition of the Company’s major assets (‘asset stripping’). For the purpose ofthis clause, assets include cash and future income. Payment of dividends or sale ofreceivables in a securitization would therefore both fall foul of this clause (subject toany applicable exception in clause 22.4(b)).


93 Hence, no exception should be made allowing disposal on arms length terms nor should the clausebe replaced by a Tangible Net Worth covenant.

94 See para 4.3 of section 4 of the Introduction at p. 22.95 Ashborder BV v Green Gas Power Ltd (2004) EWHC 1517 (Ch D).

Comment The clause may apply only to Obligors or to all members of the group.Borrowers may wish to restrict it to Obligors as lenders have no claims against othergroup members.94

Clause 22.4(b) Exceptions to no disposal clause

(b) Paragraph (a) above does not apply to any sale, lease, transfer or other disposal:(i) made in the ordinary course of trading of the disposing entity;

This exception allows such day-to-day activities as disposal of cash to pay for goodsor services.

Note the difference between the ‘ordinary course of business’ and the ‘ordinarycourse of trading’ discussed at Box 2.20.

This exception also needs to be considered in the context of any security given tothe lenders. The extent to which Obligors which have provided security are able tosell the assets which are the subject of that security in the ordinary course of theirbusiness may be a determining factor in the characterization of the security as afixed charge or as a floating charge.95 Assets which are intended to be subject to afixed charge must not be able to be sold without consent of the lenders and, ifnecessary, this clause should be adjusted to reflect that.

(ii) of assets in exchange for other assets comparable or superior as to type, value andquality;

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(iii) []; or

Other exceptions commonly allowed here include

� disposal of obsolete assets;

� distributions to shareholders;

� intragroup disposals (although lenders will need to consider whether disposalsto companies which are not Obligors are permissible);

� disposals where the proceeds are used to prepay a part of the loan.

(iv) where the higher of the market value or consideration receivable (when aggregatedwith the higher of the market value or consideration receivable for any other sale,lease, transfer or other disposal, other than any permitted under paragraphs (i) to(iii) above) does not exceed [ ] (or its equivalent in another currency or currencies)in any financial year.


96 There is no clear legal or business meaning for the expression ‘corporate reconstruction’. There is caselaw relating to ‘schemes of reconstruction’ under s427 Companies Act 1985 (Re Mytravel Group 2004EWHC 2741) and ‘reconstruction’ for the purpose of s86 Capital Gains Tax Act 1979 (Fallon (Morgan’sExecutors) v Fellows (Inspector of Taxes) (2001) BTC 438) but these give limited guidance to the meaningof the expression when used outside the context of the relevant statutes. The expression probably includesa merger, takeover, share exchange, division of a company into different entities (but see Fallon’s casequoted here), and a reorganization of share capital into different classes of shares.

Comment Borrowers may want to adjust this to allow disposals for cash if the cash isreinvested within a reasonable period in assets which would otherwise have quali-fied under this sub-clause.

Comment The threshold needs to be set at a level which does not confound normalactivities of the borrower and which allows for some flexibility in changing finan-cial circumstances. The borrower may need to sell some significant assets in adownturn and some ability to do this may be necessary.

Comment Some borrowers ask for an annual figure to be allowed with carry forward ofunused amounts.

Comment Another option is to set an aggregate figure at a percentage of Tangible NetWorth.

Clause 22.5 Merger

22.5 MergerNo Obligor shall (and the Company shall ensure that no other member of the Group will)enter into any amalgamation, demerger, merger or corporate reconstruction.96

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This clause addresses the lenders’ concerns that:

� the resultant entity may not take on the liabilities of the borrower;

� it may not benefit from all the rights which the borrower had (e.g. licenses) whichmay be necessary for the conduct of the business; and

� the merger may cause a conflict of interest for the lenders.


97 See para 4.3 of section 4 of the Introduction at p. 22.98 But the no disposals covenant probably does restrict this.99 By their nature, the areas which these additional provisions may need to deal with are endless and no

summary of them can be complete. This selection should therefore be viewed as being by way of exampleonly, of some of the more common issues.

Comment This clause applies to every individual member of the group. Borrowers maywish to restrict this to Obligors.97

Clause 22.6 Change of business

22.6 Change of businessThe Company shall procure that no substantial change is made to the general nature ofthe business of the Company or the Group from that carried on at the date of thisAgreement.

This undertaking relates to the general nature of business of (a) the Company (beingthe top company in the group to which the lenders have access) and (b) the groupas a whole. It does not98 restrict the Company or the group from selling or stoppingcarrying on any part of its business nor from acquiring new businesses, provided thegeneral nature of the Company’s and group’s businesses remain the same.

Comment Lenders may wish to make this covenant more restrictive in certain cases, forexample, if the no disposals clause is deleted.

CLAUSE 22: GENERAL UNDERTAKINGS—SECTION 2—OTHERCOMMON UNDERTAKINGS

Other undertakings

Each transaction is likely to require additional conditions precedent, representa-tions, undertakings, and/or Events of Default to reflect the credit decision takenby the lenders. The following are some of the areas which are often the subject ofadditional provisions.99

� preservation of general assets or cash;

� distribution of profits;

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100 See para 2.2 of section 2 of the Introduction on p. 9.

� restriction of claims against the company;

� change of business;

� conduct of business;

� information;

� granting powers to others;

� undertakings reflecting regulatory or legal risk;

� asset undertakings;

� income undertakings.

For the purpose of simplicity, this book deals with these additional issues of con-cern to lenders all together in relation to the undertakings. Nevertheless, for eachadditional provision which the lenders include in the undertakings, they arelikely to also require a representation and/or a condition precedent addressingthat issue. They need also to consider whether the issue is best addressed by anundertaking or by an Event of Default.100

Preservation of general assets or cash

Some examples are

� no prepayment of debts;

� no making loans/giving guarantees;

� investment restricted to certain traded securities;

� maintaining appropriate hedging arrangements;

� restricting capital expenditure;

� maintaining insurance.

Distribution of profits

Some examples are

� no dividends;

� no contracts with affiliates except as approved; and

� no payments to directors or employees except as approved.

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101 The borrower may wish to ensure they have the right to contest these claims as long as they makeappropriate reserves.

102 The lenders may be particularly concerned about new borrowing or other indebtedness by a sub-sidiary which is not an Obligor but whose assets are relevant for the purpose of financial ratios, since thelenders are structurally subordinate to such claims—see para 4.7 of section 1 of Appendix 1 at p. 269.

BOX 2.21

Environmental liabilities may have a significant impact on the borrower’s financialposition; on the value of its assets (including assets it may have given to the lenders assecurity), on the priority of the lenders’ security, or on the lenders’ exposure if it wereto take control of the assets over which it has security. It may simply be a matter oflender policy only to lend to companies or projects which can demonstrate compliancewith high environmental standards.

BOX 2.22

For example, in the US under ERISA (Employee Retirement Income Security Act) liensmay arise on a company’s assets if it fails to comply with the requirements of the Act.For a US borrower, it is therefore common to include covenants and Events of Defaultrelated to compliance with the requirements of ERISA.

Restriction of claims against the company

Some examples are

� maintaining insurance;

� environmental covenants;

– environmental report as a condition precedent to the loan; and– undertakings to comply with environmental regulations (possibly comple-

mented by insurance) (see Box 2.21);

Change of business

Some examples are

� Restricting company acquisitions or other capital expenditure.

� No new business.

� No new borrowing.102 In this context borrowers may request exceptions for

– refinancing existing debt;– intragroup borrowings;

� paying tax and other claims which have priority in insolvency or which giverise to liens101 (see Box 2.22).

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103 See para 4.7 of section 1 of Appendix 1 on p. 269.104 But the borrower will want an opportunity to find an acceptable replacement contract and, by doing

so, to avoid occurrence of the Event of Default.105 See the discussion below on income undertakings on pp. 163–164.

– derivatives (if the definition of Financial Indebtedness from the LMA TermLoan is used); and

– subordinated debt, particularly if the shareholder may wish to inject mon-eys in that way for tax reasons. Lenders’ response to this request maydepend on the degree of subordination.103 Subordination which allowspayment prior to a winding up may not be acceptable.

� No new contracts.

� If a particular contract is key to the credit decision, the lenders may want

– a condition precedent that the contract has become unconditional;– a representation that the copy delivered is the complete agreement;– an undertaking not to amend it and to comply with the obligations under

it;– an Event of Default if it comes to an end;104

– if the contract is assigned, a notice of assignment acknowledged by thecounterparty to the contract;105 and

– the various other requirements relating to any income stream under thecontract, as discussed under the heading ‘Covenants relating to incometaken as security under a contract assignment’.

� No change in group structure (or identity of group members). For example,issue of new shares in a subsidiary to a third party will affect the impact of whathas been agreed in the covenants, for example, as to intragroup transactions.

� No change in constitution (and ensure the constitution only allows the exist-ing business). This can bolster the effectiveness of the covenants relating tochange in business.

Conduct of business

Some examples are requirements to

� maintain assets in good condition;

� operate its business in a proper manner;

� insure

– in accordance with industry standards;– against key risks identified by the lenders such as key man insurance; busi-

ness interruption insurance; pollution or other liability insurance; politicalrisk insurance or insurance against physical damage to assets;

– with approved insurers (in an asset finance, the lenders are effectively tak-ing a credit risk on the insurers if there is an insured incident);

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106 See comments on clause 20.1 (Financial statements) in relation to public companies on p. 138.107 See discussion on clause 3.1.108 Such an undertaking is often included to lessen the risk of the need to effect registrations in those

jurisdictions.

� provide a regular expert opinion as to acceptability of the insurance—both asto risks covered and as to the identity of the insurers;

� provide regular evidence that the insurance is up to date;

� make mandatory prepayment of the loan (or repair of asset) out of insuranceproceeds;

� ensure the lenders have some protection (insurance?) against the risks of theinsurance not paying out for example, because it is cancelled for non paymentof premiums or because there was a breach of warranty by the insured;

� limit short-term debt and pay off all short-term debt for a minimum periodeach year. The intention is to ensure the borrower is not using short-term debtfor long-term needs; and

� pay its debts as they fall due (unless contested in good faith).

Information

Some examples are requirements to

� provide access to books and accounts;106

� provide management reports;

� give access to auditors; and

� copy the Agent in on major communications (and advise of defaults or dis-putes) under specific contracts/insurance.

Granting powers to others

Some examples are

� undertakings not to give a negative pledge to a third party (as that wouldrestrict the lenders’ ability to negotiate further security); and

� undertakings not to agree more favourable loan terms with others.

Reflecting regulatory or legal risks

Where a particular risk is identified in legal due diligence, the lenders may wantto include provisions reflecting that risk. An example is the undertaking not to usethe loan in contravention of US margin stock regulations.107 Another would be anundertaking not to establish a place of business in a particular jurisdiction.108

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109 See also para 1 of section 5 of the Introduction on p. 24.110 May be included as a compulsory prepayment event—see commentary on clause 8.2.111 See also para 2 of section 5 of the Introduction on p. 25.

Undertakings relating to assets given as security109

Asset related undertakings are often contained in the relevant security docu-ment. Some borrowers ask for a ‘stripped out’ security document (which con-tains no commercial terms, but simply creates the security) with all commercialprovisions being contained in the loan agreement. This can assist with compli-ance and with ensuring the documents are consistent. The following undertak-ings may be included (either in the security documents or in the loan agreement):

� to repair the asset;

� not to allow anyone to have a lien (e.g. for repair) on the asset or to limit theamount of any such lien to an agreed figure;

� not to make any major changes to the asset;

� not to install equipment belonging to third parties onto the asset;

� to allow inspection of the asset;

� to use the asset responsibly—that is, in accordance with applicable regulationsincluding environmental rules and not to use it for illegal trades;

� to operate the asset itself (not through a third party);

� to notify the Agent of major issues relating to the asset for example, damage orclaims; and

� to insure the asset (see earlier discussion on conduct of business).

Commonly, the following provisions will also be included

� a condition precedent as to evidence of value and condition of the asset andconstitution of the security; and

� an Event of Default if:

– any other security over the asset becomes enforceable,– the asset is confiscated or nationalized; or– a major insurance incident or environmental claim arises in relation to the

asset.110

Covenants relating to income taken as security under a contract assignment111

Some examples are

� notice to the debtor (with acknowledgement—see Box 2.23 on p. 164), andwith certain direct confirmations from the debtor as marked with an asterisk

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112 See para 2 of section 5 of the Introduction on p. 25.

BOX 2.23

Notice of assignment is frequently given to the debtor, who is often required toacknowledge the notice and give certain direct confirmations (marked with an asteriskin the list below) to the lender in that acknowledgement. Additionally, the debtor maybe asked to

� confirm that they have not received any other notice of assignment (because prior-ity of competing assignments depends on the order in which notice of assignmentwas given to the debtor); and/or

� undertake to the lender to perform their obligations under the contract.

In many cases, unless the debtor is related to the borrower or has some incentivefor assisting with the financing, they will be unwilling to give all (or any) of the confir-mations requested in the acknowledgement, some of which (particularly the waiversof rights of set off and counterclaim) would be detrimental to the debtor’s owninterests.

in the following items within this list;

� *agreement that the income will be paid direct to a specified account;

� restrictions on the use of money in the account;

� a ‘waterfall’ providing for a series of accounts with different purposes andregular payment into these accounts from income generated;112

� no sharing of the income;

� *no alteration to the contract;

� agreement to perform its obligations under the contract;

� *ability (confirmed by counterparty) for the Agent to terminate the contractand/or to step in and perform it;

� *confirmation from the counterparty that it will not exercise rights of set off orcounterclaim in relation to payments under the contract; and

� the various other requirements relating to key contracts as referred to underthe heading ‘Change of business’.

Commonly, the following provisions will also be included

� an Event of Default if contract terminates;

� a condition precedent as to commencement of the contract, constitution ofsecurity and receipt of an acknowledgement of notice of assignment.

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CLAUSE 23: EVENTS OF DEFAULT—SECTION 1—INTRODUCTION

Purpose

The purpose of the Events of Default is to give the lenders the contractual right torequire early repayment (and not to lend any new money) if certain specified eventshappen. The existence of these rights gives the lenders leverage to negotiate adjust-ments to the transaction (such as a change in security or Margin) if any of thespecified events occurs. The Events of Default are not113 concerned with fault, butonly with risk—they set out the circumstances in which it is accepted that the levelof risk has changed and the lenders should be entitled to renegotiate.

Objective versus subjective

The Events of Default should be objective, and subjective tests and words (such as‘reasonable’ and ‘material’) should be avoided as far as possible. Objective wordingmakes it easier for lenders to exercise their rights, and gives the borrower morecertainty as to the circumstances in which the loan may cease to be available.114

Nevertheless, complete objectivity is not always possible and where recourse tosubjective words is necessary, the lenders will want to add ‘in the opinion of theMajority Lenders’, to make recourse to the Event of Default more predictable in itsresults, while the borrower will wish to omit those words and thereby impose somemore objective standard of reasonableness or materiality.

Control over the relevant events

Borrowers are also concerned to ensure that they have the ability to avoid the occur-rence of an Event of Default and so to avoid the acceleration of the loan. So they willwant to ensure, as far as possible, that Events of Default do not occur automatically,but only after they have had an opportunity to rectify the situation (see Box 2.25 onp. 166) and that the acts of others over which they have no control cannot result inan Event of Default (see Box 2.24).

C L A U S E 2 3 : E V E N T S O F D E F A U LT — S E C T I O N 1 165

113 Subject to the comments made on clause 23.5 (the cross default clause).114 Although some borrowers prefer to see subjective words because it makes it harder for lenders to

exercise their rights.

BOX 2.24

For example, the borrower will not want termination of an important contract to be anEvent of Default. If that contract was key to the lenders’ credit decision, the borrowerwill want to negotiate the possibility of finding a replacement contract and avoiding anEvent of Default.

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For similar reasons, borrowers want to restrict the Events of Default to circum-stances affecting Obligors (not any group member115). They will be particularly keento avoid Events of Default relating to their joint venture partners or other contract-ing parties.


115 See para 4.3 of section 4 of the Introduction on p. 22.116 It must not be confused with a ‘default’ (as opposed to a ‘Default’), as that expression is used in

clause 19.9(b). In clause 19.9(b) the word is being used without a capital letter, and is therefore given itsnatural meaning as opposed to the meaning given by the definitions in clause 1. The natural meaning of‘default’ is simply ‘failure’ or ‘breach’.

BOX 2.25

This distinction between automatic Events of Default (such as breach of financial ratios)and others is important for both the borrower and the lenders. The borrower is keen tohave the opportunity to remedy problems before they become Events of Default. Bothborrower and lenders may be keen to ensure that Events of Default do not arise tooreadily because of the rights that they will give to other lenders under their cross defaultclauses. Hence, only certain events are automatic Events of Default. These are usuallylimited to non-payment; breach of financial ratio; breach of the obligation to notify of aDefault; insurance covenants and deliberate wrongdoings such as the breach of the neg-ative pledge. Other events give the borrower an opportunity to remedy.

Comment In some circumstances where Events of Default are included relating to par-ties over which the borrower has no control, such as a joint venture partner, thelenders may agree that no Event of Default will occur with reference to events relat-ing solely to that person if either

� that person is replaced in the relevant contract or other relationship by anacceptable substitute; or

� the borrower can show that its ability to service the debt has not suffered; and/orperhaps

� additional security is provided.

From Default to acceleration (see Box 2.26 on p. 167)

A Default (as discussed in the context of the definitions in clause 1) is somethingwhich may or may not mature into an Event of Default, such as breach of an under-taking.116 It automatically results in the release of the lenders from their obligationto lend new money unless the Majority Lenders waive the Default. See the discus-sion on clause 4.2(a)(i).

Some Defaults are automatically also Events of Default. An example is the breach offinancial ratio, which, in accordance with clause 23.2, is automatically an Event ofDefault. There is no grace period or any other requirement (e.g. to give notice) applica-ble to this particular Event of Default. Many Defaults only become Events of Defaultafter a period of time and/or the giving of notice (e.g. clause 23.3(b)) (see Box 2.25).

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167BOX 2.26

STAGES OF A DEFAULT FLOW CHART

Default occurs.Lenders entitled

not to lend

Borrowerobligation to notify

if Default arises

Notificationgiven

Notificationnot given

Event of Default occurs• lenders entitled not to lend • lenders entitled to accelerate• cross default clauses may be triggered in other loan agreements

Can lenders give notice to borroweraccelerating the loan at atime when the event of defaultis not continuing?

Is Event of Default[cured and/or]waived before noticeof acceleration given?

Lenders rights not tolend and to acceleratethe loan come to anend

Yes

No

No

Yes

Default notcured in grace

period

Lenders givenotice to borroweraccelerating the loan

Loan becomes due and payable inaccordance with the notice ofacceleration default interest payable onoverdue amounts

Default curedin grace period

No furtherconsequences

∗ See clause 1.2(d)

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117 See commentary on clause 20.5.118 See commentary on clause 1.2(d) for a discussion of ‘continuing’.

Once a Default occurs, the borrower is obliged to notify the lenders. Failure to doso results in a separate (usually automatic) Event of Default.117

Once an Event of Default has occurred, the lenders have the right to acceleratethe loan. Acceleration does not happen automatically. The lenders can elect whetheror not to exercise that right and the loan will only become repayable early if thelenders make a demand for such payment in accordance with clause 23.13.

The lenders’ right to accelerate the loan, or not to lend additional moneys, willcease to be exercisable in certain circumstances if the document (clause 23.13) statesthat those rights are only exercisable while the Event of Default is ‘continuing’.118

CLAUSE 23: EVENTS OF DEFAULT—SECTION 2—THE LMA EVENTS OF DEFAULT

23. EVENTS OF DEFAULTEach of the events or circumstances set out in Clause 23 is an Event of Default.

The events which constitute Events of Default in the LMA Term Loan are as follows.

Clause 23.1 Non-payment

23.1 Non-paymentAn Obligor does not pay on the due date any amount payable pursuant to a FinanceDocument at the place at and in the currency in which it is expressed to be payable unless:23.1(a) its failure to pay is caused by

(i) administrative or technical error; and or(ii) a Disruption Event; and

23.1(b) [payment is made within(i) in the case of clause 23.1(a)(i) above, [ ] Business Days of its due date; or(ii) in the case of clause 23.1(a)(ii) above, [ ] Business Days of its due date.]

[payment is made within [ ] Business Days of its due date].

Clause 23.1 refers to non-payment. A grace period is only normally allowed inrespect of administrative or technical error or a ‘Disruption Event’ (defined to meandisruption to the payment system or financial markets or unavoidable systemserror). There are options to allow different grace periods for different reasons fordelay. Default interest will nevertheless accrue from the due date.

Comment Sometimes a distinction is made between payments (such as principal andinterest) which have a due date, and others (such as reimbursement of expenses)which are payable on request and for which a period for payment is often stipu-lated. This distinction is not made in the LMA Term Loan since, for the most part,

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Clause 23.2 Breach of financial covenant

23.2 Financial covenantsAny requirement of Clause 21 (Financial covenants) is not satisfied.

Clause 23.2 Breach of financial covenants. This is set out separately since no graceperiod is appropriate as, in general, the breach cannot be remedied. For those ratioswhich could be remedied (such as Minimum Tangible Net Worth) the lenderswould expect the necessary avoiding action to be taken (such as injection of addi-tional equity) before the date of the breach and thereby expect the breach to havebeen avoided in the first place.

Another reason for its separate treatment is that financial ratios are not promiseswhich may be broken, in the same way as other undertakings, but, instead, they aretests which may be met or not.

Clause 23.3 Breach of other obligations

23.3 Other obligations(a) An Obligor does not comply with any provision of the Finance Documents (other

than those referred to in Clause 23.1 (Non-payment) [and Clause 23.2 (Financialcovenants)]).

(b) No Event of Default under paragraph (a) above in relation to Clause [] will occur ifthe failure to comply is capable of remedy and is remedied within:(i) (in relation to [ ]) [ ] Business Days; or(ii) (in relation to [ ]) [ ] Business Days,of the Agent giving notice to the Company or the Company becoming aware of thefailure to comply.

This clause is divided up to allow

� certain covenants (those referred to in (b)) to have a grace period so that they arenot automatic; and

� for those non-automatic Events of Default to have different grace periods.

Some lenders prefer the grace to run from the Default (rather than following theLMA Term Loan, which is to allow it to run from the date the borrower119 is aware


119 Or rather, in the LMA Term Loan, the ‘Company’. This gives rise to the possibility that if a Borroweris aware of the Default but the Company is not, the grace period will only run from the date the Companyis aware of it.

the indemnities specify within themselves the period (in most cases within threebusiness days of demand) within which payment is to be made, so no additionalgrace is required.

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of, or is notified by the lenders of, the Default). However, this approach may makethe Event of Default automatic in practice (as the grace period may expire beforeany party is aware of the Default). As a result, it may prevent the possibility ofavoiding the occurrence of an Event of Default (and thus avoiding triggering therights of other lenders under their cross default clauses).

Breaches which are often included as automatic Events of Default (i.e. with nograce period) include failure to maintain insurance and breach of covenants whichthemselves include a grace period, for example, the obligation to notify of a Default.

Clause 23.4 Misrepresentation

23.4 MisrepresentationAny representation or statement made or deemed to be made by an Obligor in the FinanceDocuments or any other document delivered by or on behalf of any Obligor under or inconnection with any Finance Document is or proves to have been incorrect or misleadingin any material respect when made or deemed to be made.


Comment The LMA Term Loan formulation requires the representation to be incorrectin a ‘material respect’. Some lenders may object to this in that it introduces a conceptof materiality to each representation, which would be better negotiated in the rep-resentations themselves. Nonetheless it is preferable to the position sometimesrequested that the misrepresentation should only constitute an Event of Default if itmaterially affects the borrower’s ability to pay.

Comment Default under this clause is automatic. There is no grace period as amisrepresentation cannot be undone. However, this leads to the result that theopportunity to remedy will be different if, for example,

� the borrower repeats a representation to the effect that there have been nochanges to a particular contract, at a time when changes have been made, asopposed to the opportunity to remedy if

� the borrower covenants not to amend a particular contract, but enters into anamendment nevertheless.

The borrower will have no grace period for the misrepresentation but would haveone for the breach of undertaking. If representations are repeated, borrowers shouldrequest an opportunity to remedy the underlying situation and thus prevent amisrepresentation from automatically being an Event of Default.

Comment Beware. Even if the representations are not deemed repeated thesame effect may be achieved if the Event of Default says something along thefollowing lines: ‘if any representation was untrue when made or would have beenuntrue if repeated at any time’. This has the same effect as clause 19.14 of theLMA Term Loan.

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Clause 23.5 Cross default

The existence of an Event of Default under a loan facility clearly gives the lenderssignificant leverage to renegotiate, for example, new Margins and/or securityand/or greater control over the borrower’s affairs, perhaps even to require somechanges in business, such as sale of assets, as a condition to their maintaining theavailability of the loan. The purpose of the cross default clause is to ensure that, ifany other lenders have this degree of leverage over the borrower, then so does thissyndicate. The intention is to ensure that this syndicate is not left out of any suchrenegotiation and to ensure that their interests are not marginalized. Nevertheless,the effect of the clause, for the borrower, is to change a localized problem, with anindividual lender, which may be relatively easy to solve, into a wider problem,affecting all its lenders, which will be more difficult to solve. A borrower will wantto restrict the circumstances in which this clause may operate.

Clause 23.5(a)

23.5 Cross default(a) Any Financial Indebtedness of any member of the Group is not paid when due nor

within any originally applicable grace period.

Two definitions are key here: ‘Financial Indebtedness’, and ‘Group’.

Financial IndebtednessUnder the LMA Term Loan, the clause is only triggered by non-payment of‘Financial Indebtedness’ and not by non-payment of ordinary commercial debts(e.g. payment for supplies). This is because,

� failure to pay Financial Indebtedness has far more serious consequences (poten-tial for the relevant creditor to accelerate their debt; causing, at the very least, aliquidity crisis) than failure to pay ordinary commercial debts (probably result-ing in court action), and

� the loan agreement deals with court action and the like under separate provi-sions (representation as to proceedings at clause 19.13 and Event of Default as tocreditors’ process at clause 23.8).

The definition of Financial Indebtedness includes derivatives (in paragraph (g) of thedefinition). These are treated in the same way as borrowed money (not ordinarycommercial debts) for the purpose of the cross default clause because a failure to paywhen due in respect of a derivative can (just as non-payment of a loan can) trigger alarge unanticipated payment, resulting in a liquidity problem for the borrower.

GroupThe second issue is the definition of ‘Group’. It is particularly important in thisclause to have exclusions for ‘non-recourse companies’. Exclusions for non-materialsubsidiaries may also be appropriate.120


120 See the discussion at para 4.2 in section 4 of the Introduction on p. 19.

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The borrower may ask that the cross default clause should relate only toObligors, as the lenders have no direct claim against other group members.However this is an instance where, in most cases, the lenders will resist on the basisthat problem with other group members may indicate wider problems, could resultin reputational problems for the Group, and may result in the Obligors needing toprovide support for their group member.

The clause applies if payment is not made within any ‘originally applicable’ graceperiod. This is intended to prevent the clause being circumvented by other lenderssimply extending their grace periods while negotiations proceed.

Clause 23.5(b)

(b) Any Financial Indebtedness of any member of the Group is declared to be or other-wise becomes due and payable prior to its specified maturity as a result of an event ofdefault (however described).

Paragraph (a) dealt with non-payment of a financial debt, and paragraph (b) dealswith its acceleration. Where another lender exercises a right to require early pay-ment of a debt, provided that right results from a default, this clause will apply.

The words ‘event of default (however described)’ are intended to indicate that thereneeds to be a default of some sort (not necessarily involving a breach of contract bythe borrower), in order for the clause to apply. For example, these words wouldcatch the occurrence of a ‘Termination Event’ in a finance lease, or early terminationof a swap due to non-payment.


Comment Some borrowers may ask for an exception to this clause if the accelerationdoes not result from a payment obligation and the ability of the borrower to makepayment and perform its other obligations under this loan is unaffected.

The argument is that where the default is not in payment, it should not concernthe lenders unless the acceleration of the loan by the other lender also impactson the ability of the borrower to service this loan.

Lenders will be reluctant to agree such an exception because actual acceleration ofa loan (unless within the threshold amount allowed in clause 23.5(e)), will changethe borrower’s financial position, regardless of the reason for the acceleration. Evenif the change does not affect the borrower’s ability to service this debt, the lenderswill want the right (which having the Event of Default gives it) to review the riskinvolved in the loan and to renegotiate terms appropriate for the altered risk.

Clause 23.5(c)

(c) Any commitment for any Financial Indebtedness of any member of the Group iscancelled or suspended by a creditor of any member of the Group as a result of anevent of default (however described).

This clause deals with the situation which might arise, for example, in the case of arevolving credit, where the lenders may not accelerate the loan, but simply refuseto re-advance it on a rollover as a result of an Event of Default. (See also Box 2.27on p. 173).

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Clause 23.5(d)

(d) Any creditor of any member of the Group becomes entitled to declare any FinancialIndebtedness of any member of the Group due and payable prior to its specified matu-rity as a result of an event of default (however described).

This clause applies if another lender becomes entitled to declare its debt due earlyas a result of an Event of Default. In other words, the other lender does not actu-ally accelerate, (which would be caught by clause 23.5(b)) but simply has the rightto do so.

Some borrowers request deletion of paragraph (d) (see Box 2.28).


BOX 2.27

It is not clear whether suspension of a facility after a ‘Default’ and before an ‘Event ofDefault’ will trigger this clause. The question is, will the fact that a lender is not obligedto advance a loan because of a ‘Default’ (as opposed to an ‘Event of Default’) amountto a ‘[suspension of the loan] as a result of an event of default (however described)’? Does thefact that we called it a ‘Default’ prevent it from being an ‘event of default (howeverdescribed)’? There is no definite answer but, given the common practice of making avery important distinction between a ‘Default’ and an ‘Event of Default’, it is probablethat the suspension of a facility during a ‘Default’ will not trigger this clause (unlessthere is also an Event of Default).

BOX 2.28

If (d) is deleted; the clause is referred to as a cross acceleration clause rather than a crossdefault clause; as it is triggered by acceleration rather than default.

Comment A borrower may suggest that if the commitment in question has never beendrawn, such as in a backstop facility, the clause should not apply, since the cancella-tion will not result in the same sort of liquidity crisis (and hence leverage for theprovider of the facility) as the requirement for early repayment of a loan.

The borrower’s argument for this is that if the other lender does not actuallyexercise its right to accelerate, for example, because the borrower persuaded thelender that the default in question was technical and unimportant, then the othersyndicates should not be entitled to accelerate. They also argue that giving this rightwould be to give this syndicate derivative rights which they had not actuallyrequired in their own loan agreements (see Box 2.29 on p. 174).

The borrower may also argue that clause 23.5(d) is unnecessary, since, providedthe borrower is paying this debt, there is no need for concern.

The difficulty with agreeing to a cross acceleration clause as opposed to a crossdefault clause is that, in many instances, particularly in unsecured corporate loans,

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it defeats the main purpose of the clause (which is to ensure that the syndicate’sinterests are not marginalized in any renegotiation between the borrower andanother lender). If the clause is drafted as a cross acceleration clause it does notachieve this objective since the syndicate will have to wait for the results of thenegotiation with the lender in question before it has any rights for itself.

Nevertheless, as in everything, much depends on the credit decision. In the caseof a stand alone asset or project finance, if the structure of the loan is such that thereis little that any other lender could do which would have an adverse impact on thisloan, a cross acceleration clause may be more appropriate than a cross defaultclause.

Similarly, in an unsecured corporate transaction with a borrower which is finan-cially very strong, a cross acceleration clause may be acceptable if the lenders can besatisfied that all lenders are being (and will be) treated equally in this respect. A con-sistent policy of agreeing only cross acceleration clauses (if achievable) helps avoidEvents of Default having a ‘spiraling’ effect—that is, turning problems which couldbe overcome relatively easily into much more intractable problems. Cross accelera-tion clauses allow the problem to be isolated to the particular creditor.

Clause 23.5(e)

(e) No Event of Default will occur under this Clause 23.5 if the aggregate amount ofFinancial Indebtedness or commitment for Financial Indebtedness falling withinparagraphs (a) to (d) above is less than [ ] (or its equivalent in any other currency orcurrencies).

This threshold is a cumulative figure applied to all the companies restricted by theclause. Sometimes a threshold is applied separately to different companies inthe Group—so, for example, there may be a different, and separate, threshold forthe parent company or for an Obligor than the amount which applies to other groupcompanies.


BOX 2.29

For example, assume a borrower has two loan agreements. One is for $10 million andis with Bank A and includes an undertaking that the borrower will maintain itsMinimum Tangible Net Worth at not less than $30 million. The second agreement is for$5 million and is with Bank B and includes an undertaking that the borrower willmaintain its Minimum Tangible Net Worth at not less than $20 million. The borrower’sMinimum Tangible Net Worth falls to $25 million and Bank A is entitled to accelerate.The borrower’s argument is that Bank B should not also be able to accelerate as other-wise, effectively, he is being given the benefit of A’s (more stringent) financialcovenant.

Comment The borrower should try to maintain a consistent position on its cross defaultclauses, and have, for example, the same thresholds in each of them. This makes

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Reducing the impact of the cross default clause

A borrower should bear in mind that careful drafting of a loan agreement (byincluding compulsory prepayment events and grace periods, in particular) willreduce the negative impact of cross default clauses in other agreements.

Compulsory prepayment events. Borrowers should ensure that issues which donot imply any form of failure by the borrower or any of its group members (e.g.change of shareholding or total loss of a secured asset) are not dealt with as eventsof default, but rather as compulsory prepayment events.121 For this to achieve itsobjective, the cross default clauses need to distinguish between early repayment ofthe loan caused by an Event of Default (which will trigger the cross default clause)and early repayment for other reasons (which will not).

Grace periods. The borrower should be negotiating grace periods into its Eventsof Default. The cross default clause will only be triggered when another lender actu-ally has the right to accelerate (or cancel) the facility. This will not happen until anyrelevant grace period has expired. In practice therefore, as long as there is, for anygiven event, a period between its being a Default and its becoming an Event ofDefault the borrower will have an opportunity to have negotiations with an indi-vidual lender so as to avoid the occurrence of an Event of Default (so long as thosenegotiations do not include discussion of rescheduling122 or extension of any origi-nal grace period for non-payment123) and therefore avoid the triggering of the crossdefault clauses.


121 For example, change of control, dealt with in clause 8.2.122 See clause 23.6(a).123 See comments on clause 23.5(a).

BOX 2.30

An example clarifies this. Assume a borrower has two loan agreements, both for$10 million. In one (Loan A) they have negotiated a cross default clause triggered byfinancial debts over $1 million. The other (Loan B) has a cross default clause triggeredby ordinary debts over $250,000. The borrower fails to pay a creditor $300,000 due to atemporary liquidity problem. This would not be a problem under Loan A alone, butbecomes so because of its effect under the cross default clause in Loan B. Loan B iscapable of being accelerated because its cross default clause is triggered by the non-payment of the debt of $300,000. Loan A is therefore also capable of being acceleratedbecause Loan B (which is a financial debt in excess of $1 million and is therefore rele-vant for the cross default clause in Loan A) is capable of being accelerated. The weak-est cross default clause in effect has benefited both syndicates.

compliance easier and prevents weak cross default clauses in one agreementindirectly benefiting other lenders (see Box 2.30).

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Clause 23.6 Insolvency

Clause 23.6(a)

23.6 Insolvency(a) A member of the Group is unable or admits inability to pay its debts as they fall due,

suspends making payments on any of its debts or, by reason of actual or anticipatedfinancial difficulties, commences negotiations with one or more of its creditors with aview to rescheduling any of its indebtedness.

Clause 23.6 covers the cash flow test of insolvency—inability to pay debts as theyfall due. It also applies if a group company commences rescheduling negotiationswith a creditor.


124 See para 4.3 of section 4 of the Introduction on p. 22.125 See e.g. Customs & Excise Commissioners v Broomco Ltd (1984) formerly Anchor Foods Ltd (2000)

BTC 8035.

BOX 2.31

The reference to contingent and prospective debts in this clause reflects the test ofinsolvency contained in s123 Insolvency Act 1986.

A ‘contingent’ debt is a debt (such as that under a guarantee) which may or may notbecome due depending on the occurrence of an event outside the parties’ control. A‘prospective’ debt is one which has not yet fallen due. Its precise ambit is unclear butcases on the meaning of the word in the context of tax provisions indicate that it doesnot include potential liability in respect of sums which may be awarded against acompany in an ongoing dispute.125

Comment The borrower may also want to restrict this so that it applies only toObligors.124

Clause 23.6(b)

(b) The value of the assets of any member of the Group is less than its liabilities (takinginto account contingent and prospective liabilities) (see Box 2.31).

Clause 23.6(b) deals with the balance sheet test of insolvency. It provides for there tobe an Event of Default if assets are less than liabilities.

Comment In some structures where guarantees are given by group members, thiscontingent liability may make them fail the balance sheet test from the date of theissue of the guarantees thus creating an Event of Default immediately on issue ofthe guarantees. Borrowers may therefore request that the amount of the contin-gent liability arising from guarantees of the loan be excluded for the purpose ofthis test.

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Clause 23.6(c)

(c) A moratorium is declared in respect of any indebtedness of any member of the Group.

Clause 23.7 Insolvency proceedings

23.7 Insolvency proceedings126

Any corporate action, legal proceedings or other procedure or step is taken in relation to:(a) the suspension of payments, a moratorium of any indebtedness, winding-up,

dissolution, administration or reorganisation (by way of voluntary arrangement,scheme of arrangement or otherwise) of any member of the Group other than asolvent liquidation or reorganisation of any member of the Group which is not anObligor;

(b) a composition, compromise, assignment or arrangement with any creditor of anymember of the Group;

(c) the appointment of a liquidator (other than in respect of a solvent liquidation of amember of the Group which is not an Obligor), receiver, administrator, administra-tive receiver, compulsory manager or other similar officer in respect of any member ofthe Group or any of its assets; or

(d) enforcement of any Security over any assets of any member of the Group, or any analogous procedure or step is taken in any jurisdiction.

Some may wonder whether an insolvency Event of Default is necessary because,even if the loan is not accelerated on insolvency, the lenders would be able to claimin the insolvency for the whole debt so, arguably, the ability to accelerate hasachieved no advantage.

The purpose of this Event of Default is to enable the lenders to accelerate, andclaim payment of the whole debt, at an earlier stage of the insolvency process thanwould otherwise be possible. This may, for example, enable them to exercise rightsof set off or enforcement of security prior to a formal winding up.

The clause applies to all companies in the group (but does allow solvent windingup of group members which are not Obligors). Borrowers may seek to restrict theclause to Obligors.127


126 This Event of Default is intended to allow the lenders to take action before an administration orsimilar is agreed.

127 See para 4.3 of section 4 of the Introduction on p. 22.

Comment Borrowers sometimes request an exception in clause 23.7(a) for anyvexatious action, because creditors may present a winding up petition, based onnon-payment of a disputed debt, not because they think the company is unable topay its debts, but as a tactic to cause maximum disruption for the company and thuspersuade it to make early payment.

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Clause 23.8 Creditors’ process

23.8 Creditors’ processAny expropriation, attachment, sequestration, distress or execution affects any asset orassets of a member of the Group [having an aggregate value of [ ]] [and is not dischargedwithin [ ] days].

Clause 23.8 deals with distress or execution (i.e. enforcement of court judgements orarbitration awards) as well as expropriation (e.g. nationalization).

The clause allows a number of options. It may be drafted so that,

� any enforcement (without any regard to the amount in question) is an Event ofDefault;

� it is only an Event of Default if the value of the assets concerned exceeds a thresh-old amount; or

� it is only an Event of Default if, in addition to the above, the relevant enforcementorder remains in place for a given period of time.

Borrowers will normally ask for all these exceptions to apply so as to allow themtime to appeal the enforcement or other action.

The clause also relates to every group member. The borrower may want torestrict it to Obligors.128

There is no other specific Event of Default dealing with litigation or with admin-istrative proceedings in the LMA Term Loan.


128 See para 4.3 of section 4 of the Introduction on p. 22.129 See commentary on clause 19.13.

Comment In cases other than unsecured corporate loans to investment grade borrow-ers, lenders may want an additional Event of Default relating to litigation or unpaidjudgements. This can be achieved by repetition of the representation as to no litiga-tion in clause 19.13, but a better option (because it would be more easily under-stood) would be to include a specific Event of Default.129 See also Box 2.32 (on p. 179)

Clause 23.9 Ownership of the Obligors

An Obligor (other than the Company) is not, or ceases to be, a Subsidiary of the Company.

Clause 23.9 is self explanatory.

Other Events of Default

Lenders will usually need to add specific events of default relating to the trans-action and credit risk in question. These will follow from the additional under-takings discussed at clause 22.

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Clause 23.12 Material adverse change

The loan agreement will often include some form of material adverse change clause.This clause can be highly contentious. Lenders argue that they cannot be expectedto list in advance every circumstance which may arise which could give them causefor concern. This clause is needed as a risk allocation issue to ensure that everythingis covered. Borrowers object to the clause principally because of its uncertainty andsubjectivity. As with other likely contentious issues, it is sensible to address the issuein the term sheet.

The arguments around the clause fall into two categories: whether to include theclause, and, if included, what it should say.

23.12.1 Should there be a material adverse change Event of Default?

The borrower’s objections to including the clause are:

(a) The uncertainty of the circumstances in which it may be used;

(b) The fact that lenders don’t use it (so why have it);

(c) The fragility it imposes on the borrower’s overall business; and

(d) The fact that it gives excessive power and discretion to the lenders.

(a) UncertaintyFrom the borrower’s perspective, one of the main issues in the loan agreement iscertainty as to continued availability of funds. If the finance is unexpectedly with-drawn, the consequences are likely to be difficult for the borrower. For this reason,the borrower wants all Events of Default to be clear and objective, including no ele-ment of subjectivity. It is argued that the material adverse change clause, because itis not clear what events can trigger it, causes too much uncertainty as to continuedavailability of funds.

Lenders may counter this with the reassurance that the very uncertainty of theclause should give the borrower comfort that it is unlikely to be used except in themost extreme circumstances. Lenders who wish to accelerate the loan would alwaysbe advised to rely on the objective events of default (e.g. non-payment or breach of


BOX 2.32

LITIGATION, JUDGEMENT, AND ENFORCEMENT

If a provision is included to the effect that litigation or other proceedings will be anEvent of Default, borrowers will normally ask for exceptions relating to litigationwhich is being contested in good faith by appropriate proceedings, diligently pursuedand with reasonable prospects of success, and for which a reserve has been established.

If a provision is included to the effect that unpaid judgements will be an Event ofDefault, borrowers will normally ask for exceptions for judgements below a certain fig-ure and for judgements which are stayed (e.g. for appeal) or paid within a reasonableperiod, so giving the Borrower time, after a judgement is issued, to consider its nextstep in the litigation without that causing an Event of Default.

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covenant) rather than the subjective ones, since, were the court to disagree with thelenders as to whether or not a particular set of facts fell within the clause, the lenderswould be liable in damages for breach of contract if, for example, they failed toadvance funds when not entitled to do so.130 The amounts involved could be signif-icant. In other words, the uncertainty works both ways.131

(b) Lack of useBorrowers often comment that the clause is rarely used and so must be pointless.132

The lenders’ response is that the existence of the clause is likely to trigger discus-sions in circumstances where there is cause for concern. Lack of use of the clause as atrigger for acceleration does not make it pointless in its role as prompting discussionsand negotiations. Moreover, even though in many cases the clause will not be used toaccelerate the loan, either because of uncertainty of application or because of publicityconcerns or concerns to avoid precipitating an industry-wide crisis, that does not meanthat there will never be cases where those concerns will not apply. See also Box 2.33.


130 This must be contrasted with merely serving notice of acceleration incorrectly, when no Event ofDefault has in fact occurred. Serving such notice may, in some circumstances, of itself, not be a breach ofcontract and may be simply ineffective. See Concord Trust v The Law Debenture Corp (2005) 1 WLR 1591.The borrower may therefore want the lenders to agree not to serve notice of acceleration unless an Eventof Default has occurred.

131 In fact, some borrowers like to intersperse the Events of Default clause with subjective words such as‘material’ and ‘reasonable’, sometimes preferring those over absolute numbers because of the uncertaintythis creates and the corresponding caution the lenders will have in enforcing their rights.

132 Nevertheless, it is used. See ‘Material Adverse Change and Syndicated Bank Financing’, Journal ofInternational Banking Law and Regulation, 2004, 19(5), pp. 172–176 and 19(6), pp. 193–198. See also BNPParibas SA v Yukos Oil Co (2005) EWH C 1321 (Ch)

133 Article 1174 French Civil Code.134 Whether a Material Adverse Change clause in loan agreement contravenes this principle is nevertheless

a moot point. See ‘Material Adverse Change and Syndicated Bank Financing’ referred to in note 132 above.

BOX 2.33

There are concerns in many jurisdictions as to whether the clause is enforceable or not inany event. These concerns are founded on a number of different legal principles including

� Uncertainty. Is the clause sufficiently clear as to the circumstances in which it willoperate or will it be void for uncertainty?

� Unilateral nature of the clause—some jurisdictions, such as France,133 have a legalprinciple that one party cannot reserve to itself unilateral and exclusive control overthe implementation of an agreement.134

� Might it be contrary to principles of good faith and fair dealing.

In English courts, the clause is not of itself unenforceable, but there may be difficultiesin establishing whether any given set of circumstances falls within the circumstancesenvisaged by the clause. This will be determined with reference to the supposedintention of the parties at the date of the agreement.

(c) FragilityBorrowers then argue that including this provision makes the provision of thefinance fragile, in that the occurrence of events which could pose a threat to the

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business can itself cause the loan to be withdrawn. Businesses face new threatsregularly. They surmount some and not others and should be given the opportunityto do so. Many businesses are cyclical, making the clause particularly unpalatable ifthe loan is agreed at the top of the cycle.

(d) Excessive power to the lendersThere are those who argue135 that the clause (in some of its varieties) may give somuch discretion to the lenders that it, in effect, makes the facility a demand facilityand not a long-term commitment at all. The ultimate decision is being given to thelenders as to what threats are acceptable. Lenders counter that the clause containsits own checks and balances against abuse of that power since the consequences tothe lenders of using this clause as a justification for failure to advance further fundsin circumstances when a court ultimately decides that the circumstances did notentitle the lenders to do so, are likely to be significant.

Nevertheless, lenders will argue strongly for inclusion of the clause, draftedappropriately to address some of the borrower’s concerns, so as to ensure that therisk of unforeseen problems would fall on the borrowers, not the lenders and to givethe lenders some opportunity to negotiate in such circumstances.

23.12.2 If included, what should the clause say?

The drafting points to be addressed are

(a) How likely must the material adverse effect be?

(b) In whose opinion is this to be decided? and

(c) Material Adverse Effect on what?

(a) How likely must the Material Adverse Effect be?The first question is, how likely must the adverse effect be? The options range from:‘the Lenders believe that a Material Adverse Effect may occur’, at one end of the spectrumto, ‘an event occurs which will have’ [or ‘has had’] ‘a Material Adverse Effect’; at theother end of the spectrum.

Options in between include ‘… which could have a Material Adverse Effect’ or ‘whichcould reasonably be expected to’. This last option provides for a fair degree of objectiv-ity and preserves the clause as one of last resort for the lenders.

(b) In whose opinion is it to be decided?If anyone’s opinion is to be specified, the lenders would generally require the clauseto be tested with reference to their opinion, for example, ‘an event occurs which theLenders reasonably expect to have a Material Adverse Effect’. This formulation slightlyeases the burden of proof in the event the lenders use the clause. They will still needto prove they genuinely held the relevant opinion. The more unreasonable theopinion on the facts, the harder it will be to prove they had that opinion.


135 This argument is sometimes made by ratings agencies, particularly in relation to loans needed forliquidity purposes.

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(c) What does there need to be a Material Adverse Effect on?Options include:

1. prospects (of the company, or the industry it is operating in, or other);

2. financial condition;

3. ability to perform its [payment] obligations under the loan agreement;

4. validity and enforceability of the documents.

1 Prospects. Borrowers are particularly concerned about clauses which lookforward and look at a change in ‘prospects’ either of the borrower or the industry itis involved in, because

� prospects change regularly, often adversely;

� a change in prospects often does not result in a change in fortunes;

� it is at such times they most need the certainty of finance;

� a clause which is triggered by a change in prospects is too uncertain; and

� all companies face threats to their prospects all the time—there is rarely a situa-tion in which any company can say that there are no circumstances which existwhich might cause a material adverse effect on their prospects (see Box 2.34).


BOX 2.34

For example, assume a loan is made to a company which runs hotels in Madrid. TheSpanish government decides to encourage the tourist industry and introduces a taxcredit for construction of new hotels in Madrid. This new tax credit could amount to amaterial adverse change in the Company’s prospects as it will presumably result ingreater supply of hotel rooms and a possible need for the Company to drop its pricesor have more empty rooms.

2 Financial condition. A second option is to provide that the Material AdverseEffect must be on the financial condition of the borrower. However, the borrowermay argue that this would be inappropriate if the agreement also contains financialcovenants, because if the borrower is meeting the objective tests which have beenset in the financial covenants, the lenders should not be able to accelerate on thebasis of a subjective test.

The lenders’ response would be that they need the material adverse changeclause to deal with a change in financial condition which has not yet been picked upby the ratios. In other words, the material adverse change clause will supplementthe ratios and help deal with the timing problem discussed in the introduction to thecommentary on financial ratios. It will permit the lenders to take action immedi-ately when a financial problem becomes apparent, without having to wait until thedate on which ratios are next due to be tested (see Box 2.35 on p. 183).

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3 Ability to perform obligations under the loan agreement. A third option is toprovide that the Material Adverse Effect must be on the ability of the borrower toperform its obligations under the agreement. Many borrowers prefer this to theformulation which talks of a Material Adverse Effect in financial condition, because,for many borrowers, there is plenty of scope for a change in financial conditionbefore ability to service the debt or perform other obligations are seriously prejudiced.This formulation preserves this clause as one of last resort for the lenders.

4 Validity and enforceability of the documents. Many Material Adverse Changeclauses will be expressed to be triggered by any Material Adverse Change in thevalidity or enforceability of the documents, as well as by change in the various otherfactors described earlier.


BOX 2.35

So, for example, assume ratios are tested every six months, and there is a requirementthat the Tangible Net Worth should not fall below $30 million. Assume also that theTangible Net Worth figure drops to $10 million, one month after the last test date. If theMaterial Adverse Change Event of Default is triggered by a change in financial condi-tion, the lenders will be able to accelerate without having to wait until the next date onwhich the ratios are tested.

BOX 2.36

An example may clarify. Assume the financial ratios require the Tangible Net Worth tobe tested six-monthly and, if below $30 million, to be an Event of Default. A dropbelow $35 million simply changes the Margin. Assume that the Tangible Net Worth onone test date was $40 million, but it falls to $35 million over the next month. This is amaterial adverse change in financial condition, but should not give the lenders theright to accelerate, because that is contrary to the intention agreed in the financialratios. The right to accelerate should only apply if the figure drops below £30 million.

Comment Where there are financial ratios, any material adverse change clause whichlooks at a change in the borrower’s financial condition should reflect the agreementon the ratios (see Box 2.36). The simplest way to achieve this would be to provide thata material adverse change in financial condition is only an Event of Default if thelenders have reason to believe that the change is likely to result in a failure to meet afinancial ratio when next tested and that such failure would be an Event of Default(rather than simply result in a change in Margin or a requirement for security).

Comment Other suggestions sometimes made by borrowers to ameliorate thisclause are

(a) in a syndicated loan, to require a higher proportion of the lenders than nor-mal (not just Majority Lenders, but introduce a concept of ‘Supermajority’) tohave to agree before this clause can be used.

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(b) Require notice to be given to the borrower before the clause can be used—soas to allow an opportunity for discussion and to avoid triggering crossdefaults.

Clause 23.13 Acceleration

23.13 AccelerationOn and at any time after the occurrence of an Event of Default [which is continuing] theAgent may, and shall if so directed by the Majority Lenders, by notice to the Company:(a) cancel the Total Commitments whereupon they shall immediately be cancelled;(b) declare that all or part of the Loans, together with accrued interest, and all other

amounts accrued or outstanding under the Finance Documents be immediately dueand payable, whereupon they shall become immediately due and payable; and/or

(c) declare that all or part of the Loans be payable on demand, whereupon they shallimmediately become payable on demand by the Agent on the instructions of theMajority Lenders.

Clause 23.13 sets out the contractual remedies for an Event of Default. These reme-dies are to cancel the commitment and/or to accelerate the loan. The wordingrequires the Agent to exercise the relevant right on behalf of the syndicate and pro-vides that the Agent may act on its own initiative.136 It also provides that the Agentwill exercise the rights if the Majority Lenders so require (subject always to theprovisions of clause 26, the agency clause).

An issue which the LMA Term Loan leaves open is whether the contractualremedies disappear at any point after an Event of Default occurs. Borrowersfrequently ask for the words ‘which is continuing’ to be included so that the reme-dies cannot be exercised after the Event of Default has been remedied. If thesewords are included, clause 1.2(d) of the LMA Term Loan defines what is meant by‘continuing’.137


136 See clause 26 as to the Agent’s liabilities to syndicate members.137 See comment on clause 1.2(d).

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This Part deals with the remainder of the loan agreement (clauses 24–38 in the LMA TermLoan) and with the schedules. These provisions are often referred to as ‘boilerplate’. Theboilerplate contains important clauses relating to issues such as loan transfers, the agencyrole, notices, and jurisdiction. The schedules are used to attach additional documents andlists, such as the drawdown notice, confidentiality letter, and list of conditions precedent.

P A R T I I I

Boilerplate and Schedules

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CLAUSE 24: CHANGES TO LENDERS—SECTION 1—METHODS OF TRANSFER

Clause 24 deals with loan transfers. Before looking at the wording of the clauseitself, this introduction looks at the methods of transfer available and at issueswhich arise in relation to transfers of secured loans.

In summary, the methods by which a new lender can derive an interest in theloan under English law are:

� transfer (see Box 3.1 on p. 188) of rights and obligations (classically, by novation);

� assignment of rights;

� subparticipation (which is a contract between selling and buying lender); and

� credit derivatives.

Within each of these categories there are numerous options available and each has adifferent regulatory and accounting impact as well as a different impact on thecredit risk of the parties and on their rights and obligations. The first two options(novation and assignment) result in the new lender becoming a lender of recordwith direct claims against the borrower. Under the last two options (subparticipa-tion and credit derivatives) the original lender remains the lender of record and thenew lender’s rights are against the original lender, not the borrower.1 Generally theloan agreement seeks only to regulate the first two options, since the other optionsdo not involve the borrower, save for the need to obtain the borrower’s consent todisclosure of confidential information, which is dealt with in clause 24.7.

187

C H A P T E R 9

Changes to Parties

1 At least, that is the case initially. The new lender may gain rights against the borrower at a later stageunder a risk subparticipation or a credit derivative which is settled by physical settlement.

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Whichever of the four methods outlined earlier is used, a lender planningto transfer an interest in a loan must ensure that it complies with any relevantprospectus legislation in the country in which it is operating and in the countries inwhich it is inviting participants to consider taking an interest in the loan. It mustalso ensure that it has authority from the borrower to disclose any confidentialinformation which it may be planning to disclose to potential participants and thatthe wording of such authority from the borrower covers the circumstances in hand.2

The four methods of giving a new party an interest under the loan agreement arediscussed here.

1 Novation

This is the method most commonly used in syndicated loans and provided for in theLMA Term Loan. Novation involves the discharge of the original contract and itsreplacement by a new contract between the new parties (see Box 3.2 on p. 189).

There are two key issues to be considered in relation to a novation, which are:

� mechanics of the novation—what documents need to be signed? and

� effect of novation—what issues does the fact that it creates a new contract giverise to?

1.1 Mechanics

Originally, novation was thought to be a cumbersome method for transfer ofsyndicated loans as it required all parties to the loan agreement to be party to thenovation. The mechanism now included in most syndicated loan documentation

C H A N G E S T O PA R T I E S188

2 See discussion of clause 24.7 of the LMA Term Loan.

BOX 3.1

The word ‘transfers’ may be used:

� to indicate a complete transfer of the entire legal relationship (or a specified per-centage of it) from one lender to another, for example, by novation, rather than atransfer of some aspects of the legal relationship—for example, rights only but notobligations, as would be achieved by an assignment; or

� in a less technical sense, to include all the different methods by which a party otherthan one of the original lenders can come either to be a lender of record or to havean interest in the loan.

Clause 24.2(b) of the LMA Term Loan uses the word ‘transfer’ in its technical sense ofa transfer of the whole legal relationship. Often the word ‘transfer’ is used in thistechnical sense when making a distinction between the legal effect of a novation andan assignment.

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avoids this difficulty by providing for the novation to be effected by the selling andbuying lender signing a ‘Transfer Certificate’ which is countersigned by the Agent(and sometimes the borrower), with the result being specified in the agreement tohave the effect of novation. This operates on the principle that the lenders which arenot party to the transfer certificate make an offer at the time of signing the loanagreement,3 to accept any person as a lender under the agreement if that personfollows the mechanism for novation provided for.

1.2 Effect

The effect of novation is to create a new contract. This may cause difficultywith such things as security, consents, and hardening periods, as discussed in thefollowing paragraphs.

1.2(a) SecurityThe effect of a novation on any security requires consideration of the law whichgoverns the security as well as the law which applies to the loan agreement.

In many countries, security can only be given for a debt which exists at the timethe security is given. So, in such countries, security cannot be given at the timethe loan agreement is signed, as security for a debt which will or may come intoexistence (by the novation) at a future date.

In other countries security can be given for future debts but priorities issues mayarise (does a creditor who had second priority security and who advanced fundsagainst that security before the new loan was created gain priority to the new loan?)Security problems with a novation can be avoided if the security secures a differentdebt, such as the covenant to pay in favour of a security trustee contained in the

C L A U S E 2 4 : C H A N G E S T O L E N D E R S — S E C T I O N 1 189

3 Which offer is made to the public at large and may be accepted by a person completing the mechanismspecified in the offer—being, in this case, the execution of a Transfer Certificate. This idea of an offer to thepublic at large being established by Carlill v Carbolic Smoke Ball Company (1892) 2QB 484 and consideredby the courts in the context of loan transfers in The Argo Fund Ltd v Essar Steel Ltd (2005) EWHC 600.

BOX 3.2

Clause 24.5(c) of the LMA Term Loan creates a novation by the following words.‘On the Transfer Date;(i) to the extent that in the Transfer Certificate the Existing Lender seeks to transfer by

novation its rights and obligations under the Finance Documents each of the Obligors andthe Existing Lender shall be released from further obligations towards one another underthe Finance Documents and their respective rights against one another shall be cancelled(being the ‘Discharged Rights and Obligations’);

(ii) each of the Obligors and the New Lender shall assume obligations towards one anotherand/or acquire rights against one another which differ from the Discharged Rights andObligations only insofar as that Obligor and the New Lender have assumed and/oracquired the same in place of that Obligor and the Existing Lender;’

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security document, or a parallel debt. This issue is dealt with in section 2 of thiscommentary on clause 24.

1.2(b) ConsentsAny consent given (e.g. exchange control consents) for the loans made by theoriginal lenders will not necessarily also apply to the new loans made by newlenders as a result of novation. If using novation, parties should ensure that, as amatter of construction, all relevant consents apply not only to the original loansmade by original lenders, but also to new loans which spring up from novationseffected under the loan agreement.

1.2(c) Hardening periodsIn most countries, if a company is wound up, certain transactions that it has enteredinto within a certain period prior to the winding up (the ‘hardening period’) may bechallenged in certain circumstances. Because novation results in a new contract, anynew loans that arise may fall within a relevant hardening period and they, orany security for them, may be open to challenge where the original loans (or loanstransferred in a different way) would not. Precisely what transactions may be suc-cessfully challenged will depend on the law in the place in which the insolvency ofthe company concerned occurs.

2 Assignment4

Assignment is an alternative method of transfer which avoids many of the problemsof novation as it does not create a new contract. Assignment keeps the existingcontract in place but has the effect that rights once owned by one lender (principallythe right to be repaid and receive interest) will, after the assignment, belong to adifferent lender (see Box 3.3).


4 English law assignments are quite different to New York law assignments which may have a similareffect to the assignment and assumption agreement discussed in paragraph 2.3 on p. 192.

BOX 3.3

So the key differences between this and a novation are that

� obligations are not transferred; and� it is the original lender’s rights which now belong to the new lender, rather than the

new lender owning a new set of rights.

Unless the loan agreement says otherwise (which it often does) consent of theborrower is not required.

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The principal issues with assignment relate to:

� effect on indemnities;

� effect on security; and

� effect on obligations.

2.1 Effect on indemnities

Personal rights (where one party is only willing to perform in favour of a particularcounterparty and it would be unjust to enforce performance in favour of a differentparty) cannot be assigned5 (see Box 3.4).


5 British Waggon Co v Lea & Co (1879–80) LR 5 QBD 149.6 Griffith v Tower Publishing (1897) 1 Ch 21.7 Tolhurst v Associated Portland Cement Manufacturers (1900) Ltd (1903) AC 414.8 Even if this argument is unsuccessful, assignees would now be entitled to the benefit of the indemni-

ties by virtue of the definition of ‘Parties’ in the LMA Term Loan which makes it clear that they areintended third party beneficiaries as envisaged by the Contracts (Rights of Third Parties) Act 1999—see commentary on clause 1.3.

9 If the lenders did not give notice, the assignment would, as a matter of English law, still be effective ina liquidation of the existing lender, but the new lender would not be able to receive payment direct, onlythrough the existing lender.

BOX 3.4

For example, an employer may not assign an employment contract so as to requirethe employee to work for a different company. A publisher cannot assign the benefit ofan author’s contract to write a book if the author relied on the publisher’s skill as apublisher.6

This may not be the case where the contracting party expressly or impliedlycontracted with the original counterparty or its assigns.7

Indemnities are probably personal rights because it is likely that attributes of theperson holding the indemnity will affect the likelihood of a claim being made underit. For this reason any new lender who takes an interest through an assignmentneeds to be sure that the contractual provisions of the loan agreement (and inparticular any indemnities such as the indemnity for broken funding costs) areexpressed to benefit not only the original lenders, but also assignees, so reinforcingthe argument that the indemnities are not personal in the first place.8

English law assignments come in many forms (see paragraph 2.5 of section 2 ofAppendix 1 on p. 275). Usually a lender will be transferring only part of its interestin the agreement and therefore the assignment will be equitable, not statutory. Thelenders will usually give notice to the borrower through the Agent. The effect is thatthe borrower must pay the new lender (through the Agent) in order to be dis-charged from the debt.9

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2.2 Effect on security

The assignment does not cause the security problems which novation causesbecause the debt which is secured does not change. That debt still exists but simplybelongs to a new party.

In many jurisdictions, an assignment of a debt automatically carries with it (andallows an assignee to benefit from) any security for the debt without the need forthat security to be specifically transferred. However, there may be requirementswhich need to be complied with in the jurisdiction where the security is, for example,for the new lender to be registered on the security register. Such requirementswould be fatal to the liquidity of the loan in the secondary market. In such cases,therefore, use of a structure which avoids these additional requirements may benecessary, for example, trustee/parallel debt/guarantee structure. See furtherSection 2 on pp. 196–201 in relation to transfers of secured loans.

2.3 Effect on obligations

It is not possible to assign obligations under English law (see Box 3.5).


BOX 3.5

There is a difference here between assigning and delegating. A person may delegatetheir obligations to another and the person to whom the obligations are owed mayhave to accept the performance of those obligations by another if the identity of theperson performing the obligation is not critical to the person to whom the obligation isowed. For example, a company which has agreed to deliver cement to a specified placecan delegate that obligation, while an architect who has a contract to design a newbuilding for housing the national opera cannot delegate that obligation because theskills of the person performing the obligation are important to the other party to thecontract.

Lenders under a syndicated loan have obligations (principally to advance funds) aswell as rights. The obligation to advance funds to the borrower cannot be delegated,since the identity of the person performing that obligation is relevant for the borrower.So assignment is inappropriate for loans where there are significant ongoing personalobligations on the lenders. This would be the case in a revolving credit; a multicur-rency loan; and a term loan which has not yet been fully drawn, for example.

Nevertheless, a hybrid can be, and often is, used in these situations. This isreferred to as an ‘Assignment and Assumption Agreement’. The commercial effect ofsuch an agreement is similar to the novation but without its disadvantages. Theassignment and assumption agreement involves three parts

� the existing lender assigns its rights to the new lender;

� the new lender agrees with the borrower to perform the obligations owed by theexisting lender (to the extent of the amount transferred) and the borrower agreesto accept that performance; and

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� the borrower agrees with the existing lender not to pursue it for performance ofits obligations (to the extent of the amount being transferred).

The effect is that the new lender has assumed the obligations but there is nodischarge of a contract and replacement with a new contract as in a novation. Thesecurity, consents, and hardening period issues which novation gives rise to aretherefore avoided. The document has the effect of an assignment coupled with anassumption of obligations by the new lender. Of course, this document is similar toa novation in that it will be necessary for all parties to the loan agreement to be partyto it. Therefore, it is usually effected using a transfer certificate mechanism as usedfor a novation and discussed at para 1.1 on p. 188.

3 Subparticipation

A subparticipation is very different from an assignment and a novation because itdoes not involve the new lender in acquiring a relationship with the borrower. Thenew lender acquires rights against the existing lender, but not against the borrower.It is sometimes referred to as a ‘silent’ participation. This can be achieved either by:

� a risk subparticipation; or

� a funded subparticipation.

3.1 Risk subparticipation

For a fee, the subparticipant gives a guarantee to the existing lender in relation tothe portion of the loan the risk of which is being transferred. The effect for the existinglender is to change its credit risk from a risk on the borrower to a risk on thesubparticipant. For the subparticipant, if it is required to make payment, it will besubrogated to the rights of the existing lender in relation to the borrower and enti-tled to take direct action against the borrower.10

3.2 Funded subparticipation

This is usually achieved through a sub loan. Here the new lender advances fundsto the existing lender on the basis that the obligations of the existing lender to repaythose sums are limited to amounts received by the existing lender from the bor-rower. The effect for the existing lender is to reduce the amount of its total credit riskby the amount of the sub loan. The effect for the new lender is that it takes two creditrisks: does the borrower repay the existing lender, and does the existing lenderrepay the new lender? It may also involve additional tax risk in relation to possiblewithholding taxes on interest payable under the sub loan.


10 But its rights to be indemnified by the borrower and to be subrogated to the original lender’s positionwill be limited as discussed at Box A1.22 and para 2.2 of section 3 of Appendix 1 on p. 285 because theguarantee was not given at the request of the debtor.

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4 Credit derivatives

An alternative method of transferring credit risk is by using credit derivatives.These are highly flexible instruments which can be used to create investmentswhich differ from the underlying debt in many significant ways, such as credit riskand pricing. The documents are in simple standard form International Swaps andDerivatives Association (ISDA) agreements. Because there is no change in the legalrelationship between the lender and borrower, there is no effect on the underlyingloan or its security.

There may be issues in some jurisdictions on whether these derivatives amountto gambling or insurance. ISDA maintains a wealth of legal opinions on these issuesin various jurisdictions which are available to ISDA members on their website.Credit derivatives are described here in their simplest form.

4.1 Credit Linked Notes

The existing lender issues a promissory note which relates to a particular paymentinstalment due to it under the loan agreement. That note is purchased by the organ-ization that wishes to assume the credit risk represented by the promissory note.The note is linked to the credit risk in the payment due under the loan agreement, inthat the note will provide that on occurrence of a ‘Credit Event’ (e.g. non payment ofthe amount due under the loan agreement) the note will fall due for settlement.Settlement of the note will effectively compensate the original lender for the loss invalue of the loan caused by the Credit Event. The mechanism by which this com-pensation is achieved depends on whether the Credit Linked Note provides for cashsettlement or physical settlement.

Cash settlementIf it provides for cash settlement then the original lender will be required to pay thenoteholder an amount equal to the current market value of the loan at the time ofsettlement. Hence, the original lender will have benefited from the fact that the notewas valued more highly on the date it was issued than at the date of the CreditEvent. It will have received payment for the note at the original valuation, prior tothe Credit Event, but settled the note at the lower valuation (see Box 3.6).


BOX 3.6

An example may assist. Assume Lender A is owed $5 million by a borrower andwishes to pass the credit risk to B. A will issue a Credit Linked Note which B willpurchase for whatever price it believes the note to be worth. We will assume thatB purchases the note for $5 million. A will pay interest on the note on the dates speci-fied in it. Assume a Credit Event occurs and the debt owed to A is now valued at$3 million. A will make payment of $3 million to B. B will have made a loss of $2 mil-lion on the deal. A will keep the debt and the amount of its ultimate profit or loss willdepend on how much the debtor eventually pays in respect of the debt. If the debtorpays in full, A will have made a profit. If the debtor pays $3 million, A will break even.

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Physical settlementIf the Credit Linked Note provides for physical settlement, the original lender willtransfer its interest in the loan to the noteholder at the time of settlement, instead ofmaking payment. This method is often preferred because it protects the originallender from further losses after the note has been settled. To facilitate this it is sensible,when negotiating loan agreements, to ensure that, if the borrower’s consent to trans-fer is required, then such consent will not be necessary after an Event of Default.

The effect of a Credit Linked Note for the original lender is to reduce the totalamount of their credit risk, as in a funded subparticipation. The purchaser’s11 riskdepends on whether the note is cash settled or physically settled. In a cash settlednote the purchaser has a double credit risk, again, as in a funded subparticipation.In a note which is physically settled, the purchaser has a performance risk on theseller (i.e. will the loans be transferred as promised?).

It should be said that Credit Linked Notes, like other credit derivatives, are rarelyissued in relation to a single debt under a single instrument such as a loan agreement,but are more commonly used in relation to all, or a specified part of, the exposurewhich a lender has to the credit risk of a given borrower (or a number of borrowers)(see Box 3.7).


11 By ‘purchaser’, we mean here the purchaser of the note. Confusingly, that person may also be referredto as the ‘seller’ and the issuer of the note as the ‘purchaser’ because the issuer of the note is purchasingan assumption of credit risk from the other party.

BOX 3.7

The Credit Linked Note, as all the credit derivatives, is very flexible. It may relate to asingle payment instalment. The credit risk being sold may also be enhanced by theseller absorbing part of the risk itself. For example, if the amount due from the bor-rower is $5 million, the note could provide that the issuing lender will pay the whole$5 million unless it receives less than $4 million under the loan agreement. The interestrate payable under the note may differ from that under the underlying loan agreement.In these ways and others, credit derivatives are very versatile.

4.2 Credit default swap

Credit default swaps are the most commonly used credit derivatives. Under a creditdefault swap the original lender makes periodic payments to the counterparty of asmall percentage of the principal amount due to the original lender from theborrower. These payments are similar in amount to the fee which would be paid inrelation to a risk subparticipation. If a Credit Event occurs, the swap will becomedue for settlement. As in a Credit Linked Note, the swap may provide for cash set-tlement or for physical settlement. In the case of cash settlement, the counterpartywill pay the difference between the face value of the debt (the amount due from theborrower) and its current market value. In other words, they will compensate theoriginal lender for the loss in value of the debt. In the case of physical settlement,

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the counterparty will pay (usually) the full amount of the face value of the loan andthe loan will be transferred to it.

The commercial effect of a credit default swap is similar in many respects to a risksubparticipation. Like a risk subparticipation, the effect for the original lender is tochange the credit risk it is taking from a risk in the borrower to a risk in the swapcounterparty.

CLAUSE 24: CHANGES TO LENDERS—SECTION 2—TRANSFERS OF SECURED LOAN

It will be clear from the previous paragraphs that transferring secured loans givesrise to particular problems. This section looks at the different structures which havedeveloped to allow syndication of secured loans. The first point to make is that theissues discussed in this section relate to syndications, not subparticipation or creditderivatives. Because subparticipation and credit derivatives do not affect the legalrelationship between the borrower and its lenders, they also do not affect the securityfor the loan. The problems addressed in this section arise only when there is achange in the members of the syndicate, that is, under English law, when there is anassignment or novation.

As well as the legal issues discussed in section 1, syndicating secured loans givesrise to the administrative question of how to avoid the need for signatures from alllenders when security needs to be released or amended. Any requirement (as insome jurisdictions) that any change in identity of a secured party needs to be regis-tered in the registry where the security is registered, can be fatal to the liquidity ofthe underlying debt. So it is common in secured syndicated loans for security to begiven to one of the lenders (often the Agent, or a special Security Agent or SecurityTrustee) on behalf of all the lenders.

Two questions therefore need to be addressed in considering the structure fortransferring secured loans:

� who should the security be given to; and

� what debt should it secure.

There are three common options, with the choice depending on the jurisdictions ofthe parties and of any security.

� security given to a trustee for the lenders, as security for the covenant to pay thetrustee contained in the security documents;

� security given to an agent for the syndicate; either– as security for the underlying debts to syndicate members;12 or– as security for a parallel debt.


12 Or for the obligation to pay the underlying debts to the Agent on behalf of the syndicate members.

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1 Security to a trustee for the covenant to pay13

In jurisdictions which recognize the concept of trusts, the security is given to aSecurity Trustee (normally one of the lenders) as trustee for the lenders from time totime.14 It will be given to the trustee as security for the covenant, in the security doc-uments, to pay the trustee the amounts due to the lenders from time to time. It isimportant to take care in drafting the security to ensure that it does indeed securethe covenant in favour of the trustee.

2 Security to an Agent

In jurisdictions which do not recognize the concept of trust, the security will be heldby the Agent as agent for the syndicate members from time to time. In such cases,due diligence will be necessary on the question of what will happen to the securityand its proceeds in the event that the Security Agent becomes insolvent whenholding proceeds but before they have been distributed.15

2.1 Security to an Agent as security for the underlying debts16

This structure is only available if, in the jurisdiction where the security is located, itis possible for security to be given to (and to be enforceable by17) one person assecurity for debts owed to different persons (although payable to the securityholder on behalf of those persons) and without the need to make any changes to theregistration when there is a change in the members of the syndicate.

If this structure is to be used, it will be necessary to ensure that the securitysecures the debts owed to lenders who take an interest in the loan after the date ofcreation of the security.18 This involves consideration of the method of transfer.

If interests in the loan are transferred by assignment or by assignment andassumption, the original debts made by the original lenders, which are secured bythe security, remain in place throughout, despite any transfers, but are owed to newlenders. Security can be given for the debts existing at the time the security iscreated, and that security should remain effective to secure those debts as assignedto new syndicate members.

If, on the other hand, interests in the loan are transferred by novation, it isimportant to ensure that the security secures any new debts made by new lenders

197C L A U S E 2 4 : C H A N G E S T O L E N D E R S — S E C T I O N 2

13 See ‘Selected Legal Issues for Finance Lawyers’, Martin Hughes, p. 196.14 It is not necessary to identify all beneficiaries of a trust at the time the trust is created as long as it is

clear enough to be able to identify who the beneficiaries are at any given time.15 See discussion on trustees versus agents at para 4.8 of Section 1 of Appendix 1 on p. 270.16 Or for the obligation to pay the underlying debts to the Agent on behalf of the syndicate members.17 The lenders’ lawyer will need to consider how such security would be enforced in practice—for

example, will the Agent be able to claim as secured creditor for the whole debt?18 Unless under the law which governs the security, and taking account of its conflict of law rules, the

obligation to pay the Agent will be regarded as a different debt, independent of the underlying debts, inwhich case the security may be given for the obligation to pay the Agent and the method of transfer maybe disregarded.

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as a result of the novation as well as the original loans made by the original lenders.It is not sufficient for the security to be given to an agent (or trustee) on behalf ofthe syndicate from time to time. It must also secure the debts created from time totime. This is an area for due diligence in the country of the security. In many coun-tries it is not possible to create security for future debts which may or may not beadvanced by persons unknown. In others, such security may be possible but theremay be priority issues if second priority security has been created on the securedassets after the date of the original loan but before the date on which the novationoccurred.

2.2 Security to an Agent as security for a parallel debt

This route is often used in those countries in which trusts are not recognized but itis also not possible for security to be given to an agent on behalf of the syndicatebecause security can only be given in favour of the secured creditors themselves andnot to an agent on their behalf. In these countries, syndicates must either accept theadministrative inconvenience of registering a change in security holder wheneverthere is a change in the syndicate (which would severely hamper the liquidity ofthe loan and therefore the amount of money which could be raised) or use an alter-native route.

The alternative route often used is the so-called ‘parallel debt’. Here, security isgiven to the Agent as security for a ‘parallel debt’ expressed to be owed to theAgent. This debt is equal to the total amount outstanding under the loan agreement.It is specified that the amount of the parallel debt reduces pro rata with all paymentsof the underlying debt (see Box 3.8 and its wording).


BOX 3.8

The following wording, supplied by the Dutch Bankers Association to theirmembers, for use in secured syndicated loans where the loan agreement is

governed by Dutch law, is an example of parallel debt wording.

1. DefinitionsIn this Agreement, unless the context otherwise requires:‘Finance Document’ means this Agreement, any Security Document, [ … ] and any other document desig-nated as such by the Facility Agent and the Borrower.

‘Finance Parties’ means the Facility Agent, the Security Agent, the Arranger and the Lenders and‘Finance Party’ means any of them.

‘Lender’ means any Original Lender and any bank or financial institution which has become a Party inaccordance with Clause […] (Changes to the Lenders), which in each case has not ceased to be a Party in accor-dance with the terms of this Agreement.

‘Obligor’ means the Borrower or a Guarantor.

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199

‘Original Lenders’ means the financial institutions listed in Schedule […] (The Original Lenders).‘Parallel Debt’ has the meaning ascribed thereto in Clause X.‘Party’ means a party to this Agreement and includes its successors in title, permitted assigns and

permitted transferees.‘Principal Obligations’ means, in relation to each Obligor, all monetary obligations (other than its

Parallel Debt) which now or at any time hereafter may be or become due, owing or incurred by such Obligorto any Finance Party, whether due or not, whether contingent or not and whether alone or jointly with otheras principal, guarantor, surety or otherwise, under or in connection with or pursuant to the FinanceDocuments, as such obligations may be extended, restated, prolonged, amended, renewed or novated fromtime to time.

‘Secured Claims’ means, in relation to each Security Provider, (a) the claims (vorderingen) of the SecurityAgent pursuant to the Parallel Debt and (b) the claims (vorderingen) under the Finance Documents of theSecurity Agent (as Security Agent, as Lender or in any other capacity) other than the claims (vorderingen)mentioned in (a).

X. Parallel Debt

X.1 Each Obligor hereby irrevocably and unconditionally undertakes, as far as necessary in advance, topay to the Security Agent an amount equal to the aggregate of all its Principal Obligations to all theFinance Parties from time to time due in accordance with the terms and conditions of such PrincipalObligations (such payment undertaking and the obligations and liabilities which are the result thereof, its‘Parallel Debt’).

X.2 Each of the Parties hereby acknowledges that (i) for this purpose the Parallel Debt of an Obligorconstitutes undertakings, obligations and liabilities of such Obligor to the Security Agent which are separateand independent from, and without prejudice to, the Principal Obligations which such Obligor has to anyFinance Party and (ii) that the Parallel Debt represents the Security Agent’s own claim (vordering) to receivepayment of such Parallel Debt by such Obligor, provided that the total amount which may become due underthe Parallel Debt of such Obligor under this Clause shall never exceed the total amount which may become dueunder all the Principal Obligations of such Obligor to all the Finance Parties.

X.3 (i) The total amount due by an Obligor as the Parallel Debt under this Clause X.l shall be decreasedto the extent that such Obligor shall have paid any amounts to the Finance Parties or any of them to reducesuch Obligor’s outstanding Principal Obligations or any Finance Party otherwise receives any amount inpayment of such Principal Obligations (other than by virtue of Clause X.3 (ii)); and

X.3 (ii) To the extent that an Obligor shall have paid any amounts to the Security Agent under theParallel Debt or the Security Agent shall have otherwise received monies in payment of such Parallel Debt, thetotal amount due under the Principal Obligations shall be decreased.

X.4 Security Agent as co-creditor

X.4(i) In connection with each indebtedness of any Obligor towards any of the Finance Parties underany Finance Document, each of the Parties hereby agrees that the Security Agent shall, insofar as theSecurity Agent is not a creditor (crediteur) itself in respect of such indebtedness, be a ‘co-creditor’(hoofdelijk schu1deiser) with such Finance Party in respect of such indebtedness. Accordingly theSecurity Agent shall be entitled to demand as a creditor performance in full of such indebtedness by therelevant Obligor owing the same (als schuldeiser de prestatie van hem voor het geheel kunnen vorderen), wherebysatisfaction of such indebtedness owed to one creditor (either the Security Agent or the relevant Finance

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19 Of course, the other issues referred to at 1.2 on p. 189 will still need to be investigated.

Party) shall release such Obligor from its obligations to the other creditor (des dat de voldoening aan de eenhem ook jegens de ander bevrijdt) and consequently Section 6:16 of the Dutch Civil Code applies to suchindebtedness for which the Security Agent has become a ‘co-creditor’ (‘hoofdelijk schuldeiser’).

X.4(ii) If and to the extent that the Security Agent is no longer a creditor (crediteur) itself in respect ofsuch indebtedness, then the Security Agent shall be ‘co-creditor’ in respect of such indebtedness pursuant toClause X.4(i).

Syndicate ofleaders

Specialpurposecompany

Counter-indemnitysecured by security

Limited recourseguarantee

LoanChangingidentity

of lendersBorrower

BOX 3.9

AN ALTERNATIVE STRUCTURE TO A PARALLEL DEBT

In this way, the security can be given to the person to whom the debt is owed. Aside effect of this is that, as far as the security is concerned,19 it ceases to matter howthe underlying debt is transferred—whether by novation or otherwise, as thesecurity secures a different debt. While this structure has become market standardin some countries, it may be vulnerable to challenge as being a fiction in otherjurisdictions.

2.3 An alternative to a parallel debt

An alternative which avoids the fictional element of a parallel debt is for a company(an spc subsidiary of a lender) to guarantee the loan on a limited recourse basis,with recourse limited to its recoveries under security. The security would then begiven to the spc as security for the borrower’s obligation to indemnify (or cashcollateralize) the spc for payments made under the guarantee (see Box 3.9).

In this way security is given in favour of the person to whom the debt is owed withoutthe need to create a ‘parallel debt’. The method of transfer of the underlying

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debt then becomes irrelevant as far as the security is concerned. The main disad-vantages of this route are the added structural complexity and the need to establishand maintain a special purpose company.

CLAUSE 24: CHANGES TO LENDERS—SECTION 3—THE LMA TERM LOAN

Clause 24.1 Assignments and transfers by the lenders

24.1 Assignments and transfers by the LendersSubject to this Clause 24, a Lender (the ‘Existing Lender’) may:

(a) assign any of its rights; or(b) transfer by novation any of its rights and obligations,

to another bank or financial institution or to a trust, fund or other entity which isregularly engaged in or established for the purpose of making, purchasing or investing inloans, securities or other financial assets (the ‘New Lender’).

Under the LMA Term Loan, assignment or transfer may only be made to an entityregularly engaged in purchasing or investing in loans, securities, or other financialassets.20 This broad wording allows transfers to special purpose vehicles established,for example, for the purpose of a collateralized debt obligation.


20 This does not, of course, restrict the nature of subparticipants, or of those to whom risk may be soldin a cash settled credit derivative.

Comment The ability of non-financial companies who are ‘regularly engaged in …purchasing loans’ to buy into the loan may be of concern to the borrower (or thelenders, if the borrower itself would be a permitted transferee under this wording).They may want to further restrict the nature of transferees to ensure that competi-tors or customers do not become syndicate members.

An alternative is to leave this clause but rely on the borrower’s right (if included) towithhold consent to a transfer under clause 24.2.

Clause 24.2 Conditions of assignment or transfer

Clauses 24.2(a), (b), and (c)

24.2 Conditions of assignment or transfer(a) The consent of the Company is required for an assignment or transfer by an Existing

Lender, unless the assignment or transfer is to another Lender or an Affiliate of aLender.

(b) The consent of the Company to an assignment or transfer must not be unreasonablywithheld or delayed. The Company will be deemed to have given its consentfive Business Days after the Existing Lender has requested it unless consent isexpressly refused by the Company within that time.

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(c) The consent of the Company to an assignment or transfer must not be withheld solelybecause the assignment or transfer may result in an increase to the Mandatory Cost.

Clause 24.2 requires the borrower’s consent to be obtained for an assignment ortransfer (other than to an Affiliate of an existing lender). This consent is not to beunreasonably withheld or delayed and is deemed given if not refused within fiveBusiness Days of a request.


21 Although increasing regulatory recognition of credit derivatives enables this spread of investments tobe achieved by methods which do not involve the borrower and do not require the borrower’s consent.Nevertheless, many lenders also want full flexibility of choice of method of transfer, including assign-ments and novations and do not want to find themselves limited to subparticipations and cash settledcredit derivatives.

Comment The lenders should perhaps say that the borrower’s consent would not beneeded if there were an Event of Default. See the commentary on credit derivativesin section 1 of the commentary on this clause on pp. 194–6.

Comment Many lenders feel that requiring the borrower’s consent is too restrictive.Lenders want the ability to spread their investments without restriction by the bor-rower.21 Borrowers, on the other hand, particularly in club deals, often want torestrict transfers because they regard the relationship with their lenders as impor-tant, as the loan agreement often gives the lenders significant rights in relation to theconduct of the borrower’s business. They take comfort from the identity of theirlenders and their lenders’ understanding of and commitment to the borrower’sbusiness. Even in a large syndicate, borrowers may want the right to approve pro-posed transferees. Borrowers need to bear in mind that the more restrictive thetransfer provisions, the smaller the pool of money will be for funding the loan.Restrictions on transfer may come at a cost.

Comment If the borrower�s consent is not needed for transfer, it should consider speci-fying certain parameters within which the right to transfer must be exercised (seeBox 3.10 on p. 203).

Clause 24.2(d) and (e)

(d) An assignment will only be effective on:(i) receipt by the Agent of written confirmation from the New Lender (in form and

substance satisfactory to the Agent) that the New Lender will assume the sameobligations to the other Finance Parties as it would have been under if it was anOriginal Lender; and

(ii) performance by the Agent of all ‘know your customer’ or other checks relating toany person that it is required to carry out in relation to such assignment to aNew Lender, the completion of which the Agent shall promptly notify to theExisting Lender and the New Lender.

(e) A transfer will only be effective if the procedure set out in Clause 24.5 (Procedure fortransfer) is complied with.

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Documentation for assignments is left up to the parties, with the only requirementbeing in clause 24.2(d), that the new lender confirms it accepts the obligations in theloan towards the rest of the syndicate members and that all applicable ‘know yourcustomer’ checks are completed.

Clause 24.2(e) provides that the documentation to achieve a transfer (which,under clause 24.1(b), must take the form of a novation) must follow the require-ments of clause 24.5. Due diligence is necessary to ensure that novation is a satisfac-tory method of transfer for the loan in question and that a different method may notbe more suitable.23

Clause 24.2(f)

(f) If:(i) a Lender assigns or transfers any of its rights or obligations under the Finance

Documents or changes its Facility Office; and(ii) as a result of circumstances existing at the date the assignment, transfer or

change occurs, an Obligor would be obliged to make a payment to the New Lenderor Lender acting through its new Facility Office under Clause 13 (Tax gross upand indemnities) or Clause 14 (Increased Costs),

then the New Lender or Lender acting through its new Facility Office is only entitled toreceive payment under those Clauses to the same extent as the Existing Lender or Lender


22 For example, problems may arise if the borrower’s debt is being traded at a discount. Assume that adebt of $100 is bought for $70 by a purchaser which owes $100 to the borrower. The purchaser may now,in some jurisdictions, offset its debt to the borrower against the borrower’s debt to it. The result is that, foran outlay of $70, the purchaser can avoid a payment of $100. The effect may be to make it more difficultfor a company whose loan is being traded at a discount to collect their debts from customers. In the eventof liquidation of the company, it will be the company’s creditors who will lose out. In some countries, setoff exercised shortly before liquidation may be unwound, so the advantage which the customer obtainedmay not be permanent. Nevertheless, avoiding such sales in the first place would be preferable.

23 See sections 1 and 2 of the commentary on this clause 24 on pp. 187–201.

BOX 3.10

Examples of limits on transfers which a borrower may wish to specify include:

� no transfers such that the amount of the participation of any lender of record is lessthan a given figure. This will have the effect of limiting the number of lenders ofrecord with whom the borrower needs to deal and also ensuring each of them has areasonable level of commitment to the borrower;

� no transfers to be made to a competitor or to a lender to a competitor;� no transfers to a lender with lower than a certain credit rating (particularly for

revolvers or term loans with long drawdown periods);� no transfers to a lender which is a counterparty to [significant] transactions with the

borrower because it will give rise to rights of set off;22 and� no transfers by the Agent if it would reduce the Agent’s participation below a

certain figure.

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acting through its previous Facility Office would have been if the assignment, transfer orchange had not occurred.

Clause 24.2(f) ensures that no additional withholding tax or increased cost expensewill be borne by the borrower as a result of any transfer or change in Facility Officeif that extra cost would arise in the circumstances existing at the time of the transfer.


Comment Some lenders require an adjustment to this clause to allow transferees orother lending offices to have the benefit of the tax and increased cost indemnityclauses if the change was made for the benefit of the borrower pursuant to clause 16(the mitigation clause).

Clause 24.3 Assignment or transfer fee

Clause 24.3 provides for the buyer to pay a transfer fee to the Agent.

Clause 24.4 Limitation of responsibility of existing lenders

Clause 24.4 is an exclusion clause limiting the sellers’ responsibility to buyers inrelation to the borrower.

Clause 24.5 Procedure for transfer

24.5 Procedure for transfer(a) Subject to the conditions set out in Clause 24.2 (Conditions of assignment or transfer)

a transfer is effected in accordance with paragraph (c) below when the Agent executesan otherwise duly completed Transfer Certificate delivered to it by the ExistingLender and the New Lender. The Agent shall, subject to paragraph (b) below, as soonas reasonably practicable after receipt by it of a duly completed Transfer Certificateappearing on its face to comply with the terms of this Agreement and delivered inaccordance with the terms of this Agreement, execute that Transfer Certificate.

(b) The Agent shall only be obliged to execute a Transfer Certificate delivered to it bythe Existing Lender and the New Lender once it is satisfied it has complied with allnecessary “know your customer” or other similar checks under all applicable lawsand regulations in relation to the transfer to such New Lender.

(c) On the Transfer Date;(i) to the extent that in the Transfer Certificate the Existing Lender seeks to transfer

by novation its rights and obligations under the Finance Documents each of theObligors and the Existing Lender shall be released from further obligationstowards one another under the Finance Documents and their respective rightsagainst one another under the Finance Documents shall be cancelled (being the“Discharged Rights and Obligations”);

(ii) each of the Obligors and the New Lender shall assume obligations towardsone another and/or acquire rights against one another which differ from theDischarged Rights and Obligations only insofar as that Obligor and the New

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Lender have assumed and/or acquired the same in place of that Obligor and theExisting Lender;

(iii) the Agent, the Arranger, the New Lender and other Lenders shall acquire the samerights and assume the same obligations between themselves as they would haveacquired and assumed had the New Lender been an Original Lender with therights and/or obligations acquired or assumed by it as a result of the transfer andto that extent the Agent, the Arranger and the Existing Lender shall each bereleased from further obligations to each other under the Finance Documents; and

(iv) the New Lender shall become a Party as a ‘Lender’.

Clause 24.5 of the LMA Term Loan uses a Transfer Certificate mechanism. Thisinvolves seller and buyer of a portion of the loan signing a transfer certificate,24 withdetails of the transfer completed, and delivering that to the Agent. The aim of thismechanism is to simplify the trading of interests in the loan and avoid the need fora lengthy new document to be prepared, agreed, and signed by all lenders, eachtime there is a loan transfer.

Clause 24.5 specifies that the effect of this certificate is to discharge the rights andobligations of the existing lender vis-a-vis the borrower (to the extent they are beingtransferred) and to substitute the same rights and obligations as between the bor-rower and the new lender. This is a novation—discharging one contract and replac-ing it with another contract which is identical except for the parties. The agreementprovides for a transfer to be effective on the later of the date proposed in the trans-fer certificate and the date on which the Agent completes the certificate. There is anobligation on the Agent to complete the certificate as soon as practicable, subject tocompletion of necessary ‘know your customer’ checks.

The certificate does not deal with commercial issues which are of no concern tothe Agent such as apportionment of interest if the sale is part way through aninterest period. Such matters will already have been dealt with in the document25

signed by seller and buyer at the time the trade was agreed and which set out thecommercial terms of the trade such as its effective date.

Clause 24.6 Copy of transfer certificate to Company

Clause 24.6 requires the Agent to deliver a copy of any transfer certificate to theCompany.

Clause 24.7 Disclosure of information

24.7 Disclosure of informationAny Lender may disclose to any of its Affiliates and any other person:(a) to (or through) whom that Lender assigns or transfers (or may potentially assign or

transfer) all or any of its rights and obligations under this Agreement;


24 See para 1 of section 1 of the commentary on this clause 24 on pp. 188–190.25 See, for example, the LMA forms of documentation for loan transfers.

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(b) with (or through) whom that Lender enters into (or may potentially enter into) anysub-participation in relation to, or any other transaction under which payments areto be made by reference to, this Agreement or any Obligor; or

(c) to whom, and to the extent that, information is required to be disclosed by anyapplicable law or regulation,

any information about any Obligor, the Group and the Finance Documents as that Lendershall consider appropriate [if, in relation to paragraphs (a) and (b) above, the person towhom the information is to be given has entered into a Confidentiality Undertaking].

Clause 24.7 is vital for the trading of loan assets. Often, in order to attract investors,the lenders will need to disclose non public financial information about the bor-rower. This requires the borrower’s consent. Hence this clause permits disclosurenot only to potential assignees and transferees but also to proposed sub participantsand parties to credit derivatives (a ‘transaction under which payments are to be made byreference to this Agreement26’). Borrowers often require that any such person firstsigns a confidentiality undertaking.27

CLAUSE 25: CHANGES TO THE OBLIGORS

Clause 25.1 Assignments and transfers by Obligors

Clause 25.1 prohibits the borrowers and guarantors from transferring their rights orobligations under the agreement.

Clause 25.2 Additional borrowers

25.2 Additional Borrowers(a) Subject to compliance with the provisions of paragraphs (c) and (d) of Clause 20.7

(‘Know your customer’ checks) the Company may request that any of its [whollyowned] Subsidiaries becomes an Additional Borrower. That Subsidiary shall becomean Additional Borrower if:(i) [all the Lenders]/[the Majority Lenders] approve the addition of that Subsidiary;(ii) the Company delivers to the Agent a duly completed and executed Accession

Letter;(iii) the Company confirms that no Default is continuing or would occur as a result

of that Subsidiary becoming an Additional Borrower; and(iv) the Agent has received all of the documents and other evidence listed in Part II

of Schedule 2 (Conditions precedent) in relation to that Additional Borrower,each in form and substance satisfactory to the Agent.


26 See para 4 of section 1 of the commentary on this clause 24 on pp. 194–196.27 This is particularly important in relation to subparticipants and counterparties to credit derivatives as

there are no restrictions on the identity of these parties and, since the borrower is not a customer of theirs,they may not be subject to the bankers’ duty of confidentiality in relation to the borrower—see commentson clause 24.1 and see also commentary on Schedule 10.

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(b) The Agent shall notify the Company and the Lenders promptly upon being satisfiedthat it has received (in form and substance satisfactory to it) all the documents andother evidence listed in Part II of Schedule 2 (Conditions precedent).

Clause 25.2 allows additional group members to become entitled to make drawingsunder the facility if

� the new party is approved by the lenders (with an option for the draftsperson torequire only Majority Lender approval);

� the new party signs an Accession Letter; and

� the new party delivers certain conditions precedent (notably, legal opinions satis-factory to the Agent relating to the relevant country and compliance with any‘know your customer’ checks).

In addition, clauses 19.14(b) and 25.5 provide for the Repeating Representations tobe repeated by a new borrower on the date it becomes a new borrower, and there-fore accession of a new borrower is also conditional on those RepeatedRepresentations being true.

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28 Lenders may resist this point, particularly if the facility has a long drawdown period, so as to protectagainst change in law in the intervening period.

Comment The Company (the top company in the group to which the lenders haverecourse) needs to ensure that, when the document is being negotiated, they iden-tify the companies which may be wishing to rely on the availability of funds fromthe facility and specify them as borrowers in the first instance. They will also wantto minimize the requirements which need to be satisfied for other group companiesto draw the facility. For this reason, the Company may request:

� that where the new borrower is from the same country as one of the existingObligors, they should be entitled to draw the loan without consent of thelenders (because that consent is imposed largely to enable lenders to considerany legal issues which may be highlighted by a legal opinion) and thereshould be no need for a new legal opinion;28

� that addition of borrowers from other jurisdictions should require MajorityLender (not all lender) approval. Nevertheless, many lenders will resist thisand require unanimous consent for addition of such borrowers, so as to enablethem to review any relevant legal opinion as a condition of their consent,rather than rely on the Agent (in accordance with clause 25.2(a)(iv)) to deter-mine its acceptability.

Clause 25.3 Resignation of a Borrower

25.3 Resignation of a Borrower(a) The Company may request that a Borrower (other than the Company) ceases to be a

Borrower by delivering to the Agent a Resignation Letter.

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(b) The Agent shall accept a Resignation Letter and notify the Company and the Lendersof its acceptance if:(i) no Default is continuing or would result from the acceptance of the Resignation

Letter (and the Company has confirmed this is the case); and(ii) the Borrower is under no actual or contingent obligations as a Borrower under

any Finance Documents,whereupon that company shall cease to be a Borrower and shall have no further rights orobligations under the Finance Documents.

This clause allows a borrower to cease to be an Obligor once it has repaid its loansand other moneys due from it under the agreement, provided there is no Default atthat time. The Company, if it is a borrower, may not resign.

Clause 25.4 Additional Guarantors

25.4 Additional Guarantors(a) Subject to compliance with the provisions of paragraphs (c) and (d) of Clause 20.7

(‘Know your customer’ checks), the Company may request that any of its [whollyowned] Subsidiaries become an Additional Guarantor. That Subsidiary shall becomean Additional Guarantor if:(i) the Company delivers to the Agent a duly completed and executed Accession

Letter; and(ii) the Agent has received all of the documents and other evidence listed in Part II of

Schedule 2 (Conditions precedent) in relation to that Additional Guarantor, eachin form and substance satisfactory to the Agent.

(b) The Agent shall notify the Company and the Lenders promptly upon being satisfiedthat it has received (in form and substance satisfactory to it) all the documents andother evidence listed in Part II of Schedule 2 (Conditions precedent).

Clause 25.4 provides for a mechanism for a new group company to become anadditional guarantor. This is likely to be used when other guarantors are resigning.The only prerequisites to addition of guarantors are the conditions precedent(including a legal opinion satisfactory to the Agent) and Repeated Representations.

Clause 25.5 Repetition of Representations

Clause 25.5 states that the Repeated Representations are repeated on a new Obligorbecoming a party to the agreement.

Clause 25.6 Resignation of a Guarantor

25.6 Resignation of a Guarantor(a) The Company may request that a Guarantor (other than the Company) ceases to be a

Guarantor by delivering to the Agent a Resignation Letter.


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(b) The Agent shall accept a Resignation Letter and notify the Company and the Lendersof its acceptance if:

(i) no Default is continuing or would result from the acceptance of the ResignationLetter (and the Company has confirmed this is the case);

(ii) all the Lenders have consented to the Company’s request; and(iii) [ ].

This clause provides a mechanism for guarantors to resign. The Company, if aguarantor originally, may not resign. Other guarantors may resign but only if alllenders agree and there is no Default.

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CLAUSE 26: ROLE OF THE AGENT AND THE ARRANGER

Clause 26 is the only clause in the agreement where the Arranger appears. At thetime the loan agreement is signed, the Arranger’s task is completed and the mainpurpose of referring to the Arranger in this clause is to give them the benefit of theexclusion clause. However, given that the exclusion clause is effectively retrospec-tive insofar as the Arranger is concerned29 this clause is no substitute for includingan exclusion clause in appropriate pre-loan agreement documentation.

Clause 26 is concerned with defining the role of the Agent and the Arranger asbeing that of facilitators of the transaction but not standing in for the lenders norlooking after their interests, nor assuming the fiduciary duties which attach topersons who represent others in a legal matter (see Box 3.11 on p. 211).

The intention in a syndicated loan is that the Agent should have an administra-tive role only and should not be obliged to look after the interests of syndicatemembers nor to exercise any discretions on their behalf and that therefore, a fiduci-ary relationship should not arise. Instead, it is intended that it should simply act asa conduit for receipt of money and information. See also commentary on clause 26.4.The extent to which other lenders are relying on the Agent is limited as far aspossible. The loan agreement does, in certain cases, allow the Agent to takedecisions on behalf of the syndicate (as opposed to requiring it to do so). Notably,clause 23.13 permits the Agent to exercise the right of acceleration without beingdirected to do so by the syndicate. Clauses 4.1 and 25.2(a) and 25.4(a) permit the

210

C H A P T E R 1 0

The Finance Parties

29 See Sumitomo Bank v Banque Bruxelles Lambert (1997) 1 Lloyds Law Reports 487 for a case where anexclusion clause in the loan agreement did not protect the Arranger from liability in respect of its duty ofcare as Arranger. See also ‘Risks and Responsibilities of the Agent Bank and the Arranging Bank inSyndicated Credit Facilities’, Journal of International Business Law 1997, 12(5), at p. 182.

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Agent to decide whether conditions precedent have been met satisfactorily.32

In exercising these rights, and in the relationship with the borrower generally, theAgent should be aware that, if in practice it takes decisions on behalf of the syndi-cate (such as the decisions to approve conditions precedent, or to approve a legalopinion for the purpose of accepting a new Obligor), it may expose itself to liabilityto the syndicate for breach of fiduciary duty.

Clause 26 clarifies this administrative function of the Agent.

Clause 26.1 Appointment of the Agent

Clause 26.1 is the appointment of the Agent by the lenders.

Clause 26.2 Duties of the Agent

26.2 Duties of the Agent(a) The Agent shall promptly forward to a Party the original or a copy of any document

which is delivered to the Agent for that Party by any other Party.(b) Except where a Finance Document specifically provides otherwise, the Agent is not

obliged to review or check the adequacy, accuracy or completeness of any document itforwards to another Party.

(c) If the Agent receives notice from a Party referring to this Agreement, describing aDefault and stating that the circumstance described is a Default, it shall promptlynotify the Finance Parties.

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30 See Ross Cranston ‘Principles of Banking Law’, p. 187 et seq for further details on fiduciary duties.31 See e.g. Kelly v Cooper (1993) AC 205. See also Law Commission Consulation Paper ‘Fiduciary duties

and Regulatory Rules’ (Cons Paper No 124 1992).32 See clause 4.1.

BOX 3.11

The general English law position is that, where someone represents another in a legalmatter, that person has duties (known as ‘fiduciary duties’) to look after the interests ofthe person he is representing.30 However, a fiduciary relationship cannot be superim-posed on a contract in such a way as to alter the operation which that contract wasintended to have in accordance with its true construction.

Fiduciary duties generally include:

� a duty to act carefully;� a duty to avoid conflicts of interest and subordinate his own interests to that of his

principals;� a duty not to make a secret profit; and� a duty not to sub-delegate one’s actions.

It is not necessarily the case that if there are fiduciary duties then all the above dutieswill apply.31 The existence and scope of fiduciary duties depends on the situation ineach case.

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(d) If the Agent is aware of the non-payment of any principal, interest, commitment feeor other fee payable to a Finance Party (other than the Agent or the Arranger) underthis Agreement it shall promptly notify the other Finance Parties.

(e) The Agent’s duties under the Finance Documents are solely mechanical andadministrative in nature.

The duties of the Agent specified in clause 26.2 are to pass on documents received, passon information received as to existence of a Default, and, if it is aware of a non-payment,33 to advise the lenders. These are in addition to other duties specifically setout in the agreement, such as the duty to distribute moneys received (see Box 3.12).

T H E F I N A N C E PA R T I E S212

33 And, in this respect, see clause 26.12.34 Box 3.12 is intended to give a brief overview only. A document explaining the Agent’s responsibilities

in some detail is available to members of the LMA through their website.

BOX 3.12

The Agent’s duties set out in other clauses of the LMA Term Loan fall into thefollowing categories:34

� Agreeing alternative arrangements if necessary, including,– In consultation with lenders, changing the Screen Rate (see definition of ‘Screen

Rate’) or approving additional Optional Currencies (clause 4.3(a)(ii)), and– Agreeing different Reference Banks (see definition of ‘Reference Banks’) or a

different form of Transfer Certificate (see definition of ‘Transfer Certificate’).� Making currency calculations (clauses 5.4(c), 6.3, and 6.4(a)).� Demanding payment of moneys (clauses 9.3(a), 11.4(b), 13.3, 14.1, and 17.1).� Receiving and distributing money (clauses 12.1(a), 28.1, 29.1, and 29.2).� Agreeing methods of communication (clauses 20.6 and 31.5).� Receiving documents in relation to changes in parties (clauses 24.2(d), 24.5, 25.2,

25.3, 25.4, and 25.6).� Receiving information to pass on/passing on notices/notifying of events (clauses

6.1(c), 6.2, 8.1(b), 8.2(a)(iii), 8.6(f), 9.4, 11.2(a) and (b), 13.2(b), 14.2, 20.1, 20.2, 20.3(c),20.4, 20.5, 20.7, 22.1(b), 31.3(c), and 31.4).

� Deciding whether conditions precedent have been satisfied (clauses 4.1, 25.2, and 25.4).� Operating the provisional treaty relief scheme for the purpose of English withhold-

ing tax (clause 13.7).� Signing documents giving effect to amendments and waivers which have been

approved by Majority Lenders (clause 35.1).� Shortening (if it wishes to) an Interest Period to end on a Repayment Date (clause

10.2(a)).� Starting (if it wishes to do so) discussions about a substitute basis for calculation of

interest if a Market Disruption occurs (clause 11.3(a)).� Giving notice of the existence of a Default (once it is aware of the same) and trig-

gering commencement of a grace period (clause 23.3(b)).� Giving notice of acceleration (which it must do if instructed to by Majority Lenders,

and may do at its discretion) (clause 23.13).

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Clauses 26.4–26.6

26.4 No fiduciary duties(a) Nothing in this Agreement constitutes the Agent or the Arranger as a trustee or

fiduciary of any other person.(b) Neither the Agent nor the Arranger shall be bound to account to any Lender for any

sum or the profit element of any sum received by it for its own account.

26.5 Business with the GroupThe Agent and the Arranger may accept deposits from, lend money to and generallyengage in any kind of banking or other business with any member of the Group.

Clause 26.6 Rights and discretions of the Agent(a) .... (b) ....(c) The Agent may engage, pay for and rely on the advice or services of any lawyers,

accountants, surveyors or other experts.(d) The Agent may act in relation to the Finance Documents through its personnel and

agents.

Clause 26.4 states that the Agent has no fiduciary duties. See Box 3.11 on p. 211.Much of clause 26 specifically allows the Agent to do things which would be

in breach of their fiduciary duty if they had such a duty—for example, clause 26.5allowing the Agent to conduct other business with the borrower (even though thismay give rise to a conflict), clauses 26.6(c) and (d) allowing the Agent to sub-delegate, and clause 26.4(b) allowing it to keep profits earned.

Clause 26.7 Majority Lenders’ instructions

26.7 Majority Lenders’ instructions(a) Unless a contrary indication appears in a Finance Document, the Agent shall

(i) exercise any right, power, authority or discretion vested in it as Agent in accor-dance with any instructions given to it by the Majority Lenders (or, if so instructedby the Majority Lenders, refrain from exercising any right, power, authority ordiscretion vested in it as Agent) and (ii) not be liable for any act (or omission) if itacts (or refrains from taking any action) in accordance with an instruction of theMajority Lenders.

(b) Unless a contrary indication appears in a Finance Document, any instructions givenby the Majority Lenders will be binding on all the Finance Parties.

(c) The Agent may refrain from acting in accordance with the instructions of theMajority Lenders (or, if appropriate, the Lenders) until it has received such securityas it may require for any cost, loss or liability (together with any associated VAT)which it may incur in complying with the instructions.

(d) In the absence of instructions from the Majority Lenders, (or, if appropriate, theLenders) the Agent may act (or refrain from taking action) as it considers to be in thebest interest of the Lenders.

Clause 26.7 gives control of the loan to the Majority Lenders; provides for all lendersto be bound by the decisions of the Majority Lenders; allows the Agent to require


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security for liabilities before taking action at the direction of the Majority Lenders;and gives the Agent discretion to act on its own initiative.

Clause 26.8 Responsibility for documentation

26.8 Responsibility for documentationNeither the Agent nor the Arranger:(a) is responsible for the adequacy, accuracy and/or completeness of any information

(whether oral or written) supplied by the Agent, the Arranger, an Obligor or any otherperson given in or in connection with any Finance Document or the InformationMemorandum; or

(b) is responsible for the legality, validity, effectiveness, adequacy or enforceability of anyFinance Document or any other agreement, arrangement or document entered into,made or executed in anticipation of or in connection with any Finance Document.

The intention is that the Agent and the Arranger should simply be facilitators butshould not assume any responsibility in relation to information circulated to thesyndicate or for the effectiveness of the loan documentation. They are simply actingas co-coordinators, not inviting the syndicate to rely on them. The Agent instructsthe lawyers and leads the negotiation but:

� the syndicate members are not bound by that negotiation—they are given theirown opportunity to review the documents and make comments; and

� the Agent is not underwriting the effectiveness of their lawyers—if a mistake ismade which impacts on the transaction, the intention is that that risk should beborne equally by all the syndicates members.

Clause 26.9 Exclusion of liability

26.9 Exclusion of liability(a) Without limiting paragraph (b) below, [and without prejudice to the provisions of

clause 29.10(e) (Disruptions to Payment Systems etc.)], the Agent will not be liable[including without limitation, for negligence or any other category of liabilitywhatsoever)] for any action taken by it under or in connection with any FinanceDocument, unless directly caused by its gross negligence or wilful misconduct.

(b) No Party (other than the Agent) may take any proceedings against any officer,employee or agent of the Agent in respect of any claim it might have against theAgent or in respect of any act or omission of any kind by that officer, employee oragent in relation to any Finance Document and any officer, employee or agent of theAgent may rely on this Clause [subject to Clause 1.3 (Third Party Rights) and theprovisions of the Third Parties Act].

(c) The Agent will not be liable for any delay (or any related consequences) in creditingan account with an amount required under the Finance Documents to be paid by theAgent if the Agent has taken all necessary steps as soon as reasonably practicable to


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comply with the regulations or operating procedures of any recognised clearing orsettlement system used by the Agent for that purpose.

Clause 26.9 states that the Agent is only liable for ‘gross negligence or wilfulmisconduct’—that is, liability for negligence is excluded. The gross negligence stan-dard is generally accepted market practice. It supplements the general principle thatthe Agent is simply an administrator and all risks (including the risk of negligenceby lender’s employees) are shared equally among the syndicate. Nevertheless, it isdifficult to specify in advance what circumstances a court might hold to fall withinthe definition of ‘gross negligence’,35 particularly given the general approach whichcourts take to exclusion clauses.36 The main protection for the Agent is to exercise itsrights with care and to involve the syndicate members in any potentially contentiousdecisions which have to be taken.

Clause 26.10 Lenders’ indemnity to the Agent

Clause 26.10 requires the lenders to indemnify the Agent for any losses andexpenses incurred in its role as Agent.

Clause 26.11 Resignation of the Agent

26.11 Resignation of the Agent(a) The Agent may resign and appoint one of its Affiliates acting through an office

[in the United Kingdom] as successor by giving notice to the other Finance Partiesand the Company.

(b) Alternatively the Agent may resign by giving notice to the other Finance Parties andthe Company, in which case the Majority Lenders (after consultation with theCompany) may appoint a successor Agent.

(c) If the Majority Lenders have not appointed a successor Agent in accordance withparagraph (b) above within 30 days after notice of resignation was given, the Agent(after consultation with the Company) may appoint a successor Agent [(actingthrough an office in the United Kingdom)].

(d) The retiring Agent shall, at its own cost, make available to the successor Agentsuch documents and records and provide such assistance as the successor Agent mayreasonably request for the purposes of performing its functions as Agent under theFinance Documents.

(e) The Agent’s resignation notice shall only take effect upon the appointment of asuccessor.

(f) Upon the appointment of a successor, the retiring Agent shall be discharged from anyfurther obligation in respect of the Finance Documents but shall remain entitled tothe benefit of this Clause 26. Its successor and each of the other Parties shall have the


35 See Appendix 2.36 See para 4.4 of section 1 of Appendix 1 at p. 267.

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same rights and obligations amongst themselves as they would have had if suchsuccessor had been an original Party.

(g) After consultation with the Company, the Majority Lenders may, by notice to theAgent, require it to resign in accordance with paragraph (b) above. In this event,the Agent shall resign in accordance with paragraph (b) above.

Clause 26.11 allows the Agent to substitute a different group member as Agentwithout consent of any other party. It also allows the Agent to resign and (in para-graph (g)) allows the Majority Lenders to require the Agent to resign. If the Agentwants to resign and have its position assumed by a third party, the syndicate (notthe Borrower) has the right to appoint a substitute, but if they fail to do so within30 days, the Agent may do so. This right can be useful for an Agent as it may be theonly way to resolve a conflict of interest. It is therefore important that the Agent’sability to resign cannot be restricted by other parties (although it may be frustratedif it cannot find a third party willing to take on the role).

Clause 26.12 Confidentiality

26.12 Confidentiality(a) In acting as agent for the Finance Parties, the Agent shall be regarded as acting

through its agency division which shall be treated as a separate entity from any otherof its divisions or departments.

(b) If information is received by another division or department of the Agent, it maybe treated as confidential to that division or department and the Agent shall not bedeemed to have notice of it.

Clause 26.12 is self-explanatory. It is particularly important in the context of theAgent’s duties set out in clause 26.2.

Clause 26.13 Relationship with the lenders

Clause 26.13 requires the lenders to give the Agent five Business Days’ notice ofa change in Facility Office or lender and to deliver to the Agent all informationnecessary to allow the Agent to calculate the Mandatory Cost.

Clause 26.14 Credit appraisal by lenders

26.14 Credit appraisal by the LendersWithout affecting the responsibility of any Obligor for information supplied by it or onits behalf in connection with any Finance Document, each Lender confirms to the Agentand the Arranger that it has been, and will continue to be, solely responsible for makingits own independent appraisal and investigation of all risks arising under or in connectionwith any Finance Document including but not limited to:(a) the financial condition, status and nature of each member of the Group;


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(b) the legality, validity, effectiveness, adequacy or enforceability of any FinanceDocument and any other agreement, arrangement or document entered into, made orexecuted in anticipation of, under or in connection with any Finance Document;

(c) whether that Lender has recourse, and the nature and extent of that recourse, againstany Party or any of its respective assets under or in connection with any FinanceDocument, the transactions contemplated by the Finance Documents or any otheragreement, arrangement or document entered into, made or executed in anticipationof, under or in connection with any Finance Document; and

(d) the adequacy, accuracy and/or completeness of the Information Memorandum and anyother information provided by the Agent, any Party or by any other person under or inconnection with any Finance Document, the transactions contemplated by the FinanceDocuments or any other agreement, arrangement or document entered into, made orexecuted in anticipation of, under or in connection with any Finance Document.

Clause 26.14 contains confirmation by the syndicate members that they have notrelied on any representations by the Agent or the Arranger but have undertakentheir own financial due diligence and will continue to do so. This is designed toprotect the Agent and Arranger from liability for misrepresentation and from theargument by syndicate members that they were led to join the syndicate in relianceon the superior expertise of the Arranger and/or the Agent in relation to the proposedtransaction.

CLAUSE 27: CONDUCT OF BUSINESS BY THE FINANCE PARTIES

27. CONDUCT OF BUSINESS BY THE FINANCE PARTIESNo provision of this Agreement will:(a) interfere with the right of any Finance Party to arrange its affairs (tax or otherwise)

in whatever manner it thinks fit;(b) oblige any Finance Party to investigate or claim any credit, relief, remission or

repayment available to it or the extent, order and manner of any claim; or(c) oblige any Finance Party to disclose any information relating to its affairs (tax or

otherwise) or any computations in respect of Tax.

Clause 27 is self-explanatory and is discussed in the context of clause 13.4.

CLAUSE 28: SHARING AMONG FINANCE PARTIES

Clause 28.1 Payments to Finance Parties and Clause 28.2 Redistribution of payments

28.1 Payments to Finance PartiesIf a Finance Party (a ‘Recovering Finance Party’) receives or recovers any amount froman Obligor other than in accordance with Clause 29 (Payment mechanics) and applies

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that amount to a payment due under the Finance Documents then:(a) the Recovering Finance Party shall, within three Business Days, notify details of the

receipt, or recovery, to the Agent;(b) the Agent shall determine whether the receipt or recovery is in excess of the amount

the Recovering Finance Party would have been paid had the receipt or recoverybeen received or made by the Agent and distributed in accordance with Clause 29(Payment mechanics), without taking account of any Tax which would be imposed onthe Agent in relation to the receipt, recovery or distribution; and

(c) the Recovering Finance Party shall, within three Business Days of demand by theAgent, pay to the Agent an amount (the ‘Sharing Payment’) equal to such receipt orrecovery less any amount which the Agent determines may be retained by theRecovering Finance Party as its share of any payment to be made, in accordance withClause 29.5 (Partial payments).

28.2 Redistribution of paymentsThe Agent shall treat the Sharing Payment as if it had been paid by the relevant Obligorand distribute it between the Finance Parties (other than the Recovering Finance Party)in accordance with Clause 29.5 (Partial payments).

Clause 28 is the pro rata sharing clause. Its function is to ensure that each lenderrecovers the same proportion of its debt as each of the other lenders. The clauseprovides that if any lender recovers a greater proportion than any other, then it willshare the excess with the others, reflecting the basic concept of a syndicated loanthat, if there is a loss, the lenders should suffer equally.

This clause does not however oblige any lender to exercise its set off rightsagainst the syndicated loan (see Box 3.13).


BOX 3.13

For example, assume lender A,

(a) has a bilateral facility of $10 million to borrower B; and(b) is a member of a syndicate of ten lenders which have provided a loan of $100 million

to B with each lender lending $10 million. Assume that B fails to repay either loanbut has a bank account with A with $5 million in it and that the law in the countrywhere the bank account is held allows set off rights as against either of the facili-ties. A has two choices (absent any special relationship as discussed below).

� It may use the $5 million deposit to set off against its $10 million bilateral facil-ity. In this case, after the set off, it will be owed $10 million on the syndicatedloan and $5 million on its bilateral facility.

� Alternatively, it may use the $5 million deposit to set off against its interest inthe syndicated loan. It would then need to share the $5 million with all other9 members of the syndicate—leaving A retaining a benefit of only $0.5 millionfrom the set off. The result would be a continued debt to B of $10 million on itsbilateral facility and of $9.5 million in respect of the syndicated loan.

Clearly A would prefer to use the set off for the purpose of the bilateral facility. This isnot prohibited by the clause.

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It may be, however, that exercising a set off for the benefit of a different debtcould be challenged if the lender in question had some special relationship37 withlenders who would have benefited from the sharing clause had the set off beenapplied to this loan, those other lenders may be able to claim that the lender’s actionwas in breach of a fiduciary duty (if they can show that such a duty exists).

Clause 28.3 Recovering Party’s rights

28.3 Recovering Finance Party’s rights(a) On a distribution by the Agent under Clause 28.2 (Redistribution of payments), the

Recovering Finance Party will be subrogated to the rights of the Finance Partieswhich have shared in the redistribution.

(b) If and to the extent that the Recovering Finance Party is not able to rely on its rightsunder paragraph (a) above, the relevant Obligor shall be liable to the Recovering FinanceParty for a debt equal to the Sharing Payment which is immediately due and payable.

A lender which makes a payment of a surplus under this clause takes over the rightsof those who are compensated, to the extent of the payment made to them. They dothis by subrogation or, to the extent subrogation is ineffective, by contract. Thisclause is necessary since the exercise of the right of set off will have extinguished thedebt owed to the recovering lender (see Box 3.14).

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37 E.g. if it was the Agent or a lender of record with responsibilities to subparticipants.

BOX 3.14

In the example in Box 3.13, if the set off was exercised against the syndicated loan,after the set off the borrower would only owe A $5 million, as the other $5 million hasbeen extinguished by the set off. However, after the sharing, A has a shortfall of$9.5 million. This clause provides that the debt which B owed to the other syndicatemembers, to the extent they have been paid by a sharing of A’s payment (i.e. $4.5 million)can be pursued by A.

Alternative versions of this clause provide for

� The borrower’s debt to the lender which makes a sharing payment, to be rein-stated to the extent of the amount of the sharing payment. Taking the examplein box 3.13, the borrower would be treated as having only paid A $0.5 million,and to remain indebted to A in the amount of $4.5 million. This, however, maybe contrary to the pari passu rule in an insolvency—that all debts must betreated pari passu.

� The lender which is obliged to make a sharing payment must do so by pur-chasing interests in the loan from the other lenders. The difficulty with this isthe need for documentation, which will need to be negotiated.

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Clause 28.4 Reversal of redistribution

This clause provides for the payments to be reversed if, after the sharing hasoccurred, the lender that had recovered more than the others is required to refundthat excess recovery to the borrower or other Obligor.

Given that some countries require rights of set off which have been exercisedshortly before an insolvency to be reversed on an insolvency, this is an importantprovision for the lender which originally had the extra recovery.

Clause 28.5 Exceptions

28.5 Exceptions(a) This Clause 28 shall not apply to the extent that the Recovering Finance Party would

not, after making any payment pursuant to this Clause, have a valid and enforceableclaim against the relevant Obligor.

(b) A Recovering Finance Party is not obliged to share with any other Finance Party anyamount which the Recovering Finance Party has received or recovered as a result oftaking legal or arbitration proceedings, if:(i) it notified that other Finance Party of the legal or arbitration proceedings; and

(ii) that other Finance Party had an opportunity to participate in those legal or arbi-tration proceedings but did not do so as soon as reasonably practicable havingreceived notice and did not take separate legal or arbitration proceedings.

The obligation to share additional recoveries does not apply if the result would bethat the lender which had the additional recovery would not have a valid claimagainst the borrower (e.g. pursuant to clause 28.3) after the sharing. It also does notapply if a lender recovered a greater percentage of its loan than other lenders as aresult of taking legal action (including amounts paid in settlement of that action)which others could have joined in but declined to do so. This exception is importantif the right of individual action referred to at clause 2.2(b) (p. 57) is to have any realvalue.


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CLAUSE 29: PAYMENT MECHANICS

Clause 29.1 Payments to the Agent

29.1 Payments to the Agent(a) On each date on which an Obligor or a Lender is required to make a payment under a

Finance Document, that Obligor or Lender shall make the same available to the Agent(unless a contrary indication appears in a Finance Document) for value on the duedate at the time and in such funds specified by the Agent as being customary at thetime for settlement of transactions in the relevant currency in the place of payment.

(b) Payment shall be made to such account in the principal financial centre of thecountry of that currency (or, in relation to euro, in a principal financial centre in aParticipating Member State or London) with such bank as the Agent specifies.

Clause 29 sets out the payment mechanics. Payments are to be made to the Agent inthe principal financial centre for the currency concerned (or in the case of Euro, inone of the principal financial centres or in London). This effectively passes exchangecontrol risk and risk of insolvency of intermediaries38 to the borrower.

The reference to ‘such funds as are customary’ refers to the practices in differentmarkets from time to time, for example, payments may be in federal funds in somemarkets or in CHIPS39 in others.

Clause 29.2 Distributions by the Agent

This clause provides for the Agent to distribute moneys received to the bankaccounts specified by the various parties, with at least five Business Days’ notice ofthe bank account details being required.

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Administration

38 Other than the Agent’s correspondent bank in the relevant country.39 See Goode “Commercial Law”, p. 464 for a discussion of payment systems.

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Clause 29.3 Distribution to an Obligor

This clause allows the Agent to use moneys which are owed to an Obligor under theagreement in settlement of any moneys due from that Obligor.

Clause 29.4 Clawback

29.4 Clawback(a) Where a sum is to be paid to the Agent under the Finance Documents for another

Party, the Agent is not obliged to pay that sum to that other Party (or to enter intoor perform any related exchange contract) until it has been able to establish to itssatisfaction that it has actually received that sum.

(b) If the Agent pays an amount to another Party and it proves to be the case that theAgent had not actually received that amount, then the Party to whom that amount(or the proceeds of any related exchange contract) was paid by the Agent shall ondemand refund the same to the Agent together with interest on that amount from thedate of payment to the date of receipt by the Agent, calculated by the Agent to reflectits cost of funds.

Clause 29.4 provides protection for the Agent if it disburses sums (e.g. to theborrower) on the assumption that all others will contribute when due and any party(e.g. a lender) fails to do so. In these circumstances the party which received thepayment must repay it to the Agent up to the amount of the missing contributionplus interest. This clause operates in both directions, that is, both for payments tothe borrower which are to be funded by the syndicate and for payments to thesyndicate which are to be funded by the borrower.

The clause does not oblige the Agent to make payments before they havereceived the corresponding sum. If they do so, they are in effect taking an additionalcredit risk on the recipient, that it will honour its obligations under this clause.

Clause 29.5 Partial payments

29.5 Partial payments(a) If the Agent receives a payment that is insufficient to discharge all the amounts then

due and payable by an Obligor under the Finance Documents, the Agent shall applythat payment towards the obligations of that Obligor under the Finance Documentsin the following order:(i) first, in or towards payment pro rata of any unpaid fees, costs and expenses of

the Agent under the Finance Documents;(ii) secondly, in or towards payment pro rata of any accrued interest, fee or

commission due but unpaid under this Agreement;(iii) thirdly, in or towards payment pro rata of any principal due but unpaid under

this Agreement; and(iv) fourthly, in or towards payment pro rata of any other sum due but unpaid under

the Finance Documents.

A D M I N I S T R AT I O N222

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(b) The Agent shall, if so directed by the Majority Lenders, vary the order set out inparagraphs (a)(ii) to (iv) above.

(c) Paragraphs (a) and (b) above will override any appropriation made by an Obligor.

Clause 29.5 deals with partial payments. It provides that where the borrower paysless than the full amount due, that payment will first pay the Agent’s fees, costs, andexpenses; then interest, other fees, and commission; then principal; then any othersums (e.g. broken funding). This clause prevents the borrower specifying how sucha payment is to be allocated (see Box 3.15).

C L A U S E 2 9 : PA Y M E N T M E C H A N I C S 223

40 See discussion of ‘Majority Lenders’ at the end of clause 1.1 in the context of a combined term loanand revolving credit facility on p. 52.

BOX 3.15

For example, lenders would not want a partial payment to be applied against principal(and therefore reduce the amount on which interest was chargeable) when interestremained outstanding, particularly in countries where there are restrictions on theability to charge interest on interest.

Comment Other lenders (e.g. a security trustee) who receive fees may wish to have theirfees and expenses in the first level, pro rata with the Agent. Lenders which have nospecial role may wish to have the Agent’s fees (as opposed to its expenses) dealt withat the second level, pro rata with interest. However, in vanilla transactions, marketpractice is for Agent’s fees to come out at the first level.

The clause provides that the order of application (excluding paragraph (i) pro-viding for the Agent’s fees and expenses to be paid first) may be amended by theMajority Lenders.

Comment The Majority Lender override may require adjustment in a combined facilitywhere the lenders may be different for the different facilities, so as to ensure the ordercannot be changed to the detriment of the lenders of one of the facilities.40

Clause 29.6 No set off by obligors

All payments to be made by an Obligor under the Finance Documents shall be calculatedand be made without (and free and clear of any deduction for) set off or counterclaim.

Clause 29.6 provides for payment to be made by the borrowers free of set off orcounterclaim. If the borrowers have a claim or debt due from any lender, they mustpursue their other remedies for that and not simply withhold payment under theloan agreement (which would cause the lender to incur additional costs in fundingthe amount withheld).

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Clause 29.10 Disruption to payment systems, etc.

Clause 29.10 provides an optional mechanism to deal with disruption topayment systems (defined to mean disruption to the payment system or financialmarkets or unavoidable systems error) and allows the Agent to bind the syndicatein relation to any payment arrangements which it agrees with the borrower to dealwith such an eventuality.

CLAUSE 30: SET OFF

A Finance Party may set off any matured obligation due from an Obligor under theFinance Documents (to the extent beneficially owned by that Finance Party) against anymatured obligation owed by that Finance Party to that Obligor, regardless of the place ofpayment, booking branch or currency of either obligation. If the obligations are indifferent currencies, the Finance Party may convert either obligation at a market rate ofexchange in its usual course of business for the purpose of the set-off.

Clause 30 gives the lenders a contractual right of set off. This is more extensive thanthe right of set off they would have in the absence of express provision if the bankaccount were in England. For example, it allows amounts due in different currenciesto be converted into the same currency to allow a set off.

CLAUSE 31: NOTICES

31.1 Communications in writingAny communication to be made under or in connection with the Finance Documentsshall be made in writing and, unless otherwise stated, may be made by fax or letter.

31.2 Addresses …

31.3 Delivery(a) Any communication or document made or delivered by one person to another under

or in connection with the Finance Documents will only be effective:(i) if by way of fax, when received in legible form; or

(ii) if by way of letter, when it has been left at the relevant address or [] BusinessDays after being deposited in the post postage prepaid in an envelope addressedto it at that address;

and, if a particular department or officer is specified as part of its address detailsprovided under Clause 31.2 (Addresses), if addressed to that department or officer.

(b) Any communication or document to be made or delivered to the Agent will beeffective only when actually received by the Agent and then only if it is expresslymarked for the attention of the department or officer identified with the Agent’ssignature below (or any substitute department or officer as the Agent shall specify forthis purpose).

(c) All notices from or to an Obligor shall be sent through the Agent.


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31.4 Notification of address and fax number …

31.5 Electronic communication(a) Any communication to be made between the Agent and a Lender under or in

connection with the Finance Documents may be made by electronic mail or otherelectronic means, if the Agent and the relevant Lender:(i) agree that, unless and until notified to the contrary, this is to be an accepted

form of communication;(ii) notify each other in writing of their electronic mail address and/or any other

information required to enable the sending and receipt of information by thatmeans; and

(iii) notify each other of any change to their address or any other such informationsupplied by them.

(b) Any electronic communication made between the Agent and a Lender will beeffective only when actually received in readable form and in the case of any elec-tronic communication made by a Lender to the Agent only if it is addressed in sucha manner as the Agent shall specify for this purpose.

31.6 English language … .

Clause 31 deals with notices. E-mail may be an acceptable form of communicationas between the lenders but is generally not accepted as between the Agent and theborrower. Particular care should be taken with any notices of default or accelerationto ensure they are delivered in accordance with this clause.

It is also sensible to ensure that if other documents are involved in the transac-tion (e.g. security documents) the notices clauses in those documents conformto this.

CLAUSE 32: CALCULATIONS AND CERTIFICATES

Clause 32.1 Accounts

32.1 AccountsIn any litigation or arbitration proceedings arising out of or in connection with a FinanceDocument, the entries made in the accounts maintained by a Finance Party are primafade evidence of the matters to which they relate.

As far as English law is concerned, there is no need to have a promissory note toevidence the debt and market practice is not to require notes (see Box 3.16 on p. 226).

Clause 32.2 Certificates and determinations

32.2 Certificates and DeterminationsAny certification or determination by a Finance Party of a rate or amount under anyFinance Document is, in the absence of manifest error, conclusive evidence of the mattersto which it relates.

C L A U S E 3 2 : C A L C U L AT I O N S A N D C E R T I F I C AT E S 225

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This clause is self-explanatory. Nevertheless, evidence which is conclusive underthe agreement may not be accepted as such in court.

Clause 32.3 Day count convention

32.3 Day count conventionAny interest, commission or fee accruing under a Finance Document will accrue fromday to day and is calculated on the basis of the actual number of days elapsed and a yearof 360 days or, in any case where the practice in the Relevant Interbank Market differs, inaccordance with that market practice.

The 360-day year convention matches the currency markets for most currencies(see Box 3.17). Some currencies (e.g. Sterling) work on a 365-day year. Regulationsin some countries require the annual (i.e. on the basis of a 365-day year) interest rateto be specified. In this case the interest would still be calculated in accordance withthe convention in the relevant currency market but there would need to be furtherdescription in the agreement converting the interest rate to a 365-day basis.


41 However, Lee Buchheit, How to Negotiate Eurocurrency Loan Agreements, 2nd edition, p. 150 indicates thatloans without notes can also be accepted.

42 Questions may arise under English law as to whether a promissory note which relates to a floatingrate of interest would benefit from this advantage because of the requirement that a promissory noteshould contain a certain and unconditional payment obligation. Nevertheless, it is thought that, even ifthe promissory note relates to a floating rate of interest, it will benefit from the advantages of negotiableinstruments as a result of commercial usage—see Goode Commercial Law, pp. 481, 570.

BOX 3.16

Promissory notes are often found in loans with US lenders. There are two main reasonsfor requiring notes:

� Loans supported by notes could be used as collateral for loans from the FederalReserve Banks.41

� Notes may give a procedural advantage in terms of enforcement since they arecontracts quite distinct from the underlying arrangement and courts are reluctant toallow the debtor to raise a defence based on the underlying arrangement.42

BOX 3.17

The effect of the convention is to marginally change the interest calculation byassuming that there are only 360 days in a year. So, to calculate 30 days’ interest on$3 million, the calculation is $3 million � 30/360 (not $3 million � 30/365 as onemight expect).

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CLAUSE 33: PARTIAL INVALIDITY43

If, at any time, any provision of the Finance Documents is or becomes illegal, invalidor unenforceable in any respect under any law of any jurisdiction, neither the legality,validity or enforceability of the remaining provisions nor the legality, validity or enforce-ability of such provision under the law of any other jurisdiction will in any way beaffected or impaired.

This clause is self-explanatory.

CLAUSE 34: REMEDIES AND WAIVERS

No failure to exercise, nor any delay in exercising, on the part of any Finance Party,any right or remedy under the Finance Documents shall operate as a waiver, norshall any single or partial exercise of any right or remedy prevent any further or otherexercise or the exercise of any other right or remedy. The rights and remedies providedin this Agreement are cumulative and not exclusive of any rights or remedies providedby law.

Clause 34 addresses the issues of waiver and estoppel.44 In the principal case45 LordCairns said that if one party leads another ‘to suppose that the strict rights arisingunder the contract will not be enforced, or will be kept in suspense or held inabeyance, the person who otherwise might have enforced those rights will not beallowed to enforce them where it would be inequitable having regard to the dealingswhich have thus taken place between the parties’.

The main concern in relation to a loan is that, following a default, the lendersmay lead the borrower to believe that they do not intend to exercise their rightsand, ultimately, they may be held to have waived the rights or be estopped fromexercising them. This clause provides that that will not happen.

Nevertheless, the clause will be read contra proferentem and should not berelied on to be effective in the circumstances of any given case. If the borrowerdefaults and the lenders do not plan to exercise their rights immediately, theyshould write to the borrower advising that they are reserving their rights to beexercised as they see fit in the future.

C L A U S E 3 4 : R E M E D I E S A N D W A I V E R S 227

43 A provision may only be severed under English law if it passes the ‘blue pencil test’ set out inGoldsoll v Goldman (1915) 1 Ch 292, which requires that the rest of the contract must be able to stand ifthe offending part is simply deleted.

44 For further detail see Treitel The Law of Contract, p. 102 et seq.45 Hughes v Metropolitan Ry (1877) 2 App Cas 439.

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CLAUSE 35: AMENDMENTS AND WAIVERS

35.1 Required consents(a) Subject to Clause 35.2 (Exceptions) any term of the Finance Documents may be

amended or waived only with the consent of the Majority Lenders and the Obligorsand any such amendment or waiver will be binding on all Parties.

(b) The Agent may effect, on behalf of any Finance Party, any amendment or waiverpermitted by this Clause.

35.2 Exceptions(a) An amendment or waiver that has the effect of changing or which relates to:

(i) the definition of ‘Majority Lenders’ in Clause 1.1 (Definitions);(ii) an extension to the date of payment of any amount under the Finance

Documents;(iii) a reduction in the Margin or a reduction in the amount of any payment of prin-

cipal, interest, fees or commission payable;(iv) an increase in or an extension of any Commitment;(v) a change to the Borrowers or Guarantors other than in accordance with Clause 25

(Changes to the Obligors);(vi) any provision which expressly requires the consent of all the Lenders;

(vii) Clause 2.2 (Finance Parties’ rights and obligations), Clause 24 (Changes to theLenders) or this Clause 35; or

(viii) [] shall not be made without the prior consent of all the Lenders.

(b) An amendment or waiver which relates to the rights or obligations of the Agent or theArranger may not be effected without the consent of the Agent or the Arranger.

Clause 35 regulates the level of consent between lenders required for amendment orwaiver of provisions of the documents. The general provision is that Majority Lender46

consent is required to amend or waive. However, consent of all lenders is needed forcertain issues—generally the key issues which will have been subject to credit com-mittee approval. These are set out in clause 35.2. They include the margin, interest, fees,commission, and so on; the loan amount; the drawdown period; the due dates forpayment (see Box 3.18) the definition of Majority Lenders; and clause 35.2 itself.


46 See discussion of ‘Majority Lenders’ at the end of clause 1.1 on p. 52 in the context of a combined termloan and revolving credit facility.

BOX 3.18

It is important that alterations to the due dates for payment cannot be made withoutthe consent of all lenders as otherwise the rights of individual lenders discussed atclause 2.2 would be illusory. Similarly, a clause saying that due dates can only bechanged with the consent of all lenders will be of little comfort if individual lenderscan only take action to recover their debt with the approval of Majority Lenders.

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� the guarantee clause;

� the pro rata sharing clause;

� release of security; and

� any particular conditions precedent which are key such as any relating to security.

C L A U S E 3 6 : C O U N T E R PA R T S 229

Comment Lenders need to consider whether any other issues should requireunanimous approval to change. This may include:

Comment The borrower may also consider requesting that a provision be included tothe effect that, in relation to any requests for consent which the borrower may makeunder the loan agreement, a lender is treated as giving consent if it does not respondto the request within a specified time. This would address the concern that someborrowers may have that, if the facility is widely syndicated, some transferees maynot respond to requests. A non-response has the same effect as a no vote, since gen-erally, where consent is sought, the requirement is to obtain consent from whateverconstitutes ‘Majority Lenders’.

CLAUSE 36: COUNTERPARTS

Clause 36 allows the agreement to be executed in counterparts. In this case, theAgent’s lawyer will produce a conformed copy which indicates the signatories.

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CLAUSE 37: GOVERNING LAW

This Agreement is governed by English47 law.

Lenders commonly require loan agreements for large sums of money to begoverned by English or New York law. This generally makes syndication of verylarge sums of money easier than many other governing laws because the marketcustomarily deals in agreements under English or New York law. Another factor isthe predictability of these laws. They respect freedom of contract to a large extentand are reluctant to interfere in negotiated agreements, making for a fair degree ofcertainty in relation to the effect of the agreement.

The ability of a party to choose the law which applies to a contract may be limitedand this is an issue for due diligence. Many countries disallow a choice of law if it ismade in order to avoid a mandatory provision of the law which would otherwiseapply. Others require there to be some connection between the transaction and thelaw chosen.48

CLAUSE 38: ENFORCEMENT

Clause 38.1 Jurisdiction

38.1 Jurisdiction of English courts(a) The courts of England have exclusive jurisdiction to settle any dispute arising out of

or in connection with this Agreement (including a dispute regarding the existence,validity or termination of this Agreement) (a ‘Dispute’).

230

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Governing Law and Enforcement

47 Incidentally there is no such thing as UK or British law. Technically it is the law of England and Wales.48 See discussions on Schedule 12.

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(b) The Parties agree that the courts of England are the most appropriate and convenientcourts to settle Disputes and accordingly no Party will argue to the contrary.

(c) This Clause 38.1 is for the benefit of the Finance Parties only. As a result, no FinanceParty shall be prevented from taking proceedings relating to a Dispute in any othercourts with jurisdiction. To the extent allowed by law, the Finance Parties may takeconcurrent proceedings in any number of jurisdictions.

Lenders commonly require borrowers to submit to the jurisdiction of the courts ofthe country of the chosen governing law. Clearly it makes sense, if English law hasbeen chosen as the governing law, to choose the English courts to settle disputes sothat they will be applying a law they are familiar with. English and New York courtsare also popular because of their expertise in dealing with this nature of transactionand because of the predictability of the results.

The submission to the jurisdiction is expressed (in clause 38.1(c)) to be for thebenefit of the lenders. The intention behind this wording (and its effect underEnglish law) is that the lenders should be entitled to take action in other countries,while the borrower should not. However, if the lenders seek to take action in a countryother than England, that country will apply its own law in interpreting the effect ofclause 38.1(c) and in deciding whether to accept jurisdiction.49

Lenders generally want the right to take action in other countries as well as thecourts specified as they may find, in practice, that it is simpler to start proceedingsdirectly in the country of the borrower or guarantor rather than obtaining anEnglish judgement which they will then need to enforce locally.

See Box 3.19 for the relevance of arbitration.

C L A U S E 3 8 : E N F O R C E M E N T 231

49 See comments on Schedule 1 of the LMA Term Loan, at para 1.2 on p. 235.50 This may be the case if the relevant country is party to international treaties as to reciprocal enforce-

ment of arbitration awards (the 1958 United Nations Convention on the Recognition and Enforcement ofForeign Arbitral Awards—the ‘New York Convention’).

BOX 3.19

WOULD ARBITRATION BE BETTER?

Arbitration is unusual for loan agreements. It may be considered in cases where thealternative is to use courts which are known to be slow, expensive, and/or unpre-dictable. It may also be considered if the due diligence unearths the fact that the coun-try where the borrower’s assets are located will not necessarily enforce a judgementgiven by the chosen court.50 In this event, it may be that an arbitration award would bemore effective than a court judgement, at least in relation to an unsecured loan.Whenever arbitration is considered as an alternative to the courts however, it willbe necessary to consider whether it will be necessary to have recourse to the courts inany event in order to enforce any security. In many jurisdictions, security can only beenforced with the assistance of the courts and/or the assistance of the courts may benecessary to enable the lenders to give good title to the property which is the subject ofthe security.

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Clause 38.2: Service of process

38.2 Service of processWithout prejudice to any other mode of service allowed under any relevant law, eachObligor (other than an Obligor incorporated in England and Wales):(a) irrevocably51 appoints [the Company] [] as its agent for service of process in relation

to any proceedings before the English courts in connection with any FinanceDocument; and

(b) agrees that failure by a process agent to notify the relevant Obligor of the process willnot invalidate the proceedings concerned.

English courts have discretion to serve proceedings on a party outside the jurisdic-tion. However, given that doing so is in the discretion of the courts, the lenderswill require non-English borrowers to appoint someone in England to accept serviceof any proceedings on their behalf. This will be a condition precedent to advance ofthe loan.

Some lenders do not like borrowers to appoint group members because ofthe risk of sale or dissolution, and prefer that the borrower use a third party whichspecializes in providing agents for service of proceedings as a commercial service.

G O V E R N I N G L A W A N D E N F O R C E M E N T232

51 Even though the clause states that the appointment is irrevocable, it is clear that (except in the specialcase of an appointment of an agent coupled with an interest), an agent’s appointment may be revoked bythe principal.

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SCHEDULE 1: PARTIES

Schedule 1 specifies the parties.

SCHEDULE 2: CONDITIONS PRECEDENT

1. Part I Conditions precedent to initial utilization

For the original borrowers, the conditions precedent set out in the LMA Term Loanconsist of

� corporate documents;

� legal opinions; and

� other.

1.1 Corporate documents

Conditions (a) and (b)(a) A copy of the constitutional documents of each Original Obligor.(b) A copy of a resolution of the board of directors of each Original Obligor:

(i) approving the terms of, and the transactions contemplated by, the FinanceDocuments to which it is a party and resolving that it execute the FinanceDocuments to which it is a party;

(ii) authorising a specified person or persons to execute the Finance Documents towhich it is a party on its behalf; and

233

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Schedules

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(iii) authorising a specified person or persons, on its behalf, to sign and/or despatch alldocuments and notices (including, if relevant, any Utilisation Request and SelectionNotice) to be signed and/or despatched by it under or in connection with the FinanceDocuments to which it is a party.

It is normal to require copies of the constitutional documents and of board resolutionsof the Obligors despite the provisions of section 35(A) Companies Act 1985,52 aslenders do not want to be involved in unauthorized transactions. The resolutionswill, of course, need to have been made in accordance with the company’s constitu-tion, including such matters as quorum, notice of meeting, and declaration ofdirectors’ interests.

Conditions (c) and (d)(c) A specimen of the signature of each person authorised by the resolution referred to in

paragraph (b) above.[(d) A copy of a resolution signed by all the holders of the issued shares in each Original

Guarantor, approving the terms of, and the transactions contemplated by, theFinance Documents to which the Original Guarantor is a party.]

A shareholders’ resolution from the shareholders in the guarantors will be requiredif there are concerns as to breach of directors duties; see para 2.1 of section 3 ofAppendix 1 on p. 284. Such a resolution will not assist if the company was insolventat the time of, or as a result of, the guarantee (not least because the question of trans-action at an undervalue will be relevant in those circumstances).

Condition (e)(e) A certificate of the Company (signed by a director) confirming that borrowing

or guaranteeing, as appropriate, the Total Commitments would not cause anyborrowing, guaranteeing or similar limit binding on any Original Obligor to beexceeded.

It is not unusual for the powers of the directors to authorize borrowings orguarantees to be limited by the company’s constitution, sometimes with reference tomatters which are not a matter of public record. This condition precedent addressesthis issue.

Condition (f)(f ) A certificate of an authorised signatory of the relevant Original Obligor certifying

that each copy document relating to it specified in this Part I of Schedule 2 is correct,complete and in full force and effect as at a date no earlier than the date of thisAgreement.

S C H E D U L E S234

52 Which reads ‘In favour of a person dealing with a company in good faith, the power of the board ofdirectors to bind the company or to authorise others to do so shall be deemed to be free of any limitationunder the company’s constitution.’

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1.2 Legal opinions

2. Legal opinions(a) A legal opinion of [], legal advisers to the Arranger and the Agent in England,

substantially in the form distributed to the Original Lenders prior to signing thisAgreement.

(b) If an Original Obligor is incorporated in a jurisdiction other than England andWales, a legal opinion of the legal advisers to [the Arranger and the Agent] in therelevant jurisdiction, substantially in the form distributed to the Original Lendersprior to signing this Agreement.

The LMA Term Loan provides for legal opinions to be obtained from Englishlawyers, because that is the governing law of the agreement, and from lawyers fromthe countries in which Original Obligors are incorporated, because that law willgovern issues such as how the documents are authorized and, assuming that theplace of incorporation is also the main place of business of the companies, will alsogovern issues relating to winding up and enforcement of judgements.

In many cases, lenders will need to consider asking for legal opinions in otherjurisdictions. This section looks at what countries are relevant for the purpose ofobtaining opinions, and at the question of who should give the opinions. In theinterests of convenience, this book includes a commentary on the form of a legalopinion at Schedule 12.

Where should the lenders consider asking for legal opinions?The form of legal opinion(s) required in any given transaction and the countriesfrom which they will be required will be determined by the Agent in consultationwith their lawyers. The decision will be made on the basis of

� a conflict of law analysis by the lawyers: which laws may be relevant to whichaspects of the transaction; and

� a cost–benefit analysis by the Agent—in the context of the transaction and ofpotential risks, is the benefit of due diligence in each potentially relevant countrysufficiently important to justify the cost of obtaining it?

Lenders need to consider all countries which may have an impact on the enforce-ability of the borrower’s obligations to repay the loan and of any security given, todecide whether to obtain legal opinions in those countries.

This will include the following (many of which may be the same single countryin any given transaction).

� The country of the law (the ‘proper law’) chosen (clause 37 of the LMA TermLoan) to govern the agreement (or any associated documents).

� The country of the courts chosen (clause 38 of the LMA Term Loan) by the partiesto have jurisdiction to deal with disputes under the agreement (usually the sameas the proper law).

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� The country in which any relevant party may undergo a winding up procedure(because insolvency laws such as clawback of transactions are usually governedby the law in the place of the winding up).53

� The country in which any assets are located which are the subject of security. Thisis because enforcement of rights resulting from security will take place in thecountry where the security is. The courts in that country will apply their ownlaws, and their own rules on conflict of law, to determine disputes relating toownership of that property.

� The country in which any judgement obtained from the chosen courts needs tobe enforced. This is because a judgement from the chosen court may be worthlessif it will not be enforced (e.g. because it is contrary to public policy) by localcourts against the borrower’s assets.

� Any other country whose courts might hear a dispute relating to the agreement(see Box 3.20). This is because the choice of law clause and the choice of jurisdic-tion clause are each only as good as the courts in which a dispute is heard decide.


53 This may be the country of incorporation but may also include other countries where the borrowerconducts business. EC countries will wind up companies in the country in which they have their ‘centre ofmain interests’ (EC Regulation on Insolvency Proceedings—Regulation 1346/2000). There is a rebuttablepresumption (Article 3.1) that the main centre of interests is the place of incorporation. There have been anumber of cases where the identification of the centre of main interests has been an issue—see for exampleShierson v Vlieland-Boddy (2004) EWHC2752 (Ch).

BOX 3.20

It is of course impossible to predict what courts a dispute may be taken to. The functionof the jurisdiction clause in the loan agreement is therefore not only to try to ensurethat the chosen courts do accept jurisdiction but also to try to persuade other courtsnot to do so. The courts of many countries will not accept jurisdiction in breach of anexclusive jurisdiction clause.

BOX 3.21

For example, under English law, the general position is that laws relating to, for example,incorporation, corporate procedures, and authorization are governed by the law of theplace of incorporation.

� Those countries which, in accordance with the law chosen to govern the agree-ment, will govern other aspects of the transaction (see Box 3.21).

� Where other contracts are relevant to the transaction such as a sale agreement,construction contract, or other, the countries which are relevant for the purposesof that contract may also have to be investigated. This will include all the placeslisted above (proper law, place of jurisdiction, place of winding up, location ofassets, place of enforcement of judgements, etc.) in relation to the given contractand counterparty as well as the place in which the contract is to be performed.

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Clearly, in many cases, taking legal advice from all potentially relevant jurisdictionswould be prohibitively expensive, and lenders and their advisers will need to makeinformed decisions on where to seek advice. See para 1.2 of the commentary onSchedule 12 on p. 248.

Who to take advice fromA legal opinion is only an opinion. Its value depends on the expertise of the lawyergiving it. The choice of lawyer is of course very important. It is also important thatthe lawyer is adequately insured!

Advice from the borrower’s in-house counsel is helpful in relation to factualissues which external lawyers would be unable to confirm (e.g. as to no breach ofother contracts). However, generally lenders will require an opinion of externallawyers, mostly because of their independence from the borrower.

1.3 Other conditions precedent

3. Other documents and evidence(a) Evidence that any process agent referred to in Clause 38.2 (Service of process), if not

an Original Obligor, has accepted its appointment.(b) A copy of any other Authorisation or other document, opinion or assurance which the

Agent considers to be necessary or desirable (if it has notified the Company accord-ingly) in connection with the entry into and performance of the transactions contem-plated by any Finance Document or for the validity and enforceability of any FinanceDocument.

(c) The Original Financial Statements of each Original Obligor.(d) Evidence that the fees, costs and expenses then due from the Company pursuant to

Clause 12 (Fees) and Clause 17 (Costs and expenses) have been paid or will be paidby the first Utilisation Date.

The other conditions precedent required by the LMA Term Loan are

� an acceptance by the person appointed to accept service of legal proceedings inthe English courts (see clause 38.2);

� delivery of the Original Financial Statements; and

� payment of fees and expenses.

In most cases additional conditions precedent will be required reflecting the creditdecision, as discussed in Section 2 of the comments on clause 22.

2. Part II Conditions Precedent To Additional Obligors

Part IIConditions precedent required to be delivered by an Additional Obligor1. An Accession Letter, duly executed by the Additional Obligor and the Company.2. A copy of the constitutional documents of the Additional Obligor.


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3. A copy of a resolution of the board of directors of the Additional Obligor(a) approving the terms of, and the transactions contemplated by, the Accession

Letter and the Finance Documents and resolving that it execute the AccessionLetter;

(b) authorising a specified person or persons to execute the Accession Letter on itsbehalf; and

(c) authorising a specified person or persons, on its behalf, to sign and/or despatch allother documents and notices (including, in relation to an Additional Borrower,any Utilisation Request or Selection Notice) to be signed and/or despatched by itunder or in connection with the Finance Documents.

4. A specimen of the signature of each person authorised by the resolution referred to inparagraph 3 above.

5. [A copy of a resolution signed by all the holders of the issued shares of the AdditionalGuarantor, approving the terms of, and the transactions contemplated by, theFinance Documents to which the Additional Guarantor is a party.]

6. A certificate of the Additional Obligor (signed by a director) confirming thatborrowing or guaranteeing, as appropriate, the Total Commitments would not causeany borrowing, guaranteeing or similar limit binding on it to be exceeded.

7. A certificate of an authorised signatory of the Additional Obligor certifying that eachcopy document listed in this Part II of Schedule 2 is correct, complete and in full forceand effect as at a date no earlier than the date of the Accession Letter.

8. A copy of any other Authorisation or other document, opinion or assurance whichthe Agent considers to be necessary or desirable in connection with the entry intoand performance of the transactions contemplated by the Accession Letter or for thevalidity and enforceability of any Finance Document.

9. If available, the latest audited financial statements of the Additional Obligor.10. A legal opinion of [], legal advisers to the Arranger and the Agent in England.11. If the Additional Obligor is incorporated in a jurisdiction other than England and

Wales, a legal opinion of the legal advisers to the Arranger and the Agent in thejurisdiction in which the Additional Obligor is incorporated.

12. If the proposed Additional Obligor is incorporated in a jurisdiction other thanEngland and Wales, evidence that the process agent specified in Clause 38.2 (Serviceof process), if not an Obligor, has accepted its appointment in relation to the proposedAdditional Obligor.

The key conditions precedent to future Obligors are

� the delivery of an accession letter;54 and

� the corporate authorities, legal opinions,55 financial statements, and processagent letter relating to the new obligor.


54 See Schedule 6.55 See comments on clause 25.2.

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3. Conditions precedent In other commercial circumstances

3.1 Conditions precedent in asset finance

In an asset finance transaction, because some conditions, such as those relating tosecurity over the asset being acquired, cannot be satisfied before the loan isadvanced there will be two sets of conditions precedent

� those which are to be satisfied on or before the time of the drawdown notice(as with a corporate transaction);

� those (e.g. the mortgage) which are to be satisfied on drawdown.

The first set will generally include approval of insurances and delivery of a copyof the purchase contract in addition to the conditions precedent normallyrequired for a corporate loan. For the sake of practicalities, the legal opinions willoften be delayed and will form part of the second set of conditions (to enable theopinions to cover the mortgage issues). However, the lender’s lawyer will usu-ally agree the form of legal opinion with the relevant lawyers before the loanagreement is signed.The additional conditions precedent applicable on drawdown will include

� Experts’ reports (e.g. environmental and/or safety issues and reports on theinsurances);

� evidence of ownership and registration of the asset;

� delivery (and registration as needed) of the security documents;

� evidence of the state of repair of the asset; and

� evidence of all consents, etc. needed for operation of the asset.

The moneys will be advanced direct to the seller and/or the seller’s mortgagee.The agreement should provide for the conditions precedent to be satisfied by a spe-cific time of day on the drawdown date, to ensure that they are satisfied in suffi-cient time to enable the lenders to authorize payment. See also Box 3.22 on p. 240.

3.2 Conditions precedent in project finance

In a project finance transaction there will be at least two different circumstancesin which conditions precedent will be required: the first drawdown, and subse-quent drawdowns. There may be an additional requirement for conditionsprecedent (e.g. to the release of certain guarantees or security which apply dur-ing the construction period only) to be satisfied once construction is completeand the project moves into the operational phase.

Conditions precedent to first drawingThese will include similar documents and facts to those required in a corporatetransaction (corporate authorities, process agent’s letter, legal opinions, specimen

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BOX 3.22

Given that some conditions precedent to drawdown (e.g. the mortgage) cannot besatisfied until after the moneys have been drawn, and the lenders will not want toadvance until the conditions are satisfied, the parties will need to agree how this issueis to be resolved.

One solution is to use a ‘payment letter’. The lender tables a letter irrevocablyundertaking to pay the relevant amount, for value on that day to the seller’s account.The seller will exchange the title document for this payment letter. Of course the lenderwill not proffer the payment letter for exchange until it is satisfied that:

� all conditions precedent to the loan (other than the title document and the mort-gage) are in order; and

� the original title document and mortgage are acceptable (and, if applicable, areacceptable for registration in any relevant registry).

This solution relies on the seller (and its banker) accepting the credit risk of thelending bank.

signatures plus a requirement that there is no Default and that RepeatingRepresentations are true).

In addition there will be other conditions precedent, such as,

� All contracts necessary for the project (such as a construction agreement, off-take agreement, concession agreement, shareholders’ agreement, and anysupply contract) must have been signed and become effective.

� All financing documents (such as funding commitments from other lenders andshareholders, intercreditor arrangements and security sharing arrangements)must have become effective.

� All security must have been constituted and perfected.

� All necessary consents and licenses must have been obtained.

� The insurance must be in place and have been approved by the lenders.

� Auditors must have been authorized to communicate directly with the lenders.

� The financing plan (containing budgets and assumptions of income) must havebeen agreed.

Conditions precedent to subsequent drawingsThese may include (as well as a requirement that there is no Default) such issues as

� confirmation of completion of a particular stage of construction of the project;

� updating of the assumptions in the financing plan and compliance with finan-cial ratios (possibly more strict than those which justify acceleration);

� injection by other lenders and shareholders of a specified amount of funds.

� evidence that the relevant funds are required for the project.

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S C H E D U L E 4 : M A N D AT O R Y C O S T F O R M U L A 241

56 See clause 6.

Comment Some borrowers may request that the Mandatory Cost should be calculatedby reference to the Mandatory Cost applicable to certain specified Reference Banks,in the interests of certainty and avoiding changes in this cost as the syndicate

SCHEDULE 3: REQUESTS

Schedule 3Schedule 3 sets out the form of various notices to be given by the borrower.

Part 1—Utilization request

This specifies the date, currency, amount, and interest period for the drawing as wellas the account to be credited. It also confirms the factual conditions precedent set outin clause 4.2 (no Default and all Repeating Representations are true). The main pur-pose of this is to ensure that the borrower considers these issues at the time of draw-ing so that it does not issue a drawdown request if these statements are untrue.

Part 2—Selection notice

This selects the interest period for a loan (after its initial advance) and specifies anyrequired change of currency. As with the utilization request, if there is to be a changeof currency, the form requires the borrower to confirm the factual conditions prece-dent (no Default and Repeating Representations true). This is because a change ofcurrency can result in the lender advancing additional funds to the borrower.56

SCHEDULE 4: MANDATORY COST FORMULA

Schedule 4 is for the insertion of the current LMA wording for the calculation ofthe Mandatory Cost. This is the cost to the lenders of compliance with any relevantliquidity requirement applicable to lenders in the jurisdiction of their Facility Office,or of mandatory fees payable by lenders in that jurisdiction, to the extent that thatcost is attributable to the loan in question. The amount of this cost is set by theregulatory authorities in the location of each lender’s lending office. The lenders

The funds will be paid to a Disbursement Account and only available for drawingfrom that account on production of invoices or other evidence of their utilization.

Conditions precedent to release of security on completion of constructionThis will include confirmation from an expert that the project is in all respectsready for operation.

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will advise the Agent of this cost. The formula should allow for the possibility ofchanges in the calculation resulting from a change in the make up of the lenders.In some markets the practice is to absorb these costs in the Margin and only to chargethe borrower (under the increased costs clause) if there is a change in the cost.

SCHEDULE 5: FORM OF TRANSFER CERTIFICATE

Schedule 5 sets out the form of transfer certificate.This document is used to transfer interests in the loan to new lenders. It confirms

� relevant contact details;

� tax status for the purpose of withholding tax (if applicable);

� the limitation on the seller’s responsibility to the purchaser in respect of the loaninterest purchased; and

� details of the amount transferred and the effective date of the transfer.

It is signed by the seller, buyer and Agent and, under the LMA Term Loan, takeseffect as a novation. There will be an additional document between the partiesdetailing issues such as apportionment of interest.

FORM OF TRANSFER CERTIFICATESPart I

To: [ ] as AgentFrom: [The Existing Lender] (the ‘Existing Lender’) and [The New Lender] (the “New

Lender”) Dated:

[Company]-[ ] Facility Agreement dated [ ] (the “Agreement”)

1. We refer to the Agreement. This is a Transfer Certificate. Terms defined in theAgreement have the same meaning in this Transfer Certificate unless given a differentmeaning in this Transfer Certificate.

2. We refer to Clause 24.5 (Procedure for transfer):(a) The Existing Lender and the New Lender agree to the Existing Lender transferring

to the New Lender by novation all or part of the Existing Lender’s Commitment,rights and obligations referred to in the Schedule in accordance with Clause 24.5(Procedure for transfer).

(b) The proposed Transfer Date is [ ].(c) The Facility Office and address, fax number and attention details for notices of the

New Lender for the purposes of Clause 31.2 (Addresses) are set out in theSchedule.


changes. This would, of course, mean that syndicate members may find that theirown costs were not accurately compensated for by the calculation.

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3. The New Lender expressly acknowledges the limitations on the Existing Lender’sobligations set out in paragraph (c) of Clause 24.4 (Limitation of responsibility ofExisting Lenders).

[4.] The New Lender confirms that the person beneficially entitled to interest payable tothat Lender in respect of an advance under a Finance Document is either:a) a company resident in the United Kingdom, for United Kingdom tax purposes; orb) a partnership each member of which is:

i) a company so resident in the United Kingdom; orii) a company not so resident in the United Kingdom which carries on a trade

in the United Kingdom through a permanent establishment and whichbrings into account in computing its chargeable profits (for the purposes ofsection 11(2) of the Taxes Act) the whole of any share of interest payable inrespect of that advance that falls to it by reason of sections 114 and 115 of theTaxes Act; or

iii) a company not so resident in the United Kingdom which carries on a tradein the United Kingdom through a permanent establishment and whichbrings into account interest payable in respect of that advance in computingthe chargeable profits ( for the purposes of section 11(2) of the Taxes Act) ofthat company 57

[4/5] This Transfer Certificate may be executed in any number of counterparts and thishas the same effect as if the signatures on the counterparts were on a single copy ofthis Transfer Certificate.

[5/6] This Transfer Certificate is governed by English law.

THE SCHEDULECommitment/rights and obligations to be transferred

[insert relevant details][Facility Office address, fax number and attention details for notices and account

details for payments,][Existing Lender] [New Lender]

By: By:This Transfer Certificate is accepted by the Agent and the Transfer Date is

confirmed as [ ][Agent]

By:

SCHEDULE 6: ACCESSION LETTER

Schedule 6 sets out the form to be signed to add a borrower or guarantor.The letter simply has the new party:

S C H E D U L E 6 : A C C E S S I O N L E T T E R 243

57 This will be included if the new lender comes within sub paragraph (i)(B) of the definition ofQualifying Lender set out in Box 1.34 on p. 96.

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� agree to be bound by the agreement;

� confirm its country of incorporation; and

� provide contact details.

In the case of the addition of a guarantor, the document is effected by a deed toavoid consideration issues.58

SCHEDULE 6FORM OF ACCESSION LETTER

To: [ ] as AgentFrom: [Subsidiary] and [Company]Dated:Dear Sirs

[Company]-[ ] Facility Agreementdated [ ] (the ‘Agreement’)

1. We refer to the Agreement. This is an Accession Letter. Terms defined in theAgreement have the same meaning in this Accession Letter unless given a differentmeaning in this Accession Letter.

2. [Subsidiary] agrees to become an Additional [Borrower]/ [Guarantor] and to be boundby the terms of the Agreement as an Additional [Borrower]/[Guarantor] pursuant toClause [25.2 (Additional Borrowers)]/[Clause 25.4 (Additional Guarantors)] of theAgreement. [Subsidiary] is a company duly incorporated under the laws of [name ofrelevant jurisdiction].

3. [Subsidiary’s] administrative details are as follows:Address:Fax No:Attention:

4. This Accession Letter is governed by English law. [This Guarantor Accession Letteris entered into by deed.] [Company] [Subsidiary].

SCHEDULE 7: FORM OF RESIGNATION LETTER

Schedule 7 sets out the form to be signed by a borrower or guarantor which isceasing to be an Obligor under the agreement. As well as requesting release fromthe agreement, the Obligor confirms that no Default exists.

SCHEDULE 7FORM OF RESIGNATION LETTER

To: [ ] as AgentFrom: [resigning Obligor] and [Company]Dated:


58 See Appendix 1 for an explanation of deeds and consideration.

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Dear Sirs[Company]-[ ] Facility Agreement dated [ ] (the ‘Agreement’)

1. We refer to the Agreement. This is a Resignation Letter. Terms defined in theAgreement have the same meaning in this Resignation Letter unless given a differentmeaning in this Resignation Letter.

2. Pursuant to [Clause 25.3 (Resignation of a Borrower)] [Clause 25.6 (Resignation of aGuarantor), we request that [resigning Obligor] be released from its obligations as a[Borrower]/ [Guarantor] under the Agreement.

3. We confirm that:(a) no Default is continuing or would result from the acceptance of this request; and(b) [ ]*

4. This Resignation Letter is governed by English law.[Company] [Subsidiary]By:* Insert any other conditions required by the Facility Agreement.

SCHEDULE 8: FORM OF COMPLIANCE CERTIFICATE

Schedule 8 sets out the form of certificate to be signed to confirm compliance withspecified covenants in the agreement (such as the financial covenants inclause 21).

SCHEDULE 8FORM OF COMPLIANCE CERTIFICATE

To: [ ] as AgentFrom: [Company]Dated:Dear Sirs

[Company]-[ ] Facility Agreement dated [ ] (the Agreement)1. We refer to the Agreement. This is a Compliance Certificate. Terms defined in the

Agreement have the same meaning when used in this Compliance Certificate unlessgiven a different meaning in this Compliance Certificate.

2. We confirm that: [Insert details of covenants to be certified]3. [We confirm that no Default is continuing.] [If this statement cannot be made, the

certificate should identify any Default that is continuing and the steps, if any, beingtaken to remedy it.]

Signed:Director of [Company]Optional provisions are included here for Auditor Certification.

S C H E D U L E 8 : F O R M O F C O M P L I A N C E C E R T I F I C AT E 245

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SCHEDULE 9: EXISTING SECURITY

Schedule 9Schedule 9 is to list existing security for the purpose of the negative pledge.

SCHEDULE 10: FORM OF CONFIDENTIALITY UNDERTAKING

Schedule 10Schedule 10 is the form of confidentiality undertaking required from potentialinvestors in the loan.

The letter contains five principal undertakings:

� to keep ‘Confidential Information’ confidential;

� to use it only for a ‘Permitted Purpose’;

� to require those to whom such information is passed to also comply with the letter;

� not to make queries of the borrower’s group; and

� to return Confidential Information and destroy all records of it on request.

‘Confidential Information’ is information which is not publicly available and whichthe signatory of the letter did not already have. The ‘Permitted Purpose’ is theconsideration of buying an interest in the loan.

Confidential Information may be passed on to group members and their advisersfor the purpose of deciding whether to buy an interest in the loan; or to assignees ortransferees of an interest in the loan; or as required by law or regulatory body orStock Exchange.

For the letter to be enforceable there needs to be consideration for its issue. Thatis expressed to be the provision of the information. It is important that the letter issigned before the information is delivered, both for practical reasons and becauseotherwise, the consideration would be past, and therefore ineffective. See para 4.2 ofsection 1 of Appendix 1 on p. 266.

SCHEDULE 11: TIMETABLES

Schedule 11Schedule 11 sets out timings for notifications for requests for different currenciesand in different markets.

SCHEDULE 12: LEGAL OPINIONS

For the sake of convenience, the form of a legal opinion is discussed here as though it wasattached to the LMA Term Loan as Schedule 12.


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This commentary on legal opinions is not intended to be a comprehensive reviewof the subject,59 but rather an overview of the process and of the expectations ofthe parties involved. In particular, suggestions as to qualifications which may benecessary for certain opinions, and issues which need to be considered before anopinion can be given, are intended as examples only.

1 INTRODUCTION

1.1 The lawyers’ roles

The purpose of a legal opinion in a loan transaction is to ensure that the lenders areaware of the risks involved in that transaction and that those risks are kept to aminimum. It is the responsibility of the Agent’s lawyer to arrange the issue ofappropriate60 legal opinions.

The Agent’s lawyer’s role is not simply to request the correspondent lawyers toissue an opinion, but also to try to ensure that those lawyers address the issues andadvise of all potential problems. This can be a difficult task if the relevant countryhas laws which are completely different to those in the country of the Agent’slawyer. For example, the concept of overcollateralization61 (relevant, e.g. underGerman law) is unknown to lawyers in many other countries. As a result, unless thecoordinating lawyer happens to be aware of the overcollateralization concept, theyare unlikely to ask for advice on that topic.

To minimize the risk that the Agent’s lawyers will only raise queries on legalissues with which they are already familiar under their own law, the usual opinionobtained in the context of a loan financing addresses very broad principles whichshould, together, cover all potential issues.62

The risk remains that the coordinating lawyer and local lawyer may havedifferent understandings of the meaning of the opinions requested (e.g. did theyboth appreciate that the opinion on power—referred to at 2.3.2 below on p. 250—required confirmation that the transaction was within the company’s express powerrather than a confirmation given in reliance on protections given by law), or that thebreadth of the opinions requested will result in the local lawyer failing to givespecific advice.63 If those involved in agreeing legal opinions are aware of thesehazards, they are more easily avoided.

S C H E D U L E 1 2 : L E G A L O P I N I O N S 247

59 For which see Michael Gruson, Stephan Hutter, and Michael Kutchera, Legal Opinions in InternationalTransactions, 4th edition, 2003.

60 See comments on Schedule 2.61 The idea that security may be open to challenge if the value of the asset taken as security is substan-

tially greater than the amount secured.62 These general principles are: due incorporation and continued existence, power, authority, due

execution, no contravention of law or constitution, valid and enforceable obligations, effectiveness of secu-rity, no consents or filings needed, no unexpected tax consequences, choice of law and jurisdiction, andenforcement of judgements. Each of these topics is discussed in more detail in paragraph 2 below.

63 See, for example, the comments at para 2.4.1 below (p. 257).

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1.2 Cost effectiveness

The analysis below identifies a large number of jurisdictions64 which might be rele-vant for any given transaction as well as suggesting (see 2.4.1 on p. 257) that theopinion itself may not be sufficient advice and that further detailed advice may berequired. The intention is not to suggest that advice should always be sought in allpotentially relevant jurisdictions but rather to assist readers to decide, in the cir-cumstances of any case, where to seek legal advice and in relation to what issues.Readers should be aware that it is, in practice, often neither practical nor cost effec-tive to obtain legal opinions which cover all legal risks in a given transaction. Thedecision on where to seek advice and in what level of detail is one which must bemade by the lenders, with assistance from the Agent’s lawyer, in the light of thefacts of the particular transaction. For example, lenders may be content not to seekadvice in a particular country, or not to charge the borrower for the cost of suchadvice, on the basis that the lenders deal with that country regularly and are fullyaware of the legal implications in that country of transactions of this nature.Similarly, they may decide not to take advice in one of the borrower’s places of busi-ness as they do not anticipate any need to take legal action in that jurisdiction.

2 FORM OF OPINION

The advice obtained will often be encapsulated in a legal opinion. The usual form ofopinion is divided into

� the introduction

� the assumptions

� the opinions

� the qualifications.

2.1 Introduction

The introduction sets out the lawyer’s role in the transaction and specifies thedocuments reviewed.

We have acted as solicitors to the Agent in connection with a credit agreement dated [](the Credit Agreement) made between [] (the ‘Borrower’), the lenders party to the CreditAgreement and [] (the ‘Agent’). Terms defined in the Credit Agreement have the samemeaning in this letter.


64 Although the number of potentially relevant jurisdictions is usually more theoretical than real sincesome are alternatives and others overlap. For example, the place of business, the location of assets, and theplace of incorporation or seat of the company are often one and the same.

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We have examined the following documents. [This section will list the documentsreviewed which will usually be the Credit Agreement itself plus the appropriatecorporate authorities and any consents reviewed and searches of public recordswhich have been conducted]

and such other documents as we have deemed necessary as a basis for the opinions setout in this letter.

This section may also identify who is entitled to rely on the opinion. In a syndicatedloan, the opinion must be able to relied on not only by the lawyer’s client (that is theAgent), but also by all other syndicate members. This should preferably include notonly the original lenders but also future members of the syndicate, as this will givecomfort to future transferees and should therefore aid the liquidity of the facility inthe secondary market (see Box 3.23).


BOX 3.23

As a result, for each of the opinions stated, the opinion giver must consider its accuracyboth initially and, having regard to the method of transfer provided for in theagreement, also for future syndicate members. For example, if transfers are effected bynovation, will any consents which have been obtained for the original loan also beeffective in relation to the debts owed to new syndicate members?

2.2 Assumptions

We have made the following assumptions

The assumptions will cover issues which are outside the opinion of the lawyerssuch as

� that copies of documents supplied are complete and accurate;

� that signatures are genuine;

� that information provided by searches is up to date;

� that certain statements of corporate officers (e.g. as to the persons attendingboard meetings and the issue of notice of meeting and the like) are true.

The assumptions will also include relevant assumptions as to the effect of laws ofother countries.

2.3 Opinions

The opinions give the legal confirmations required. The opinions themselves mirror,to a large extent, the representations in the loan agreement. Adjustments to oneoften need also to be made to the other.

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The legal opinions will cover some or all of the points discussed here, and thosepoints will be addressed by the lawyer in the relevant jurisdiction, as identified bythe conflict of law analysis conducted by the Agent’s lawyer.65 For example, the dueincorporation opinion may be required from a different lawyer than the opinion onthe effectiveness of the security.

For each opinion discussed in the following paragraphs, it is discussed inrelation to the principal jurisdiction(s) from which that opinion is usually required.

2.3.1 Due incorporation and continued existence

We are of the opinion that the Borrower is a limited liability company, duly incorporatedand validly existing [in goodstanding] under [English] law.

This opinion will be required in the place of incorporation.66 Giving this opinioninvolves not only ensuring that the company is indeed a limited liability company,but also ensuring that no resolution for winding up (or similar in the relevantjurisdiction) has been passed nor has an administrator or similar officer beenappointed. In countries which have a concept of goodstanding (where, for example,failure to pay an annual registration tax may result in the company being struck offor its license to conduct business removed) the opinion will include confirmation ofgoodstanding.

2.3.2 Power

The execution, delivery and performance by the Borrower of the Credit Agreement arewithin the Borrower’s corporate powers.

This opinion will be required in the place of incorporation.67 Lenders want to besure that the transaction is specifically within the company’s power. They do notgenerally want to rely on protections (such as those in s35 Companies Act inEngland) for those dealing with companies where there is a problem with thecompany’s capacity (power) to enter into particular transactions. Hence, this opin-ion requires the lawyer to confirm that the transaction is within the company’spower.

2.3.3 Authority

The execution, delivery and performance by the Borrower of the Credit Agreement havebeen duly authorised by all necessary corporate action (if any)


65 See comments on Schedule 2.66 A company may also be subject of an insolvency process (such as an English administration) in

its place of business. For example, a company may be made the subject of a winding up procedure in theEC in the country where it has its ‘centre of main interests’, regardless of the place of incorporation of thecompany. This opinion may also therefore be required in those places.

67 In some cases the ‘seat’ of the company is the place which determines these issues.

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This opinion will be sought in the place of incorporation.68 The requirement isfor the lawyer to confirm that the company has complied with whatever proce-dures (such as holding a board meeting and associated issues e.g. notice of meet-ing, quorum, voting at the meeting, and disclosure of interests) as are necessaryto authorize the signing of the agreement and that the directors are not exceedingtheir powers in authorizing the transaction. In some cases there may be internal,non-public limits on the directors’ authority which do not affect third parties.Nevertheless, lenders will not wish to become involved in a transaction whichwas not properly authorized, so will usually require specific confirmation that thedirectors were authorized.69

2.3.4 Due execution

The documents have been duly executed by the Borrower

This opinion will be required in the place of incorporation at the minimum and isoften also required in the place of the proper law.70 The opinion requires the lawyerto confirm that all necessary signatures were obtained, all necessary formalitiesobserved (e.g. any requirement for witnesses or for initialling each page) and thatthose who signed the documents had authority to do so.

This opinion is a mix of fact and law and often involves considering legal issues ina number of places, including the place of execution as well as the place of incorpo-ration (or seat) and the place of the proper law.71 Assumptions will therefore beneeded in relation to the impact of those other laws and also as to relevantfactual issues, such as that the person who signed the document is the person heclaimed to be.72

2.3.5 No contravention of law or constitution

The execution, delivery and performance by the Borrower of the Credit Agreement do notcontravene any provision of [the Borrower’s constitutional documents] or any law rule orregulation applicable to the Borrower in [England].


68 Also relevant may be the place of the seat. Also, if a power of attorney has been used, an opinion willbe needed that the power of attorney itself has been duly authorized, and that it authorizes the executionof the documents. This may involve the place of the proper law of the agreements (in relation to the effec-tiveness of a power of attorney to authorize a given document) as well as the place of incorporation (inrelation to the authorization of the power of attorney itself).

69 This opinion usually involves a mix of fact and law and the opining lawyer may have to rely oncertificates from directors (such as a certificate confirming who attended at a board meeting or a certificateas to compliance with any non-public restrictions on the directors’ authority) and include an assumptionthat those certificates are accurate.

70 The proper law may impose requirements as to formalities, such as the English law requirement thata document which confers a power of attorney must be executed as a deed, with the formalities which thatnecessitates.

71 See Legal Opinions in International Transactions, pp. 137, 221.72 The lenders may obtain comfort on this by requiring notarization of the documents.

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This opinion is usually required in all places from which an opinion is sought.This opinion is required because some breaches of law may result in fines or othersanctions but not unenforceability of the documents. This opinion therefore supple-ments the enforceability opinion. It will be necessary for the lawyer giving this opin-ion to ascertain what regulatory authorities (e.g. authorities regulating the bankingand insurance businesses, or the offering of investments, etc.) the borrower’sbusiness, and the transactions contemplated by the loan agreement are subject to.73

Given that sanctions may be imposed in any country with which the loan, orthe borrower, is connected, this opinion should be sought (but excluding the refer-ence to constitutional documents, which will only be needed in the place ofincorporation or seat), in all countries in which an opinion is sought.

2.3.6 Valid and enforceable obligations

The agreement constitutes the legal, valid, binding and enforceable obligations of theBorrower under [English] law

This opinion will usually be required in the place of the proper law and, if different,the law of the country chosen to have jurisdiction. The lenders often also requireconfirmation from lawyers in the place of incorporation and/or business that theagreement will be enforceable against the borrower in those places.74

It is expected that the lawyer providing the opinion will consider all circumstancesin which the agreement or any clause of the agreement may not be enforceable asexpected. So if, for example, there is a risk of recharacterization75 or there may be aproblem enforcing the grossing-up clause, this should be stated (usually in thequalifications).

The opinion is only that the local court will give a remedy. Further details as tocosts, procedures, priorities and the likely time involved in any enforcement mayalso be needed. These issues are normally addressed in advice but not included inthe legal opinion itself.

A number of qualifications need to be made in relation to this opinion, forexample,76

� the bankruptcy qualification;77

� the equitable principles qualification;78


73 For example, might any aspect of the transaction, such as a swap, be regarded as insurance, or gam-bling, in the relevant jurisdiction, and therefore be subject to regulatory approval. Or might any activityconstitute insurance mediation for the purpose of the Insurance Mediation Directive (2002/92/EC).

74 This opinion from any place other than that of the proper law requires careful consideration of theconflict of law issues—see Legal Opinions in International Transactions, pp. 145–151, pp. 207–211, andpp. 222–228.

75 See Appendix 2.76 This in not a complete list. For example, some lawyers may wish to include a qualification that

specific performance is not available, or assumptions as to acceptance of jurisdiction—see further LegalOpinions in International Transactions.

77 See 2.4.1 below.78 See 2.4.2 below.

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� qualifications and/or assumptions as to all available defences which may beavailable to the borrower, such as mistake, commercial benefit, financial assis-tance, duress, fraud, or lapse of time;

� assumptions as to corporate existence, capacity, authority, and due execution(unless these are governed by the law of the country from which the opinion issought);

� qualifications in relation to any individual clause which may be unenforceablefor any reason not already covered by the other qualifications. So, for example,an English opinion will probably include qualifications as to the enforceability ofthe default interest clause,79 the severability clause,80 any clauses requiring theborrower to pay the lenders’ costs of enforcement,81 any clause stating that cer-tificates are conclusive,82 and the effectiveness of exclusion clauses.83

2.3.7 Effectiveness of security84

The security documents constitute legal, valid and enforceable security interests overthe property expressed to be the subject of the security documents and constitute validsecurity for the Outstanding Indebtedness.

This opinion will be sought in the place of the proper law85 of the security (notnecessarily the same as the proper law of the loan agreement).

The ability to give this opinion will depend on many factors including

� Whether it is possible under the proper law to create security over the assets inquestion (e.g. property which does not yet exist, intangible property, movableproperty, or property which has been mixed with, and cannot be separated from,other property such as oil in a pipeline).

� Whether it is possible under the proper law to create security for the type of lia-bility in question (e.g. as security for a future debt, such as might be constituted ifthe loan is transferred by novation, or is repaid and redrawn, as in a revolvingcredit or a multicurrency loan, or for a debt which is uncertain or fluctuates inamount).


79 Is it a penalty? See Treitel 11th edition, p. 999 et seq for a discussion on the law on penalties.80 E.g. clause 33 of the LMA Term Loan—on the basis that such a clause may not affect the basis

(outlined in Goldsoll v Goldman (1915) 1 Ch 292) on which a court will disregard (or “sever”) provisionsof a contract.

81 Since, in any legal proceedings, the court will make its own award on payment of costs.82 Such a clause will not necessarily make such certificates admissible in evidence.83 E.g. liability for fraud cannot be excluded, and exclusion clauses will be read contra proferentem—see

further Goode Commercial Law, p. 96.84 An opinion may be required as to the priority of the security as well as its effectiveness. Given the

different regimes affecting priority of security, the formulation of the opinion and appropriate assump-tions will be made on a case by case basis.

85 Other laws may be relevant depending on the type of asset over which security is being taken asdiscussed below.

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� Whether the security can be created in favour of that security holder (e.g. arethere restrictions on the identity of security holder or are there problems with acharge back86).

� Whether the security over the asset in question has been correctly established inaccordance with the requirements for creating security over that asset (e.g. arethere notification requirements, registration requirements, or formal require-ments, for example, as to delivery or as to the form in which such security mustbe created?) (see Box 3.24)


BOX 3.24

Where the security needs to be registered, that will be referred to here. There may be atiming issue if the security is to be registered after the opinion is to be given. In thatcase the Agent will usually rely on the lawyer (acting for the Agent, not the borrower)who is responsible for the registration to confirm that that will be done and that lawyerwill need to ensure they are in possession of everything which is necessary to ensurethat the registration will be effected.

� Whether the security has been correctly constituted so as to create security forthe debt in question (e.g. can the security be given to an Agent on behalf of thelenders or must it be given to the person to whom the debt is owed? If thesecured debt is repaid and redrawn, as in a revolving credit or, often, a multicur-rency agreement, or if it is novated, as in a loan transferred by novation, will thesecurity be discharged by the intermediate repayment or by the novation?)

� Whether there are any restrictions on the enforceability of the security, such as– overcollateralization issues;

– duties to prior mortgages;

– duties to give the borrower an opportunity to pay;

– other duties such as interference with contracts.

The opining lawyer will need to include all the assumptions and qualificationswhich are necessary for the enforceability opinion as well as any other assumptionsas necessary under the proper law, such as, in England, assumptions that the trans-actions do not involve unlawful financial assistance and that the lenders do nothave notice of any facts which could taint the security (such as knowledge that it iscreated in breach of the provisions of a negative pledge).

As with the enforceability opinion, the opining lawyer is expected to state if anyspecific provision of the security documents may not be enforceable as stated.

The opinion does not generally deal with issues such as

� how long enforcement might take;

� what it might cost;

86 Creating security in favour of A over a debt owed by A.

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� whether self help is available;

� the predictability of the courts; or

� any restrictions which may be imposed on the sale of the asset concerned inthe event of enforcement (e.g. restrictions on the identity of any purchaser orany requirement for consent, such as an export licence, before such sale canproceed).

The lawyer will be expected to advise on these issues either in the opinion orseparately.

Lenders need to be aware that the opinion is only that a remedy will be availablein the country of the proper law of the security and that it is subject to the insol-vency qualification. It gives no comfort as to enforceability of the security any-where other than in the country of the proper law (e.g. with security over moveableproperty or over a chose in action which may need to be enforced in other juris-dictions). Lenders and their coordinating lawyers also need to consider the cir-cumstances in which an insolvency of any person could have an impact. Forexample,

� If the borrower becomes insolvent, in what circumstances might the security beset aside (e.g. transactions at an undervalue if the borrower is English)?

� If security is taken over rights under a contract, will that security be recognizedin an insolvency of the parties to the contract?

2.3.8 No consents or filings needed

No authorisation or approval (including exchange control approval) or other actionby, and no notice to or filing with, any government, administrative authority or court isrequired for the due execution, delivery and performance by the Borrower of its obliga-tions under the Credit Agreement except for [] [which has been effected].

This opinion is usually required in all places from which an opinion is sought. Thisopinion is required because some absences of approval may result in fines or othersanctions but not unenforceability of the documents. This opinion therefore sup-plements the enforceability opinion. It will be necessary for the lawyer giving thisopinion to determine whether any aspects of the transaction may require approvalsor filings and also to ascertain what regulatory authorities the borrower’s businessis subject to that may result in a need for approvals. The lawyer will also beexpected to consider the effect on any necessary consents etc of any intermediatepayment of the loan, as in a revolving credit or multicurrency loan, or any transferof the loan by novation. Will the relevant consent apply to all future advances andall novated loans or will it fall away as a result of the intermediate payment ornovation?

Given that sanctions may be imposed in any country with which the loan, or theborrower, is connected, this opinion is usually sought in all countries in which anopinion is sought.


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2.3.9 No unexpected tax consequences

There is no tax imposed by [the Borrower’s country] or any taxing authority thereofeither (i) on or by virtue of the execution of the documents or (ii) on any payments to bemade by the Borrower pursuant to the documents and neither the Agent nor any of theLenders is or will be resident or subject to taxation in [the Borrower’s country] by reasononly of the execution, delivery performance or enforcement of the documents.

There may be tax consequences (in addition to the normal corporation tax issues ofthe lender and the borrower) in the place of execution (e.g. stamp tax), any place fromwhich payment is to be made (e.g. withholding tax), or from which payment may bemade, for example, under a guarantee (e.g. deemed tax residence of lender), as well asin any other country with which the loan, or the borrower, is connected. This opinionis therefore usually required in all places from which an opinion is sought.

2.3.10 Choice of law and jurisdiction

The choice of [English] law to govern the documents and the submission to thejurisdiction of the [English] courts are valid under the law of [the country chosen to havejurisdiction] [the borrower’s country].

This opinion is usually sought in the place of the courts chosen to have jurisdiction(probably the same as the proper law) as well as in the country of incorporation. Thelenders will wish to be satisfied that (all else being equal87) the country chosen tohave jurisdiction will accept jurisdiction and will apply the chosen law.

The lenders may also want lawyers in the country of incorporation to confirmthat the choice of law and jurisdiction is valid from their perspective. For example, theywant to be sure that there is no prohibition on citizens of that country submitting tothe jurisdiction of other courts.

2.3.11 Enforcement of judgements

Final and conclusive judgements issued by the courts of [England] are recognised andenforceable in [the borrower’s country of incorporation/ business]

This opinion is usually required in the place of incorporation.88 This opinion will, ofcourse, need to be qualified by whatever matters as are relevant to the enforceabil-ity in the relevant country of foreign judgements. For example, these might includequalifications that the original proceedings did not contravene natural justice andthat enforcement will not contravene public policy.


87 The opinion does not require confirmation that the courts will actually accept jurisdiction and applythe chosen law, since that depends on the facts at the time—for example, whether proceedings havestarted elsewhere. The opinion, instead, requires confirmation that the submission, and choice of law are‘valid’.

88 Other places which may be relevant include any place of business or location of the borrower’sassets.

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2.3.12 Pari passu

The obligations of the Borrower under the Credit Agreement rank at least pari passu withall other obligations of the Borrower which are not secured and which are not mandatorilypreferred by law applying to companies generally.

This opinion will usually be sought in the place of incorporation and/or potentialinsolvency. The lawyer giving the opinion will need to consider whether there are, ormay be, any obligations of the borrower which may be preferred over otherobligations, or whether this particular debt may be subordinated to other debts, otherthan as a result of security, or as a result of law affecting companies generally. Examplesare the subordination that affects loans to English borrowers89 where the lenders’return varies with the profitability of the borrower,90 and the priority that may beobtained in certain jurisdictions91 by executing a loan agreement as an escrita publica.

2.4 Qualifications

Finally come the qualifications. These list the legal issues that may result in difficultiesfor the lenders. Given that the purpose of the opinion is to ensure the lenders areaware of the risks inherent in the transaction before they advance funds, it is impor-tant for lenders (with assistance from the co-coordinating lawyers) to ensure thatthey understand the implications of the qualifications for the transaction in hand.

2.4.1 Insolvency qualification

The enforceability of the rights and remedies provided for in the documents may belimited by insolvency, bankruptcy, reorganisation, moratorium or other similar lawsaffecting generally the enforceability of creditors’ rights from time to time in effect.

This qualification is necessary in relation to the opinions as to enforceability andeffectiveness of security discussed at 2.3.6 and 2.3.7 earlier. However, acceptance ofthe qualification without further investigation may result in the lenders failing to bemade aware of issues which are important in the assessment of the transaction. It istherefore often necessary for the co-coordinating lawyer to investigate the detailsbehind this opinion to determine how insolvency of an obligor might affect thelenders. In particular they will be concerned to investigate

� In what circumstances92 might the lenders need court approval to enforce theirrights against the borrower or the assets which are the subject of the security?93

� Are any transactions vulnerable to be set aside if the company is insolvent orwound up?94


89 And borrowers in other jurisdictions whose law is based on English law.90 See s3 Partnership Act 1890 discussed in Box 1.13 on p. 48.91 Whose law is based on Spanish law, for example, the Philippines.92 See ‘Administration’ in Appendix 2.93 This is not only an issue for the place of incorporation but also for any other place of business—see

para 2.3.1 of the commentary on this Schedule 12 on p. 250.94 E.g. transactions at an undervalue or preferences under English law. Set off under some laws.

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2.4.2 Equitable principles qualification

The enforceability of the rights and remedies provided for in the documents is subject togeneral principles of equity including application by a court of competent jurisdictionof principles of good faith, fair dealing, commercial reasonableness, materiality,unconscionability and conflict with public policy and other similar principles.

This qualification is necessary in relation to the opinion as to enforceability discussedat 2.3.6 earlier (see Box 3.25).


95 See Lancashire County Council v Municipal Mutual Insurance Limited (1997) QB 897.96 The concept is referred to as ‘Wednesbury unreasonable’ after the case in which it was first

established. See for example Ludgate Insurance Co Ltd v Citibank (1998) Lloyds Rep 221, Abu DhabiNational Tanker Co v Product Star Shipping (No 2) (1993) 1 Lloyds Rep 397, and Concord Trust v The LawDebenture Corp plc (2005) 1 WLR 1591.

BOX 3.25

Some countries have general principles requiring lenders to act reasonably in exercisingtheir rights. See, for example, the discussion in Box 2.33 on p. 180. This may (e.g.) preventthem from relying on an Event of Default if the event is minor in nature but the lenders’remedy (acceleration) is disastrous for the borrower. In England, outside of consumerareas, there is no general principle of fair dealing but there are a number of principleswhich apply in specific instances, such as estoppel, the contra proferentem rule, reliefagainst forfeiture, restitution for unjust enrichment, the law on exclusion clauses, andequitable principles which apply to equitable remedies. There is also a rule of interpreta-tion that the more unreasonable an item in an agreement seems to be, the more unlikelyit is that that is the true intention of the parties.95 Courts may also interfere with the exer-cise of discretions if they are exercised perversely or capriciously or in a manner whichno reasonable person could have believed was reasonable96 Because of these variousprinciples and rules, this qualification is included in an English legal opinion.

2.4.3 Other qualifications

The opinion will then list the other qualifications necessary for the opinions, asdiscussed in relation to each opinion above, plus any other qualifications which thelawyer giving the opinion considers necessary.

The lenders and the co-coordinating lawyer need to examine each qualification(and assumption) and decide

� Is the risk it discloses acceptable (e.g. in relation to the issue on the risk thatdefault interest may be unenforceable as a penalty, are the lenders happy toproceed nevertheless?)

� Is the risk likely to be a real risk in the circumstances of the case (e.g. if the lawyerhas included an assumption or qualification as to mistake, is there a possibility ofmistake being an issue in this transaction?) and

� Can anything be done to reduce the risk (e.g. if the opinion shows that judgementsmay not be enforced, would submission to arbitration be a better arrangement?)

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This Appendix seeks to give those readers who do not have an English legal background a verybasic road map to some of the areas of English law which are important for the purpose of internation-al lending and which are not covered in other parts of this book. It is intended to be a brief introduc-tion to the topics covered and to where to look for further information on those subjects. It is notintended to be a comprehensive list of the relevant topics nor a comprehensive treatment of any of thosesubjects.

INDEX

Section 1: Some Basic Concepts 261

1 English law 2612 Sources of law 261

2.1 Common versus civil law 2612.2 Case law versus statute 2622.3 Common law versus equity 262

3 Types of claims and rights 2633.1 Action in rem versus action in personam 2633.2 Chose in action 2633.3 Contract versus tort 2633.4 Damages versus debt 2643.5 Joint versus several 2643.6 Legal versus beneficial interest 2653.7 Ownership versus possession 265

4 Miscellaneous legal concepts 2664.1 Bona fide purchaser for value without notice 2664.2 Consideration 2664.3 Deed 2674.4 Exclusion clauses 267

259

A P P E N D I X 1

Some English LawConcepts

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4.5 Misrepresentation 2684.6 Pari passu 2694.7 Subordination 2694.8 Trustees versus agents 270

Section 2: Security 271

1 Introduction 2712 Types of security 272

2.1 Mortgages 2722.2 Pledges 2722.3 Liens 2722.4 Charges 272

2.4(a) Floating charge 2722.4(b) Fixed charge 274

2.5 Assignment 2753 Registration requirements 276

3.1 Registration against the asset 2763.2 Registration against the company 2763.3 The proposed new regime 277

4 What types of asset can security be created over? 2784.1 Future property 2784.2 Intangible assets 2784.3 Shares or other investments 2784.4 Moveable property 2784.5 An entire business 2794.6 A bank account 2794.7 Comingled property 280

5 What can the security secure? 280

Section 3: Guarantees 281

1 The nature of a guarantee 2811.1 Guarantee versus indemnity 2811.2 Primary versus secondary obligation 2821.3 Indemnity versus first demand guarantee 2821.4 Continuing guarantees 2831.5 Guarantee versus third party charge 2831.6 Guarantee versus letter of comfort 283

2 Hazards with guarantees 2842.1 Transactions at an undervalue/commercial benefit 2842.2 Subrogation/reimbursement 2852.3 Discharge by amendment and other defences 285

A P P E N D I X 1 S E C T I O N 1260

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SECTION 1 SOME BASIC CONCEPTS

1 English law

English law is more strictly known as the law of England and Wales. England is part of theUnited Kingdom, which comprises three different legal jurisdictions.Scotland has its own laws. Northern Ireland has similar but not the same law as Englandand Wales.English law comprises statutes and common law1 as well as European law.2

2 Sources of law3

2.1 Common versus civil law

To a certain extent, the distinction between common and civil law is historical (see Box A1.1).The most significant distinction between civil law systems and common law systems is

that civil law systems are based on a codified set of rules, while common law systems developthrough cases which come to court, and with decisions in those cases binding in (or creating‘precedents’ for) future cases unless they can be distinguished from the earlier cases4. Judgesin a common law system help to create the law.

S O M E B A S I C C O N C E P T S 261

1 See para 2.2 By which we do not mean the laws of different countries within Europe, but rather the laws promulgated by

European bodies such as the Council of the European Union or the European Parliament. Some types of Europeanlaw are directly enforceable in English courts without a requirement for further steps to be taken by the nationallegislature to transpose this law into the English national law. Others must be transposed into the domestic law ofEngland before they become effective in England.

3 See Goode Commercial Law, in pp. 11–20.4 I.e. if a difference can be identified which justifies a different decision being reached.

BOX A1.1

Civil law systems developed from Roman law, which was the earliest significant exampleof a legal system. It influenced most of the legal systems of the world. In the fifth centuryBC, the Twelve Tables of Rome were engraved on bronze tablets. They were largely a dec-laration of existing customs concerning such matters as property, payment of debts, andappropriate compensation or other remedies for damage to persons. These tables andtheir Roman successors, including the Justinian Code, led to civil law codes that providethe main source of law in much of modern Europe, South America, and elsewhere.

The common law system of England developed in a different manner. Before theNorman Conquest (1066), England was a loose confederation of societies, the laws ofwhich were largely tribal and local. The Anglo-Norman rulers created a system of cen-tralized courts that operated under a single set of laws that superseded the rules laiddown by earlier societies. This legal system, known as the common law of England,began with common customs, but over time it involved the courts in lawmaking thatwas responsive to changes in society.

To an increasing extent this distinction is becoming blurred as, in common law jurisdic-tions, the case law is supplemented by an ever increasing volume of formal rules and regula-tions (statutes or legislation) created by modern governments. Similarly, in civil law countries,the subtleties of judicial interpretation and the weight of judicial precedents are recognized asinvolving the courts in significant aspects of lawmaking.

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2.2 Case law versus statute

Case law is another expression for common law—that is, the law which emerges from caseswhich come before the courts. Statute (or legislation) is the expression used for the formalrules and regulations issued by the government of the relevant jurisdiction.

2.3 Common law versus equity5

The distinction here is based on the origin of the law (or the right or remedy) in question.Equity was the system of rules which were applied in one system of courts (the courts ofChancery), while the common law was applied in other courts (Box A1.2)

Now all English courts apply all law, whether it derives from common law, equity, orstatute. However the concept of equity is still important, for example, because certain princi-ples (some of which are discussed in the following paragraphs by way of example) apply toequitable remedies and equitable interests which do not apply in other circumstances.Equitable remedies which are available include (among an array of other equitableremedies):6

� Specific performance (requiring a party to perform their obligations, as opposed torequiring them to pay damages instead). Specific performance will not be granted wheredamages is an adequate remedy (e.g. in the case of a breach of a contract for sale of genericgoods) or for breach of a contract for personal services.

� Injunctions (usually requiring a party not to do something).

� Restitution (requiring a party to refund assets if he has been unjustly enriched at another’sexpense).

Equitable concepts developed by the courts include (again, by way of example, and among anarray of other equitable concepts):

� the distinction between legal and beneficial ownership,7 giving rise to the developmentof trusts;8

� mistake and misrepresentation.


5 See Hanbury and Martin Modern Equity, 17th edition, 2005.6 See I. C. F. Spry Equitable Remedies, 6th edition, 2001.7 See para 3.6 of this section 1 on p. 265.8 See Appendix 2.

BOX A1.2

Until 1854 there were two sets of courts in England which gave two different types ofremedy and recognized different rights and obligations. One court applied thecommon law and the other (the Chancery Court) applied ‘equity’. The historical reasonfor this was that, before the establishment of the courts of equity in the fourteenthcentury, the remedies available in courts were limited to damages and delivery ofproperty and there was no relief available for breach of faith. Claims for other reliefwere to the King, who delegated these issues to the Lord Chancellor who decided theseissues in the Courts of Chancery. So the Courts of Chancery arose in order to mitigatethe harshness of the common law courts. The courts of Chancery applied ‘equitable’principles and remedies.

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Some equitable principles are that

� Equity treats as done that which should have been done. So, for example, an agreement tocreate a mortgage of an asset will, subject to certain conditions, be given effect to in equityas if the mortgage has been effected and so will create an immediate equitable interest9 inthe asset for the transferee.10

� Parties must come to equity with clean hands. So an equitable remedy will not be availableto a party which has not acted in good faith.

� An equitable interest can be defeated by a bona fide purchaser for value without notice.11

3 Types of claims and rights

3.1 Action in rem versus action in personam12

This is the distinction between the method of enforcement of a “real” right (or right inproperty, otherwise known as a “proprietary interest”) and the method of enforcement of“personal” rights. ‘Real’ rights are rights in property, for example, ownership is a real right.Security is also a real right—someone with security has a right, in certain circumstances, totake the property over which he has security and use proceeds of that property to pay thesecured debt. That is a right in property as opposed to the personal right to require theborrower to pay the debt.13

3.2 Chose in action

This is the name given to an asset which is not a physical asset but which is simply a rightwhich must be enforced by taking legal action. For example, money in a bank account is not aphysical asset. It is a claim against the bank with whom the account is held. If the bank doesnot pay the moneys over on request, the only right which the person who deposited themoney has is to take legal action against the bank. Hence the name chose (or thing) “inaction”, that is, enforceable only by taking legal action.14

3.3 Contract versus tort

Contracts are agreements or promises which are enforced by the courts. Tort is the word givento the law relating to the circumstances in which a person will be liable for the consequencesof their actions in circumstances where there is no contract. (It is similar to the continentalconcept of ‘delict’).

Damages for breach of contract are broadly based on the loss which arises as a result of thebreaking of the arrangement, and so will generally cover lost profit.

Tort is based on liability for the foreseeable consequences of your actions for others(e.g. negligence). Damages in tort are therefore based on the extent to which the harm causedby the tort was foreseeable.


9 See para 3.6 of this Section 1 on p. 265.10 See Goode Commercial Law, p. 626.11 See para 4.1 of section 1 of this Appendix at p. 266.12 See further Goode Commercial Law, p. 25.13 Or, more accurately, it is a right enforceable against all the world (a right in rem) as opposed to a right which

is enforceable only against specific person(s)—(a right in personam).14 See further Goode Commercial Law, p. 29.

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3.4 Damages versus debt15

A claim for a debt is a claim to be paid a sum of money which is outstanding (e.g. the purchaseprice of goods delivered, or a claim under a guarantee). A claim in damages is a claim formonetary compensation for some action or inaction by another party, which has resulted inloss. So, for example, if one party does not perform its obligations under a contract, the otherwill have a claim in damages. See Box A1.3.

The main disadvantages of a claim in damages, as opposed to a claim for a debt which isdue, are

� the claimant will have to prove that the loss he suffered was caused by the other’s actionor inaction;

� the amount which will be recovered will be calculated on the basis of the loss which wouldhave been suffered had the claimant taken reasonable steps to mitigate its loss;16 and

� the amount which will be recovered under a claim in damages is uncertain.17

A provision in a contract for payment of liquidated damages avoids these difficulties,although the issue may arise as to whether such a provision is a penalty.18


15 See Goode Commercial Law, pp. 114–123.16 Often (misleadingly) referred to as the “duty to mitigate”, as this is a rule of the measure of damages—there

is no ‘duty’ involved.17 Of course, there is also the commercial disadvantage that, if the contract is onerous on the counterparty, they

may seek to renegotiate for lower payments, and, in practice, acceptance of that lower rate may be better forthe borrower than the alternative, of insisting on maintaining the original terms and, in the event that thecounterparty is unable to pay, claiming in damages against the counterparty, potentially making it insolvent, andreceiving only a small proportion of the damages awarded.

18 See Appendix 2.

BOX A1.3

This distinction is particularly important in those structures (such as are common instructured, project and asset finance and also in secured corporate based lending)where loans are made to a company, relying in part on the security of contracts (suchas an offtake agreement in project finance, or a residual value guarantee in assetfinance) which that company has with a third party. The lender is taking security overa particular payment, or series of payments, which will be used to service the debt incertain circumstances. In the event that there is a default by the third party under thecontract, however, the claim on which the lender is relying is usually a claim for dam-ages for breach of the contract.

3.5 Joint versus several

A joint obligation is one which a number of parties owe jointly, as in the situation wheretwo parties borrow a sum of $10 million and undertake to repay it jointly. The lender must joinboth borrowers in any claim on the debt. The borrowers must, together, pay the full debt andif either one is unable to pay, the other is liable to pay the full amount.

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A several obligation is an independent obligation of one party which is not affected by theobligations of other parties. So if two parties each had a several liability to pay $10 million, thetotal due would be $20 million. Each debt is entirely independent of the other.The lender maypursue each party on its debt without involving the other party, and non-payment by oneparty of its debt does not give the lender a claim on the other party.

A joint and several obligation is a combination of the above. So if two parties borrow$10 million and undertake, jointly and severally, to repay it, the lender may sue both partiestogether on their joint undertaking or it may sue either individual borrower on its severalundertaking (which, under English law at least, is to repay the whole loan of $10 million).

Obligations of borrowers and guarantors are usually made joint and several so as to allowlenders the option of choosing which parties to pursue and not involving parties where theremay be procedural or cross border difficulties or where it would be uneconomic to do so.Obligations of lenders are usually several since lenders are not prepared to take responsibilityfor the actions of other lenders.

3.6 Legal versus beneficial interest19

The legal owner of an asset is the person who has title to it. The beneficial owner may bedifferent—it is the person who is entitled in fairnessto the benefit of having that asset. He is alsodescribed as having an ‘equitable interest’ in the asset (see Box A1. 4).

Where legal ownership is with someone who is not also the beneficial owner, the legalowner holds as trustee20 for the beneficial owner (or beneficiary). A trust may be created by adocument, or it may arise simply as a result of the circumstances, as in the example referredto in Box A1.4.


19 See further Goode Commercial Law, pp. 31–42.20 See para 4.8.21 See Goode Commercial Law, pp. 31–42.

BOX A1.4

For example, if two people (A and B) pay for something, but one only (A) gets title,that one may be both the legal and the beneficial owner if it is clear that the other(B) intended to make a gift. If B did not intend to make a gift, then A will be the legalowner and both A and B will be beneficial owners (those entitled to the benefits ofownership) with beneficial interests proportionate to their contribution to the price.

3.7 Ownership versus possession21 (see Box A1.5 on p. 266)

Ownership involves having title. This gives the person having it the right to deal freely withthe thing, for example, to sell it.

Possession is a much more limited concept. The person with possession may or may nothave the consent of the owner. They do not have the right to dispose of the thing, and theircontinued right to possession depends on the terms agreed with the owner (e.g. a lease orlicense) or on the law (e.g. a lien created by operation of law).

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4 Miscellaneous legal concepts

4.1 Bona fide purchaser for value without notice

Otherwise sometimes called ‘equity’s darling’, because an equitable interest can be defeatedby such a purchaser (see Box A1.6).

The expression means a party

� acting in good faith (‘bona fide’);

� which acquired a legal interest, either a security interest, such as a mortgage, or anownership interest (a ‘purchaser’);

� which gave value for that interest (‘for value’); and

� which had no notice of the prior equitable interest.

4.2 Consideration23

Some benefit given in exchange for a promise (but see Box A1.7 on p. 267).Gratuitous promises (e.g. gifts) may be enforceable if the agreement to make them is made bya deed.24 Otherwise, English contract law requires some form of exchange, or benefit, or‘something of value in the eye of the law’25 in order for a promise to be enforceable. There arenumerous rules relating to consideration (such as the rule that past consideration is noconsideration) that are outside the scope of this book26 .


22 See para 2.4(b) of section 2 of this Appendix at p. 274.23 See Treitel The Law of Contract, pp. 67–16124 See 4.3 of this section 1 at p. 267.25 Thomas v Thomas (1842) 2 QB 851 at p. 859.26 And for which see Treitel The Law of Contract, p. 67 et seq.

BOX A1.5

The difference can be illustrated by the situation in which a company sells itswarehouse to a purchaser (the purchaser has ownership), and where it temporarily letsthe warehouse to another company (the lessee has possession).

BOX A1.6

This concept is relevant where two entities have conflicting interests, for examplewhere one party has security over an asset but another person has bought the assetwithout knowing of the security. Under the current law regulating priorities ( which isdue to the reformed during 2006 as discussed at para 3.3 of section 2 of this Appendix)the buyer will take free of the security if the security was an equitable interest only(such as a charge,22 but not a legal mortgage) and the buyer is a bona fide purchaserfor value without notice.

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4.3 Deed

An agreement will only he enforced by a court if either

� there is consideration for it; or

� the agreement is executed as a deed.

So, executing a document as a deed will have the effect of making the agreement enforceableby a court even though there is no consideration for it, and the agreement is gratuitous (e.g. anagreement to give a gift).

Originally deeds were formal documents which the person signing had to seal with theirpersonal wax seal. This formality helped to ensure that those agreeing to make gifts wereprompted to consider their action before proceeding. With the disappearance of personal waxseals (and their substitution by red stickers) much of the extra formality involved in executinga deed fell away. In 1989, legislation was introduced in England27 which abolished the needfor a seal at all28 and stated that a document would be a deed if it made clear on its face that itwas intended to be a deed;29 and if it was executed as a deed (and, in relation to execution asa deed, set out requirements for witnessing without the need for sealing); and if it had beendelivered.30

Deeds are required for certain types of transactions, such as powers of attorney.31

4.4 Exclusion clauses32

Exclusion clauses are included in a wide variety of transactions. This explanationfocuses on exclusion clauses in the types of documents which are common in international


27 s1(2) Law of Property (Miscellaneous Provisions) Act 198928 At least, in relation to execution of deeds by individuals and by companies incorporated under the

Companies Acts.29 Of course, countries with laws based on those of England and Wales may still require deeds to be sealed and

sealing is still required in England for bodies in relation to which the common law requirements have not beenmodified by statute.

30 See Treitel Law of Contract p.159 for further discussion of the requirement for delivery.31 s1 Powers of Attorney Act 1971.32 See Elizabeth Macdonald, Exemption Clauses, Penalty Clauses and Unfair Terms 1999.

BOX A1.7

One aspect of consideration which many non-English lawyers find strange is that thecourts will not enquire into the value of the consideration, and that, for example, acontract under which a company disposes of an asset for a price which is only a verysmall percentage of the value of the asset, will nevertheless not be open to challenge onthe basis of absence of considertion.

Nevertheless, shareholders and creditors of companies which enter into uncommer-cial bargains are not without redress. In relation to shareholders, the directors have acommon law fiduciary duty to shareholders to run the company in the interests ofthe company—see Box A1.21 on p. 284. Creditors are protected by the provisions relatingto transactions at an undervalue—see para 2.1 of section 3 of this Appendix on p. 284.

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finance—therefore, it does not look at exclusion clauses contained in transactions withconsumers or in contracts which are conducted on one party’s standard terms.

An exclusion clause is a clause which seeks to reduce the circumstances in which one partywill have liability to another, or to reduce the amount of that liability (see Box A1.8).


33 A clause which states that the written document constitutes the entire agreement between the parties—the intention of which is to prevent parties from asserting that representations made prior to the agreementbeing signed had any contractual force and therefore, indirectly, of limiting liability in relation to any suchrepresentations.

34 See Elizabeth Macdonald, Exemption Clauses, Penalty Clauses and Unfair Terms p. 89 et seq.35 See Goode Commercial Law at pp. 96–97.36 See Appendix 2.37 s3 Misrepresentation Act 1967.38 s2(2) Unfair Contract Terms Act 1977. The reasonableness test will also apply to clauses excluding liability for

breach of contract (i.e. not only to clauses excluding liability for negligence) in certain cases involving consumersand standard form documents—s3 Unfair Contract Terms Act 1977.

39 Contained in s27 Unfair Contract Terms Act 1977.40 See Treitel, The Law of Contract, Chapter 9.

BOX A1.8

Clauses will be subject to the same restrictions as exclusion clauses if they have theeffect of restricting liability even if that is done indirectly (e.g. by an ‘entire agreement’clause,33 which seeks to exclude the possibility of reliance on representations madeoutside the written agreement) or only partially (e.g. by restricting the counterpart’sremedies in respect of any breach—such as restrictions on rights of set off34).

BOX A1.9

This reasonableness requirement is subject to a rather unusual qualification39. That is,in relation to excluding liability for negligence, the reasonableness test will only applyto exclusion clauses in contracts which are governed by English law and would havebeen governed by English law had there been no express choice of law. Many interna-tional loan agreements are only governed by English law by choice and therefore theexclusion clause, insofar as it excludes liability for negligence, will not be subject to thereasonableness test.

Exclusion clauses may be challenged under the common law on a variety of grounds.35

In particular, they are read contra proferentem.36 They are also subject to a statutory test ofreasonableness if they attempt to exclude liability for statutory misrepresentation37 or negli-gence.38 Any attempt to exclude liability for statutory misrepresentation or negligence willonly be effective in circumstances where the court considers it reasonable for this to beeffective on the facts in question. (but see Box A1.9)

4.5 Misrepresentation40

There are numerous types of misrepresentation under English law, each of which has differ-ent consequences. This explanation relates only to liability for negligent misrepresentation,which is (hopefully) the most likely category in the context of international finance.

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Liability for negligent misrepresentation may arise either at common law41 or underthe Misrepresentation Act 1967 (statutory misrepresentation). In each case, liability arises if aperson is induced to enter into a contract by a statement which was misleading. Broadlyspeaking liability will only arise if

� a person gives information negligently;

� the other person relied on it;

� the person giving the information entered into a contract with the other (in the case ofestablishing liability under the statute) or owed a duty of care to the other (in the case ofestablishing liability under the common law); and

� the other suffered loss as a result and that loss was foreseeable at the time the misrepre-sentation was made.

An exclusion clause in relation to liability for misrepresentation42 will be effective only if thecourts hold that it is fair and reasonable for it to be effective (which will depend, among otherthings, on how much opportunity there was for the recipient to verify the information).

Statements of opinions and forecasts are capable of being representations, particularly ifthose relying on the statements reasonably perceive that the person making the statement(e.g. an Arranger in an information memorandum) is in a position, for example, because of itsspecial expertise, such that its opinions carry weight.43

Under English law (apart from any specific legislation which may apply in particularcircumstances, such as prospectus legislation) there is no duty to disclose information butinformation disclosed must not be misleading. There is a duty to disclose if subsequent factsmake a statement untrue before it has been acted on.44

4.6 Pari passu

Pari passu means having an equal level of priority. If two pari passu debts owed to A and Brespectively) are due on the same day and there are not enough funds to pay both—they willbe paid pro rata.45

Debts are pari passu even if due on different dates. Therefore it is quite feasible for Ato recover in full while B faces a shortfall simply because A’s debt falls due first. Moreover,voluntarily paying one debt while leaving another unpaid is perfectly permissible even forpari passu debts,46 unless such payment constitutes a preference (see Box A2.2).

4.7 Subordination47

Giving one debt a lower ranking in terms of its priority of payment than another debt. Theexpression encompasses a wide variety of arrangements.

� Subordinate security. This does not necessarily involve subordinated debt (see Box A1.10on p. 270).


41 See Hedley Byrne & Co Ltd v Heller & B Partners Ltd (1964) AC 465.42 Including clauses which will have a similar effect such as an “entire agreement” clause—see Box A 1.8 on p. 268.43 See further Treitel, The Law of Contract, p. 330.44 See further Treitel, The Law of Contract, p. 390 et seq.45 See Appendix 2.46 See commentary on clause 19.12 of the LMA Term Loan.47 See Philip Wood Project finance, Subordinated Debt and State Loans.

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� Different levels of subordination of the debt. The ‘subordinate’ debt may be subordinate

– as to principal only—that is, interest may be paid on the subordinated debt but notprincipal;

– as to both principal and interest—that is, no payments, whether of principal or interest,may be made on the subordinated debt;49

– in a winding up (or on the occurrence of some other condition such as an Event ofDefault) only—that is, unless the condition occurs, payments may be made on thesubordinated debt; or

– at all times—that is, the prohibition on payments under the subordinated debtcommences immediately.

� Structural subordination. It is not necessary to have a contractual subordinationagreement in order for a debt to be subordinate. This can also be achieved through the cor-porate structure by lending to a shareholder without taking any rights against its sub-sidiary through which income is generated. By doing this, the lender is structurallysubordinate to all creditors of the subsidiary, since it has no claim against the subsidiaryand can only access the subsidiary’s assets via any dividend which the subsidiary pays toits parent.That dividend can only be made after retention of sums to pay the subsidiary’screditors—(see Box A1.11 on p. 271).

For this reason, many lenders will normally only lend to operating companies and not theirshareholders. Alternatively they will require guarantees from the operating companies of loansto their shareholders (subject to any legal difficulties involved in giving upstream guarantees50)or will take assignments of intercompany loans made by the shareholder to its subsidiary.51

4.8 Trustees versus agents

A trustee is the legal owner of property which it holds on behalf of others—who have benefi-cial ownership of that property as discussed at para 3.6 of this section 1 on p. 265. The trust


48 The assets of $3 million are shared in the ratio of the outstanding claims which, after B has taken the security,are $5 million to B and $10 million to C, which is 1:2.

49 This might be expected for a shareholder’s loan, but not for a loan made by a commercial lender.50 See para 2.1 of section 3 of this Appendix on p. 284.51 However, in some countries, e.g. Germany, shareholder loans are automatically subordinated to creditors so

that an assignment of such a loan would not have the desired effect.

A1.10

For example, assume Company A borrows $10 million from B and gives B a mortgageon land as security. It then borrows $10 million from C and gives a second (subordi-nate) mortgage to C. Assume A is wound up and the land sold at a price of $5 million.A has other assets worth $3 million and no other creditors. B will recover $5 millionfrom the security. A’s remaining assets ($3 million) will be shared pro rata between Band C, with B recovering $1 million and C recovering $2 million.48

If the loan to C had been subordinate to B`s loan (as well as the security beingsubordinate) then B would have recovered all of the surplus $3 million and C wouldhave recovered nothing.

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property, although belonging to the trustee, will not form part of its estate, so that in a liqui-dation of the trustee the trust property will not be available to the trustee’s liquidator. Agency,on the other hand, also involves one person representing another, but, in the case of agency,the agent does not own property on behalf of another, they simply owe contractual duties tothe persons they represent. Those persons have rights in personam, not the rights in remwhich beneficiaries of a trust have.

SECTION 2 SECURITY52

1 Introduction

Under English common law there are a number of ways to create security, each of which hasa technical description (mortgage, charge, lien, pledge). These words are often not used intheir technical sense. Moreover, statutes have added to the common law and created statutorymortgages and liens which have different characteristics to their common law equivalents.These factors make a focus on the common law meanings of the words used to describedifferent concepts of security of limited value. Nevertheless, we summarise those meanings inthis section in the interests of clarity.

‘Security’ means a proprietary right (i.e. an interest in property) to secure a liability. In otherwords, security requires the secured party to have an ownership interest in an asset which itcan use to secure a liability. Guarantees will not fall within this definition—they do not givean ownership interest.53 Rights of set off also do not fall within the definition as they areprocedural rights which do not amount to an ownership interest.

S E C U R I T Y 271

52 See Goode Legal Problems of Credit and Security.53 They are referred to as personal security as opposed to real security.

BOX A1.11

Assume a lender lends $10 million to a holding company (Company A), whose onlyassets are its shares in its subsidiary, Company B. The lender takes security, in the formof a mortgage on the shares in Company B. Company A has no business of its own, andis simply a holding company.

Assume both Companies A and B become insolvent and are wound up at a timewhen Company B has assets worth $20 million and debts of $20 million. Company A’sonly debt is the loan.

The assets of Company B will be used to pay its debts. There will be no surplus andthe shares in Company B (and therefore the mortgage on those shares) will be worth-less. The lender to Company A will therefore recover nothing as Company A has noassets. If, on the other hand, the lender had a guarantee from Company B, it wouldhave been entitled to make a claim in the insolvency of Company B. Without such aclaim, it is structurally subordinate to the creditors of Company B.

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2 Types of security54

The types of security which can be created at common law55 in England are

2.1 Mortgages

These56 involve the borrower giving legal title (i.e. ownership) of the asset to the lender.The lender will own the asset subject to the borrower’s ‘equity of redemption’—its right toredeem, or pay off, the debt and have title passed back to it. This method is often used forshares—the shares are registered in the name of the lender (or its nominee) until the secureddebt is repaid, at which point the security is transferred back to the borrower. Anotherexample is a statutory assignment of a chose in action—see para 2.5 of this section.

2.2 Pledges

These involve the Borrower physically handing an asset (or something, such as a key or adocument of title, which gives control of an asset) over to the lender (or other party), in orderto persuade the lender to advance funds. Pledges can only be used with physical assets ordocuments of title representing assets, such as bearer shares or bills of lading57. The lender canretain the asset till the debt has been repaid or, in default of payment, the lender can sell theasset and apply the proceeds to the secured debt.

2.3 Liens

A common law lien is a right to retain goods to secure payment of a contract debt. As with apledge, a lien involves one party having possession of an asset owned by another but, in thecase of the lien, possession was given for some other contractual purpose and not for the pur-pose of raising funds. A common example in international finance is the repairer’s lien—anitem of machinery may be delivered to a third party for repair. The repairer can keep theequipment, and has a security interest in it, until he is paid for his services. The distinctionbetween this and the pledge is the fact that, in the case of the lien, the security is not deliber-ately created for the purpose of raising money. Another difference is that the lien holder(unlike a pledgee), has no implied right of sale.

2.4 Charges

Charges do not depend on title, or on possession. A charge gives its holder the right to take thecharged asset in certain circumstances and apply its proceeds against the debt. A charge maybe a floating charge or a fixed charge.

2.4(a) Floating charge58

A floating charge is a security which gives the chargor the freedom to deal with the subjectmatter of the security until the charge ‘crystallises’. A floating charge is generally expressed


54 See Goode Commercial Law, pp. 584–587.55 Excluding those which arise by operation of law, which are discussed at Goode Commercial Law, pp. 619–623.56 Other than in relation to land, where the common law position has been supplemented by statute.57 Which can even be released to the borrower without discharging the security, by using the trust receipt

device discussed at p. 1015 of Goode Commercial Law.58 The expression ‘floating charge’ does not mean that the security interest in question needs to be a charge as

opposed to a mortgage or an assignment. Any security interest which gives the chargor the freedom to deal withthe property may take effect as a floating charge.

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to crystallise on the occurrence of an event of default in accordance with the terms of the loanagreement (usually, whether or not the charge has delivered a notice accelerating the loan).The charge is usually (but not necessarily59) created over a category of assets (such as thechargor’s stock in trade) and automatically catches new assets which the chargor acquiresfrom time to time which fall within the relevant category.

The existence of this form of security allows a company to use, as security, those assetswhich the company buys and sells as part of its ordinary business. Without the concept of afloating charge this would not be possible because the security would need to be dischargedto allow sale.

However, a floating charge has three significant disadvantages over a fixed charge.

� First, if a company gets into financial difficulties it is quite likely to find itself unable toreplenish stock. So, when a chargee enforces the security, there may be very few assets there.

� Second, unlike all other forms of security, the chargee cannot keep all proceeds of thesecurity but must (except in some circumstances where the security constitutes ‘financialcollateral’) use part of the proceeds to pay certain other creditors.60

� Third, it may lose priority to a subsequent holder of a fixed charge over the assets of thechargor (see Box A 1.12), although the proposed reformation of the law relating tocompany security interests discussed at para 3.3 on p. 277 includes proposals which willremove this disadvantage.

For these reasons, a floating charge should only be used for assets in respect of which no otherform of security is realistically available.

S E C U R I T Y 273

59 Re Cosslett (Contractors) Ltd (1998) Ch 495.60 Under the Enterprise Act 2002 payments to tax authorities no longer have preferential status. However,

under s252 of the Act a ‘prescribed part’ of a company’s assets must be allocated to unsecured creditors, ahead ofthe holder of a floating charge. The amount of the prescribed part was fixed by SI 2003/2097 at 50% of the first£10,000 of a company’s assets, plus 20% of any surplus over £10,000, up to a maximum of £600,000.

61 Unless the floating charge has crystallized at the time the fixed charge is created and the fixed charge holderhas actual or constructive notice of the crystallization.

62 It is not clear whether this is effective or not. See Goode on Commercial Law at p. 662.

BOX A1.12

A floating charge may lose priority to a later charge61 because, by its nature, a floatingcharge does not prohibit dealings with the assets concerned, and so a subsequent fixedcharge may be created and this charge will rank in priority to the previously createdfloating charge. The floating charge therefore usually includes a negative pledge.Theexistence of this negative pledge is usually then explicitly referred to in the details ofthe floating charge submitted for registration to the Registrar of Companies. The inten-tion is to try to ensure that a subsequent fixed charge holder, who would be expectedto inspect the register before taking a charge, knew of the existence of the negativepledge and that any charge taken by such a person would not have priority over thefloating charge.62 Under the new system for registration and priority of security whichis currently proposed (as discussed in para 3.3) the floating charge would have prior-ity over a subsequent charge without resort to this registration of the existence of a neg-ative pledge since, under the new system, the priority will be determined by the dateof registration of the charge (even if that date is before the date on which the securitybecomes effective).

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Difficulties often arise in determining whether a given security document creates a fixed ora floating charge. See Box A1.13. Issues which will be relevant include.

� The nature of the asset—is it a ‘circulating’ asset63—in which case security over it is likelyto be floating.64 Nevertheless, security over assets which are not ‘circulating’ may still befloating.65

� The degree of control which the giver of the security has to deal with the asset—can theydispose of it in the ordinary course of business? Care therefore needs to be taken to ensurethat any exceptions to a no disposals clause do not have the effect of changing what wasintended to be a fixed security into a floating one by allowing disposals of charged assetsin the ordinary course of business.66


63 I.e. one which the chargor disposes of and replaces regularly with similar assets in the course of its business.64 Re Yorkshire Woolcombers Association (1903) 2 Ch 284 and (1904) AC 355.65 Re Cosslett (Contractors) Ltd (1998) Ch 495.66 See Ashborder BV v Green Gas Power Ltd (2004) EWHC 1517. See also commentary on clause 22.4(b) of the

LMA Term Loan.67 National Westminster Bank Plc v Spectrum Plus Limited (2005) 3 W.L.R. 58. In that case a borrower had given

security over all its book debts, and agreed to pay those book debts to a specified bank account to which the bor-rower had free access. The court held that the security over the book debts was a floating charge.

68 See para 4.1 on p. 266 and para 3.3 on p. 277.

BOX A1.13

There are particular problems when security is taken over the borrower’s income,either by taking an assignment of a stream of payments under a particular contract orby taking security over all of a borrower’s present and future book debts withoutbeing more specific as to the source of those debts. This isue has recently come beforethe House of Lords,67 which held that the determining factor in deciding whether asecurity interest was fixed or floating was the degree of control which the borrowerretained over the assets which were the subject of the security. The case held that, in thecontext of security over debts, if the proceeds of the debts are required to be paid to aspecified account, but the borrower is able to draw on that account in the ordinary way,the security over the debts is floating security. The case did not decide how much con-trol the lender would need to have over the bank account in order to ensure that thesecurity was fixed security.

The emphasis which the case placed on control and ability to access the account asbeing the determining factor has thrown into question those arrangements which areintegral to, for example, project finance, where security is taken over specific incomestreams and use of the income is highly regulated but, nevertheless the borrower, innormal circumstances, has access to the income for operating expenses. Pending fur-ther cases being decided, it is unclear whether such security is fixed or floating securityover the income stream.

2.4(b) Fixed chargeA fixed charge (like a floating charge) is equitable. As such under the current system regulat-ing priorities (but not under the proposed new system discussed at para 3.3), it may bedefeated by a subsequent mortgage or by sale of the charged asset. This is because any equi-table interest may be defeated by a bona fide purchaser for value without notice.68 In practice,for many assets, this potential defect of a charge is not relevant since the existence of the

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charge is registered with the Companies Registry69 and therefore subsequent purchasers andmortgagees will be put on notice of the existence of the charge when they search the register.If the subsequent purchaser or mortgagee did not search the register then they will be treatedas having notice of the prior charge if they could reasonably be expected to have searched theregister.70 A charge may therefore be vulnerable if the assets over which the lender is takingsecurity are assets of the type which purchasers may ordinarily be expected to buy, or lendersto take security over, without first doing a search of the Companies Registry (which wouldgenerally be the types of assets over which a floating charge would be taken) or if the securedassets are of a type against which security is not registrable.71

2.5 Assignment72

In addition, security may be created over rights (such as rights under contracts) by way ofassignment or by way of a charge.73

Assignment may be used either to sell a debt or to give security over it.74 The difference isthat where the assignment is being given as security, the lender’s interest in the debt will lastonly until the secured claim has been paid.

There are three main categories of assignment in England,75 each of which may be used asa method of sale or as a method of creating security.

A statutory assignment under s136 Law of Property Act 1925. This form of assign-ment must be of the whole debt; notice must be given to the debtor and it must be absolute(see Box A1.14).

This form of assignment results in the debtor having to make payment direct to theassignee. It has a minor procedural advantage over an equitable assignment of which notice

S E C U R I T Y 275

69 See para 3.2 of this section 2 on p. 276.70 See Goode Commerical Law at p. 662 et seq Para 2 ‘The effect of registration’.71 This is one reason why lenders may at present prefer to take a share mortgage instead of a share pledge—i.e.

to have the relevant shares transferred into the name of a nominee of the lender, with provisions for a transfer backwhen the secured debt is paid—because security over shares is not currently registrable.

72 See Goode Legal Problems of Credit and Security, p. 95.73 A chose in action, like any other asset, may have security created over it either by passing title to the asset

(as in a mortgage) until the secured debt is repaid, or by agreeing (as in a charge), that the asset may be taken andits proceeds used to pay the secured debt if there is a default in payment. If the route of passing title is to be used,the chose in action will be transferred by assignment, since that is the only way to pass title to a chose in action. Ifassignment is not used, the security can be created by a charge i.e. an agreement which creates security but doesnot amount to a transfer of title.

74 See para 2 of section 1 of the commentary on clause 24 on p. 190.75 Ignoring assignments of proceeds of the debt and the different mechanisms by which equitable assignments

can be created as discussed in Goode Legal Problems of Credit and Security, pp. 96, 107.76 See Treitel The Law of Contract p. 676 et seq on absolute assignments.

BOX A1.14

The expression ‘absolute’ is used to mean a complete transfer, in which the assignordoes not retain any interest in the property assigned. It is commonly compared with anassignment by way of charge. Nevertheless, this is not to suggest that just becausean assignment is being used as a method of security, the result is that that assignmentcannot be absolute.76

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has been given to the debtor, in that, in order to take legal action against the debtor, theassignor does not need to be joined in the proceedings.An equitable assignment with notice given to the debtor. This form of assignment resultsin the debtor having to make payment direct to the assignee. It has a minor procedural disad-vantage to a statutory assignment in that the assignor needs to be joined in to any proceedingsagainst the debtor.An equitable assignment without notice given to the debtor. This form of assignmentresults in the debtor having to make payment to the assignor, which will then be obliged toaccount for the moneys to the assignee. One of the main disadvantages of this form of assign-ment (in addition to the fact that payment will be made to the assignor) is that priorities ofcompeting assignments of the same debt depend on who gave notice to the debtor first.77

Hence this assignment can be defeated by a subsequent assignment of the same debt whichhas been notified to the debtor.

3 Registration requirements

The requirements for registration and priority of security in the UK is expected to undergofundamental changes following proposals from the Law Commission78 which are currentlythe subject of a consultation exercise by the Department of Trade and Industry. This sectionfirstly sets out the current situation and then (see para 3.3) briefly summarizes the principalchanges proposed by the Law Commission.

There are two potential registration requirements for security created by companies79

under English law. One is registration against the asset and the second is registration againstthe company which created the security.

3.1 Registration against the asset

In England there are asset registers for certain types of property including land, ships, aircraft,and intellectual property. Security over any of these types of property needs to be registeredin the asset register. Generally,80 registration against the asset creates priority so that prioritywill be governed by the date of registration.

3.2 Registration against the company

In addition to any applicable registration against the asset, most security81 created by anEnglish company (except that created by physical possession such as pledges and liens) mustbe registered on the company’s public records at the Companies Registry. That is the casewherever the asset which is the subject of the security happens to be.


77 The rule in Dearle v Hall (1828) 3 Russ 1.78 Law Commission on Company Security Interests (Report Paper 296 Aug 2005). Note that the changes pro-

posed by Part IV Companies Act 1989 were not, and are not expected to be, brought into effect.79 The Bills of Sale Acts 1878 and 1882 impose registration requirements on security created by individuals.

Security created by individuals is beyond the scope of this book.80 Although there are special procedures for land.81 s396(1) of the Companies Act 1985 lists the types of security which require registration under the Act. There

are questions over the registrability of charges over certain assets, such as shares and investment securities.

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Most security created by a non English company must also be registered at the CompaniesRegistry if the company has an established place of business in England and the propertywhich is the subject of the security is situated in England83 (see also Box A1.15).

Failure to register against the company in accordance with these requirements within21 days of creation84 of the security has the effect of making the security void against anEnglish liquidator.

Apart from the possibility that notice of the existence of the security may have an effect onpriorities as discussed in 2.4(a) and (b) above (pp. 272–275), registration against the companyhas no effect on priorities (provided all security is registered within the required 21 day period).

3.3 The proposed new regime

The new regime is proposed to simplify the registration process in the United Kingdom andto solve some of the complexities which the current law gives rise to. The key differenceswhich the new regime, as currently proposed, will make are

� Registration of original documents will be replaced by a requirement to file a ‘financingstatement’ which will include notice of the security. That filing will be able to be madebefore the security has been created and will be able to be done electronically.

� There will be no time limit for filing but the security will be ineffective against a liquidatorif the company becomes insolvent before the registration is effected and any filing madeshortly before insolvency may be invalidated.

� Priority will principally depend on the time of filing and this priority will relate to allmoneys advanced against the prior charge (except where the chargee has notice of anexecution creditor before the advance) and will give priority to a floating charge withoutthe need to give notice of a negative pledge as at present (see Box A1.12 on p. 273).

� The requirement for registration of security in specific asset registers (where they exist,such as for land, ships, aircraft, patents, and trademarks) is maintained, and, if the statuteswhich established those registers provide for priority issues, priority will still be regulatedby the specialist statutes. For security in land, there will be no obligation to file financingstatements and the Land Registry will automatically add the details to the CompanySecurity Register so that it is available to searchers.

S E C U R I T Y 277

82 Slavensburgs’ Bank NV v Intercontinental Natural Resources Ltd (1980) 1AER 955.83 s409 Companies Act 1985.84 There are different provisions for security documents executed abroad.

BOX A1.15

The registration requirements for foreign companies apply even if the lender does notknow that the company has an established place of business in England, and even ifthe property was not situated in England at the time the security was created butcomes to England later.82 As a result it is customary (pending the proposed change inthe law in this area discussed at para 3.3 below) to attempt to register security createdby overseas companies over moveable assets or over assets in England even if the com-panies have little apparent connection with England. This is referred to as ‘Slavenburgregistration’.

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� Foreign companies creating security over assets in England and Wales will be required tofile a financing statement in respect of that transaction whether or not the company has aplace of business in England and Wales. The same will apply to property which is alreadysubject to security when it enters England and Wales if it remains for 60 days (with specialrules for ships and aircraft).

� The system will apply to sale of ‘receivables’ as well as to traditional security (although theoriginal proposals to extend the system to quasi security have been deferred for furtherconsideration) and all charges will be registrable unless specifically exempt (as opposed tothe current system which lists the types of security which is registrable).

� There will be special provisions for financial collateral such as investment property andfunds in bank accounts. See para 4.3 below.

4 What types of asset can security be created over?

Under English law, security can be created over most types of assets. Some of these arediscussed in the following paragraphs.

4.1 Future property

This may be made the subject of floating security through a floating charge. It may also bemade the subject of fixed security through an agreement now to create security when the prop-erty is owned. This is because of the equitable principle that ‘equity treats as done that whichought to have been done’. So an agreement to create security is an effective (equitable) security.

4.2 Intangible assets

Security can be created over intangible assets such as intellectual property.

4.3 Shares or other investments

Security can be created over shares or other investments in a company. How this is achievedand what effect it has depends on whether the security has been ‘delivered’ to the securityholder (how much control does he have?) such that the security constitutes a ‘financial collat-eral arrangement’85 and on the nature of the investment, including, in particular, whether theinvestments are traded on a public market, and on whether the investments are held directlyor through an intermediary.86

4.4 Moveable property

Security can be created over moveable property without the need for the lender to keeppossession—this is achieved by way of creation of a fixed or floating charge over the property.But see Box A1.16 on p. 279.


85 If the security constitutes a ‘financial collateral arrangement’ it will be governed by the Financial CollateralArrangements (No 2) Regulations 2003. In that event it will benefit from a number of simplifications to the gen-eral law, including abolition of the need to register the security, continued ability to enforce the security despitethe appointment of an administrator, and, broadly speaking, if the security is a floating charge, abolition of therequirement to allocate a ‘prescribed part’ of the proceeds of realization of the security to other creditors.

86 See Part VI of Goode Legal Problems of Credit and Security.

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4.5 An entire business

This is achieved by a document (known as a debenture, or, more accurately, a mortgagedebenture91) which contains a combination of mortgages, charges (fixed and floating), andassignments over all items of the company’s property.

4.6 A bank account

Security can be created over a bank account held by the borrower with the lender. There arefour possible routes for a lender to take an interest in a bank account. In practice, securitydocuments usually provide for all the options to be available, so as to give greatest flexibilityto lenders at the time of enforcement. The lender may:

(a) rely on general rights of set off;

(b) extend rights of set off by contract;

(c) use the ‘flawed asset’ route (see Box A1.17 on p. 280);

(d) take a charge.92

S E C U R I T Y 279

87 See generally Philip Wood Comparative Law of Security and Guarantees, 1995 p. 178 on Security and Conflictof Laws.

88 E.g. the Australian case of Luckins v Highway Motel (Caernarvon) Pty Ltd (1975)133 CLR 164, discussed onp. 135 of Comparative Law of Security and Guarantees where security over a bus failed for lack of regrstration in thejurisdiction where the bus was seized by creditors although the security was recognized as valid security andwould have been effective had it been registered.

89 E.g. Brussels Convention of 1926 relating to Maritime Liens and Mortgages, the Geneva Convention of 1948on the International Recognition of Rights in Aircraft, and the Cape Town Convention on International Interestsin Mobile Equipment 2001.

90 It should not be assumed that these conventions are worldwide in their operation, or anything like it. Forexample, the 1926 Brussels Convention was acceded to by only 19 countries.

91 See ‘debenture’ in Appendix 2.92 Rather than an assignment. Note Re Charge Card Services (1987) Ch 150 held that neither an assignment

nor a charge over a bank account in favour of the bank which held the deposit could be effective. This was effec-tively overruled in relation to charges (but no mention was made of assignments) in Morris v Agrichemicals Ltd(1998) AC 214.

BOX A1.16

However, the main problem with security over moveable property is the question ofrecognition of the security if the property moves into a different jurisdiction.87 Manyjurisdictions have a conflict of law rule which recognizes interests in movable propertyif those interests were validly created in accordance with the law of the jurisdictionwhere the property was at the time the interest was created. Other jurisdictions will notrecognize interests in property if they cannot be ‘translated’ into an interest which isequivalent to some legal interest which could have been created under the local law.Even if the interest is recognized, it may be defeated for lack of registration.88

For certain major assets however, the issue of recognition (if not of registration) isaddressed by international treaties89 under which countries which are signatories tosuch conventions90 agree to recognize ‘foreign’ security in those assets.

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There are a number of detailed differences between the effects of these arrangements, withsome of the most significant being as follows.

� Security can enable an earlier application of proceeds than set off if the debt ‘secured’ isa contingent debt or is in a different currency than the bank account (each of whichtherefore requires valuation on an insolvency before a set off can be applied).

� Set off can be used without the consent of an administrator in the event of administration,while security cannot unless the security constitutes a ‘financial collateral arrangement’ asdiscussed in para 4.3.

� If any security on the bank account is construed as a floating charge (see para 2.4(a) of thissection on p. 272) then unless the security constitutes a ’financial collateral arrangement’ thelenders will retain less funds through a security interest than they would through set off.

� Under English law, use of set off is not open to challenge, for example, as a transaction atan undervalue, while security may be.

For these reasons security on a bank account in England will usually include all the arrange-ments described here so as to give the lenders the option of choosing which rights to pursueat the time of enforcement.

4.7 Comingled property

It is not however possible to give security over assets which have merged (or comingled) withassets belonging to a third party—such as gas in a pipeline. In this case the lender will need totake a pledge on a document of title or security over some other asset representing the mergedproperty, such as the right to take delivery.

5 What can the security secure?

Security can be given under English law for debts in any currency, for future loans,93 for actualor contingent debts,94 and without the need to specify a maximum secured amount.

As far as English law is concerned until such time as the Law Commission’s proposals onregistration of charges take effect as discussed at para 3.3, if English security95 secures futureadvances which a lender is obliged to make, then those future advances will benefit from thesecurity given even if another lender has made earlier advances against the same security.96

This is referred to as ‘tacking’ of further advances.97 If the lender is not obliged to make


93 Such as the new loans which are made on rollover under a revolving credit facility, or under a multicurrencyloan which operates by repayment and redrawing.

94 Such as the contingent liability in respect of the exposure which would arise if a swap were to terminate early.95 Over property to which the Law of Property Act applies.96 S 94 Law of Property Act 1925.97 For further detail on tacking see Goode Commercial Law, p. 656.

BOX A1.17

That is, provide in the documents that the obligations of the bank to pay the borrowerthe amount in the bank account is conditional, and will not arise until the borrower hasrepaid the secured loan. This solution has not been tested and it may be regarded assimply creating a contractual right of set off and thus having the same effect as (b).

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further advances (as in an uncommitted overdraft facility) but the security expressly securesfurther advances if made,98 then the subsequent advances will have priority only if the firstlender was unaware of intervening advances (see Box A1.18). For this purpose, registration ofa subsequent mortgage does not give notice.99

Lenders should not advance further moneys against the security if they are aware of theexistence of second priority security (unless, of course, they are obliged to do so or there areinter-creditor agreements100 documenting the position).

SECTION 3 GUARANTEES101

1 The nature of a guarantee

The expression ‘guarantee’ may be used to describe a variety of instruments includingtraditional (suretyship) guarantees, demand guarantees,102 and performance bonds.103 Thesedifferent instruments are all secondary in function but some (the demand guarantee and per-formance bond) are primary in form (see 1.2 on p. 282). In this section, the expression ‘guar-antee’ is used in its traditional sense—that is, to mean a suretyship guarantee—see 1.1 below.

1.1 Guarantee versus indemnity

A suretyship guarantee is an agreement to be answerable for the debt of another if that otherdoes not pay.

An indemnity, on the other hand, is an agreement to make payment in certaincircumstances (see Box A1.19 on p. 282).

G U A R A N T E E S 281

98 Tacking is also possible where the security does not expressly secure future advances, but, in that case,registration of the subsequent security will constitute notice.

99 Law of Property Act s94 (2).100 See Appendix 2.101 See Goode Commercial Law, Chapter 30.102 See para 1.3 on p. 282.103 See Appendix 2.

BOX A1.18

For example, assume A lends $10 million to B taking security over assets which secure the $10 million plusany future advances.C then lends $5 million to B taking second security over the same assets.A then lends a further $2 million to C.If the advance of the additional $2 million was pursuant to an obligation binding onA then A’s $2 million will have priority over C’s $5 million.If A was not obliged to lend the additional $2 million, A will have priority if he wasunaware of C’s advance at the time he lent the additional $2 million. Otherwise,the additional $2 million will rank behind C’s debt. Significant simplication of thesepriority rules are proposed as discussed at para 3.3.

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The indemnity is an independent debt; no underlying claim is necessary. In legal terms, it is aprimary obligation, while a guarantee is a secondary obligation; it depends on the existenceof an underlying debt.

1.2 Primary versus secondary obligation

An indemnity is simply an example of a primary obligation. A primary obligation is anyobligation which is not dependent on the existence of an underlying debt. Any undertakingto pay is usually a primary obligation (e.g. the undertaking to pay the price of goods ordered)(see Box A1.20).


104 Nevertheless, the lender need not exhaust its remedies against the borrower before making claim on theguarantee. It is sufficient that there should be a default by the borrower in due payment.

105 See Philip Wood Comparative Law of Security and Guarantees, pp. 331–332. See also Heald v O’Connor (1971)2 AER 1105, and General Produce Co v United Bank Ltd (1979) 2 Lloyds Reps 255.

106 See Goode Commercial Law, pp. 799–802.

BOX A1.19

This can be illustrated by the difference between the following two situations

� A buys goods from B and C states ‘If A does not pay you, I will’. That is a guarantee.

� A buys goods from B and C states ‘I will make sure you are paid for those’. That isan indemnity.

In the first case, C is only liable to pay if A does not.104 In the second case, C must paywhether or not A is liable to pay.

BOX A1.20

As discussed in the context of clause 18.1(b) on p. 110, English law guarantees com-monly include indemnities as well as guarantees. Some English law guarantees do notdo this but instead state that the guarantor guarantees ‘as primary obligor.’ This short-hand approach is not recommended as it may have a number of different interpreta-tions.105 The clearest solution is to insert a primary undertaking to pay the debt on itsdue date as well as a guarantee.

1.3 Indemnity versus first demand guarantee106

A first demand guarantee is a guarantee under which the guarantor must pay, regardless ofwhether the underlying debt is legally due and unpaid. Payment must be made by the guaran-tor on demand by the beneficiary of the demand guarantee and without looking into the meritsof the claim against the debtor. A demand guarantee is similar to, but not the same as, an indem-nity. They are usually issued by banks and may, for example, take the form of a letter of credit.

It is simply a question of construction as to whether any document takes effect as aguarantee (under which default must be demonstrated before demand may be made), a

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demand guarantee (under which payment must be made regardless of any defences whichmay be available under the underlying debt), or an indemnity (under which there is no needfor an underlying debt). If payment can be triggered without real evidence of default (e.g. bya simple statement of the lender that he has not been paid) then the document is either anindemnity or a demand guarantee.107

1.4 Continuing guarantees

Just as loans may be revolving in nature, with the amount outstanding both decreasing andincreasing in accordance with the borrower’s needs,108 so also guarantees may be continuingin nature and may secure, not simply a fixed loan, but instead a loan, such as a revolvingcredit, which may be repaid and re-advanced from time to time. The guarantee relates to afluctuating balance of the facility.

A continuing guarantee may also be given on an ‘all moneys’ basis—to secure any moneywhich is outstanding from the borrower when the guarantee is called on—whether under anagreement in place at the time the guarantee was entered into or under any subsequentarrangements. The guarantee relates to the amount outstanding when the demand is madeunder the guarantee. The question of what debts are covered by a guarantee is simply aquestion of interpretation of the wording of the guarantee.

Where the guarantee relates to advances which the lender is not committed to make at thetime the guarantee is given (e.g. under an all moneys guarantee) the guarantor will oftenbe able to give notice terminating its liability in respect of advances not yet made at the timethe notice of termination is given.109

1.5 Guarantee versus third party charge

A guarantee is a right in personam.110 A third party charge is a security interest (a right in rem)granted by a party which is not the borrower. The third party charge may be given as securityfor the third party’s obligations under a guarantee or may be given directly for the borrower’sobligations under the loan. Whichever route is chosen, the effect is that the third party ismaking its asset which is the subject of the charge available to meet the debts of the borrower.Since the third party is standing surety for the borrower to the extent of the value of the asset,it has the rights of a surety and the various issues discussed in relation to guarantees(e.g. effect of discharge of security) apply equally to third party charges.

1.6 Guarantee versus letter of comfort

A letter of comfort is usually intended to give a moral but not a legal assurance. It is a questionof interpretation of the document as to whether it is legally binding or not. Simply calling it aletter of comfort does not result in it not being a legal commitment.111 To achieve that effect,words of promise (such as ‘undertake’ or ‘agree’) should be avoided and, preferably, thedocument should clearly state the intention that it should not be legally binding.


107 See Goode Commercial Law, p. 1015 et seq for further detail on demand guarantees.108 As opposed to loans of a fixed sum, which, once advanced, must be repaid but are not available for re drawing.109 Because a continuing guarantee may be terminated if the consideration for it was ‘divisible’—see Goode

Commercial Law, p. 812. It has been suggested this may even be possible where the guarantee is executed as a deedsee ‘Selected Legal Issues for Finance Lawyers’ p. 59–60.

110 See para 3.1 of section 1 of this Appendix 1 on p. 263.111 See Chemco Leasing SpA v Rediffusion plc (1987) 1 FTLR 201, and Kleinwort Benson Ltd v Malaysian

Mining Corp (1989) 1 AER 785.

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2 Hazards with guarantees

2.1 Transactions at an undervalue112/commercial benefit

Under English law, guarantees may be vulnerable to be set aside as transactions at anundervalue113 if

� given at a time when the company was insolvent114 or if it became insolvent as a result ofthe guarantee; and

� the company subsequently goes into liquidation under a process which commencedduring the hardening period;115 and

� the company cannot take advantage of the defence which is available. It is a defence if theguarantee was entered into for the benefit of the company and there were reasonablegrounds to believe it would benefit the company. In the case of a downstream guarantee116

this benefit to the guarantor is often not hard to show—improving the financial position ofa subsidiary generally improves the prospects of receiving dividends. In the case of anupstream or sister guarantee,117 there may be more difficulty establishing this requirement.

In addition to the hazards of transactions at an undervalue, payment under a guarantee maybe challenged on the basis of a lack of corporate benefit (see Box A1.21).

Lenders will therefore be concerned to ensure that the guaranteeing company obtains abenefit from the guarantee, or alternatively, in the case of a guarantor which will be solvent


112 s238 Insolvency Act 1986. See further Goode Commercial Law, pp. 839 et seq.113 A transaction under which a company gives substantially more than it receives. In a guarantee, an assurance

is given and, in exchange the company receives the right to be indemnified by the original debtor if payment ismade under the guarantee.

114 I.e. unable to pay its debts as they fall due or its liabilities exceed its assets, s123 Insolvency Act 1986.115 I.e. the period during which the transaction is open to challenge. The longest hardening period under

English law is two years.116 I.e. a guarantee given by a parent for the benefit of a subsidiary.117 I.e. a guarantee given by a subsidiary for the benefit of its parent or of a fellow subsidiary.118 Following a comment from Slade L.J., in the case, which was not, however, part of the decision.

BOX A1.21

The principal case is Rolled Steel Products (Holdings) Ltd v British Steel Corp andothers (1986) Ch 246 where a guarantee was set aside due to a lack of corporate benefitto the company itself. It was stated in that case that directors owed a duty to act in theinterests of the company. The case held that where a third party knowingly (includingsomeone with constructive notice) received a payment which was made in breach ofthat duty, it would be obliged to refund that payment to the company. While CompaniesAct 1985 s35A (enacted after the Rolled Steel decision) virtually abolished the rule (ultravires) relating to capacity, it expressly retained the liability of directors for any breach oftheir duty. Lenders taking guarantees therefore remain concerned to ensure that direc-tors do not act in breach of their duty outlined in Rolled Steel and therefore to ensurethat they (the lenders) do not have constructive knowledge of a misuse of the com-pany’s assets. In the case of a solvent company it is thought 118 that this duty may bewaived by all the shareholders.

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after the giving of the guarantee, to ensure that shareholder approval of the guarantee isobtained (see comments on Schedule 2 at para 1.1(d) on p. 234).

2.2 Subrogation/reimbursement

A guarantor which pays another’s debt is generally entitled to be reimbursed by the debtor.The scope of this right depends on whether the debtor requested the issue of the guarantee. Ifthe guarantee is entered into voluntarily by the guarantor (e.g. in a risk subparticipation) theright of the guarantor to be reimbursed is more limited than it otherwise would be.119

Guarantees usually require guarantors to agree that any claim for reimbursement whichthey have will be subordinate to the guaranteed debt.120

A party which pays under a guarantee is also entitled to take over (or be subrogated to)the creditor’s rights against the debtor, including any security held by the creditor(see Box A1.22).


119 In this situation, the right to reimbursement is based on restitution rather than implied contract and so, forexample, will not be available if the guarantor pays a debt which could not have been enforced against theBorrower. See The Modern Contract of Guarantee, Dr James O’ Donovan and Dr John Phillips, 2003 at para 12.02.

120 See comments on clause 18.7.121 s5 Mercantile Law Amendment Act 1856.122 See The Modern Contract of Guarantee at para 12–282. See also Esso Petroleum Co Ltd v Hall Russell & Co Ltd

the Esso Bernicia (1989)AC 643.123 See comments on clause 18.7.

BOX A1.22

This right derives from the equitable remedy of restitution and has been supplementedby statute.121 There are differences in the detail between the rights given to the guarantorby the statute and the rights which it has under the equitable remedy. In particular, thestatutory right arises whether or not the debtor requested the giving of the guarantee.The equitable remedy however may be limited in circumstances where the right toreimbursement is limited.122

Guarantees usually require guarantors to waive their right of subrogation until the lenderis paid in full.123

2.3 Discharge by amendment and other defences

As discussed in relation to clause 18.4, care must be taken not to amend or waive the loanagreement or otherwise deal with it or any security for it, without obtaining the guarantor’sconfirmation that their guarantee will remain effective after the proposed action (or inaction)has been taken. See the discussion on clause 18.4 of the LMA Term Loan.

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This glossary is intended to assist practitioners by giving brief explanations of certain words commonlyencountered in international finance. It includes technical legal and banking expressions as well as col-loquial terms.

APPENDIX 2 GLOSSARY OF TERMS

Acceleration The giving of notice to the borrower, following the occurrence of anEvent of Default, requiring the loan to be repaid immediately.

Acceptance credit A facility under which the ‘borrower’ may issue bills of exchange facility which require ‘acceptance’ (or agreement to pay the amount specified

in the bills of exchange) by the ‘lender.’ Amounts which the ‘lender’has paid under the bills of exchange are treated as loans made to the‘borrower.’

Accrued interest The interest which, on any given day, has been earned (but is not yetdue and payable) on a loan, bond or similar instrument.

Acquisition finance Finance provided for the purpose of funding a company acquisition.Administration An English legal expression describing the legal situation which results

from the issue of an administration order under the Insolvency Act1986. Such an order may be issued in relation to a company which is infinancial difficulties, if a court is persuaded that granting the companya period of protection from action by its creditors will assist in preser-vation of the company’s business or the most profitable realization of itsassets. While the order is in force, creditors cannot take action againstthe company, or enforce security against its assets, unless they obtainthe consent of the court. Similar to Chapter 11 in the United States.

286

A P P E N D I X 2

Glossary of Terms Used in International

Lending

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Administrator The official who will take control of the business of a company while itis in administration.

Advance A drawing of money under a loan facility.Agent In the context of a syndicated credit facility, the Agent is the lender

which administers the facility, acting as a channel between the borrowerand the syndicate for the purpose of communications and payments. In other contexts, an agent is anyone who represents another (his ‘prin-cipal’) in a negotiation or other transaction.

Amortisation The repayment of debt in stages.Annuity A basis for repaying a loan which results in the total amount paid by the

borrower on each payment date being the same. In the early years, thisamount will be made up largely of interest, while in the later years itwill constitute mostly principal.

Arbitrage Profiting from the difference in prices between markets, for example,between Tokyo and London.

Arbitration A process for settling disputes without having recourse to courts of law.The dispute is decided either by a person appointed by the parties tothe dispute or chosen by a third party they have nominated to make theappointment. See further Box 3.19 on p. 231.

Arranger The lender which is originally mandated by the borrower to arrange asyndicated loan.

Asset Any thing which has value. It may be physical, such as a ship, intellectual,such as a patent, or otherwise intangible, such as a debt.

Asset backed Securities (such as those issued in a securitization) which are supportedsecurities by assets such as credit card receivables (as opposed to normal debt

securities issued by a company, which are often unsecured and paripassu with that company’s general creditors).

Asset finance Finance which is provided for the purpose of funding the acquisition ofa major asset.

Asset stripping Sale of assets for cash instead of keeping them to generate income.Assignment A method of transfer of choses in action. An English law assignment

may be used in an outright transfer, such as a sale, (as to which seepara 2 of Section 1 of the commentary on clause 24 of the LMA TermLoan on p. 190), or as a method of security, (as to which see para 2.5 ofSection 2 of Appendix 1 at p. 275). An English law assignment may onlybe used to transfer rights, not obligations. In the United States, theexpression may also refer to a transfer (by assumption) of obligations.

Availability period The time during which a borrower may draw down advances under a loan.Backstop facility A facility to be used in the event of a problem with alternative financing

arrangements.Back to back A colloquial expression for two linked transactions on identical (or transactions practically identical) terms—for example, a loan from X to Y and a

corresponding loan from Y to Z.Balance sheet Lending on the strength of the borrower’s balance sheet (as opposedlending to lending on the value of a particular asset or income stream).Balloon repayment A final repayment of principal on a loan transaction which is substan-

tially larger than earlier repayment instalments.Bankruptcy The situation which arises if a person has been declared by a court not

to be able to pay his debts and whose affairs have been put into the

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hands of a receiver. In England, this term is applied only to persons.Companies go into liquidation as opposed to bankruptcy.

Base rate A fluctuating interest rate, peculiar to individual banks and used bythem as a reference point for lending rates when lending on an inclu-sive (as opposed to a ‘cost plus’) basis. See Section 3 of the Introduction.

Basis point One hundredth of one percentage point (e.g. 45 basis points is 0.45%).Basel II The agreement updating the capital adequacy requirements which

were originally set down in 1988. The new regulations are expected tobecome fully effective in 2006 and are discussed at Box 1.35 on p. 102.

BBA LIBOR British Bankers Association LIBOR—see ‘Screen Rate.’Bells and whistles Unusual features of a transaction.Beneficiary Any person for whose benefit assets are held in trust. See Appendix 1

at para 3.6 of section 1 on p. 265.Bible Complete set of copy or conformed copy documents relating to a

particular transaction.Bid bond A bond provided by a bank which is payable if a bidder, on winning the

bid, does not enter into a binding contract in accordance with the bid.Bilateral facility A loan facility between one lender and one borrower.Bill of exchange A form of short-term promise to pay widely used to finance trade and

provide credit. It is an instruction by the drawer to the person accept-ing the bill of exchange to make a payment to a third party. It differsfrom a promissory note in that a promissory note is a promise by oneparty to make a payment. It differs from a letter of credit in that a let-ter of credit is payable only against presentation of documents (and isusually issued by a bank at the request of a customer).

Bona fide A Latin expression meaning in good faith. A bona fide purchaser is onewho believes he is entitled to buy, and that the seller is entitled to sell.

Bona fide purchaser An English legal expression meaning a person who, acting in goodfor value faith and acquiring, for a price, a legal interest in property, may defeat

an equitable interest in the same property.1

Bond In the context of capital markets, means a medium- to long-termpromise to pay a certain amount at a certain date in the future, tradedin the capital markets. It may or may not be interest-bearing. (if it is, itis referred to as having a ‘coupon’) OR In other contexts (as in bid bond or performance bond) some form ofassurance given (in the form of a promise to pay a fixed sum in certaincircumstances) that a person will perform as promised.

Book debts The items in a company’s balance sheet which represent amountsowing to the company.2

Book value The value of a company’s assets as shown in its balance sheet.Bridge financing Interim financing used as a short-term stop gap until the intended

long-term financing facility is available.Broken funding The cost to a lender of breaking its underlying funding if the lender iscosts paid earlier than agreed.3

A P P E N D I X 2288

1 See Appendix 1 at para 4.1 of section 1 on p. 266.2 Whether an item of income is a ‘book debt’ or not is important in considering whether security over it is

registrable or not (pending reform of the law in this area, discussed in para 3.3 of section 2 of Appendix 1). Securityover ‘book debts’ is registrable against the company creating the security. See further para 3–27 of Goode LegalProblems of Credit and Security.

3 See commentary on ‘Break Costs’ in Part 1 on p. 38.

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Bullet repayment Repayment of a debt obligation in a single instalment at the date ofmaturity of the debt (i.e. with no amortization).

Business day A day on which banks are open for business in the relevant place.Call option An agreement which gives the recipient the right, but not the obliga-

tion, to require the donor to transfer a specified asset to the recipient,normally at a specified price, on a specified date (or within a range ofdates). The recipient of this right can be expected to exercise it if thevalue of the asset, on the date on which the option may be exercised, ishigher than the price at which the option can be exercised. It thereforegives the recipient an option to participate in any increase in price ofthe relevant asset.

Cap A limit or ceiling, for example, setting the maximum interest rate ona loan.

Capital markets The markets for sale and purchase of tradeable financial instrumentssuch as bonds and commercial paper.

Capitalized interest Interest which has accrued but which has been added to the principalamount of the loan and is itself bearing interest. Often interest is capi-talized during the construction phase of a project finance before thereis any income to fund it.

Certain funds An English expression meaning funds with minimal conditions prece-dent to availability as necessary for meeting the requirements of theTakeover Code for financing the acquisition of a UK quoted company.

Chapter 11 US rules allowing a company a period of protection from its creditorswhile it seeks to reorganize its affairs and avoid winding up. Similar toEnglish administration.

Charge An English legal expression meaning a security interest under whichthe chargee does not get either title or possession but simply the right,in a default, to take the asset and apply its proceeds against the secureddebt. See para 2.4 of section 2 of Appendix 1 on pp. 272–275.

Chinese wall An artificial barrier restricting communication between different areaswithin an organization, allowing them to act for parties who may haveconflicting interests. The concept originated in securities houses. It isalso commonly used within large firms of solicitors and accountants.

CHIPS A clearing system used in the United States for settlement of largevalue payments4.

Chose in action An English legal expression meaning rights (such as rights undercontracts) which can only be enforced by taking legal action5.

Civil law Codified systems of law which have developed from Roman law—seepara 2.1 of Section 1 of Appendix 1 on p. 261.

Clawback clause A clause enabling one party to retrieve money already paid out. Anexample is the clause (Clause 29.4 of the LMA Term Loan) found insyndicated loan agreements enabling an agent to recover moneyalready paid out by it to a party, wrongly believing that the agenthad received the corresponding payment from another party. Thisallows an agent to distribute money (e.g. repayment instalment) tothe bank syndicate without confirming receipt of the payment from the


4 See Ross Cranston Principles of Banking Law 2nd edition, p. 279.5 See Martin Hughes Selected Legal Issues for Finance Lawyers at pp. 70–71.

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borrower, knowing if it does not receive the monies from the borrowerit may ‘clawback’ the monies paid out to the syndicate. Another exam-ple is clause 13.4 of the LMA Term Loan, relating to withholding taxand allowing the borrower to ‘clawback’ some of the moneys paidunder the grossing-up clause (clause 13.2(c) of the LMA Term Loan) inthe event that the relevant lender receives a tax credit which it attrib-utes to those payments by the borrower.

Clear market clause Clause in a term sheet by which a borrower undertakes, while its loanis being syndicated, not to put other offerings on sale which couldcompete with the syndication.

Club A small group of banks who finance a loan without the need for a fullsyndication process.

Co-financing A financing where a number of different lenders or syndicates areinvolved, each providing a different facility to the borrower, under a dif-ferent facility agreement, often with common undertakings and events ofdefault as set out in a ‘Common Terms Agreement.’ Generally, the lenderswill share any security in accordance with pre-agreed rules which are notsimply based on one lender being senior in all circumstances to another.Distinct from a syndicated loan in that there are different facilities, to beused for different purposes, and with different pricing.

Collar A combination of a cap and a floor limiting movement (e.g. of interestrates) to stay within a defined range.

Collateral Assets used to secure a loan or other financing transaction.Collateralized A bond or other tradable financial instrument issued by a company debt obligation which is secured (with the security usually being held by a trustee).Commercial paper Short-term promise to pay a specified amount at a future date, traded

in the capital markets.Commitment The specified amount of money agreed to be lent by a lender in a

committed facility.Commitment fee An annual percentage fee payable to a bank on the undrawn portion of

its commitment under a committed facility. The commitment fee isusually paid periodically in arrears.

Committed facility A facility which the lenders are committed to make (or keep) available,subject only to the satisfaction of conditions precedent and non-occurrence of an Event of Default.

Common law Law as laid down by decisions of courts, rather than by statute.See para 2.1 of section 1 of Appendix 1 on p. 261.

Compound interest Interest charged on interest.Conditions A word with many meanings. It may refer to

� the provisions of an agreement generally;

� things which need to be done in order for particular parts of anagreement to become, or to remain, operative (as in ‘conditionsprecedent’ or ‘conditions subsequent’); or

� those provisions of an agreement which are sufficiently important towarrant the termination of the agreement if there is a breach of theprovision (as opposed to a warranty, breach of which gives rise onlyto damages).


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Conformed copy A copy of a final executed document in which all signatures and anyother handwritten words (e.g. dates or alterations) are printed in typedform. Conformed copies are often used to make up the transactionbible.

Consideration An English law expression meaning some benefit given in exchangefor a promise in order for the promise to be legally enforceable.6

Constructive notice In many situations English law provides that a party’s rights dependon whether or not it had notice of certain facts. In order to preventparties from deciding not to enquire about things they might rathernot know about, English law includes a concept of ‘constructivenotice’. Precisely what constitutes constructive notice in any given sit-uation will depend on the facts of the case, but the concept is that aparty will be treated as having notice (and will have constructivenotice) if that party would have had notice if it had acted in a mannerwhich the court decides that it should have acted, bearing in mind allthe circumstances of the case.

Contingent debt A debt which may or may not mature. The obligation to pay it isdependent on the occurrence of some intervening event. An exampleis a guarantee, payment under which will only become due if theborrower defaults.

Contingent liability A liability which is dependent on the occurrence of an uncertain event(such as the liability under a guarantee).

Contra proferentem A rule of interpretation. The rule states that, where there is ambiguityin the wording of any provision of a contract, that provision is to beread against the party at whose instigation it was included in the con-tract and who is now seeking the benefit of the relevant provision.

Counterparty The other party to a contract.Covenant Apromise to do or not do specified acts. Same meaning as ‘undertaking’.Credit derivative A derivative relating to a particular credit risk, such as a credit linked

note, total return swap, or credit default swap. See para 4 of section 1of the commentary on clause 24 of the LMA Term Loan.

Credit enhancement A guarantee or other form of support which will enable the rating of aparticular issue of securities to be improved.

Cross default An event of default in a loan to a borrower which is triggered by adefault in the payment, or the potential acceleration of repayment, ofother indebtedness of the same borrower.

Cross security Security given for one loan also being given as security for anotherloan and vice versa.

Crystallisation The termination of the freedom which a chargor has, under a floatingcharge, to deal with the assets which are the subject of the charge. Seepara 2.4(a) of section 2 of Appendix 1.

Current asset Any asset which is not intended to be retained in a company andwhich is available to be turned into cash within one year.

Current liability A liability of a company which falls due within one year.Debenture EITHER

A document, such as a bond or promissory note, which evidencesa debt. Often these securities are freely transferable and listed.


6 See Appendix 1 at para 4.2. of Section 1 on p. 266.

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They may be secured on the company’s property (‘mortgagedebentures’).ORA document which creates security over all of a company’sbusiness. The document contains, in the charging clause, mort-gages, fixed and floating charges, and assignments which togethercreate the necessary security.

Debt service Payment of principal and interest in respect of the loan.Deductible The amount which an insurer will deduct before making payment

of a claim. The expression is also used in relation to tax, meaning the abilityto deduct a particular payment from profits for the purpose ofcalculating tax liability.

Deed An English law expression meaning a document which will beenforced by the courts without the need for consideration.7

Default In its ordinary sense, this means a breach or a failure to perform aspromised under a contract. It is usually also a defined term in theloan agreement, meaning something which may, or may not, resultin an Event of Default. See commentary on ‘Default’ in clause 1 ofthe LMA Term Loan.

Defeasance A structure which creates certainty that a payment obligation will bemet from a specific source other than by the original debtor.

Dematerialize To transfer to a system which is based on book entries.De minimis Too small to be concerned with.Derivatives Assets (such as futures) which derive their value from underlying

assets. See, for example, the discussion of credit derivatives at para 4of Section 1 of the commentary on Clause 24.

Disbursement account The account to which the proceeds of a loan provided in a projectfinance transaction are paid. Money will be drawn from thataccount against approved invoices.

Distressed debt Debt which is, or which the lender believes will be, non-performing(i.e. repaid late, partially, or not at all) and which is usually sold forsubstantially less than the value of principal outstanding.

Distributable reserves The amount which a company is allowed to pay to its shareholdersat any given time by way of dividend.

Dividend A payment by a company to its shareholders out of profits.Double dipping Structuring a transaction in such a way that it becomes possible

to utilize the tax benefits on capital investments in more than onejurisdiction.

Double taxation treaty An agreement between two countries intended to limit the doubletaxation of income and gains, under the terms of which an investorwhich is tax resident in one country but invests in another may beable to apply for an exemption or reduction in the taxes imposed onhis income or gains by the country of his investment, on the basisthat such income or gains will have tax levied on them in the coun-try in which he is tax resident. This type of treaty encourages tradeand financial transactions between countries. See commentary onclause 13 of the LMA Term Loan.


7 See Appendix 1 at para 4.3 of section 1 on p. 267.

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Drawdown The borrowing of money under a loan facility.Drop dead fee A fee payable to a lender in the event the proposed transaction does

not proceed.Due diligence The process of checking all relevant facts before entering into a

transaction. Involves both financial and legal due diligence.Encumbrance A general description of any restriction on rights of ownership. It

includes all forms of security as well as other restrictions such asrights of way.

Engrossment The final version of a contract, ready for signature.Equity Has many meanings

� Moneys invested into a company by its shareholders (including,perhaps, accumulated profits not yet distributed)

� The principles of law which are embodied in equitable principles(See para 2.3 of section 1 of Appendix 1 on p. 262)

� Fairness

Equity kicker An option, often included in certain loan transactions, particularly inmezzanine finance and venture capital, to take a share in the profitsarising from the transaction financed by the loan.

Equity of redemption A mortgagee’s right to pay off the secured debt and obtain title backfrom the mortgagor.

ERISA Employee Retirement Income Security Act of 1974 in the UnitedStates. Failure to comply with the requirements of the Act can resultin penalties and security interests arising. US borrowers are thereforeoften asked to give representations and covenants as to compliancewith ERISA.

Escrow arrangement Documents held in escrow are executed documents given by oneexecuting party to a third party (usually a solicitor) to hold to itsorder until a certain condition is satisfied, or event occurs. The thirdparty will usually be instructed that, on the satisfaction of such con-dition or occurrence of such event, the documents must be releasedout of escrow, usually to the other executing party. Money may alsobe held in escrow—that is, held by a third party with irrevocableinstructions as to how to dispose of it in different circumstances.

Estoppel An English law principle that, in certain circumstances, it would beunfair to allow a person to do something (such as enforcing theirlegal rights) and that he will therefore be ‘estopped’ from doing it. Inthe classic case8 a landlord, having promised not to charge the fullrent he was entitled to, was subsequently estopped from suing forthe full rent.

Eurobond A bond denominated in a Eurocurrency and traded on the capitalmarkets.

Eurocurrency Traditionally, any currency held by a non-resident of the country ofthat currency9.

Event of Default The circumstances listed in the loan agreement which entitle thelender to demand immediate repayment of the loan.


8 Central London Property Trust Ltd v High Trees House Ltd (1947) KB 130.9 But see How to Read the Financial Pages, Michael Brett, 5th edition, p. 276.

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Evergreen A colloquial expression which means that the relevant thing is alwaysthere. For example, an evergreen repetition of the representations isone which requires them to be repeated daily and an evergreen facil-ity is one which is renewable annually.

Exclusion clause A clause under which a person seeks to exclude the liability, which hewould otherwise have had, to another.10

Execute Sign.Export credit Support provided by a country’s government or an agency on behalf

of the government, for the purpose of encouraging exports from thatcountry. The support may take the form of guarantees, loans at sub-sidised interest rates, or other. The terms of export credit are regulatedby the OECD Guidelines for Officially Supported Export Credit.

Export credit A government body created for the purpose of providing exportagency credit.Facility A generic description for any form of financial support, whether by

way of loan, guarantee, acceptance credit, or other.Factoring The sale and purchase of receivables, either on a recourse or

non-recourse basis. In other words, the seller may or may not remainsubject to the risk of default in relation to the receivables sold.

Fiduciary duty This is the duty of the trustee or agent (including directors of compa-nies, who are agents of the company by virtue of their position asdirectors) to act in the interests of those he represents. The existenceand exact scope of any fiduciary duty depends on the situation. Ingeneral, fiduciary duties include a duty

� not to make a secret profit,� not to put oneself in a position where a conflict of interest may

arise,� not to sub-delegate; and� to act in good faith.11

Finance lease A means of financing involving a lease of an asset, the commercial effectof which is that the owner of the asset is in a similar position to a lenderand the lessee is in a similar position to owner and borrower. Leasepayments during the life of the lease are sufficient to enable the ownerto recover the cost of the asset from the lessee, plus a return on itsinvestment, regardless of any fluctuation in the value of the asset. Foraccounting purposes, the lessee under a finance lease is treated in thesame way as if it were the owner of the relevant asset. Any lease whichis not a finance lease is an operating lease. The distinction depends onthe accounting rules in the relevant jurisdiction. For English accountingpurposes, the distinction depends on whether substantially all the risksand rewards of ownership are with the lessor (in which case it is anoperating lease) or the lessee (in which case it is a finance lease).

Financial assistance An English legal expression meaning support12 given by a companyor any of its subsidiaries for the acquisition of its own shares. This is an


10 See para 4.4 of section 1 of Appendix 1 on p. 267.11 See further Goode Commercial Law, p. 171 (Chapter 5 para 8(ii)).12 Or, more accurately, any of the activities listed in s150 Companies Act 1985 under the definition of ‘financial

assistance’ contained in that section—including the provision of security.

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offence under s151 Companies Act 1985 and, unless provided inaccordance with the exceptions in the statute, it is a criminal offenceand any such assistance given is void. See also ‘whitewash’.

First demand guarantee A guarantee or other instrument (such as a letter of credit) underwhich the guarantor must make payment without first requiring toreceive evidence of default by the underlying debtor. See para 1.3of section 3 of Appendix 1 on p. 282.

Fixed charge Security over a specific asset which prevents the owner from dealingwith the asset. See para 2.4(b) of section 2 of Appendix 1 at p. 274.

Floating charge Floating charges are security interests which allow the persongiving the security to sell the items over which the security exists,free of the security until the security ‘crystallizes’. They are oftenused to give security over categories of assets such as a trader’sstock in trade from time to time. They have a number of disadvan-tages as against other forms of security; one of which is that thesecurity holder cannot retain all the proceeds of the security. Seepara 2.4(a) of section 2 of Appendix 1 at p. 272.

Floor An agreed limit below which a particular figure, such as an interestrate, is not allowed to drop.

Force majeure A continental law concept meaning occurrences of a type (e.g. actsof God) which are outside the control of the parties and which jus-tify the non-performance of obligations under a contract (withoutthe contract itself having to set this out). Under English law, non-performance of a contract for reasons which are not specified in thecontract but which are outside the control of the parties, is justifiedif the contract is ‘frustrated’. This is a much narrower concept thanthe continental concept of force majeure. For this reason, manyEnglish law contracts contain force majeure clauses, specificallyallowing non-performance in circumstances which would notamount to frustration.

Frustration The circumstances in which English law will release parties fromfurther performance of a contract as a result of unanticipatedoccurrences. A contract is frustrated if it is incapable of being per-formed in a manner which will give the parties the same nature ofbenefit as they originally contracted for. Further performance isthen excused.13

Full recourse In relation to an obligation, ‘full recourse’ means that the personwho is owed the obligation has all the rights which the law gives inrelation to enforcement of that obligation, for example, to sue thecounterparty for all sums due and enforce any judgement againstany of the assets of the counterparty.

Fungible assets Assets where the precise identity of the asset is irrelevant—eachasset of that type is interchangeable. For example, in relation tocash, a deposit of £10 with a bank may be reimbursed by the bankreturning £10—even though the precise notes are not the same asthose originally deposited.


13 See Chapter 20 of Treitel The Law of Contract.

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Futures Contracts to buy or sell specific assets for agreed prices on an agreedfuture date.

Gearing The ratio of a company’s debt to its equity.Gilts Securities such as commercial paper issued by the British government.Goodstanding A concept which is relevant in some (e.g. some US) jurisdictions where

failure to pay taxes may jeopardize the company’s existence or ability todo business.

Goodwill The value attributed in a company’s balance sheet to certain of thecompany’s non-physical assets such as its name, reputation, andcustomer base.

Governing law See ‘proper law’.Grace period The period of time given to a borrower, in relation to the events of

default in a loan agreement, in which it is allowed to remedy any givensituation, and to avoid that situation becoming an event of default.

Gross negligence A concept which is not clearly defined under English law. Unlikemany other jurisdiction (such as Scotland) where there is a difference inkind between negligence and gross negligence, under English law, thedifference is one of degree.14

Gross-up A borrower may be required to gross-up payments it has to make to thelenders, meaning it must make additional payments to compensate forwithholding taxes, or similar deductions, which would otherwisereduce the amounts actually received by the lenders. See commentary onclause 13.2(c) of the LMA Term Loan.

Guarantee A promise to pay a debt which has been made to another if that otherdefaults in payment. See para 1.1 of section 3 of Appendix 1 on p. 281.

Hardening period The period of time before the commencement of an insolvency process(e.g. winding up) in respect of which a liquidator can challenge certaintransactions entered into by the insolvent company. See ‘Transactionsat an undervalue’ and ‘Preference’. The longest hardening period inEnglish law is two years.

Hedging Arrangements made to protect against loss due to market or currencyfluctuation.

Hell or high A clause which requires payment regardless of any eventualities (e.g. to water clause continue paying hire for an asset, regardless of its destruction, as will be

contained in a finance lease).Hire purchase A form of finance lease under which the lessee has the right to purchase

the asset for a nominal sum at the end of the financing period.Indemnity An agreement to hold another harmless against loss. See para 1.1 of

Section 3 of Appendix 1 on p. 281.Information A document prepared in connection with a proposed syndicated loanmemorandum or issue of securities, providing information in relation to the proposed

transaction for review by potential participants. See ‘Prospectus’.Insolvency In its technical sense, a company is insolvent if either

� it cannot pay its debts as they fall due (the cash flow test) or


14 Charlesworth and Percy on Negligence (10th edition 2002) para 1–11 says that ‘gross’ negligence ‘is intended todenote a high degree of careless conduct, such as where a defendant did not intend a particular consequence tohappen, but nevertheless must have been able to foresee its occurrence’. See also Consultation Paper 171 of theLaw Commission on Trustee Exemption Clauses at para 4.67 et seq.

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� its liabilities exceed its assets (the balance sheet test)15

Failure to meet either of these tests does not necessarily result in thecompany being wound up but it does give rise to additional duties fordirectors (see ‘wrongful trading’) and to the potential for certain trans-actions entered into (see ‘transactions at an undervalue’ and ‘prefer-ence’) being subsequently set aside if an insolvency process (such as awinding up or administration) starts during the hardening period.

The expression is sometimes (inaccurately) used to mean the sameas winding up.

Institutional investor An organization whose function is to invest its assets, such aspension funds and investment funds.

Intangible assets Any asset which does not have a physical form. Examples aredebts and patents.

Intercreditor deed Any deed made between different creditors (or groups of creditors,such as different syndicates) of a company. Such a document maydeal with any issues which those creditors seek to regulate amongthemselves, but commonly covers such issues as priorities of debts,(perhaps prior to insolvency as well as in the event of insolvency ofthe debtor), priorities of security, agreement on the application of pro-ceeds of sale of assets belonging to the debtor, rights (or restrictionson rights) to take action against the debtor or its assets, commitmentsrelating to provision of further funding and/or provision of informa-tion, and rights (or restrictions on rights) to adjust the existing con-tractual arrangements with the debtor. Such a document may also goby other names such as ‘priorities deed’, or ‘subordination deed’.

Interest Period The period(s) with reference to which interest is calculated for thepurpose of a loan agreement. See commentary on clause 10 of theLMA Term Loan.

Initial public offering A flotation of a company on a stock exchange.Investment grade Securities which are rated by the rating agencies at a specified rate

high enough to be eligible for investment by certain organizations,such as pension funds.

ISDA International Swap and Derivatives Association. An associationresponsible for publishing standard terms for swaps and otherderivatives.

Joint venture A business which is run by two or more companies in cooperation.The joint venture may take the form of a partnership between thecompanies, a separate legal entity, or other contractual arrangements.

Judgement currency An indemnity sometimes included in credit facilities (e.g. clauseindemnity 15.1 of the LMA Term Loan) to protect the lenders against losses

they may suffer if judgement is obtained against the borrower in acurrency different to that in which the facility is denominated. Suchan indemnity may not be enforceable in all circumstances and this isan issue for due diligence.

Jurisdiction The concept that any given court is only able to deal with certainissues, being those which fall within its ‘jurisdiction’. The jurisdiction


15 s123 Insolvency Act 1986.

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of any court may be limited with reference to the type of issueconcerned (e.g. the family courts), the amount in dispute or the coun-try or countries with which the dispute or the parties to it have a con-nection. Parties to a loan agreement will expressly submit to thejurisdiction of the courts of a specified jurisdiction. These need not be(but usually are) the courts of the country whose law has been chosenas the proper law of the agreement.

Lender of record A member of the syndicate, with direct claims against the borrower.See section 1 of the commentary on clause 24 of the LMA Term Loan.

Lending office The branch or office of a lender through which the funds for a facilityare provided.

Letter of credit A document commonly used in connection with the sale and purchaseof goods. It is a written undertaking by a bank (the issuing bank)given at the request of, and in accordance with the instructions of,the applicant (the buyer of the goods) to the beneficiary (the seller ofthe goods), to effect a payment of a stated amount of money, within aprescribed time limit, against the production of stipulated documents(such as evidence of shipment of the goods).

Leverage Ratio of debt to equity. Also known as gearing.Liability A legal responsibility (may either be a responsibility to do a specified

thing or to make a specified payment).LIBOR London Interbank Offered Rate. The rate of interest quoted by banks

in the London Interbank Market at which they are willing to lendmoney, that is, offer deposits in a particular currency for a particularperiod of time. See section 3 of the Introduction at p. 13.

Lien A right to retain possession of an asset until paid where this rightarises as a result of some commercial activity (such as repair ofthe asset) and was not created for the purpose of raising funds. In theUnited States the expression may be used to mean all forms of securityinterest. See para 2.3 of section 2 of Appendix 1 on p. 272.

Limited recourse A limited recourse loan is one with limited comeback (or recourse) tothe borrower. The comeback is usually limited to certain specifiedassets—usually the assets involved in, and income derived from, theproject being financed.

The expression may also be used in circumstances where there isfull recourse to the borrower, but the borrower is an SPV, which onlyowns assets relating to the project being financed. In this case, thetransaction is limited recourse to the shareholders of the SPV. This is astructural limitation on recourse.

Liquidated damages A sum specified in a contract as being the amount to be paid by oneparty to the other in the event of a breach of (or of a specified provi-sion of) the contract. Care needs to be taken in fixing the amount toensure that it is not a penalty. See ‘Penalty’.

Liquidation The winding up of a company and distribution of its assets.Liquidator The official who will be responsible for collection and distribution of a

company’s assets in a liquidation.Liquidity The ability of a company to pay its debts as they fall due. Often

assessed by the liquidity ratio—the ratio of current assets to currentliabilities. If a company is unable to pay its debts as they fall due, it isinsolvent. See ‘Insolvency.’


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Listed A bond, note, company share, or other instrument which is quoted on arecognized stock exchange.

Loss payee A person named on an insurance policy as the person to be paid in theevent of a claim.

Mandate The authorization from one person to another to conduct the relevanttransaction on the agreed terms. Usually given in the form of a lettersigned by both parties.

Margin In relation to floating interest rates, the rate of interest charged by thelender over and above the relevant cost of funding, such as LIBOR.

Mark to market Valuing an asset against its current market value (particularly used forswaps and other derivatives.)

Market disruption The clause in a loan agreement (clause 11.3 in the LMA Term Loan)clause which deals with what happens if funds are unavailable in the specified

market.Market flex clause The clause in a term sheet which allows the Arranger to alter the terms

if there are changes in market conditions.Matched funding The process of matching a loan (asset) with a deposit (liability) of the

same maturity.Maturity The date upon which a debt is finally repayable.Mezzanine Usually high-interest bearing debt, which ranks behind (i.e. is subordinatefinance or debt to) the ‘senior debtors’ so far as repayment and security is concerned. In

terms of risk and reward it ranks between debt and equity. The debt maybe structured as a subordinated loan or as preference shares, dependingon the legal, regulatory, and tax regime. See ‘Subordinated debt’.

Misrepresentation An untrue statement. See para 4.5 of section 1 of Appendix 1 on p. 268.Monoline insurer Insurer whose business is the provision of financial insurance.Moratorium A period in which creditors agree to allow a borrower to delay payment

of a debt, usually to allow negotiation of a rescue.Mortgage A type of security interest. Under a common law mortgage, title passes

to the mortgagee, subject to the mortgagor’s equity of redemption. Seepara 2.1 of section 2 of Appendix 1 on p. 272.

Mutatis mutandis A Latin expression meaning ‘with such changes as are necessary’. Thisis a shorthand expression, occasionally used in drafting. For example,the following statement may be used to avoid repetition. ‘Clause {}(Agency) shall apply to the Security Trustee mutatis mutandis’.

This avoids the need to repeat the clause replacing all references to‘the Agent’ with references to ‘the Security Trustee’.

Negative pledge Undertaking by a borrower not to allow indebtedness to be maintainedon a secured basis.

Net present value The current value of a given future payment or payments, discountedat a given rate (see Box A2.1).


BOX A2.1

For example, if the current interest rate is 5% per annum, the net present value of apayment of $105 due to be made in 12 months time is $100, since that is the amountwhich, if deposited in an account today and bearing interest at 5% for the year, wouldyield a payment of $105 in 12 months time.

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Novation A method of transferring rights and obligations from one party to acontract to a third party.16 This method involves the discharge of onecontract and its replacement by a new, identical contract, with differ-ent parties.

Offtaker A party which commits to purchase a quantity of the product pro-duced in a project finance transaction.

Operating lease A lease which is not a finance lease.Originator A party who sells its receivables in a securitization transaction.Pari passu Equally and without preference in terms of entitlement to payment (as

opposed to pro rata, which relates to actual payment, and requiresthat all receive the same percentage of what is due to them.) Two debtswhich are pari passu will, when payment is made, be paid pro rata.

Performance bond A guarantee for a non-monetary obligation (such as due performanceof a contract). The expression may be used to describe a suretyshipguarantee or an instrument which is primary in nature.17

Penalty An English law expression. Under English law, any provision of acontract which seeks to penalize a party to the contract if it fails to per-form under the contract is a penalty and may be unenforceable. Such aprovision will however be enforceable if, in summary, the provision isa genuine attempt to compensate the other party for loss it will sufferas a result of the failure to perform.18 Common areas where this ques-tion arises are in relation to default interest and liquidated damages.

Plain vanilla A colloquial term used to describe loan facilities with no additionalfeatures such as call options.

Pledge The security created by the actual or constructive delivery of anasset to a lender where the possession of the asset was delivered forthe purpose of raising funds (as opposed to a lien, where possessionwas delivered for some other purpose). See para 2.2 of section 2 ofAppendix 1 on p. 272.

Pool A combination of assets into a single unit, such as a single investment(e.g. commercial paper) which is based on a number of investmentinstruments.

Power of attorney A legal document authorizing one person to act on behalf of another.Preference An English law expression for a transaction which puts a person in a

better position in the insolvency of another than they otherwisewould have been in (see, for example, Box A2.2 on p. 301). Any suchstep is vulnerable to be set aside as a fraudulent preference19.

Preference shares Shares which receive their dividends before all other shares and arerepaid first if the company goes into liquidation.

Preferential creditors Those creditors (such as, in many countries, employees) whose debtsmust be paid in priority to other unsecured creditors in a winding up.

Prepayment A payment made before it is scheduled to be made.Principal EITHER


16 See para 1 of section 1 of the commentary on clause 24 of the LMA Term Loan.17 See Goode Commercial Law at p. 1017.18 See Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd (1915) AC 79 at 87–88 for rules of con-

struction as to whether a clause is penal or a pre-estimate of damages.19 s239 Insolvency Act 1986.

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The amount which the lender advanced to the borrower and which theborrower must repay (as opposed to the interest due in respect of suchamount).ORIn relation to a person, the principal is the person for whom some otherperson acts as agent.

Privity The common law doctrine that no person is entitled to enforce a contractunless they are a party to it. See Box 1.18 on p. 55, commenting on clause1.3 of the LMA Term Loan.

Process agent The agent appointed by a non-English company to accept service ofproceedings in the English courts on its behalf. See commentary on clause38.2 of the LMA Term Loan.

Project finance The financing of a specific project, the revenue from which will providethe lenders with repayment of their investment.

Promissory note A promise in writing to pay a fixed sum on demand or on a determinablefuture date.20

Proper law The law which applies to a contract. Sometimes referred to as the ‘governinglaw’. This is the law which the court in which a dispute is heard decidesshould apply. In general a court in the European Union will give effect tothe law chosen by the parties.21

Pro rata In the same proportion (see Box A2.3).


20 See Goode Commercial Law, p. 566.21 This is governed by the Rome Convention on the Law Applicable to Contractual Obligations 1980. There are

exceptions e.g. for real rights relating to immovable real property which must be governed by the law where theproperty is.

BOX A2.2

For example, assume a company has two loans, one of which has been personallyguaranteed by the company’s directors. If the company starts having financial difficul-ties, it might decide to pay off the guaranteed debt in order to obtain the release ofthe personal guarantees. If it subsequently goes into liquidation during the hardeningperiod, the bank which had been repaid might be required to refund that sumto the company on the basis that the original repayment of the loan was a fraudulentpreference. The only reason the company chose to pay off that loan was because itwould result in release of the personal guarantee and put the directors who had giventhe guarantees in a better position on an insolvency of the company than theyotherwise would have been in.

BOX A2.3

If A owes $10 to B and $20 to C, and a sum of $6 is to be distributed pro rata between Band C, then A will recover $2 (20% of the amount due to it) and B will recover $4 (20%of the amount due to it).

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Prospectus A document relating to investments (such as an issue of securities,or, potentially, participation in a syndicated loan) which sets out therelevant information in relation to the investment and is circulatedto potential investors. See ‘Prospectus legislation’.

Prospectus legislation The legislation which exists in many countries which regulates thecontents of any prospectus distributed in that country and/orrequires those issuing prospectuses to be authorised to do so.

Put option An agreement which gives the recipient the right, but not theobligation, to require the donor to take title to a specified asset(e.g. shares) from the recipient, normally at a specified price on aspecified date (or within a range of dates). The recipient can beexpected to use this right if the value of the asset is less than thespecified price on the specified date. Hence, such an agreement maybe used to cap one party’s potential losses in relation to an asset.

Quasi security A transaction, such as a finance lease, which has the same commercialeffect as security. Otherwise referred to as ‘title financing’. Seesection 6 of the introduction.

Rating Grading of a debt’s quality as an investment.Receivables Money which is owed to a company.Recharacterization The decision by a court not to take a transaction at face value but

instead to look at its commercial effect in order to determine itsvalidity. For example, a court in certain jurisdictions may determinethat the true character of a transaction which involves quasi securityis one of security, not ownership, and, as a result, may require thatthe transaction be registered as security or may treat the transactionas ineffective.

Redemption The repayment by a borrower of outstanding loans, in accordancewith their terms, with the effect of extinguishing the outstanding debt.

Repo The sale of securities with an obligation to buy back at a future date.Representation A statement. Statements made before another party enters into a

contract (or as part of the contract as a condition to its effectiveness)may be ‘mere representations’ or they may be ‘warranties’.Warranties go to the root of the contract and amount to promisesthat the statement is true, such that, if it is not, the other party is enti-tled to the contractual measure of damages. Representations do notgo to the root of the contract. Generally speaking,22 representationsentitle the other party only to the tort level of damages23 if untrue.

Repudiation Evidencing an intention no longer to be bound by a contract towhich the person repudiating the contract is a party.24

Rescheduling In relation to debt obligations, the renegotiation and agreement ofrevised terms of a loan facility (usually involving the spreading ofinterest and capital repayments over a longer period).

Rescission Treating a contract as at an end as a result of a breach by thecounterparty.25


22 There are four different categories of misrepresentation, each of which has different consequences.23 Which, unlike the contractual measure of damages, does not include loss of profit.24 See Treitel p. 807.25 See Treitel pp. 370 et seq.

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Residual Value A guarantee from one party that if the value of a given asset is less than aGuarantee set figure at a particular date in the future (subject to specified conditions,

such as the state of repair of the asset), that party will compensate theother for the shortfall in value.

Restitution An equitable remedy26 under which a party which has been unjustlyenriched at the expense of another will be required to refund the amountof that unjust enrichment.

Retention An ability by one person to keep moneys (or other assets) belonging toanother pending occurrence of a specified event.

Reuters screen A telecommunications system, subscribed to by banks and financialinstitutions, which provides regularly updated financial information rele-vant to banking and securities trading.

Revolving credit A loan which may be drawn, repaid, and redrawn as needed.Ring fence To separate valuable assets or businesses27 from others and limit transfers

and other cash flows out of the area where the valuable assets or businessesare situated into other areas. For example, funds may be ring fenced ifthey are separated and allocated for use only in payment of given debts,or companies may be ring fenced in a group and payments out of the ringfenced companies restricted.

Rollover The renewal of a drawing under a loan facility, for example, at the end ofan interest period, or the reissue of short-term commercial paper on itsmaturity.

Rollover loan In a revolving credit, any loan in respect of which the amount outstandingis equal to or less than the amount outstanding under the immediatelypreceding loan—see also commentary on clause 4.2(a)(i) in relation torevolving credit facilities on pp. 63–64.

Same day funds Funds which will be available to the recipient with good value on thesame day as that on which the instruction to transfer the funds is made.

Screen rate The rate of interest (e.g. for six-month LIBOR) specified on a computerscreen such as Reuters screen.

SEC The Securities and Exchange Commission. A US agency whose role is tooversee the US securities market.

Securities Tradable financial assets such as bonds, notes, and commercial paper.Securitization Packaging assets (usually receivables such as credit card receipts) in such

a way as to allow them to be used to back up an issue of securities.Security EITHER

An interest in property to secure a liability. See section 2 of Appendix 1 onp. 271. Thus it would not include a guarantee, which does not give aninterest in property. A guarantee is personal (not real) security.ORMay also be used as in the singular version of ‘Securities.’

Set off The right of a person who owes money to another but is also owed moneyby that other, to reduce the amount it pays by the amount it is owed. Setoff is not a security, but a procedural right not to pay one debt to the extentthat another is due from the payee to the payer.


26 See para 2.3 of section 1 of Appendix 1 on p. 262.27 Or, indeed, assets which have the potential to give rise to extensive liabilities.

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Several liability Where there is more than one obligor (such as in a guarantee, wherethere are a number of guarantors) if their liabilities are several, theyare completely independent of each other. Payment by one obligorhas no effect on the liability of other obligors.

Shadow director Anyone in accordance with whose instructions the directors of acompany are accustomed to act.28 Such persons will have the sameliabilities as directors.

Sovereign immunity In many countries, the assets of the sovereign government and organsof that government may not be seized by a court nor may the sover-eign government or its organs be sued, but it may be possible for thisimmunity to be waived.

SPC/SPV/SPE Special purpose company/ vehicle/ entity. A legal entity (it may not bea company) set up for a specific purpose (e.g. the project company in aproject finance or the issuer of securities in a securitization) whose assetsare limited to those relating to the transaction for which it was set up.

Sponsors In a project finance, the parties who join together to arrange thefinance, being shareholders (usually) in the project company.

Spread In relation to securities—the difference between the offer and bidprices, that is, the price at which a broker would buy those securitiesand the price at which he would sell them. The word may also be usedas another word for profit—in relation to a loan, the margin may bereferred to as the spread.

Standby letter A letter of credit issued by a bank but which is intended to be secondaryof credit in function29 (like a guarantee). It is intended to be used as a fall-back

if there is a payment default under a specified instrument such as aloan agreement. A beneficiary of this arrangement is able to make adrawing on the letter of credit merely by providing a certificate ofnon-payment of the underlying debt.

Statutes Laws passed in Parliament. See para 2.2 of section 1 of Appendix 1 onp. 262.

Subordinated debt A debt which, in the event of the borrower’s liquidation, ranks behindsenior debt holders. See para 4.7 of section 1 of Appendix 1 on p. 269.

Subparticipation A method of transfer of the credit risk in the loan which does notresult in the transferee having direct rights against the borrower, orbecoming a lender of record. See para 3 of section 1 of the commen-tary on clause 24 of the LMA Term Loan.

Subrogation The right to take over the rights and security of another. In relation toa guarantee it is the right to take over the rights and security of thecreditor on making payment under the guarantee—see para 2.2 ofsection 3 of Appendix 1 on p. 285. In relation to insurance, it is theright of the insurer to take over the claims of the insured on makingpayment of the claim.

Supplier credit Finance made available by a supplier by way of allowing delayedpayments for the goods delivered or services provided. Supplier creditis often interest bearing and with similar documentation to a loan.


28 s741(2) Companies Act 1985.29 See paras 1.1 to 1.3 of section 3 of Appendix 1 on pp. 281–283.

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Supranationals Entities set up by several sovereign states, for example, World Bank.Surety A party (A) which agrees that, if a debt owed by another (B) is not

paid, then A will pay B’s debt or allow A’s asset to be used towardspayment of B’s debt.

Swap The exchange of one asset for another, usually currencies, intereststreams, or securities.

Swingline facility A facility which is available immediately and without notice, andwhich will be used to overcome short-term liquidity issues. For exam-ple, it may be used to pay commercial paper if it cannot be rolledover. Such a facility can only be provided by lenders with access toimmediate funds in the currency concerned. So, if a Dollar facility isrequired, it cannot be funded in Eurodollars (which require a periodof notice before they can be accessed) but must be provided by alender with access to immediately available funds in sufficientquantities.

Syndicated loan A loan made available by a group of lenders under a single loanagreement.

Synthetic Manufactured. In the context of loans or derivatives, it is used todenote the fact that the synthetic instrument has been created out ofmore than one underlying instrument (such as a combination of afixed rate bond and a swap to create a stream of floating rate paymentswhich may be represented by a synthetic instrument).

Tacking The right to advance further moneys against the security given for adebt. See para 5 of section 2 of Appendix 1 on p. 280.

Take or pay contract A contract which commits the counterparty to purchase a givenquantity of a particular product at an agreed price, even if it does not,in the end, need that quantity.

Tangible net worth The value of all the assets of a company minus its intangible assetssuch as goodwill.

TARGET Day A day when the Trans European Real time Gross Settlement ExpressTransfer System is operating for payments of Euros.

Tax lease A finance lease under which the lessee benefits (by reduced rentals)from some part of the tax benefits available to the owner resultingfrom the owner’s acquisition of the asset.

Tenor The period until maturity of a debt.Thin capitalization Thin capitalization is the situation which exists if the capital injected

into a company by way of shares is low in relation to the capitalinjected by way of shareholder loans. It is often more tax efficient for acompany to be financed by debt rather than equity, because paymentsof interest are deductible in calculating the company’s taxable profits,while payments of dividends are not deductible. As a result, sub-sidiaries are often capitalized by a combination of shares and share-holder loans.

Title financing Using title as an alternative to security. Otherwise known as quasisecurity. See section 6 of the Introduction.

Tombstone An announcement, usually placed in the financial press, made byeither the borrower or the lenders announcing provision of a loanfacility. Tombstones are not intended as an advertisement to entice


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prospective lenders, they simply contain a brief description of the facilityand a list of the participating banks.

Transaction at an A transaction under which a company gives substantially more than itundervalue receives.30

Trust An English legal expression referring to the situation where the legalowner of property holds it on behalf of another (or others)—the benefici-ary.31 There are a number of different types of trust. Charities are anexample where trusts are commonly used. The property of the charitybelongs to the trustees who must use it for the benefit of those for whomthe charity was established.Where someone wishes to create a trust, that trust will be createdprovided there is certainty as to:

� the intention to create a trust;

� the property vested in the trust; and

� the beneficiaries of the trust.

A trust once created is irrevocable. See para 3.6 of section 1 of Appendix 1on p. 265.

Trustee A person who holds ownership of an asset on behalf of another (thebeneficiary). In the insolvency of the trustee, the trust property will not beavailable to the trustee’s creditors. This compares with agency which is apurely contractual relationship.

Undertaking Either

� the business of a company, or

� a promise (as in covenant) to do or not to do, specified things.

Venture capital Equity finance made available to, usually, newly established businessesto enable them to expand.

Warranty A word with many meanings. When used in connection with pre-contractual statements, a warranty is compared to a representationand means the more commercially important statement, which hascontractual force and, if untrue, gives a right to the contractual level ofdamages.When used in connection with provisions of the contract, a warranty iscompared to a condition and means the less commercially important pro-vision, which gives rise only to damages if breached, as opposed to abreach of condition which gives the right to terminate the contract.

Whitewash An expression used in the context of financial assistance. It is the use ofthe procedure set out in the Companies Act32 whereby financial assis-tance may be given, if that procedure is followed and subject to certainother conditions set out in the statute.

Withholding tax A tax deducted at source on certain payments (e.g. interest or dividendpayments).

Working capital Money required by a company to run its day to day activities, for example,to finance payment to employees and suppliers pending receipt ofincome from the sale of the product which the company supplies.


30 See para 2.1 of section 3 of Appendix 1 on p. 284.31 See para 3.6 of section 1 of Appendix 1 on p. 265.32 At s155.

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Workout Common term for the long-term rescue of a defaulting borrower by itslender(s) (and other creditors).

Wrongful trading Carrying on trading after the point at which it should have been clearthat insolvent liquidation was inevitable. Directors and shadow directorsmay33 have to contribute to the company’s assets on a winding up if thecompany has been guilty of wrongful trading.

Yield The annual rate of return on an investment.


33 Under s 214 Insolvency Act 1986.

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BOOKS

Brett, Michael, How to Read the Financial Pages, 5th edn, Random House Business Books,London, 2000.

Buchheit, Lee, How to Negotiate Eurocurrency Loan Agreements, 2nd ed, EuromoneyPublications Plc, London, 2000.

Charlesworth, J. and R. A. Percy, 10th edn, Charlesworth and Percy on Negligence, Sweet &Maxwell, 2002.

Cranston, Ross, Principles of Banking Law, 2nd edn, Oxford University Press, Oxford, 2002.Goode, Roy, Legal Problems of Credit and Security, 3rd edn, Sweet & Maxwell, London,

2003.Goode, Roy, Commercial Law, 3rd edn, Penguin Books Ltd., London, 2004.Gruson, Michael, Hutter, Stephan, and Kutchera, Michael, Legal Opinions in International

Transactions, 4th edn, Kluwer Law International, The Hague (www.kluwerlaw.com),2003.

Hughes, Martin, Selected Legal Issues for Finance Lawyers, LexisNexis UK, London, 2003.Macdonald, Elizabeth, Exemption clauses, Penalty Clauses and Unfair Terms, LexisNexis UK,

London, 1999.Martin, Jill, Hanbury and Martin Modern Equity, 17th edn, Sweet & Maxwell, London,

2005.McGhee, John, Snell’s Equity, 31st edn, Sweet & Maxwell, London, 2004.O’Donovan, James and Phillips, John, The Modern Contract of Guarantee, Sweet & Maxwell,

London, 2003.Rhodes, Tony, Syndicated Lending—Practice and Documentation, 4th edn, Euromoney

Publications, London, 2004.I.C.F. Spry, The Principles of Equitable Remedies, 6th edn, LBC Information Services, Perth,

Australia, 2001.G.H. Treitel, The Law of Contract, 11th edn, Sweet & Maxwell, London, 2003.Wood, Philip, Comparative Law of Security and Guarantees, Sweet & Maxwell, London,

1995.

308

Bibliography

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Wood, Philip, Project Finance, Subordinated Debt and State Loans, Sweet & Maxwell, London,1995.

LAW COMMISSION PAPERS

Law Commission Consultation Paper, ‘Fiduciary Duties and Regulatory Rules’, (ConsultationPaper 124, 1992).

Law Commission Consultation Paper no 171, ‘Trustee Exemption Clauses’, (January 2003).Joint Report of the Law Commission (Paper No 283) and the Scottish Law Commission (Paper

No 192) on Partnership Law, (November 2003).Law Commission Report on Company Security Interests, (Paper no 296, August 2005).

ARTICLES AND PAPERS

Davies, Rhodri and Halliday, David G., ‘Risks and Responsibilities of the Agent Bank andthe Arranging Bank in Syndicated Credit Facilities’, Journal of International Banking Law,12(5), p. 182, 1997.

Financial Markets Law Committee, ‘Pari Passu Clauses in Sovereign Debt Obligations’Report, March 2005, available from their website www.fmlc.org.

Henry, Robin,’Defining the Ordinary Course of Business’, Journal of International Banking Lawand Regulation, 19(12), p. 513, 2004.

Julien, Franck, and Lamontagne-Defriez, Jean Marc, ‘Material Adverse Change andSyndicated Bank Financing’, Journal of International Banking Law and Regulation, 19(5) pp.172–176 and 19(6) pp. 193–198, 2004.

Wood, Philip, ‘Pari Passu Clauses–What Do They Mean?’, Journal of International Banking andFinancial Law, 10, p. 371, 2003.

B I B L I O G R A P H Y 309

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310

Index

acceptance credit 7, 31accession letter 243–4acquisition finance 5action in personam 263action in rem 263additional obligors

borrowers 206–7conditions precedent to 237–8guarantors 208

agency fee 91, 92agent

appointment 211confidentiality 216distributions by 221duties 211–13exclusion of liability 214–15lenders indemnity to 215lenders, relationship with 216majority lender’s instructions 213–14no responsibility for documentation 214payments to 221resignation 215–16role 210–11vs trustees 271

amendment costs 106amendments and waivers 228–9appropriations 113–14arbitration 231arrangement fee 91, 92arranger 57

Syndication process 57exclusion of liability 210

asset finance 4–5, 24–5conditions precedent in 26, 239financial covenants 144–7purpose clause 60

assignment 190–3, 275–6assignment and assumption agreement 192–3assignment of rights 187, 190–3

effect on indemnities 191effect on obligations 192–3effect on security 192

bank accountsecurity 279–80

base currency amount 38, 71, 73base rate 14, 288beneficial owner 265bilateral facilities 7bona fide purchaser for value without

notice 265bonds 31, 288borrowers

additional 17, 206–7resignation 207–8

break costs 38–40, 90–1bridge finance 5–6business day 40

calculations and certificates 225–6accounts 225certificates and determinations 225–6day count convention 226

cancellation, voluntary 77capital leases

see finance leasescase law 262charges 272–5

fixed 274–5floating 272–4

chose in action 263, 275 n.73civil law 261

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clawback clause 99–100, 110–11, 222, 289club loans 7, 89commingled property

security 280commitment fee 91committed overdraft facility 4common law 261

vs civil law 261vs equity 262–3

company/companiesable to use the facility 17excluded from covenants 19, 21–2insignificant 21non-resource 21–2

compliance certificate 41, 138, 245confidentiality undertaking 246consideration 265–6continuing guarantee 110, 283conditions precent see utilizationcorporate documents 233–4corporate reconstruction 157cost-plus lending 14–15costs 105–6

amendment 106break 90–1enforcement 106increased 100–3mandatory 16, 80, 101regulatory 16

counterparts 229credit default swap 195–6credit derivatives 187, 194–6credit linked notes 194–5

cash settlement 194–5physical settlement 195

cross default 171–6reducing the impact of 175

currency indemnity 104

damages 264day count convention 226debenture 279debt

subordinate 270vs damages 264

deed 267default 41–3, 166–8

see also event of defaultas a condition to advances 63cross 171–6interest 81–3notification of 140–1in a revolving credit 63–4

definitions 38–55

demand guarantee 282–3demand loan 3disruption event 168documentation

responsibility 214double tax treaty 93, 94drawstop/acceleration 118

EBITDA (earnings before tax, interest depreciation and amortization) 143

enforcement costs 106English courts

jurisdiction 230–1English law 260–1

guarantees 281–5security 271–81sources 261–3types of claims and rights 263

equitable assignment 276equitable principles qualification 257–8equity

vs common law 262–3Euribor 14, 44event of default 130–1, 168–84

see also defaultacceleration 184as compared to Default 41–3, 63breach of financial covenant 169breach of other obligations 169–70control over relevant events 165–6from default to acceleration 166–8in LMA Term Loan 168–84purpose 165

exclusion clause 267–8existing security 151–2, 245export finance 7

facility 56facility office 44fees 91–2

agency 91, 92arrangement 91, 92commitment 91loan transfer 204

fiduciary duties 211, 213finance document 44finance leasing 151finance parties

see also agentconduct of business 217exceptions 220payments to 217–18recovering party’s rights 219

I N D E X 311

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finance parties – continuedredistribution of payments 218–19redistribution of payments, reversal 220rights and obligations 56–9

financial covenants 141–7in asset finance transaction 144–7breach of 169consequences of breach 144ratios to test 142–3

financial indebtedness 31, 44–5, 171event of default 172–5

financial statements 132, 137–8requirements 138–9

fixed charge 274–5fixed charge cover ratio 143floating charge 272–4forward purchase 30forward sale 29–30, 31funded subparticipation 193future property

security 278

GAAP (generally accepted accounting principles) 46

gearing ratio 142governing laws 230

enforcement 230–2no contravention of law of

constitution 251–2grossing-up clause 94–5

limitations 95–8group 17, 19, 171–2

covenants 22–3guarantee 109–116, 281

appropriations 113–14continuing 110, 283deferral of guarantors rights 114–16demand 282–3English law 281–5hazards with 284–5immediate recourse 113reinstatement 110–11vs indemnity 281–2vs letter of comfort 283vs third party charge 283waiver of defences 111–13

guarantors 17, 18additional 208resignation 208

hardening period 110effect of novation 190

hire purchase 28

immediate recourse 113increased costs 100–3

claims 102exceptions 103

indemnity 104–5currency 104effect of assignment of right 191lender’s indemnity to agent 215tax 98–9vs demand guarantee 282–3vs guarantee 281–2

information 162disclosure 205–6memorandum 131–2

information undertakings 137–41compliance certificate 138financial statements 137–9‘know your customer’ checks 141miscellaneous 139–40notification of default 140–1use of websites 141

insignificant company 21insolvency 176

proceedings 176–7qualification 257

instalment sale agreement 29intangible assets

security 278interbank markets 13–14interest

alternative basis of interest or funding 89

calculation 80calculation, changes to 87–91changes to interest periods 87consolidation and division of

loans 87default 81–2deferral of guarantors rights 116notification of rates 83payment 81selection of interest periods 83–5

in a loan advanced by instalments 86in a revolving credit facility 85–6

interest cover ratio 143International Loan Documentation

instructions to use 1–2International Swaps and Derivatives

Association (ISDA) agreements 194

joint and several obligation 265joint obligation 264judgement currency indemnity 104

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legal opinions 235–7, 246–58assumptions 249authority 250–1choice of law 256cost effectiveness 247–8due incorporation and continued

existence 250effectiveness of security 253–5enforcement of judgements 256form of 248–50lawyer’s role 247no consents or fillings needed 255no contravention of law of

constitution 251–2pari passu 256–7power 250qualifications 257–8tax 255tax consequences 255valid and enforceable obligations 252–3

legal owner 265lenders 18

agent, indemnity to 215agent, relationship with 216credit appraisal of agent 216–17legal opinions 235–7qualifying 95, 96specific concerns about individual

group members 23–4lending

cost-plus 14–15LIBOR-based 13–17

letter of comfort 283letter of credit option 69–70LIBOR (London Interbank Offered Rate)

14–15, 46–7LIBOR-based lending 13–17

cost-plus lending 14–15interbank markets 13–14

liens 272in the context of litigation 154–5

limited recourse financing 5liquidity ratio 142–3LMA (Loan Market Association)

definitions 38–51recommended forms 8

LMA events of default 168–84acceleration 184breach of financial covenant 169breach of other obligations 169–70creditors process 178cross default 171–6insolvency 176

insolvency proceedings 176–7material adverse change 178–84misrepresentation 170non-payment 168–9

LMA general undertakings 147–58assets given as security 163authorization 147change of business 158, 160–1compliance with laws 147conduct of business 161–2consequences of breach 149distribution of profits 159granting powers to others 162income taken as security under a

contract assignment 163–4information 162merger 157–8negative pledge 148–55no disposals 156–7other undertakings 158–9preservations of general assets or

cash 159reflecting regulatory or legal risks 162restriction of claims against the

company 160LMA loan transfer 201–6

conditions of 201–4information disclosure 205–6procedure 204–5

LMA representation 124–36binding obligations 125–6deduction of tax 129financial statements 132governing law and enforcement 128–9no default 130–1no misleading information 131–2non-conflict with other obligations 126–7no proceedings pending or threatened

135–6pari passu ranking 133–4power and authority 127status 124–5validity and admissibility in evidence 128

LMA Term Loan 17, 21for combined facility for a term loan and

revolving credit 51–5legal opinions 235

loanadvanced by instalments 86club 7consolidation and division 87demand loan 3maximum number 64–5

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Loan – continuedmulticurrency 70–1rollover 52, 64types 3–7

loan agreements 1–2, 7borrower’s key concerns 10–11definitions in 13, 35–7hazards in reviewing 12–13lender’s key concerns 11–12LMA documents 8scope 17–24structure 9–10

Loan Market Associationsee LMA

loan stock 31loan transfer 188

fee 204in LMA Term Loan 201–6methods 187–96syndication of secured loans 196–201

London Interbank Offered Ratesee LIBOR

majority lenders 47instructions to agent 213–14

mandatory costs 16, 80, 101formula 241–2

mandatory liquid asset costssee mandatory costs

margin 47–9, 101market disruption 87–9material adverse change/effect 48, 49, 121

event of default 178–84merger 157–8mezzanine finance

see venture capitalmismatch facilities 6misrepresentation 170, 268–9

liability in 119mitigation 105monitoring 60month 49mortgage 272moveable property

security 278–9multicurrency loans 70–2multiple drawdown facilities 62

negative pledge 148–55exceptions to 151–5prohibition on quasi security 150–1prohibition on security 149–50

no disposals 156–7non-business days 87

non-payment 168–9non-resource company 21–2note purchase facility 31notices 224–5novation 187, 188–90

effect on consents 190effect on hardening period 190effect on security 189–90mechanics 188–9

obligationseffect of assignment of rights 192–3finance parties 56–9joint 264joint and several 265primary vs secondary 282several 265

obligors 17, 21, 22additional guarantors 208assignments and transfers 206distribution to 222no set off by 223–4original 233–4resignation of guarantor 208–9

optional currency 50, 64original borrowers 17original financial statements 50original guarantors 17original obligors 233–4overdraft facility 3–4

committed 4uncommitted 4

ownership 265–6

parallel debt 199security agent 198, 200

pari passu 133–4, 269legal opinions 256–7

partial invalidity 227payments 221–4

to agent 221agent, distributions by 221clawback 221to finance parties 217–18no set off by obligors 223–4obligor, distributions to 222partial 222–3redistribution 218–19redistribution, reversal 220

pledges 272negative 148–55

positive covenants 147possession 265–6potential event of default 41

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prepayment and cancellation 74–9change of control 76illegality 75restrictions 79voluntary cancellation 77voluntary prepayment 77–8

profit distribution 159project finance 5, 25–8

conditions precedent in 239–41purpose clause 59–60

qualifying lender 95, 96quasi security 28–30

prohibition on 150–1quotation day 50–1

reborrowing 74receivables

selling, risk retained 29reference banks 46–7, 51

absence of quotations 87refinancing 6registration

against the asset 276against the company 276–7proposed new regime 277–8

regulatory costs 16reinstatement 110–11remedies and waivers 227repayment 74

in relation to a single lender 78–9repeated representations 51,

119–20, 136guidelines 122–4purpose 120

representationsdifferent circumstances 136hazards 120inconsistencies 120–4in LMA Term Loan 124–36purpose 117–19repetition of 119–22and warranty 124

resignationagent 215–16borrowers 207–8form of letter 244–5guarantor 208–9

revolving credit 4, 58default in 63–4LMA recommended form 51–5optional currencies 71repayment 74selection of interest periods 85–6

risk subparticipation 193rollover loan 52, 64

schedules 233–58accession letter 243–4conditions precedent in other commercial

circumstances 239–41conditions precedent to additional

obligors 237–8conditions precedent to initial utilization

233–7existing security 245form of compliance certificate 245form of confidentiality

undertaking 246form of resignation letter 244–5form of transfer certificate 242–3legal opinions 246–58mandatory cost formula 241–2parties 233requests 241timetables 246

screen rate 46–7secured loans

syndication 196–201security

and assets 278–80assets given as 163effectiveness 253–5effect of assignment of rights 192effect of novation 189–90English law 271–81existing 151–2, 245operation of law 152, 153prohibition on 149–50registration requirements 276–8secured loan transfer 196subordinate 269–70types 272–6

security agent 197–201alternative to a parallel debt 200–1as co-creditor 199–200security for parallel debt 198, 200security for underlying debts 197–8

security cover ratio 144, 145security trustee 197selection notice 241seller’s credit 31service of process 232set off 30, 224

in the course of ordinary banking arrangements 152

no set off by obligors 223–4several obligation 265

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sharessecurity 278

sovereign debt 7stamp taxes 130statute 262statutory assignment 275–6subordinate debt 270subordinate security 269–70subordination 114–15, 269–70subparticipation 187, 193, 196

funded 193risk 193

subrogation 112, 285subsidiary 51

consent for sale or acquisition 19swingline facilities 6, 68–9syndicated loans 7

tangible net worth 142TARGET day 50–1tax

confirmation 96credit 99–100deduction of 129evidence of tax payment 98gross-up 93–100indemnity 98–9stamp 130withholding 93, 97, 129

term loan 3LMA recommended forms 51–5optional currencies 71–2

third party charge 283time

interest periods 83–6interest periods, changes 87payment of interest 81

timetables 246title financing

see title retentiontitle retention 28–9tort 263transaction expenses 105, 106transfer certificate 189, 204–5

form 242–3treaty lender 96trust arrangements 30trustee 270–1

uncommitted overdraft facility 4utilization

completion of a utilization request 68conditions 60–6

further conditions precedent 62–4initial conditions precedent 60–2maximum number of loans 64–6precedent to initial utilization 233–7

delivery of utilization request 67–8lender participation 68in other commercial circumstances 68–70requests 241

venture capital 6voluntary cancellation 77voluntary prepayment 77–8

waiver 227, 228–9of defences 111–13

warranty 124waterfall 27websites 141withholding tax 93, 97, 129

yield protection 15

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International Loan Documentation

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