1 - Introduction to Bank Lending and Debt Securities

Raising Finance – An Overview

Key Players

Borrowers

 Governments (sovereign debt) (may be short-term or long-term)

 Local Authorities (typically to invest in infrastructure)

 Individuals

 Companies

 Others (partnerships, sole traders, supranational organisations (e.g. World Bank), educational institutions)

Lenders

 Banks and institutional lenders (known as funds). Both are intermediaries (lend money raised from
others)

Commercial banks  Raise money by attracting deposits and then lend money to individuals,
companies and governments who need it
 Intermediaries; move money to where it is required and provide basic
banking services
 As long as they lend prudently, there is a relatively low risk and lucrative
business
 N.B. universal banks – combined retail, wholesale and investment bank
services in one institution but now there are attempts to force banks to
separate their businesses (ring-fencing) (Vickers Report)

Investment banks  Sell advice and underwrite securities issued

 Trade and speculate on bonds, shares and complex financial instruments
 Huge reward, but risk of a large loss

Central banks  All countries with developed economies have a central bank (functions vary
across jurisdictions)
 Main function of the Bank of England is to act as the government’s banker
(holds its main account and borrows on its behalf, and advise on monetary
policy, to issue bank notes, to regulate the money markets by lending or
borrowing and to set interest rates)
 Also helps other banks with short-term liquidity issues as a lender of a last
resort, for long-term liquidity issues, advice will be given

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 Finance Solicitor

 Structure the deal (if particularly complex)

 Draft and negotiate loan documentation

o Be aware of current market practice as this will dictate the terms that most banks are likely to
accept

Financing a Company

 Issuing shares in return for capital investment (equity finance, not debt)
 The more shares that are issued, the more this dilutes profits per share
 If voting shares are issued, control is diluted as shares are issued
 There is no absolute obligation to give shareholders dividends
 Unless you are a public company, it can be difficult to find subscribers for new
Share capital allotment of shares
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(Equity)  Funds are non-returnable (except on winding-up), so the company is able to commit
the monies in long-term investments
 Cannot really raise small amounts on a regular basis (can with loan facilities)
 Company can borrow money at a relatively fixed cost and use it to make greater
profits for its shareholders (gearing and leverage)

 Profits of the company are kept to provide working capital and funding
 Thus, the profits are not distributed to SH as dividends (but where there is a surplus
Retained profits
it will be distributed to the SH’s as a return on their investment in shares)
2 (Neither)
 These are shown in the Profit/Loss Reserve section of the balance sheet
 Timing and amount of profits is unpredictable so may not be helpful

 Borrowing by way of a loan (usually known as a ‘loan facility’) can provide a

3 Loan facilities company with a flexible and ‘reliable’ source of funds.
(Debt)
 Includes overdraft, (provides an instant source of variable borrowing, helping a
company with cash flow), term loan (lump sum borrowed for a period of time) and
revolving credit facility (below)
 Can borrow in a choice of currencies

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  Can be good for temporary-cash flow issues (raise small amounts on regular basis)
 Can be good to fund a specific project (long-term loan)
 However, company must pay interest (fixed or floating)

 Must be PUBLIC company to issue bonds to public – s755 CA

 A company issuing a series of instruments (i.e. a form of certificate) to investors in
acknowledgement of an amount of capital it has borrowed from them (these
instruments are known as ‘debt securities’).
 The most common forms of capital markets debt security involve the issuer
agreeing to repay the borrowed capital on a specified date (on ‘maturity’) and to
pay interest on the borrowed capital in the meantime.

 These act as an IOU (DEBT SECURITY – borrowing – security is the instrument)

Capital market
issued to investors (used by large companies)
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 Investors (gives money) and issuer (receives money)
(Debt)  Such security includes bonds, notes, certificates of deposit, loan stock, commercial
paper
 Interest is payable in addition to the capital lump sum on maturity (specific date)
 They can be sold on secondary markets too; company pays interest to whoever is
the current owner of the debt; original investor is therefore able to recover some
before maturity date (subsequent investor then gets the remaining interest
payments and receives the borrowed capital on maturity)

Factors Influencing a Company’s Choice of Financing – loan versus debt securities

Bank Loan

HARD TO GET LOAN ABOVE £500M, even if syndicated loan (likely banks won’t want such a concentration of risk)

Advantages Disadvantages

 Confidentiality: Unlike with a bond issue, a loan  Security (generally): In contrast to a bond issue,
agreement can be kept confidential between the you will almost certainly need substantial security.
parties involved (confidentiality clause). Borrower Note: It is not uncommon that banks will take fixed
not exposed to market rumours and allows them to charges over what they can and floating charges
handle its affairs more discretely. Listed bond over everything else that is left.
issues will almost inevitably require publicity.

 Costs - Higher interest rates: Interest rates are

 Speed: A loan agreement can be made much likely to be much more rigid and higher
quicker than a bond issue if necessary (particularly (particularly if high risk). Tends to be more costly to
an overdraft). So, if company urgently needs reflect that bank has own cost of funds and wants
money, loan more effective. Can take around 6 wks to make a margin. Lower in a bond issue due to the
 Don’t have to draw down straight away – e.g. if much wider base of potential investors meaning
dependent on an acquisition, can wait until certain

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 less risk for individual investors compared to a loan.
it will go ahead.

 Obtainable: A loan is in many ways easier to get. It  More onerous terms: A loan agreement will
is not subject to market fluctuation and less generally impose very onerous terms on the
dependent on your reputation in the market and borrower and try to cover for every eventuality to
liquidity of the market (these are more likely to avoid the bank losing any money. These terms
reflect interest payments). A convincing business could limit a business’ activities and thus adversely
plan likely to get you a loan if risk is deemed affect its future prospects.
acceptable (but will pay interest according to risk)

 Control / covenants: The bank will have a

 Flexibility: loan agreement offers a lot of flexibility substantial amount of control over how you
with regard to the individual terms. You can agree: manage and conduct the company as a result of all
 Repayment (e.g. amortisation; bullet; balloon) the covenants they will impose (e.g. financial
 Instalment size and overall amount borrowed covenants, information covenants (supply certain
 Interest info to bank), events of default (like material
 Type of facility – which type would be best on adverse change)).
the facts (could have term loan + RCF)
 Option to pay back early (for a penalty) and
thereby save on the interest payments.

 Chance for renegotiation: A major advantage is  Disclosure: As part of the DD, banks will require
that you are often dealing with 1 party (the very extensive disclosure from the borrower and
arranger). 1 party will be a fairly sophisticated party impose strict information covenants on it to
who knows the market and will be willing to listen provide the bank regularly with information.
to what you have to say. This gives you more scope
to reason with that party if you are in breach.

 Need for a guarantor: Loan agreements will

 Relationships: KEY - you build a relationship with generally require a party to guarantee in case the
the bank over a period of time which can be borrower defaults. This is another onerous term
important also with a view for future borrowing. A imposed on the borrower that can make loan
good relationship can benefit the borrower if arrangements less attractive.
renegotiation of the terms of the loan is required.

 Credit Rating – No credit rating for a loan.

However, bank will do Due Diligence to investigate  Smaller investor base compared to debt securities.
company and security where credit rating will be
considered. Interest payments and fees will vary
according to the risk assessment from the DD.

 Able to take out a loan in multiple currencies

Bond Issue (debt securities) – only for public companies!

Debt securities = companies issuing BONDS on the capital market for investors to buy. Investment will have a
maturity date and investor will have a right to receive an interest payment (coupon) or investment may be issued at
a ‘discount’ to its face value on redemption at maturity. Investor does not take any equity in the issuer.
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 NOT WORTH IF < £100M (as it is only cost effective (profitable) to the bank if the bond is above this amount).

Advantages Disadvantages

 Lower interest rates and regulatory costs: Interest  Not confidential: A bond issue will be public
rates are more flexible under a Bond Issue. The because they are listed on public markets –
reason for this is that there is smaller risk attached requires prospectus and details of what the
to the investment for investors (take a smaller slice borrower plans to do with money.
of the risk) and wider pool of potential investors Note: This may expose the company to market
 AND more liquid and tradeable market so no need rumours (e.g. this company is in need of money, so
to keep investment until maturity something is not going well). This in turn can affect
 AND with direct lending bonds, the investors can the share price and spook exiting creditors (who
miss out the ‘middle-man’ (bank) so costs reduced may start considering finding events of default in
order to claim their money back)

 Less onerous undertakings and terms: The terms  Risk that money will not be raised: A bond issue is
under a bond are considerably less onerous and in many ways subject to your reputation in the
the issuer has much more bargaining power in market, investors’ interest and other factors that
dictating terms. E.g. grace periods tend to be more generally cannot be influenced by the issuing party.
generous.  The issue can be underwritten, but this will cost a
Note: You DO NOT want sensitive default triggers fee, and underwriters may try and get out of it.
in a bond issue. Huge problem if required finance not raised.

 No security (generally): Bonds are commonly not  Lack of flexibility: Get an upfront payment of
secured as it raises issues with dealing on the money from the issue (cannot draw down at
secondary market. However, can link a particular different stages). Once issued, only in exceptional
security to a bond issue. circumstances can you redeem bonds early.
Generally, must pay interest payments until
maturity and then bullet payment on maturity date.

 Disclosure: Disclosure requirements are minimal  Bond holders: It is almost impossible to reason
and limited to information that is ALREADY with all individual bond holders who often will be
available in the public domain. regular (unsophisticated) private investors who
bought the bonds in the secondary markets (if you
even know who your bond holders are as there is
no requirement to register)

 Broader investor base: A public bond issue brings a  High Up-front costs: The up-front costs of arranging
remarkable exposure which cannot be matched by a bond issue, particularly if first time, will be
a bank. Whenever you need serious money, bond significantly higher than just negotiating a loan
issues are the way to go (e.g. £500m upwards) (issuing prospectus, acquiring credit rating for bond
 Could deal with just one trustee rather than and borrower, marketing the issue, disclosure,
multiple bond holders listing the bonds, legal fees to ensure regulatory
compliance). Also = higher admin burden.
 Need to be for about £100m for the higher costs of
a bond issue to cost the borrower less than the
higher interest rates of a loan.

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 No control / fewer covenants: Bond holders give  Time: It takes substantially longer to arrange a
you the money and wait for repayment. They do bond issue than it takes to arrange a loan. Can take
NOT obtain any form of control over the company. around 3 months. BUT if there is a programme in
place, may be quicker.

 Transferability: One of the conditions for bonds to  Credit Rating – Particular issue AND company. Must
be listed is that they are freely transferable. This be good as some institutional investors can only
opens up a huge secondary market in which bonds invest in highly rated issues due to constitutional
can be traded. So, people may take the bonds in requirements (e.g. can only invest in AAA rated
order to speculate by selling them later on the securities/investment grade). Company with low
secondary market. More people take a speculative credit rating will struggle to access funds on the
position the more money the borrower obtains – so capital market. If credit rating of bond itself is poor,
the existence of a secondary market (and investors would struggle to sell them in secondary
speculators) means that the borrower is more market. If not previously rated, then this process
likely to meet their financing requirements. can take time and introduce more delay.

 Size and maturities of debt can be much more  Regulation: Listing bonds is strictly regulated which
varied. Certain debt securities can be for much makes them costly but also the regulatory
longer terms than commercial loans compliance required is onerous and requires legal
representation to be arranged.

 Can help to raise public profile of company  May need to do more to increase publicity

  Only public limited companies can issue debt

securities (s.755 CA 2006)

  Can only borrow in currency specified

Direct Comparison of Loan versus Bond

KEY TO CO- FACTS? LOAN BOND (DEBT SECURITY)

Greater than £100m = GET SYNDICATED

AMOUNT £ LOAN NOT WORTH DOING UNDER £100m
(SEE SET UP COSTS) – GET LOAN
Less than £500m = UNLIKELY TO GET LOAN INSTEAD
SO BOND

CONFIDENTIALTY CAN BE KEPT CONFIDENTIAL BETWEEN THE PUBLIC (PROSPECTUS REVEALS

PARTIES (NO MARKET RUMOURS)– INTENTION FOR CO = COMPETITORS
Þ HOW IMPORTANT ALTHOUGH MORE DETAILED DISCLOSURE KNOW + RISK OF MKT RUMOURS –
REQD, BORROWER CAN PROTECT WITH MAY AFFECT SHARE PRICE – MAY
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 TO CO? CONFIDENTIALITY CLAUSE + BANK UNLIKELY SPOOK EXISTING CREDITORS WHO MAY
Þ RISK OF MARKET TO BE A COMPETITOR OF THE COMPANY. LOOK FOR EVENTS OF DEFAULT)
RUMOURS A
CONCERN?

SPEED QUICKER – 6 WEEKS, or even faster for SUBSTANTIALLY LONGER (3 MONTHS

overdraft MIN DUE TO REG. REGIME) UNLESS
Þ DOES CO HAVE PROGRAMME ALREADY IN PLACE.
CASH-FLOW
ISSUES/ NEED TO
FUND QUICK ACQ?

CERTAINTY OF £ MORE WITHIN CO’S CONTROL AS LESS ISSUE = SUBJECT TO MKT REP/SECTOR
SUSCEPTIBLE TO MKT FACTORS. ALSO FIXED ETC. SO OUTSIDE ISSUER’S CONTROL
Þ MKT FACTORS A AMOUNT WITH OPTION FOR FLEXIBILITY TO A DEGREE
RISK? (E.G. RCF)
Þ HOW STRONG IS UNDERWRITING IS AN OPTION BUT
CO REP? THIS COSTS £££

OBTAINABLE CAN BE EASY TO GET IF POWERFUL CO/ BROAD INVESTOR BASE – GOOD
CONVINCING BUSINESS PLAN EXPOSURE THAT BANKS CAN’T MATCH
EVEN WITH SYNDICATE.

SET UP COST CHEAPER TO SET UP (BUT HIGHER HIGH UP-FRONT COSTS

INTEREST)
Þ SHORT TERM CASH - ARRANGEMENT MUCH HIGHER
AN ISSUE FOR CO? THAN LOAN (PROSPECTUS/CREDIT
Þ WOULD IT RATHER RATING/ MARKETING/ LEGAL FEES)
PAY HIGHER - >£100M = COSTS MAY BALANCE
INTEREST IN THE WITH HIGHER RATE OF LOAN
LONG TERM? INTEREST

INTEREST RATE HIGHER + MORE RIGID (PARTICULARLY IF LOWER (+ MORE FLEX) INTEREST RATES
HIGH RISK CO) + BANK’S MARGIN A FACTOR – INVESTORS HAVE SMALLER RISK (CAN
Þ HOW SURE IS CO PASS ON RISK ON SECONDARY
OF SUCCESS OF MARKET) + DIRECT LENDING = NO
PURPOSE OF MIDDLEMAN (BANK) = NO MARGIN TO
FUNDING (E.G. IF ACCOUNT FOR.
ACQUISITION IS IT
100% LIKELY TO
GO THROUGH?)

FLEXIBILITY (FUNDING) CAN NEGOTIATE AMOUNT IF NEEDS UP FRONT AMOUNT OF BOND IS FIXED
CHANGE + NEGOTIATE CURRENCY (RCF, – IF NEEDS CHANGE CAN’T
Þ LIKELY TO REQUIRE O/DRAFT, TERM LOAN) RENEGOTIATE - STUCK WITH THAT
NEGOTIATION? AMOUNT + INTEREST PAYMENTS

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FLEXIBILITY CAN NEG. REPAYMENT SCH; INSTALLMENT V UNLIKELY YOU CAN REDEEM BONDS
(REPAYMENTS) SIZE; INTEREST + OPTION FOR EARLY EARLY = STUCK WITH INTEREST
REPAYMENT OFTEN INCL. (PENALTY) PAYMENTS TILL MATURITY
Þ LIKELY TO REQUIRE
NEGOTIATION?

FLEXIBILITY ONE SOPHISTICATED PARTY (AGENT) - CAN SECONDARY MARKET MAKES NEG.
(NEGOTIATION) BUILD POSITIVE RELATIONSHIP WITH BANK NIGH ON IMPOSSIBLE (IDENTITY? + ARE
= MORE SCOPE FOR RE-NEG + FUTURE UNSOPHISTICATED USERS)
Þ LIKELY TO REQUIRE FUNDING
NEGOTIATION?

SECURITY SUBSTANTIAL SECURITY ALMOST CERTAINLY GENERALLY, NOT NEEDED (DUE TO

REQD. FIXED + FLOATING CHARGES SECONDARY MARKET) BUT, NEED
Þ AVAILABLE COMMON. CREDIT RATING INSTEAD.
SECURITY? GROUP
CO?
Þ EXISTING NEG.
PLEDGES?
Þ RESTRICTIVE ON
CO?

GUARANTOR LOAN GEN REQS A PARTY TO GUARANTEE NOT REQD

IN CASE OF BORROWER’S DEFAULT
Þ POTENTIAL G ON
FACTS? GROUP
CO?

CREDIT RATING NOT AS IMPORTANT FOR LOAN ISSUE AND CO (TIME + COST IF NO
AGREEMENT – EXTENSIVE DD + SECURITY PREVIOUS RATING) MUST BE GOOD OR
TAKEN + HIGHER INTEREST TO REFLECT RISK INVESTORS WON’T BUY (e.g.
CONSTITUTIONAL RESTRICTIONS OF
PENSION FUNDS – AAA ONLY)

ONEROUS TERMS? V ONEROUS - TO COVER ALL EVENTUALITIES CONSIDERABLY LESS ONEROUS THAN
AND AVOID LOSS OF BANK’S £. LOANS + CO HAS MORE FLEXIBILITY IN
Þ POTENTIAL TO DICTATING THEM (SENSITIVE DEFAULT
LIMIT BUSINESS TRIGGERS NOT WANTED)
ACTIVITIES?

DISCLOSURE AS PART OF DD EXTENSIVE DISCLOSURE MINIMAL REQMNTS LIMITED TO INFO

REQD AND INFO COVTS TO SUPPLY BANK IN PUBLIC DOMAIN
REGULARLY
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 Þ COST/TIME FOR CO

CONTROL/COVTS BANK WILL HAVE SUBSTANTIAL CONTROL BHs HAVE NO CONTROL OVER CO
OVER MGMT/CONDUCT OF CO
Þ IMPACT ON CO’S (FINANCIAL/INFO COVTS +EOD (e.g. MAC))
FUTURE PLANS?

TRANSFERABILITY VERY LIMITED SCOPE FOR BANK TO FREELY TRANSFERABLE = SECONDARY

TRANSFER - though depends on the contract MKT. SPECULATION AND PROFIT FOR
INVESTORS THUS, LIKELY TO MEET
FINANCE REQMNTS

REGULATION MUCH LESS REGULATION, CONTRACT LISTING = HEAVY REG = COST + DELAY
BASED

Loan Facilities

General Purpose Loan Facilities

A facility agreement is a contract. The three most common types of general-purpose loan facility are:
1. Overdraft
2. Term loan
3. Revolving credit facility
Þ What distinguishes them is the way in which it allows the borrower to utilise the credit.
Þ Facility with relatively straightforward mechanics were traditionally referred to as “plain
vanilla” loans, while any additional features were known as “bells and whistles”
Þ What particular loan is appropriate depends on the purpose for which the money is required

COMMITTED OR UNCOMMITTED?
 Committed facility: once the lender has made an agreement with the borrower, they are obliged to come up
with/advance cash on request, unless the borrower hasn’t complied with a condition of the agreement
 Uncommitted facility: the bank has discretion whether or not to advance any loan monies to the borrower

 Clean-down provision: provision that ensures the borrower is using the facility for working capital and not a
long-term capital expenditure. Specifies that the overdraft facility must be undrawn for a specified number of
consecutive days in each of borrower’s financial years or other specified period (e.g. balance must be reduced
to £0 for 5 continuous days in any given year)

TYPE DESCRIPTION ADVANTAGES AND DISADVANTAGES

Overdraft  Provides cash in a readily accessible form to  Speed and Cost: simple to arrange
meet any temporary shortfalls in working therefore fast and less legal fees
capital (solves short-term cash flow
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 problems).  No substantial documentation is required
Þ Uncommitted funds: bank has discretion  Flexibility - the borrower can take the cash
before advancing any loan monies (but as and when needed.
general understanding that bank will not
 Subject to less restrictions than RCF
pull the plug without good reason)
Þ Repayable on demand: bank can
 Uncommitted funds which must be repaid
demand at any time (hence, current
on demand – element of uncertainty, may
liability on the balance sheet).
not be able to rely on bank to
Þ Clean down provision (e.g. each month):
provide/maintain funding.
ensures OD is used for working capital  High interest rates - costly
rather than for long term capital  Expensive form of borrowing; pay interest
expenditure. (fixed percentage above bank’s base rate)
Þ Shows as a current liability on balance and possibly a fee for the use of the facility
sheet as it is payable on demand (short- (administration)
term), even if no terms have been  Repayable on demand
breached

Term loan  Borrower (B) loans an agreed capital sum for  Provides the Borrower with the Certainty
(or term a specified term – requiring full repayment of a Pre-determined Repayment Schedule
facility) at or by the end of the term (usually to  Early repayment of loan poss. – often for a
finance capital expenditure).
pre-arranged fee to be paid to the lender(s)
Þ Committed facility
 The only facility that is suitable for large-
Þ Availability/commitment period
 Period where you can draw down a scale debt finance.
lump sum up to specified amount  Use of Tranches & currency options can
Þ Single/multicurrency provide B with degree of flexibility – extra
Þ Duration: generally, between one and availability period during which money can
five years be drawn in a number of proportions
Þ Interest may be fixed but more usually  Interest is likely to be lower than on
floats
overdraft
Þ Repayment will be agreed in a
predetermined repayment schedule
(typically paid in one, three or six  Once a term loan has been repaid it
month plans): generally cannot be re-borrowed – cf RCF
 Amortisation – repaid in equal  Not particularly flexible and heavily
instalments at regular intervals regulated - set repayments may have to be
over term made (certain businesses may prefer to
 Balloon – repaid in increasingly reduce their payments in quieter trading
large instalments periods).
 Bullet – whole repaid on maturity  Restrictive— Whole amount has to be
date drawn down rather than what is actually
needed.

Revolving  Maximum aggregate amount of capital  Gives the B maximum flexibility.

credit available over a specified period. Offers the B can draw as much or as little as it
facility flexibility of overdraft and certainty of term requires at any time and, if cash flow is
sufficient, it can repay outstanding tranches
loan
that are no longer required – without
Þ Similarity to Term loan: committed repayment costs.
facility that provides for a specified  Further drawdown – each tranche is
maximum amount of capital that may be
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 borrowed over an agreed period. normally available for a short period of
Þ Similarity to Overdraft: borrower may time. However, if the borrower has not
draw down and repay tranches up to defaulted it can be immediately withdraw
the specified max amount of capital in the proceeding interest period.
whenever it chooses throughout the  Can save money by not drawing down the
term of the loan. whole loan at once and repaying tranches
that are no longer required to keep interest
SO, GREATER FLEXIBILITY. payments to a minimum
 Can raise much larger amounts of cash
Þ However, in exchange for such a flexible Although it shares some of the
facility the bank will want a characteristics of an overdraft it tends to be
COMMITMENT FEE. Such a fee may much easier to raise large amounts of cash
seem like a disadvantage for the with a RCF.
borrower, but it is relatively cheap  Ancillary facilities Some RCFs allow the
compared to the potential interest borrower to utilise part of the commitment
payments one might incur if one were to as a bilateral loan with one of the syndicate
overestimate the amount they needed banks.
to borrow from a bond issue.
 More restrictions imposed upon facility
Þ Further funds can be drawn down at any than typical overdraft (e.g. min notice
time, with interest periods running in period before a sum can be advanced)
parallel.  Because commitment period is so long –
Þ May be subject to restrictions in commitment fee is higher. The extent of
agreement I.e. limits on amount of each money saved by not making the drawdown
advance and number of advances is reduced by the fact that the bank will
Þ Clean down provision (i.e. each month): charge a commitment fee.
ensures that used for working capital  Clean down This may be included to ensure
rather than for long term capital that the RCF is being used for working
expenditure. capital rather than long term capital
Þ Revolving facilities tend to be used if a expenditure.
borrower requires a substantial
advance rather than a temporary and
relatively small cash injection to solve
short-term cash flow problems.

Types of Loan Facilities (bilateral and syndicated)

Bilateral Loan
Overview
 Finance from SINGLE SOURCE.
 Two parties: lender and borrower. (N.b. generally 2 parties but there can be more
than one borrower)
 Small term loans and overdraft facilities are usually bilateral.

 The main advantage of a bilateral Loan is that it is a PRIVATE TRANSACTION BETWEEN 2

PARTIES. It also offers a lot of confidentiality and is also CHEAPER to arrange.
 The main disadvantage is that it ONLY ALLOWS FOR BORROWING ON A SMALL SCALE
and is not suitable if a corporate borrower needs a lot of money.

The LARGER THE SUM TO BE ADVANCED, THE MORE RISK it carries for an individual bank

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 so, when large sums of money are being lent, banks often group together thereby reducing their individual
exposure to risk of the borrower being unable to pay.

Syndicated Loan
Overview A syndicated Loan means that the borrower is BORROWING MONEY FROM A GROUP OF
BANKS and/or Institutional investors:

 Each lender provides a PROPORTION of the loan on a SEVERAL BASIS (each lender is
ONLY liable for its individual obligation). Note it is not done on a ‘joint and several basis’.
Hence, if one lender drops out of syndicate, other lenders under NO obligation to
increase their shares of the loan to cover the lost amount.
 All lenders in the syndicate LEND ON THE SAME T&CS and the lenders deal with the
borrower as a group, via an agent rather than on a one-to-one basis.
 TRANSFERABLE COMMITMENT – The lenders can transfer their commitment to lend to
another lender thereby leaving the syndicate and being replaced (secondary syndication).
(i.e. novation)
 The ARRANGER is the bank responsible for advising the borrower as to the type of facility
it requires, finding other banks to form the initial syndicate (primary syndication) and
negotiating the broad terms of the loan
 The AGENT deals with the loan on a day to day basis. Point of contact between the
borrower and the other members of the syndicate. The agent will be responsible for
collecting all payments due from the borrower under the facility agreement and
forwarding each bank’s share to it. N.B. agent for the banks not borrower
 There is also generally a SECURITY TRUSTEE who holds the security for the lenders – This
reduces the administrative obstacles if a lender wants to leave / join the syndicate
Big advantage for Þ Syndicated loans are a common source of acquisition finance for large deals as lending
the bank through a syndicate REDUCES THE RISK TO EACH INDIVIDUAL LENDER.
Þ NB: Syndicated lenders TEND TO CHARGE LESS INTEREST than bilateral lenders – this is
because the more lenders there are to a borrower, the smaller the risk to each individual
lender, and the less the lender can justify charging.

Bank’s position ADVANTAGES DISADVANTAGES

 A syndicate is a way around Regulatory  Will not be able to charge as high
limits which provide that a Bank: interest rate as it would under a
o cannot lend more than 25% of large bilateral agreement, but less risk so
exposure capital base to a single makes sense!
source- i.e. REGULATORY CAPITAL
REQUIREMENTS
o requires notification to the banks
regulator of exposures of 10%+
 A bank may be prevented from lending all
the money by its own IN-HOUSE investment
criteria
 Limit exposure to certain areas

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  Provides a platform to form new
relationships with the borrower but also with
the other banks
 Taking the lead role in such an agreement
brings a lot of prestige to the bank

Borrower’s ADVANTAGES DISADVANTAGES

position  Can borrow LARGE SUMS OF MONEY that a  The lenders have CONSIDERABLE
single bank may not be able to offer CONTROL over the borrower
 Enjoys the CONFIDENTIALITY of a loan  Agreement often on very STRICT
agreement (as opposed to issuing bonds) TERMS
 Enjoys the FLEXIBILITY of a loan agreement  INTEREST RATES LIKELY TO BE
HIGHER than on a bond issue
 More FLEXIBLE TERMS  Will require VERY STRICT
COVENANTS
 TIMING – allows for short term borrowing  Will require CONVINCING SECURITY

Other Short Term Lending

Standby facility - Borrower does not intend using under normal circumstances but may need to utilise if
other uncommitted funding is unexpectedly unavailable
Bankers’ - A written acknowledgement by one party that is owes the second money at a further
acceptance date, which the bank has agreed to be responsible for paying when it falls due
Swing-line facility - Made available to a compnay which has a commercial paper program
- A short term (between 1 day  1 year) uncommitted debt security ‘IOU’ issued by a Co
to investors

Potential Areas of Concern for Banks Lending to Borrowers

A bank normally faces 2 key questions:

1. Are there any factors which might affect B’S ABILITY TO REPAY the facilities, together with interest? Will they
pay on time? (TIME = RISK)
2. How can the bank PROTECT ITSELF in case something goes wrong?

 Bank’s PRINCIPAL CONCERNS:

 Get Principal back on time
 Receive interest (so transaction makes a profit)
 Fees paid

Question Structure:

1. Identify the risk

2. Explain why the risk would be of concern to the bank
3. Further information that banks will need/how can bank limit exposure to the risk

Factors Affecting the Borrower’s Ability to Pay (look at facts carefully)

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Nature of the The Due Diligence NEEDS TO ESTABLISH:
company
 STRUCTURE OF THE COMPANY (group structure or individual company)
Þ Does it have subsidiaries?
Þ How many companies are in the group and in what relation are they to one
another?
 LEGAL STATUS
Þ ltd, plc, llp, lp
 What REGULATIONS is it affected by?
Þ Is it listed? (LR, Prospectus Regulation, DTR, CCoG)
 VALUE of the company
Þ Value of its assets
Þ Goodwill
 What is the NATURE OF ITS BUSINESS?
Þ Retail, Manufacturing, Services
 What is the BUSINESS’ POSITION in the market?
Þ newcomer, established
 What is the BUSINESS’ STRATEGY?
Þ organic growth, rapid expansion, maintenance of position
 What is its BUSINESS PLAN?
Þ Marketing strategies
 What is the NATURE OF THE MARKET?
Þ Competitive or consolidated
Þ How much competition is there? Will an acquisition cause problems with
competition authorities?
Þ Barriers to entry
 Who are the DIRECTORS and KEY EMPLOYEES?
Þ Are any of them planning on leaving the company?
 Who are the SHAREHOLDERS?

 What is the FINANCIAL SITUATION of the borrower like?

Prospects
Þ Does it have any debts and if so, what is the extent of these?
Þ E.g. pension scheme deficit
 What is the MARKET like?
 What are the prospects of the COMPETITION?
 BUSINESS PLAN / STRATEGIES
Þ Are they sustainable and profitable?
 EXPANSION plans
 Possible TAKEOVER?
 New CONTRACTS?
 New MANAGEMENT?

Risks  Nature of the market?

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  Cash flow problems?
 Internal management problems?
 Possible takeover from another co.?
 Market volatility? e.g. fluctuation in price of raw materials
 Outsourcing risks?
 High existing debt?
 Price fluctuations in goods bought/sold?
 Customer base?
Þ Any information on customer loyalty etc?
 Bad debts or difficulties collecting debts?
 Impending litigation?
 Valuation of property and stock?
Þ E.g. how is stock valued
Þ How are leases valued (asset or liability)
 Risk of disruption (e.g. disagreement on the board level?)
 Cost of contracts (e.g. sale and leaseback)?
o Any option to re-negotiate?
 Is there any insurance in place to mitigate any operational risks?

Commercial  HOW MUCH does the B want to borrow?

considerations  What are current interest rates?
 WHEN does the B want to REPAY the capital?
 How fast does the B want the money?
 how much FLEXIBILITY does B want to retain over its assets?
 how does the B want to structure repayment*?
Þ *TYPICAL REPAYMENT SCHEMES for a term facility include:
 Amortisation – principal is repaid in instalments over the term of the facility
 Balloon – principal is repaid in increasingly large instalments
 Bullet – where the whole of the principal is repaid on the maturity date.
 INSOLVENCY RISKS
Þ What are the CHANCES of the B becoming insolvent during the term of the
facility?
Þ Where does the bank stand in relation to B’s OTHER CREDITORS? Do they have
security? Are there NEGATIVE PLEDGE clauses?

Important factors:
 credit ratings – may be a good indicator of reliability of the borrower
 value of assets
 any guarantees to be given
 general market situation
 any disputes
 outsourcing
 changes to composition of business strategy
 Bank might have to limit exposure to:
- Certain sector

15
 - Each client
- Types of business

 Bank internal policy might preclude one very large loan to the specific client = if
syndicate then can get income, share risk and limit exposure i.e. still involved in the deal
but rather than loaning X they are loaning a %age of X that suits their policy/needs etc.
 Regulatory restrictions possibly
 Can the company give further security?
 Preserve relationship with the borrower e.g. if cannot loan the full amount must try to
syndicate to avoid borrower looking elsewhere
 Control:
Þ restrict changes/transferability in shareholders in private companies - don’t want
dividend going out of the group
Þ appoint director on behalf of bank

ASK TO SEE:
Further info
required  Articles of associations of the group– to check whether there are restrictions on
how much can be borrowed
 Accounts – to check the financial stability of the B/ B’s group: how solvent, profitable
o Ask for all sort of accounts: management accounts, group accounts, interim
accounts etc.
 Terms of any other loans B currently has - priority
 Cash flow forecasts
 Gearing (relationship: equity/debt)
 Title docs – to check ownership of property
 Charges over group assets – what has already been granted? Bank may want to
insert a negative pledge clause to prevent later chargers taking priority over the
same assets

Detailed info of B and its assets to be revealed by relevant SEARCHES e.g. impending
litigation/disputes, environmental issues, new business plans etc...
- What charges already been granted - want a negative pledge clause
- Credit rating of borrower
- Rent review clauses on leases
- Personal guarantee on personal assets
- Breakdown of profits
- Review all recent accounts/ cash flow forecasts/ contracts/ asset valuation
- Relationships between personnel
- Foreign law advice
- Financial due diligence- how much debt is company in?
- Company search against all companies- memos and arts- within power to borrow?

IMPORTANT: HOW EXPOSED IS BANK ALREADY IN THIS MARKET?

– IF ALREADY EXPOSED MAY NOT WANT TO GET INVOLVED MAKING LOANS TO ANOTHER
COMPANY IN THIS SECTOR

Protection Methods the Bank can use to Limit Exposure to Risk

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 Structural  Lender must think about where the debt is going to go. When a subordinated company
Subordination goes bust, the creditors of those companies will be paid out before any money goes up to
a parent company.
 Therefore, a bank who has lent to a parent company is structurally subordinated to those
who have lent to the subsidiaries as the creditors will be paid before the parent company
(shareholder) and therefore in a more precarious position?
o THEREFORE, WOULD WANT TO GET THE DEBT DIRECTLY INTO THE COMPANY
THAT NEEDS IT
 If lending is structurally subordinate, need to ensure a robust security package is in place so
in the event of liquidation, you have security to meet the debt you lent to the companies

Comfort letter  Any non-contractual support ranging from: parent co acknowledging that subsidiary is
undertaking its obligations, to statement of intention to maintain an interest in, and
support for, a subsidiary, and to ensure it is capable of fulfilling those objectives.
Þ If lending to Subsidiary Company of a large group, obtaining comfort letter from the
Parent is advisable (only necessary in cases where the parent is not acting as
guarantor).
 Important: NOT intended to be legally binding (ensure careful drafting to avoid promises)
BUT creates very bad PR etc if don’t adhere to statements in letter.
 Not that common anymore

Available  Must make sure it does not hinder the borrower from carrying on business and making a
security profit but at the same time you want as much security as you can possibly have.
 Is security possible?
Þ What assets does B have that could be used for security? Are these assets already
charged? Do they contain negative pledge clauses?
 What security is most appropriate?
Þ Fixed charge over borrower’s land, buildings and machinery. Means that borrower
cannot deal with the asset, e.g. cannot sell it, w/o bank’s consent
Þ Floating charge over stock, goodwill, IP, big contracts – with a negative pledge
(prohibits borrower from creating later charges with priority to floating charge)
 N.B. must try and secure assets up to the amount being borrowed

Guarantees  THIRD PARTY

 PERSONAL GUARANTEES FROM DIRECTORS OR SHAREHOLDERS
o Not usual unless they are high net worth individuals
 Are there other companies in the GROUP you could get a guarantee from? (usually FROM
ALL OTHER CO’S IN GROUP – intra-company guarantees)
 Parent
 Subsidiary
o Be careful: if there are already existing loans the guarantees may be hooked to those
already. You will need to discharge the existing loan + guarantee so you can ensure you
are first entitled to the assets.
o Remember: Guarantees are needed because the bank is unable to pierce the corporate
veil – parent companies are essentially SHs and therefore different legal entities. Bank
cannot simply enforce against the parent company
o NB: if takeover, material changes in business or entity, may discharge the guarantee.
o Careful: giving a guarantee is financial assistance (unlawful for plcs if linked with takeover)
and may amount to a preference or transaction at an undervalue in the event of

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 insolvency.

Increased  The Lender can balance its exposure by CHARGING GREATER INTEREST. The greater the risk
profit margin the bank is exposed to, the more interest it will charge.

Term duration  The longer the loan, the greater the lender’s exposure. Lender can therefore limit its
exposure by reducing the length of the term

Change of  Need change of control clause which will say if there is a change of control, the bank has
control the right to ask for their money back – this is a mandatory pre-payment event.
 If control changes, bank wants to consider whether it still wants to lend if it is now run by
someone else and effectively a completely different company?

Other ways to  Amount lent

deal with risk  Due diligence
 Financial covenants
 Information covenants
 Undertakings
 Events of default (Representations and Warranties = acceleration)
 Derivatives (Credit Default Swaps, Total Return Swaps)
 Type of loan (amortisation – to get some money back from the start. Bullet loan with a
shorter loan period – to raise likelihood of getting all the money back)

Key Provisions in Facility Agreement

 Type of facility (could be a combination)

 Amount of loan + margin
 Repayment method and schedule
Þ If the borrower has a lot of expenses at the beginning of the loan, they will not want to use the
amortisation method. Instead balloon repayment would be ideal. The bullet repayment method could be
problematic as it could cause cash flow problems when the repayment is due (because it will be due as a
single instalment)
 Securities and guarantees
Þ Floating charge over assets of borrower or assets of other companies in the group (debts, property, IP
rights, stock etc)
Þ If borrower is making an acquisition, will take a floating charge over the target’s assets also
Þ If borrower is part of a group, parent company will need to guarantee the loan
Þ Directors may be asked to give personal guarantee
 Change of control clause
Þ The bank only want to rely on existing management of the borrower • Bank may want to insert a change
of control clause so that if the borrower is taken over, the change of control will constitute an event of
default and the loan will become repayable

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 General undertakings
 Negative pledge clause
 Information covenants
 Financial covenants
 Personal guarantees

How Banks Fund Themselves and How Interest is Calculated

How Banks Fund Themselves

How?

 Generally, banks fund themselves from their deposit base HOWEVER

 Banks cannot fund large commercial loans or loans in non-domestic currencies from deposits alone so must
borrow from other banks in the London Interbank Market (“interbank funding”)
Þ Banks borrow from each other at LIBOR rate (London Interbank Offered Rate) (SEE MORE BELOW)
Þ There may be a different LIBOR for each bank because a bank’s LIBOR will depend on...
 Its credit rating
 Currency/length of the loan
 Liquidity in the interbank market (cost to lending bank of borrowing the money it’s prepared to lend)
 LIBOR rates fluctuate throughout the day, so if interest rate on a loan is pegged to LIBOR, should
specify date and time at which rate is to be taken (usually 11am)

“MATCHED FUNDING” Banks lending money that they have themselves borrowed interbank market (SEE MORE
BELOW)

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  Used when banks borrow from other banks in order to make large loans or foreign currency loans (i.e. in
situations where the bank can’t loan using just its deposits)

 The process/duration of matching a loan (asset) with a deposit (liability) of the same maturity

Þ Bank A lends to borrower

Þ To fund this Bank A borrows from Bank B
Þ Object is that the borrower repays Bank A at the same time/before and at least the same amount
(pref more) of interest as Bank A repays Bank B-Interbank funding normally operates as ‘matched
funding’

What is LIBOR?

 LIBOR is an interest rate benchmark that was developed to facilitate syndicated loan transactions and

increase pricing transparency.
 It is intended to reflect the average rate at which major banks can obtain unsecured funding in the London
interbank market in a specified currency and particular period i.e. the inter-bank exchange rate
 LIBOR rate is calculated depending on that bank’s credit rating, currency and length of borrowing
 ICE Benchmark Administration Limited (IBA) is the administrator of LIBOR.
 ICE LIBOR – screen rate - average rate for borrowing on the inter-bank market that day
 ICE LIBOR is produced and published for five currencies (US dollars, pounds sterling, euros, Japanese yen and
Swiss francs) with seven maturities quoted for each, ranging from overnight to 12 months.
 ICE LIBOR is used as a point of reference for calculating the interest rate in a syndicated facility

Why use LIBOR?

 In a syndicated loan, each lender is likely to have a slightly different borrowing cost, depending on factors
such as its credit rating so better to use ICE LIBOR
 Using LIBOR ensures that a borrower is not exposed to changes in a lender's financial health that would
cause it to have a higher funding cost than other lenders in the same market.

Calculating ICE LIBOR

 To determine an ICE LIBOR rate, the relevant panel banks (usually 11 to 16 banks; generic panel of banks not
specific to the syndicated loan) are asked to indicate the rate at which they could borrow funds in each of
the maturities in that currency, were they to do so by asking for and then accepting interbank offers in a
reasonable market size just before 11am (this is the LIBOR submission question). Each panel bank may then
use its own methodology to respond to the question with a LIBOR submission.
 IBA then calculates each rate using a trimmed arithmetic mean. The rates are published at 11.55 am London
time on each London business day (subject to certain holidays for specific currencies and tenors).
 Calculated by asking a panel of banks each to submit information. The highest and lowest 25% of submissions
are excluded and the remainder arithmetically averaged to create ICE LIBOR rate.

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 Issues with ICE LIBOR

 Advantages of LIBOR
o Forward-looking interest rate so borrower knows how much interest will be payable for that interest
rate when the period starts
o Includes an element of term risk – takes into account that loan will be outstanding for a period of 3 or
6 months rather than just overnight
 Disadvantages of LIBOR
o Not enough underlying transactions to base the rate on
 There was a huge number of illegible transactions and this led to a lot of rigging etc. SONIA
seeks to address this.

 Following 31/12/2021 – no longer compulsory for panel banks of currently provide their information to ICE to
do so

 Most facility agreements will contain fallback wording to enable interest to be calculated if there is no
published LIBOR rate, but this is not a long-term solution

 Facility agreements based on a Loan Market Association recommended form and documented since October
2018 are likely to contain a mechanism to make it easier to move to an alternative rate, but these clauses do
not set out what the replacement rate will be.

SONIA

 SONIA – Sterling Overnight Index Average

 Published at 9am for previous London business day
 SONIA looking like the frontrunner for the replacement of LIBOR for sterling loans and it is now being built
into agreements as a replacement
 Advantages of SONIA

o SONIA is a backward-looking interest rate - looks at actual transactions so less chance of rigging

 Disadvantages of SONIA

o Because it is backwards looking, borrower has less certainty over longer, future term

o Does not take into account term risk

Matched Funding

 Funds required to be made available by a bank to a borrower are MATCHED by funds borrowed by that bank
in the interbank market i.e. bank’s lending money that they have themselves borrowed on the interbank
market.
 Banks usually borrow from the interbank market.
 Bank will be borrowing for a term, typically short (e.g. 1, 3 or 6 months) and never longer than a year

21
  Bank will borrow same amount of money in same currency for same amount of time.
 Then in say 6 months’ time, the interbank loan must be repaid, therefore the bank will take a second
interbank loan to repay the first. They have to keep refinancing (i.e. keep borrowing and repaying) that
interbank loan in the interbank market until the borrower who the bank originally lent money to has
paid the money bank
 The interest rate payable on the first interbank loan (LIBOR) is recovered from the borrower and the
process is repeated through a succession of these ‘interest periods’ until borrower who the bank
originally lent money to has paid the money bank
o Therefore, every time the bank is refinancing, they may be paying a different interest rate on
this and therefore interest period is the period for which these banks are in theory going out
into the interbank market and borrowing money.
o So, have a series of very short term fixed rate loans – overall a floating rate
o Rates may fluctuate from one interest period to the next, but once fixed at the start of an
interest period (e.g. 3 or 6 months), it will remain fixed throughout that interest period
 N.B. loan facilities will not actually require banks to fund through matched funding, matched funding is
just an assumption
o The assumption drives numerous provisions in the facility including interest periods, repetition
of representations, repayment, prepayment and break costs
 Facility agreement allows the borrower to choose the interest periods (gives them some scope to control
the rate of interest e.g. if interest rates are fallings, borrower would choose shorter interest periods)
 Screen rate (ICE LIBOR) varies depending on the interest period selected.
 LIBOR is shown as an annual rate and therefore we have to use the DAY COUNT fraction to work out how
many days there are and therefore how much interest is due.
 Effectively dividing up a floating rate loan into a series of fixed rate loans.

Calculating Interest (common MCQ)

Calculating  Interest is calculated (on a floating rate loan, which is standard) with reference to:
interest by  A Benchmark Rate (LIBOR) (the only varying part of the interest rate)
reference to  Banks’ Profit Margin (represents bank’s profit and covering regulatory capital costs;
LIBOR
usually agreed at term sheet stage and set for the duration of the loan agreement)
 Mandatory Cost Rate IF ANY (costs of borrowing incurred in making loan available)
 No longer explicitly takes into account Mandatory Cost Rate (rare) as a separate
component (cost generally absorbed into an increased margin (above)) so it still
gets passed on to the borrower

Interest Rate = LIBOR + Bank’s Profit Margin

22
 Þ LIBOR is used because for a large commercial loan the bank has more than likely used
matched funding to raise the loan monies itself (borrowed it from another bank at the
LIBOR rate, which fluctuates)
Þ The margin element represents the bank’s gross profit on the loan. It is agreed at the
term sheet stage and is usually set for the duration of the loan agreement.
Þ Interest periods are used to calculate the amount of interest payable, and are usually of
one, three or six months' duration

Calculating  Each bank in syndicate will have a slightly different LIBOR rate
SYNDICATE  A ‘SCREEN RATE’ (read off a screen, which is an AVERAGE) is used over the whole syndicate or
interest by way of reference to a few ‘representative’ banks (who are not necessarily participants)
Þ ICE LIBOR RATE – a screen rate which is an average of LIBOR
 This is a rate published by ICE at 11am every morning.
 Take an average rate based on info submitted to them by a panel of banks.
 Therefore, this rate is tied to panel banks rather than the individual banks’
lending/borrowing.
 Screen rate varies depending on the interest period selected.
 If the screen rate is not available, the fall-back is to rely on a small group of ‘reference banks’
from the syndicate providing their own LIBOR rates, which are averaged, or the market
disruption clause if not

Calculating  Interest payable at end of interest period – (interest rate is annual)

interest  Interest rates will be recalculated at the start of each interest period (periods can be
periods chosen by borrower) so in effect a floating rate loan functions as a series of fixed rates
 In some cases, borrower can select the interest period (1, 3 or 6 months)
 If borrower thought the rates were going up, advise to lock in for longer time at this
smaller rate before it increases
 So, LIBOR is a floating rate – but throughout the life of the loan there are various points
where the rate is fixed by the LIBOR rate from the day starting that period.

 Day Count Fraction - Interest Payable for Period (i.e. precisely how much borrower needs
to pay in terms of interest)
 Work out interest payable over the whole year (above)
 Calculate the amount of days in interest period and divide by number of days in year (day
count fraction)
 Multiply both together
 Multiple this by the unpaid loan (the Principal Amount less all amounts the lender has
allocated from the borrower’s repayments towards the repayment of the Principal
Amount

Interest Rate (above) x Day Count Fraction* x Outstanding Principal

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 *Day Count Fraction = Actual/365 (even if leap year)

 Repayments are required to coincide with end of interest period (when the bank will
theoretically be repaying its interbank loan)
 If the borrower prepays mid interest period, it will be charged ‘break costs’ (difference
between total interest bank would have received less the interest it can raise by lending
the prepaid amount in the interbank market)
o This is because the banks will match the interest periods and repayment dates on
any interbank borrowing required for them to fund the term facility under the
Facilities Agreement and early payment can disrupt this

Reduction in Rates

 Reduction in market interest rates will not lead to a reduction in interest immediately
(though it would be expected that LIBOR will go down and the amount of floating interest
rate will decrease long-term), because the interest period must expire before the
interest is recalculated (not an immediate effect)
 When interest rates change nationally, the bank cannot simply pass the effects on to the
borrower because it is part of the syndicated facility

How can Borrowers Keep Interest Payments Manageable?

Floating rate can be a serious liability for businesses and make it difficult to plan to meet liability.
Often a condition precedent to a drawdown that borrower enter into swap with a syndicate bank. This is because it is
in the lender’s interest to ensure that borrower can handle the risk.

Ratchet Margin decreases as borrower’s financial performance improves because risk of

default decreases

Interest Cap (hedging Borrower pays a premium to counterparty to offset the risk of interest rates rising
arrangement) beyond an agreed upper limit e.g. 10%. If rates rise beyond upper limit, counterparty
will pay borrower difference between the rate and the upper limit. (Note may also
require floor – so borrower will never pay below certain rate).

Interest Rate Swap Borrower could enter derivative i.e. agreement with third party that it will exchange
(hedging) its floating interest rate liability for the fixed interest rate liability of another party.

24
 This gives borrower certainty and helps with long term planning – know how much
interest will be because it is fixed. Will have to pay for benefit of fixed rate but usually
worth paying for the certainty.

Interest periods More sophisticated agreements will divide the life of each tranche into successive
‘interest periods’ of varying duration – see p.45 for functions of the interest period.
N/b borrower may elect length of the next interest period throughout life of the loan.

Fixed rate interest Is possible but will come at a cost – bank will charge much higher than current
floating rate to compensate it for taking risk of rate increases. Borrower looking for
medium or long term funds at fixed rate better advised to use cap markets or ‘hedge’
their floating rate

Don’t default Will charge default interest if borrower defaults on any obligations under the
agreement – above calculation plus a default interest rate (around 1%) – must be
justifiable as reasonable compensation for the bank having to deal with loan in default
(otherwise would be a penalty clause). Usually justified due to increased risk of
lending to borrower

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 2 - Syndicated Facilities Agreements and Term Sheets
Analysing Credit Risk

 Once a contract has been made with a potential borrower, the parties cannot continue without first obtaining
approval. Before approval is given, the bank will want to make sure that the borrower is CREDITWORTHY and
NOT LIKLEY TO DEFAULT on payment (sound commercial investment).
Þ Therefore, the bank will need to assess the credit risk of the borrower through due diligence.

Credit Risk

 The risk that the borrower cannot make payment obligations under the credit agreement .
 This must be assessed and mitigated. This can be done via ADJUSTING the facility agreement by:
 margin/price
 financial covenants
 security
 repayment provisions
 a one-year loan is more likely to be paid back than a 30-year loan
 higher risk that the prevailing conditions and company situation will change in a longer loan
 tightening of the events of default
 requiring more information from borrower at earlier stage
EFFECT
 If the credit risk is SMALL then many banks will be prepared to lend and therefore fees and margin
(profits) that can be charged will be driven down by the competition.
 If the credit risk is HIGH then there is a high chance of default and therefore fees and margin
demanded by the banks will be higher to compensate for the risk

Due Diligence

Dependent on two key sets of investigations

Initial Investigations (financial due diligence)

STAGE 1:  Each borrower assigned an accounts officer within bank who provides consistent
Accounts officer pool of contact for the borrower’s officers
Þ Accounts officer builds relationship with borrower’s officers
Þ Accounts officer will put together basic package of terms for the proposed
loan, e.g.
 Amount and term of loan
 Repayment dates
 Principal financial covenants
Þ Will be based largely on accounts officer’s knowledge

STAGE 2:  Accounts officer then undertakes credit analysis of borrower

Credit analysis Þ He usually does own assessment with aid of credit assessment manual
providing checklists for points covered.
 Manual: includes policy guidelines peculiar to the bank, e.g. mandatory inclusion

26
 of material adverse change, or cross default clause
 Sources of info for credit analysis: (depends on borrower and proposed deal)
Þ Borrower’s most recently published accounts
Þ Current information such as interim accounts (since for private companies,
they have 9 months from when their financial year ends to publish their
accounts; for public companies, 6 months; listed, 4 months).
 Confidentiality: if borrower provides sensitive info, the bank will be asked to keep
this confidential from third parties (via confidentiality letter)
 Effect: The better the credit rating the borrower has, the less risk

STAGE 3:  Once credit analysis completed, it will be sent to the credit department for
Credit clearance sanctioning by more senior officer of the bank
Þ Credit department (or credit committee) will see all credit requests and so
will have overview of overall lending
Þ They check
 Internal limits and policies and
 External restraints (e.g. for exposure) will not be breached
Þ May defer analysis to an industry department (with industry expertise) or
Area Credit Officer (with geographical expertise) to obtain more specialised
view of borrower in context of contemporary business
Þ Decisions that could be made by credit department
 Reject proposal
 Approve loan on the basis of the analysis or
 Make approval subject to revised terms being agreed (e.g. smaller
loan, stricter undertakings, or shorter term)

STAGE 4:  Once clearance has been given, accounts officer will draft term sheet.
Draft term sheet Þ May involve solicitor at this stage if deal is particularly complex to help
construct term sheet

 If BORROWER AGREES with draft term sheet, then SECOND PHASE of due
diligence begins.

Subsequent Investigation (legal due diligence)

Key tasks  Ensure no restrictions on company’s ability to borrow/grant security/give

guarantee/director’s authority to agree contracts w/o shareholder approval
 Put together an initial draft facility agreement on the basis of the term sheet

Possible searches and  COMPANY SEARCH (obtaining memorandum and articles) – to check:
investigations Þ factual info - name and number of company
Þ corporate capacity of company – any restrictions in articles?
Þ borrower in compliance with objects
Þ who are the shareholders and directors?
Þ most up to date copies of constitutional documents filed

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 Þ directors duly appointed
Þ do the directors have the power to do what they have done?
Þ no court order for schemes of arrangement
Þ no administrator appointed
Þ not in process of winding up
Þ not granted security over assets - if so, what?
Þ issues with company registry - borrower might not have filed its returns
correctly? this might result in a fine but there is no provision for
compensating a third party who suffers loss
Þ financial info – accounts (although won’t be particularly up to date)
 WINDING UP SEARCH
 BANKRUPTCY SEARCH
 Investigate any OTHER COMPANIES
 Property searches at LAND REGISTRY/LAND CHARGES REGISTRY
 Most RECENT ACCOUNTS
 Information from BORROWER HIMSELF

Ongoing information A bank must monitor the borrower to ensure it has a reasonable chance of getting
its loan repaid.

Analysing Searches

Companies Search

- N.B. Make sure to do Companies search on ALL the relevant companies

- N.B. Companies searches are only accurate as at the date and time they are undertaken. They should be
done early on in the transaction, but the searches will be updated at the eleventh hour prior to completion

Documents to be Details to be checked Why are details checked/

checked

Certificate of Company number  Number never changes

Incorporation  Always quote company number in any
document that a company is a party to

Date of incorporation

 Different rules for CA 06 vs CA 85

Act it is incorporated under.

Register of members Shareholders’ details

Register of directors Directors’ details  Directors will need to have a quorate

28
 meeting to approve entry into finance docs
 Likely to be the individuals authorised to sign

Register of Company secretary

secretaries

Company constitution Power of directors: Power of directors:

Articles of  Check Ds’ authority to enter into  Bank is concerned that the transaction
Association transactions to borrow. Are would be void against the company if D
there any limits to their power they were dealing with lacked authority
to borrow? to borrow (or borrow that amount).
 Check the Article relating to  s39(1) CA 06: an act done by a company
Solution to restriction D’s general authority (Art 5 will not be void even if there is a
in articles = change in the Prep Task gave Ds restriction in the co.’s constitution (n.b.
articles or make sure unrestricted power) doesn’t cover things that aren’t in the
condition in article  If a MA company, see MA3 constitution)
e.g. need ordinary (which says they DO have  s40(1) CA 06: the power of the Ds to
resolution of SHs, is authority and there are no bind the co. is deemed to be free of any
met. limits on their power to limitation so long as the person the D is
borrow) dealing with acts in good faith.
 If the bank knows of the limit in the co.’s
AoA it could be argued that the bank is
dealing in bad faith (although this is
difficult to prove).
 Although the bank is likely to be
protected by ss39 and 40, the lenders
will not want to rely on them - bad for
their reputation and SHs could take
proceedings against Ds for breaching
objects (lender not want to lend where
there is litigation between SHs and Ds)
 Therefore, the bank must check that the
Ds have the proper authority to enter
into the transaction

 Check that Ds have power to  Bank will be concerned because if the

grant security decision to grant security was made by
 Check Art relating to D’s someone without authority, this security
general authority (Art 5 in will be invalid.
the Prep Task)  The lender will not be able to demand the
 If a MA co – MA3 (DO have security.
authority & there are no
limits on their power to
borrow)

 Do Ds have power to prevent  If the banks are taking security over shares
registration of shares on their (check facts) they will want to be confident
transfer? (If a MA co. MA 26(5) – that there will be no problem with the
they will have the power to transfer of shares to them if and when they
refuse the registration of shares come to enforce the security.
when they have been
29
 transferred)  In prep task, if can refuse to register can
affect the ability to realise their security
over shares. Would deal with this with a CP.

 Decisions made properly  This is linked to ensuring Ds have authority

 Check that the decision- to borrow £ on behalf of the co. – any failing
making process was properly in the process could invalidate co.’s decision
complied with e.g. to grant D authority to borrow.
quorum/voting
 Get copy of board minutes
and then compare this with
the Articles to see if the
board meeting complied with
procedural requirements.
Quorum for BM is at least 2
(art. 13.2 of prep task)
 Make production of board
minutes condition precedent
so cannot borrow until they
produce minutes to prove
decision duly made to grant
authority to director

Capacity of company to: Capacity of co.

 Borrow (co. is borrowing)  Bank is concerned that the transaction

 Carry out business of the sort would be void against the co. if D they were
(do they conflict with MAC dealing with lacked authority to borrow (or
clause?) to borrow the amount he did)
 Sell/acquire land  s39(1) CA 06: an act done by a co. will not be
 Grant guarantees (is bank looking void even if there is a restriction in the co.’s
for guarantees from all the constitution
companies)  s40(1) CA 06: the power of the Ds to bind
 Any restrictions on any of these? the co. is deemed to be free of any limitation
so long as the person the D is dealing with
acts in good faith
 However, for reasons above, lenders would
not want to rely on either of these provisions

NB: Ds will remain liable to company for acting

outside its objects

Check the objects clause  If there is one it will bind the company by
Memorandum of virtue of s28 CA 06 (which states that the
association  If it’s a pre-1 Oct ’09 company, memorandum forms part of the articles).
the objects clause will be in the
memorandum of association. N.B. if no memorandum, under s31(1) CA 2006,
company’s objects are unrestricted unless
In prep task see footnotes on front company’s articles specifically restrict the
page of AoA (a SR was passed to objects.
remove restrictions on the objects of
the co.)

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 Does the borrower have pre-existing Pre-existing debt: concerned about this because
Mortgages debt, mortgages or charges?
(1) Particulars of harder for borrower to repay loan
 If so, how much for?
Mortgage or charge  Over what assets is this debt
charged/ mortgaged?
(Form 395 under 1985  Will the lender rank first or will Pre-existing charge: concerned because
Act and Form MG01 they need to enter into priority preexisting fixed charge would rank in priority
under 2006 Act) agreement? of later fixed charge, thus bank would be 2nd in
 Is there a Negative Pledge line to sell assets to satisfy debts on insolvency.
– to see if there is any clause?
 What borrowings were the If that is the case – will need to either
pre-existing charge security for?
 Is the client aware? • Get borrower to discharge mortgage

See on the facts if there is a pre- • Enter priority agreement with first lender so
(2) Statement of existing undischarged mortgage etc. we obtain priority (intercreditor agreement)

satisfaction in full or
in part of mortgage or
Prep task - there is an undischarged Negative pledge: Must require borrower to
charge (Form MG02) charge with negative pledge (the
– to see if mortgage 2007 one). This is partly to refinance discharge first loan in order to get rid of
has been discharged the big bank deal. When bank lends,
we need to ensure that the money is negative pledge. If left in place, the negative
used to pay off (discharge) the first
loan so that we are ranked in first pledge clause would give priority to the floating
priority and so that negative pledge charge on the first loan over our fixed charge
is terminated. The first loan is no for the current loan, thus rendering the bank’s
longer relevant once discharged. security ineffective.

Annual Return See how up to date this info is.

Date of last return
(AR 01)  Important things may have changed since
then.

In the case of the prep activity they have

(change of secretary etc.). Must therefore check
the forms for change of persons (terminations
& appointments)

Company number  Ensure that it corresponds to the borrower

Authorized share capital  Part of transaction is issue of additional

shares to a new shareholder
 This would not be applicable if it  Nothing of direct concern to the bank, but if
has been removed by ordinary this share issue is crucial for the transaction
resolution and issued share to proceed, banks would want to beware of
capital current authorised/ issued share capital and
31
 any issues that this gives rise to in relation to
the proposed issue of additional shares
 BUT mainly just check that their record
keeping and management is appropriate:
check that everything is done correctly

 This is of particular concern if there is going

Shares to be security granted over these shares.
 Provisions relating to transfer of shares –
things like pre-emption rights in the Articles.
Pre-emption rights on transfer would also
be a problem in relation to realisation of
security if this security is taken over the
shares.
 If bank wants to enforce security, may need
to use these transfer of shares provisions

 Important to check that they can do this so

Appointment of an attorney someone else can sign this if director is not
available to effect the deal.

 Will affect whether bank will lend or not

Whether the company is in
liquidation/administration

 Important to make sure it is valid if

Telephone meetings permitted telephone board meeting.

 Will show if decision is valid

Interested directors voting

TMO1 – termination/ Directors  Would be of concern because bank needs to

know who makes up the management with
appointment of  Old D removed (TM01). whom they liaise with in respect to the loan.
 If new D was being appointed –
director must check he is duly appointed
(MA 17 – by board or OR) –
require evidence of resolutions

TM 02 – termination Secretary  Want to ensure that Ds/secretaries have

of secretary been duly authorized – require evidence of
 Old secretary terminated (TM02) board and shareholder resolutions
AP03 - appointment - new one appointed (AP03). appointing officers
of secretary  Need to check that secretary has
been duly appointed

SUMMARY: Process of going through Companies Search

 Date: you would need to do the search again just before completion to see if there are any changes.
 Company number
 Authorized share capital: not applicable if it has been removed by ordinary resolution

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  Issued share capital: 1000 shares. Annual return – p. 9
 If limitation on power of directors: resolution might be required.
 Shares: why particular concern? Because there is going to be security granted over these shares.
Provisions relating to transfer of shares – things like pre-emption rights in the Articles. If bank wants
to enforce security, may need to use these transfer of shares provisions
 Secretary: looking at Annual return and updating change of secretary
 Directors: Annual return
 Date of last annual return: important because things may well have changed since then
 Mortgage and charges

Other Searches

Relevant searches Documents to be Details to be checked Why are details

against borrower checked checked/

Winding up search  Companies search is  Any evidence of  Bank will want to

always a little out of appointment of check that there are
date – may have receiver, no petitions for
lodged petition but it administrator/windin winding up against
has not gotten as far g up order the co. it is lending to
as Company Search
yet. Therefore, would
do this on the day of
closing (via telephone
call). Will give most up
to date information
on whether someone
has petitioned to wind
up the company.

Search against  Often just rely on  Check that borrower  Where there are
borrower’s principal Certificates of Title has good title to the potential problems
assets (i.e. property) at prepared by assets and that there which will reduce the
Land Registry borrower’s (and had been no adverse value of the assets of
sometimes seller’s) entries against it that the Borrower? Search
lawyers could reduce value of on premises they are
 Will be done within assets buying and on
about 5 days of premises they already
completion own
 N.B. Land Registry
search (OS1) has a 30
day priority period

 Contamination could
Environmental search  Check that there is no lower value of assets
contamination of land over which bank has
security

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  if there is
Inspection of key  All key contracts –  Check for any disputes dispute/litigation-
contracts with main suppliers / pending litigation could be costly, thus
and customers hamper company’s
ability to repay loan

Companies search on all  Need to check that  if all companies are

the companies of the there is nothing about giving guarantees and
group them that would security –would want
affect their ability to to ensure that they
give guarantees (e.g. are able to, e.g. of
restrictions in their good financial
constitutions, that standing, no
they have not gone restrictions on
into insolvent company to give such
liquidation or guarantees etc
administration) etc

Check that the Ds have  Search against names

not been disqualified as of Ds and prospective
directors Ds for evidence that
they have been
disqualified and for
evidence that a
disqualification order
has been made

The Term Sheet

What is a Term Sheet?

 Document which records in writing the principal terms of a transaction: e.g.

 purpose;
 type of facility;
 currency and amount;
 availability (and number of drawings);
 repayment/prepayment and cancellation provisions;
 margin;

34
  representations;
 undertakings and Events of Default;
 conditions precedent
 Signed by parties to the transaction
 NOT usually intended to be legally binding (but for confidentiality and costs/fees)
o But has a degree of moral force
 Used by lenders to obtain credit committee approval and by the arranger’s solicitors to
prepare the first draft of the credit agreement
 Usually attached as an Appendix to a short letter (commitment letter or mandate letter)
Þ Commitment Letter: contains legally binding terms required at outset of lending
process

Purpose of a Term Sheet

1. Clarity

 Focus minds of borrower and lender to fundamental issues. If even pricing/structure of loan
cannot be agreed, no point doing extensive due diligence
 If proposed facility syndicated, will be helpful for bank which is arranging loan to have accurate
summary of main terms when trying to sell the deal to early syndicate members before an
information memorandum has been produced.
 When markets flush with cash (so borrowing has become easy), borrowers would want to draft
own term sheets in attempt to dictate terms to prospective lenders

2. Summary If loan facility likely to be complicated – acts as helpful summary of main provisions for
parties and advisors. Good for these reasons:

 Allows solicitor to be able to give a rough estimate of the likely fees for a large transaction
 Gives Bank’s Solicitor a guide to drafting definitive facility agreement.

What to Include in a Term Sheet

1. What it should not cover

 Not a facility agreement

 Not a first attempt at drafting
 e.g. term sheet might specify the type of undertakings that are to appear in final
agreement, but it will not include draft clause 
 Aim is brevity
 e.g. guarantees will be given by ‘material subsidiaries’
 Do not define now, they will be subject to careful negotiations subsequently. 

2. ‘Inclusive lists’

 When lists are involved – danger that parties later claim that these lists were exhaustive, 
 So, language used should be ‘including, but not limited to…’ 
3. Only specify unusual provisions

35
  Common to see generic terms
 e.g. conditions precedent: “the facility agreement will contain the usual conditions
precedent applicable to this type of facility.” 
 Only if the term is unusual should you state specifically what it is in the term sheet
 e.g. condition precedent that the borrower is to win a particular contract before the
loan facility can be utilized. 

Other Key Info Regarding Term Sheet

Legal status  NOT LEGALLY BINDING, BUT moral force:

Þ difficult to introduce significant material changes later on in negotiations.
Þ Therefore, bank should specify non-standard material conditions in the TS.
Þ Similarly, borrower should negotiate as much as possible early on; weaker
bargaining position later on b/c may have time pressure to get money. 

 Why not legally binding? 

Þ As matter of English law, it is not binding because: 
 It is an agreement to agree and there will be material terms of the future
contract which have not been expressly or impliedly agreed. 
 A binding contract will require consideration. 
Þ HOWEVER – note that it can be made binding where the document is made by
deed, or if the benefitting party makes a promise or other gesture in return. 

 HOW TO MAKE SURE THAT THE AGREEMENT WILL NOT BIND ? 

Þ State expressly that the term sheet is not intended to be legally binding.
Important to rebut presumption that commercial contracts automatically contain
intent to bind.
Þ Can be done by: 
 Heading the document Expressed to be “Subject to Contract”; or 
 An express clause stating ‘Please note that the terms set out in this term
sheet are indicative only and do not constitute an offer to arrange or finance
the Facility. The provision of the Facility is subject to due diligence, credit
committee approval, the terms and conditions of the Mandate Letter and
satisfactory documentation.’

 PARTS INTENDED TO BE LEGALLY BINDING  

 Parts which are intended to be legally binding should state this and must comply with
the common law requirements; they are usually put separately in a commitment
letter which must be signed and returned. 

 2 Clauses you WANT to be legally binding (make expressly binding or deal with in
commitment/mandate letter, detail below): 
 Banks costs and fees: An obligation on the B to pay the lender’s reasonable costs
and expenses incurred in connection with the lending proposal, whether or not
the B ever utilises the facility; 
 Confidentiality undertaking: An obligation on the bank to treat as confidential
any info that is has in respect of the B, its business and financial condition and the
circumstances surrounding the facility. 

Private equity term  In acquisition finance deals – private equity house borrowing to finance acquisition
36
 sheets commonly produces own term sheet from which to negotiate the loan. 
 In contrast to standard form term sheets, these are long, complex and more in favour
of borrower, though credit crunch has weakened this position. 

Duty to negotiate in  There is NO implied duty to negotiate in good faith in English law:
good faith  i.e. either party CAN WITHDRAW at any time without reason. 
 Note that this is not the same in other jurisdictions, particularly the EU. 

Commitment  WHAT IS IT?

letter/mandate Þ A letter sent from the bank which is arranging the facility to the borrower .
letter  Contains any legally binding terms required at the outset of the lending
process.
Term sheet often annexed to commitment/mandate letter (attempt by
arranger to mitigate risk)

 WHAT SHOULD IT INCLUDE?

 Whether bank’s obligation to arrange facility is best efforts or
underwritten 
 Any general conditionality on offer to arrange, e.g. time limit for executing
the facility document, obtaining credit committee approvals, completion of
satisfactory due diligence etc. 
 Material Adverse Change provision: allowing bank to withdraw from offer if
there is a MAC in market generally or borrower’s situation specifically 
 Clear market clause: borrower agree not to raise any other finance (loan or
capital market) while facility being arranged 
 Market flex clause: allows bank to change aspects of negotiated facility
agreement if necessary to attract other banks to participate 
 if can’t find enough banks to join market for any reason
 change to pricing/terms/structure of facility if determine changes are
advisable to ensure successful syndication of facility 
 Costs & expenses: Provisions for bank to recover fees, costs, expense if deal
not go ahead 
 Indemnity for any losses bank may suffer 
 Confidentiality – protects the arranger from loss or liability in relation to
information which it provides to syndicate banks in the course of putting
together the transaction 

 The intention is that commitment letter is signed and returned by borrower within a
few days, although it must be said this is not always enforced in practice. 

Confidentiality Protection  Issue

for arranger  In syndicated loan, arranger will have to obtain information from
buyer and then provide them to the rest of the syndicate.
 Danger – rest of syndicate might want to bring warranty
claim/misrep claim against arranger if any of that information
turns out to be wrong.
 Solution
 That is why arranger would want to put in provisions in certain
documents protecting arranger from loss or liability in relation to
information which it provides to syndicate banks in the course of
37
 putting together the transaction.
 e.g. arranger will put in provision stating that:
 ‘the information provided is sourced from the borrower and
the arranger itself is not giving any warranties or
representations in relation to them – arranger simply
providing the information’.
 The following documents containing such a provision are:
 Mandate letter
 Information memorandum (below)
 Facility agreement

Protection  Receipt of confidential information:

for  Bank likely to receive confidential information from borrower e.g. the
borrower purpose for which borrower requires loan, such as project finance,
funding buy out, funding flotation
 Confidentiality protection under common law:
 Whilst bank subject to confidentiality obligations (under agency
principles, due to bank/borrower relationship), most borrowers will
require bank to sign confidentiality letter.
 Short letter contains an undertaking by bank NOT to
disclose confidential info other than in limited
circumstances to aid syndication of loan.
 Any bank joining syndicate will have to sign confidentiality
letter before receiving any info

Information memo  ARRANGER PRODUCES INFORMATION MEMORANDUM to persuade banks to join

the syndicate
 Usually contains
Þ Financial info relating to borrower and its group companies
Þ General info about the borrower’s group companies
Þ Info about the group’s business and the markets in which it operates
 Will include confidentiality agreement. 
 Since the arranger compiles the info memo, it is potentially liable for any wrong info
the memo contains which is relied on by the lenders deciding to join the syndicate
Þ There is a tortious duty of care between arranger and syndicate banks (Sumitomo
Bank v Banque Bruxelles)
Þ Claims might be bought for misrepresentation or negligence
 ARRANGER WILL PROTECT ITSELF BY: 
Þ Including a clause in the info memo which states
o the borrower has supplied the information and confirms it is true,
complete and accurate; has been prepared with reasonable care; is not
misleading; and does not omit anything material;
o the borrower confirms that any assumptions or projections it makes are
reasonable and in good faith;
o the arranger has not independently verified the information; does not
make any representations or undertakings with respect to it; does not
take responsibility for it; and accepts no liability for loss caused by
reliance on it; and
o participants in the facility acknowledge the info memo is not a valuation
of the borrower’s credit; that it is not a recommendation to participate;
and that they should make their own independent assessment of the
38
 documentation and the borrower
Þ A broad disclaimer of responsibility will also appear in the loan agreement
Þ Disclaimers should satisfy reasonableness test under UCTA 1977 and they should
cover excluded and included info AND oral and written info

N.B. Fee letter sets out the details of the arranger’s (and sometimes the facility agent’s) fee, payable by the
borrower. Confidential between arranger (and facility agent where relevant) and borrower.

The Facility Agreement

Overview of a Facility Agreement

What is it?  A contract. Therefore acceptance, consideration, intention to create legal relations and
agreement on all material terms needed.

 In common with most commercial contracts, the detailed provisions of a facility agreement
will be tailored to the specific requirements of the parties.
 Will always be the lender’s lawyers who draft the facility agreement.
 Overdraft facility
Most common  Term loan
types of  Revolving credit facility
facility

Terminology  Straightforward facilities known as ‘plain vanilla’ loans.

 Additional features known as ‘bells and whistles’.

Obligor  Definition should refer to borrowers and guarantors

 Representations and warranties should be made by the obligors

Committed  Bank obliged to advance money at borrower’s request (subject to the borrower complying
with certain pre-agreed conditions). Commitment is the amount lender has agreed to lend.

Uncommitted  Bank has some discretion before advancing any loan monies (e.g. overdraft)

 Can be withdrawn at any time after drawn (hence, current liability for B’s balance sheet).
On Demand

 Period of time in which the facility is available for drawing. If borrower does not borrow all
Availability
within the time, the unutilised facility is automatically cancelled. For a RCF, you can
Period
withdraw and repay throughout the whole period of the facility but last month usually cut
off because banks do not want borrowers to be borrowing money very shortly before final
39
 maturity date.

 Date on which all of the debt has to be repaid aka termination date
Final Maturity
Date

 Part of interest calculation that reflects the bank’s profit

Margin

 Banks charge fees on undrawn facility so if borrower does not ever intend on using the
Voluntary
facility, it will want the option to voluntarily cancel so banks cannot charge commitment fee
Cancellation

 If borrower has surplus cash flow so wants to pay early to reduce interest fee
Voluntary
 Bank will want prepayments to apply in inverse order i.e. against future scheduled
Prepayments
payments, rather than rateably as this will reduce the length of the facility and therefore
the length of time that the banks will be exposed to the risk that the Borrower cannot repay
the facility
 May require borrower to pay ‘break costs’ if it prepays on any date other than the first day
of an Interest Period to cover Syndicate’s costs on their own borrowing on the interbank
markets
o This is because the banks will match the interest periods and repayment dates on any
interbank borrowing required for them to fund the term facility under the Facilities
Agreement.
 Made pro rata amongst all banks in syndicate (unless stated otherwise - rare)
 Bank may charge a prepayment fee

 Fee payable by the borrower calculated by reference to amount undrawn and uncancelled
Commitment during the availability period
Fee

ALWAYS NEED TO AMEND THE FACILITY AGREEMENT TO ACCORD WITH THE TERM SHEET AS THIS HAS BEEN
SIGNED ALREADY.

It is in everyone’s interest to have a facility agreement that is negotiated as this is more likely to be workable in
practice. I.e. if this is too lender friendly then the borrower is likely to breach. The bank doesn’t want the borrower
to breach.

Benefit of Negotiating the Facilities Agreement:

- To ensure that the content of the agreement is factually correct and appropriate
- To help ensure all parties understand the terms
- To produce an agreement which works in practice
- To produce an agreement which is reasonably balanced so that it is fair to both sides.
 This makes it more likely that the parties will perform its terms

N.B. A clause in a facilities agreement requiring the borrower to pay additional interest if it fails to pay any
amount when due is NOT always enforceable under English law. The facilities agreement is simply a contract so
basic contract law applies. If the level of default interest could be regarded as punitive, then it may be declared
void.

40
 Conditions Precedent

What are they?  Conditions precedent (CPs) are specific conditions which a bank requires a borrower to
fulfil before part or all of a facility agreement takes effect.
 Conditions to the borrower being able to borrow the money (i.e. utilise the facility) and
sometimes from being able to put in a utilisation request (request for money) (not a
condition to the facility coming into force).

Specific conditions that lender requires the borrower to fulfill before the borrower
can draw down capital from loan facility
 Usually in the form of borrower providing documents/evidence to show that
they have complied with these conditions (e.g. something that came up in due
diligence that has now been resolved)
 They confirm the legal and commercial assumptions that the lender based its
decision to lend on and are a form of backing up representations and warranties.
 Number of CPs will depend on transaction – investment grade borrower may have less
CPs
 Agent has to be satisfied that the CP has been met
o Borrower will try to get agent to sign off as much CP documentation as possible
before it signs the facility agreement
 Lender has absolute discretion as to whether they will waive a CP that has not been
satisfied to allow borrower to borrow
o If lender does waive, generally will make CP a condition subsequent (condition
that has to be satisfied within an agreed period following drawdown of the facility)
o More likely to waive for administrative rather than substantive matters

NB: Conditions Precedent are not conditions for the facility agreement to take effect, but for
the lender to make the draw downs available. The Facility Agreement will come into effect as
soon as it is executed by all the parties so at that point, commitment fees etc. have effect– but
borrower will not be able to access the capital UNLESS and until the CPs are satisfied.

Advantages (for the bank):

 Borrower is locked in into the main provisions of the agreement, so that bank’s FEES
are payable and remedies for default apply.
 The representations, warranties, undertakings and events of default and boilerplate
will all become operative as soon as document is executed. This means the bank can
BEGIN MONITORING the borrower, even whilst borrower is trying to satisfy CPs.
Purpose  CPs provide evidence that the representations and warranties are met.
 Used to resolve banks concerns/address issues from the Due Diligence process.
 Rationale behind conditions precedent from bank’s perspective
 Ensure company is of sufficient legal standing when utilise the loan
 Company is run well - other than just financially
 All must be in order before will lend
Where in loan Usually in beginning, but if lengthy, will be in schedule.
FA?

Watch out for… (a) Time limits/Waivers


Most of the time, CPs will be satisfied by ‘closing’ (i.e., the time the loan documentation
is executed and goes ‘live’ and the facility is intended to be available).

If borrower believes cannot satisfy CPs before Closing, need to ask banks for temporary or
permanent waiver.

Borrower needs to collect paperwork and deliver to bank’s solicitors BEFORE execution

41
 
In practice, bank’s solicitor also takes responsibility for ensuring that the CPs are
either satisfied (or waived) and may have to write a ‘CP CONFIRMATION LETTER’ to
the agent confirming the position.

If the loan is for a specific purpose e.g. an acquisition, the timing of the CPs and first
utilisation will almost certainly be tied into the acquisition timetable.
(b) Uncertainties

Possible that a CP could be so vague as to make the agreement void for uncertainty.
 E.g. clause in a contract which stipulated that the sale was ‘subject to the
purchaser obtaining a satisfactory mortgage’ was held to make the entire contract
void in Lee-Parker v Izett (No 2) [1972] 2 All ER 800.

However, common to see wording requiring a CP document to be ‘in form and
substance satisfactory to the banks’. This is probably certain enough in legal terms,
although it may trouble the borrower
Typical MOST COMMON CPs:
conditions (a) current constitutional documents of any companies giving guarantees or security;
precedent (b) a board resolution approving the terms and conditions of the facility agreement and
authorising signatories (usually the directors);
(c) a list of names of authorised signatories, together with a specimen of their signatures;
(d) a shareholders’ resolution from any guarantor, approving the guarantee (if there are any
possible corporate benefit issues associated with it);
(e) legal opinions from the bank’s lawyers confirming the validity of the agreement and
effectiveness of any security (see Chapter 16);
(f) a comfort letter from the borrower’s parent;
(g) insurance policies (including any ‘Keyman’ insurance);
(h) certificates of title for any properties;
(i) executed security documents, together with any documents of title (e.g., share
certificates) which those documents require;
(j) copies of any other related documents (e.g., fee letters, hedging agreements,
intercreditor, and of course the loan facility executed by all parties);
(k) in an acquisition finance, ‘Reliance Letters’ allowing the bank to rely on expert due
diligence reports on the target, commissioned by the purchaser;
(l) management accounts;
(m) payment instructions notifying the bank where loan monies should be paid;
(n) any consents or licences which are necessary in connection with the purpose of the loan;
(o) an agreement for an agent for service of process to be appointed by a borrower which is
domiciled abroad.

NO ORIGINAL Copy = Certified Copy

If a borrower does not want to provide an original document, ‘certified copy’ might be
sufficient.

copy which has been signed, usually by a director or secretary of the borrower, as a true
copy of the original as at a given date.
 Copy allowed: certified copies of board minutes.
 Copy not allowed: certified copies of share certificates.

If borrower, based overseas / original docs likely to be in another language - facility
agreement should require the borrower to provide translations.
Conditions In some transactions, e.g. acquisition finance bids - which are required to happen quickly, some
subsequent of the usual CPs are made ‘conditions subsequent’ i.e. condition that has to be satisfied within
an agreed period following drawdown of the facility

E.g. the borrower may be required to give share security over its subsidiaries as a condition
precedent, but the remaining security as a condition subsequent within, say, 90 days of
utilisation.
CPs: Bank's  Viewed in conjunction with the contractual representations.
perspective  LOOKS TO CPs TO SATISFY THE LENDER OF THE BOOROWER’S POSITION BEFORE ANY
42
 MONEY IS UTILISED. Checking the provided-for documentation, the lender can be satisfied
that everything is in place (e.g. Board Minutes evidence that B is duly authorised to enter the
FA).
 More specifically, CPs can be used to check resolution of any problems uncovered during DD

CPs: Borrower's Borrower must ensure that it can fulfil the required CPs within the allotted time frame.
perspective 
If this is not possible, it must ask the lender for a temporary or permanent waiver of
any specific CPs.

The potentially problematic CPs for the borrower are those where a third party is
involved.

Borrower should avoid any CPs with language such as “in form and substance
satisfactory to the bank” as this gives the bank a wide discretion to decide that
something is not satisfactory and utilization cannot be made.

Borrower should organise as early as possible. Wherever possible, an agreed form
should be settled in advance.

If a form cannot be settled in advance, qualifying the bank’s discretion with the word
‘reasonable’ gives a borrower some comfort.

This is one area where the borrower in a syndicated loan might press for acceptance of
documents to be in the discretion of the agent or, if not, a simple majority of the
syndicate. The agent is likely to be the entity with which the borrower has the best
relationship, and so may be more flexible.
CPS can be split into:
(i) Those to be satisfied before the first advance; and
(ii) Those that apply to all advances (i.e. the first and any subsequent advances).

Consequence for Cannot make a drawdown and sometimes cannot even make a utilisation request until
borrower if not conditions precedent are satisfied, in the form satisfactory to the agent.
satisfied with  It is prerequisite for drawdown; not execution but in practice fulfilled before execution
conditions anyway.
precedent?  Facility Agreement still stands, but cannot borrow any money!
Cl 4 FA: CONDITIONS OF UTILISATION
▪ 4.1: initial conditions precedent - no borrower may deliver utilization request unless Agent
received all docs and other evidence in Schedule 2 (CPs). Agent shall notify company and
lenders upon being satisfied of these.
Conditions  Generally, lender’s lawyers take the lead on monitoring the progress of satisfaction of CPs
Precedent  At the outset of the transaction, lender’s lawyers will prepare a checklist that reflects the CPs
Checklist o Enables the parties to allocate responsibility and track progress towards satisfying CPs
 Checklist is updated regularly
 Generally, borrower/borrower’s solicitors will be party responsible for action to be taken
o Constitutional documents of the Subordinated Lenders will also be the responsibility of
the borrower’s solicitors to provide to the lender’s solicitors
 But there are exceptions e.g.
o Legal Opinion = responsibility of lender’s lawyers/lenders
o Producing first drafts of the Intercreditor Agreement, Security Trust Deed, the Security
Agreement and each Fee Letter = responsibility of lender’s lawyers

43
 3 - Utilisation, Representations, Undertakings, and Default
Representations (and Warranties)

A bank will want to lend only if it is happy with the ‘status quo’ of a borrower.
 A facility agreement will therefore contain STATEMENTS which the bank requires the BORROWER TO
MAKE about various matters.
 These REPRESENTATIONS (also referred to as ‘representations and warranties’) are made on signing the
facility agreement and usually repeated periodically thereafter
 N.B. Representation and undertakings are some of the most heavily negotiated clauses in a facility
agreement because of a breach of either will result in an event of default

 Representations and Warranties are statements of facts made by the borrower (and
DEFINITION sometimes by their guarantors) regarding information that is material to the Facility
Agreement.

 Reasons to include representations in a facility agreement include:

PURPOSE 
To elicit information (as part of the due diligence process) – i.e. provide full disclosure
of facts whilst the loan is being negotiated

To provide a ‘draw-stop’ (money may not be borrowed) if they are untrue: Once the
FA has been executed, the representations will allow for a draw-stop if they
subsequently prove to have been untrue – i.e. bank doesn’t have to lend any more.

To allow the bank to call a default: once the money has been lent, the bank will be
able to call a default if the representations turn out to be untrue. They will then be
able to demand immediate repayment of the loan together with interest and any
other amounts outstanding under the Agreement

Examples of COMMON Representations

 RELATE TO THE VALIDITY OF THE BORROWER, ANY GUARANTOR AND THE LOAN
Legal DOCUMENTATION.
Representations  Status:
 The borrower must state that its duly incorporated under the laws of its ‘original
jurisdiction’ and that it has power to own its assets and carry on its business.
 Binding obligations:
 Borrower must confirm that the obligations it undertakes in the FA are legal,
valid, binding and enforceable.
 Non-Conflict:
 Borrower must usually state that entering into the FA will not conflict with any
laws or regulations, their constitutional documents, or any other agreement or
instrument to which they are party.
o If entering into the FA in breach of another contract, the other party to that
contract can sue the BANK in tort for “procuring a breach of contractual
relations”.
o The representation that there is no conflict with other agreements should
protect the bank, since the tort requires the bank to act with knowledge or
indifference to any conflict.
 Power and authority:
 Borrower must represent that he has the power and authority to enter into the
loan, and to perform its obligations.

44
  Validity and admissibility in evidence:
 B must represent that he has done everything required to ensure that the FA is
admissible in evidence in its jurisdiction of incorporation. (particularly important
if borrower is incorporated in a different jurisdiction from the governing law).
 Governing law and enforcement:
 B must represent that the governing law of the FA, and any judgment obtained in
relation to it, will be recognised in the borrower’s jurisdiction of incorporation.
 ALL LEGAL REPRESENTATIONS ARE COMMONLY REPEATED – i.e. they will continue as if
‘re- stated’ each day the facility agreement is active.

 RELATE TO COMMERCIAL POSITION OF BORROWER

Commercial  Deduction of tax:
Representations 
Borrower will have to represent that it is not required to deduct tax from
payments made to banks which are defined as ‘Qualifying Lenders’.

Primarily aimed at ensuring there is no withholding tax imposed on interest
payments which would mean the banks getting less interest than expected, or
the borrower having to increase its interest payment under gross-up provisions.
o This representation is NOT commonly repeated because ongoing tax issues
are dealt with in a separate section of the facility agreement.

No filings or stamp duties:
 Will not usually apply to a loan facility or related documents, but a
representation that none is payable is required to protect against possible
foreign duties of which the bank is unaware.

This representation covers for the situation the law changes.

Not usually repeated unless new borrowers accede to the FA.

No event of default:

B must represent that there is NO event of default continuing or which
might reasonably be expected to occur as a result of utilising the facility.

Also, must represent that there is no event of default under any other of
its agreements which would have a material adverse effect on the FA.

No misleading information:
 Representation that the borrower has not supplied information to the bank
which is misleading.
 Three points to it:
1) Information provided for the information memorandum was true and
accurate.
2) Financial projections prepared by the company’s directors were
prepared based on recent projections and contain reasonable
assumptions.
3) All information provided to the banks was true, complete and accurate at
the time it was given.
o Borrower will want that qualified to – “was true, complete and accurate
in all material respects”

Accounting principles:

B must represent that the financial statements presented were prepared
in accordance with the GAAP (Generally Accepted Accounting Practice)
and that they give “a true and fair view”. Will also give undertaking to
deliver future accounts on the same basis.
o Will commonly also state that: “there has been no material adverse
change in the business or financial condition of the borrower since a
particular set of financial statements”
o Point for negotiation – if the Rep is to be repeated, should it refer to a
Material Adverse Change from the original financial statements

45
 produced, or should it refer to the latest financial statements (p. 50)

Ranking:

B must represent that the bank will rank at least pari-passu (equally) with any
other unsecured creditors, other than as a result of any preference through
insolvency regulations (just repeating the common law position)

Litigation:

B will have to represent there is no existing, pending, threatened or planned
litigation.
o This should include “de minimis” provision (e.g. no litigation over a
certain value) as this would otherwise be too onerous, especially if it
has to be repeated – always possibility that someone will
threaten/commence litigation in the future.

Winding Up Proceedings:

B will have to represent that no insolvency proceedings in any form have
been started or are threatened against the borrower.

Encumbrances:

Representation that there are no encumbrances other than those
disclosed before execution. Also, possibly a representation that B has good
title, in its own name, to all property over which security is to be given.

Environmental:

Increasingly common for banks to require an expert’s report on
environmental issues before lending. Use of environmental audit will
depend on the nature of the business.

Representation that the borrower is in compliance with all environmental
laws and has obtained, and complies with, all environmental licences
necessary for its business.

Catch all:
 Sometimes have to represent that there is nothing the borrower has
omitted to tell the banks that if it had told them they would not want to
lend. (unlikely)

Other info – Representations

 Timing:
Timing and  Most FAs require the representations to be given on execution and then repeated
repetition immediately prior to each utilisation, AND on the first day of each interest period.
 Repeated so banks can continue to monitor the position of the borrowing group
throughout the life of the facilities
 Repetition:
 The bank may want the representations to be repeated from time to time and may
even deem them to be repeated every day (“evergreen provision”).
 NB: Evergreen provisions are very onerous as it puts the borrower under a daily
risk of default.
 Important: Note that you CANNOT qualify repetitions by disclosure. Disclosure
letter is only effective in relation to breaches of representations and covenants at
the time of the execution of the facility agreement, it cannot be effective in
addressing subsequent breaches. Everything you disclosed pre-completion will
have been incorporated into representations already

Bank’s  Element of caveat emptor which applies when a bank makes a loan: essentially, there is no
perspective common law obligation on a borrower to disclose information which might be pertinent
to the bank’s decision to lend.
46
  The representations will need careful drafting to achieve the required disclosure.
Some representations are best cast in very wide terms, for example that a borrower
has ‘no litigation, arbitration, or similar proceedings pending or threatened’.
 However, a representation that a borrower ‘has insurance’ could benefit from being
more specific.
 Sometimes a borrower will ask to qualify its ‘legal’ representations by any
qualifications used in the bank’s legal opinions.
 This may be accepted for the ‘binding obligation’ and possibly ‘governing law’
representations, but a ‘blanket’ application is not appropriate or necessary.
 From the bank’s perspective, the representations are about ‘risk allocation’, allowing
them to take action if a situation is not what they had been led to believe.

Borrower’s  If a representation is untrue when made or repeated it will trigger an event of default,
perspective and therefore borrowers will want to negotiate wide margins for error.
 A repeated representation should avoid the need for an undertaking or an event of
default on the same issue, but, at the very least, any concessions negotiated in
drafting any equivalent or related events of default or undertakings (such as de
minimis provisions) should be reflected in any representations which are to be
repeated.
 A borrower should never repeat a representation that there is no ‘potential event of
default’ or equivalent, since breach would turn a ‘potential’ into a ‘full’ default.
 There is a particular danger for the borrower if the representations are to be deemed
repeated. The bank will argue that when representations are first made, they should
be tightly worded in order to flush out any problems (by way of a disclosure letter).
However, on repetition, the disclosure letter is ineffective against new breaches.
 NB: The borrower should ensure that any materiality qualification will not make
representation TOO uncertain to be given. A borrower must also check if the
representations are given in relation to just himself, or if they include a defined “group” its
“material subsidiaries from time to time” or even “all subsidiaries”.

 Statement of fact made to induce the party to whom it is addressed to enter into a
Reps in contract. The statement may be oral or written, and if it is drafted into the contract it also
contract law becomes a term of that contract. If the statement is untrue, it constitutes
(p.54 TB) misrepresentation
 Misrepresentation Act 1967: Governs the right to claim for contractual misrepresentation.
 A claim will be recognised only if the misrepresentation was of a material fact, was
intended to induce a party to contract, and did induce the party to contract.
 Two categories:
1) Fraudulent misrepresentation; and
2) Non-fraudulent misrepresentation.
 Remedies
 Rescission (to put parties back into their pre-contractual positions)
 Damages
 Tort of negligent misstatement (based on judgment in Hedley Byrne v Heller)

 No misleading information:
Reps in facility  Make sure you keep the bank informed whenever something comes up that could
agreement compromise your compliance with this provision
 No proceedings pending or threatened Cl. 18.12: The borrower will want:
 De-minimis provision (i.e. ignore litigation under £X)
 Disclosure letter:
47
 Make sure you disclose everything ongoing to prevent a breach of this provision
Important: disclosure letter can only be used ONCE at initial signing – only
excludes this specific issue that existed then. Does not protect against fresh
breaches
 Carve out provision:
 Allow for small claims
 Include a provision that you can litigate to protect your rights. At the moment, this
provision would be breached EVEN if you are suing somebody else for non-
payment.

Undertakings

These are PROMISES given by the borrower to the lender. They will normally have the form of:
-
A promise to do something
-
A promise not to do something
-
A promise not to procure that something is (or is not) done by a third party within the borrower’s control.

NB: The choice of whether to use a repeated representation or an undertaking will often depend on the drafting
preferences of the solicitor. Some practitioners feel uncomfortable with repeated representations and prefer to
have an undertaking that the borrower will maintain the position throughout the loan.

Purpose


To protect the loan monies as far as possible by controlling the assets and activities of the borrower.

Control is achieved using three different types of categories:
1) Financial Covenants
2) Information undertakings
3) General undertakings

 Financial targets which the borrower is required to meet during the life of the loan relating to
Financial profit, generation of cash or net worth
Covenants  Designed to check adherence to the borrower’s projected performance under its business plan
 Maintenance covenants
Þ Require borrower to maintain a specified level of financial performance and are tested
regularly over the life of the loan facility
 Incurrence covenants
Þ Also set financial targets but borrower only has to show compliance if it wants to do
48
 specified things e.g. dispose of large assets, acquire new companies, pay dividends
 Some financial covenants simply set a financial limit which a borrower must attain but most
financial covenants compare 2 figures derived from borrower’s accounts (ratio)
Þ Leverage ratio
Þ Interest cover ratio
Þ Cashflow cover ratio
Þ Minimum net worth– company must maintain a minimum value of assets in the
business
Þ Capital expenditure – limit on amount borrower can spend on ‘long-term’ assets of the
business over a given period
Þ Borrowing – cap on total borrowings

Information Promise to provide the bank with information so they can check the Borrower’s compliance with
Undertaking the provisions under the FA. They include:
s 
Financial information – to provide the bank with:
 Year-end accounts and even interim accounts
 Management accounts including cash flow statements, income statements and cash
flow forecasts
 Forecasts on the Borrower’s performance, usually in the form of projected balance
sheet, P&L and cash flow statements for the year ahead
 A compliance certificate that shows that shows that all financial covenants have been
complied with
 A “sweep-up” provision requiring the borrower to provide any other information
within its control, which relates to the financial condition or operation of the
borrower and which the bank requests.

Shareholder documents – a copy of all information sent to S/Hs

Annual schedule of insurance – to make sure that the borrower has and maintains insurance

Notification of default – there will invariably be an undertaking requiring the borrower to
notify the bank if it defaults under the loan.

General Designed to control the business in general terms. Can be Negative OR Positive:
Undertaking  Negative Covenants: - prohibit borrower from doing something
s  Negative pledges – obligation on the undertaker NOT to create any security over its
assets
 The borrower MAY require a carve-out to ensure it can continue its business as usual. This
could include:
 B can give security that might be necessary under equipment leasing or hire purchase
agreements
 Liens arising under the common law, statute and in the ordinary course of business
(as the B has no control over these occurring)
 Security which pre-dates the agreement
 Retention of title clauses which will allow creditors to recover their assets in case of
insolvency
 A de-minimis amount (known as basket) allowing an aggregate amount of debt for
which the borrower may create any security.
 Prohibiting disposals of assets
 To make sure that the net-worth of the business is kept steady

49
  Also ensures that the lenders security (e.g. floating charge) is not compromised

Not diversifying from the key business
 Avoids risk of unsuccessful business ventures which may drag the business down and
compromise ability to pay.
 Positive Covenants: - require some sort of positive action by borrower

Insurance of assets – avoids the B losing assets which it then cannot replace

Maintain assets in good conditions

Compliance with all relevant laws

Obtaining all necessary licenses and permissions to enter and stay in the agreement.

Effect A breach of the undertakings will be an event of default.

How to Negotiate an Undertaking

The volume of the Undertakings will be determined by:


The identity of the borrower: the larger the company the less risk will be attached to lending to it. Big
companies also have much more power to negotiate and are commonly in a strong bargaining position

Type of loan: the more complex the facility (for say an acquisition) the more undertakings it will require to
minimise the risk of the banks involved

Market conditions: liquidity of the debt market can be a big factor. The more lenders are willing to
loan, the greater the negotiating power the Borrower has.

What to
consider  Undertakings give the bank a substantial amount of control over what the borrower can or
cannot do.
 The bank must be careful that in case of a liquidation of the borrower it is not deemed to
have been a shadow director whose actions led the borrower into liquidation (or
hindered it from preventing it).
 Otherwise the bank may be facing costly claims for wrongful trading.
 For these reasons the bank must make sure that the undertakings do not impose too
much a burden on the borrower’s business
 Requests should be reasonable wherever possible
 Undertakings should not hinder the borrower in carrying on his business in the usual
way
 Undertakings should not hinder the borrower from entering into smaller
transactions

NB: Generally, there should be something like a de-minimis provision that restricts the
undertakings to significant events. E.g. a claim to collect a bad debt should NOT be construed as
an impending litigation that will then be an event of default.


NB – best wording for lenders is “Each Obligor will…” as this gives an absolute undertaking to
perform the required act. Second best would be “best endeavours”

PROBLEMS IN FA FOR BORROWER

Amending representations and undertakings

 De-minimis means that minor breaches of the term are excluded, and we would do this
De-minimis by setting a sum below which any litigation is ignored – it essentially creates a carve out

50
 for small claims.
 This should be set at a level which enables borrower leeway to run its day-to-day
business, and so in tune with (and slightly above) the usual or standard sum
brought against it.
 Notably, in response to this, the lender may set an aggregate outstanding
maximum to avoid multiple minor breaches which, together, prove harmful.
 We should resist this or, at least, ensure the aggregate sum set is high enough to
allow company leeway.

 We could qualify the clause with materiality. This would amend the clause to stating that
Materiality no litigation (or other rep/undertaking) has been started or threatened against it which
“may have a material adverse effect on its ability to perform its obligations” under the
Facility Agreement.
 This would soften the clause and ensure that minor claims threatened or started
against Borrower would not fall foul of the Facility Agreement.
 The bank may, however, resist this due to uncertainty as to what is “material” and
thereby try to define it in its favour.
 E.g. the bank may try use such wording as “material in the opinion of the bank”.
 If this is insisted, then it would be important to ensure that the word “reasonable”
is inserted so it is “the reasonable opinion of the bank”. This reduces the severity
of the provision and would be of value to borrower because the bank would have
to consider what objectively reasonableness is, making it less likely to call a
default.

 Disclosure letter is an agreed list of specific things that would amount to a breach and
Disclosure prevent borrower from making the representation, but that bank has agreed to waive.
letter
 By using a disclosure letter, detailing the current threat of litigation, the clause will
become subject to it and protect borrower against a breach in relation to this
particular claim.
 This, however, would not protect company against further and new threats,
especially if the clause is repeating, and hence amendments to the clause by de-
minimis and/or materiality are essential.

 For specific things – e.g. minor breaches of law (but would require definition of what
Carve out minor is) or a particular thing that the borrower does
 Exclude frivolous and vexatious claims in the Facility Agreement as another carve out.

 Gives borrower time to fix a breach

Grace period

 Clause could be amended not only to include materiality but also qualified with “to the
Knowledge and best of our knowledge and belief”. The bank, again, will try and resist this. And so, it may
belief carry the caveat “after due and careful enquiry”.

How to Deal with Problems Identified During Due Diligence

51
In general, make sure you understand the clues in the facts (possible FA extract) and how the law relates to the facts.
Then make sure you highlight each significant fact element in your answer. Note that for whichever side you are
representing (bank or borrower), the FA will probably be friendlier to the other side.

Whether and if so how, the issues may affect the syndicate’s decision to lend:
Commercial  What is the cost of resolving the problem (what are the potential costs – direct and indirect
Impact – that may be incurred by the borrower)?
 Will there be any change in the valuations that have been provided and/or value generally
(e.g. will the problem affect the value of the lender’s security?)
 Will it impact upon the business and projections of the Borrower and thereby limit the
borrower’s ability to make its interest repayments?

Will it affect  Discuss the impact on the bank’s willingness to lend

the bank’s o Does the legal issue affect the security the bank wants?
decision to o Does the legal issue impact the borrower’s ability to repay the facility?
lend?

Legal impact  Whether it prevents the borrower from making any of the representations and/or
on the terms complying with any of the undertakings as they currently appear in the draft FA .
of the FA  Why are these representations and/or undertaking important to the syndicate – can they be
waived?
 Also, is the financial issue likely to lead to an event of default? (if so, see below)

How can the See below for example of problem resolution.

situation be
resolved to
the
satisfaction of
both parties?

PROBLEM RESOLUTION – EXAMPLE (another example p.10 WS 3 Lecture)

Problem – Dispute with supplier

The DD report has revealed that Indigo Retail Limited (“Retail”) is refusing to pay for a batch of new computer
equipment which was purchased with the intention of upgrading the centralised warehousing system. Compell
Computers Limited, the supplier, has admitted that they have installed the incorrect software (which is in German)
and has promised to fix the problem in the next couple of weeks when Retail has paid the invoice in full. Retail is
refusing to make any payment until the correct software has been installed. The value of the contract is £15,000.

NOTE – look at the situation from both parties’ perspectives – does the lender want to lend and does the
borrower actually want to proceed – do they actually have similar aims regarding this issue? Also, how
important is the issue? Only minor risk?

Lender’s Perspective:
Potential costs to borrower – likely to arise from disruption to borrower’s system; if litigation is
threatened/commenced borrower will incur costs to deal with it; loss of goodwill cos business relations with
52
supplier soured; but other party appears to be the one in default not the borrower
Change in value of security – nothing material
Impact on business – loss of business could happen because of the software fault and litigation could have an
impact. But, should be short term impact and only small value contract
Decision to lend – likely unaffected. Minor dispute esp. in relation to loan size and dispute does not go to heart of
business or affect a valuable asset.

Borrower’s Perspective:
Prevent borrower from making rep/complying with undertakings:
Cl 18.8(b) – refusal to pay is a default under another binding agreement but if dispute will not have a “material
adverse effect” will not breach rep
Cl 18.12(a) – so far, no proceedings pending or threatened but this is a repeating representation. Also, Cl 22.4,
even of default if rep is incorrect or misleading in a material respect – so borrower should be careful
Cl 22.7 – if conflict escalates, Compell could petition for Indigo’s winding up which would be an event of default
(insolvency proceedings)
Cl 19.4(b) – borrower should be aware that there is an obligation to supply details of any litigation current/or
threatened that has a material adverse effect (breach of this would be a remedial event of default – Cl 22.3)

Solution?
Probably best from Borrower’s POV to qualify by reference to material adverse effect as that would cover this
potential dispute and future disputes with other suppliers.

OPTIONS for resolution – discuss whether acceptable to both sides:

 Get counsel advice if litigation is possible/threatened
 Offer more Conditions Precedent (favourable counsel’s opinion/more DD/indemnities/insurance/issue
resolved prior to borrower being able to draw down)
 For minor issues, probably best not to use CPs as it may hold up the entire transaction
 Change wording of clause (add will/would not/may/might etc)
 Change/add materiality – qualify by reference to material adverse effect (define “material” in such a way
that no breach would occur)
 Change/add de minimis clause – carve out proceedings that fall below a certain threshold (e.g. litigation
<£100,000)
 Add ‘to the best of our knowledge and belief’ (limited to reps re: knowledge of threatened
litigation/market information)
 Add / remove reasonableness (“might reasonably be expected”)
 Add grace periods (enough time to solve problem)
 Carve out proceedings which are frivolous or vexatious
 Carve out petitions that are being contested in good faith
 Lender may want this qualified e.g. as long as petition is withdrawn w/i a particular period of time
 ‘Carve out’ an individual dispute – by amending the clause or by reference to a separate document
(usually a disclosure letter)
 Bank may only permit this if e.g. proceeds of transaction are used to pre-pay the facility
 Add clause saying need lender/majority lender consent to e.g. enter into transactions over £X
 Borrower would likely ask for a clause saying consent cannot be unreasonably withheld

N.B. Borrower should disclose any issue immediately (as soon as sign agreement, making reps/ undertakings etc.
Hence, need to make sure everything disclosed in line with agreement, otherwise will be in breach of agreement
immediately); adapt reps/undertakings/consider insurance.

53
 Events of Default

Events, specified in the Facility Agreement, which provide the bank with a contractual right to terminate the loan,
cancel any commitment and to demand repayment for all outstanding principal interest (known as acceleration).
 They are based on risk of the lender not getting their money back, NOT on the fault of the borrower
 This is because a bank will not want to rely on common law or statutory remedies if the breach is
serious, they will want to take immediate action.

STEP 1: Identify if there has been an Event of Default

LATE E.g. Cl. 22.1 – An obligor does not pay on the due date ANY amount payable pursuant to a finance
PAYMENT document unless:
a) Its failure to pay is caused by:
(i) Administrative error; OR
(ii) A disruption event; AND
b) Payment is made within 3 business days of its due date”. (GRACE PERIOD)
N.B. This clause is largely non-negotiable – very significant event of default. It covers payment
of ANY amount due under the agreement, including fees and expenses, as well as interest and
repayments of the principal. There is usually also a general requirement to indemnify the bank
against any costs associated with a default.

POINTS TO NEGOTIATE: BORROWER

 Will argue it should cover situations where late payment is “due to an administrative
error” or “for technical reasons”
 Include a grace period of 3 – 5 days to cover for events like this
POINTS TO NEGOTIATE: BANK
 The bank may want to limit the errors allowed to those of third parties and NOT of the
borrower
 Bank’s solicitor must make sure that ANY default interest and indemnity provisions are
drafted so that they will run from the date when the payment is overdue and NOT from
the end of any grace period

BREACH OF Cl. 22.2 – “any requirement of clause 20 (Financial covenants) is not satisfied.
FINANCIAL E.g. Cl 20.1(a) – the ratio of Current Assets to Current Liabilities will not at any time be less than
COVENANT 1.5 to 1

54
 Cl. 22.3
OTHER  (a) “obligor does NOT comply with ANY provision of the Finance Documents (other than
OBLIGATION those referred to in 22.1 (non payment) and clause 22.2 (financial covenants)
S  (b)“NO EoD under para.(a) above will occur if the failure to comply is CAPABLE of remedy
AND is remedied within 7 business days of the earlier of (A) the agent giving notice to
the company AND (B) the company becoming aware of the failure to comply”

Note: This provision provides that any breach of the finance documents will NOT be an event of
default if it can be remedied within the agreed period.

POINTS TO NEGOTIATE: BORROWER

 The borrower will want to increase the period from 7 to something longer. Maybe 14
days.

POINTS TO NEGOTIATE: BANK

 For Cl 22.3(b), bank may want to add ‘save in respect of cl 21.3 (negative pledge), cl. 21.4
(disposals) and cl. 21.5 (acquisitions)’
 So, for breach of these clauses it will still be an EoD even if they can be remedied in time.

cl. 22.4 – any representation OR statement made OR deemed to be made by an Obligor in the
REPS AND Finance Documents or ANY other document in connection with the Finance documents is OR
WARRANTIES proves to have been incorrect, or misleading in any MATERIAL respect when made or deemed to
be made

POINTS TO NEGOTIATE: A bank will often concede some softening of this event of default usually
in the form of the “misstatement, or its consequences to be material or have a material adverse
effect”
 The bank may want to include that it will be the judge of what is material and what is not

CROSS Cl. 22.5 –

DEFAULT a) any financial indebtedness from ANY member of the GROUP is not paid when due nor
within any originally applicable grace period
b) any financial indebtedness of ANY member of the GROUP is declared to be or otherwise
becomes due and payable PRIOR to its specified maturity as a result of an event of default
c) any commitment for any financial indebtedness of any member of the group is cancelled
or suspended [...]
d) any creditor of any member of the Group becomes entitled to declare any Financial
indebtedness of any member of the Group… as a result of an event of default
e) NO event of default will occur under this clause if the aggregate amount of financial
indebtedness or commitment for financial indebtedness falling within para. (a)-(d) above
is LESS than £100,000 (so check it is above this!)
Note: This clause operates by automatically defaulting the borrower under the loan in the event
that it defaults under certain OTHER types of agreements. i.e. if borrower becomes indebted to a
third party outside this FA, then it can be a breach of this FA.

Note: Cross-default vs. cross-acceleration

Þ Clauses 22.5(a) and 22.5(d) are true cross-default clauses.
Þ Clauses 22.5(b) and 22.5(c) are cross-acceleration clauses (require action on part of the
other creditor).
Þ Cross-acceleration clauses are generally better for the borrower.
o Banks will resist relying on JUST a cross acceleration because they would worry

55
 borrower will convince the other lender not to take action.
Þ Clause 22.5(d) is the most favourable to the syndicate because it operates on the basis
of entitlement and it is triggered by any breach of the other agreement, not just non-
payment (like 22.5(a)).

PURPOSE: This clause ensures that the bank is in a position to lock down the relevant money i.e.
legally gets its hand on the money. By accelerating the loan like this, the bank is in the same
position as the third party whose agreement was breached.

Example: Borrower defaults on a loan with Lender C. This will cause a cross default automatically
defaulting the borrower’s loan with Lender B (even if the borrower is not behind on his payments
with B). The purpose is that B can ask then for its money back not worrying that C will take
everything and rendering the Borrower insolvent.

EFFECT: This could cause a significant domino effect where the Borrower is forced to terminate
ALL his contracts due to a breach in one of them.

GENERAL POINTS TO NEGOTIATE:

 Definition of financial indebtedness
 De-minimis amount
 Does not include default of any other Group Co.
 Material effect on ability to perform obligations under this agreement
 Carve out contracts on cross defaults (e.g. any defaults on debts the borrower is
disputing in good faith)
o Banks will strongly resist such a clause as they do not want a dispute about what
is in ‘good faith’ and what is not

SOLUTION: BORROWER TO NEGOTIATE:

 Limit the conditions that can cause the cross default to documents providing financial
indebtedness (e.g. debt finance agreements).
 Cl. 22.5(a)– include a threshold below which the default will NOT apply
 Cl 22.5(d) – reduce scope e.g. only specified events of default
 Cl.22.5(e) – a de-minimis clause
 The cross default should operate only if the other default will have a material effect on
its ability to perform its obligations under the facility agreement. The borrower will
want a cross default to be set to trigger only at a specific point in the initial default.
There are three options:
a) Default if B simply fails to pay an amount due under another agreement; OR
b) Default if the creditor under another agreement obtains a right to demand early
repayment; OR
c) Default if the creditor under another agreement actually exercises a right to
demand early repayment (cross-acceleration clause)
POINTS TO NEGOTIATE: BANK
 If the borrower is part of the group, a bank will often want the cross default provision to
extend to a default of ANY OTHER company in the group. The reasoning behind this is
that the financial difficulty of a member of the group is likely to have an effect on the
Borrower.
 The borrower should resist that or at least LIMIT the default to material or principal
subsidiaries from time to time.

Cl 22.6 three cases where insolvency is an EOD:

Insolvency

56
 Þ any member of the Group admitted inability to pay debts as they fall due, suspend
making payments of debt or negotiate with creditors to reschedule indebtedness
Þ value of assets of any member of the Group is less than liabilities
Þ A moratorium is declared in respect of any member of the Group

Cl. 22.9 An Obligor (other than the Company) is not or ceases to be a Subsidiary of the Company
CHANGE OF (if borrower ceases to be a subsidiary of parent who is providing guarantee)
CONTROL

Note: There are several reasons why a bank will be concerned about any change in control of the
borrower:
 The parent of a borrowing subsidiary might have provided support which may be lost
 A bank may have a particular relationship with a parent which has been influential in its
decision to lend to a subsidiary
 A banks original credit assessment has been based on the group structure to which the
borrower then belonged

Cl. 22.12 Any event or series of events occur which, in the opinion of the Majority Lenders, has or
MAC CLAUSE is reasonably likely to have a Material Adverse Effect.
(Material
Adverse
Change)
This clause provides the bank with the power to call default if there is a Material Adverse Change
in the borrowers’ position or circumstances which MIGHT prevent him from complying with the
provisions of the FA
 Controversial clause because it provides the lender with a sweep-up provision.
 Very broad and gives the lender a substantial degree of discretion.
Should be resisted or qualified by the borrower if possible

STEP 2: What is the Effect of an Event of Default?

Acceleration The result of any event of default will be that the lender can ACCERLATE the loan:
Cl. 22.13: [...] occurrence of an event of default, the Agent may, and shall if so directed by the
Majority lenders, by notice to the company:

a) Cancel the total commitments whereupon they shall immediately be cancelled

b) Declare that all or part of the loans [...] be immediately due and payable AND/OR
c) Declare that all or part of the loans have become payable on demand… on
instruction of the majority lender
Note: This clause gives the lender the power, upon an event of default, to choose from the
above options depending on which would be best for the lender/situation

 Cancel any outstanding commitments (i.e. any further drawdown)

Þ N.B. if a term loan has been utilised in full, cancellation would be irrelevant
 Declare that the outstanding principal and all interest payments are repayable
immediately; AND/ OR
Þ i.e. ask for money back immediately

57
  Declare that all/ parts of the loan are payable on demand
Þ i.e. can demand money back at any point in future w/o having to give a reason
Þ Lenders unlikely to do this immediately because it would have the potential for
triggering cross acceleration provisions in other facilities which risks putting the
borrower in a worse financial position than they are already in
 NB: Bank could also waive EoD/renegotiate terms of loan

Further Cl 4.2 – if there is an event of default, borrower will be prevented from drawing down any new
drawdowns money while an Event of Default is continuing (irrespective of whether the lenders take any
action under Cl 22.13)

Points to Consider

Mirroring  Carve outs in the events of default should be matched with representations and
Other Terms warranties and undertakings given (e.g. those provisions must enjoy the same carve outs
or otherwise you will not be able to repeat them without being in breach of a
representation)

 During a grace period, an event of default becomes a “POTENTIAL event of default”

Grace Periods  It is common that the bank will provide that during this period, its commitment to lend
new money is suspended.
 Rollovers in RCF should however specifically be allowed during a “potential event of
default” – otherwise bank can stop borrower lending via the back door – a de facto
default provision

Repeating  A borrower should NEVER AGREE to give a repeating representation that there are no
Representation potential events of default, because if there are the borrower will be unable to make the
of “no event of representation, which is, in itself an event of default (it creates an event of default out of a
default” potential event of default).

Example Scenarios

State the Breach and the OPTIONS available:

 The banks could WAIVE the specific breach

There is an EVENT OF
 Cl. 25.2 – if the majority does NOT instruct otherwise, the agent can act in any way it
DEFAULT but the
thinks is in the best interest of the majority (i.e. unless specifically instructed the
BANK DOES NOT
agent can just waive the breach by own initiative but for events of default, agent is
WISH TO TERMINATE
likely to get instructions from the majority)
the facilities at this
Note:
stage as they have a
 If the bank does decide not to accelerate, it will be in a strong bargaining position to
good relationship with
re-negotiate the terms of the loan
the borrower?
 The bank may want to renegotiate the margin as the risk of the loan has increased

58
  Cl. 25.2(a) – must follow the decision of the majority
The AGENT DOES NOT
 Cl.22.13 – agents shall act if directed by majority lenders (otherwise may act)
WANT TO TERMINATE,
 Cl.1.1 – majority lenders must have more than 66.66%
but the OTHERS DO?
 Look at Sch 1 and calculate what % each lender has (N.B. first limb is for
when no money has been drawn, second limb applies any time). The
majority needs MORE THAN 66.66% to make decisions (therefore if one
holds 33.33% they effectively have power of veto).
 Percentage participation of a bank = total amount given by bank/total
amount given to borrower x 100. E.g.
o Facility A

 Poleton lent 5,000,000

 Total facility is 16,000,000

o Facility B

 Poleton’s Total commitment = 1,000,000/5,000,000 = 20%

 20% of 2,500,000 = 500,000

 So, Poleton has lent 500,000 under Facility B

o 16,000,000 + 2,500,000 = 18,500,000 (total amount of money given to

Indigo so far)

o 5,000,000 + 500,000 = 5,500,000 (total amount of money Poleton has

given)

o 5,500,000/18,500,000 = 29.73%

 The agent could terminate despite the majority being against it given his stake in
The AGENT WANTS TO the facility
TERMINATE, but the  Commercially it is unlikely the agent would do that
OTHER BANKS DON’T  The agent of the syndicate has fiduciary duties
AND the AGENT HAS  The agent MAY be acting outside the common law scope of its authority as an agent
33%?  Other lenders MAY try and claim against the agent to the extent that they cannot
recover from the borrower.

 Cl 22.3 – agent is able, in its capacity as agent, to take action

If MAJORITY LENDERS  Cl 25.2(e) – Agent may act as it considers to be in the best interest of the Lenders
DO NOT DIRECT o So, Agent cannot pursue a course of action that only benefits them as one of the
AGENT? lenders
 In practice, circumstances where Agent would take unilateral action in the absence
of instructions are very limited
o Agents usually consider their role as just administrative

59
 Repayment, Pre-payment and Cancellation Clauses

The following clauses are part of the mechanics of funding and settlement (‘funding mechanics’).

Repayment  It will appear before the representations, undertakings and events of default.
 The form of repayment will depend on the type of facility:
 A non-amortising loan will simply refer to a fixed date; if the loan is amortising, tables
listing the amount to be repaid on specific dates are usually attached as schedules to the
agreement.
 An overdraft is usually on demand and so does not strictly require a repayment date.

 Most loans will allow (and in certain circumstances require) a borrower to repay capital before
Prepayment the dates envisaged by the facility agreement.
 W/o some form of contractual provision, a borrower probably has no right to prepay a loan.
 From a borrower’s perspective, the ability to pay down the loan as soon as spare capital is
available will save interest payments.
Points a bank’s solicitor will want to ensure the following are covered:
 Broken funding: If a borrower prepays part of the loan, the bank may be left to service an
interbank loan without an equivalent interest stream from the borrower. Alternatively, the
bank would have to terminate the interbank loan early and incur breakage fees (there is
usually no provision for prepayment in interbank borrowing). FA will include “break costs”
clause - borrower must reimburse the bank for matched funding losses it incurs as a result of
prepayment.
 Prepayment fee: to cover the administration costs of early repayment.
 Order of application – pre-payments generally apply in inverse order i.e. against future
payments rather than rateably
 Preference: If the borrower was to become insolvent within six months of a prepayment
(extended to two years for connected parties), there is a risk that a liquidator or administrator
could apply to set aside the prepayment as a preference under the IA 1986, s 239.

 In some circumstances a borrower will be required to prepay the facility,

Mandatory 
In an investment grade facility, there are usually only two circumstances requiring
Prepayment
mandatory prepayment:
 if it becomes unlawful for a bank to lend to the borrower.
 This is typically due to sanctions being imposed - sanctions may prevent banks
lending to borrowers subject to the sanctions. In a syndicated facility, the
borrower is usually required to repay just the affected bank and not the whole
60
 syndicate; and
Þ if there is a change in control of the borrower.
 Control is typically defined as the ability to remove half or more of the directors,
the ability to dictate how the company is run, the holding of a majority of the
shares in the borrower, or the ability to cast more than half the shareholder votes.
 The bank’s concern is that the borrower may be run differently or supported less
by the new controller, so will require prepayment of whole amount outstanding

Cancellation  If a loan provides a commitment period over which the borrower is allowed to utilise the
facility, the bank will almost certainly charge a fee for making the facility available during that
period (known as a ‘commitment fee’.
 However, a borrower may realise part way through the commitment period that it will not
require the full amount of the available facility.
 Many loans allow the borrower to cancel any available amounts during the commitment
period and so save on commitment fees (although sometimes a bank will charge cancellation
fees!).

Schedules


At the end of the document, after all the operative provisions but before the execution clause.

Attach lists of information which could be included in operative provisions but too long etc.
 E.g. banks’ commitments, condition precedent documents, repayment dates and amounts, and
mandatory costs formula.
 E.g. agreed drafts of documents required under the loan such as transfer certificates, accession deeds.

Negative Pledge Clause (Cl 21.3)

 Restriction on how the borrower may use its assets – prevents borrowers being able to create additional
security over their assets (even if lenders are secured, they do not want borrower granting second ranking
security because those lenders could enforce thus forcing the hand of the first ranking lenders)
o Clause may exclude some types of security of quasi-security (Cl 21.3(c))
 A negative pledge clause is not technically a security interest (although it might provide a claim in tort for
damages against a third party which induces a borrower to breach the prohibition, and there is an argument
that the third party holds any such security on trust for the negative pledge holder).
 The Companies Act 2006 security registration form MR01 includes a tick box notification if the ‘terms’ of the
security include a negative pledge.

Set-off

It is not a security interest (and so not registrable) but an equity – a right to set a debt owed by a
What is creditor to a debtor against the debtor’s debt, and so reduce or extinguish that debt.
it?  Facility agreements typically prohibit the borrower from exercising set-off against the bank

61
When is Three ways in which a bank is likely to have a right of set-off against a borrower.
it
available 1) Equitable right of set-off: a bank may set off a liquidated debt owed to it by a borrower
to the against a liquidated debt owed by it to that borrower.
bank? 2) Contractual right of set-off: Most security documents supporting a loan will enhance the
equitable right of set-off by allowing the bank to set off unliquidated (i.e., contingent) claims.
3) Set-off liquidation: any ‘mutual’ credits, debts or dealings can be set off so long as the bank
did not know of the petition for insolvency against the borrower when it gave credit.

Legal Opinion

Legal opinions have the purpose of confirming that all documents associated with the loan are
What are legally valid and enforceable and highlight areas which may be problematic.
they?
 Legal opinions relate ONLY to matters of LAW – NOT on fact and NOT commercial opinions
 They do NOT provide a guarantee that the borrower will service or repay the loan

 They are NOT a complete risk assessment or a confirmation of the commercial efficacy of
the transaction.

Legal opinions almost always required for:

Þ Large loans

62
 Þ Secured lending

Þ Overseas jurisdictions

1. Legal opinion firm gives to client (i.e. an Arranger): confirming to client you have done job
Two Types properly (i.e. confirming that you have done the DD)

2. Legal opinion given by foreign counsel. (TB p.185). Lawyers instructed because:

Þ taking security over assets in another jurisdiction; or

Þ obligor is incorporated in a different jurisdiction

A legal opinion has two main purposes:

Purpose
a)
Inform the addressee of the legal opinion of the legal effect of the transaction

E.g. companies incorporated in England and Wales who are entering into English law
governed finance documents – opinion on capacity, due execution and enforceability
b)
Identify legal risks that the addressee should consider further and evaluate

They are generally required by lenders to reassure them that the legal effect of the FA is as they
think it is. Liability will be transferred to the lawyers. Consequently, they will focus on whether the
transaction documents:
1)
Bind the borrowers, any 3rd party providing security and any guarantors
2)
Will be enforceable against the obligors

NB: A legal opinion is no substitute for legal advice. In finance transactions, their main
purpose is to satisfy a Condition Precedent - thereby allowing the transaction to proceed.

A legal opinion NEVER confirms that the lender will definitely get their money back in the event
that the Borrower becomes insolvent. This is because the court could always use its discretion to:
a)
Invalidate a charge (s245 IA 1986)
b)
Find a preference (s230 IA 1986)
c)
Apply equitable remedies

Therefore, legal opinion should include a qualification that the validity, performance and
enforceability of the finance documents may be affected by insolvency proceedings and similar
processes (Schedule 4, para 3.11)

 Any security interest created under the Finance Documents may be held to be wholly or partially
invalid pursuant to certain provisions of the Insolvency Act 1986, for example those dealing with
transactions at an undervalue and preference

 The Legal Opinion will be:

Structure/
content  Given by a law firm
 In writing

 Addressed either to the bank, or if there is a syndicate it may be addressed to the agent
bank on behalf of all existing banks or to each bank individually (i.e. finance parties as at

63
 date of legal opinion)

 Should be signed by the firm (NOT own name of solicitor)

How Are They Designed? They are usually in the format of:

1) Preamble

2) Assumptions and reservations – opinions are subject to the assumptions and reservations
e.g.

All signatures are genuine

Docs submitted as originals are authentic and complete

Docs submitted as copies are complete and conform to the original docs

Any resolutions were properly passed

Docs on which the opinion relies remain accurate

Any searches remain unchanged

Company not subject to any insolvency procedure

No foreign law would affect the conclusions reached in the opinion

If opinion covers security docs:

• Bank had no notice of any prohibition or restriction on creating security or notice of

any other security in the same assets

• Immediately after providing guarantee, each obligor was fully solvent, guarantee was
in good faith, for the benefit of the obligor and did not constitute financial assistance

3) Opinions – most common opinions


Borrower was properly incorporated and is not in liquidation

Its capacity, power and authority to execute and perform the transaction docs

Facility agreement will not contravene English law, regulation applicable to companies and
not violate any provision of the borrower’s articles

Payments made by borrower will not be subject to UK taxes and no taxes are payable on
execution or registration of the facility agreement

All necessary registration, filings, licences and consents have been obtained

Opinion that each Agreement to which each Company is a party constitutes that Company’s
legally valid, binding and enforceable obligations

A statement that a winding up search has been carried out

4) Qualifications - Opinions will be very heavily qualified


E.g. Cl 5.4 – “Legal validity. The obligations of each of the Original Obligors under the
Finance Documents to which it is a party constitute its legal, valid, binding and enforceable
obligations.”

64
 
But Sch 4 para 1 – “The term enforceable means that an obligation is of a type which the
English courts enforce.” – reduces scope of Cl 5.4 significantly

Most common qualifications:

The validity, performance and enforcement of the facility agreement may be affected by
insolvency proceedings

Facility agreement is enforceable read on basis that equitable remedies are at the
discretion of the court

Provision purporting to create fixed charge may be construed as creating a floating charge

The enforcement of some security rights is controlled by law

Any claims under loan may be affected by lapse of time, rights of set-off or counter-claim

Opinion can only take account of the law of England and Wales

A court may refuse to entertain proceedings if a claim has/is being brought elsewhere

Certain specific provisions may not be upheld by a court

The opinion will only comment on questions of law = not of fact:

 Cl. 5.16 – “no original obligor is unable to pay its debts within the meaning of s. 123 IA
1986 at the time it enters into an agreement and no original obligor will become unable to
pay its debts as a result of doing so” …

 The solvency of a company is a question of FACT: it can only be a qualification of

the opinion but NOT an opinion.

N.B. will not opine whether charge created is fixed or floating because of Spectrum - see WS 5

A lot of the points a legal opinion will be sought on will also be repeated in form of warranties
Repeated? and representations by the borrower. E.g. representation as to the enforceability of the finance
documents. Why is there repetition?

At the stage the Legal Opinion comes the FA has not been entered into

Legal opinion speaks as of its date

• The law may change after the legal opinion is given and before FA is entered

• Borrower repeats reps and warranties because risk of change of law has to be taken
by the borrowers, not the lenders and certainly not the lawyers

Remedies

• If opinion is wrong, banks will have the ability to sue the lawyers but will likely also
want recourse against the borrower directly

• If borrower has breached a rep, bank will be able to declare an event of default
allowing them to

• Refuse to lend borrower any more money

• Call for borrower to repay what has already been lent

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 Every opinion will be qualified by a section entitled: “scope of opinion” in which the lawyers for the
Scope first type of legal opinion will limit the scope of the opinion to:

 English Law

 Matters of law only

 Generally, only an addressee may sue the solicitor if the opinion proves wrong, although the
Legal effect solicitor will owe a general responsibility to anyone they know has relied on their advice.
 If opinion is addressed to agent, agent would have to take action against the law firm on behalf
of the banks. If each bank was an addressee, then they could each sue individually.

 Lawyers will attempt to limit the liability by stating that only the addressee/finance parties as at
date of opinion or facility agreement are authorised to rely on the opinion.

 But law firm may agree that where an arranger is agreeing to underwrite a loan on day 1 with a
view to selling part of the loan very shortly thereafter, the legal opinion may also cover the
bank the arranger intends to sell down to. Usually this is time limited e.g. finance parties who
become finance parties within 6 months of the date of the facility agreement.

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 4 - Guarantees and Indemnities
What is a Guarantee?

A guarantee is a form of UNDERTAKING by one party to answer for another party’s liabilities , usually on its default.
 In the context of a loan, the guarantor will frequently be a company in the same group as the borrower.
Þ E.g. a bank might make a loan conditional on receiving a guarantee of the borrower’s obligations from its
parent company.
 Furthermore, the company which has given the guarantee may be required to give security over its own
assets to support its potential liability under the guarantee.
 As well as providing a second source of repayment, a parent company will also guarantee punctual
performance of the borrower’s obligations under the facility, to encourage supervision of the borrower by
the parent.
 Guarantees often referred to as quasi security because it does not create any rights over an actual asset

Guarantee versus Indemnity

Difference between Guarantee and Indemnity

 A GUARANTEE
Promise to be liable for the debt, or failure to perform some other legal obligation, of another party.
Þ Creates a ‘SECONDARY’ obligation which relies on there being a valid primary obligation between two
parties other than the guarantor
 EXAMPLE: Guarantor (G) undertakes that the B will perform his obligation to the lender (i.e.
repaying the loan and paying interest repayments etc. – if B fails to do so, G will be liable to
the lender for those obligations.
 An INDEMNITY
Promise to be responsible for another party’s loss
Þ Creates an obligation to indemnify a party for a specified loss which it may incur.
 Unlike a guarantee, an indemnity creates a ‘stand alone’ (or PRIMARY) obligation which is
independent of the liability or default of another party.
 In general terms, an indemnity is more ‘robust’ than a guarantee: most loan facilities
therefore contain a guarantee plus an indemnity, in case the guarantee fails

Direct Comparisons
GUARANTEE INDEMNITY
Less Robust (+ for guarantor) More Robust (+ for lender)

Must support a primary liability between two parties  Creates a binding obligation to indemnify a party
other than the guarantor. for a specified loss which it may incur.

I.e. guarantee agreement is a secondary contract,  I.e. Indemnity creates a ‘stand alone’ (or
will not create a ‘stand alone’ obligation primary) obligation which is independent of

Validity of obligation under guarantee will be the liability or default of another party
dependent on the guaranteed obligation.  The obligation survives the invalidity/ discharge

The guarantor has given an undertaking to guarantee of the original facility agreement.
the performance of the borrower’s obligation.  Indemnifier has given a direct undertaking to

The guarantor's liability for the non-performance of perform the borrower’s obligation itself.
the principal debtor's obligation is co-extensive with  An indemnity is more ‘robust’ than a guarantee –
that obligation, i.e. if principal debtor’s obligation most loan facilities combine the two.
turns out NOT to exist, or is void, diminished or
discharged, so is the guarantor’s obligation in respect
of it.
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 
So, with a guarantee the lender can be prevented
from claiming repayment from the G when it most
needs to rely on the guarantee i.e. when the FA fails
because of illegality/ is discharged etc...
Changes Immune from changes
 Guarantees – unlike indemnities – are also vulnerable  Immune from changes made to the original facility
if any changes are made to the FA. Any such changes agreement.
– made after the giving of the guarantee – will
discharge guarantor’s liability, unless either...
(a) G gives consent to the variation(s); OR
(b) Variation is patently insubstantial or incapable of
adversely affecting the G
More formalities Less formalities
 S.4 Statute of Frauds Act 1677 states that guarantees  Indemnities do not need to be in writing.
must be in writing and signed by the G in order to be
effective.
 Where these formalities have not met, lenders will try
to have the promise characterised as an indemnity.

Legal Implications of a Guarantee

Once a contract is classified as a guarantee there are a number of consequences at common law (most of which the
bank will want to vary), including the following.

Consequences of Being a Secondary Obligation

 Not liable unless debt becomes due

Þ Since the guarantee creates a ‘secondary’ obligation, the guarantor will not be liable unless the
borrower’s debt becomes due.
Þ BANK’S RESPONSE: Will want to negate this - Most banks will therefore require that the ‘guarantee’ is
‘on demand’ and payable as if a ‘principal debt’: once the borrower defaults, the bank can immediately
demand performance from the guarantor.
 The primary contract becomes void = guarantor’s obligation discharged
Þ If the contract between bank and borrower (the primary contract) is void (or if the borrower’s
obligation is discharged), the guarantor’s obligation will fall away.
Þ BANK’S RESPONSE: A bank will therefore usually include a provision that the guarantee survives failure
of the underlying obligation, as well as an indemnity within the guarantee document in order to create
a primary obligation on the ‘guarantor’ if the guarantee fails.
 If the contract between bank and borrower is varied in any material way without the guarantor’s consent,
the guarantor is released from the guarantee (even if the variation was not prejudicial to the guarantor)
Þ Similarly, certain acts which might be prejudicial to the guarantor (e.g., if the bank fails to register
security for the debt) will void the guarantee.
Þ This issue commonly arises where the facility which the guarantee supports is to be increased.
 Triodos Bank v Ashley Charles Dobbs - any amendment or variation must be ‘within the
general purview of the original guarantee’
 In Triodos the guarantee was held not to survive an increase of the underlying facility, in part
because the facility was to be used for a different purpose. The fact that the guarantor knew
of the amendments made no difference – he had to consent with a clear understanding of the
facts.
 Maxted, Lorimer v Investec Bank plc – more recently held that amendments to a loan (inc. an
increase in amount and extension of the term) were within the purview of guarantees.
Confirmed if amendments were beyond purview, could be cured by guarantors consenting

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 Other Key Rights (usually waived or postponed)

 A guarantor may use most rights of set-off or counter-claim which the borrower has against the bank (and
which arose before the borrower defaulted) to reduce its liability under the guarantee.
 Once it has paid out under the guarantee, a guarantor will be entitled to reimbursement from the borrower.
o This right will arise through an implied or actual indemnity between the borrower and guarantor.
 The guarantor will also be entitled to any security the bank holds for the borrower’s debt, under the
doctrine of subrogation.
o Subrogation arises only once a guarantor has paid the full amount to which it is liable under the guarantee
(and does not arise automatically for an indemnity).
 If there is more than one guarantor of the debt, any guarantor that pays out will have a right to claim back a
share of the payment from the co-guarantors (a right of ‘contribution’).

 The problem with all these rights from a BANK’S PERSPECTIVE is that it may not want the guarantor to
enforce them immediately (e.g., if the subrogated security secures borrowings in addition to the
guaranteed loan).
 The guarantee document should therefore postpone the rights until such time as the bank has been
repaid in full and no longer requires the security.
 It will also want any obligation of contribution to be waived in respect of any subsidiary it wants to sell
(e.g., on enforcement of security).

Measuring the Risk of Guaranteeing the Obligations of the Borrower

 If borrower is unable to meet its obligations under the FA – Guarantor will have to meet them

So… Guarantor will Therefore want to Check the Following:

The financial 
Is the borrower likely to default on its loan obligations?
position of the Þ Guarantor will want to check
borrower  The financial accounts – any cash flow problems?
 Commercial position of the borrower (strength of competitors etc)
 The assets of the borrower (sufficient to repay the loan?)
 Prospects of the business e.g.
• If borrower is developing a new technology, will it actually produce cash
for the business?
• Does the borrower have cash coming in from other sources/projects?
• N.B. greater the risk to the guarantor that borrower is going to default, the greater the
corporate benefit must be

The financial 
Are they a solvent?
position of the 
Will it be able to cover B’s obligations to the lender?
guarantor Þ i.e. How likely is it that they will default?

The security 
Guarantor will want to check that the security the bank has over the borrower’s
being provided assets are enough to cover the debt
by the Þ If the security is sufficient to cover the debt, lender will be able to enforce
borrower the security against borrower without having to go to the guarantor
Þ May also want other guarantors in place to water down their risk
Þ HOWEVER, there are two problems:
 Easier to enforce guarantee = even where borrower has sufficient security, it’s
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 likely that lender will go straight to guarantor to satisfy debt, before enforcing
buyer’s security (as it’s harder and time-consuming to sell the secured asset
than to enforce the guarantee)
 ‘Fire-sale’ devaluation of asset = on insolvency, borrowing co. might have
to do a fire-sale, so will not be able to negotiate good prices. Lender may
recover more money by enforcing against the guarantee
 How does the guarantor get their money back?
Þ If lender pursues guarantor rather than enforcing the borrower’s security,
guarantor has a right to be indemnified by the borrower.
Þ Guarantor also has a right of subrogation (meaning guarantor can enforce the
bank’s security against the borrower)

Corporate Benefit

G Must Benefit from its Agreement to Guarantee the Loan

 It is necessary for a company providing a guarantee, indemnity or real security to PROVE it derives sufficient
‘corporate benefit’ from granting the security
Þ s 172 CA 2006 requires director to ‘act in a way he considers, in good faith, would be most likely to
promote the success of the company for the benefit of its members as a whole’.
Þ At first sight, seems difficult to justify a company giving guarantee or security for another
company’s loan as being in its best interest…
 PARENT company: Might justify supporting subsidiary (“DOWNSTREAM guarantee” –
easier to show validity)

Directly or indirectly it will normally receive dividends from its shareholdings = profit

Increased value of shares

Explain with expansion plans and overall group success

This argument can be strengthened by a down-stream support letter especially if
borrower is a small company in a big group
 SUBSIDIARY company: Might justify securing its parent (“UPSTREAM guarantee” – more
difficult to argue, but possible)

Could argue that the support it receives from its parent (financial, marketing,
product development, enables use of software etc.) provides sufficient corporate
benefit – how closely do they work together? Same line of business?

Positive effect on the group (all subsidiaries) – e.g. if parent benefits from the loan it
can maintain software assistance etc.

The money borrowed by the parent will be part invested back into the subsidiary.

The parent borrows the money because it can achieve a better rate – but can only
do so with a G. So, the subsidiary benefits from guaranteeing the loan.
Þ If a company believes there is INSUFFICIENT corporate benefit to provide security, there is
authority to suggest that it may still be given, provided that:
 The company’s shareholders unanimously direct the security to be given
 The company is not insolvent either at the time of giving the security, or immediately
following the giving of the security
N.B. payments under guarantees may be set aside by liquidator/administrators if they challenge the payment as
being a preference (payment can be challenged up to two years later). Defence would be to say the transaction
was entered into in good faith and for the purpose of carrying on its business and had reasonable grounds for
believing the transaction would benefit the company.

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 Power of G to Enter into the Guarantee

Ds must have the REQUISITE POWER to enter into a guarantee (corporate capacity) and its officers must be
properly authorised.

 s171 CA 2006 – directors must act in accordance with the company’s constitution and exercise their powers for
the proper purpose
 Ideally, G should have an EXPRESS POWER to do so but ensure no restrictions either in its:

Memorandum – if incorporated before Oct 09; OR

Articles – if incorporated after Oct 09

Check articles for:
 An article permitting Ds to act in ways which are ancillary to the object of the co. – giving a
guarantee/indemnity is likely to be ancillary to the object of most trading co’s – if it is
deemed that there is a Corporate Benefit
 Any limitations on the Ds’ exercise of their powers

Ds MUST COMPLY with DIRECTORS’ DUTIES under CA ’06


s171 = duty to act in accordance with company’s constitution (requisite power)
 D could be in breach of this if he caused the co. to enter into guarantee despite restrictions on the
Ds’ authority to enter into such a transaction, or on the co. itself to give guarantee

s172 = duty to promote success of co. (relates to corporate benefit) - above
 D must, ‘act in the way he considers, in good faith, would be most likely to promote the success of
the co. for the benefit of its Ms as a whole’ – when deciding to let co. give guarantee, this must be in
the best interests of his own company – and not just to protect another co.
o Ds must have regard to s172 a non-exhaustive list of the factors
(a)
Likely consequences of any decision in the long term,
(b)
Interests of employees
(c)
Company's business relationships with suppliers, customers and others,
(d)
Impact on the community and the environment
(e)
Need to maintain high standards of business conduct; and
(f)
Need to act fairly as between members of co.
o Ds could also be liable under s212 IA ’86 – Misfeasance
o NB. if guarantor/borrower are members of a group business, consider the interests of the group (i.e.
the borrower may not have to be regarded as another co.)

s173 = duty to exercise independent judgment
 D must look after interests of own co. and not have his discretion fettered by benefits he has been given

s174 = duty to exercise reasonable care and skill
 Breach of any of the above will probably amount to a breach of this also
 N.B. directors should consider their duties to that particular company rather than companies within the group.
 HOW DIRECTORS DEMONSTRATE COMPLIANCE: If Ds are satisfied that they’ve complied with these duties –
should record this in the BOARD MINUTES
 If Ds of the guarantor make a loan improperly they will be in breach of these duties
 CONSEQUENCES: SH derivate action against Ds on behalf of the company (s260) – so if Ds worried, get SH
resolution authorising (ratification)
o Ds in breach of duty must account for profits, pay equitable compensation and any contract entered
into (inc. any guarantee) might be rescinded

Lender’s Concerns and Bank Protections

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 If Ds of guarantor have no CAPACITY to enter into guarantee agreement, the guarantee
agreement COULD still be valid against the lender (due to statutory protection - see below).
CAPACITY
HOWEVER, the lender will not want to rely on this protection SO WILL WANT TO CHECK THEY
HAVE CAPACITY

Pre-2006  An objects clause that was in the memorandum will bind the co. (s28 CA):
company  This will be an issue if the co. has not removed the objects clause and the objects
clause does not entitle a co. to give guarantee, or if there is a limit on giving
guarantees. Co. would be acting ultra vires and the validity of the guarantee could be
challenged on this basis
 BUT see bank’s protections

Post-2006  No restriction on the objects unless expressly stated (s31 CA)

company 
If company had not decided to put in restrictions – not an issue

If the company decided to put in restrictions – and they acted outside that power,
then the company would have acted ultra vires and the validity of the guarantee
could be challenged on this basis
 (BUT – see bank’s protections below)

Bank’s  s39(1): The validity of an act done by a co. shall not be called into question on the
protections: grounds of lack of capacity by reason of anything in the co.'s constit. This means the
s39(1) CA bank can enforce the guarantee even though the co. acted in breach of their constit
 Bank will not rely on s39 because the guarantee might be challenged on grounds other than
the constitution (i.e. s39 does not offer full protection)

Bank’s  s40 – in favour of a person dealing with a company in good faith, the power of the directors
protections to bind the company, or authorise others to do so, is deemed to be free of any limitation
– good under the company’s constitution
faith: s40 
Not doing a search when you should have is not enough to be bad faith;
CA 
A person is presumed to have acted in good faith;

A person does not act in bad faith just because they knew of a restriction. 40(2)(b)(iii):
This means even if directors did not have authority to enter into guarantee agreement, bank’s
right to enforce guarantee will not be affected.
 BUT there is uncertainty over definition of ‘good faith’.
o ‘bad faith’: if criminal activity, defrauding/sham that you know about, is shown
that this is LIKELY to be bad faith

What  Lender should check the company’s memorandum and articles and speak to the directors
lender will themselves to find out if there are any restrictions on the company giving guarantees
do rather o If there are restrictions, ensure that the company gets rid of the restrictions before
than rely on entering into guarantee
protections o Ask for copies of board minutes/shareholders resolutions amending the articles to
take away the restrictions as a condition precedent
 Also, even if s39 and s40 could be relied upon by the lender to enforce the guarantee, the Ds
could still be personally liable and get sued by their own SHs (s260 above)
o May destabilise the company and make the bank less likely to get their money back
o Therefore, check the board minutes to see if Ds considered their duties
 Reason why we are doing this transaction

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  Benefit of the transaction (corporate benefit)
 Preferably, want a SH resolution authorising guarantee – lender should check for this
 Check all relevant signatories have signed the docs and they are all properly appointed Ds

Common Law Rights and Defences of the Guarantor

The default position w/o FA amendment

Right Purpose
Indemnity against  Apart from any express contract between the principal debtor and the guarantor, IF the
creditor guarantor gives the guarantee at the express or implied request of the principal debtor,
there arises at the time when the guarantee is given an implied undertaking by the
principal debtor to indemnify the guarantor in respect of any sums the latter pays under
the guarantee
 The indemnity will be either implied or actual (an express counter-indemnity).
 This right provides that once the guarantor has paid out under the guarantee, a G will
be entitled to reimbursement from the B.
 B indemnifies G against any payment G must make (on behalf of B) under the terms of
the guarantee.
Subrogation  G assumes rights of lender.
 Arises once a G has paid the full amount to which it is liable under the guarantee.
 The G will then be entitled to any security the lender holds for the borrower’s debt
(whether the creditor held them at the time that the guarantee was given or
obtained them afterwards)
BOTH ABOVE PROVISIONS TEND TO BE USED TOGETHER BY G TO ENSURE IT GETS ITS MONEY BACK
Contribution  If there is more than one Guarantor of the debt, any G that pays out will have a right to
claim back a share of the payment from the co-Gs.
 Note: The right of contribution arises against other guarantors of the same obligation
whether they are liable jointly, severally or jointly and severally , and whether they
are liable under the same or separate instruments.

Defence Purpose
Co-extensiveness  Due to the co-extensiveness of guarantees, the Guarantors principal defence is that
IF THE PRIMARY OBLIGATION (FA) is:
 discharged;
 invalidated; or
 materially varied –
 The SECONDARY OBLIGATION guarantee becomes immediately void.
Disclosure  A contract of guarantee, unlike that of insurance, is not uberrimae fidei (utmost good
faith; as opposed to caveat emptor) – therefore, the creditor has NO DUTY to
disclose to the guarantor, before the contract is concluded, all material
circumstances known to the creditor.
 Yet a creditor does have a limited duty of disclosure:
 In particular the bank must disclose contractual arrangements made
between it and the principal debtor which make the terms of the principal
contract something materially different in a potentially disadvantageous
respect from those which the surety might naturally expect.
 The surety will be discharged if he relied on the absence of the non-
disclosed fact in giving the guarantee

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 A lender will attempt to include a series of contractual provisions which override these guarantor’s common law
defences – the guarantor may not accept them.

Main Clauses in a Guarantee

Different TYPES of Guarantee

 “G guarantees to the Lender performance by B of all its obligations under the FA”.

 Effect: G guarantees to the lender performance by b of its obligations under the fa:
 Secondary obligation
Pure guarantee of  If B fails to fulfil its obligations, it will be in breach of the FA and G will
performance automatically be in breach of the guarantee – it must then fulfil B’s obligations
to the lender.
 The lender has an action in damages against the G.
 Technically, the Guarantor would be obliged to perform any of the obligations
the Borrower promised to do – such as purchase a piece of land (as this was a CP
of the loan). However, this is unlikely to be enforced.
 If there are cross-default provisions in the Guarantor’s own loan agreements
then this can be a significant problem for the Guarantor.
 “G undertakes with the Lender that, whenever B does not pay an amount when it is due
under the FA, the G will immediately on demand pay that amount as if it were the B”.

Conditional  Effect: G is only under an obligation to pay if B breaches its obligation.

Payment  When borrower does not pay any amount when due, guarantor shall
Guarantee immediately on demand pay that amount as if it were principal obligor
 On such a breach, G does not breach its own agreement (so no damages
against it) but is under an obligation to pay the lender – on the demand of that
payment from the lender.
 So the payment is “conditional” on the lender demanding the sum.
 The lender has a debt action against the G – for a fixed and ascertainable sum.
 This is similar to an indemnity in its effect BUT – remains a secondary obligation
so still a guarantee.
 Note: The “on demand” provision also has the effect that the statutory
limitation period does not start to run until the money is actually demanded.
 This is a primary obligation and provides the G will indemnify the lender in respect of the B
Indemnity  “if any obligation guaranteed by G is or becomes unenforceable, invalid or illegal it
will, as an independent and primary obligation, indemnify the Lender immediately on
demand against any cost, loss or liability it incurs as a result of the B not paying”
 Should the guarantee fail (i.e. the original FA is declared void or is discharged) an
indemnity will kick in to indemnify the lender against any loss it incurs as a result of B
not paying any amount when due under the terms of the FA

Combination of all 3….

Often a guarantee will contain both, a pure guarantee and a conditional payment guarantee – to ensure that the
Lender receives the widest possible protection i.e. to provide him with a damages and debt action against the G.

So… most guarantees will contain:

 Pure guarantee = providing a damages action should G breach the terms of the guarantee. Cl 2.1
 Conditional payment guarantee = providing a debt action should B breach any of its payment obligations.
AND Cl 2.2
 Indemnity = should the guarantee fail (i.e. the original FA is declared void or is discharged) an indemnity
will kick in to indemnify the lender against any loss it incurs as a result of B not paying any amount when due
under the terms of the FA (Cl 2.3). The indemnity is a primary obligation.

Common Clauses
 Irrevocable and unconditional obligations
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 o tries to change the nature of the guarantee into an indemnity to make it an unconditional obligation
 Joint and several liability
o allows the bank to take action against any one or more of the G/I in respect of the whole debt
 Continuing guarantee
o the guarantee covers subsequent advances made by the bank to the BW under a revolver/overdraft
 Appropriations
o bank can reserve any money recovered under g/I in a suspense accounts instead of using it to discharge
the debt immediately: this is to ensure that if BW goes insolvent bank’s provable debt for the purposes of the
liquidation is the whole amount, so it reduces the loss that the bank may suffer if BW goes insolvent.
o Note: clause can be voted void under UCTA as it makes BW/G/I liable for the whole debt even though they
repaid a proportion
 Waiver of guarantor rights
o any variation to the primary contract that is guaranteed may discharge G’s obligation (includes
extension of a grace period)
 Deferral of guarantor rights
o subrogation, indemnification

Clause (in draft

Purpose
guarantee)

Continuing  Rule in Clayton’s case

guarantee clause  Payments paid back to a lender, discharge the oldest standing obligation first.
(CGC) Once a guaranteed liability has been fixed in value, the guarantee sits over that
amount and guarantees that amount. If you have an RCF, as sums are paid back
Aims to nullify co- in, the guarantee starts shrinking. But when borrower withdraws more, the
extensiveness (avoid guarantee does not extend to cover these new withdrawals. So, guarantee does
Clayton’s case) not cover the entire liability.
 A CGC is an attempt to avoid the rule in Clayton’s case
 Cl 3: The clause stipulates that:
 “this guarantee is a continuing guarantee and will extend [...], regardless of
any intermediate payment or discharge in whole or in part”
 Guarantee lasts for duration of B’s obligations under the FA and covers all sums
lent i.e. liable for ultimate balance BUT capped at max amount G agreed to.
 Summary
 Relevant for revolving credit facilities/ overdraft – where a B can borrow
money, repay it and then subsequently re-borrow it again.
 CGC negates the effects of Clayton’s Case – if sum is repaid & re-borrowed,
the guarantee survives for final amount outstanding
 When the B repays any money – G’s liability is reduced in line with the
payment. But when that money is re-borrowed G’s liability increases to reflect
this re- borrowing
 Effect
 GCG– means that G has agreed to avoid C layton’s C ase and accept that
guarantee covers all subsequent advances made by the lender to B

Reinstatement  Cl 4: Provides that a G will still be liable for any payment by the B or G to the lender
which is avoided, restored or reduced by a liquidator/ administrator of B.
Aims to nullify co-  i.e. if payments made either under loan by the borrower or under guarantee by
extensiveness the guarantor are later set aside for insolvency reasons then guarantee is
reinstated and continued as if those sums had not ever been paid
 Bank trying to protect itself from administrators and liquidators seizing
payments under loan or guarantee
 Only operates in the event of insolvency
 where a liquidator “claws-back” a payment made to the lender by the B or G – for

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 reasons of a preference (more likely) or transaction at an undervalue
 Effect:
 Such a clause overrides the common law concept that a guarantee is purely co-
extensive with the original obligation
 as if a payment under the original loan should falter so too should the G’s
obligation regarding that payment. Reinstatement clauses prevent that from
happening.
 instant remedy for the bank where a liquidator “claws-back” a payment
 Guarantor’s position
 G should attempt to avoid such a clause as it exposes the G to liabilities that are
beyond the obligation of the B i.e. funds which have been paid to the bank – but
which the bank has been forced to repay by order of liquidator/ court. G should
not accept liability for such reinstatement.

Waiver of defences  Bank trying to separate the guarantee from the loan
Aims to nullify co-  (N.B. this clause not relevant in relation to indemnities because indemnities are
extensiveness primary obligations)
 Cl 5: Contractual provision “switching-off” g’s common law defences
 thereby removing g’s rights to discharge its obligations using normally available
defences.
 Common-law defences which are “switched-off” in draft guarantee :
 Cl. 5.1 = any time, waiver or consent granted
 Obligations of guarantees will not be affected by these things
 under common law, if this provision was not included, the guarantor would
have certain remedies if the bank gives the borrower more time
 Cl 5.2 = obligations of guarantee not affected by release of borrower from any
obligations they may have to make
 Cl 5.3 = if bank does not enforce any rights of the security, does not release G
from obligations under guarantee
 Cl. 5.4 = incapacity by the borrower
 If borrower lacks power or is incapacitated in some way, that does not
impact on the guarantee
 Cl. 5.5 = should the terms of the primary obligation (FA) be varied WITHOUT his
consent, this does not affect the guarantee
 Triodos case and Maxted, Lorimer v Investec Bank (above)
 Most lawyers will prefer to ask guarantors to consent to variations rather
than relying in language in this clause
 Cl. 5.6 = guarantee still intact if “any unenforceability, illegality or invalidity of any
obligation of any person under the FA or any other document or security”
 But if guarantee is in itself illegal, then beneficiary cannot rely on guarantee
 this clause may NOT work if the repayment by the borrower is found to be
a penalty example: if the principle is found illegal / penalty for whatever
reason, you CANNOT then claim it from the guarantor. In other words, you
cannot claim for money from the guarantor which you would not be able to
obtain legally from the original borrower.
Þ Cl 5.7 = if obligations of borrower are impacted by insolvency or similar, does not
impact the guarantee
 NB: These waivers are an attempt by the lender to nullify the Guarantor’s principal
rights under the Guarantee. Such a clause is therefore unnecessary for any indemnity
– a primary obligation which does not benefit from the rights presented by co-
extensiveness.

Immediate recourse  Cl 6: Guarantor can’t first require lender to exercise any security etc. against lender.

76
 Appropriations Cl 7 – allows bank to receive amounts paid by borrower in connection with the FA and
refrain from applying those amounts against the debt owed. This means the guarantor
(typical clause remains liable for the whole of the guaranteed debt until all debt is paid
though it may seem
unfair) Cl 7.1:
 This clause provides that the bank can use the money received from the borrower in
any way it thinks fit (as opposed as setting against the guaranteed debt and thereby
reducing the amount guaranteed for)
 Example: If the borrower owes a loan AND an overdraft then the bank can
decide to use any money received to set-off against the overdraft instead
against the loan. So, it’s the bank’s decision how to treat the money
 Reasoning: If a borrower owed two amounts (a loan and an overdraft) only 1 of
which is guaranteed for then it is clearly in the banks interest to clear the non-
secured amount first as they have the guarantee always to be able to recover
the amount secured anyway.
Cl 7.2:
 Any amounts received by lender from guarantor or in relation to guarantor’s
liability can be held in a suspense account – instead of using it to discharge the debt
immediately.
 Required in the event of insolvency of B – allows bank to claim max amount in
the event of liquidation of B
 Also prevents G seeking cash back from B until bank has got all of its money
 Normal circumstances (i.e. no Suspense Account):

All money received from the G under the terms of the guarantee is applied to
the debt.

This means that the provable debt for the purposes of a liquidator is the
outstanding debt owed by B minus the amounts contributed by G under the
terms of the guarantee.
 B has been lent £200 from Lender (L). The debt is guaranteed by G.
 B must make 5 repayments to L of £40 each. It makes its first 2 but misses
the third. G guarantees the obligation and so pays L £40.
 The outstanding debt is £80.
 B is then declared insolvent. L is still owed £80. It has no security.
Unsecured creditors receive 50p to every £1 in the winding up.
 Lender receives £40 – only one half of outstanding debt.
 With a suspense account

All money received from the G under the terms of the guarantee is put in a
suspense account

This means that the lender’s provable debt for the purposes of a liquidator is
the full amount of outstanding debt that the B has not paid = get highest
amount out.
 B is declared insolvent.
 B has been leant £200 from Lender (L). The debt is guaranteed by G.
 B must make 5 repayments to L of £40 each. It makes its first two but
misses the third. G guarantees the obligation and so pays L £40.
 Instead of using this payment to discharge part of the debt, L places the
£40 in a suspense account.
 The outstanding debt is officially £120.
 B is then declared insolvent. Unsecured creditors still receive 50p to every
£1 – so the lender receives £60 – three quarters of the actual outstanding
debt.

Therefore, the guarantor pays less money to the bank than if the lender had
not used a suspense account. This is because the bank has received MORE
money upon insolvency than they otherwise would have.
 In this instance, the guarantor would have to pay the remaining £20 (£120
77
 owed, lender gets back £60 from insolvency and £40 from the guarantor,
leaving £20 outstanding), meaning they have paid £60 in total. Compare
this to a situation where the bank paid off the debt with the guarantor’s
money (G pays £40, then £80 is left outstanding on insolvency and the
lender gets £40 leaving £40 outstanding on the loan which the guarantor
will have to pay – meaning that the guarantor pays a total of £80).

NB: The Lender can still ONLY receive from the liquidator the amount it is owed
– no scope for double repayment.

 Guarantor’s view

G always left open: can’t exercise set-off etc. against any money held by the
bank.

ADV for G:
- More likely the lender will recover a greater proportion of his money
from the B if B insolvent, so ultimately the G will have to pay less to the
lender to discharge the debt.
 DISADV for G:
- G’s often object to Apportionment clauses as it makes them liable for
the whole debt – even after they have paid a proportion of it. Clause is
therefore vulnerable to being declared void under UCTA.
- Also, this clause acts with Clause 8 to delay the G’s ability to recover
its money from B until the insolvency proceedings have completed so
likely to object
- More likely to be considered reasonable if the interest on the
outstanding amount of the debt is reduced to account for the
proportion of debt held in the suspense account.

Deferral of G’s rights  This prevents G from employing any of its rights against borrower until the lender
has been paid in full.
Aims to nullify  This is also known as a non-competition clause.
common law rights  Until bank has been paid in full, guarantor will not
 Cl. 8.1 – exercise any rights to be indemnified by the borrower;
 Cl. 8.2. – Claim any money from any other G of B;
 Cl. 8.3. – Claim Subrogation (most important right Lender wants to defer):
 Right to subrogation

Allows the G to assume all the rights the lender had in relation to B under the
FA once the G has met B’s obligations (i.e. paid off the Lender).

NB: particularly important to the lender if G is guaranteeing only part of B’s
obligations – because it means that the lender may have to compete with G for
the same assets if B becomes insolvent.

Effect: Such a clause obviously means that the G will have to wait until it can
enforce its rights as G. This means that the Guarantor will not compete with
the bank for the borrower’s assets.

Summary: The effect of all these clauses is to avoid the guarantor and the
lender chasing after the same money in case the Borrower is declared
insolvent. The Lender is taking a contractual promise from the guarantor to step
back, let the lender take all and only collect what is left afterwards.

N.B. if guarantor does receive any benefit, must hold that benefit in full and on
trust for the lender and must pay it over to the lender when the lender asks for
it

How Might G Seek to Limit its Exposure Under Such a Restrictive Guarantee?
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 Definite time limit  G can limit the ambit of the guarantee by including a definite time span to the
length of the guarantee e.g. ensure that the final repayment date is the final date of
the guarantee.
 Currently says ‘on demand’ which means that the statutory limitation of 6 yrs
does not start until the bank makes the demand
 You should negotiate that the final repayment date is final date of
guarantee (normally the guarantee is designed to run longer than that in case
clawback kicks in)
A maximum sum  Max sum that the guarantee will cover thus easier for G to determine if they can
cover it if they know the amount to be covered.
Suspense account  Argue that if there is any money in the suspense account, the interest under the FA
interest should not accrue as much to reflect this.
Renegotiate  If there is any chance, try to renegotiate to keep the guarantors defences’ alive (i.e.
take clause 5 out)
NB: guarantors often held jointly and severally liable - hence, can pursue all of them or each of them individually for
the full amount

The Grounds Upon which a Guarantee may be Challenged

Guarantee not in writing  Challenge:


Guarantee is void unless evidenced in writing and signed by guarantor (S.4
Statute of Frauds Act 1677)
Consideration required for  Challenge:
guarantee 
All contracts must have valid consideration to be binding

Past consideration is not good consideration

A guarantee will be void for past consideration if it is pre-dated by the
obligation it supports, e.g. existing indebtedness or overdraft of the principal
debtor or merely keeping the customer's overdrawn account open

Another problem for guarantees is benefit tends to all be one way
 Bank’s Protection:

Forbearance to sue = Good consideration
 Bank’s forbearance to sue customer or enforce rights in relation to
existing indebtedness can be good consideration
 Actual forbearance for a reasonable time at request (express or implied)
of the guarantor – also good consideration
 If creditor asks for security over existing debt, presumption is that the
creditor is NOT forbearing to sue (i.e. the inference - but for obtaining
the security he would have taken action which he forbears to take on
the strength of the security)
Þ Creating guarantee document as deed
Contractual Issues  Guarantee given under duress, misrepresentation or under influence must be set
aside
Guarantee given ultra vires  Guarantee will have been given ultra vires where there is lack of corporate
capacity or lack of authority on the part of the directors of the guarantor – article
restrictions (above)
Transactions at undervalue  Guarantee can be transaction at an undervalue: unlike a borrower granting
and preference (IA 1986) security (which has no real value of its own so the company is not losing out), a
guarantee usually increases the guarantor’s liabilities (thus co. would be giving far
more consideration to the bank than what they are getting back)
 Guarantee can be a preference: where the guarantor had previously only given 3rd
party security, with no guarantee. So, the danger is of the guarantee being set
aside under IA 1986, ss238 and 239 respectively
79
 Material variation of  If contract between bank and borrower varied in any material way without the
borrower’s contract guarantor’s consent, guarantor is released from the guarantee (even if the
variation was not prejudicial to the guarantor)
Corporate benefit  If giving the guarantee was not in the commercial interest of the guarantor, the
guarantor might have been acting outside its powers or in breach of s172, but this
will not make the guarantee void but will be a breach of director’s duty
Borrower’s contract void  If the contract between bank and borrower (primary obligation) is void or if it has
been discharged, the guarantor’s obligation will fall away
 Bank’s solution

Include a continuing guarantee clause. Guarantee survives failure of the
primary obligation
Clayton’s case  According to Clayton’s Case the guarantee will only apply to the first drawdown
on a revolving credit facility. When the borrower makes further drawdowns the
guarantee will not cover this if repaid for earlier and not later
Financial assistance  If guarantee is capable ‘financial assistance’ under the provisions of CA 06, ss678–
680, the guarantee itself is void (see below)

Financial Assistance

SHARE ACQUISITION & PUBLIC COMPANY SOMEWHERE IN TARGET GROUP

= The usual scenario is that a company (Bidder) wants to acquire another co (Target) and finance the purchase
through a loan to be guaranteed by the subsidiary of Target

Section Detail
s677(1)(b)(i) Meaning of financial assistance includes assistance by way of guarantee, security or indemnity
s678(1)  It is unlawful for:

A public co to give financial assistance (guarantee) directly or indirectly for the purpose
of the acquisition of its own shares (SHARE ACQUISITION)

A subsidiary of a parent public company to give financial assistance (guarantee)
directly or indirectly for the purpose of the acquisition of shares in the parent public
company (PUBLIC COMPANY IN TARGET COMPANY GROUP)

… before or at the same time as the acquisition takes place.

s678(3) The same provisions applying to assistance in reducing or discharging liability for an
acquisition that has already taken place
s679(1)  It is unlawful for a public co that is a subsidiary of a private co to give assistance for the
acquisition of shares in its parent private co.

s679(3)  The same provisions applying to assistance in reducing or discharging liability for an
acquisition that has already taken place
Exceptions  Subsection (1) does not prohibit a co from giving financial assistance for the acquisition of
to ss678(1) and shares in it or its holding co if—
679(1) in (a) The co’s principal purpose in giving the financial assistance is not to give it for the
s678(2) and purpose of such acquisition; or
s679(2) (b) The giving of the assistance for that purpose is only an incidental part of some larger
purpose of the co,
 AND the assistance is given in good faith in the interests of the co
Note there are the same exceptions to ss678(3) and 679(3) contained in ss678(4) and 679(4)

Exceptions to
ss678 and 679 S681 (Unconditional exceptions) is for distributions by way of dividends etc
contained in S682 (conditional exceptions) is for banks, employee share schemes etc.
80
 ss681 and 682
s680 1. If a co contravenes s678(1) or (3) or s679(1) or (3) an offence is committed by:
Consequences a. The Co; and
b. Every officer of the co who is in default

Liable for a fine and/or imprisonment up to 2 years

Often directors will be in breach of their duty and may have to account for any
losses suffered by the company – s 171, s 172, s 173, s 174
Also, any transaction involving giving of unlawful financial assistance will be void and
unenforceable (Brady v Brady)
How to avoid?  Restructure the acquisition so that company being acquired is no longer public when the
guarantee is given
Þ Have acquisition take place by way of a bridging loan (short term, probably unsecured
loan by bank to bidder in order for them to purchase target)
Þ Bidder purchases all the shares in target plc and target delists and becomes private
Þ Replace bridging loan with long-term loan from bank with guarantee and security from
now private company (at this point, company in which shares were acquired is not
public so no breach)
Þ N.B. Ds should still consider their duties under s 171, s 172, s 173, s 174

Comfort Letter

If G is Unable to Give a Guarantee or Indemnity, Give Comfort Letter Instead

 Sometimes a company will refuse to give a guarantee (either not allowed to or not in best interests or not
allowed to because of an existing security document – NEGATIVE PLEDGE [mortgage etc.]
 BUT bank wants parent/that co to be liable to repay the B’s debt(s) especially if B’s credit rating is low or
it’s an SPV with low assets
 Therefore, potential G will often be happy to provide a Comfort letter – aka:
• Support letter
• Letter of intent
• Keep-well agreement
 Purpose:

Comfort letters are usually given by a parent company in respect of a subsidiary. They range from a
simple written acknowledgment of the fact that the subsidiary is undertaking the obligations created
by the loan, to a statement of intention to maintain an interest in, and support for, a subsidiary
 Important:

Comfort letters are NOT normally intended to be legally binding but are used to reassure a bank
that the parent company is aware of, and supports, its subsidiary’s borrowing and other general or
specific activities.
 Drafting must be very careful:
o Don’t want to create a legal obligation inadvertently
o Should be statements of intent or policy and not requirements which the bank could enforce
o Try to make statements ‘statements of fact’ and/or intent and NOT undertakings as to future
actions/policies (e.g. Kleinwort Banson– “it is our policy to…..” is generally a statement of current fact
not an undertaking as to future actions).
o Test for whether a comfort letter has legal effect is to analyse it as though it were a contract
 Offer and acceptance, intention to create legal relations and consideration?
o Common intention of the parties must be ascertained from the letter as a whole, not from bits out of
context (Atlantic Computers) – e.g. in that case the letter in parts said it was an “expression of

81
present intent only” and was “not intended to be a guarantee” and therefore is was held not to be a
guarantee.

82
 5 - Security and Perfection
Security

 There are THREE STEPS/REQUIREMENTS to creating a valid security:

1. Creation = an agreement to create a particular security interest between debtor and creditor
2. Attachment = ensuring that the security interest binds on specific assets
3. Perfection = ensuring the security interest is valid against third parties, giving priority
• Three main ways in which security might need to be perfected
• Possession – giving creditor possession of assets
• Registration
• Notice – particularly relevant in the context of assignments over chose in action

 There are THREE DIFFERENT TYPES of security:


Legal security: liens/pledges/mortgages and charges

Commercial security: devices such as retention of title clauses and hire-purchase arrangements

Third party security: for example guarantees and indemnities

Why Might a Lender Want Security?

Main Reasons

 Security is taken in order to increase the likelihood of getting paid. It avoids the need for litigation, ensures
priority over other creditors and speeds up the recovery of debt.
 Lender may prevent other banks from providing finance to the borrower if there is insufficient value in the
assets to support the further security (essentially gives the bank a monopoly over a company’s borrowing)
 Personal guarantees concentrate the directors’ minds as it is their money which is on the line. This can
ensure more efficient / effective running of the business.
 It may carry a right to involvement in management decisions, but banks should be careful to avoid shadow
directorship;
 Secured loans carry less risk and compliance with regulatory capital requirements sometimes makes
secured loans cheaper for the lender.
 Security helps to ensure that assets are not disposed of in normal circumstances;
 It puts unsecured creditors off winding up the company in pursuance of their debt as they will be wary
that there is little chance of them getting anything

Further Reasons
Asset control and Bank does not want to resort to borrower’s assets for repayment if it can be avoided.
stability Taking a fixed charge over the borrower’s assets will prevent the borrower from
disposing of them in normal circs.
- Will ensure that fixed assets that formed the basis of the DD do remain the
company and this maintains stability.
Creates degree of Can prevent other banks from providing finance to the borrower if insufficient value in
control over assets to take further security. So, bank has control over a company’s lending.
management of the Bank will sometimes require directors to provide security via personal guarantee.
company Security will allow bank the right to take part in management decisions if borrower
defaults even if security not realised (beware the risk of shadow directorship)
Costs Secured loans carry less risk for banks.
83
 Because of risk regulations and capital requirements, will make some types of loan
cheaper than unsecured loans.
Miscellaneous NB: might not be bank’s primary reason for taking security, but are a welcome
consequence of doing so.
- May be other consequences which might benefit the bank e.g. tracing proceeds of
illegally sold assets.

Appointing an Administrator or Administrative Receiver

 If a bank wants to enforce security it will invariably do so through a third party and when the borrower is, is
about to become, insolvent
Administration pre- Bank with security would appoint administrative receiver with wide-ranging powers to
Enterprise Act 2002 manage the company and sell off assets to repay the bank.
Administration Post- Requires administrator to:
EA 2002 - Attempt to rescue the company as a going concern. If not reasonably practical or
would not produce best result for creditors as a whole, then…
- Attempt to achieve a better result for creditors than if the company were wound
up. Only if administrator thinks the first two purposes are not reasonably
practicable then…
- Realise the company’s property to distribute to secured or preferential creditors,
as long as he does not unnecessarily harm the interests of creditors as a whole.

Administrator may be appointed:

- By court order.
- Out of court by the holder of a qualifying floating charge.
- Out of court by the company or its directors.
Administrative Eight exceptions (Intended to apply to ‘specialised financing’ and not general commercial
Receiver can still be bank lending – IA 1987 ss 72B-72G inserted by EA 2002, s250):
appointed when: 1. Floating charges pre-15 September 2003
2. Capital market exception
3. Public-private partnership exception
4. Urban regeneration projects exception
5. Project finance exception
6. Financial markets exception
7. Protected railways and other companies’ exception
8. Registered social landlord exception

84
 Main Types of Security

POSSESSORY security

These are securities which allow the lender to take actual possession of the secured asset from the outset of the
loan agreement. For reasons of practicality these are rare in Syndicated Loan Facilities.

Type of Nature of security Rights security allows over Perfection

security the asset

 POSSESSION: Way of creating  Bank takes possession of  Pledged asset must be

Pledge security by actual (or the asset whilst the delivered to the lender
constructive) delivery of a borrower retains – either by means of
tangible movable asset to the ownership. physical delivery
lender, to be held until the  Pledge confers certain (delivering a car) or by
performance of an obligation implied rights to the Bank means of vesting control
(e.g. repayment). e.g. right to sell the (passing over the keys to
 Common problems: the car).
pledged assets on default
 Keeping the pledged assets  There is no legal
by the borrower.
secure requirement to
 Assets commonly pledged:
 Insurance issues document a pledge
 bearer documents such
 Liability as bailee (although desirable for
as bills of exchange,
evidential reasons)
promissory notes or
 A pledge need NOT be
bearer bonds.
registered
 E.g. Pawnbroker

 A right to keep possession of  Entitles the Lender to retain

Lien property belonging to another possession of the asset
person until a debt owed by until B has paid in full. The
that person is discharged lender holds the asset in
 N.B. different to pledge lieu of payment.
because lender already holds  Confers no right to sell the
asset, lien just gives it the right asset
to keep possession  E.g. dry cleaning
 Different types of lien:
 Common Law Lien;
 Statutory Lien;
 Equitable Lien

Security which Grants TRANSFERRAL OF OWNERSHIP of the Asset

Such security is appropriate where the bank can take legal/equitable title of the asset and therefore control of
the asset without this having a detrimental effect on the borrower’s running of the business and his ability to
make profit and thereby successfully service the debt

Type of Nature of security Rights security allows over Perfection

security the asset

85
  Legal Ownership/ Title of  The bank has legal  Formalities: s.2 LP(MP)A
Legal the asset transfers to the ownership of the asset – 1989 legal mortgage must
mortgage lender at the outset of the granting it the right to sell be:
of property loan subject to the equity of the asset on the B’s  in writing,
redemption. default of the loan under  incorporate all the
(not land –
see below)  Equity of redemption – s.101 LPA 1925 (which expressly agreed
when underlying debt is confers the power of sale terms
repaid, the debtor has the among other powers)  be signed by or on
right to get ownership  Because of the behalf of, all the
transferred back to it requirement to transfer parties.
 Transfer of title enhances title, it is NOT possible to  To complete a legal
the bank’s ability to realise take a legal mortgage mortgage, title to the
the security IF necessary – over future property, or assets must be
and in the meantime to take more than one transferred to the
prevents B from dealing (i.e. legal mortgage over the secured lender such that
selling/ devaluing) the same assets the secured lender (or its
secured assets.  Mortgage also carries an nominee) becomes the
 Commonly used either for (express/ implied) legal titleholder.
land (see below), or obligation on the bank to  If a legal mortgage is
otherwise heavy and re-transfer title on not completed in this
expensive machinery like satisfaction of the debt manner it will
aircrafts or ships. (equity of redemption). normally take effect
 Legal mortgage is a secure  The holder of a legal as an equitable
and comprehensive form of mortgage also has the mortgage.
security interest right to appoint a receiver  s. 859A CA 2006 must
over the assets. therefore be registered at
Companies House
 s.870(1)(a) CA – All
charges are registrable
within 21 days from day
of creation

Equitable  An equitable mortgage does  Same rights as a legal  Must be registered at CH

mortgage NOT transfer legal title. mortgage, however: in accordance with
 They arise when:  An equitable mortgage s.859A(7)
 formalities to create a can be ignored by:  All charges registrable
legal mortgage have not  a bona fide purchaser within 21 days from day
been completed; (“security taker”) for of creation (s870(1)(a))
 the asset being value of the legal title
mortgaged is only an to an asset without
equitable interest notice (actual/
 the mortgage is over constructive) of the
property not yet owned equitable security.
by the borrower (i.e.  This major disadvantage
leased property with can be overcome by
option to buy at end) registering the equitable
 the parties agree that it mortgage (ss 860-894 CA
should be an equitable 2006) which provides
86
 mortgage notice of the security to
 the parties enter into an anyone searching,
agreement to provide a deemed to search, the
mortgage in the future register e.g. any 3P
(once the money has purchaser or bank looking
been lent, agreement to to secure the asset.
provide a mortgage will  An equitable mortgage
take effect as an may not benefit from
equitable mortgage). s.101 LPA 1925 (i.e. power
 NB: An equitable mortgage of sale) unless:
only transfers a beneficial  the mortgage is made
interest in the asset to the by deed; or
Bank i.e. transfer of  the mortgage
equitable title expressly grants the
bank the power of sale

NB: Mortgages over Land:

 Under LPA 1925 a legal mortgage over freehold/ leasehold land can be created by way of a “CHARGE BY
DEED EXPRESSED TO BE BY WAY OF LEGAL MORTGAGE” = s. 87 LPA 1925.
 A legal mortgage over land is neither a typical mortgage nor a typical charge:
 It is not a mortgage because it does not transfer ownership of the land to the bank, but it does more than
create an encumbrance over the land so is more than a charge.
 Mortgage over land is its own entity – provides the bank with rights equivalent to granting it a 3,000 year
lease if the property is freehold, or a lease for 1 day less than the lease if the property is leasehold.
 It therefore creates rights in the asset akin to legal ownership – the bank takes rights equivalent to those
enjoyed by a title holder.
 A mortgage over land must also be registered at the Land Registry within 30 days of creation. The Land
Registry will request to see prove that the mortgage has been registered with Companies House as well.

ASSIGNMENTS
NB: Form of mortgage (NOT different type of security) – chose/thing in action

 An assignment is a mortgage  Assignment confers the  Legal assignment requires

Legal over a chose in action (i.e. same rights on the banks (s.136 LPA 1925):
assignment intangible assets e.g. as mortgages i.e. the  In writing and signed
(by way of contract, goodwill etc.). transfer of title. by the assignor
security) o Most commonly used to  Will include a provision  Absolute (i.e. not by
You assign secure a borrower’s (either explicit or implied) way of charge only)
rights, right against a 3rd party for reassignment on  Whole of the debt
novate  Does not require consent as satisfaction of the debt – due must be
burdens/ long as it makes no similar to equity of transferred (not part
obligations difference to the borrower redemption. only)
to whom he discharges the  It is subject to terms in the  Notified in writing to
rights - Tollhurst v facility agreement. any person(s) against
Associated  Disadvantages: whom the assignor
 The assignment involves the  An assignment cannot could enforce the
transfer of an intangible transfer the assignor’s assigned rights (i.e.
the debtor in the
87
 asset from the borrower to obligations. Therefore, underlying asset
the Bank. the existing bank being assigned)
 Title to the asset is cannot assign any  In order to be absolute,
therefore transferred just as undrawn cannot be ‘by way of
a mortgage (provided no commitments without charge’ and whole of the
consent required) the borrower’s debt owed must be
 An assignment can transfer consent, which makes transferred (Walter v
only rights and not assigning a revolving Sullivan)
obligations credit facility  Registration at
o Could have a collateral problematic. Companies House (s.
agreement, separate  In addition, any 859A CA 2006)
contract between bank obligation the bank  If any condition for legal
and debtor in underlying owes to fellow assignment is not fulfilled,
asset, to assume the syndicate members assignment will be an
burden will not be transferred equitable one
 Actual Notice of the  CANNOT TAKE LEGAL
assignment must be ASSIGNMENT OVER
received by the debtor (in FUTURE CHOSES IN
the underlying asset being ACTION
transferred) for the
assignment to take effect.
o Priority of competing
assignments is
determined by the date
of actual notice to the
debtor (Dearle v Hall)
o However, if assignee
who gave notice first
had actual or
constructive notice of
the earlier assignment,
then the assignee who
gave notice later takes
priority
 Example:
o C is owed £1000 by D
and C assigned the debt
to B. B notified D that his
debt is assigned. B has
priority
o If B fails to notify and C
latter assigns the same
right to E, then E’s
assignment will gain
priority over B’s, if E
notifies D first and did
not have actual or

88
 constructive notice of
earlier assignment.
 Assignee subject to equities
(e.g. mutual rights of set-off)
which arise between the
existing parties to the asset
UNTIL notification

Equitable  An assignment which  ADV:  Just need the intention to

assignment does not fulfil one or  No notice is necessary assign
more of the conditions for to the 3P. This is  One or more of the above
legal assignment (but advantageous for the s136 LPA conditions may
there is still intention to B who does not want not be met
assign) will be an equitable to inform 3Ps  If you deliberately want
assignment. (clients/ suppliers an equitable assignment,
 Alternatively, the parties etc.) that they have likely that you will not
can willingly proceed with borrowed a lot of meet the s136
an equitable assignment: money (3Ps may think requirement of notice
o If a bank wants to assign something is wrong)
PART of an outstanding  Can be used for
loan, it must use an future debts
equitable assignment.  Easier if you have lots
of contracts – may
 Priority rule in Dearle v Hall
not want to give
applies to equitable
notice to all debtors
assignments
(lots of low value
 N.B. if there was more than
contracts so not
one equitable assignment
worth the hassle)
over the same asset and in
 Equitable assignee (bank)
both cases the debtor was
is unable to bring an
not notified, priority will
action against the 3P in
have to be governed by date
his own name – needs to
of creation
join the assignor in any
action (Three Rivers DC v
Bank of England).

Security which Grants CERTAIN RIGHTS Over the Asset

A charge is a security over an asset which gives the lender a proprietary interest in the asset that allows the
lender to take possession of the asset and sell it and pay its debt out of the sale proceeds.
NB: A charge does not transfer title – it is merely an encumbrance on the asset.
Where appropriate? Where taking physical possession or legal title of the asset is impractical as it would prevent
the B from running its business effectively. e.g. Machinery, Vans, Office Equipment, Premises, Stock

Type of Nature of security Rights security allows over Perfection

security the asset

89
  Gives a proprietary interest in  Fixed charge grants rights  Register at Companies
Fixed the asset over the specific asset House within 21 days of
charge  A charge over a particular asset which... creation at CA
(equitable where the lender controls any  Prohibit B from (s859A(7)(b))
) dealing or disposal of the disposing of the asset
asset by the B – and can take without permission;
possession and sell the asset  Attempt to maintain
upon default to discharge its the asset’s value
debt. whilst it is in the B’s
 For a charge to rank as “fixed” hands; and
the lender must be able to  Allow the bank
show suitable degree of recourse to the asset
control over the assets in the event of B’s
 B is permitted to use the default under the loan
charged assets (subject to – in order to discharge
conditions designed to its debt.
maintain their value, and a  Ranks before a Floating
prohibition on disposal) unless Charge (and all the other
and until any “enforcement creditors floating charge
event” occurs as specified in holders rank behind (see
the charge doc. below)) in the order of
 On an enforcement event, repayment on insolvency.
bank may require B to sell the  The holder of a fixed
asset or the bank may take charge has a power of
possession and sell the asset sale in relation to the
(or appoint a receiver to do the charged asset, can
same) and use the proceeds to appoint a receiver, has
discharge the debt. the right to apply to court
 Fixed charge simply gives the for the appointment of an
bank a claim over the administrator (but cannot
proceeds of a sale of the appoint an administrator
charged assets in priority to themselves even if they
other creditors. notify the court)

 A charge over a general class  Borrower can continue to  Voluntary registration

Floating of assets. The assets may use the assets in the at CH (s859A) within 21
charge fluctuate from time to time. ordinary course of days of creation
(equitable)
 3 characteristics (Yorkshire business until (s8859A)
Woodcombers (1903)) crystallization/future  Remember: The date of
 Charge is over a class of event – flexibility charge from which
assets of the co – held now  Holder of a qualifying priority can be
or in the future; floating charge (covers all calculated is not the
 The class changes from or substantially all a date it is registered but
time to time; company’s assets and the date it is created
 Business has the ability to undertaking) has the right  E.g. a charge created on
deal with the assets until to appoint an the 5th and registered on
crystallization/the administrator over the the 10th will still rank
happening of some future company if it gets into behind a charge created
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 event financial difficulty (para on the 1st but registered
 The assets secured by means 14, Schedule B1 on the 20th.
of floating charge are Insolvency Act 1986)
described generically e.g.  Disadvantages:
trading stock.  vulnerable to later
Crystallisation: fixed charges - this
 A floating charge will provide can be alleviated by a
that if certain specific events prohibition on
occur, or if the lender takes a creating further
specified step, the charge security
crystallises i.e. floating charge  Ranks behind costs of
in essence becomes a fixed an administrator
charge and the B can no longer  Ranks behind the
dispose of the assets. costs of a liquidator
 The crystallised charge will be  Ranks behind
subject to any third party rights preferential creditors
of set-off accrued prior to  Ranks behind the
crystallization prescribed or
 Two ways in which ringfenced part –
crystallisation might occur: amount of floating
Common law ways: charge realization
 The borrower’s liquidation which is set aside to
(when a winding up order pay unsecured
is made NOT when a creditors. Therefore,
petition to wind up is in relation to the value
presented) of the prescribed part,
 Administrator or receiver is floating charge holder
appointed by the bank ranks behind
 The borrower ceases to unsecured creditors
carry on business (for any  Limited to granting the
reason) bank recourse to the asset
 Intervention by the bank in the event of B’s default
which prevents the under the loan – in order
borrower from dealing to discharge its debt.
with its charged assets  Bank has no right of
Under the charge document: control over the
 Any event contractually asset until
agreed between parties crystallisation.
 Vulnerability means it will
usually be second choice
for bank if a fixed charge is
available
 But sometimes a fixed
charge will not be
commercially feasible so a
floating charge must be
used (see below)

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 Fixed versus Floating Charge… Which is Preferable?

Advantages of Floating Charge Disadvantages of Floating Charge

 Allows borrower to deal freely with charged assets  Will subordinate to any preferential creditors.
in ordinary course of business - flexibility - Main types: outstanding employee wages,
- N.B. can be a disadvantage to bank but pension scheme contributions.
sometimes flexibility is needed because  Might be vulnerable to later fixed charges, even if
borrower needs charged assets to run business it contains registered negative pledge.
and it is in bank’s best interest for borrower to  Can be set aside by court on the application of a
be able to run its business liquidator or administrator (s245 IA 1986) - wider
 If a mortgage, charge or assignment over the
circs than fixed charge (i.e. not for valuable
other assets of any company were to be
consideration).
ineffective or invalid for any reason, then the
- S245 IA: degree of vulnerability of floating
banks would still have the benefit of the
charge will depend on whether it is granted to
floating charge over these assets. Despite
connected person.
preferential creditors having first call on
- To CP: can be set aside if granted within 2 years
proceeds of sale, banks’ claim would still rank
of onset of insolvency.
ahead of most unsecured creditors by value
- To UP: can be set aside if given within 12
 In restricted circs, allows bank to appoint
months of onset of insolvency provided
administrative receiver who may manage the company was insolvent when it gave charge or
borrower’s business and block an admin order (no became insolvent as result.
longer particularly relevant following Enterprise  Some of the proceeds realised from a floating
Act 2002). charge may be allocated to unsecured creditors
 Holder of qualifying floating charge (IA 1986 Sch  Rank behind costs and expenses of
B1 para 14) can appoint administrator using an administrator/liquidator.
out-of-court procedure.  For bank – borrower free to deal with assets.
- Can also choose identity of administrator.

Suitability of Different Types of Security

Asset Security Commercial considerations Perfection

Stock  Floating charge  Want borrower to have  Register at CH –

freedom to deal with stock s.859A within 21
in the ordinary course of days
business whilst bank still get
some security
 It is a class of assets that
changes from time to time,
so FC is appropriate - no need
to keep repeating the charge
when it changes.
 BUT – look at level of stock in
co to see if worthwhile, is
there a ‘just in time’ system =
low stock

Freehold land  Charge by deed by way of  Secured creditor (big asset)  By deed s.2 LP(MP)A
legal mortgage but allows borrower to keep 1989
 Registration at CH
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 o the legal title does operating s.859A within 21
not pass, instead  Existing mortgage holder? days (MR01)
provides bank with ‘Inter-creditor/subordination  Registration at Land
rights equivalent to /deed of priority’ = agree a Registry s.27 LRA
granting it a 3,000- ranking with pre-existing 2002 within 30
year lease charge-holder (you want working days
priority for your client) OR  DS1 if it was
discharge the existing discharging existing
mortgage (more common) mortgage

Leasehold land  Charge by deed by way of  Rights under LPA  May need third party
legal mortgage (possn/foreclosure) consent
o the legal title does  Check if Landlord’s consent  By deed s2.LP(MP)A
not pass, instead to charge is required 1989
provides bank with  Is lease valuable enough to  Registration at CH
rights equivalent to be worth taking security s.859A CA
granting a lease for 1 over?  within 21days and
day less than the o Do the leases have any  Registration at Land
lease on the capital value? If leases are Registry s.27 LRA
leasehold land being short and at full market 2002 (for leases
charged rents this is unlikely more than 7 years)
 KEY questions re lease:
 Term
 Amount compared to
market rate
 Conditions (any
onerous ones?)

Cash  Fixed or Floating charge  More likely to be floating if  Register at CH s.859A

cash is needed for company’s  Within 21 days
day to day running  Technically no
requirement to
register because
financial collateral
but market practice
still to register

Plant and  Fixed charge  Register at CH 859A

machinery  - within 21 days
owned  If ships or aircrafts,
may need to be
registered elsewhere

Plant and  Cannot get security over this as not owned by co and not a potential future asset of co (no
machinery hired equitable int) (cf. hire-purchase agreement or sale and leaseback)
(under finance  Is there something that you’re going to get under the contract? If unlikely that we will
lease) with no get the underlying assets e.g. cars in 2 years time, cannot get security
option to  Is there value in the contract itself? – if it’s just for market rate, could get the same
purchase terms elsewhere… no real benefit worth securing

P&M hired  Can only take an  Clause will state ‘if at

(under hp lease) equitable charge or any time you acquire
with an option equitable mortgage over the P&M, you will
the future interest to grant a charge over
93
 to purchase own, not legal. the property’

Computer/office  Fixed charge OR  [But if going to replace soon  Register at CoHo –

equipment with  Floating charge and low value, fixed charge 859A
finite life impractical (as they would  Within 21 days
need to get permission from
the lender to
replace/upgrade)]
 Floating = better for more
fluid property as no
permission needed

Entire issued  Equitable mortgage OR  equitable mortgage is better  Register at CH:

share capital  Equitable charge as it is a promise to transfer technically financial
legal title – while a fixed collateral so exempt
charge is really only a power but should register
of sale [with no transfer of anyway! Form MR01
title]  Document that
 Don’t want to have legal as creates the equitable
this would give bank, as legal mortgage
owner of the shares, the right  Signed, blank Stock
to dividend payments and to Transfer Forms
exercise voting rights - This is (transferor filled in
not what the group and the and signed but
bank want to happen. transferee left blank)
 Enviroco Scottish case – said and a power of
if we transfer legal ownership attorney giving bank
of the shares to the bank, we right to complete the
effectively destroyed the blanks in form if
parent/subsidiary want to exercise
relationship as it would security and share
suggest the subsidiaries are certificate to the
now of the bank. bank
 DD on shares – check articles
to ensure no pre-emption
rights or directors’ discretion
to refuse to register share
transfers and ensure stamp
duty has been paid

Registered  Fixed charge  Not legal mortgage because  Register at CH 859A

trademark this would mean bank would  within 21 days
own the trademark and  Reg at UK Intellectual
would then have to licence it Property Office
back to the Company.
 A fixed charge would not
interfere with the company’s
everyday use of the
trademark as the ownership
doesn’t change.

Sale contracts  Equitable assignment of  Disadvantages of equitable:  Could do via promise

(low value, high benefit of contract  The debtor can get good as no formalities for
volume) discharge by paying the

94
 borrower rather than equitable interest.
e.g. number of paying the bank, so the  If higher value one
individual bank is not guaranteed not yet formed, then
contracts to receive the debt. could state that
 A subsequent legal borrower would
assignee gains priority perfect by legal
over the equitable assignment when
assignment contract entered into
 Take the debt subject to (then need to give
any accruing equities, i.e. notice under s136)
the right of set off. (always beneficial to
 Advantages for a Co. with perfect a high value
LOTS of contracts: contract into a legal
 The administrative assignment)
burden of notifying
hundreds of 3rd parties
(the debtors) in order to
perfect the legal
assignment would be
prohibitive – so
equitable is quicker and
cheaper.
 Other considerations:

Look at terms of
contract to ensure no
restrictive terms.

May look bad in market.

Sale contracts  Legal assignment –  Advantages of legal:  s136 LPA 1925 –

(high value, low benefit of contract  Stops a subsequent legal  In writing and
volume) assigned assignee jumping ahead signed by the
o subject to restraints provided notice has assignor
e.g. building in the contract been given  Absolute (i.e. not by
contract or o doesn’t transfer  Debtor can only get way of charge only)
“exclusive burden, only benefit good discharge by  Whole of the debt
contract” N.B. can have a collateral paying the bank directly
due must be
agreement between the bank (as opposed to the
e.g. key man borrower) transferred
and the debtor in the
insurance policy underlying asset to assume  Don’t have to have to  Notified in writing
– will result in the burden – depending on worry about accruing to any person(s)
company the contract, bank may need equities (such as rights against whom the
receiving a lump to assume the burden (e.g. if of set off) once notice assignor could
sum if the burden is the ability to has been given enforce the
something force contractor to accept  Disadvantages:
assigned rights (i.e.
happens to a further payments in return for  Administrative burden
person who is carrying out further work to give notice to the debtor in the
identified as a under the contract) debtors (but not that underlying asset
keyperson bad as small number of being assigned)
within the contracts)  Registration at CH
organisation  DD – check if contract is (s859A CA)
assignable/consent necessary  N.B. Business
to assign Contract Terms
(Assignment of
Receivables) Regs
95
 2018 – apply to
contracts entered
into after 31
December 2018. May
render
unenforceable any
restriction on
assignment. Unlikely
to apply to large
enterprises

Book debts  Potential fixed charge  Floating = Allows co freedom  Register at CH – 859A
o if the debt to deal with class of assets  Within 21 days
(sums owed to receivables go into a but gives bank security on
company in the separate blocked crystallisation and priority to
ordinary course account (unlikely – some unsecured creditors
of its business) not practical) OR  See below for why floating
 Floating charge (more charge over fixed
likely)

Miscellaneous  Floating charge  Can continue to use assets in  Register at CoHo –

assets  Unless valuable asset ordinary course of business 859A
until crystallization/future  Within 21 days
event
 Consider priority – negative
pledge

Artwork  Fixed charge  Pledge would defeat the  Register at CH –

 Pledge, but not likely point of having artwork as 859A
they would not be able to  Within 21 days
exhibit it as it would have to
be delivered to bank.

Is it FIXED or FLOATING Charge? (Book debts – also applies to cash, stock, raw materials)

Book debts – says FIXED, but why is it more likely to be FLOATING?

 FIXED:

Fixed charges rank ahead of floating charges (they will be paid out first). If charge is only floating,
preferential creditors (i.e. amounts of outstanding employees’ wages and pension scheme
contributions), costs of liquidator/administrator, ring-fenced money that is set aside for unsecured
creditors will rank ahead.

 Fact that it states that it is a fixed charge is not determinative, have to look to the SUBSTANCE of the
term/arrangement, not the FORM. (National Westminster Bank plc v Spectrum Plus Ltd)
Characteristics of floating charge: (Yorkshire Woodcombers (1903))
1) Charge is over a class of assets
2) The class changes from time to time
3) Business has the ability to deal with the assets until crystallisation/ the happening of some future event.

96
 o This is the hallmark of a floating charge. (National Westminster Bank plc v Spectrum Plus Ltd)

 WHY COULD BE FLOATING CHARGE? Because the debts have to be paid into a current account - this means
that the borrower would have control over the proceeds of the debts and be able to use them in the ordinary
course of business like a normal current account
 The fact that B can pay in and use the money as they wish suggests that this is a constantly shifting
asset and therefore not one which can be subject to a fixed charge

 Lord Scott’s judgment in National Westminster Bank plc v Spectrum Plus Ltd

Merely restricting ability to dispose of the book debts is not enough to restrict the business’s ability to
deal with the assets such that the charge will be fixed

To ensure a charge is fixed: It is not enough to say business cannot deal with their book debts - it is not
enough to just look at the book debts,

For there to be a fixed charge, must have control over the PROCEEDS of the book debts

These proceeds must be put into a blocked account that borrower does not have access to to ensure
that this is a fixed charge.
o Business would need consent from charge holder to access the proceeds
o N.B. simply paying into a specific bank account would not be good enough

If valuable asset, want fixed charge so follow this approach

Why Might it Not be Commercially Feasible to Ensure it is Fixed

 May not be commercially feasible because to be a fixed charge the bank would have to have control over the
proceeds of the debt
 Fixed charge means proceeds would have to be blocked in an account that business cannot access
 If business needs the proceeds of the debt to keep business in the running, it is impractical for the cash to be
in a blocked account
 Need money from book debts to e.g. buy new stock, buy raw materials, pay employees, meet
overheads etc.
 Could ask the bank for permission to take money out of the blocked account but this would be an
administrative nightmare – Co will need access to the account several times a day
 Therefore, keeping money in a blocked account could severely damage business as they will have very little
money coming in with which to run business, meaning that they could go insolvent
Þ This is not good for borrower or lender – is in both parties’ best interests for business to be able to run its
business and make money

Perfection

This is the THIRD STAGE of creating a valid security.

Types of perfection…
1. Registration
2. Delivery
3. Notice
97
  Perfection through registration – it’s IMPORTANT

The safest way to take security over an object is to take physical possession of it, but this is not practical
in most circumstances.

Therefore, an issue arises because if a borrower retains the secured asset, then what is to stop the
company selling/re-securing the asset to an unsuspecting third party? (this would be illegal but still
possible)
 this is alleviated by statutory requirement for the registration of security interests
 this places the security contract on a public register, thus creating a system of actual/deemed
notice to third parties

Registration

Voluntary s859A After company creates a charge, company OR person interested in the
registration of CA 2006 charge should register it (normally charge-holder as more risk for them if no
charge registration):

1. Where company OR any person interested in the charge (incl. charge holder)
delivers:
 s859D statement of particulars (i.e. Form MR01 + fee) (s859A(2)); and
 Certified copy of charge instrument (only where charge created by charge
instrument) (s859A(3))
2. Before end of “period allowed for delivery” (s859A(2))
 the Registrar MUST register charge (s859A(2))

Period allowed s859A(4)

 The period allowed for delivery of above docs to registrar is 21 days (weekends
for delivery
and bank hols included), beginning with the day after the date of creation of
charge

Definition of s859A(7)
 Charge includes a mortgage and standard security, but not a pledge (i.e. fixed
charge
& floating charges over land, ships, aircraft, machinery, book debts, shares, IP =
registrable, but no need to register guarantees)

Particulars to s859D(1) A s859D statement of particulars (normally form MRO1) must contain s859D(1):
be delivered to
registrar
a. Registered name and number of company;
b. Date of creation of charge;
AND - Where charge is created or evidenced by an instrument the following
particulars from s859D(2) must be contained:

a. Name of each of the persons in whose favour charge has been created
or of the security agents or trustees holding the charge for the benefit of
another; (i.e. name of charge holders)
b. Whether contains floating charge and if it covers all property and
undertaking of the company;
c. Whether company is prohibited or restricted from creating further
security that will rank equally or ahead of charge;
d. Whether (and if so, a description of) any land, ship, aircraft or IP is
subject to a charge (not floating) or fixed security;
e. Whether there is a charge (not floating)/fixed security over any tangible
98
 or corporeal property or any intangible or incorporeal property
OR - Where charge is NOT created or evidenced by an instrument the following
particulars from s859D(3) must be contained:

a. Statement that there is no instrument creating or evidencing the charge;

b. The names of each of the persons in whose favour the charge has been
created;
c. The nature of the charge;
d. A short description of the property or undertaking charged;
e. The obligations secured by the charge.

Date of s859E When was the charge created?

creation of
charge  Standard Security  date recorded in Register of Sasines OR registration in
Land Register of Scotland
 Charge other than Standard Security created by charge instrument:
o Instrument is deed executed and has immediate effect  date of delivery
o Instrument is deed executed and held in escrow  date of delivery into
escrow
o Instrument not deed, but immediate effect on execution  date of
execution
o Instrument not deed, not immediate effect on execution  date on which
instrument takes effect
 Charge other than Standard Security NOT created by charge instrument 
date on which charge comes into effect

Effect of s859I Upon registration in accordance with above, Registrar must (s859I(2)):
registration –
entries of the
a) Allocate 12-digit unique reference code to charge + make note of it on the
register
register;
b) Include the certified copy of the charge instrument on the register
s859I(3): registrar must give certificate of the registration of the charge to the
person who delivered the registration docs (i.e. who registered charge):

o The certificate must state registered name and number of company giving
charge and unique reference code of charge and be signed by the registrar
or authenticated by registrar’s official seal
 Perfects the security by providing notice of its existence to all third
parties who search the register or ought to have searched the register.

For parties who actually search the register: will provide actual notice.

For parties who do not search register, but ought to (e.g. banks, but not
ordinary customers): will provide constructive notice.

Once a later bank has had actual or constructive notice of the negative
pledge, then later bank will not be able to get priority for its fixed charge
over pre-existing floating charge.

Consequences s859H s859H(3) - Failure to register charge makes it void against: (bad news for lender,
of failure to treated as unsecured lender – other charges on same asset automatically have
deliver charges priority) i.e. – on insolvency, the debt is deemed unsecured

 Liquidator;

99
  Administrator; and

 Creditor,

s859H(4) - but the debt is still owed and becomes immediately payable in full (still
valid against co) for failure to register – so lender gets money back


It therefore loses its ranking / priority on winding up

BUT remains valid against bank (i.e. person who gave security to)

If Co fails to register, offence committed by Co & every officer in default
s. 859A(4)

Extension of s859F The requirement is—(2)

deadline
 (a) that the failure to deliver those documents—
o (i) was accidental or due to inadvertence or to some other sufficient
cause, or
o (ii) is not of a nature to prejudice the position of creditors or
shareholders of the company, or
 (b) that on other grounds it is just and equitable to grant relief.
 (3) The court may, on the application of the company or a person
interested, and on such terms and conditions as seem to the court just and
expedient, order that the period allowed for delivery be extended
But any charges registered in the intervening period correctly will take priority.

Admin: s859P Co. must keep available for inspection copy of (s859P):
Company’s
records and s859Q a) MR01
registers
b) Instrument creating a charge; and
c) Instrument effecting any variation or amendment to charge
They must be kept available for inspection at co’s registered office (s859Q(2)(a));
OR at the SAIL (s859Q(2)(b))

Redemption of Loan/Release of Charge

Entries on s859L
When the loan is repaid to the lender, a director or the company secretary may
satisfaction and
(usually will) make a statutory declaration that the debt has been paid and will
release
send form MR04 (even where charge registered before 6 April 2013) to the
registrar of companies
 Registrar will include statement of satisfaction on co’s file

If instead the charge is released or property sold, must send form MR04 in either
case, the Registrar will include a statement either of release or that property no
longer belongs to company in company’s file.

if any entries were made at Land Registry, these need to be removed

Further Issues on Taking Security

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 Contractual  If the creditors wish to alter priority, may enter into a ‘subordination agreement’ or
subordination ‘deed of priorities’/priority/intercreditor agreement between themselves (see below)

Tacking  Is the ability to secure new advances under existing security. Depends on whether
the secured asset is unregistered land, registered land or personalty

Hardening  Period during which new security is vulnerable to provisions of IA 1986. Primary concerns:
periods  Transactions at an undervalue (s.238)
 Preferences (s.239)
 Floating charges not for valuable consideration (s.245)
 Important hardening periods are: 6 months (preference), 12 months (floating charge) and
two years (transaction at an undervalue or preference to connected person)

Further issues  Public companies cannot provide financial assistance (inc. giving guarantees or
securities) to any person in order to purchase co. shares (s.678)
 The directors must also consider capacity (articles) and corporate benefit (and duties)
(s.172) when giving security
 Check any prior security docs for negative pledges etc. consider whether subordination doc
necessary
 Need to notify any third parties? – tenants, landlords, licensing authorities?

Syndicated  Important difference between common law and civil law for syndicated loan agreements:
loans – 
Common law = security held by security trustee on trust for the syndicate banks
security (beneficiaries) – so, lenders will not be party to security document, will instead be the
agent vs security trustee - allows syndicate banks to change w/o any priority or renewal issues.
security o Trust prevents you having to grant separate security to every lender in the
trustee syndicate
o Trust avoids the need to execute new security every time there is a change of
lender
o N.B. may still have to grant new security if lender sells participation by way of
novation as this is strictly cancelling contract and replacing it with a new one
so it is uncertain if old security will work. Therefore, old security is left in place
in case it works and then new security is granted
o If you did have to grant new security, it could affect priority and time periods
under Insolvency Act will be reset so security may be set aside even if under
the old security, the time limits had expired

Civil law = security held by security agent b/c civil law jurisdictions do not recognise
trusts. However, most will only allow party to hold security to the extent it is owed a
debt. Therefore, instate parallel debt structure – creates debt owed to agent in same
amount as owed to syndicate, which runs parallel. Not as secure as trust structure – if
agent goes insolvent then agent’s assets are part of its estate (not the case for security
trustee)

How to Minimise the Extent to which the Bank’s Security may be Defeated by 3 rd Party

 Due diligence and accompanying guarantees to ensure no prior security or restrictions

 Ensure any prior encumbrances are released (e.g. MG02) and undertakings to that effect
 Negative pledges
 Take as many fixed charges and legal mortgages as possible (especially over expensive items/goodwill/
important assets etc.) – co. can’t deal with/dissipate the assets
 Ensure perfection – either the Bank registers itself (s.859A(2) CA) or undertakings to that effect form
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 the borrower
 Power of attorney in order to execute STF when taking an equitable mortgage over shares

Rules on Priority for Security and Protecting Priority

 Prescribe order in which creditors who have competing perfected security over the same asset will be paid.
 If creditor has not perfected its security, it will be invalid against third parties
o Therefore, the priority rules will never come into play.
 There are exceptions to the general priority rules.
 Priority rules can be varied by agreement between the creditors – deed of priority

Between fixed  Generally

charges and 
Fixed charges and mortgages rank in order of creation (provided they are properly
mortgages registered).
 At common law

A legal mortgage will take priority over an existing equitable security interest
(i.e. a fixed charge), only if the legal mortgage was taken bona fide, for value
and without notice of the prior equitable security
 Notice by registration

Registration in accordance with s 859A CA 2006 gives notice to anyone who has, or
ought to have, searched the register, which will usually protect a prior registered
equitable security.

 Governed by their time of creation (if properly registered)

Between fixed
charges

Between fixed  General Rule

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 
and floating Fixed charge (and a mortgage) will rank ahead of a floating charge.

Why? Floating charge, ostensibly, allows the chargor to deal with the charged asset,
and this will include granting security over it.
 Exception: Negative Pledge

If later fixed charge holder has notice of a negative pledge in an earlier floating
charge, floating charge will NOT rank below fixed charge

Should include negative pledge in security document as then you can tick the box in
form MR01 which says your security document creates a negative pledge
o Later charge holder who does a search will see tick and know there is a
negative pledge
o Still a grey area whether ticking box amounts to constructive notice to a later
charge holder who does not search
o N.B. not enough to just have the negative pledge in the facility agreement,
needs to be in security document to tick the box

If company granted subsequent charges in contravention of the negative pledges, it
would likely trigger an event of default. If the second chargee was aware of the
pledge, they could be liable for the tort of inducing breach of contract

 Effect of Crystallization of floating charge


Fixed charge created before crystallization:
 The floating charge will still rank behind a fixed charge which was created before
crystallization, whether the fixed charge was created before the floating charge,
or after (provided there is no negative pledge).

Fixed charge created after crystallization:
 After crystallisation, the company no longer has the power to sell the assets to a
third party. The company has also lost its power to grant a fixed charge ranking
ahead of the floating charge i.e. a fixed charge created after a floating charge has
crystallised ranks behind the floating charge
BUT =

An entity which takes a subsequent fixed charge may have a good argument that it
had prior dealings with the company and absolutely no notice of the crystallisation
and therefore it is "equity's darling" (a bona fide purchaser/chargee for value
without notice) and should rank ahead of the floating charge §holder.

Some crystallisation events are "public" (such as the winding up of the company or it
ceasing to trade)
o so any entity dealing with the company should be on notice and know
that they cannot buy the company's assets or take a fixed charge which
ranks ahead of the crystallised floating charge.
o However, non-public crystallisation events, such as notice being given from the
Security Agent to the Borrower, or a single payment default, would arguably
not be sufficient to bind a bona fide purchaser (or chargee) without notice.

Between  Governed by their time of creation (if properly registered): an earlier charge will take
floating priority even if the later one has crystallised - subject to contrary agreement
charges

Between legal  Legal mortgage will take priority over earlier equitable mortgage but only if the legal
mortgages mortgagee is a bona fide purchase for value without notice
and equitable o Registration at CH would amount to notice
mortgages

Effect of  Date of charge from which priority can be determined is the date of creation, not
registration date of registration.
 Thus, it could be the case that charge 1 was created, but not yet registered (has 21
days to do so), and then within these 21 days, charge 2 was created and creator of
charge 2 goes to register charge 2. Creator of charge 2 would not yet be able to see
charge 1 registered, yet will still rank below charge 1, as was created later.
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Security over  Registered land
land  Under the LRA 2002, s 48, priority between two registered mortgages will be
determined by the date when they appear in the charges register. The date of their
creation is irrelevant.
 Unregistered land
 General Rule: Registration in the land charges register (under the LCA 1972) gives
notice of a mortgage to third parties, and therefore priority is determined by the
order of registration.
 If registrable mortgages not registered = will usually be void against subsequent
mortgagees for value.
 Equitable mortgages protected by the deposit of title deeds are not registrable, but
will automatically take priority over any subsequent mortgages in most
circumstances (unless a subsequent legal mortgagee acts on the basis of a reasonable
explanation for the absence of the deeds).

Between  Governed by date of creation

equitable
mortgages

Between  General Rule

assignments

Dearle v Hall

Priority of competing assignments is determined by the date of actual notice to the
debtor
 Exception

If assignee who gave notice first had actual or constructive notice of the earlier
assignment, then the assignee who gave notice later takes priority
 Example
o C is owed £1000 by D and C assigned the debt to B. B notified D that his debt is
assigned. B has priority
o If B fails to notify and C latter assigns the same right to E, then E’s assignment will gain
priority over B’s, if E notifies D first and did not have actual or constructive notice of
earlier assignment.
 N.B. if there was more than one equitable assignment over the same asset and in both
cases the debtor was not notified, priority will have to be governed by date of creation

Contractual  What is it?

subordination 
Where creditors to decide between themselves on the order in which they will
benefit from claims against a defaulting debtor.
 Most frequently used…

In large financings which involve several ‘layers’ of debt: if the borrower defaults,
the order in which the banks will have their loans repaid is contractually
prearranged.
 Typical Arrangement

Participating lenders divided into an agreed order of priority for repayment of their
credit.
 ‘Senior creditor’ – enjoy top priority
 ‘Subordinated creditors’ – lower priority, further subdivided depending on
the gain they are making out of the loan, i.e. ‘mezzanine’, ‘loan notes’, ‘high
yield’

No participating bank may enforce any security or otherwise proceed against the
borrower without the agreement of the senior banks (or occasionally only with
majority consent);

when any security is enforced, or any money received after a specified event (eg,

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 a potential default by the borrower), either:
 subordinated creditors agree contractually not to claim against the borrower
until the senior creditors are repaid (thus maximising the assets available to
satisfy senior debt)
 subordinated creditors agree to hold any money they receive on trust for
senior creditors (known as a ‘turnover trust’). More robust than contingent
debt subordination and maximises return in all circumstances.
- NB: though Turnover trust did create a proprietory right, but since it was limited to the debt
owed there was no charge over the ‘junior’ creditor’s property (SSSL Realisations Limited
[2004])

Pooled money will then be distributed in accordance with the agreement.
 ‘senior’ banks will be paid back first. Once they have been repaid in full, any
remaining money will be used to repay the ‘mezzanine’ and other
subordinated creditors, as appropriate
 When is contractual subordination used?
 Where banks want to get higher return, they will trade that with bearing greater risk
of not getting money back on default of borrower.
 All banks will want to diversify their lending to create a mixture of risk
 when a syndicate is formed,
o some banks look to less risky loan and will participate only as senior banks;
o other banks will accept subordinated positions because they can take
more risk
 Contractual subordination might also be used where an unsecured bank requires any
debts to a borrower’s directors or parent company to be subordinated to its own.
 An existing bank might benefit by allowing new finance into the borrower to enhance
the business. The only way to attract new finance might be to release some existing
security, or to agree subordination to the new bank.

Key Terms of a Precedent Debenture to Provide Security for Lender

DEBENTURE: At common law = any document which a company issues to acknowledge, or create, a debt
NB = in common banking language, a debenture is the name given to the document under which a borrower creates
the security for a secured loan, usually incorporating fixed and floating charges along with other security interests

Structure of Typical Debenture

Covenant to  Clause that acknowledges debt obligation of the borrower to the bank (making the
105
 pay document a ‘debenture’ to comply with IA 1986, s 29(2) if it is able to appoint an
administrative receiver).

Document can refer to:
 Specific debt obligation; or
 To all debts between the bank and borrower (‘all monies clause’)

Phrase ‘on demand’ is used to prevent Limitation Act 1939 operating against the bank
until it makes a demand.
Þ But it does not later the payment obligations in any facility agreement which it
secures.

Charging  Specifies which of the borrower’s assets are charged to repay the debt acknowledged in
clause the covenant to pay AND how each type of assets is secured.
 Land

Debenture will secure leasehold and freehold by way of ‘charge by deed expressed to
be by way of legal mortgage’ (s87 LPA 25)

Details of registered land which is to be secured will be included in a schedule to the
debenture so that security can be registered at Land Registry (under LRA 2002)

Terms of lease to be secured should be checked to ensure do not prohibit particular
forms of security interest being granted over them.

Future land cannot be secured by legal mortgage and therefore must be secured by
equitable mortgage over the property once acquired.
 Fixed plant and machinery

Mortgage of land will automatically secure any assets which are, or become,
permanently fixed to the secured property

The charging clause should specifically mention which fixed assets which are not
fixtures but need to be secured
 Cash

Depositor cannot charge or mortgage its account with a bank to that bank because
account is debt owed by bank to depositor, and debt is simply right to sue debtor for
amount owed. Therefore, if that right were charged in favour of debtor it would be
right to sue oneself. (Re Charge Card Services… Highly criticized).

Given the above problems, the bank should usually require:

Express (contractual) right of set off

Fixed charge over account

Prohibition on depositor assigning the account; and

If the depositor’s obligation is contingent, a flawed asset arrangement (deposit
only becomes repayable at same time depositor’s debt becomes due and unpaid)
– protecting account from liquidator until bank can exercise set-off
 Goodwill

Automatically secured as inseparable part of borrower’s secured undertaking – but
debenture will provide for the securing of goodwill anyways by way of fixed charge.
 Book debts (debts owed by customers – retail)

To create a fixed charge over book debts, charge must control both debt and its
proceeds. (National Westminster Bank plc v Spectrum Plus Limited)

Exact degree of requisite control is unclear. House of Lords said the principle might
apply to other assets, leading to concern over shares, insurance policies and land.
 Shares

Registered shares are usually secured in one of two ways:

Creating legal mortgage by transferring shares into bank’s name and issuing new
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 share certificate to that effect. Debenture will allow bank to sell shares on default of
borrower and provide for re-transfer when loan is repaid.
o Uncommon method because creates greater administration issues and
potential liabilities for bank as owner of the company.

Creating equitable mortgage by taking custody of share certificate together with stock
transfer form executed by borrower, but transferee’s name and other details left
blank. Security document should also have power of attorney allowing bank to
complete stock transfer form and submit it to register the new owner.
o Advantage is that the bank does not have the inconvenience of ownership
pre-enforcement and does not run the risk of the company whose shares are
secured becoming a subsidiary of the bank.

In both cases, always check that shares are fully paid up and stamp duty payable has
been paid and no restrictions in company’s articles of transfers (e.g. pre-emption
rights)

For bearer shares, security achieved by taking delivery of share certificate and
memorandum of deposit (i.e. pledge)
 Stock in trade and sundry assets

Sometimes known as inventory

Asset that borrower needs to sell so will typically be secured by a floating charge .
 Choses in action

Rental or leasing rights, debts, property rights, insurance proceeds can be secured by
way of legal or equitable assignment

Further  Debenture usually includes undertaking by borrower to do anything necessary in order to

assurance perfect the security, which can include:
clause 
Execution of documents required by the bank;

Conversion of equitable mortgage to legal mortgage;

Deposit documents of title;

Provision of additional security to ensure bank obtains fully security.

Undertakings  Debentures will include undertakings such as:

 Negative pledge – must be included in the debenture to tick box in MR01;
 Undertaking to execute, at the bank’s request, a legal mortgage in place of an
equitable one;
 Undertaking to provide bank with any documents of title it might request;
 Undertaking to repair and maintain land, and insure all assets, together with a power
of attorney allowing bank to do these things (and recover expenses incurred) if
borrower does not.

Crystallisation  If the debenture creates a floating charge, it will specify when the floating charge
clause crystallises. This will usually be:

At any time the bank notifies the borrower in writing (NB. Borrower may resist bank
being able to crystallise at will and insist that it is linked to default under facility
agreement); and

Automatically on specified events, example on demand by bank for repayment,
petition for winding up, or administration order, or borrower ceases carrying on
substantial part of business

Appointment  Bank will have right to immediate possession of any assets over which it has legal

107
 of receiver, mortgage (subject to contrary agreement).
administrator 
However right does not extend to assets where bank has equitable mortgage or
or charge.
administrative
 Debenture should give bank express contractual right to take possession of charged assets
receiver
on specified ‘enforcement events’.
 Bank should also be given right on enforcement events, to appoint receiver of secured
property, an administrator, and where appropriate an administrative receiver.

Usually appointed to avoid bank being liable for their acts or omissions

Debenture will note any powers the office-holder is to have beyond his normal
statutory powers

Collection of
 Debenture will usually require borrower to collect in any debts and claims of the business
debts
‘promptly’ and pay them into specified accounts

Power of  PoA allows bank to carry out any borrower’s obligations under debenture which borrower
attorney fails to honour

Instrument creating PoA must be executed as a deed, and provided it is also
expressed to be irrevocable, it will still survive the borrower’s liquidation (Powers of
Attorney Act 1971, s4).

Redemption of  Debenture must provide for release of security once obligations are satisfied.
security  However, bank may require right to retain security for a period after satisfaction of debt in
case monies used to repay loan are reclaimed by court as preference (may not be workable)
 No specific formalities for discharge, other than registered land where requisite form should
be filed with Registrar.
 Borrower usually made liable for any costs involved in discharging the security

Administrative
 Insert appropriate boiler plate clauses for administrative matters, notice periods, costs and
provisions
expenses, service of documents etc.

Execution  Debentures should be made by way of deed following Law of Property (Miscellaneous
Provisions) Act 1989 that it should be clear on the face of it that it intended to be a deed.
 Debenture should be drafted as a deed because:
 Avoids any doubt as to sufficiency of consideration;
 It is necessary because debentures invariably create a power of attorney and power of
attorney has to be made by deed;
 Necessary if a debenture conveys or creates a legal estate in land (LPA 1925 s52); and
 It is necessary if the bank is to take powers under LPA 1925 s 101 (statutory powers of
sale and to appoint a receiver)
 Longer statutory limitation period – 12 years rather than the usual 6 years

108
 6 - Derivatives
What are They?

Companies use derivatives in order to hedge their risk.

 Companies do not want to bear the risk of something they have no control over or have no ability to predict
 Risks can include weather event, exchange rates, interest rates etc.

A derivative is a financial contract with a value that is reliant upon or derived from an underlying asset or group of
assets.


A DERIVATIVE is a transaction under which the future obligations of one or more of the parties are linked in
some specified way to another asset or index, whether involving the delivery of the asset or the payment of
an amount calculated by reference to its value or the value of the index.

The transaction is therefore treated as having a value which is separate (although derived) from
the value of the underlying asset or index.

As a result, the parties’ rights and obligations under the transaction can be treated as if they
constituted a separate asset and are typically traded accordingly


The term “derivative” covers a wide variety of instruments and new variations are being invented all the time.
However, all derivatives transactions fall into one of three basic categories: swaps and related products, options
and swaptions and futures and forwards

Types

Futures and Forwards

WHAT IS IT?


A future or forward contract is a contract under which:


an agreement to acquire or dispose of a quantity of a particular asset at a specified future date at a
pre-agreed price OR


one party has the RIGHT to receive a payment if the asset increases in value and the other party has
the right to receive a payment if the asset or index decreases in value between the two dates


Both parties have an obligation once they have entered into a derivative– one party will make a loss,
but parties believe the risk of making a loss is worth it for the certainty of price

Structure  A future can involve physical OR cash settlement


Each party is exposed to movements in the value of the underlying asset or index in
either direction.

Type: FX  Pick a date in the future when you are going to need to change a certain amount of

109
Forward currency from one currency to another

 Example:


A UK retailer which has to import electrical goods from Japan in three months’
time for 1.1 million Yen may want to plan its budget and therefore will need to
know what the exchange rate is going to be so he can plan accordingly.


The retailer could enter into a Forward FX contract under which it agrees to buy
Yen in exchange for sterling, for settlement in three months’ time.

o UK retailer agrees to pay £1 million in exchange for 1.1 million Yen


Since the contract will be entered into at exchange rates prevailing when the
contract is entered into with the FX dealer, the retailer is able to work out the
cost of the transaction and budget accordingly.

 Thus, allows the Co to guarantee the cost of its foreign currency and reduces its exposure
to volatility of exchange rate

Future vs.  While futures and forward contracts are both contracts to exchange assets on a
forward future date at a prearranged price, they are different in two main respects:

(different  Futures tend to be standardised exchange-traded, while forwards tend to be

products, bespoke over-the-counter.
similar
economic  Thus, futures are standardized while forwards are customized and face a
effects) non-exchange counterparty – increasing counter-party risk b/c of the lack of
clearing.

 Futures are not normally held to maturity


Holder of futures can normally terminate their commitment by entering into an
equal but opposite transaction at a date of their choosing


The future contract itself takes on its own value, depending on the market, the
underlying asset itself and the length to expiry – they can be heavily traded


Thus, futures have significantly less credit risk, and have different funding.

 In the case of physical delivery, forward contract specifies to whom to make the
delivery. The counterparty for delivery on a future is chosen by the clearing house.

Swaps

WHAT IS IT?

110

A swap is an OTC (Over The Counter - bespoke) bilateral contract which involves an exchange of payment
streams, each of which is calculated on a different basis from the other.


KEY = periodic payments – recurring (ongoing) obligation

o Repeats at a certain amount of time for a set period


Can swap the principal (underlying amount) or simply the income stream/cash flow

 Used by banks and businesses to hedge interest and exchange rate exposure.
Who uses it?

 Floating rate is fluctuating/will change over the time, so the party receiving a floating rate
What for? payment has a risk of rise in interest rate and the opportunity to profit from a fall in
Economic effect interest rates.

 If that party has agreed to pay a fixed rate (by swapping), it is therefore provided with
certainty about what its payment obligations will be over the life of the contract.

 Over the counter

How traded?

Being OTC instruments swaps can come in a huge number of varieties and can be
structured to meet the specific needs of the counterparties.


By far the most common are fixed-for-floating, fixed-for-fixed or floating- for-floating.
The legs of the swap can be in the same currency or in different currencies.


OTC contracts carry counterparty risk that one party to the contract may not honour
their part of the deal

TYPES OF SWAPS

 Interest Rate Swap:

Interest rate

The most common interest rate swap is one where counterparty A pays a fixed rate
(the swap rate) to counterparty B, who then pays the floating rate (usually pegged to
a reference rate such as LIBOR).


Usually netted.

 Why Use it?


The effect of such a contract is to pass on to the recipient of the floating payments
the risks of a rise in interest rates and the opportunity to profit from falling
interest rates (or at least, a rate below the fixed interest rate). Interest rate swaps
are used to hedge against or speculate on changes in interest rates.


The person who swaps gains the assurance that the interest rate they will pay will
remain fixed and so they can plan accordingly.

111
  Example:


X may be paying a floating rate of interest currently at 3%. Z may be paying a
fixed rate of interest at 4%. X may prefer the security of paying fixed 4% over
the risk that its own floating rate will increase to 6%.


So, you are trading risks. If Z thinks it is unlikely that this will happen, it will,
for a premium, take the risk and swap rates. Z then has the Premium AND is
paying potentially lower interest than he normally would (e.g. if rate stays the
same or goes down).

 Practically:


With interest rate swaps you are not exchanging the notional amount. You are just
exchanging the rate. It involves a swap of the rate and periodic payments.

Currency  Currency Swap:


A currency swap is a foreign-exchange agreement between two parties to
exchange aspects (namely the principal and/or interest payments) of a loan in
one currency for equivalent aspects of an equal in net present value loan in
another currency; see foreign exchange derivative.


Currency swaps are motivated by comparative advantage. (Better than exchanging
currency in a UK bank – counterparty will be in the other country)

 Use: Currency swaps have two main uses:


To secure cheaper debt (by borrowing at the best available rate regardless of
currency and then swapping for debt in desired currency using a back-to-back-loan).


To hedge against (reduce exposure to) exchange rate fluctuations.


Borrowers who want to raise money in one currency but need the money to
finance expenditure in a different currency

 Example:


A US-based company needing to borrow UK pounds, and a UK-based company
needing to borrow a similar present value in US dollars, could both reduce their
exposure to exchange rate fluctuations by arranging any one of the following:

 If the companies have already borrowed in the currencies each needs the
principal in, then exposure is reduced by swapping cash flows only, so that each
company's finance cost is in that company's domestic currency.

 Alternatively, the companies could borrow in their own domestic currencies (and
may well each have comparative advantage (easier and cheaper for UK company
to borrow pounds than for US company) when doing so), and then get the
principal in the currency they desire with a principal-only swap


N.B. bank does not care that the loan they provided is being swapped because the
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 swap does not interfere with the loan agreement between the bank and the company

 Practically:


There is an actual exchange of the currency and periodic payments – usually (but not
always) exchange the principal

Credit Risk  Market risk is the risk that the market may move against you (i.e. risk that the financial bet
is the wrong one) but credit risk…

 Risk that you make the right financial bet (you win) but the person who should pay you is
insolvent

 Banks will often try to mitigate credit risk by entering into various derivatives:


Credit default swap


Total return swap

 With these derivatives, the banks are essentially entering into a form of insurance against
the borrower going bust

Credit Default  Bank enters into a credit default swap (bilateral contract) for a premium with a
Swap counterparty who, if there is a default, pays the amount borrower owes to the bank


Premium tends to be in the form of bank paying counterparty a fixed amount of the
loan (small percentage) periodically (e.g. every month)


If there is no default, counterparty can keep these payments


Effectively a swap of exposure to the risk of default by the borrower from bank to
counterparty

 Example


Bank in a loan agreement with X


Bank enters into a credit default swap with a counterparty


Counterparty, if X goes insolvent, will pay bank all the amount owing under the loan


Bank will give counterparty all debt obligations under the loan (inc. right to proceed
against X)


Therefore, counterparty can try to get money back from X through insolvency
proceedings but unlikely to get all of it back


Bank has money back and so has mitigated the risk

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 Total Rate of  Another form of insurance
Return Swap
 Bank worried about one of its borrowers or a section of its borrowers


Bank worried they have a lot of clients in a particular sector and a shift in that sector
could cause them to go bust

 Bank wants to insure borrowers, either individually or as a group, with counterparties

 Total return swap effectively works by saying the bank will pay to counterparty any money
that they actually get from the loan

 If for any reason bank gets less money than they were expecting, they will only pay that
amount to the counterparty


If bank gets £0, they will pay the counterparty £0

 In return, counterparty pays bank slightly less than what the bank was expecting to receive
from the borrower


So, if things go well and X repays loan in full, counterparty will make a profit

 Risk effectively transferred to counterparty and counterparty has received a cut for
agreeing to take on this risk

 Example


Bank expecting £100,000 every 3 months from X


Counterparty will pay bank £95,000 in total through periodic payments


Bank will pay £100,000 to counterparty IF they get it

 Contract under which a cash payment is made on the termination date to reflect the
Contract for change in value of certain defined shares over the life of the contract including the amount
Differences of any dividends paid on those shares over that time

 Effectively the same as a total return swap but rather than periodical payments, Party B
pays a lump sum at the end of the contract based on the appreciation of the underlying
asset, and Party A pays a lump sum based on depreciation. Other difference = TRS will take
into account e.g. dividend payments whereas CFD does not.

Options

WHAT IS IT?


An option is a bilateral contract under which one of the parties has: PAY PREMIUM FOR
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  The RIGHT, BUT NOT THE OBLIGATION to acquire or dispose of an asset at a fixed price (the strike
price) on a future date; or

 The right to receive a payment IF the value of the asset or an index increases or decreases, without an
obligation to make a payment if the value moves in the opposite direction.


An option to acquire an asset or receive a payment if the asset increases in value is known as a call
option.


An option to dispose of an asset or receive a payment if there is a decrease in value is known as a
put option


The price at which the acquisition or disposal takes place is the STRIKE PRICE


EXERCISE DATE – has to take place on these dates.

 Practically:


The consideration for the option will be a single payment (premium) that will be paid regardless of
whether or not theoption is exercised


The premium can be high as it essentially keeping an option to enter into the agreement open for the
future So in x months’ time, if a price is higher than the company agreed to pay, it will exercise a call
option. But if the price of currency decreases it will not exercise an option, the option will thus lapse, and
the Co will instead purchase the currency through an FX spot transaction.

 Example


X wants to buy dollars at £1 for $1.1 in 6 months’ time


X has the option to buy $1.1 million for £1 million in 6 months’ time


If in 6 months, X could get a better price through the market, X will buy the dollars from the market and
let the offer lapse


If in 6 months, going through market is more expensive, X will exercise the option

 Example: An option to acquire 1000 shares at a strike price of £1.10 per share. At the time
Choice of the transaction is entered into, the market price will be somewhat less than the strike
settlement price.


The option is therefore said to be out of the money at the time.


If the share price rises to a level where it is cheaper to exercise the option than
to buy in the open market, the option will be said to be “in the money”


Same price = at the money

 Settlement:


Note that you can normally decide if you want physical settlement or cash
settlement. This means that you can pick to either

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 
receive the amount by which the market value of the shares exceeds the
aggregate strike price OR

receive the actual shares (note that this may carry additional costs (e.g. stamp
duty, transaction costs) - If you exercise this – it will be a PUT option

Option styles  The right to acquire or dispose of the asset to which an option relates, or receive a
payment based on any movement in its value, is contingent on the option being
EXERCISED.

Exercise dates 
The circumstances in which an option can be exercised can be structured un
a number of different ways, but the main permutations are as follows:

 American – can be exercised on ANY business day within a specified exercise

period (most expensive, most flexible)

 European – can be exercised ONLY on a specified day (and time) (simplest)

 Bermuda – can be exercised on ANY ONE OF A NUMBER of specified days.


Exercise of options: A contractual option must be exercised strictly within the time
limits specified – otherwise it WILL LAPSE.

 The unique feature with options is that a buyer has the opportunity of making an
Why are options unlimited profit, with his potential losses being limited to the amount of the premium.
interesting

Use  Options can be used for investment purposes but have also hedging applications.

 Example:


An oil exporter wanting protection against a fall in the price of its oil could purchase a
cash settled put option under which, if the value of the oil falls below a certain level
(i.e. the strike price) it is entitled to a payment based on the amount of the
difference.

 Yes
Standardised

INTEREST RATE OPTIONS

What are 
These option products can be used to establish maximum (cap) or minimum (floor) rates or
they? a combination of the two which is referred to as a collar structure. These products are
used by investors and borrowers alike to hedge against adverse interest rate movements

 Use
CAPS

An interest rate cap is a derivative in which the buyer receives payments at the
end of each period in which the interest rate exceeds the agreed strike price.

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 
A cap is a transaction under which one party agrees to pay a floating rate to the
other if the rate EXCEEDS A SPECIFIED LEVEL.


An example of a cap would be an agreement to receive a payment for each month
the LIBOR rate exceeds 2.5%.

 Example


If the buyer has borrowed money from a third party at a floating interest rate, it is
exposed to any increase in rates until they reach the level of the cap. If, however,
they rise above 10%, the seller of the cap will meet any additional payments that
have to be made.

 Note: The seller will do so for a premium

 Use
FLOORS

It is a transaction under which one party agrees to pay a floating rate to the
other if the rate is less than a specified level.
 Example


If a person lends money at a floating rate it may want to be certain that its income will
NEVER fall below a certain level. It could then buy a floor from a third party under
which, in return for a premium, the third party agrees to make payments if the floating
rate is less than the level of the floor.

 Use
COLLARS

A collar is in economic terms, a transaction which involves BOTH the sale of a CAP
and the purchase of a FLOOR.

In other words, it is a transaction, under which 1 party agrees to pay a floating rate
to the other IF the rate exceeds one level, but is ENTITLED to receive a floating
payment if the rate is less than another, lower level.

 How do they work


In an interest rate collar, the investor seeks to limit exposure to changing interest
rates and at the same time lower its net premium obligations.

Hence, the investor goes long on the cap (floor) that will save it money for a strike
of X +(-) S1 but at the same time shorts a floor (cap) for a strike of X +(-) S2 so that
the premium of one at least partially offsets the premium of the other.


Here S1 is the maximum tolerable unfavourable change in payable interest rate and
S2 is the maximum benefit of a favourable move in interest rates.

 Application


The main advantage of a collar over a cap is that collars tend to be cheaper to reflect
the additional risk to which the buyer is subject.

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 Warrants

What is it?  A warrant is an option which takes the form of a transferable security rather than bilateral
contract.


They may be issued either alone (the subscription money representing the premium for
the option) OR in conjunction with the issuer of a series of bonds.

 Warrants are frequently attached to bonds or preferred stock as a sweetener, allowing the
Use issuer to pay lower interest rates or dividends. They can be used to enhance the yield of the
bond and make them more attractive to potential buyers.

 Warrants are very similar to call options.

Comparison
with call 
For instance, many warrants confer the same rights as equity options (so they contain
options an equity option), and warrants often can be traded in secondary markets like
options.


However, there also are several key differences between warrants and equity options:


Warrants are issued by private parties, typically the corporation on which a
warrant is based, rather than a public options exchange.


Warrants issued by the company itself are dilutive. When the warrant issued by
the company is exercised, the company issues new shares of stock, so the number
of outstanding shares increases. When a call option is exercised, the owner of the
call option receives an existing share from an assigned call writer (except in the
case of employee stock options, where new shares are created and issued by the
company upon exercise). Unlike common stock shares outstanding, warrants do
not have voting rights.


Warrants are considered over the counter instruments, and thus are usually only
traded by financial institutions with the capacity to settle and clear these types of
transactions.


A warrant's lifetime is measured in years (as long as 15 years), while options are
typically measured in months.

 Warrants are not standardized like exchange-listed options.

Standardised

Swaptions

WHAT IS IT?


A swaption is an option granting its owner the right but not the obligation to enter into an underlying
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 swap.


An upfront premium will be paid to compensate the counterparty for the risk they are being put under

Use  Since Swaptions do not create any exposure until they are exercised, they can be
used to take advantage of favourable interest rate/exchange rate movements
whilst protecting buyer against the consequence of an adverse movement in rates

 The buyer and seller of the swaption agree on:

Structure
 the premium (price) of the swaption

 the strike rate (equal to the fixed rate of the underlying swap)

 length of the option period (which usually ends two business days prior to the start
date of the underlying swap),

 the term of the underlying swap,

 notional amount,

 amortization, if any

 frequency of settlement of payments on the underlying swap = basis point spread

 Practically:


Pay a premium to enter into the swaption, then a periodic payment once the
swaption is exercised

 OTC
Market

Trading of Derivatives

Exchange

Exchange trading:

A derivatives exchange is a market where individuals trade STANDARDIZED contracts that have been
DEFINED by the exchange.

A derivatives exchange acts as an intermediary to all related transactions and takes Initial margin from both
sides of the trade to act as a guarantee.
Advantages  The exchange will only make available for trading the products for which there is the greatest
market demand
 Trading of the products is on standard terms
 As a result, products that are traded are highly liquid
 Buying and selling prices are readily available, the “spread” between them is usually fairly close
and they tend to be less volatile than they would be if the products were traded less
frequently.
 Buyer can be reasonably confident of being able to close out its position at a price close to the
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 purchase price.

OTC

OTC trading:
The major disadvantage of the exchange is that it lacks flexibility.
An OTC transaction is a privately negotiated contract on whatever terms the parties agree. The parties therefore
have complete flexibility to adapt the terms of the transaction to the commercial objectives they are trying to fulfil.
Advantages  much less regulated
 May be more suitable to the specific parties’ needs
 no price reporting requirements applied by the FCA
Disadvantages  Subject to counter-party risk, like an ordinary contract, since each counter-party relies on
the other to perform.
 There is no secondary market to sell the derivatives on, so an OTC derivative is rather
illiquid – so once arranged the buyer is likely stuck with it (it is unlikely anyone else
would find a bespoke OTC arrangement attractive to purchase)
Note:
Even OTC products offer some level of standardisation nowadays. This is mainly because:
 limiting the number of points which require negotiations reduces the time it takes to agree and document
a trade
 standardisation of key terms makes it easier to find a party to trade
 with a reduction in the number of variables comes an increase in liquidity as it leads to an increase in the
number of participants trading broadly the same product

Securitised Derivatives

 A third way in which a derivative can be traded is as part of a security with an embedded derivative.


A securitised derivative is an instrument that derives its value from another security (the underlying
security), such as a share, share price index, currency or bond.

 Example: A bond that redeems at par unless the FTSE 100 Index has increased since the issue date, but
otherwise pays an amount based on the extent of the increase (this is very similar to a cash settled call
option on that index).

Use of Derivatives

Hedging

Reduction of risk:

Derivatives allow RISK related to the price of the underlying asset to be transferred from one party to
another.

For example, a wheat farmer and a miller could sign a futures contract to exchange a specified amount of
cash for a specified amount of wheat in the future. Both parties have reduced a future risk: for the wheat
farmer, the uncertainty of the price, and for the miller, the availability of wheat.

However, there is still the risk that no wheat will be available because of events unspecified by the
contract, such as the weather, or that one party will renege on the contract.

Although a third party, called a clearing house, insures a futures contract, not all derivatives are insured
against counter-party risk.
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Arbitrage Derivatives can be used to take advantage of market pricing differences in ways that would be
too awkward or expensive if it were not for the availability of a hedging transaction. For
example, derivatives can be used to short shares, which is not possible otherwise.

Investment

 Derivatives can also be used for investment purposes.


Here the speculative nature of the transactions does come into play.
 Example: A fund manager may take the view that shares in a UK company are going to rise in value. To take
advantage of this it could either buy the shares themselves and enter into an equity swap linked to the share
or an index of UK share prices. Alternatively, it could purchase a financial future, or if it wants an element of
gearing, a call option.

Repackaging

 An intermediary may wish to MAKE A PROFIT by acquiring financial assets and repackaging to make them
more attractive to investors.


In other words, a basket of assets is typically contributed or placed into a separate legal entity such as
a trust or SPV (special purpose vehicle), which subsequently issues shares of equity interest to
investors.


This allows the sponsor entity to more easily raise capital for these assets as opposed to finding
buyers to purchase directly such assets.


The benefits and risks of those assets can be ‘neatly’ mixed for a desired risk/reward ratio

Netting

Netting is a method of reducing the credit risk involved in a series of transactions so that the net value of the
transactions represents the maximum loss that can be suffered in relation to them as a result of a default.

 On Insolvency:
What is it trying to
prevent? 
The commencement of winding up proceedings may entitle the counterparty to
insist on performance by the insolvent party of its obligations under the
contract, BEFORE performing its own.

If the liquidator agrees to this, the solvent party will not be entitled to withhold
performance.

 Cherry picking:


s. 178 IA 1986 – the liquidator of a company has the power to disclaim
unprofitable contracts. The effect of this is to terminate the company’s rights
and obligations under the disclaimed contract. (i.e. neither party needs to

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 perform)

This would result in converting the counterparty into a (potentially) unsecured
creditor for any loss it has suffered.


The liquidator is therefore in a position to ‘cherry-pick’ i.e. disclaiming the
unprofitable transactions, while enforcing the rest (and performing the
company's obligations under them)

 Result:


The counterparty could be OBLIGED TO PERFORM CONTRACTS unprofitable to it
and will therefore suffer a loss in respect of them.

Use  The primary purpose of a netting agreement is to PREVENT the liquidator of an

insolvent party from cherry picking between different transactions AND, as a result,
ensure that its counterparties have a NET rather than a GROSS exposure in respect
of the transactions they enter into with it.

1. Close-out netting: (section 6(e) MA)


In the event of counterparty bankruptcy or any other relevant event of default or
termination specified in the agreement if accelerated (i.e. effected), all
transactions or all of a given type are netted (i.e. set off against each other) at
market value; or

if otherwise specified in the contract or if it is not possible to obtain a market value at
an amount equal to the loss suffered by the non-defaulting party in replacing the
relevant contract.


The alternative would allow the liquidator to choose which contracts to enforce and
which not to (and thus potentially "cherry pick").

 Effect:


decreases credit exposure, increases business with existing counterparties, and
reduces both operational and settlement risk and operational costs

o E.g. X owes £9.5 million and Y owes £12 million

o Inefficient and risky for X to pay £9.5 mil to Y and for Y to pay £12 mil to X
because the money could be doing other things

 Money could be tied up in long term investments

 May have to pay fees to transfer the money

 Could be opportunity costs for paying the money

o Furthermore, it takes time (2-3 days) to transfer the money

o Also, if X paid but Y went insolvent, X would lose the £2.5 mil profit it should
have made as well as the £9.5 mil it has put into Y’s insolvency (could claim
money back through insolvency proceedings but unlikely to get all of it
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 back)

o If you net the payments, then only one payment will be made, Y pays £2.5
mil to X which is much less risky

 How does it work?


Parties enter into a single master agreement (Clause 1(c) ISDA – see below)

Each new transaction is merely to supplement or amend the existing payment and
delivery obligations under the agreement


The idea is that if there is only ONE agreement, the liquidator will have to choose
between enforcing or disclaiming the agreement as a whole.


The liquidator will likely disclaim the agreement if the liquidated co is out of the
money, but if the liquidated co. is in the money then it will enforce the agreement.

 The benefit of the closed-out netting is it gives the counter-party the best
chance of paying as little to the liquidated company as possible, as the
liquidator will have to accept the agreements which the counter-party is in
the money as well as those which the counter-party is out of the money.

 If there was no closed out netting, then the counter-party would have to
pay for all of the transactions which it was out of the money, but not have
the benefit of any of the transactions it was in the money (as the liquidator
could disclaim those individually).

 Monetary nature:
Requirements
 For a set-off to be available under the Insolvency rules, the claims in question
must be monetary in nature i.e. they MUST result in a liability to pay money.

 IT IS NOT Possible to set-off a claim for the delivery of goods against a debt or an
obligation to deliver identical goods

Example An obligation to deliver 10,000 barrels of crude oil to an insolvent company
on a particular date under a futures contract therefore cannot be set-off against a
debt which is due from the company under another transaction, OR even a right to
receive crude oil of the same specification on the same date.

 Mutuality:

 Only rights and obligations which arise from mutual dealings may be the subject
of a set-off

Mutuality simply requires the respective claims to be owed between the same
parties and for those parties to be acting in the same capacity


Example: A debt owed jointly by TWO or more persons to an insolvent company
generally may NOT be set-off against a claim by one of them against the company.

Term  Operation and Effect

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  It is not clear if the single agreement provision would be upheld by the courts so
the master agreement also provides that on the occurrence of certain events, the
outstanding transactions may be terminated.

 So even if the individual transactions were construed as separate contacts for the
purpose of s. 178, closing out the transactions will mean that there is nothing left
for the liquidator to disclaim

 Creation of flawed assets

 This provision states that the obligations of each the parties are conditional on no
event of default having occurred with respect to the other.

 The other party can then prevent cherry picking by saying that the insolvency is an
event of default and therefore the contracts are not to be performed

Payment Netting  Payment netting and close out netting are not the same thing

 Payment netting occurs when there has been no termination/event of default

o E.g. 4 derivatives with payments due every month between them

 It still does not make sense for X to pay all the money that is owed under every contract
one way and Y to pay all the money owed under every contract the other way

 Payment netting is netting all those payments so just the difference is paid

 Payment netting is not difficult when money is owed at the same time and there is no
difficulty in calculating how much money is owed

o Therefore, will normally have payment netting on individual transactions

 Multiple transaction netting can be more difficult in terms of working out exactly how
the payments should be netted

o Section 4(i) of the Schedule gives the choice of multiple payment netting or not

o Some banks can calculate it, but others cannot

o If you can do it, you definitely want multiple transaction payment netting

Hierarchy and ISDA Documentation

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 ISDA DOCUMENTATION (for swaps – OTC; exchanges have their own standardised documents)

Master Agreement allows the counterparties to negotiate standard terms between them at the outset of
their relationship
THEN they enter into a Confirmation for each transaction incorporating the standard terms
which means that only the specific financial terms of the transaction must be set out

1. Master Agreement:
o UMBRELLA DOCUMENT – framework for the derivative
o Sets out the standard (non-economic) T&Cs including representations, undertakings, events of
default, termination events, change of law and netting
o Pre-printed, cannot be amended; all modifications are done in Schedule (transferability point)
o Cl 1- 4: interpretation, obligations, representations, agreements
o Cl 5 – 7: events of default, termination and early termination
o Cl 8 – 14: admin stuff

2. Schedule:
o Allows parties to tailor the agreement by modifying Master and adding extra provisions to
agree their own economic terms
 Within the Master Agreement there are various options you can select and in the
Schedule you choose from the options
 Economic terms = e.g. I am buying gold on a swap
o Takes precedence over master agreement
o Details about derivative
o Part 1 – termination events
o Part 2 – agreement to deliver documents
o Part 3 – miscellaneous matters/administration – governing law/notices/netting
o Part 4: parties amend and delete MA provisions and incorporate additional provisions
o Fewer amendments in the schedule = more transferability

3. Confirmation:
o The information is often referred to as “dates and rates”
 Locks down the exact price at the last minute
 Sets out the key details for a particular trade, covering how payments are to be
calculated and when they are due from each party
o Final short document
o Confirmation may incorporate, amend or disapply any of the provisions of the standard ISDA
definitions applicable to the transaction
 If there is inconsistency, the terms of Confirmation prevail

Collateral can be held under ISDA Credit Support Documents: Credit Support Annex or Credit Support Deed
- Collateral falls under the Financial Collateral Arrangements (no 2) Regulations 2003 (SI

125
 2003/3226)
- The Annex is classified as a Title Transfer Collateral Arrangement
- The Deed is classified as a Security Financial Collateral Agreement
- Therefore, there is no need to register collateral at Companies House (s859A CA 2006)
o Registering is time consuming and registering collateral negatively impacts credit rating
so would not want them registered

4. Credit Support Annex

o An optional document. Bank needs it to support its risks as the borrower owes more
money to the bank as a result of entering into more derivative transactions
o Parties agree that if certain events occur, one party will have to transfer title to the
collateral they are giving to the other party based on its exposure to the other party.
o The English law annex: allows a transfer of title to the collateral. In the event of
default, the collateral holder can net off the amount of collateral against what is
owed under the ISDA transactions
 Transferee can use the collateral in any way it wishes and only has an
obligation to redeliver equivalent collateral
 This allows the transferee to use the collateral for its own purpose and
only has an obligation to redeliver equivalent collateral
 This is rehypothecation
 E.g. if the collateral was cash, transferee could use the cash as
collateral for one of its own derivatives
 E.g. if collateral was oil and thought price of oil was falling, could
sell oil to get the cash and buy back the oil in the future when it is
cheaper and return this oil at the end of the derivative
o Credit support annex is recognised in more jurisdictions around the world than
credit support deed
o The Annex forms part of, supplements and is subject to the ISDA Master
Agreement and will be part of its Schedule (see intro para in annex)
 This is why when you do the close out calculation (how much money is
owed to each party) any collateral given under the annex counts as
money you have given to them
 E.g. you give £500 collateral, that amount is taken off your bill
 Linking the annex to the Master is also important because it ensures a
liquidator cannot set it partially aside as an unprofitable transaction

5. Credit Support Deed

o No title transfer
o Creates security over the collateral by charge (effectively and equitable interest)
 Similar to a fixed charge rather than a mortgage
o Enforced in the event of default
o Does not allow for rehypothecation
o If collateral was something valuable like property, may prefer this to CSA as less risk of
transferee doing something with the property
o Standalone document – does NOT form part of the Master and Schedule
 Therefore, does not count towards close out amount

Title transfer - annex Charge - deed

 Less complicated formalities and so  Will be necessary in jurisdiction which
easier to ensure that the transfer is may not recognise netting-off
binding  Over-collateralisation: the collateral
 Rehypothecation – collateral becomes taker ranks on insolvency of the
the property of bank who can deal collateral giver as an unsecured creditor.
freely with it If a charge is taken, the
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  Enforcement is easier – since the title collateral forms part of the collateral’s
has been transferred there is no taker estate to the extent of the secured
necessary further enforcement per se liabilities only
 Negative pledges are less likely to  Taxation: title transfer may give raise to tax
catch title transfer than to apply to liability which doesn’t apply to creating a
creating a charge charge

 Sequence of events for entering into the swap (common exam question)
o Normal sequence
 1 – negotiate and agree Schedule to ISDA Master Agreement
 2 – execute ISDA Master Agreement and Schedule
 3 – trade interest rate swap (oral contract made in telephone call because it is quicker)
 4 – execute interest rate swap confirmation
o Fast sequence
 1 – trade interest rate swap (oral contract made in telephone call between the parties)
 2 – execute “long form” interest rate swap confirmation
 Contains normal terms in a confirmation as well as various key terms e.g. election
that you are going to be under UK law
 In it you will undertake to negotiate a Schedule in good faith
 So, you are already trading but you are undertaking to negotiate in good faith
 The long form confirmation can be either alongside an executed MA with no
schedule or with no sch or MA (in which case state subject to standard MA, no
amendments)
 3 – negotiate (in good faith) and agree Schedule to ISDA Master Agreement
 If you cannot negotiate an agreement to get the MA to work, you still have the bare
bones T&Cs from MA that you will end up using
 These T&Cs are unlikely to be good for both parties, so it works for both parties to
negotiate the Schedule
 4 – execute ISDA Master Agreement and Schedule

 Why would a bank’s exposure to a borrower increase if it enters into more derivative agreements with it?
o If it enters into more FX options this is less of a concern as the bank will get an up front
payment in the form of a premium for providing the product
 So even if the other party goes into liquidation, the bank already has its money.
 However, it is still exposed in the sense that if the option is in the money by the
time it can be executed, then the liquidator will still exercise it
 Bank will have to honour the option but would have had to if other party was
solvent so no real difference to them
o However, if it enters into more IR swaps then this is a problem.
 If counterparty were to go insolvent then they would no longer need to pay the
periodic payments to the Bank (if the swap was in the favour of the bank at the
time), but if the swap were to go to the benefit of counterparty then the Bank
would still have to pay counterparty.
 This means they are exposed to the risk of the swap without any of the benefit.
Moreover, if the bank hedged against the risk that the swap would move against
them (by entering into another derivative) then they would still be paying that
counterparty something, while making no money itself from the arrangement with
counterparty that was meant to cover that hedging cost. The bank may be able to
cope with the potential loss of one swap going badly, but if there are many swaps
with the insolvent company then the loss will be much larger

SPECIFIC MA CLAUSES
o s1(c): all the transactions entered into form a single agreement
o This includes the Master, Schedule, all Confirmations and any Credit Support Annex
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 o This prevents cherry picking – administrator can either affirm every single derivative or
disclaim every single derivative but he cannot cherrypick within the derivatives
o S2(c): netting of payments
o There is only one payment – the positive difference between the two payments in
the same transaction and currency, so the party who owes the larger amount
makes the payment.
o It is good for a credit risk if one party goes insolvent (there is no delay between one
party paying and the other party paying and risking insolvency of one in between)
o Schedule allows modifying the netting so that it applies to all sorts of transactions. A
good tool to reduce operational costs of making/receiving payments and credit risk
o S3: representations
o Each party makes representation and undertakings to the other
 Whereas facility agreement, only borrower makes the reps and undertakings
o Some of them repeated, some ongoing
 Usually deemed repeated on each date on which a transaction is entered into
o Helps to allocate the risk
o Breach of a rep is an event of default – e.g. s5(a)(iv)
o S4: agreements
o Covenants and obligations with which both parties have to comply with.
o Covers things like legal capacity, requesting accounts
o Part 3 of Schedule allows specifying who and what actually delivers
o S5: Events of Default and Termination Events
o Events of Default – implies fault
 E.g. 5(a)(i) – failure to pay or deliver
 Closes out all derivatives between the counterparties
 No obligation on other party to help the party at fault
o Termination – no fault - specified event which could bring the agreement to
an end, but is not necessarily related to what the party did,
 E.g. 5(b)(i) – illegality (unlawful to pay, deliver etc.)
 E.g. force majeure
 Only terminates the affected transaction, not all the derivatives
 Generally, includes an obligation to try and get around the
termination event
o Schedule allows adding additional events of Termination only
o S6(e): close-out netting (see above)
o Close-out netting is only relevant when there is a termination event/ default event
o When close-out netting kicks in, all transactions between the parties under the
Agreement are considered and the gain / loss of each party is calculated
including the future gains/losses that would have been made under the
agreement had it not been terminated
o Consequently, it is netted off against all transactions and all of them are
treated as parts of a single transaction (s1(c)) which prevents the liquidator
disclaiming ‘unprofitable’ transactions)
o This prevents a liquidator from cherry picking transactions that may not have been
profitable – he has to aggregate all the transactions and look at them as a whole
o NB: The liquidator could still disclaim the entire transaction if the net value of the
transactions meant the liquidated company owed the counter-party money.
However, because the liquidator cannot cherry pick it means that the counterparty
will lose less money as it will only lose the net value of the transactions, but not be
forced to pay for derivatives that are, from the insolvent company’s perspective, in
the money only.
o Essentially, closed out netting will mean that the amount of loss the counter-party
suffers is limited to the net value of all the transactions.
 In the event that the liquidator decides not to disclaim the transactions –
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 because, considering all the transactions, the liquidated company is in the
money – then the close-out netting still allows a more beneficial situation
for the counter-party as the counterparty will pay out less to the
liquidated co than if the liquidator could cherry pick the transactions
where the liquidated co. is in the money

Examples of how the Schedule Interacts with the Master:

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 7 - Debt Securities (1)
Main Parties Involved in an Issue of Debt Securities

PARTY Explanation of Role

Issuer  Issues bonds to the bondholder - the borrowing entity

o May be backed by a parent company guarantee – consider if there is sufficient
corporate benefit (upstream harder)

 Stands behind the issuer’s obligations – usually but not always the parent company (if
Guarantor there is one)

Lead Manager/  Is appointed by the issuer (by a mandate letter)

Joint Lead Managers  Goes out to find other lenders (co-managers)
 Will be responsible for arranging the bond issue and managing the issue process from
receiving its mandate through to the issuer receiving funds
 The lead manager will advise the issuer on the structure, timing and pricing of the
issue and so takes the credit for success and responsibility for the failure of the issue
to sell
 Determines the syndication strategy for the notes and organises the road shows to
market the issue
 Responsible for instructing the lawyers
 Usually underwrite the lion’s share of the issue (take up the notes that other
managers do not take up)

Co-managers  Syndicate members who subscribe for the bonds and then sell the issue to investors
by ‘making a book’ (finding investors who want to buy)
 The syndicate (in return for a fee) take the risk that the issue is not fully subscribed by
investors, in which case they will buy the unsold bonds
 Liability of the managers is joint and several
o Therefore, they will enter into a separate agreement to record the number of

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 bonds each manager will take
 Usually a group of financial institutions who are selected jointly by issuer and lead
manager

Principal Paying  Co-ordinates payments of interest and capital to bondholders/noteholders and deal
Agent or Paying with replacements of definitive bearer bonds if they are damaged or defaced
Agent  Usually only have this if you have a trustee
o If you have a trustee rather than a fiscal agent, you need someone to deal
with the payment to the bondholders
 As well as a principal paying agent, there are often paying agents in different
jurisdictions
o May have these even if you have a fiscal agent
 Paying agents have no duty of care to the bond holders

Fiscal Agent  A bond issue will use either a fiscal agent (under a fiscal agency agreement), or a
trustee (under a trust deed)
 The fiscal agent is primarily responsible for paying principal and interest to the
bondholders (basically carries out the same role as a principal paying agent)
 Does not owe the bondholders any duty of care
 More common to have a fiscal agent than a trustee because it is cheaper

Trustee  Acts as intermediary between bondholders and issuer.

 Owes duty of care to bondholders
 Have to have a trustee if the issue is secured – trustee holds the security
 Also have to have a trustee if the debt needs to be subordinated

 Advises issuer on and handles all listing aspects

Listing Agent  Listing agent not required if issues listed on UK’s stock exchange

Solicitors  There will be lawyers for the issuer and separate lawyers for the lead manager
 Often trustee will appoint own legal advisors
 Lead manager’s lawyers prepare documents

Auditors  Agree use of their report on the accounts in the prospectus.

 Confirm no recent changes to the financial position
 Will likely have to issue a comfort letter that will give the managers additional
reassurance that the financial info that is included in the prospectus is correct and not
misleading in any respect

 Only for MTN programmes. Similar to a leader manager

Arranger

 Only for MTN programmes. Equivalent of co-managers

Dealers

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 Bonds

 Capital Markets: large pool of investors willing to invest in debt securities (easily traded on various
exchanges).
 Debt security: instrument in which borrower acknowledges debt from issuer

Types of Debt Security

N.B. Bonds and notes are strictly types of debt securities, but terms are often used interchangeably (p.193). When in
doubt just use term notes.

Bond - Certificate of debt: issuer (borrower) obligates itself to pay principal to bondholder
(lender) on a specified date
• (norm. Medium to long term maturity i.e. 3 years or more)

• Essentially an IOU
- s755: Only public companies can issue bonds
• If company is not public, look for a parent company who is already a plc or for a special
purpose vehicle to be incorporated as a plc
- Marketable instrument: has established secondary market upon which bond may be
sold usually to investors e.g. institutional investors such as pension funds, large
companies and insurance companies,
- May or may not be listed on a recognised stock exchange
- Bond will either:
• Bear interest and therefore provide income to the BH; or

• Be issued at a discount to its face value at redemption (‘zero coupon’ i.e. no

coupon)
o e.g. A purchases a bond for a discounted price of £80 from B. Three years later
the bond is redeemed and B repays to A the full price of £100
- N.B. a high yield bond is a bond issued with a credit rating that is not investment grade
- Sale of a fixed-income bond when interest rates go up – the market value (i.e. price paid
by buyer) goes down and the yield (i.e. what a bond pays by way of interest as a
percentage of its value) goes up – par (nominal) value of bond will never change
Commercial Paper Interim source of finance
-
Appropriate for co’s with short term borrowing requirements i.e. cash flow problems
-
Can be issued in large amounts but must be repaid within a maximum of 365 days.
-
Available in various maturities e.g. for periods of 1, 3, 6 or 9 months

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  In practice, maturities will often be just one or two months
-
CP is issued under a programme – but the documents are shorter and simpler than those
used in an MTNP.
-
It is usually unsecured, sold at a discount rather than being interest bearing (for withholding
tax reasons) and is almost always in global form
-
Does not have a coupon
Convertible Bonds Bonds which contain terms which permit the issuer to force the BHs to convert the
bonds into shares when market value of its shares increase. CBs pay a lower coupon.
Contain an equity option.

Facility Agreement (Loan) versus Bonds (perspective of issuer)

FACILITY AGREEMENT BONDS

Advantage ✓ Disadvantage ✗ Advantage ✓ Disadvantage ✗

Risk for lender  A small group of lenders (the syndicated  A much wider group of investors
banks) are lending the entirety of the invest a smaller amount each in the
money – this means that their exposure borrower (here the issuer) and so
to risk/ creditworthiness of the
each lender’s (bondholder’s)
Borrower is high – resulting in more DD,
financial covenants and the need for exposure to the issuer is reduced.
security.
 The BHs can also sell their holding –
further reducing their potential
exposure to risk.
Any deterioration in the issuer’s
ability to service the bond will be
reflected in its credit rating and the
price the bonds command in the
market.

 So, there is less need for security,

financial covenants and such an
extensive DD process.

 Wide: Issuer is able to access much

Investor base  Narrow: Restricted to certain wider group of potential lenders –
commercial banks who are authorised to through syndicate of investment banks.
lend money.

 Transferable Instruments: (often listed

Trading  Rarely Transferable: Although loan on a stock exchange) that can be traded
Transferable securities agreements may allow banks to transfer in the international capital markets =
are more popular for their interests to other banks – there is
investors who can sell more appealing to investors (don’t have
their bondholding
little secondary trading (except in the to wait until maturity date for
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 repayment – can sell)
“distressed” debt market).

Flexibility  Flexible in amount borrowed: Borrower  Rigid: Issuer receives the full
Does the client require can draw down funds as and when subscription on the issue date – thus no
the capital for needed and flexible in amount repaid: flexibility on when/ if it can draw down
something contingent –
or furthermore is the
Borrower can repay loan on more capital.
amount needed flexible terms – B can repay and redraw  MTNP Bonds usually only provide for
uncertain? money as required one payment on maturity (a "bullet
repayment") as well as regular interest
payments (although some bonds can be
repaid in instalments)

 No Renegotiation: Too many investors

Renegotiation of  Renegotiation: If the borrower is in (most of whom will be unknown to
terms financial trouble there is poss. of issuer) to renegotiate terms with each
Tie in w/ Flexibility renegotiating the terms of the loan – one – therefore terms cannot usually be
section giving him leeway. renegotiated.

Syndication In a syndicated loan each bank will lend The syndicate will underwrite the bond issue
money to the borrower in proportion to its but will only actually subscribe for bonds
commitment in accordance with the terms (and hence provide funding to the issuer) if
of the FA. Each bank will be liable for its they are unable to find sufficient investors to
own commitment not that of the others. purchase the issue. Liability of the
underwriting syndicate on the bond issue is
(usually) joint and several.

Covenants  More stringent: cov’s imposed upon  Less stringent

Is client able/ willing to borrower
comply w/ stringent  Terms and conditions of issues of debt
cov’s customary of securities generally contain far fewer
syndicated loan? covenants by the issuer than in a
syndicated loan

 Flexible: Debt securities usually have

Interest rate  Rigid: Syndicated Loans often only offer more flexible interest rate options:
current floating rate option. fixed, floating zero coupon etc...

 Currency of Issue: Issuer will usually

Currency  Multi-Currency Option: May be in FA – borrow in the currency specified when
Is the client using the enables borrower to switch the loan the debt securities are issued – and then
capital for an overseas from one currency to another for
project? have to change money on FX. NB:
successive interest periods. Remember Currency Swap Derivatives

 Typically Unsecured: Due to their

Security over  Secured: Security provides lender with limited exposure and transferability,
assets recourse against borrower’s insolvency. bonds are not secured. Issuer retains
Does the client wish to Security limits the borrower’s control control of assets. However, issuer may
retain control of its over its assets.
assets?
want to offer security to make bonds

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 more marketable (rare)

 Public Domain: Details of the debt sec.

Confidentiality Is  Confidential: Syndicated Loans are will become public if the issue is listed
the reason for lending private contracts between borrower and on a stock exchange – listing requires
confidential i.e. the syndicated banks.
acquisition? ...then circulars and public disclosures.
must be loan...?

Size of borrower  Loans available to Co’s of all sizes  Only established companies with good
Is the client an  Increased willingness to lend: due to credit ratings: Issuers of debt securities
established co with a greater protection (security etc.) banks generally need to be established
good credit rating? i.e.
will it be able to attract
will be more willing to lend to smaller companies with good credit rating.
interest from capital sized companies with a questionable  If the issuer is not of sufficient size and
markets credit rating. creditworthiness to be acceptable to
debt securities markets, it will not be
able to issue debt securities and will
probably have to rely on loans from
banks.
 Moreover, if the issuer goes to the bond
market despite poor creditworthiness,
he will have to pay an excessive interest
rate on the bonds for investors to justify
taking the risk.

Disclosure  Comprehensive DD: In syndicated loan,  Limited to Public Info: info about the
Does the client wish to lending banks require thorough DD to issuer is usually limited to info that is
keep disclosure to a identify any risk of borrower defaulting publicly available, for example, financial
minimum? Link in w/
size of borrower section
in its repayments. statements rather than detailed
– for limited disclosure  Hence, borrower disclosing much more management accounts.
co must have good info to the lender than for a bond issue  This is because companies that can issue
credit rating? (BUT confidential). tend to have good credit ratings.

Speed  Quicker than an issue of bonds  Slower than loans

Does the client need to  However – client may seek to issue
raise the finance Commercial Paper (see below) or have
quickly e.g. cash flow
probs
an MTNP programme

 Faceless. Often you do not even know

Relationship  Does client already have an existing who holds your bonds, and if you do it
relationship with a bank – who it trusts? will be too many people to have any
If yes this could be an advantage. form of relationship

Stand-Alone Bond Issue and a Medium-Term Note Program

Stand-Alone Bond Issue


This is a one-off issue of a bond (usually for a specific purpose for which the company knows how
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 much is needed)

Medium Term Note Programme (MTNP)


Multiple issues of bonds within a framework governed by a set of master documents (useful
where the company is going to raise debt finance on multiple occasions and for multiple purposes)

Puts in place a basic set of master documents containing a standard set of terms and conditions
with certain variables that will govern not only the current issue but also future issues

What is it? - A Medium Term Note Programme (also known as a “debt insurance programme”, is a
way of issuing bonds quickly and easily
- It is a set of master documents containing standard terms and conditions and other
contractual provisions that can be used to do any number of bond issues in the future,
subject to a maximum limit
- Bonds issued under an MTNP are called noted (but are the same in substance and form
as a stand-alone bond issues)
NB: The phrase “medium-term” is misleading, as notes issued under a programme can have
a maturity of any length (e.g. 1 month to 30 years)
Terminology -
Drawdowns – these are the individual issues of notes under the programme (also known
as take-downs or trades)
-
Euro – essentially means international meaning that an issuer is borrowing from a
foreign lender in a foreign currency (as opposed to domestic issue)
Advantages of a The advantages of setting up an MTNP programme (rather than doing a stand-alone bond
MTNP issue):
 Save cost and time – once the programme documents are in place each issue
of notes involves the production of small supplemental documents that identify the
relevant provisions of the master documents and set out the specific commercial
terms of the particular issue.
 Negotiations – the negotiations of the principal terms will already have been done
when the programme was initially established
 Disclosure – disclosure by the issuer will already have been made and have been
verified by the dealers’ due diligence.

These points will mean that for a single-dealer drawdown, the documents can be produced
in house without the need to instruct external lawyers.
 Flexibility – the issuer will be able to issue almost any kind of note at short notice,
whenever you want to hit the market, because the provisions for different types of
issues and the relevant documents are already in place
 Size and number of documents – for practical purposes, establishing an MTNP
programme reduces the number and size of documents needed for each issue; a
MTNP drawdown requires fewer and smaller documents than a stand-alone issue
Disadvantages of a  Cost-effectiveness – a programme is only cost-effective if the issuer intends to do
MTNP several bond issues over the following year or so, otherwise it will not be worth the
cost of establishing the programme

Unusual or complex terms – if the issuer proposes to issue notes with very unusual or
complex terms that are not contemplated by the programme documents, the changes
required to be made to the programme in order to do each issue may be so numerous
that a stand-alone issue from scratch would be preferable.

Choosing Between Stand-Alone Bond Issue and a MTNP

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 STAND-ALONE ISSUE MEDIUM-TERM NOTE PROGRAMME

One off Multiple

One-off or 
This is a one-off issue of a bond 
Multiple issues of bonds within a framework
multiple governed by a single master document
issues? No master document:

Because it’s a one off issue a full set of docs Master doc:

must be produced for each issue The Master Document is drafted containing
standard terms and conditions and other
contractual provisions that can be used to
issue any no. of bond issues in the future,
subject to a maximum limit for the
programme

-
Suitable when the issuer needs to raise all If client seeks to
When the £ he needs in one go (e.g. not when -
Raise significant amounts of debt finance
suitable? there will be a need to refinance or make over a period for a series of purposes
further acquistions in the future) -
However, he does not need all of the money
-
This is NOT economical if issuer does not at once and would like to draw down the
actually need some of this money, yet still funds as and when needed
has to keep paying interest on the bonds to
bondholders
-
Suitable when the issuer does not
contemplate making changes to the terms
and conditions during the life of the bond

-
Flexible at the outset because the -
Under MTNP, the 1 master document is
Flexibility bond issue is bespoke, i.e. parties can not bespoke, rather it provides a general
agree whatever specific requirements framework within which the various
they want issues can be made
-
However, if the parties want to make -
The flexibility is limited by the fact that
amendments, then there would be a lot of the only variations from the original terms
work to be done in making amendments to and conditions in the Master Doc of the
the document MTNP are those provided for by the
Master Doc (i.e. they must have actually
Inconvenient if plan to make multiple issues: contemplated the necessary permutations
-
Will need to negotiate an agreement for in order for each issue to be capable of
every individual bond issue variation)
-
General changes e.g. fixed vs floating charge
can easily be provided for, but unpredictable
points cannot be
-
If issuer finds later that terms do not cater for
a required option, they must either update
the programme or do a stand alone issue

Convenient if planning multiple issues:

-
Issuing bonds quickly and easily after the
master document had been set up

 Specific subscription agreement is  A programme agreement records the

Documents drafted under which investors (banks) possible terms of a future issue and an
agreed standard form of subscription
137
 agree to invest in the bond issue agreement to be used at the time of each
required?  Agreement among managers issue
 If bonds are going to be listed, a prospectus  A maximum value of issues under the
may be needed programme is also agreed at the start (this is
the “programme limit”)
 If notes are going to be listed, a base
prospectus may be needed
 Procedures memorandum (see below)
 So much upfront docs reduces number of
docs needed for future draw downs
o On drawdown, just need a Menu Picker
that has the final terms setting out pricing
info in relation to the specific draw down
and identifying the provisions of the T&Cs
relevant to the particular issue

 Initially: EXPENSIVE – due to amount of the

Costs  Lower cost if only contemplating 1 issue documentation, legal costs will be higher
and no more issues coming in the future  Later: CHEAPER – subsequent issues
can be carried out quickly using the
standard form documentation and the
costs of this would not be high

 Initially: May take up to 6-8 weeks due to

Time Taken  Principal terms of each issue will need to complexity of documentation
be produced in full every time issuer  Later: Once programme docs in place, each
issues bonds (BUT quicker than the issue of notes only involves production of
creation of the original MTNP master doc) small supplemental documents, so will only
take 7 – 10 days to issue bonds from this
master doc

- Issuer = the borrower - Issuer = the borrower

Parties - Guarantor = stands behind the issuer’s - Guarantor = stands behind the issuer’s
obligations obligations
- Lead Manager = - Arranger =
• Appointed (mandated) by issuer via the • Arranger is the exact equivalent of
‘mandate letter’ the Lead Manager
• Lead manager will be part of the • Arranger will act as a dealer every time
syndicate with the co-managers there is a draw down (i.e. when new
• Arranges the issue of the bonds and bonds are issued)
manages the process, advises on • Arranger has all the same
structure, timing and price of the issue powers and responsibilities
• Prepares and negotiates (arranges the issue of the
documentation with the issuer bonds and manages the
• Markets the issue and (usually) process, advises on structure,
underwrites the majority of the issue timing and price of the issue) &
• If bonds are to be listed, lead manager • Co-ordinates the establishment of the
often acts as sponsor and listing agent programme
for the issuer • Monitors the programme to identify need
- Co-manager = to update documentation and provisions
• Appointed by lead manager and issuer - Dealer =
• They are also called ‘syndicate members’ • Exact equivalent of a co-manager

• Responsible for finding purchasers for • Does all the same things (copy list on the

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 the bonds issued
• Underwrite those bonds not left)
underwritten by the lead manager (i.e. - Trustee; or Fiscal Agent =
commit to buying those bonds not • Trustee – Trust company appointed by
bought by investors) the issuer that acts on behalf of the
- Trustee; or Fiscal Agent = bondholders
• Trustee – Trust company appointed by • Fiscal Agent is the representative of the
the issuer that acts on behalf of the issuer. Pass on the payments of
bondholders principal and interest to the
• Fiscal Agent is the representative of bondholders
the issuer. Pass on the payments of • For detail on roles of T/FA see outcome 2
principal and interest to the - Principal paying agent =
bondholders • Where there is a Trustee, a separate,
- Principal paying agent = ‘principal paying agent’ must be
• Where there is a Trustee, a separate, appointed. Responsible for collecting the
‘principal paying agent’ must be principal and interest payments from the
appointed. Responsible for collecting issuer and distributing them to the
the principal and interest payments investors. Where there is Fiscal Agent, the
from the issuer and distributing them Fiscal Agent acts as the Principal Paying
to the investors. Where there is Fiscal Agent
Agent, the Fiscal Agent acts as the
Principal Paying Agent

How Does Stand-Alone Bond Issue Work? Process and Documents

1: Pre-signing

-
Issuer appoints a lead manager. They:
• Arrange the issue of the bonds and manage the process
• Advise on structure, timing and price of the issue
• If bonds are to be listed, lead manager often acts as sponsor and listing agent for the issuer
-
Once the main terms of the issue have been finalised, mandate letter is prepared – by which the
issuer authorises the lead manager to launch the issue and form a syndicate
-
Issuer and lead manager instruct solicitors, who take a leading role in the due diligence before
the issue is announced
-
If bond is to be listed, make initial contact with the UKLA
-
When the issue is launched, it is announced by the lead manager, who issues an invitation telex
to potential syndicate members (syndicate members = co-managers)
• Before they respond to the telex, they contact their clients to ascertain how many bonds they
can sell on (co-managers and the lead manager subscribe for bonds, and then sell them to
investors)
• In most bond issues, the syndicate agrees to take all the bonds, even if they cannot find
investors. They will buy any unsold
• The co-managers who are willing to subscribe respond to the telex within 24 hours, by when,
under ICMA rules, the bonds must be conditionally allotted, subject to the subscription
agreements being signed
-
Allotment Telex = notifies all co-managers of amount of issue allotted to them (NB: ICMA requires
that allotments are made within 24 hours after the launch of the issue). All managers can be
139
 individually required to subscribe for all shares (‘jointly’ liable).
-
The managers enter into the AGREEMENT AMONG MANAGERS by which each manager
commits to taking the number of bonds that have been conditionally allotted to them. This
commitment to one another is necessary because, under the subscription agreement, the issuer
can require any one manager to subscribe for the whole issue, as they have joint and several
liability. Agreement also covers payment and allocation of the managers’ commission and
delegates power to the Lead Manager.
-
THE SUBSCRIPTION AGREEMENT =
• Contract between issuer, lead manager and co-managers which records basis on which issuer
will sell, and managers will buy, bonds on issue
-
Does not address allocation of bonds between managers or delegation of powers to the lead
manager to act on behalf of the syndicate
• A conditional contract – it only becomes unconditional if and when the CPs are satisfied. Only at that
point will the syndicate be bound to subscribe for bonds.
• Includes issuer’s representations and warranties.
• If a prospectus is required, the issuer must warrant that the info in it is accurate
• Under subscription agreement, liability of co-managers to the issue is joint and several.
Although the managers can decide between themselves how many bonds they each subscribe
for, their liability is not limited to this amount. The issuer can require any one manager to
subscribe for the entire bond issue if necessary
• NB: before co-managers agree to subscribe for the issue, they will normally have lined up investors
to buy the bonds from them

2: Signing

-
Signing happens within a week or two after the issue is launched. Only occurs if lead manager
and issuer are confident that issue may progress to closing.
-
What should have happened before signing?
• Requisite resolutions should have been passed to authorise the issue
• Issuer should have appointed
-
Signatories to execute all relevant documents at signing and the global bond at closing
-
Common depository
-
At the signing:
• Documents signed
-
Subscription agreement
-
Agreement among managers
• Auditor’s comfort letter provided
-
Confirms to the managers that the info given in the bond issue documents about the issuer’s
financial condition is accurate and not misleading
• Other contractual documents agreed in final form
• Prospectus signed and dated for approval by UKLA

3: Closing

140
-
Between 2 days and 1 week after signing
-
Outcome: deposit of global bond with the depository and release of funds to the issuer
-
Follows an agenda prepared by lead manager’s solicitors
-
Pre-requirements for closing to occur
• Subscription agreement has gone unconditional
• Admission to listing has been granted, subject to closing
• All other necessary documentation has been executed or are ready for execution at closing
-
Documentation for execution, signature or authentication on closing
• Fiscal agency agreement and deed of covenant (where appropriate)
• Trust deed and paying agency agreement (where appropriate)
• Global bond to be authenticated
-
The form of the bonds is set out in the schedule to the fiscal agency agreement or the trust
deed. The bond is then produced as a separate document for closing.
• Legal opinions
-
From issuer’s solicitor confirming certain legal info.
-
Opinions will include
• The agreements do, and the bonds will, create valid, binding and enforceable obligations
of the issuer
• No stamp duty is payable
• All necessary consents have been obtained
• Auditor’s comfort letter
-
Confirms to the managers that the info given in the bond issue documents about the issuer’s
financial condition is accurate and not misleading
• Issuer’s closing certificate
-
by this document, issuer affirms its representations and warranties in the subscription agreement
• Receipts for payment and delivery

How Does MTNP Work? Process and Documents

1: Establishment of MTNP

-
Issuer appoints an arranger. They:
• Advise the issuer and coordinate the establishment of the process
• Monitor the programme to identify any need to update documentation and provisions
• Are appointed as a dealer in a draw down. May act as lead manager in a drawdown.
-
The programme is created.
-
Programme agreement:
• Contract between the issuer, the arranger and the dealers
• Provides for the establishment of the programme and regulates the relationship between the parties.

141
 2: Signing on an Establishment

-
Different from signing on standalone, because the dealers do not commit to subscribing for an
issue of notes at that time (this is done at drawdown).
-
What should have been done before signing:
• Appointment of common depository
• Passed requisite resolutions to authorise establishment
-
Documents executed
• Programme agreement
• Trust deed and paying agency agreement (if appropriate)
-
Other documentation agreed in final form
• Procedures memorandum = This is not a legal document. It sets out the administrative
procedures for the notes issue and future draw downs, e.g. contact details of all the parties
-
If the notes to be issued under the programme are to be listed, a base prospectus must be
published, which must first be approved by the UKLA. It must be in final form for signature and
dating at signing
• NB: the final terms on which the notes are actually issued are released when the notes are
issued. They cannot be set out in the base prospectus, as they are not known at the time when
it is published

4: Drawdown of an MTNP

-
If it is intended for the drawdown to be syndicated, meaning that more than one dealer will
subscribe for the notes, one of the dealers, acting as lead manager, will issue the invitation telex.
-
If a drawdown is not syndicated, one dealer subscribes for all the notes. This is a “single dealer”
drawdown.
-
Issue will proceed on similar basis to standalone bond issue. Allotments made within 24 hours,
parties enter into a subscription agreement.

5: Signing on a Drawdown

-
Subscription agreement signed (if it is a syndicated drawdown)
• Form and contents are almost the same as for a standalone issue, except that it may also
provide for appointment of additional dealers.
• Form of the agreement is pre-determined as an agreed document scheduled in the programme
agreement
• CPs must be satisfied before closing on a drawdown (see below)
-
Final terms supplement
• sets out the specific commercial terms of the drawdown, and identifies the terms and
conditions in the master documentation that applies to the issue
• intended to be read alongside the base prospectus

142
 • will be submitted to UKLA and made available to the public

6: Closing on a Drawdown

-
follows an agenda prepared by the lead manager’s solicitors
-
outcome of closing: deposit of global bond note with depository and release of the funds to the issuer
-
pre-requirements for closing to occur
• subscription agreement has gone unconditional
• admission to listing has been granted, subject to closing
• all other necessary documentation has been executed or is ready for execution at closing
-
Documentation for execution, signature or authentication on closing
• Supplemental agreements – these include any agreements to update the programme or to
supplement or amend the terms of any agency agreement or trust deed
• Global note to be authenticated – done by fiscal agent or principal paying agent
• Legal opinions and auditor’s comfort letter (as above)
• Issuer’s closing certificate (as above)
• Receipts for payment and delivery

Closing Mechanics for Both Stand-Alone Issues and MTNP

CLOSING: The Movement of Global Bond and Cash

-
At the launch of the issue, the lead manager sent the invitation telex to prospective syndicate
members. They responded to say how many bonds they would take.
-
Lead manager responded by issuing its allotment telex to inform the co-managers how it has
divided up the issue.
-
Allotment takes place within 24 hours of the launch.
-
2 to 4 days before closing, the pre-closing steps are taken to set up the closing mechanics:
• Co-managers instruct the clearing system that they will take their allotments, and to debit their
accounts with the amounts they must pay
• Co-managers confirm to the lead manager that they have given these instructions
• Clearing systems confirm to the lead manager that they have received these instructions
-
At closing, the clearing systems transfer the subscription monies to the lead manager’s account
with the depository, and the issuer delivers the authenticated global bond.
-
The depository then simultaneously releases the global bond and the funds. This system is
“delivery against payment” – designed to ensure that payment is simultaneous with delivery of
the bond
-
Post-closing mechanics:
• Outstanding documentation may need to be lodged with the UKLA

143
 • If it is in temporary form, global bond will need to be replaced with permanent global bond.

Summary of Documentation

1. Base prospectus (will satisfy Listing Authority, and ALSO functions as advertising
MTNP document). Offering document for the notes. Contains final terms (so people know what
they are signing up for)
2. Procedures memorandum = not a legal document. Sets out how this is going to work,
how issuer is going to contact the dealers
- just a practical help document for those involved in the issue, because there might be many
parties involved.
3. Pricing supplement = supplement of the specific terms of a drawdown

NB: When the bonds themselves are issued (whether in TGN/ PGN or Definitive form) the terms
Stand-alone printed on the bond overrule the terms set out in pre-issue documents mentioned above (e.g. SA
and Agreement between Managers)
1. Fiscal Agency Agreement (overruled when bond issued) = contract between issuer, fiscal
agent and any other paying agents. Records structure through which bondholders will
receive payment of coupon and principal.
2. Paying Agency Agreement (overruled when bond issued) = if a trust structure used,
Trustee is not responsible for making any payments; hence a principal paying agent must be
appointed. Terms of the bond can also be included here.
3. Trust Deed (overruled when bond issued) = will contain the terms of the bond (where there
is a trustee involved)
4. Temporary Global Note =
-
When a bond is first issued it will be in the form of TGN – a single document prepared by
the lead manager’s solicitor, which represents all the bonds to be offered under that
particular issue.
-
Main purpose of TGN: prevent a bond from being sold within a certain ‘lock-up’ period
(usually 40 days) of being issued – so as to comply with foreign jurisdictions’ restrictions
on selling – e.g. in US. So TGN’s cannot be traded.
5. Permanent Global Note =
-
Represents all the bonds in issue.
-
PGN is issued on the closing date of the issue and is usually held by a bank known as the
“common depository” for safe-keeping on behalf of the clearing systems.
6. Deed of Guarantee = guarantees any SPV created for tax purposes
7. Deed of Covenant =
-
For bond issues that don’t use a trust structure, necessary to create a document which
gives the bondholders a right to sue the issuer in accordance with their bond allocations
shown in the clearing system
-
Prevents problem of bondholders being left unable to enforce their claims).

Trustee Structure and Fiscal Agency Structure (mutually exclusive)

N.B. trustee is likely to be a professional trust association or a dedicated subsidiary of a financial institution which
acts solely as a trust corporation.

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 TRUSTEE FISCAL AGENT (if no trustee)

 Issuer (through its advisors)

Appointed by?  NB: if trustee appointed, must also appoint  Issuer
paying agent
 (Trustee likely to be either a professional
trust association (e.g. The Law Debenture
Trust Corporation), or a subsidiary of the
bank or other financial institution, whose
sole function is to act as a trust
corporation)

 Bondholders  Issuer
Represents /  Trustee’s power and duties recorded in a  Fiscal Agency agreement
Works for / trust deed, but will also owe bondholders appoints the fiscal Agent and
Agent of… duty of care under trust principles. explicitly states that doesn’t
owe bondholders any duty of
 Concern: conflict of interest – Trustee is paid care.
by issuer and rely on them to be
recommended, yet they owe a duty to the
bondholders.
 initially: trustees more mindful of issuers’
interest
 now: focus more on the duty of care
towards bondholders (e.g. if there is
an error in bond and arguable
whether trustee might be able to rely
on discretion to make amendment
without bondholder consent – would
probably take safer route and seek
consent anyway

Generally: acts as intermediary between the (1) Pay interest / principal to

Role note-holders and the issuer (appointed by issuer bondholders
but acts on behalf of note-holders): (2) Authentication of the
(1) Holds the following property on trust = temporary global bond and
-
issuer’s covenant to pay the bondholder (i.e. any definitive certificates
bondholders’ right to receive payment) (3) Keeping and maintaining
-
security over issuer’s assets (if one had been records of payments on the
taken out) bonds and issuing replacements
(2) Negotiates with issuer: Under a trust for lost or destroyed bonds
arrangement, Trustee has legal ownership (4) Also has other administrative
of any claims that the Bondholders have functions in relation to the issue of
against the issuer. the notes, including publication of
-
This benefits both Issuer and notices to the bondholders and
Bondholders as the Trustee will be a acting as a depository for the
professional entity that can properly issuer’s accounts and other
negotiate with the Issuer and financial info which is open to
successfully agree on necessary inspection by the bondholders
amendments to the bond. (5) If fiscal agent used, the individual
(3) Litigates on bondholders’ behalf Bondholders enforce their rights
against the Issuer individually (no

145
 one to litigate on their behalf)
- NB: trustee will not distribute payments on behalf
of the issuer. When a trustee is appointed, issuer
also instructs a paying agent.

 Bondholders  Issuer
Serves  Cannot be removed without  No duty of care to note holders
bondholders’ consent.
 Statutory duties under Trustee Act

 Bondholders reserve individual

Bondholders’  Bondholders can only act against the issuer for rights against the issuer, as have no
any breach of terms of the bonds through representative.
Trustee.

Document  Trust deed  Fiscal agency agreement. Signed on

under which closing.
they are
appointed

 Yes – which may put issuer off, including cost of  Can be reduced – if also e.g.
Fee (inc. extra documentation and trustee’s fee common depositary bank
lawyers)

 Fiscal agent is cheaper

Cost  Trustee is more expensive

When Would you Use Which?

When MUST the Trustee Structure be Used?

Majority of bond issues will use fiscal agent rather than a Trustee (because it’s cheaper)
- HOWEVER, there are specific circumstances in which a Trustee MUST be appointed
1. Secured Issues

If bonds are secured, a Trustee is required to hold the security for the benefit of the bondholders
o It would be impractical to provide individual bondholders with a right to part of the security,
which would have to be transferred every time the bond changes hands

A fiscal agent cannot hold the security for the benefit of the bondholders, since he is the agent of the
issuer and so acts in the issuer’s interests

2. Subordinated issues
 If bonds are to be issued which are subordinated to (i.e. ranking behind) the repayment of another
bond issue, the same Trustee may be appointed to both senior and junior issues to ensure effective
subordination (although it is now possible to achieve subordination contractually through the terms of
the issue, creating “contingency debt”)

3. Required by law

146
  Some jurisdictions have statutory requirement for a trustee arrangement in order to protect
bondholders

Trustee MAY BE APPOINTED even Though Not Required by any of the Above Reasons

Advantages for the Advantages for the

ISSUER ✓ BONDHOLDER ✓

 Administrative ease:  Professional entity to deal with

TRUSTEE  The issuer can deal with one issuer
STURCTURE: sophisticated party only (the trustee),  If an event of default occurs,
There are representing all bondholders, rather bondholders can rely on a
advantages to than dealing with the individuals (who professional entity (the trustee)
using a Trustee little understand commercial and legal to act on their behalf (trustee
regardless of issues) owes a duty of care to
security bondholders).
 Protection in event of default:  T will be able to better protect
 Issuer will avoid claim for event of bondholders’ interests than they
default following a slight breach: could themselves
 Under a trustee arrangement – if  (NB. disadvantage of this is that
bondholder wants to claim event of BHs with a minority opinion will
default by the issuer, he must go not be able to take the action
through the trustee. they want to as cannot bring
 Since trustee is professional 3rd party – individual actions)
more likely to look at issue objectively  Better for Negotiation in the event
and decide whether it was serious of insolvency
breach.  Most bond issues unsecured.
 THUS, it avoids any one single Trustee acting on behalf of all
bondholder calling in the loan at bondholders is more likely to
slightest breach. Trustee acts as buffer achieve a moratorium, or a
between bondholders and issuer negotiated resolution with
 Bondholders cannot sue issuer other creditors, than
individually UNLESS trustee neglects its bondholders would if acting as
duty to do so individuals
 Source of advice for bondholders
The following conditions from the prospectus  If bondholders need to make
illustrate the above point… a collective decision, the
-
Condition 8 (of prospectus) = Calling in loan: Trustee can chair any
Single bondholder cannot demand to meetings and make
call in loan, must do so by requesting trustee to recommendations
serve notice on the Issuer to call in the loan. And  Protection for minority bondholder
bondholders holding at least one-quarter of the  after default, an issuer must
value of the principal must request it make any payment through
(sometimes, Bond will state that in the event of Trustee rather than individual
non-payment and insolvency, bondholder can bondholders, who would then
call in loan personally without going through fairly distribute proceeds back
trustee) to bondholders.
-
Condition 12 = Enforcement: Single  This avoids a powerful
bondholder cannot bring proceedings against bondholder negotiating himself
issuer; there must be bondholders holding at a good deal at the expense of

147
 minority bondholders
least one-quarter of the value of the principal
 Investigative/monitoring powers
requesting it to the trustee
 Trustee will have investigative
and monitoring powers which
 Issuer can avoid being subject to the
a fiscal agent will not
aggressive view of a minority
 the trustees’ duty to represent the
N.B. fiscal agent has no duty of care to
interests of all bondholders means the bondholders.
that they can legitimately allow
the majority view to trump that
of a dissatisfied minority

 Can give trustee certain discretions that

could not be given to a fiscal agent

 Trustee’s discretion to make decision

(without consent of bondholders)
 Trustee is given power to - Agree
certain amendments to terms of a
bond without calling meeting of
bondholders; provides issuer with
greater flexibility and convenience.
 NOTE: usually trustee only given
power to make minor amendments to
the prospectus

Condition 11(b) = trustee may agree, without

the consent of the Bondholders, any
modification to the Trust Deed which is of a
‘formal, minor or technical nature… and not
materially prejudicial to the interest of the
Bondholders’

 Cost =
FISCAL  Fiscal agent structure is cheaper than  BUT disadvantage for bondholders
STRUCTURE: trustee structure = A fiscal agent does not represent
Sometimes a co.  Trustees are expensive because: their interests; hence, have to
will elect to use a o Trustee will require his own consider bringing individual lawsuits
FA rather than a T solicitors (whose fees must be etc if problem arose)
(decision will be met by the issuer)
based on cost and o Trustees charge high fees to
complexity of the reflect the substantial
matter) responsibilities they must
undertake
 Fiscal agents are cheaper because
o There is a lot of competition to
take the high profile and
prestigious role of fiscal agent.
o This drives down the fiscal
agent’s fees

Key Terms and Conditions in a Stand-Alone Bond Issue

148
  BOND HOLDER will have FIVE MAIN CONCERNS:
 issuer’s and issue’s credit rating
 amount of its investment
 return it will receive
 when able to redeem its investment
 its rights on the issuer’s default ranking paripassu with any other holders of the same/similar debt
instruments

 Terms of a Bond can be contained in:

(1) Schedule to the Fiscal Agency Agreement/Trust Deed;
(2) Paying Agency Agreement; OR
(3) Prospectus (more common)
 BUT when bonds issued, T&Cs contained on the relevant document, whether it is TGN or PGN/
Definitive Bearer Bond (thus replacing terms and conditions on any of docs mentioned above)

Preamble Initial para: Confirms authorisation of the issue, parties, dates and relevant contractual
docs
Form, denomination and First clause states: Form bonds take; amounts in which issued; statement as to how title
title will pass
Status clause Specify characteristics of the debt obligation and how it ranks among others of the issuer
Negative pledge See below
Coupon If fixed coupon, rate will be predetermined and paid annually in arrears.
If floating, calc is explained in the interest clause and coupon payment dates specified.
See p.234 for interest calculation
Payments Mechanics of payment – surrender bond for principal and surrender coupon for interest
Redemption & purchase Bond usually specifies three occasions for redemption:
 Maturity (usually ‘at par’)
 For tax reasons – if change in law renders issuer’s borrowing more expensive
 Re-purchase/early redemption by issuer – this may be at majority BH’s request
Taxation May have to gross up payments to investors, very ltd circumstances – usually only
benefits non-domestic investors
Events of default See below
Prescription Period in which BH must claim principal and coupon – usually 10 and 5 years respectively
from due date for payment – after those periods the BH will no longer be able to claim
either principal or coupon
Replacement of bonds Deals with lost/stolen/defaced/destroyed bonds. Ensures BH will indemnify the issuer
and coupons should original be presented for payment
Meetings of BHs and Procedure for meetings and business threat is provided for in fiscal agreement. See
modification p.235 for explanation. BHs meeting usually only convened if there is a problem with
the issue/issuer or modifications of T&Cs required. Trustee usually given power to
approve minor modifications, or waive minor breach, provided action not materially
prejudicial to the BHs.
Notices Identity of bond investors will be unknown to issuer. SO, notice can only be given by RIS,
FCA or national newspaper. If listed on LSE, notices must also be given to the LSE. When
held in clearing systems, must also be sent to the systems, which have a duty to notify
relevant securities account holders.
Further issues On exactly the same terms are usually permitted; increasing the size of the issue.
Governing law Will usually be English law, with submission to non-exclusive jurisdiction of the English
and jurisdiction courts

149
Relevan
t Prospectus for bond issue Facility agreement for loan
clauses

Negative Pledge Reasons bonds (prospectus) includes a negative  More onerous

Clause pledge clause 1. Security over ‘any indebtedness’
-
Bond holders do not want subscribers to Cl 21.3:
-
 Why is the subsequent bond issues to rank higher in the ABSOLUTE PROHIBITION
-
clause included event of insolvency Restricts the issuer from
-
in the Bond? To protect the value of the bond e.g. if 2 bonds creating any subsequent
 Difference in are issued at different times on the same terms security over the relevant
the scope of the except that the first is unsecured and the assets to secure ‘financial
NP clauses second secured, the first bond will be less indebtedness’ = which is
attractive to investors as unsecured, therefore defined in a long list,
its value will fall effectively covering any
indebtedness
 Restricts the negative pledge to certain types 2. No carve out
-
of debt FA = no such carve out, but
 Less onerous because because there is more of a
1. The issuer cannot create any security to secure relationship between lender
any ‘relevant indebtedness’ for a new and borrower - usually easier
bondholder unless the same security is granted to negotiate a variation and
to the existing bondholders (carve out) reach agreement
-
SCOPE:
-
Definition of ‘relevant indebtedness’ is
narrow = has limited scope (Prospectus
Condition 3) does not include bank
lending...the negative pledge only covers
listed debt securities (i.e. bonds) –
restricted to capital markets
• SO – negative pledge clause does not
prevent issuer using assets as
security, for example, for a Bank loan
-
NOT ABSOLUTE PROHIBITION
-
Doesn’t stop you doing it for “relevant
indebtedness” – if you want to grant
security, you can do it, as long as you give
these note holders the same security or
security that is not materially less beneficial
as approved by trustee or a requisite % of
noteholders (usually 75% of votes)
-
NB: Bank lenders can get higher ranking
security over the same assets as they do not
fall within ‘relevant indebtedness’ and
therefore the negative pledge clause does
not apply to them
-
Reason why the pledge is restricted to this is
because the company does not want its
bonds to lose value in the secondary
market. This would happen if some
bondholders could have secured bonds, and
some unsecured as the secured bonds would
be worth more on the market (safer

150
 investments).
-
Thus, to prevent this, the NP exists to ensure
all bondholders get equal protection in the
event of insolvency and if security granted,
equivalent security is granted to existing BH.
ALL RANK PARI PASSU

Role of TT N/A
 Condition 2(b): “Bonds and Coupons constitute
 Why is a TT direct, unconditional and unsecured
obligations” – no security – so why is a TT
employed
involved?
where there is
no security
o negative pledge is worded so that at some
attached to the
point in the future the bonds may be secured
bond?
cos issuer will not be able to release future
secured notes w/o first giving these
noteholders security

o administrative ease (act on behalf of all

bondholders)

o on event of default, only TT can act (prevents

BHs from acting individually)

o TT can agree certain amendments etc. on

behalf of BHs without calling meeting of BHs
– a number of terms in this agreement give
discretion to the trustee. Noteholders are fine
with giving the trustee discretion because
trustee has a duty of care to act in the best
interests of the noteholders

o Trustee is a sophisticated entity = issuer can

include more complex conditions in the notes
which will suit its needs better

Examples of discretion:

 Condition 10(b): trustee can agree to

amendments/waivers of the conditions
without the consent of the noteholders
 Condition 10(c): gives the trustee
discretion to agree the substitution of the
issuer without the consent of the
noteholders – this type of provision would
never be included in a note with a fiscal
agent

151
  Condition 12: if BHs want to enforce via a
trustee, it must be done either via
Extraordinary Resolution (75%) or by
request in writing by bondholders holding
at least ¼ in principal amount outstanding.

Events of Default  Will always be far fewer and less onerous  To trigger an EOD under the
events of default in a note issue than in a FA, majority of members of the
 Difference in facilities agreements and are drafted in less syndicate must require the
treatment of detail but the purpose is the same (i.e. that arranger to call an EOD
events of the investors can get their money back if
default in Bond certain events happen that put their  Shorter grace period under FA
and Facility investment at risk) - Clause 22.1(a) and (b): grace
Agreement  Condition 9 period for non-payment only
 Difference 1 = trigger an event of default allowed if the non-payment is
-
To trigger an event of default under the caused by an administrative or
Prospectus, holders of min ¼ of the bonds must technical error; or a Disruption
request Trustee to call an EOD (or T could call it Event, and even then, only
at his discretion) given grace period of 3 days
- Cl 22.3(b)
 Difference 2 = grace period • For breach of any
-
Longer grace period is given to issuer of a bond obligation other than non-
for non-payment of principal payment – 7 days
and interest, and other events of default
-
non-payment of…  Cross acceleration/cross default
o Principal is 7 days, - Cl 22.5(b): ‘If any financial
o For non-payment of interest – 14 days indebtedness …is declared to be or
-
other than non-payment otherwise becomes due and
o For breach of any obligation other than payable prior to its specified
non-payment – 30 days maturity as a result of an event of
-
for bonds = issuer has 60 days to discharge or to default…’ The cross-default
stay the winding up order. provision will apply. This is subject
 Why is there a difference in grace periods? to…
If borrower misses a payment to a bank - Cl 22.5(e): There is no event of
under an FA by a few days, borrower will be default until the amount of
able to negotiate with the bank (not to financial indebtedness reaches
accelerate the loan) due to the existing £100,000
relationship. If the issuer misses a payment - Therefore, easier for lender to
under a bond, there can be no negotiation trigger cross default and call in
so it’s the end of the bond. The ramifications the loan based on event of
are much more serious, the whole bond will default
become repayable – creates a huge amount - Cl 22.3
of upheaval = do not want EOD triggered • Breach of obligations other
unless there is a very serious problem than non- payment
constitutes an event of
 Difference 3 = de minimis for cross default and can lead to cross
acceleration/cross default default
-
if any other Applicable indebtedness of the - Wider application of cross
Issuer becomes due and payable prior to its default:
stated maturity by reason of any default… • There is no carve out in the FA
-
Cross acceleration will be triggered but this is
subject to a de minimis of $15m  Insolvency
-
Therefore, harder for bondholder to trigger - Cl 22.7(b)(ii): winding up order
152
 cross acceleration (call in all loans) based on an must be discharged or struck
event of default (i.e. larger de minimis for cross- out within 14 days (must also be
acceleration) defended in good faith)
 Why is there a difference in de minimis? If - Cl 22.12: any event that occurs
borrower misses a payment to a bank under which has or is reasonably likely
an FA by a few days, the borrower will be to have a Material Adverse
able to negotiate with the bank (not to Change is included in the
accelerate the loan) due to the existing definition of events of default
relationship. If the issuer misses a payment - Provisions under the FA will be
under a bond, there can be no negotiation triggered more easily than the
so it’s the end of the bond. The ramifications conditions of the note
are much more serious, the whole bond will programme
become repayable. Also, the total debt
under the note will be significantly higher
than under the FA = would expect a higher
de minimis
 [Definition of cross acceleration/cross default
– if the issuer or borrower default under one
bond or loan with lender/investor 1, it will
automatically default the borrower’s loan
with lender/investor 2, even if the borrower is
not behind with lender/investor 2]

 Difference 4 = application of cross

default/acceleration
• Narrower application of cross acceleration
(same as cross default) than the FA. Only
the non-payment under one bond issue can
trigger a cross default under another bond
(as opposed to the FA, where breach of any
other obligations inc. warranties or
representations, will trigger cross default)
 Why is there a narrower application of cross
default? In contrast to lenders who rely on
reps and warranties by the borrower, the
investors rely on the heavily regulated
prospectus in order to decide whether to
make the investment. Investors in bonds do
not need to rely on the reps and warranties of
the issuer, unlike in an FA, the prospectus
provides comfort because it regulates what
representations/warranties are given.

 Difference 5 = good faith carve out

• There will be no cross acceleration
triggered if the issuer contests in good
faith the obligation to make the relevant
payment – no carve out in FA

 Difference 6: Narrower definition of events of

default
• Bond = No Material Adverse Change clauses

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 – will not lead to event of default.
 Why is there this difference? if the financial
position of the issuer deteriorates, the value of
the bond will drop, however the bondholder
can sell the bond on (whereas the lender in an
FA cannot)

N.B. insolvency condition will not differ greatly

from FA but more easily triggered under FA.

 Condition 4  Clause 8
Interest  Difference 1: Rate of interest  Floating rate calculated by
• Fixed rate at 3.375% p.a reference to LIBOR. Changes
 Compare the  Difference 2: When to pay every 3 months
differences in • Pay semi-annually for this bond  At the end of each interest
the way interest  Difference 3: day count fraction period, Borrower has choice
is payable under -
Day count fraction is how the interest period between 1,3 and 6 months –
the bond vs the BUT has chosen to pay monthly
is calculated. Under the prospectus, the
FA  Day count fraction is
number of days in the relevant period
always 365
excludes the date on which the interest falls
due (i.e. no. of days in interest period less 1
day)

The Different Ways a Bond May be Held

1. Definitive form (either bearer or registered)

2. Temporary global notes, which are then converted into either
• Permanent global form (bearer only, not registered), or
• Definitive form (either bearer or registered)
3. Permanent global note from the outset (bearer only)

When a bond is issued it can be either be BEARER or REGISTERED:

BEARER Bond
Most common in UK market – can be global (temporary or permanent) or definitive

 What they are:


Create a promise to pay the person who holds the bond certificate

Holders of the bond are not registered in a register of Bond owners held by the issuer

Can be held anonymously, as issuer will not know at any time who owns the bond

 How do you prove ownership/how are the rights enforced in a bearer bond (whether definitive or global
form)?

Definitive bonds always in paper form (see below for detail on definitive)

Prove ownership by physical possession (physical possession = legal title)

The definitive bearer bond may be held by investor himself

If the definitive bearer bond is held in a depository (because it is traded through a clearing system)
• Some investors do not have their own accounts in the clearing system and so rely on a financial

154
 institution (‘participant’) to act as their nominee
• The bond transaction involves a chain of parties and legal ownership is transferred through this
chain: owner = participant = clearing system = depository (the depositary which has physical
possession of the bond has legal title to it)
 Problem:
• How does an investor prove their legal title to the bearer bonds which is held in the depository?
• Bond holder needs legal title in order to enforce the bond. This is because the clearing
system/common depository WILL NOT enforce on the bondholder’s behalf (i.e. will not sue issuer
on bondholder’s behalf if issuer defaults on the bond)
 Solutions to the problem: either
o 1) Definitive forms are printed at the moment of an “exchange event” (exchanging permanent
global note for definitive bonds).
Common exchange events:
 If bondholder requires a definitive bond in order to prove his legal entitlement to the bond
in which he has invested, in connection with legal proceedings, e.g. in a tax dispute
 If bondholder requires definitive bond in order to trade the bonds (i.e. physically deliver the
bond certificates) because the clearing systems have for some reason ceased to operate,
preventing trading through the clearing systems with reference to the global note
 On or following a default by the issuer (where the bondholder might need to sue the issuer)
 Problem with solution 1: even if the global note states that the issuer must print
definitive bonds on an exchange event, issuer may refuse to comply. Therefore, other
solutions are used by practitioners…
o 2) Provide investors with direct rights of enforcement in the text of the bond itself, which is
executed by the issuer
o 3) Deed of covenant (most common)
 Issuer executes a separate unilateral deed in favour of the bondholder, meaning that
even if the bondholder does not have a definitive bond, they can still sue the issuer in
certain circumstances
 Contains a declaration by the issuer to pay those persons shown as investors on relevant
accounts at clearing systems
 The declaration therefore provides the contractual link between the issuer and investors
on which an investor can sue the issuer for breach of the terms of the bonds
o 4) Appoint a trustee to the issue. Trustee will hold the issuer’s ‘covenant to pay’, on trust
for the bondholders. The trustee can then enforce on the bondholder’s behalf
 If trustee appointed, noteholder has no right to enforce notes directly against the
issuer unless the trustee has been asked to enforce by noteholders and fails to do so
 May be a provision saying e.g. if noteholders holding at least 25% of outstanding notes
ask trustee to enforce the notes, trustee must do so
 N.B. if it was a fiscal agency, noteholders have to enforce their rights individually
against the issuer and that causes problems cos of the ownership issues as described
 How they are transferred?
 Ownership of bearer bonds is transferred by physical delivery
 Physical delivery would leave them vulnerable to theft, so most bearer bonds are traded through
clearing systems
 Clearing systems:
o Record trading in debt securities
o Maintain records of the investor’s right to receive payment of principal and interest
o Issuers, managers under the issuer and investors have accounts with one or more clearing
systems. The big clearing systems: Euroclear and Clearstream
 Has negotiability (i.e. is freely marketable)
 How this is achieved:
o Bills of Exchange Act 1882 - but bonds must be unconditional instruments (Events of default –
making payment conditional rather than unconditional; tax gross up provisions or floating rate

155
 of interest which make the amount uncertain – therefore, workshop task bonds were not
unconditional instruments)
o Mercantile custom
 Bearer bonds are recognised as negotiable by mercantile custom
 Established principle of English common law that an instrument can achieve negotiability
simply because it is customarily treated as negotiable in the markets in which it is usually
traded
 To be negotiable under mercantile custom, must satisfy certain conditions
 Legal title must pass by delivery
 Good title must pass to bona fide purchaser for value without notice of any defect
 Holder of bearer bond must be able to sue in his or her own name
 Consequences of negotiability
o Transferee of the instrument gets good legal title to it – provided that the transferee acquires
the instrument
 in good faith,
 for value and
 without notice of the equity or defect in title
 e.g. If the seller had obtained it dishonestly, current transferee would still obtain good title, even
though he had bought it from the rogue seller
o Purchaser will take a clean legal title to the bond and is entitled to payment in full,
notwithstanding any claims of set-off or other defence which the issuer may have had
against any previous holder
 Purchaser can sue the issuer directly in the case of a dispute over the bond, and does not need to join
the transferor in the claim

REGISTERED Bond
More common in US market, RARE in the UK

 What they are:

 Registered bonds create a promise to pay the person whose name appears on a register of Bondholders
held by the Issuer – rather than the holder of the actual bond certificate.

 How do you prove ownership/how are the rights enforced?


Title will NOT pass by physical delivery of the bond instrument

For registered bonds, ownership is proved by entering the name of the investor on the register of bonds

 How they are transferred?

 Process:
• Execution of an instrument of transfer

• Filing the instrument of transfer and the original bond certificate with the issuer or his agent (whoever
maintains the register of bondholders)
• Amendment to the register
 Is a lengthy process, takes much longer than the transfer of a bearer bond

 Does not have negotiability:

 (implication is not freely marketable so can only transfer by the formal process described above)

A DIRECT COMPARISON

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 Bearer Bonds Registered Bonds
Title  A bona fide purchaser for  Purchaser of a registered bond, which is NOT
value without notice (of negotiable, will NOT obtain good title if seller
defects in title) of a bearer stole bond certificate and was able to obtain a
bond can obtain better title transfer in the register.
than the seller
Claims and  Always sold free from any claim  In principal at least (but may be varied under
defences of an issuer might have against contract), subject to rights the issuer might have
issuer previous holder. against transferor, such as set-off.
Priorities  Take bond free of any equities  Only take bond free of competing interests
(i.e. 3P claims) e.g. beneficiary of which he had no actual or constructive
of a trust notice.
Anonymity  Can be held anonymously since  Issuer will know identity of registered holder
issuer will NOT know at any time of registered bond BUT true beneficial
who owns the bond. ownership may lie behind a nominee holder.
Transfer  Transferred by delivery  Transfer requires execution of an instrument
(vulnerable to theft if of transfer and filing of instrument and
transferred by physical original bond certificate with the issuer or his
delivery; hence, most bearer agent for that purpose (whoever maintains
bonds traded through clearing the register of bondholders), and finally an
system). amendment to the register. Lengthy process.

WHICH ONE??

Investors generally PREFER BEARER BONDS because…

How to CHOOSE 
Transfer of registered bond takes longer than transfer of bearer bond (because you have
between to wait for the register to be updated)
registered bonds 
Transfer of registered bond is more expensive than transfer of bearer bond
and bearer bonds 
Privacy issues – in registered system cannot keep investor’s name confidential

Rarely used when bonds first issued

Definitive form  Definitive form bonds are always in paper form. Separate paper certificates represent
(bearer** or each bond = definitive are negotiable/freely tradable
registered)  These are security printed documents (makes forgery difficult) upon which the
issuer’s debt obligation is printed
 Each certificate represents an amount of debt (the “denomination”)
 Definitive bonds are held in a depository, and traded through a clearing system
 Can be either ‘bearer’ or ‘registered’ (see above for differences incl detail on how to
prove ownership)

Commonly used when bonds first issued

Temporary  Global note is used in place of individual bonds in definitive form
global form  1 word processed doc represents ALL bonds to be offered under that particular issue
(bearer)  The doc contains all the terms and conditions which apply to the issue
 A schedule is attached to it on which the fiscal agent (or principal paying agent) can
record all exchanges of the temporary global note for definitive bonds, as well as
interest payments made during the life of the temporary global note
 Legal title to the bond rests with whoever holds the global note, (investors retain
beneficial ownership of the note)
 Investors cannot trade TGN (The TGN only exists for a short time, it will then be

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 replaced by definitive form or permanent global form

Why use a temporary global note?

-
Time constraints
• A bond issue normally has a timescale of 3–5 weeks between launch (when offer is
announced) and closing (the issue of the bonds)
• This short timetable makes it difficult to complete security printing &
authentication of definitive bonds for every single bondholder
• Producing a temporary global note allows the issue to close, and be
placed in a clearing system, before the final certificates are ready
-
Comply with selling restrictions imposed by other jurisdictions
• Arise most commonly under US securities and taxation laws
• Where the restrictions apply, they require that definitive bonds cannot be issued
during the “lock up” period of usually 40 days (or may only be offered to certain
investors during this period);
• Therefore, TGN is issued to represent bondholders’ ownership during lock-up period
-
Cheaper
• It is word processed – cheaper than producing lots of certificates in definitive form

Permanent  Where there is a “lock up” period. The TGN can be exchanged for the PGN at the end
global note of the period
(bearer)  PGN is a word processed document, not security printed
 Produced by the lead manager’s solicitor
 Represents all the bonds in an issue. Evidences beneficial ownership of a whole series
of bonds (depository has legal ownership of the PGN)
 Issued on the closing date of the issue
 Bearer form only, not registered
How is it held?
-
Usually held by a bank known as the “common depository” for safe-keeping, on behalf
of the clearing systems
-
As it is a bearer bond, ownership is indicated by physical ownership – means that the
depository legally owns the bond (bondholders only have beneficial ownership)

How to prove ownership and how to enforce rights

-
[SEE BEARER BOND NOTES FOR REST OF ANSWER]

Advantages
-
Cheaper
• As it is word processed, not security printed
-
More secure
• As interests in the global note are usually traded through clearing systems, a global
note, which is always held by the depository, offers greater security for the investor
than an individual high value piece of paper which the investor needs to keep secure
himself.
• But note that, if requested by the investor, the issuer should provide the investor
with an individual definitive bond in specific limited circs set out in the global note

PERMANENT GLOBAL NOTE DEFINITIVE BONDS

ADVANTAGES DISADVANTAGES ADVANTAGES DISADVANTAGES
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 No Risk of Loss/  Proof of Ownership - Only  Difficult to Forge - A security  Risk of Loss or
Theft or Forgery proof of ownership = the printed note – printed by a Theft
entry at the Common specialist printer so that it
Depository (However, see cannot be forged
above for solutions)
 Cost - Individual bonds  More Cumbersome to  Negotiable  Costly to
do not need to be Trade. One document  Easy to trade (simply by Produce (as
produced. Cheaper and cannot be simply handing over possession) – they require
less admin. handed over – the and can be done so free of specialist
registry must be any previous defect in title. printing).
informed.
 Problem of proof of
ownership is easily fixed

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 8 - Debt Securities (2): Listing
Subscription Agreement

The subscription agreement is a CONTRACT between the issuer, the lead manager and the co-managers which
RECORDS the basis on which the ISSUER WILL SELL, and the MANAGERS WILL BUY, the bonds on issue.

Will cover

Conditions precedent

Pricing

Fees and commissions of managers

Issuer’s costs and expenses

Reps and warranties from issuer to managers [that information in any prospectus is correct]

Reps from managers – will comply with all applicable selling restrictions

Force majeure clause
N.B. SA only meant to cover risk arising between date of signing SA and date issue is closed.

Main Obligations of Each Party

Obligations of Managers
Agreement by the Clause 2.1: Subscription: Managers jointly & severally agree to subscribe and pay for the
managers bonds at the Issue Price.
(Clause 2) • This means that – whilst the managers will decide between themselves how many bonds
they each subscribe for – their liability is not limited to this amount
• The SA allows an issuer to require any one manager to subscribe for the entire bond
issue if necessary, i.e. they are each joint & severally liable i.e. individually liable for the
whole amount, and liable together as a group.
• Contrast with syndicated loan facility (FA) where the banks are simply severally liable
(liable for only their respective obligations).

Clause 2.2: Restrictions: A set of terms are set out in the Schedule which the managers must
abide by. Includes:
- How the bonds will be sold and marketed
- Sort of jurisdictions you can and cannot sell in
• Note: that these representations are made severally but NOT jointly (i.e. you only sue
whoever made the representation)

Clause 2.3: Agreement among the Managers – directs the reader to the separate
“Agreement among Managers” document
- Contract between the lead manager and the co-managers
- Records the number of bonds which each member of the syndicate has agreed to take
- Also covers payment and allocation of the managers’ commission
- Delegates power to the lead manager to act on behalf of the syndicate in certain circs.
- Will be a standard form doc based on a precedent produced by the International Capital
Markets Association
- NB: this agreement is only severally liable.
Clause 8.2 Confirmation by common depositary that it has made payment is evidence of payment
by the lead manager to the issuer
- Payment is expressed as being made against delivery of the temporary global bond
- Lead manager’s responsibility to coordinate this
- Payment in delivery/payment against delivery = subscribers give instructions to
160
 clearing system so that their accounts are only debited with the amount of their
subscription upon receipt by the common depositary of the bonds which are then held
to the order of the clearing systems and credited to the subscriber securities accounts
(p.246 flowchart)
• i.e. when depositary receives the bonds and it debits the lead manager’s accounts
• Important as it reduces the risks which could be caused by delay because of
administrative or bank transfer problems and having to deal with different time
zones in different jurisdictions
-
NB. Everything happens simultaneously

Main Obligations of the Issuer

- Clause 1.1: Agreement to issue the bonds

Obligation to - Clause 1.2: Provide lead manager with copies of the trust deed and paying agency
issue agreement
Clause 1 - Clause 1.3: Confirm that issuer has prepared the prospectus and authorized the managers
to distribute it
• manager will want them to be listed to ensure that they are marketable (more
liquid as tradable)
- Clause 1.4: Confirm the arrangements made by the lead manager for publicity

- Clause 4.2: To make application and apply for listing

Listing • Makes clear that the ultimate responsibility is with the issuer - It’s the directors
Requirements way of delegating liability to the issuer
Clause 4 - Clause 4.2: To get prospectus approved by UK Listing Authority
- Clause 4.5: maintain listing

-
6.1 - Deliver prospectus
Undertakings by -
6.2 - Responsible for supplementary prospectus
Issuer Clause 6 -
6.3 - Not to make announcements without manager’s consent
-
6.6 - Pay all applicable taxes
-
6.8 - Deliver the bonds
-
6.9 - Provide financial information

- deliver the Temp Global Note on the closing date (important for lock-up periods in e.g. US)
Clause 8.1

- To pay expenses and costs in connection with preparing Bonds, Prospectus etc.
Clause 10

- communications
Clause 13

-
No fiduciary relationship between the issuer and the managers
Clause 14

How is the Bank Protected by Terms of Agreement?

161
 Protection of the Banks (managers)

- Issuer provides the bank with a series of W&Rs – which are indemnified (5.3 below).
Warranties and • e.g. that all info provided is correct; Bonds are correctly authorised
Representations - Breach of the reps and warranties will entitle the managers to terminate the agreement
(Clause 5) and not subscribe for the bonds on the closing date
- Note: The representations and warranties are much more limited than in a facility
agreement because the purpose is a different one. Fewer reps and warranties, repeated
less frequently and more difficult to trigger
• Period of relationship is shorter - Managers are not long-term lenders (only
until closing) and subscription agreement not addressed at them - so the
representations are very basic
• e.g. complied with all the relevant laws etc.
• Terms and conditions (inc reps and warranties) are in the note itself – this is
protection for the actual bondholders - and also in the prospectus
- 5.1.1 valid incorporation, 5.1.2 contracts, 5.1.3 valid bonds etc., 5.1.6 valid prospectus,
5.1.8 no events of default
- Clause 5.1.7(b): MAC Clause: Any changes, up to issuer to update the information.
- Clause 5.1.10: notes that in other jurisdictions there are selling restrictions
- Clause 5.2: The Warranties and Representations are given at the date of the agreement
and repeated at the date of Prospectus publication and/or any supplement is published.
• They are NOT repeated afterwards….WHY? Because the bonds will be in the
secondary market and the managers do not take responsibility for this.
• NB: Lead Managers are concerned that UK Listing Authority has approved the
prospectus, otherwise cannot sell them. Need to make sure bonds are listed (so
relevant applications need to be made). If not done, cannot sell the bonds on the
secondary market.
- Clause 5.3: Indemnity. If managers suffer loss as a result of incorrect representations, the
issuer will reimburse them. Onus on issuer to make sure everything completely correct

- e.g. Issuer undertakes to deliver to the managers the Prospectus

Undertakings by - Clause 6.9: Outlines some limited causes of action even after the closing date
Issuer (Clause 6)

-
Provides a series of obligations Issuer must meet before the Managers are obliged to
Conditions subscribe for the bonds.
Precedent • if these are not complied with, manager cannot be in breach if they do not take
(Clause 7) the bonds on
-
Lead Manager can waive CPs (with the exceptions of agreement to listing admission to
trading and execution of other contracts 7.1.1 and 7.1.2)
• Exceptions are so fundamental to the constitution and the marketability of the bonds
that there is no right to waive them

- Outlines the Manager’s ability to terminate the agreement. States that:

Termination  11.1.1 Up until payment of the subscription money, the bank can terminate
(Clause 11) the agreement if any of the warranties, representations or condition
precedents are breached.
 Right to terminate regardless of what has happened previously.
- Overall a very important clause for the managers. Essentially risk cover up until closing
11.1.3: Force majeure clause
- Very subjectively drafted (in the manager’s opinion...)

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 Note: Just-in-case provision (for political, financial or economic changes). There is a REAL
reputational issue if you were to rely on it. Therefore, very unlikely to be used (e.g. even during
9/11 hardly any bank relied on it)

-
Often called a non-merger clause
Survival of -
The protection mentioned above will continue in full force and effect beyond the
representations completion of the subscription and issue of the Bonds.
and obligations -
This is to ensure that if any Bondholders (who obtained the bonds from the Manager on
(Clause 12) the secondary market) were to sue the Manager because there was a breach of the
Bonds’ T&Cs, the Manager could still sue the issuer for breach of warranty = relevant to
expenses etc. post-issue.
-
NB: new T&Cs (in the notes themselves) provide their own protection to the BHs for the
duration of the life of the bonds i.e. until they are fully repaid.
• Contrast this with Syndicated Loans: Under a Loan Facility the FA governs the entire
transaction – therefore it is the FA which sets out protection for the entire duration of the
loan. The Warranties and Representations given at the start of the facility are repeated
throughout the duration – normally at the start of every interest repayment.

Costs of issue

Who Bears the Costs of the Issue? THE ISSUER

Expenses The Issuer is to pay both:
-
Clause 10 Cl.10.1 – Cost of Issuing and Listing the Bonds;
• Printing of the bonds
• Advertising and marketing
• Prospectus
• Issuing etc.
-
Cl. 10.2 – Payment to 3Ps e.g. trustee and paying agent or fiscal agent
• Issuer is also to reimburse Managers for all their “reasonable expenses”.
Clause 11 Even if the agreement is terminated because of one of the reasons in the agreement, the
issuer remains liable for the costs above
Tax - Issuer pays taxes
Clause 6
Concession - Issuer pays manager a commission and concession
Clause 9

Financial Services and Markets Act 2000 (“FSMA”) and the Prospectus Rules

The required level of disclosure for a prospectus relating to an issue of debt securities.

Bonds aren't usually traded on the market, but are instead listed to show the issue has met the requirements of
the exchange and regulatory requirements.
Advantages of listing include a wider pool of investors; marketability of bond (vetted by virtue of listing
regulations so investors have more comfort); tax benefits (quoted Eurobond exception – see WS9); raise issuer’s
market profile and gives it more credibility.
The disadvantages are the costs and time involved.

Summary of procedure:
1. If you want to list your bonds you need admission to the official list.
163
 2. To get on the official list you need admission to trading (LR 2.2.3)
3. If you want to offer to the general public you must also satisfy s.85(1) *STARTING POINT IN EXAM*
4. To get admission to trading you must satisfy s.85(2)
5. If you satisfy s.85(2) and no exception applies, you will need a prospectus.
6. Important to note that either test may require you to publish a prospectus.
7. If I need a prospectus, what are the content requirements?
8. What is the format of the prospectus?
9. Who is responsible for the prospectus?
10. How can I keep costs down?

N.B. First contact with UKLA should be at least 20 business days before date on which parties are aiming for the
prospectus to be approved by.

Note:
-
Unless the question in the exam tells you specifically to consider the PSM you would always assume that listing
is with regard to Main Market Listing.
-
Alternatively, you may get a client who is not sure where and how to list. In such a scenario you can flag up the
PSM alternative.

Step 1: Admission to the Official List (UKLA – part of FSA)

 To obtain admission to the official list, you must satisfy Legal Requirements for a London Listing, including:
comply with Listing Rules, Prospectus and Disclosure and Transparency Rules.
• If a bond issue complies with the Listing Rules, it will be eligible for admission to trading.
• Debt securities are only subject to the rules on standard listing: LR 2, 3, 4, 17, 18, 19
 Listing rules may provide that securities may not be admitted to the official list unless:
• s.79 FSMA (a) Listing particulars have been submitted to, and approved by, competent authority and
published, or (b) in such cases as may be specified by listing rules, such document… as may be so specified
has been published.
-
NB: LR 17.4 = issuer is required to notify RIS of:
• any new issues
• change in guarantor or security of listed securities
• change in rights of listed securities
• change in paying agent
• publication of annual accounts

Requirements for Listing

NB: rules that are likely to be the MOST relevant in an action are marked with an *

Rule Heading Requirement

2.1.1 R Application This chapter applies to all applicants for admission to listing (unless
otherwise stated)

2.1.2 G Right of The FSA may not grant application for admission unless these rules are
refusal complied with

2.2.1 R Incorporation Applicant must be...

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 - Duly incorporated;
- Operating in conformity with its constitution
How will this requirement be satisfied? See subscription agreement. Initial
DD and legal opinion at closing will also give comfort on this

2.2.2 R Validity Securities must...

-
Conform with law of applicant’s place of incorporation;
-
Be duly authorised in accordance with applicant’s constitution
-
Have any necessary statutory or other consents

How will this requirement be satisfied?

- Check the memorandum and articles of association and ensure all
necessary board resolutions are obtained. Legal opinion at closing will also
give comfort on this

2.2.3 R* Admission to Securities must be admitted to trading on an RIE’s market for listed
Trading securities i.e. MM or PSM.

How will this requirement be satisfied?

- The stock exchange makes the decision as to whether to admit securities
for trading. The FSA in its capacity as UKLA makes the decision as to whether
to admit the securities to the Official List

Transferability Securities must be freely transferable

2.2.4(1) R
How will this be satisfied?
- See condition 1b of the Carnival prospectus:
- “Title: title to the bonds and coupons passes by delivery. The holder of any
bond or coupon be treated as its absolute owner for all purposes [...]”
- The terms of the issue will include a similar provision.

2.2.7(1)(b)R* Market Aggregate market value of the securities (i.e. total value of bonds issued)
Capitalisation must be at least £200,000.

2.2.9 Whole Class The application for listing must relate to all securities of the same class

2.2.10 R* Prospectus Applies where a Prospectus is required:

- A prospectus must have been approved by the FSA (UKLA) [or another EEA
see this
State with relevant competent authority with relevant ‘passporting’
together requirements] and published in relation to the securities
with: - PR 1.2.1 UK = A prospectus is needed if dictated by s.85
PR 1.2.1 UK

OR

2.2.11 R Listing Applies where Listing Particulars are required:

-
Particulars Listing Particulars for the securities must have been approved by the
FSA and published in accordance with LR 4.
Important:
-
You only need listing particulars if you want to list on the
Professional Securities Market (PSM)

Application for listing

3.2.2 R Method of An applicant for admission must apply to the FSA by submitting the

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 application documents required under LR 3.4 – 3.5 as well as pay the applicable fee

3.4.1 R Debt An issuer of debt securities must comply with 3.4.4 – 3.4.6
securities

3.4.4 R 48 Hours Following must be submitted to the FSA (by midday two business days
documents before the FSA will consider application):
- Completed Application for Admission of Securities to the Official List
- Approved prospectus or listing particulars (or copy approved by another
MS – passporting);
• Written confirmation of the number of securities to be issued

Listing Particulars for the PSM

4.1.1 R Application This section applies to an issuer that has applied for the admission of:
- Securities specified in Sch. 11A FSMA
- Any other specialist securities for which a prospectus is not required

4.1.3 R Listing An issuer must make sure that listing particulars for securities referred to
Particulars in LR 4.1.1R are approved by the FSA and published in accordance with
LR 4.3.5R

4.2.1 G Content of In accordance with s.80(1) FSMA, listing particulars must include:
-
Listing All such information as investors and their prof. advisers would
reasonably require; AND
Particulars -
Reasonably expect to find
-
For the purpose of making an informed assessment of:
• The assets and liabilities, financial position, profit and losses,
and prospects of the securities
• The rights attaching to the securities

4.2.4 R Minimum info For an issue of bonds = the minimum information required by the
to be included schedules applicable to debt and derivative securities
in listing
particulars

4.2.8 R English Listing Particulars must be in English

Language

4.2.12 G Responsibility As outlined in Part 3 of FSMA (Official Listing of Securities Order) 2000:
for the listing - Reg. 6 = specifies general liability
- Reg. 9 = modifies reg. 6 with regard to specialist securities
particulars

Step 2: Admission to Trading on One of the Two Markets

 LR 2.2.3R - securities must be admitted to trading on one of the LSE’s two trading markets (MM or PSM).
o In order to do this, the Issuer must satisfy Section 85(2) FSMA 2000:
 It is unlawful to request the admission of transferable securities to which this subsection applies
to trading on a regulated market situated/operating in the UK unless an approved PROSPECTUS
has been made available to the public before the request is made.
o If the Issuer is issuing bonds to the general public, Section 85(1) FSMA 2000 must ALSO be satisfied:

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  It is unlawful for transferable securities to which this subsection applies to be offered to the
public in the UK unless an approved PROSPECTUS has been made available to the public before
the offer is made.

Step 3-6: Is a Prospectus Required? – go through BOTH tests

A prospectus approved by the UKLA is essentially required (as a prerequisite) if a bond issue is to
 be offered to the public or
 admitted to trading on the Main Market.

SECTION 85(1): OFFERS TO PUBLIC

It is unlawful for transferable securities to which this subsection applies to be OFFERED TO THE PUBLIC in the UK
unless an approved prospectus has been made available to the public before the offer is made.
Apply to - Transferable securities = s.102A(3) – refers to definition in MIFiD II Article 4(1)(44) (includes debt
the facts to securities and bonds
show this - Offer to the public = s.102B(1) – communication to any person which presents sufficient
applies information on:
• (a) Transferable securities to be offered and
• (b) The terms on which they are offered

• To enable an investor to decide to buy/subscribe for the securities – very broad definition
-
Communication = s.102B(3)
• May be in any form and In any means
-
In the UK = s.102B(2) = if offer to person in the UK then offer to the public in the UK
-
Prospectus must be approved by competent authority i.e. FSA– s.85(7)
Exemptions
s.86(1) When is it not an offer to the public? Exemptions found in the Prospectus Regulation Article 1(4) and
referenced in s.86(1) FSMA (PR 1.2.1)
*These only
apply to A person does not contravene s85(1) if:
85(1) (a) The offer falls within Article 1(4) Prospectus Regulation
(e) Total consideration for the transferable securities being offered less than €8 million (or equivalent)
(HIGHLY UNLIKELY TO COME UP)**

Article 1(4) Prospectus Regulation Exemptions:

(a) An offer which is made to or directed at ‘qualified investors’ (e.g. governments, central banks and
entities authorized or regulated to operate in financial markets, institutional investors)
(b) An offer which is made to or directed at fewer than 150 persons (other than ‘qualified investors’)
per EEA state
(c) The minimum consideration which may be paid by any person pursuant to the securities offer is
100,000 euros or the equivalent
(d) Where the securities have a minimum denomination of 100,000 euros (or equivalent) i.e. a
‘wholesale’ offer

Or, exempt because there is a prospectus that has already been approved by the competent authority
in another MS (passporting).
s.85(5)  Provides that a prospectus is not required for an offer of securities to the public with respect to
These are specialist securities set out in Article 1(2) and 1(3) of the Prospectus Regulation
not that  Very limited application
relevant,
o E.g. Art 1(3) Prospectus Regulation only exempts offers with total consideration of less than
but state
1 million euros
none
apply  Not relevant for corporate bond issues – none will apply

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 SECTION 85(2): REGULATED MARKET OR OPERATING IN UK
It is unlawful to request admission of transferable securities [...] to trading on a REGULATED MARKET SITUATED
OR OPERATING IN THE UK unless an approved prospectus has been made available to the public before the
request has been made
Apply to - Transferable securities s.102A(3) = refers to the definition in MiFID II Article 4.1.44
the facts to (includes debt securities and bonds)
show this - Regulated market s.103(1) = refers to the definition in Art.4(1)(21) of MiFID II. Includes all of the
applies. main EEA regulated markets and exchanges i.e. Main Market (but does not include PSM and ISM)
- Prospectus must be approved by competent authority i.e. FSA in the home state in relation to the
issuer of the security = s.85(7)
Exemptions (NONE!)
s.86(4A) - s.86(4A) provides that no prospectus shall be required to admit securities to trading on a regulated
none will market (MM) if the admission to trading falls within Article 1(5) Prospectus Regulation
apply* - These exemptions are unlikely to apply to a corporate bond issue
s.85(6) - Exemption for securities listed in Article 1(2) Prospectus Regulation.
none will - Unlikely to apply to a corporate bond issue
apply*
NB: None of the exemptions really apply to bonds, therefore when issuing bonds on a
regulated market, will NEED a prospectus as none of the exemptions apply

Step 7: Content Requirements of Prospectus

 PRR 2.1.1 replicates the general content requirements contained in Article 6 Prospectus
General Regulation as to the necessary information to be contained in the prospectus
Content  Art 6(1) – the prospectus shall contain the necessary information which is material to an
Requirement investor for making an informed assessment of
o (a) the assets and liabilities, profits and losses, financial position and prospects of
the issuer and any of the guarantor
o (b) the rights attaching to the securities; and
o (c) the reason for the issuance and its impact on the issuer

Retail – much stricter ** Wholesale (ie ‘exempt’) - everything except

Content -
PR 2.1.3 = Bonds of denomination less summary, and everything is in less detail.
-
than nominal value EUR 100,000 are PR 2.1.3 = Bonds of denomination equal to
available to retail investors – thus more or more than nominal value EU 100,000
onerous requirements to declare - to will only be bought by institutional or
protect these retail investors experienced investors and therefore less
-
The relevant Annexes are 6 and 14 with emphasis is placed on protecting them.
-
regards to the content requirements Annexes 7 and 15 set out the content
requirements in respect of wholesale bond
offers
-
Largely cover the same grounds as retail
offers but less stringent standards

Summary Art 7(1) Prospectus Regulation/ PRR 2.1.1 – N/A - PR 2.1.3

obligation to include a summary of the key
information in the prospectus

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 Relating to Issuer

Risk Factors Prominent disclosure of risk factors that Similar

may affect the issuer’s liability to fulfil its
obligations under the securities to investors.
Risks must be specific to the issuer/its
industry and be categorised and ranked in
terms of materiality

-
Audited accounts covering the last Info covering the latest two financial
Financial two financial years (unless issuer years must be provided.
-
Information under 2 y/o) including: If not prepared in acc with IFRS – only a
description of differences needed.
 balance sheet, income
statement, cash flow statement
and accounting policies

Required if prospectus is dated more

Interim than 9 months after the end of last Same
Financial audited year.
Statements - Must also contain summary of financial info
for the relevant financial periods

Description of Description of issuer’s group (name, Same

the Issuer registration no, office address) and
management, objects and purposes, share
capital, any arrangements that might later
result in a change of control

Business Issuer’s activities, new products and

overview markets. And statement there has been no
MAC in prospects of the issuer since last
published accounts

Administrative, Names, business addresses and functions of

management, directors must be disclosed and, to the
supervisory extent known to the issuer, identity of any
bodies and SHs ‘controlling’ SHs

Conflicts of Actual or potential Same

Interest

Material Summarise all MCs entered into not in the Same

Contracts ordinary course of business, which could
result in member of issuer’s group being
obliged to do something

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 Profit Forecasts Info on anything that is likely to have a N/A
material effect on future profits

Annual List of Disclosure of all public info published in last N/A

Published Info 12 months [in any other jurisdiction]

Investments Principal Investments made by issuer since N/A

date of last published financial accounts.
With description of future investments
issuer has committed to.

Relating to Bonds

Info about the bonds themselves – type

Securities (reg/bearer), currency, ranking, maturity, Details of the securities do not need to contain
coupon, governing law. info about the underwriting arrangements and
-
Also details of terms and conditions of commissions.
the offer: underwriting arrangements,
commission, costs of issue, methods of
paying up and delivery back

Use of proceeds Must disclose why money being raised,

estimated total cost of the issue and detail
as to intended use

NB = PR 2.4 allows issuer to incorporate information by reference to prospectus, but summary document must
not incorporate information by reference

Step 8: Format of Prospectus

Two options for a stand-alone bond issue (PR 2.2) – refers to Articles 6, 8 and 10 Prospectus Regulation
-
Single document (incorporating the three docs) (Most issues still use single document)
-
Three separate documents (Advantage: Registration document is valid for 12 months, so can be re-used for
any number of issues for 12 months):
• Registration document: Information relating to the issuer;
• Securities note: Information relating to the bonds; and
• Summary: for retail offers, ‘a summary’ which must be concise and no longer than 7 A4 pages
-
Article 8 Prospectus Regulation (PRR 2.2.3) allows the issuer of a debt/MTN programme to use a ‘ base
prospectus’ (containing principal info on the issuer and the programme) and a ‘final terms’ document
(containing information on each particular securities issue under the programme)
-
N.B. if a bond issue is to be admitted to trading on the PSM (rare) or it benefits from an exemption to publish a
prospectus under s86(1) FSMA, the Listing particulars must be prepared

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 Step 9: Who is Responsible for the Prospectus?

-
s.84(1)(d) FSMA 2000 allows the PRs to specify who is responsible for prospectus, covered by PRR 5.3.5 for a
bond which includes:
a) The issuer;
b) Anyone who accepts (and prospectus states as accepting) responsibility;
c) The offeror (if not the issuer);
d) Person requesting admission to trading (if not the issuer);
e) Any guarantor (in relation to information on them or the guarantee) – note that the guarantor of
securities will be required to provide disclosure as if it were the issuer; and
f) Anyone else who has authorised contents of prospectus.
-
Note: For a bond, issuer’s directors are not required to take responsibility for the prospectus
• But, PRRs require each of those responsible (listed above, but does not have to be directors) to make a
declaration in the prospectus – this applies to both retail and wholesale issues
-
Also: No civil liability in respect of the summary unless it is misleading when read together with other
parts of the full prospectus. But there is no exemption for criminal liability

Step 10: How can I Keep Costs Down?

List on the exchange regulated (PSM and ISM) (possibly increase domination)
 Only need to provide listing particulars – equivalent to the wholesale regime. i.e. NO NEED FOR PROSPECTUS
(LR 4.2.2-LR 4.2.5)
s.80(4) FSMA – general duty of disclosure in listing particulars requires consideration of
(a)
the nature of the securities and their issuer
(b)
the nature of the persons likely to consider acquiring them;
(c)
the fact that certain matters may reasonably be expected to be within knowledge of professional
advisers of a kind which those persons may reasonably be expected to consult; and
(d)
any information available to investors or their professional advisers by virtue of requirements
imposed by listing rules or any other legislation or by a recognised investment exchange
• BUT securities on PSM are not available to public so you are limiting yourself in who can buy them.
 OR Increase denomination to €100,000 + to ensure wholesale regime (less onerous so less costly)

Step 11: Omission of Information

PR 2.5 = Exemption from duty to disclose may be granted if:

(a)
disclosure would be contrary to public interest (e.g. defence contracts)
(b)
disclosure would be seriously detrimental to issuer of securities (provided not likely to mislead
potential investor); or
(c)
the information is of minor importance only and not such as to influence the assessment of the assets
and liabilities, financial position, P&L and prospects of issuer

Step 12: Potential Liabilities Arising from Listing

-
S 90 FSMA 2000
Civil
liability
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 • Anyone responsible for prospectus, supplementary prospectus or listing particulars is liable
to compensate any person who acquires any of the securities and suffers a loss in respect
of them ‘as a result of any untrue or misleading statement… or any omission from them of
any matter required to be included’ under general disclosure obligation.

• Liability is far-reaching and considered to extend to buyers in the secondary market, and
reliance on the prospectus itself is not required

• There are some defences available (p.234 TB)

-
Hedley Byrne v Heller = negligent misstatement:

• Arises if person suffers loss having relied upon a misstatement and the person who made
the misstatement owed a duty of care to the one suffering loss

• This duty is only owed to the initial purchaser of the bond, not any secondary purchasers
(they would be insufficiently proximate to the issuer to enforce a duty of care).

-
Misrepresentation Act 1967 = person may rescind or claim damages if he acted
upon an incorrect misleading statement/omission in the prospectus.

• Does not extend to secondary purchases.

-
Financial Services Act 2012 s 89 = misleading statements
Criminal • Person who knowingly/recklessly makes a statement which is false/misleading to a material
liability extent or conceals dishonestly any material facts to induce an investor to enter into a
relevant agreement (i.e. buy/sell bonds) will be guilty under this offence.
• Has defence under s.90(3). Penalty under s.92.
-
Financial Services Act s.90 = misleading impressions
• Person who intentionally creates a false or misleading impression as to the market in or
the price or value of any relevant investments, in order to induce investors to
buy/sell/underwrite shares or refrain them from doing so is guilty of an offence.
• Has defence under s.90(9). Penalty under s.92.
-
Theft Act s 19 = director makes false/misleading statement with intent to make a gain or
cause a loss
-
Fraud Act 2006 s.2 = fraud by false representation
• There are other relevant fraud offences under the FA as well.

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Regulated Market of the London Stock Exchange and the Professional Securities Market

Differences between the regulated market of the LSE and PSM

Consequences of being admitted to trading on each?

Rules and Regulations Regarding Applying for Listing and Admission to Trading
IF a bond issue complies with the listing rules, it will be eligible for admission to trading

Reasons for an issuer -

Regulatory: some jurisdictions place limitations on investors holding securities that
deciding to list and are not publicly listed;
trade bonds on a -
Tax: a UK issuer does not have to deduct tax on interest at source if its bonds are
stock exchange?
“quoted Eurobonds” under s987 Income Tax Act 2007
• “Quoted Eurobonds” must be issued by a co, listed on a recognised stock
exchange and be interest-bearing (see below for more on taxation of bonds);
-
Marketability: some investors may be more willing to invest in securities that are
listed as they may be perceived to be safer investments or have more credibility
because the issuer would have had to disclose info about its financial position and
the bonds to comply with the stock exchange’s rules.

What stock exchange  The LSE’s:

are debt securities/  Main Market:
bonds listed/ traded • Gilt-Edged and Fixed Interest Market: EEA-regulated market: subject to
on? Prospectus Directive (PD) and other EU directives
• Prospectus generally regulated under FSMA S.85(1)&(2)
• Scope of disclosure depends upon whether retail (onerous) or wholesale
(less onerous);
• NB: The Prospectus Directive governs the following in the EEA:
o When prospectus is required in relation to debt securities
o Different formats prospectus in relation to debt security can take
o Contents of a prospectus in relation to debt securities that will be
listed and admitted to trading on an EEA regulated market (BUT NOT
an exchange regulated market)
 PSM:
• The Professional Securities Market: exchange-regulated market (different
from regulated market): subject to the rules of LSE.
• Does NOT need to comply with the Prospectus Directive but Listing
Particulars necessary
• Why? s.85(2) not engaged (PSM not regulated market) + must benefit from
public exemption to 85(1) set out at s86 (sold only to qualified investors) (if
no exemption, securities cannot be listed on the PSM & must comply with
the PD instead). Rules on Listing Particulars content set out at Ch4 LR.

Practical Differences

-
Level of disclosure required
• PSM has a much lower level of disclosure, which may suit an issuer of debt securities better (and may
particularly suit an issuer of convertible bonds, as it will avoid the additional disclosure for equity
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 securities that convertibles require).

Main market PSM

Governed by rules of LSE and UKLA – not

Regulation Securiti es traded on MM and any by EU directives.
Prospectuses related to those securities -
Therefore, outside of scope of PD.
must comply with PD and Transparency
Obligations Directive.

Bonds, Derivatives, Debt convertible Bonds, Derivatives, Debt convertible into

Types of Securities into Equity. Equity.
- NB: If debt securities offered to PUBLIC - No securities offered to public can be
in EEA & traded in London – must be traded on PSM, must comply with PD
traded on MM. and be on MM
- Only available for securities falling
within a public offer exemption –
normally securities offered solely to
qualified investors

Prospectus Required? YES: ALL securities traded on the MM NO: PD Prospectus not required.
FSMA 85(1)-(2) must be admitted using a PD Prospectus - s.85(2) NOT engaged (PSM not
(s.85(1)- (2)) unless an exemption regulated market) + must benefit from
applies. public exemption to 85(1) set out at s86
- s.85(2) makes clear that MM is on - Instead listing particulars required
regulated market. - UKLA approved “Listing Particulars”
NB: For securities that are to be offered required; governed by Listing Rules.
to the public in the EEA, even if they are - Disclosure requirements are FAR less
not to be traded on a stock exchange, a onerous (= easier and cheaper).
PD Prospectus is still required.

Governed by FSA’s PRRs (which comply Governed by Listing Rule 4

Content of with the requirements of the PD). - If qualify for listing particulars (rather
Prospectus/ listing -
Level of disclosure required in the than prospectus), securities of all
rules (Ps) prospectus depends on the denominations can be prepared in
denomination of the securities accordance with same standards as less
-
EUR 100,000 or more = Wholesale onerous Wholesale Regime.
Regime (less onerous) Content is very similar to wholesale regime:
-
Less than EUR100,000 = Retail - LR 4.2.2 – 4.2.5
Regime (more onerous) - NB: You do not need to know the details
of this just be aware it exists.

Prospectuses approved for listing Prospectuses do not benefit from

Passporting securities on this market can be passporting if only produce particulars
passported to other EEA member states - But issuer can produce a PD prospectus
under the PD. for trading on the PSM which can be
passported.

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 The issuer (not the Directors). PR 5.5 The issuer (not the Directors) PR 5.5
Liability for Prospectus

Securities meet “Quoted Eurobond” Securities meet “Quoted Eurobond”

Taxation definition. Hence, can pay interest gross definition. Hence, can pay interest gross

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 9 - Withholding Tax and Transfer of Loan Facilities
Withholding Tax In relation to bonds

Withholding tax is not a threat to the margin per se, but it is a POTENTIAL THREAT to a bank recovering the FULL
AMOUNT OF INTEREST it is expecting.

The interest rate is charged by a bank on a syndicated loan is typically calculated by adding a margin to the estimated
cost of lending. If the cost of lending rises, the bank must be able to pass any increase to the borrower to protect its
margin (thereby protecting its profit).

What is Withholding Tax?

 Deducting tax at the source (from the interest payer rather than entity that has the beneficial interest in the
payment) and paying it straight to HMRC
 Under the Income Tax Act 2007 (ITA 2007), there are certain circumstances in which a person paying interest
must deduct tax from the payment before it is made. IT IS A WAY OF COLLECTING TAX, NOT A TAX ITSELF
 This is known as ‘withholding tax’ or ‘deduction at source’, and (like the more familiar PAYE) it is a tax
imposed on the recipient of the payment but collected from the payer, providing a very efficient
mechanism for tax collection.
 The withheld tax is either sent to HMRC or it may sometimes be netted off against any tax credit of the
withholding party.
 Withholding tax does not apply to repayments of principal, nor on repayment of the discount element of a
loan issued at a discount.
 Withholding tax is a question of law – it is NOT a question of contract. You cannot agree to not include
withholding tax in your deal. It is a legal requirement to have it.

 Market expects international issues to be gross paying (i.e. ISSUER bears the cost of any
withholding tax). Hence, borrower will be concerned at outset to ensure that no withholding tax is
deductible from interest payments under bonds: quoted Eurobond exemption.

 Withholding tax ONLY applies to REPAYMENT OF INTEREST (coupon) it DOES NOT apply to repayment of
the principal, NOR on repayment of the discount element of a loan issued at a discount

s 874 Income Tax Act 2007 – Tax on Yearly Interest Payments

Does  s874 – interest payments may be subject to UK withholding tax at a rate of 20% if they
withholding tax have a UK source
apply?  Various factors will determine whether interest has a UK source, including
• Borrower being a UK resident
• A loan being secured on assets in the UK, and
• Payments being made from or through the UK
 If interest does not have a UK source, there is no obligation to withhold UK tax
 874(1)(a) – Withholding tax applies on YEARLY interest payments by a Company
(distinguish from loan arrangement)
 Case law suggests that yearly interest is such which is payable under a debt

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 which is capable of having, and is intended to have, a term of at least 12
months.
 Corinthian v Cato emphasises that the important point is the intention
 applies only to 'yearly' interest which is interest paid under a debt which is capable
of having, and is intended to have, a term of at least 12 months – maturity of debt
• N.B. remember it is the TERM not when the instalments are
 Less than this is known as 'short' interest;

 s. 874(2) – duty to deduct by Co (20% tax rate) i.e. have to pay ‘net interest’ rather than
‘gross’.
 S.874(5): For the purposes of subsection (1) the following are to be treated as payments
of yearly interest—
a) a payment of interest made by a registered industrial and provident society in
respect of any mortgage, loan, loan stock or deposit
THEREFORE WHEN A COMPANY MAKES A BOND ISSUE AND THEN MAKES AN INTEREST
PAYMENT, IT MUST DEDUCT TAX FROM THIS PAYMENT (CALLED WITHHOLDING TAX)…
unless exception applies

Exemption:  s.882 – the duty to withhold tax does not apply to a quoted Eurobond
Quoted  s987 – a bond is a quoted Eurobond for this purpose if it:
Eurobond?  Is issued by a company
 Is listed on recognised stock exchange (defined under s.1005 and includes the
BONDS Main Market and PSM)
 Carries a right to interest
o Therefore, QEE not available to issuers of zero-coupon discounted bonds
IF s. 882 Eurobond exemption engaged, withholding tax NOT payable i.e. can pay ‘gross
interest’

Exemption:  Interest on a debt which has a maturity of less than 12 months will not be subject to
Short interest withholding tax.
 Bonds - Commercial Paper qualifies for this exception
BONDS AND o N.B. it is the intended term or maturity of the bonds that is important, not the
LOANS length/frequency of interest payments
 Loans – this may be relevant for ‘364 day’ facilities and bridging loans

Exemption:  s879 ITA - Withholding tax will not apply if: (qualified lender – Condition 12)
Interest subject
to corporation o Interest is paid on an advance from a bank; and
tax
o The person beneficially entitled to the interest is within the scope of corporation
LOANS
tax at the time the interest is paid, and with respect to the interest.

 If both of these elements are satisfied, then the interest can be paid gross.

 Similarly, s930 ITA 2007 exempts interest paid by a company if the payer reasonably
believes that the beneficial owner of the interest is subject to UK corporation tax.

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  Assignment:

o The s879 exemption will apply to loans which have been assigned as long as the
advance was initially made by a ‘bank’ and the assignee is beneficially entitled to
the interest and within the charge to UK incorporation tax at the time interest is
paid.

 Novation:

o If the loan is novated, however, this creates a new advance and so must be made
to a ‘bank’ to ensure s879 still applies.

o i.e. the exemption cannot apply if the new lender is not a bank.

 In all asset sales between banks, and involving a UK resident/domiciled borrower, the
relevance of withholding tax on interest payments will depend largely on whether the
exemption under s879 applies.

Exemption:  s878 ITA – exempts interest paid by a bank in the ordinary course of its banking business
Interest paid by
a bank o Question of fact in each case

Exemption:  A bank can also avoid UK withholding tax if the interest is paid to a person resident
Double tax overseas in a jurisdiction which has a double tax treaty with the UK.
treaties
 Provisions of these treaties are complex but effectively they may provide for most or all of
LOANS
the tax on interest payments to be levied in the country of the recipient = the country of
the payer does not tax the payment.

o UK treaties with the USA and many European countries provide for no tax to be
collected in the payer’s country. Treaties with some jurisdictions, e.g. Australia,
reduce the amount of tax which must be withheld rather than extinguish
completely.

Risk of Quoted  If bond became UNLISTED, s.987 exemption does NOT apply (NOT LISTED)
Eurobond –
exemption no
longer applying  Hence, s. 874 would apply UNLESS ANOTHER EXCEPTION engaged:

 s.930 – a company can legally make the full interest payment if at the time it was
made the company reasonably believed it was an excepted payment.

 s.933 – A payment is an excepted payment if the person beneficially entitled to the

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 income in respect of which the payment is made is a UK resident company.

 s.934 – A payment is an excepted payment if each of the following conditions is met

in relation to the payment.
 (2) –The person beneficially entitled to the income in respect of which the
payment is made must be a non-UK resident company.
 (3) –The non-UK resident company must carry on a trade in the United
Kingdom through a permanent establishment.
 (4) – The payment must be one that is required to be brought into account in
calculating the chargeable profits (within the meaning given by section 11(2) of
ICTA) of the non-UK resident company.

 s. 937(1) –A payment is an excepted payment if each of the following conditions are

met.
 (2) – A partnership must be beneficially entitled to the income in respect of
which the payment is made.
 (3) – Each partner in the partnership must be—
a) a person or body mentioned in section 936; OR
b) a person or body to whom one of subsections (4) to (6) applies.
 (4) – This subsection applies to a UK resident company.
 (5) – This subsection applies to a company that—
a) is non-UK resident,
b) carries on a trade in the UK through a permanent establishment; AND
c) is required to bring into account, in calculating its chargeable profits
(within the meaning of section 19 of CTA 2009), the whole of any
share of the payment that is attributable to it because of Part 17 of
that Act.
 (6) – This subsection applies to the European Investment Fund.
 (7) – The Treasury may by order amend this section to add to, restrict or
otherwise alter the persons or bodies falling within subsection (3)(b).

 Condition 7 - Change in law: In which case the Issuer will Gross Up

BUT Condition 5(b): issuer can buy bonds back if Condition 7 applies - protection against Issuer
having to pay more for the life of the bonds which would be case if they had to honour the
grossing up

Grossing up Grossing up is INCREASING THE NET PAYMENT OF INTEREST (AFTER THE DEDUCTION OF
WITHHOLDING TAX) TO THE AMOUNT THAT WOULD HAVE BEEN PAID IF THERE HAD
(Condition 7) BEEN NO DEDUCTION.
o E.g. if the net payment of interest is £80 after a £20 deduction of withholding tax,
the bank/issuer would “gross up” the net payment to £100

 ONLY NEEDED IF WITHHOLDING TAX APPLIES and whether withholding applies is purely a
question of statute
 N.B. grossing up is NOT required by statute – it is contractual

Bonds

 Grossing up ensures that the bondholder still receives 100% of the expected interest due
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 from the coupon if withholding tax applies
 This means the bondholder is guaranteed to receive the full amount of interest even if
there is a change in the law that means withholding tax applies – makes bond more
tradeable
 It is applied by contractual insertion. In the case of a “qualified Eurobond”, withholding
does not apply so a bond issue normally stipulates that no grossing up applies, unless...
- Law changes;
- Bond is de-listed (and therefore does not qualify for the Eurobond exception)

EXAMPLE: Agreed interest rate of £100.

1. WT applies BUT no gross up.
 Issuer pays £80 to bondholder; and £20 to HMRC.
 HMRC issues £20 corporation tax credit to bondholder.
2. WT applies BUT issuer obliged to gross up.
 Issuer pays £100 to bondholder & £25 to HMRC.
 To calculate: divide required interest payment (£100) by 0.8 to give new total
amount (=£125). 80% of this figure = interest paid to bondholder (£100); 20% =
amount to HMRC (£25).
But this makes it more expensive for the issuer and so a provision will be in the
agreement for the issuer to be able to redeem the bonds early if withholding requirement
due to a change in law and cannot be avoided by issuer taking reasonable measures
available to them. (Condition 5(b))

Loans

 Will usually benefit from exceptions under ITA 2007

 Furthermore, a borrower will usually be required to give a representation that all
payments to be made under the loan will be free of any deductions
 But a bank will want to provide for any change in the situation, or for any unforeseen
withholding tax, particularly if a loan has a non-UK element when interest might be paid
from non-UK sources and be subject to withholding tax imposed by other jurisdictions
 Therefore, a facility agreement will usually include a ‘gross up clause’ requiring all
payments to be made ‘free and clear’ of withholding tax
o If a deduction is required by law, the borrower will be obliged to gross up the
payment so that the bank receives the full amount due after deduction of any tax
o This is particularly important if a bank has match-funded its obligations because
interest on interbank market loans is not subject to withholding tax (s878 ITA
2007) and so any withholding by the borrower would leave a bank short of money
to meet its interbank interest obligation

Typical drafting of a gross up clause:

 “If a deduction is required by law to be made by an Obligor, the amount of the payment
due from that Obligor shall be increased to an amount which (after making any deduction)
leaves an amount equal to the payment which would have been due if no deduction had
been required.”

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Possible protection for the borrower – grossing up can be expensive:
 Facilities Agreement may contain a provision that allows the borrower to make a
voluntary pre-payment of all amounts outstanding to that lender, and that lender’s
commitment will then be cancelled

£25 tax credit

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 How does the Bond Prospectus Deal with Withholding Tax and Grossing Up?

Prospectus will stipulate the following...

 All payments of interest will be made free of withholding tax provisions (Quoted Eurobond
exception);
 Unless such withholding becomes required by law;
 In that event, grossing up shall apply, and the issuer shall pay the BHs the adjusted additional amount.
 The contract will then qualify this (thereby attempting to mitigate the Issuer’s exposure to the
detrimental grossing up provision) with a series of contractual exceptions – if one of these
exceptions apply, grossing up will not apply.
 Condition 7 (a)-(i) of the Portland Prospectus for e.gs of such contractual exceptions.
 Another way that the Issuer can mitigate potential gross-up provisions... Condition
5(b)...stipulates that if the tax law changes and the Quoted Eurobond exception no longer
applies, the Issuer can redeem the bonds.

Questions to Consider

WOULD YOU EXPECT WITHHOLDING TAX TO BE DEDUCTED FROM THE BOND PAYMENTS?
 Maybe s874 ITA 2007
o Yearly interest payments may be subject to a withholding tax at rate of 20% if these payments
arise in the UK (is it longer than year maturity?)
 BUT you would not usually expect that because most bond will be exempt.
 Analyse:
 Is it a listed bond? – if YES, apply s.987 which holds that if bonds are issued by a company, listed (s.1005)
and carry the right to interest it is a EUROBOND
 s.882 – EUROBONDS are exempt from the requirement to withhold tax
o So, when borrower pays investor interest payment, it will pay that payment gross (i.e. there is no
withholding tax deduction) and the investor will be responsible for its own corporation tax
liability to HMRC
 see also condition 7 in the bond agreement – “all payments by or on behalf of the issuer and the
coupons shall be made free of withholding tax [...] unless required by a change of law”

IN WHAT CIRCUMSTANCES WOULD YOU EXPECT WITHHOLDING TAX TO APPLY?

 As explained above, only when the circumstances change so that s882 is no longer available such as:
 The bonds do no longer satisfy the conditions under s.987 (e.g. no longer listed, or no longer carry a
right to interest)

IS THERE ANOTHER EXEMPTION YOU COULD RELY ON IF YOU ARE NO LONGER CLASSIFIED A EUROBOND?
 An additional exception is under s.930 which provides that you do not have to pay withholding tax if it is an
“exempt payment”
 It will only be an exempt payment if the person entitled to the interest is a UK resident.
• However, the main problem with BONDS is that they are NOT commonly registered in the UK
which means it is next to impossible to know who is holding your bonds
• Moreover, they are freely transferable which means you can never know how they are traded
on the secondary market – and to whom.
• This makes this option pretty useless to bond issuers.

IN WHAT CIRCUMSTANCES UNDER THE CURRENT AGREEMENT WOULD THE ISSUER HAVE TO GROSS UP
PAYMENTS?

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 Condition 7 = you do not have to gross up unless required by law (i.e. a change of law OR you merely do not
match the existing provisions anymore that offered you exemption).
 Condition 7 says that if you ARE required to GROSS UP, you WILL, UNLESS one of the listed
conditions apply (which basically give the issuer a way around the gross-up payment but represent
not onerous burdens on the coupon holder)
 Example: If the law suddenly requires us to withhold tax, we will gross-up unless condition (a) applies
which holds that we will not gross up if the reason why we have to withhold tax is specific to a UK law
(this provision gives the issuer the option to require the holder to register with an agency in
continental Europe – that way getting around the tax payment in the UK)

Offloading Risk Association with Loan Assets

A bank may use its loans like fixed assets: ‘purchase’ them, keep them for a time to earn an income, and then
dispose of them – an exercise known as ‘asset sales’.

 WHY SELL A LOAN?

 BASIC AIM - Risk management – remove the risk associated: A bank may decide that its loan
portfolio has become distorted. Too much emphasis on one type of loan or one type of borrower
carries risk, and a bank may sell some existing loans to allow it to purchase others.
 Might just want money back i.e. realise some of the capital it has tied up in long-term loans in order
to improve its liquidity
 Might need money to comply with regulatory capital requirements
 Might want to securitise (only works in portfolio loans)
 May feel that selling would allow them to make a profit

Selling Assets

A bank can dispose of an asset in several different ways with different consequences.
The most common methods are:
 novation;
 legal (‘statutory’ or ‘disclosed’) assignment;
 (these two methods both result in the selling bank disposing of the asset completely)
 equitable (or ‘undisclosed’) assignment;
 sub-participation;
 risk participation.
 (Using any of the last 3 methods will entail selling bank retaining some involvement in the asset)

FACILITY AGREEMENTS will invariably prohibit a borrower from transferring any of its rights of obligations under
the agreement without consent from the bank(s).

Novation

What is  The only way in which a party can effectively ‘transfer’ all its rights AND obligations
novation? under a contract is with the consent of all the parties involved.
 Novation involves one party’s rights and obligations under a contract being
cancelled and discharged, whilst a third party assumes identical new rights and
obligations in their place.
• Novating a facility agreement simply means that a new bank is put in place

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 of the old one.
• In strict legal terms, a novation does not transfer rights and liabilities: it
CANCELS an existing contract and REPLACES it with another.
• The new bank assumes identical rights and obligations with respect to the
borrower as applied to the existing bank.
 This method is often contemplated in the original loan documentation, allowing
the new bank to step into the facility agreement in place of the existing bank.
o Existing lender and new lender would have to sign and agent would sign
on behalf of everyone else (likely scenario)
 The borrower’s promise to perform its obligations in favour of a new bank is
consideration for the existing bank releasing the old debt.

Advantages ✔  Moving obligations: Only proven method to move contractual obligations AND rights
o In particular, this allows the existing bank to dispose of a loan which has an
unutilised commitment (e.g. under an RCF)
 Risk transfer: Can fully remove loan from existing bank’s balance sheet and from any
regulatory requirements
 Easy syndication: If the original facility agreement includes transfer certificates, the
existing (and any subsequent) bank can take on a large commitment without the delay of
putting an underwriting syndicate together, knowing that it will easily be able to sell all or
part of its commitment

Disadvantages  Consent:
✘ o Consent of all parties required, including any parties which have guaranteed the
borrower’s performance under the original facility agreement
o Transfer certificates: FA contain a clause under which the parties agree in advance
that a bank may dispose of (by novation) any or all of its commitment
 To accept the offer, a new bank (together with the existing bank) must
simply execute a transfer certificate, though the FA may specify
circumstances in which borrower consent is required
 Even if transfer certificates are used, the facility agreement may still require
the borrower’s consent to transfer in specified circumstances.
 Secured loans:
o Since it replaces existing obligations with new ones, it restarts time periods
(hardening periods) during which the security might be set aside as a transaction at
an undervalue or preferred transaction under the IA 1986, ss238-241
o Time limits for any floating charge being avoided under IA 1986 s245 might also be
restarted
o Other danger of security being re-dated to time of each novation is that it might lose
priority over other security
o The favoured way to resolve these potential problems (in common law jurisdictions
at least) is to appoint a security trustee to hold any security granted under the loan
on trust for the banks.
 Disclosure: Difficult to hide the identity of a transferee bank using novation
 There may be a fee payable

Legal Assignment

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What is legal  Assignment is the transfer of RIGHTS (rights to principal, interest, voting rights etc.)
assignment?  The Law of Property Act 1925 (LPA 1925), s136 provides that an assignment of
debts and other choses in action (i.e., rights enforceable by legal action rather
than possession) will only be recognised ‘at law’ (a ‘legal assignment’) if it is:
o in writing and signed by the assignor;
o absolute (i.e., unconditional); and
o In order to be ‘absolute’ in the context of loan transfers, an assignment
must transfer the whole of the debt owed to the existing bank (Walter
and Sullivan Ltd v Murphy (J) and Sons Ltd) (and cannot be ‘by way of
charge’)
o notified in writing to any person(s) against whom the assignor could enforce the
assigned rights.
 If any one of the conditions for legal assignment is not fulfilled, the assignment
will be an equitable one (see below)
 Legal assignments are also known as ‘statutory assignments’, or ‘disclosed
assignments’
 An assignment can transfer only rights and not obligations

Advantages ✔  Rights transferred: Effective method to transfer rights under FA without requiring
borrower’s consent
 Borrower’s repayments: On receiving notice of an assignment, the borrower is obliged to
pay any monies due under the assigned loan to the new bank
 Secured loan: Any security, or a bank’s rights as beneficiary of any security sharing
agreement, may be assigned along with the debt, but is usually held by a Security Trustee
or under a parallel debt structure

Disadvantages  Obligations not transferred:

✘ o An assignment cannot transfer the assignor’s obligations.
 Therefore, the existing bank cannot assign any undrawn commitments, which
makes assigning a revolving credit facility problematic.
o In addition, any obligations the existing bank owes to its fellow syndicate members
will not be transferred.
 Some facility documents therefore include assignment mechanics which purport
to assign the existing bank’s rights, release the existing bank from any
obligations relating to that part of its commitment, and require new bank
assume equivalent obligations.
 Rights not transferred:
o The rights under a contract can be assigned WITHOUT CONSENT ONLY in ‘cases
where it can make NO DIFFERENCE to the person on whom the obligation lies to
which of two persons he is to discharge it’ (Tolhurst v Associated Portland Cement
Manufacturers).
o The test is an objective one and so, for example, the character of an assignee will be
ignored.
 In a banking context, there is a danger that any indemnity provisions for
increased costs might be unassignable without consent because they are
‘personal’ (e.g., they may vary substantially with the jurisdiction of a bank).
 The standard transfer provision will usually deal with this issue

Equitable Assignment
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 What is?  An assignment which does not meet any one (or more) of the provisions required for
legal assignment under the LPA 1925, s136 will (as long as there is an intention to
assign) be an equitable assignment
 Differences between legal and equitable assignments
 As a purely procedural matter, an equitable assignee (i.e., the new bank) must
join the assignor (the existing bank) in any action on the debt (Three Rivers DC
v Bank of England [1995]).
 However, significant differences between legal and equitable assignments arise
only if the obligor (i.e., in the case of loan transfers, the borrower) is not
given notice of an assignment
 Form of notice of assignment
 The rights of a bank taking an assignment depend almost entirely on whether
notice is given to the borrower.
 In light of the issues outlined below, a notice of assignment (legal or
equitable) should require a borrower to confirm:
o the amount of the existing bank’s debt;
o that it has no rights of set-off or counter-claim against the existing bank;
o that it has no notice of other assignments of the same debt;
o the facility agreement has not been varied; and
o that it will pay amounts due and payable under the underlying contract
to the new bank’s order

Advantages ✔  Partial assignment and non-disclosure:

o If a bank wants to assign part of an outstanding loan, it must use an equitable
assignment. (N.B. tranches will be ‘separate loans’. If all of first tranche has been
lent but none of second tranche has been lent, can still novate.)
o Likewise, if a bank wants to assign an outstanding loan without disclosing the
identity of the new bank to the borrower, it must use an equitable assignment.
o In all other material respects, equitable assignments share the advantages of legal
assignments

Disadvantages  Payments:
✘ o If the equitable assignment is not notified to the borrower, it will not know the
identity of the bank to which its debt has been assigned, and it is entitled to
continue making payments through the existing bank.
 In some circumstances, this may be an advantage to the existing bank: some
assignments allow the assignor to retain a percentage of the interest paid on
the assigned loan.
 In that situation, the existing bank will be happy to receive payments from
which it can skim its entitlement.
 However, the new bank buying a non-disclosed assignment must rely on the
borrower to pay its money, and on the existing bank to pass it on. It is
therefore taking a double credit risk.
o Furthermore, if the borrower should become insolvent the new bank might have
the near impossible task of tracing any monies which the existing bank received
from the borrower but did not pass on.
 Subject to equities: If the equitable assignment is unnotified, a new bank will be subject
to all ‘equities’ (e.g., mutual rights of set-off) which arise between the existing bank and
the borrower, even after the loan is assigned (until notification of assignment).

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  Assignor bank must join an assignee bank on any action in connection with the debt
(Three Rivers DC v Bank of England)

Sub-participation

What is?  Sub-participation is an arrangement under which an existing bank matches part or all of
its loan to a borrower with a deposit it takes from a new bank (the ‘sub-participant’).
 The new bank agrees that its deposit will be serviced and repaid only when the
borrower services and repays the loan from the existing bank.
 Remains on balance sheet
 The sub-participant has effectively taken on the risk of the first loan:
 If the borrower fails to make a payment due under its loan from the existing
bank, the existing bank will not have to pay the new bank.
 The existing bank’s obligations to the new (sub-participant) bank match, and
are conditional upon, the borrower’s obligations to the existing bank.
 Two aspects to appreciate, then:
1. First, the transaction does not involve any transfer of rights or obligations:
the existing bank’s contractual relationship with the borrower is unaffected.
2. Secondly, since the sub-participation agreement is an entirely separate
contract to the initial facility agreement, the new (sub-participant) bank will
not have any rights directly against the borrower. This is known as a ‘non-
recourse’ transaction. Any security provided by the borrower will remain with
the existing bank.

Advantages ✔  Risk transfer: Sub-participation will effectively remove a loan from inclusion in the
existing bank’s regulatory capital requirements, other than in respect of undrawn
commitments
 Consent:
o Unless there is a prohibition in the original facility agreement (which is unlikely), an
existing bank may sub-participate without the consent of the borrower.
 The only problem the existing bank might face is in providing information
about the borrower to a new bank, since all banks owe a duty of
confidentiality to their clients (set out in Tournier v National Provincial and
Union Bank of England).
 An existing bank intending to sub-participate will therefore want to include a
clause in the original facility agreement allowing it to release information
about both the borrower and the loan, without a breach of duty.
 Non-disclosure: An existing bank does not have to disclose a sub-participation to the
borrower (unless it has a confidentiality issue – see above), and most sub-participations
will be ‘silent’. The advantage to both existing bank and borrower is that the relationship
between them is maintained despite the risk being laid off.

Disadvantages  Sub participant’s credit risk:

✘ o A new (sub-participant) bank must take a credit risk on both the existing bank and
the borrower.
o If the borrower goes into liquidation, the new bank receives only what the existing
bank can reclaim (because of the non-recourse nature); and if the existing bank
goes into liquidation, the new bank will usually have to claim as an unsecured

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 creditor.
o This double risk will be reflected in the new bank’s fees for sub-participation.
 Risk transfer:
o Funded sub-participation may not be fully effective to off-load the (entire) risk of
undrawn commitments if it simply results in the existing bank taking a risk on the
new bank instead of the borrower.
o The sub-participation agreement must ensure that the existing bank is put in funds
in time to meet the borrower’s demands for utilisation in order effectively to
remove the risk.

Risk Participation

What is it?  Risk participation is a form of participation which acts like a guarantee.
 The risk participant bank will not immediately place any money with the existing
bank but will agree (for a fee) to put the existing bank in funds in certain
circumstances (typically on any payment default by the borrower).
 Risk participation might be provided by a new bank as an interim measure before
it takes full transfer of a loan.
 A more common use for risk participation is to cover so-called ‘unfunded’ assets
(i.e., assets under which an existing bank has a potential outlay such as guarantees,
letters of credit or swaps).
 If the existing bank’s customer fails to meet its reimbursement obligations under
these products, the new bank will put the existing bank in funds.
 (Risk participant bank agrees to do this because they will be paid a fee and they
will hope that the borrower does not default)

Securitisation

Sometimes a bank will want to sell not just one or two loans at a time but a whole group of loans together.
 Securitisation is a technique which allows banks to ‘sell’ a large portfolio of loans (or other income-
producing assets), thereby freeing up capital to re-invest.
 In very basic terms, securitisation involves the owner of a pool of assets (the ‘originator’) transferring them
to a specially formed company (a ‘special purpose vehicle’ or ‘SPV’).
o SPV funds its purchase of the assets by issuing debt securities (it is therefore known as the ‘issuer’).
o Coupon and redemption of the debt securities are met with, and secured over, the asset pool.

Asset Sales - Perspectives

BANK  Most banks will require the flexibility to sell a loan if they decide it is necessary or
desirable.
 They will, however, usually be receptive to a borrower’s feelings towards maintaining
some form of lending relationship during the term of the loan and allow some
restrictions
 In current markets, many entities other than traditional banks are involved in buying loans
on the secondary market.

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  Bank’s solicitor should therefore ensure the facility transfer language allows transfer not
just to other banks but also to trusts, funds, or other entities engaged in buying loans.

BORROWER  At first sight, the identity of the bank might appear to be of little importance to a
borrower. After all, on novation, assignment and sub-participation the provisions of the
facility agreement will apply to the existing bank(s) or any of their successors. Borrower will
normally just deal with agent and LIBOR unlikely to be affected.
 However, a borrower’s relationship with its lenders will be crucial if it requires
waivers to actual or potential defaults, if it wants to make changes to the loan
documents going forward or needs tolerance in interpreting provisions.
 Investment grade borrowers might look for a ‘club loan’ in which a small number of
‘relationship’ banks provide the facility and no transfers are made in normal
circumstances.
 Most facilities, however, will allow transfer but subject to obtaining the borrower’s
consent (other than for transfers between existing lenders or their affiliates), such
consent not to be ‘unreasonably withheld or delayed’.
 There are then substantial negotiations to modify the consent requirement e.g.:
 borrower consent may be deemed given if they do not reply within a given
timeframe (e.g. five business days);
 may provide certain circumstances where borrower cannot refuse consent e.g.
borrowers cannot refuse consent solely because the transfer will increase
mandatory costs
 transfers to a borrower’s competitors may be prohibited on the basis that the
competitor might then obtain sensitive information about the borrower;
 transfers to certain types of fund may be prohibited on the basis that they
acquire debt for motives other than pure lending (e.g. to take control of the
borrower or agitate in other ways): the difficulty is in agreeing a generic
definition for such funds;
 borrower may require banks to transfer to a qualifying lender i.e. lenders who
borrowers do not have any statutory obligation to withhold tax on interest
payments (e.g. s879 ITA, liable to UK corporation tax, see above)
o Or, may be a condition in the FA that borrower is not required to gross up a
new lender or pay an increased cost if on date of transfer, the existing
lender would not have had an entitlement to receive such a payment
o If borrower does have to gross up, FA may have a clause entitling borrower
to make a voluntary pre-payment of all amounts outstanding to that lender
only and that lender’s commitment would be cancelled
 N.B. exception to the general principle that pre-payments are pro
rata against all banks to ensure they are all treated equally
 a list of named institutions to which banks can transfer without consent may
be pre-agreed (known as a ‘white list’). Less commonly there may be a list of
named institutions to whom no transfers can be made (a ‘black list’); and
 banks will usually want complete freedom to transfer without borrower
consent if an event of default is continuing. Ironically this is the time when
borrowers most need a stable, sympathetic syndicate and so they will usually
resist this if possible
 Finally, the difficult credit conditions during 2008 and 2009 saw many loans trading at
substantially less than their face value (below par).
 This prompted borrowers to consider buying back portions of their own loan debt:
buying the debt at a discount is a cheap way to prepay.
 Most facility agreements did not specifically address whether a borrower could buy
back the loan, but there may be issues with prepayment restrictions, pro-rata sharing

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 between lenders, restrictions on cash usage, and issues with novation.
 Most loan facilities now include specific mechanics to deal with borrower debt buy-
back. These mechanics either prohibit buy-back completely or restrict which borrower-
related entities might buy.
 Even if buy-back is allowed, the buying entity is usually required to allow all the
syndicate banks a chance to sell (rather than approach specific banks).
 Furthermore, any debt they purchase will lose the associated voting rights to stop
borrower entities interfering with votes.

LENDERS  Unless there is a requirement in the facility for a lender to have some kind of minimal
hold, the existing lenders do not have the power to prevent another lender transferring its
interest

Provided lender fulfils the procedures required to make the transfer, there is nothing
further that existing lenders can do
 However, if Agent wishes to assign or novate its interest in the facility, the syndicate will
likely want the bank to step down as Agent

This is because if Agent disposes of its interest in the facility, it no longer has any real
interest in the success of the facility

Whether or not the syndicate can force the bank to step down would depend on the
specific clauses in the facilities agreement
 E.g. Clause 25.12(g) – “the Majority Lenders may, by notice to the Agent, require
it to resign”

However, it is likely that Agent would not want to continue as agent if they do not
have any further financial involvement in the loan
 N.B. would be highly unusual for agent to want to sell its interest and remove itself from
facility as it has an important role as the relationship bank. Main reason agent may want to
divest itself of interest in facility would be if there has been some kind of a break down e.g.
between itself and the group

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