LAW FREE ESSAY: MECHANISMS OF SECURED SYNDICATE DEBT TRANSFER
MECHANISMS OF SECURED SYNDICATE DEBT TRANSFER
Introduction: Syndicated Loan Agreements
Syndicated loan facilities constitute an arrangement where a borrower in need of a huge amount of funding engages a group of lenders in a single agreement involving the whole group of lenders. In such an arrangement, the distinct procedures that would otherwise separately involve every lender in the funding are reduced accordingly. This form of complicated lending is referred to as a syndicated loan. From a legal perspective, the agreement involving the group and the borrower is considered in a special perspective since the ordinary lending rules may not apply in by virtue of one of the parties being a group. The contractual obligations and remedies of the parties are preferentially considered under common law and civil law. In certain circumstances, the lending group members may consider selling their loan commitment to a different party thereby transferring the lender consideration that the syndicate arrangement confers. In this discourse, the mechanisms of common law and civil law jurisdictions pertaining to the transfer of secured syndicated debts are discussed and distinguished from each other.
Transferring Syndicated Debt
As mentioned above, there are certain instances when one of the lenders in the syndicate group may be forced to consider withdrawing from the commitment of the loan agreement through the sale of the consideration thereon. Some of the factors of such transfers may include financial or management considerations which differ from one case to another. Firstly, a long term lending facility may turn out to be less attractive than other available opportunities which may lead to pulling out of the arrangement to recover capital for further lending. Secondly, the lender’s management may review the risk factors of an arrangement within a particular lending portfolio and opt to diversify the lending portfolio leading to a decision to quit one arrangement for better investment. Thirdly, factors of regulatory capital requirements may force a lender to consider relinquishing its commitment in a lending arrangement through the sale of the debt to another lender. Fourthly, financial constraints after entering into a lending arrangement may force the lender to transfer the commitment to another lender thereby crystallising loss possibility. Various methods of carrying out the transfer are available depending on the legal and regulatory provisions guiding such transactions.
Common Law and Civil Law Transfer Regulations
- a) Common law
In common law jurisdictions, the syndicate loan facility arrangement is constituted under a separate trust agreement. Secured syndicate loans are secured through an independent trustee who holds the security consideration over the debt in trustee on behalf of the syndicate group. An independent trustee is appointed and constituted through a provision of the loan agreement where the syndicate partners agree to enforce the security on the loan in a certain manner that is deemed fit among the lenders. In terms of the security enforcement, the trustee is guided by the loan agreement in the procedures to follow when called upon to distribute the proceeds of the loan security among the lenders with regard to their participation in the funding of the loan. As a general rule, the constitution of the trustee is such that the credit risk involved in the agreement does not affect the trustee. According to several common law literature and sources, the role of the trustee also includes charge over the particular security given over the debt, which also becomes transferable once the lending parties decide to transfer their commitment through various ways. The trustee holds certain clear interests over the security assigned to it by the syndicate and carries out any distribution of interest as guided. There are a couple of mechanisms under the common law through which a transfer can be effected which include the following.
- i) Novation
Under a novation transfer mechanism, the lender willing to transfer the debt transfers every right and obligation to the new lender willing to buy the commitment. In this mechanism, the initial lender cancels every commitment and identical commitment on the transaction is passed onto the new lender coming in. Generally, the exit of the old lender terminates the relationship held with the rest of the syndicate group of lenders and it implies that the new lender acts as a replacement. This mechanism effectively places the new lender in charge of the contractual part supposed to be respected by the exiting lender. Apparently, a direct relationship is established upon the transfer between the new lender and the borrower. To illustrate the implications of this transfer, a term lending arrangement imply that the lender would not be advancing any more credit to the borrower having effectively assumed the obligation of the former lender. However, in a revolving lending facility, the new lender will assume the responsibility of advancing the expected disbursements as the former lender would have continued with the facility.
- ii) Legal Assignment
A legal transfer mechanism does not transfer all the aspects of the commitment to the new lender, since only rights are transferred while obligations remain with the transferring lender. Three aspects must be fulfilled in order to enforce the legal assignment in entirety which must be; absolute in terms of the existing lender’s debt commitment, in writing and signed by the existing lender and notification made to borrower. All rights to the debt’s commitment are effectively transferred to the new lender despite the fat that the two lenders play different roles in the commitment.
iii) Equitable Assignment
When any of the three conditions in a legal assignment is not met, the transfer of the rights takes a different perspective under the equitable assignment. The new lender assumes the position of the equitable assignee and must act as a co-assignor with the existing lender for any action taken on the debt. The notification of the borrower as a fundamental condition is the main differentiating factor between a legal and equitable assignment and the relevant transfer of rights. Failure to notify the borrower implies that the equities on the debt are directed to the new lender.
- iv) Funded Participation
Funded participation mechanism is characterised by the involvement of the new lender and the participant into an agreement that a full or part refund of the amount lent to the borrower is reimbursed to the existing lender. On such an agreement, the existing lender further agrees to pay all or an agreed portion of the principal as well as interest gained from the debt. Contractual rights are created for the involvement of the participant into the commitment where the shared obligation of making the loan deposits and the sharing of the returns are considered. However, the syndicated loan agreement only recognises the existing lender in terms of liability. The participant contributes to the availing of funds for the disbursement of the loan where an agreement is reached on the modalities of sharing the returns on a given arrangement.
- v) Risk Participation
In risk participation, the mechanism of debt transfer involves the introduction of the participant into the lending role as a guarantor to the existing lender. An agreement is enterer into to allow the participant to provide funds to the existing lender in case the risk of lack of funds poses before the execution. Participation involvement in either risk or fund agreements does not necessitate the alert of the borrower since the participant deals with the existing lender to assist in execution of the lending mandate. However, the risk participant may want to transform the engagement into a takeover of the lender’s position. Legal systems formulate various interpretations on the manner to deal with the circumstances of the syndicate debt matter at hand using predetermined regulations. Such system provide for the treatment of transfer of rights and obligations in an automatic version which may fail in certain circumstances that complicate such a transaction. However, using advancements from the common law applications in dealing with such complexities, various civil law considerations have been made to improve the civil law principles in delivery of justice to the investors and creditors.
- b) Civil law
Other legal transfers may be considered outside the common law arrangement, for instance where trusts are not recognised. Under such an agreement, an agency is usually involved in holding the security on behalf of the syndicate group. The main aspect of civil law in the management of debts and transfers thereon is the foundation on legal provision that are limited in terms of options available to investors in dealing with various challenges facing such transactions. Civil codes across various jurisdictions have their own set of regulations that deal with the transfer of debts in the syndicate lending business. One of the complexities in the civil law is the general practice that transferability can only be in full and assumes that the complexities of such an environment are solved upon the complete transfer. However, transfer issues such as those observed in the common law mechanisms imply that the complete transfer of the debt commitment to another lender is not always possible. Partial transfers are therefore not envisaged in a majority of civil law systems that also happen to apply a different security protection. An illustration of such an arrangement is the Dutch fiduciary system that is based on the Dutch civil law.
Civil law reliance on the current body of laws seems to face challenges of limited options in offering remedies to investors in dealing with debts and the transfers thereon. In this perspective, there is a general feeling and schools of thought that support the flexibility of the common law in dealing with various entry and exit routes that investors and parties to a syndicate debt can utilise. Trust system in the common law has been hailed as an avenue to justice to investors and creditors in syndicate lending, due to the fact that more flexible interventions regarding salvaging the agreement in defaulting instances are accordingly solved. In light of the need by the involved parties to protect their individual interests without feelings of preferential treatment on either party to the syndicate lending agreements, it is clear that the civil format of intervention is a weaker option for the business.
Comparing the civil law and common law in terms of applicability across the jurisdictions, lessons from the common law are important in offering the rigid civil law systems with alternative interventions where the civil law seems incomprehensive due to legal complications. This is particularly so in the jurisdictions that do not practice common law whereas the interventions in common law in dealing with complications of transfers seem most suitable in delivery of justice in the syndicate lending business. Versions of the syndicate lending transfer jurisdiction therefore appear to continue to be inclined to common law applications due to their flexibility.
Whereas it is clear that non-compliance with a particular requirement of transfer in common law may translate into a different form of transfer for instance in legal assignment, civil law violations may translate into nullification of the entire transfer. It therefore implies that under the civil law system of debt transfer, more risks are involved than in the common law. To illustrate the risky aspect of the civil law, nullification of a faulty transfer process may result into further costs in determination of the appropriate alternative to employ in settling the anomaly. Alternatively, many civil law jurisdictions do not accommodate the assumption that a commitment can be stretched to involve more parties in a derivative version. Whereas such a notion reduces ambiguities as intended, it blocks investors to take advantage of the opportunities that the common law jurisdiction avails.
Syndicate debt transfer presents an opportunity for the business world to open up opportunities for more players to take advantage of the lending business. However, the applicable legal system may determine whether this is opportunity is to be availed. As indicated in the above discussion, various mechanisms of syndicate debt transfer under the common and civil law jurisdictions may provide for the presence or absence of the opportunity. In common law, a flexible approach to handle the transfers is provided whereas various civil law provisions reduce the options of such opportunities.
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 R Levine “Law, Finance, and Economic Growth,” (1999) 8 Journal of Financial Intermediation, 30
 B C Esty & W L Megginson 22
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