Introduction:
In the ever-evolving landscape of English law credit agreements in the European leveraged loan market, the dynamics of lending have undergone significant transformations in the last few years. One issue that has gained prominence is the increase in limits on the ability of lenders to transfer their loans and the associated restrictions imposed on potential new lenders. European syndicated loan agreements have historically included a standardised and expected set of transfer restrictions applicable to prospective lenders, reflective of the market guidance and templates issued by the Loan Market Association (“LMA”). Certainty of terms and the capability of an existing lender to sell out of a loan position have been the hallmark (and expectation) of the LMA loan market. However, trends in the drafting of credit agreements have contained a concerning increase in limitations on loan liquidity. As a result, many lenders are finding it difficult to sell their distressed loans. This article explores these trends, as well as their implications on the secondary loan trading market.
Understanding Transfer Restrictions:
For the most part, transfer restrictions are embodied in the clauses within credit agreements that dictate the conditions under which a loan may be transferred from a lender to another party. Borrower consent is also often required for transfers to a party that is not a lender, subject to certain exceptions. Typically, no consent would be necessary for a loan assignment (a) to a party on an approved list, (b) to a current lender or one of its affiliates or related funds or (c) during a borrower insolvency or event of default. In any other circumstances, consent of the borrower (usually not to be unreasonably withheld or delayed) will be required. However, it has become increasingly commonplace for these once “typical” exceptions to be modified in significant ways.
Recent trends indicate a heightened level of scrutiny by borrowers and their private equity sponsors and consequently more stringent consent requirements for the transfer of loans. Borrowers and sponsors have become more focused on the identity, strategy and creditworthiness of potential new lenders entering into the lending syndicate. This has led to a more comprehensive assessment of prospective lenders being performed by agents and borrowers, and ultimately an increase in consents being denied.
Failure of a prospective lender to acquaint itself with these transfer restrictions can result in extended settlement delays, economic harm, trade failure, and, in some circumstances, being found to be in breach of the underlying credit agreement. As a result, it is critical to perform the necessary due diligence when considering any secondary purchase. It is also prudent to consider the limits on a lender’s ability to exit the facility in the future.
Approved Lender / White List concepts:
It has been standard practice to include an “agreed” or “approved” list of entities to which a loan can be transferred without the need for borrower consent. This list can usually be updated a set number of times during the lifetime of the loan, and generally includes the ability to remove up to 3-5 names in each year (with the express condition that there is no ability to remove existing lenders). However, increasingly credit agreements impose additional carve-outs to the approved list concept, and simply being on such list is no longer a guarantee that consent will not be required. Further recent limitations to the spirit of the “approved list” concept include:
- There is not always an overall cap on the numbers of names that may be removed from such a list, and no automatic provision to agree substitute names to the list;
- Names on the approved list may be expressly limited to banks and “par funds” only;
- Carve-outs to the types of entity on the approved list are becoming increasingly commonplace, in particular the exclusion of loan-to-own/distressed investors and competitors (or similar); and
- Being on the approved list does not always mean a transfer is automatically approved; several credit agreements still include notification or consultation formalities. In such circumstances, a transferring lender may still be required to notify or consult with the borrower or sponsor prior to the transfer being made effective, even if such proposed new lender is on the approved list.
Lenders and buy-side investors should be wary of such restrictions, and prioritise carefully reviewing the underlying transfer provisions. Delays in confirming whether a proposed new lender is or is not on the approved list and obtaining access to such a list further adds to the increasing difficulty of entering into a credit agreement. For some proposed new lenders, the approved list no longer provides an automatic guarantee that such new lender has the “green light”, and as a result careful consideration of such provisions is necessary.
Disqualified Lender / Restricted List / Blacklist Concepts:
Although more typical of US-based loan agreements and trades under terms and conditions of the Loan Syndication and Trading Association (“LSTA”), the “Disqualified Lender” concept has begun to gain traction in the European loan market. Some borrowers have sought to remove the approved list mechanism and instead include a disqualified lender list that applies regardless of whether there has been a borrower event of default. Certain credit agreements include both an approved list and a disqualified list.
A disqualified lender list acts in the opposite way to an approved lender list, and rather than confirming a list of entities that are pre-approved by the borrower to become a lender, the sponsor and borrower instead compile a list of institutions that may not become lenders. The disqualified lender lists and concepts can be vague and generic in form, and as a result it may be challenging to ascertain with certainty whether an entity would form part of the list. Names on a disqualified lender list are not usually fund specific and may unintentionally capture “par” funds too, with entities such as CLOs having to undergo unnecessary consent processes. The various disqualified lender definitions have become progressively wide in their drafting, with such terms also capturing affiliates/related funds of an entity on such a list if ‘identifiable’ as such by their name.
Most credit agreements allow a lender to request a copy of the disqualified lender list from the agent. In practice however, significant time may pass before receiving either the list or a response from the agent leading to settlements taking place without prior confirmation. Failing to undergo this type of due diligence can have serious consequences for a new lender (see below “Implications of closing without complying with transfer conditions”) particularly as many credit agreements require a new lender to make a representation in the assignment agreement that it is not a disqualified lender.
Loan-to-Own / Distressed Investors & Competitors:
The European loan market has seen a steady increase in the inclusion of “Loan-to-Own/Distressed Investor” and “Competitor” concepts into credit agreements. Despite there being variety in the detail and drafting of such definitions, almost all credit agreements which include these concepts are unified in their intention to restrict transfers to such entities which the borrower or sponsor perceive to be involved in undesirable loan-to-own strategies, or competitive industries.
As a result, any potential lender whose principal business is investing in distressed debt, the pursuant of loan-to-own strategies, or even those seeking to obtain a voting blocking stake may find themselves subject to restrictions under a credit agreement. As there is no standardised or market definition for such concepts, distressed debt investor and competitor language varies significantly, and typically does not include a specific list of persons who are designated as such by the borrower. It is therefore up to the new lender to make such analysis, and careful consideration must be given in particular if such new lender is required to make representations to this effect in the underlying assignment agreement.
These types of provisions can be an issue for distressed debt funds who face being refused consent by the borrower and prohibited from purchasing by assignment (or even by participation), and this interpretive approach can also lead to disputes with a borrower further down the line. Although these provisions are primarily intended to target the more aggressive funds with loan-to-own strategies and direct competitors, the wide and generalised drafting of such definitions mean that affiliates and related funds may also be captured.
Further complexities apply in respect of the relationship between these provisions and other conditions of transfer under the credit agreement. In the majority of credit agreements recently reviewed, typical consent exemptions such as during an event of default, or if an entity is on an approved list, will not apply to transfers to loan-to-own/distressed investors. Even an entity that is “pre-approved” may not be an eligible assignee if it is captured under loan-to-own/distressed investors provisions.
Sub-Participations:
Traditionally, under both the LMA and LSTA template credit documentation, transfer restrictions were imposed on assignments only and sub-participations were generally freely granted without consent, eligibility or notice requirements. In recent credit agreements, however, borrowers have sought to control transfers via sub-participation as well, with many new English law credit agreements including a distinction between restrictions involving sub-participations that grant voting rights versus sub-participations without voting rights. Sub-participations which provide a sub-participant with voting rights are now commonly subject to the same transfer restrictions as are applied to loan assignments.
Even for those credit agreements without consent requirements for sub-participations, there has been an increase in the requirement that lenders notify the borrower and sponsor of the existence of sub-participations held by an existing lender and details of each participant. This may be required to be provided at the time of closing or on a periodic basis, with many existing lenders now having to maintain registers to be provided upon request. In some cases, an existing lender may have to notify a borrower prior to the participation being granted, with such borrower being “consulted” as to the identify of a participant.
Consent Qualifiers:
Borrower consent has historically been subject to a standardised set of qualifications, such as consent not being “unreasonably withheld or delayed” and deemed consent being granted within a set number of business days if the borrower does not respond. This provides certainty to proposed new lenders looking to purchase a loan facility, as well as an ability to ensure that consent processes are managed fairly and in a timely manner. Despite this being the expected norm, many borrowers are now electing to push back on traditional consent expectations and the need to act “reasonably” when considering such a consent, with some favouring consent in the borrower’s “sole and absolute discretion”, as well as extending the time period in which deemed consent must be given, and in certain cases removing deemed consent in its entirety.
Event of Default Qualifiers:
The ability to transfer loans freely during an event of default is paramount in permitting an existing lender to easily sell its position into the loan market, which should include proposed assignees or sub-participants who are not on an approved list or who are on a disqualified lender list. An event of default would also typically supersede any over-arching restrictions on assignments to competitors or loan-to-own/distressed investors. Previously, this was found in all credit agreements. However, increasingly consent requirements now only fall away during specific categories of events of default (such as insolvency or payment defaults) rather than an event of default generally. These limitations are currently found in the majority of new credit agreements, with the default triggers being scaled down significantly.
Implications of closing without complying with transfer conditions:
Failure to do the necessary due diligence, and closing an assignment without the required consents or with an entity that is not deemed an “eligible assignee” under the credit agreement can have serious consequences for both the existing and new lender.
In many cases, if any of the transfer conditions under the credit agreement are breached or a settlement occurs without the necessary consents, borrowers will have several potential remedies, including:
- The commitments of the new lender being excluded for the purposes of determining a given percentage for obtaining a consent, waiver, amendment and/or other vote under the credit agreement, with the relevant assignor becoming “disenfranchised”;
- Restrictions on existing lender’s ability to attend lender meetings and excluding such persons from receiving information or other reporting materials under the credit agreement; and
- The loan transfer itself being declared void and deemed not to have occurred under the terms of the credit agreement (with such new lender not being recognised as a lender), or the new lender being designated as a defaulting lender or disqualified lender, which may permit the borrower to (A) cancel the unfunded commitments of such new Lender, and prepay its outstanding loans (which may be at a price equal to the lesser of par and the amount paid by it to acquire such loans (without related prepayment fee/breakage costs)) or (B) the unwinding of such transfer by forcing the new lender to assign its loan position to another replacement eligible lender, all of which are in addition to any remedies available at law to a borrower.
As the agent is generally not responsible for confirming whether someone is a disqualified lender and the assignee is often required to make additional representations in the underlying assignment agreement as to it not being a disqualified lender or a loan to own/distressed investor, the borrower may be able to assert that a contractual breach or a misrepresentation has been made if such conditions are not complied with, which could lead to rescission and payment of damages. It is therefore critical that the assignee be comfortable in its assessment of the transfer requirements, and that it is acquiring the loan within the parameters of the relevant conditions set out in the credit agreement.
Conclusion:
The secondary loan market is experiencing significant impact from the effect of increasingly restrictive transfer provisions found in European credit agreements. Lenders that wish to sell out of a distressed loan position now face the prospect of having to either wait for an event of default to take place, or hold onto their position indefinitely until a suitable assignee can be found.
These negative trends in transfer restrictions for lenders reflect a growing emphasis on the necessity of robust due diligence when evaluating the purchase of a loan position. Lenders and legal professionals must stay attuned to these trends to navigate the differing complexities of credit agreements effectively. This proactive approach ensures that buy-side investors remain resilient in the face of changing market dynamics, and do not find themselves falling afoul of transfer restrictions, or with an even further limited choice of counterparties to trade with in the future. As many names approach their maturity over the next 12-24 months and borrowers face the need to amend the terms of their credit agreements to stave-off insolvency, investors have an opportunity to negotiate and push for altered language around approved lists, loan to own/distressed investor concepts and consent requirements.
For further information, please contact:
Andrew M. Martin, Partner, Crowell & Moring
amartin@crowell.com
