Hedge Counterparties under the LMA REF Intercreditor Agreement
The material we have published to date on Intercreditor Agreements has primarily focused on structure, security and enforcement rights - but don't forget about the importance of the Hedge Counterparties in real estate finance.
The LMA have given this some thought and the ICA contains numerous provisions of relevance to a Hedge Counterparty in a real estate finance transaction. These provisions are usefully summarised in the LMA Users Guide which accompanies the ICA and are further summarised below. As is highlighted in the Users Guide, the ICA is only a starting point and may need significant amendment depending on the eventual deal structure. A term sheet that sets out the position of the Hedge Counterparties and a hedging strategy document are therefore highly recommended.
The following three areas are considered below: (i) general assumptions; (ii) ranking and voting; and (iii) restrictions and permissions.
(i) General Assumptions
The ICA makes a number of general assumptions as follows:
- only interest on senior loans is to be hedged
- the key requirements of the hedging agreements (which must be ISDA-based) are set out in the senior facility agreement[1]
- there may be multiple Hedge Counterparties and each must be party to the senior facility agreement
- Hedge Counterparties do not need to be senior lenders
- Hedge Counterparties benefit from the guarantee in the senior facility agreement and any additional guarantee/indemnity that is taken by the senior lenders and concurrently offered to the mezzanine lenders
(ii) Ranking and Voting
The ICA provides that amounts due by the senior borrower to the Hedge Counterparties rank first and pari passu with the senior facility liabilities as to both (a) payment and (b) transaction security; and third and pari passu with the senior facility liabilities in the post-enforcement payment waterfall (after sums owing to the security agent and enforcement costs). Of equal relevance are the provisions in the senior facility agreement relating to sharing, turnover and equalisation of recoveries as between senior lenders and Hedge Counterparties.
Hedge Counterparties additionally have a vote as members of the majority senior creditor group dependent upon the size of the relevant settlement amount (if the hedging arrangement has been closed out, an amount is owing to the Hedge Counterparty and that amount has not been paid) or the then outstanding mark-to-market amount[2].
(iii) Restrictions and permissions
The ICA sets out a number of restrictions and permissions as follows:
- payments may be made to the Hedge Counterparties in accordance with the terms of the hedging agreements and the senior facility agreement
- members of the borrowing group may not acquire hedging liabilities without consent
- amendments and waivers to the terms of the hedging agreements are permitted provided they do not breach the ICA or the relevant provisions of the senior facility agreement [3]
- Hedge Counterparties may not take guarantees/indemnities, subject to various exceptions
- Hedge Counterparties may not take enforcement action or close out hedging agreements prematurely, subject to relevant provisions of the senior facility agreement[4]
- The ICA allows and does not interfere with close-out netting arrangements under relevant ISDA master agreements
- The ICA contemplates future accession as a Hedge Counterparty.
Conclusions
The foregoing is only a summary of the various provisions relating to Hedge Counterparties as set out in the ICA and related facility agreement. There is no substitute for a detailed review of these provisions and, as is often the case where hedging is concerned, for employing the services of a dedicated derivatives lawyer to ensure that what is intended is in fact reflected in the underlying documentation.
[1] Clause 8.3 of the senior facility agreement contains the relevant hedging provisions. These set out among other things, the obligation to hedge, the size and maturity of the hedge, the requirement that the hedge should form part of the borrower security package, a restriction on waivers and amendments, a requirement to reduce the relevant notional amount(s) following a prepayment and restrictions on and conditions to the right to close-out.
[2] This may depend on whether the senior facility liabilities have been discharged in full.
[3] See footnote 1.
[4] See footnote 1.