1. Introduction
Throughout the history the structure of financing agreements is essentially based on comprehensive protections for lenders. This basic principle began to be partially abandoned following the 2008 global financial crisis and the subsequent bank defaults on lending obligations. Lessons learned from the crisis led institutions such as the LMA and LSTA to introduce model "defaulting lender" provisions into loan agreements.
Defaulting lender provisions, introduced to the market in 2008, gradually became integrated into loan agreements and currently become acceptable to lenders in almost all LMA-standard agreements, especially in club loans.
As credit market rapidly grows and most of the market actors rely on credit arrangements to manage their capital requirements, it is prudent to revisit the defaulting lender provisions and implement the protections available for borrowers in loan agreements. Accordingly, our article aims to provide the market actors an insight on defaulting lender provisions and the protections available to borrower in relation to defaulting lenders.
2. Defaulting Lender
Typically, a lender is a defaulting lender when it fails or purports to fail on providing its loan commitment or becomes insolvent. As defined in the LMA model clause, it is commonly implemented under loan agreements as a lender:
- which has failed to make its participation in a loan available (or has notified the agent or the borrower that it will not make its participation in a loan available) by the utilization date of that loan, unless its failure to pay is caused by an administrative or technical error or it is disputing in good faith whether it is contractually obliged to make the payment in question;
- which has otherwise rescinded or repudiated a finance document; or
- with respect to which an insolvency event (i.e, entity becomes insolvent or is unable to pay its debts or fails or admits its inability generally to pay its debts as they become due) has occurred and is continuing.
Commonly, the agent has the authority to determine if a lender is classified as a defaulting lender, and this determination is final and binding.
3. Protections Available to Borrowers
In cases where defaulting lender provisions are included in loan agreements, borrowers may benefit from various protections, rather than just relying on compensation by commencing legal action, which may not be efficient if the borrower is willing to retain the financing arrangement and does not want to make additional costs for legal action or a new funding arrangement. Market standard defaulting lender provisions provides a certain extent of protection to borrowers in relation to these concerns.
Typically, protections available to borrowers against defaulting lenders are as follows:
- Right of cancellation and replacement in relation to a defaulting lender: the borrower can terminate the defaulting lender's available commitment and seek a replacement from another willing lender. In such case, the borrower may retain the financing arrangement and save time and decrease legal costs. One down side of this option is that the borrower must pay the outstanding loan amounts, in many cases, prior to their maturity date.
- Withholding commitment fees: borrowers can withhold the commitment fees payable to a lender on any available commitment of that lender for any day on which that lender is a defaulting lender.
- Restrictions on voting rights: in cases where a defaulting lender fails to respond to a request for a consent, waiver, amendment of or in relation to the loan agreement or any other vote of lenders within a certain period of time, such defaulting lender shall lose its voting rights in relation to the relevant matter.
- Conversion of revolving loans into term loans: revolving credit facilities offered by the defaulting lender are converted into term loans and must be repaid by the final termination date of the facilities, regardless of their maturity date under the loan agreement.
CONCLUSION
Implementing defaulting lender provisions into loan agreements became more and more standard over time and it is prudent for borrowers to familiarize with these provisions and favor from the protections they provide given the lessons learned from numerous financial and banking crisis world has encountered. Another significance of implementing these provisions is to accustom financial market actors to borrower protective provisions and encourage borrower prosperity.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.