yank and bank article

8/7/2019 Yank and Bank Article

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S YNDICATED L ENDING U PDATE :

D EFAULTING L ENDER I SSUES

ROBIN J. MILES, M. CATHERINE OZDOGAN, STEPHANIE KOO SONG ANDCHRISTOPHER D. HEARD

The authors examine the defaulting lender provisions typically found in syndi-cated credit agreements and risks faced by administrative agents, issuing banks,and swing line lenders, which are becoming of particular importance during

this time of increasing financial instability.

A s the financial crisis has unfolded and a wide array of financial insti-tutions have faced deteriorating financial stability, concern hasincreased that lenders participating in syndicated loans may become

unable to honor their funding obligations. Most syndicated credit agree-ments contain some language dealing with the consequences of a lendersfailure to fund. Until recently, however, defaulting lender provisions havenot been the subject of much attention. Most syndicated credit agreementsassume solvency of the lenders and their ability to fund. In the current mar-ket environment, borrowers and financial institutions that take on partici-pation or funding risk from other lenders (such as administrative agents,issuing lenders and swing line lenders) have begun to focus serious attentionon the risks imposed by defaulting lenders. The defaulting lender provisionstypically found in syndicated credit agreements and risks faced by adminis-trative agents, issuing banks, and swing line lenders are of particular impor-tance during this time of increasing financial instability.

Robin J. Miles, M. Catherine Ozdogan, Stephanie Koo Song and Christopher D.Heard are energy finance attorneys with Bracewell & Giuliani LLP.

Published in the February issue of The Banking Law Journal.Copyright ALEXeSOLUTIONS, INC.


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DEFINITION OF A DEFAULTING LENDER

Most syndicated credit agreements define a defaulting lender as onethat (a) fails to fund its portion of the loans to the borrower, (b) fails to pay any other amount required under the credit agreement or (c) has becomeinsolvent. We are beginning to see in the marketplace an expansion of thisdefinition to include lenders that have defaulted under other syndicatedcredit facilities and lenders whose holding companies or affiliates havebecome insolvent. The broadening of the definition allows the protectionsafforded by defaulting lender provisions to become effective when a lendersability to meet its obligations is thrown into serious question, but before thelender actually fails to make payments required under the credit agreement.

REMEDIES AGAINST A DEFAULTING LENDER

Yank-a-Bank Clause; Assignment of Defaulting Lenders

InterestSyndicated credit agreements typically give the borrower the option to

force a defaulting lender to assign its commitments and outstanding loans toanother willing financial institution. This provision is often referred to asthe yank-a-bank clause. There are three primary drawbacks of this reme-dy. First, and perhaps most importantly in the current market, the yankedlender is only required to sell at par. Second, if the defaulting lender is thesubject of a bankruptcy proceeding, it may be necessary to seek bankruptcy

court approval before the remedy of forced assignment can be exercisedagainst the defaulting lender. Third, the remedy requires a financial institu-tion willing to assume the defaulting lenders interest. As a result of the cur-rent conditions in the credit markets, the vast majority of loans are tradingbelow par, and it may prove difficult to find a willing new participant or toconvince an existing lender to take on a larger commitment. Negotiatingthe terms of an assignment of a defaulting lenders interest can also be chal-lenging. The borrower, the administrative agent and the replacement lenderwould need to decide whether the replacement lender will be liable to fundadvances that the defaulting lender previously failed to fund. The replace-



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ment lender will probably also request indemnification from the defaultinglender and assurances from the parties to the credit agreement that no claimswill be asserted against the replacement lender as a result of the defaultinglenders failure to honor its obligations.

As an alternative to the traditional yank-a-bank remedy, there may beprovisions added to syndicated credit agreements that permit the borrowerto terminate a defaulting lenders existing commitments and repay its out-standing loans in lieu of finding a replacement lender. The reduction wouldbe to the defaulting lenders commitment only, not a pro rata reduction of each lenders commitment. This remedy would be appropriate in a situationwhere a borrower is unable to find a replacement lender, but still desires toremove a defaulting lender from the credit facility. The borrower wouldneed to have sufficient availability to pay off any outstanding loans by thedefaulting lender.

Voting Rights

Some syndicated credit agreements already provide that a defaultinglender forfeits its right to vote on amendments and waivers of the loan doc-umentation. The voting rights that a defaulting lender loses can includeissues that would otherwise require a unanimous vote of the lenders, such asreductions of principal, interest and fees. However, a defaulting lender gen-erally retains its right to approve any increase in its commitment.

Payment of Commitment Fee

Most syndicated credit agreements do not expressly relieve the borrow-er of its obligation to pay commitment fees to a defaulting lender.Notwithstanding the contractual obligation to continue to pay commitmentfees, a borrower might argue that under general contract law it should berelieved of its obligation to pay the commitment fee or should be able to setoff the commitment fees it owes to a defaulting lender against the amountthe defaulting lender has failed to fund. Most credit agreements, however,provide the borrower has no right of setoff. In jurisdictions where local lawallows, the borrower could argue that a common law right of set-off applies



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and that the borrower is relieved of its waiver of the right of setoff becauseof the defaulting lenders breach.

If the borrower desires to not pay the defaulted lenders commitmentfee, it should enlist the support of the administrative agent. Some agentshave been willing to allow the short paying of the commitment fees. If thecredit agreement provides, as some do, that commitment fees are payable onthe aggregate unused commitments, and the fees are to be divided pro rata

to the lenders based on their individual commitments, the agent will be lesslikely to cooperate.

Breach of Contract

A borrower could elect to sue a defaulting lender on a breach of contractclaim. In order to prevail, the borrower would need to demonstrate dam-ages resulting from the defaulting lenders failure to fund, such as a highercost of obtaining alternate financing. A borrower should consider that a suit

for breach of contract can be costly and time-consuming and that it may bedifficult to successfully enforce a monetary judgment against a defaultinglender that is on unsure financial footing or insolvent.

Payment of Loans; Pro Rata Sharing

Syndicated credit agreements generally provide that all repayments beapplied pro rata to each lenders outstanding loans, regardless of whether any lender is a defaulting lender. Consequently, borrowers should considerrolling over any outstanding loans previously funded by a defaulting lenderin lieu of repaying loans and subsequently requesting a new borrowing,which the defaulting lender is unlikely to fund. Going forward, there likely will be provisions that offset a defaulting lenders right to share in a repay-ment of the loans prior to maturity against the amount that the defaultinglender has failed to fund.



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FRONTING RISK OF ADMINISTRATIVE AGENTS, ISSUINGLENDER, AND SWING LINE LENDERS

Administrative Agent

Syndicated credit agreements are structured so that the administrativeagent funds requested borrowings on behalf of the bank group and looks toeach individual lender to advance its pro rata share of borrowings to the

administrative agent. Credit agreements usually contain provisions that allowthe administrative agent to protect itself from the fronting risk imposed by thisarrangement. Absent notice to the contrary, the administrative agent is per-mitted to advance funds to the borrower on the assumption that each lenderwill fund its pro rata share of each borrowing. If the administrative agentmakes a loan available to the borrower and a defaulting lender fails to provideits pro rata share of the borrowing, the administrative agent can force the bor-rower to repay the defaulting lenders pro rata share of the borrowing to theadministrative agent with interest at the base rate. The administrative agent

would also have a right to set off amounts owed to it against amounts owed tothe borrower, including proceeds of future borrowings.

Issuing Lender

Each lender acquires a pro rata risk participation in each letter of creditissued under a syndicated credit agreement. After a draw on a letter of cred-it, each lender is responsible for reimbursing the issuing lender by making itspro rata share of a revolving advance available or by funding its risk partici-pation in respect of the letter of credit. The issuing lender faces the risk thata defaulting lender may fail to honor these obligations. Some credit agree-ments contain language providing that an issuing lender is not required toissue a letter of credit where a defaulting lender is participating in the facili-ty unless cash collateral is provided to protect the issuing lender against thefronting risk imposed by the defaulting lender. This language is not stan-dard in the marketplace, but issuing lenders are beginning to request it withmore frequency. The provision can place significant hardship on the bor-rower, which would be forced to post cash collateral in order to have any let-ters of credit issued while a defaulting lender is participating in its credit



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facility. Another protection for issuing lenders that may be included morefrequently in the marketplace is reducing letter of credit availability by thedefaulting lenders pro rata share of the letter of credit sublimit. This wouldprotect the issuing lender against fronting risk imposed by a defaultinglender, but would allow the borrower to continue to rely on the letter of credit facility to the extent of non-defaulting lenders participation.

Issuing banks in synthetic letter of credit facilities also have been takingborrowers to task for exposure to defaulting lenders. Under a synthetic let-ter of credit facility, each lender prefunds its risk participation in the lettersof credit and the issuing bank holds a deposit of the prefunded amounts ina deposit account in which the borrower and the lenders hold no claim orinterest. These accounts were designed to be bankruptcy remote from thelenders and the borrowers, but we have experienced the issuing banks takingthe conservative view that the defaulting lender may have a right to thedeposit, notwithstanding the express terms of the documents. If the default-ing lender is in bankruptcy, these issuing banks also seem to believe the auto-

matic stay would prevent the issuing bank from using the defaulting lendersshare of the deposit to reimburse letter of credit draws. As with traditionalletter of credit facilities, issuing lenders taking this position are attemptingto require borrowers to cash secure the defaulting lenders share of the lettersof credit if the credit agreement gives the ability to require the borrower. Atsome point the rights to these deposits will need to be addressed in the bank-ruptcy proceedings to validate whether the deposits are not property of thebankrupt lenders estate.

Swing Line Lender

Each lender also acquires a pro rata risk participation in each swing lineloan made under a syndicated credit agreement. Each lender is responsiblefor refinancing its pro rata share of swing line loans with the proceeds froma revolving advance or for funding its risk participation in respect of swingline loans. The swing line lender therefore faces fronting risk similar to thatof an issuing lender. Most credit agreements require swing line loans to berepaid within a few days or weeks after they are initially made, limiting theswing line lenders exposure. However, swing line lenders are typically



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required to fund swing line loans even when a defaulting lender is partici-pating in the credit facility. In some instances, credit agreements providethat swing line loans are made at the swing line lenders discretion. This pro-tects the swing line lender against fronting risk, but is burdensome to theborrower because the borrower cannot be certain that swing line loanrequests will be honored. An alternative protection to the swing line lenderthat may emerge in the marketplace is reducing swing line availability by thedefaulting lenders pro rata share of the swing line commitment. This solu-tion would protect the swing line lender against the fronting risk imposedby a defaulting lender but would allow the borrower to continue to rely onthe swing line facility to the extent of non-defaulting lenders participation.This language has not traditionally been included in credit agreements butmay begin to be more common going forward.

Resignation

Where a defaulting lender is participating in a credit facility, the issuinglender and the swing line lender may attempt to resign to avoid taking onfuture fronting risk with respect to the defaulting lender. Although creditagreements generally contain language allowing an issuing lender and aswing line lender to resign their positions, it is typically necessary for areplacement issuing lender or swing line lender to be located before the retir-ing issuing lender or swing line lender is relieved of its obligations. Also, aretiring issuing lender is typically required to remain an issuing lender withrespect to letters of credit issued before its resignation.

DEFAULTING ADMINISTRATIVE AGENT

Syndicated credit agreements typically do not contemplate the risk of anadministrative agent defaulting on its obligations under the credit agreement orbecoming insolvent. Consequently, although the administrative agent canresign, there is often no provision allowing the borrower or the lenders to removean administrative agent, even when the administrative agent has defaulted on itsobligations. Removal provisions may begin to become more common going for-ward if borrowers and participant lenders push for their inclusion.



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The recent bankruptcy of Lehman Commercial Paper Inc. providesinsight into how a bankruptcy of an administrative agent may be handled by the courts. The bankruptcy court stated that the funds in Lehmans agency account were not an asset of Lehman (except to the extent of Lehmans inter-est in the funds as a participating lender). The bankruptcy court alsoallowed but did not require Lehman to resign as administrative agent formore than one hundred credit facilities. The findings of the court shouldgive borrowers and participant lenders some comfort that they can continueto make payments to an administrative agent as provided in the credit agree-ment without having those funds become a part of the administrative agentsestate in a bankruptcy.

As a result of recent events affecting the credit markets, there already aremany instances of borrowers and financial institutions requesting changes tosyndicated loan documentation to address issues related to defaultinglenders. Although no market standard for these provisions has emerged yet,future amendments to existing credit facilities and documentation for newcredit facilities are likely to include language addressing these issues, andmarket standards for these provisions are likely to evolve.


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