Negotiating transfer provisions: whose side are you on?
Notably in the LMA's guide to Improving Liquidity in the Secondary Market (May 2017) and supported in the second of its biannual updates to members (LMA News, H2 2017), where research commissioned by the LMA indicated that restrictions on transferability are on the rise in European leveraged loans. More recently at the LMA's syndicated loans conference (September 2017), a panel discussion on liquidity and efficiency again took aim at how negotiation trends in transfer provisions could be damaging the secondary market. There is nothing to suggest the LMA (and the LSTA) won't continue to beat the drum at the March gathering.
Both organisations have an understandable interest in ensuring the loan market has sufficient liquidity and is functioning well, and they will argue that a healthy secondary market is closely associated with a borrower-friendly primary market. But the issue is not confined to serving the best interests of the relevant trade associations and their members' trading activity. Transfer restrictions, when coupled with light touch covenant structures, for example, could create significant problems for individual lenders trying to dispose of loans, whether for operational (realising value, de-risking, liquidity) or regulatory capital reasons.
Yet borrower anxiety remains. Market commentary continues to warn of the dangers of "vulture funds", non-bank financial institutions and other investors and the necessary drafting responses (in light of cases such as Grant and others as Joint Administrators of Olympia Securities Commercial Plc (in administration)) v WDW 3 Investments Ltd and another [2017] EWHC 2807 (Ch)) to tighten up restrictions on assignment to ensure that borrowers reserve as much control as possible over the identity of the lender or the composition of the loan syndicate (see Preying on distressed debt: limiting the scope for transfer to vulture funds, BJIBFL, January 2018).
Furthermore, despite the scope of the LMA and Xtract's market research, the issue is not limited to leveraged deals. Trends that exist in leveraged loans may feed in to other markets and real estate finance is not immune to borrowers putting pressure on their lenders to limit the portability of their debt. Indeed investors with memories of the fallout from the 2008 global financial crisis may be particularly attuned to the more capricious nature of property lenders, and the susceptibility of REF debt to being sold off or transferred to government "bad banks". Partly attributed to the strength of the relationship banking model, the following issues have been identified:
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Prohibiting transfers to competitors of the borrower. Perhaps a natural aversion for some borrowers, restrictions may prevent loans being sold to an industrial competitor (who may be seeking to gain strategic control), unless the borrower, or its parent, consents. However care must be taken that the drafting does not inadvertently pull in entities that are indirect competitors (for example, "affiliates" of a direct competitor) or private equity investors operating in the same broad sphere as a sponsor.
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Blacklists and whitelists. Typically these restrictions will prohibit transfers to entities that might include distressed debt funds, hedge funds, non-bank institutions or other entities perhaps seen as predatory or difficult. Whitelists specify a pre-approved list of acceptable transferees. How such entities are defined or identified is crucial. In a real estate development for example, a borrower will often be concerned that the taps are not going to be turned off on any phased funding or that a new lender is less sympathetic to the borrower's ongoing finance requirements. In Carey Group Plc & Ors v AIB Group (UK) Plc & Another [2011] EWHC 567 (Ch), for example a sale to the Irish "bad bank" NAMA was thought to be problematic to the extent NAMA's remit meant that it was incapable of meeting certain loan servicing or ongoing funding obligations.
Other observations include restrictive drafting of terms like "distressed investors" where definitions linked to parties that trade in a specified portion of sub-par debt may exclude any buyer, depending on the prevailing state of the market.
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Minimum holds ("skin in the game"). A borrower may require its lender to retain a minimum hold amount or for transfer amounts to be above a certain figure (or a multiple of a certain figure) to prevent a fragmentation of the lender base. Care must be taken that the relevant amounts do not block necessary sales.
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Sub-participation. Commonly sub-participation was seen as a route around consent issues or transfer restrictions, since sub-participants are not lenders of record (subject to elevation). However some loan agreements may now include fetters on a lender's ability to sub-participate or use other synthetic structures so as to avoid syndicate members being influenced by parties unknown to the borrower. For example, restrictions may be couched in terms that prohibit sub-participation or other synthetic methods of risk allocation to lenders that are blacklisted under any direct transfer provisions.
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Other deviations from previous market norms. Syndicated loan documents, whether derived from the LMA recommended forms or not, typically include extensive, well-used transfer mechanisms that are designed to mitigate certain concerns on the part of the borrower. But they may not be operating how they should be. For example:
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Misunderstanding the role of the facility agent. Syndicate lenders and borrowers may interpret the transfer provisions such that the agent is required to seek the borrower's consent. Rather it should be the existing lender (as transferor) who should request the consent.
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Deemed consent provisions. The LMA has identified an apparent failure to use, or in some cases include, deemed consent or "standing offer" provisions that can be deployed to overcome delays in obtaining borrower approval for a transfer. Similarly, wording that requires borrowers simply to be consulted or not to withhold or delay consent unreasonably (or both) should be activated where circumstances dictate.
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In some instances the various restrictions highlighted above will be designed to stay in place even after a default, being the point when borrowers will clearly be most vulnerable and more sensitive about the identity of their lenders. However, from a lender's perspective, the restrictions will be problematic insofar as they delay or prevent vital sales of non-performing ("distressed") debt.
Where restrictions are designed to fall away only on specified events it is crucial to look at the wording to understand when a lender might be able to transfer the loan. Arguments around whether transfer restrictions still apply unless there has been a "material" event of default should be avoided. Light touch covenant (or "cov-lite") structures that eschew financial covenants or other "early warning systems" within the documents (such as reporting obligations) may also leave lenders unable to sell deteriorating loans, for example other than to approved entities or with borrower consent, until a more serious payment event of default or an insolvency event occurs.
Interestingly, while in some instances borrowers may be pushing for their loan documents to resemble bond terms, they do not want similarly to ape the absolute transferability of those securities. Some commentators have observed that creeping restrictions on transfers may be a lawyer-led (and misguided) attempt to protect their client borrower/sponsor, ignoring the fact that stifling secondary liquidity creates its own problems. However, others argue the lawyers are simply reflecting what is "market". To the extent customers ask for it, and the lenders accommodate those requests, it is not for the customer to concern themselves with the secondary market.
However, from a lender's perspective it may be more than helping. Conceding to a seemingly innocuous request in negotiations from a borrower (perhaps spooked by analysis following Grant v WDW 3 Investments Ltd (2017) that restricting assignees to “financial institutions” provides no meaningful protection against the kind of entity that could become a lender), may ultimately limit a lender's ability to offload a loan until more calamitous events occur. And of course it probably won't be appreciated by their debt trading desks.
Whichever side of the debate you favour, there is no doubt that rather than shutting down transfers, some borrower anxiety as to the effect of a loan sale may be tackled in other more creative ways. For example, it may be more appropriate to address typical issues arising out of a change of lender such as confidentiality, loan servicing and ongoing funding, renegotiation of terms, lender voting rights and increased costs elsewhere in the documents. But for as long as the market allows borrowers to wield the red pen, transfer provisions will remain in the firing line.