Loan Syndication Participation Agreement - Research Proposal Example

Loan Syndication participation agreements International syndicated loan agreements are essentially arrangements which are put in place for corporate borrowers in different countries who need to have a convenient, efficient and flexible borrowing source. Syndicated loan arrangements are often the best financing arrangement appropriate for international commercial transactions. Banks may chose to enter into syndicated loan participation agreements in order to spread the risks involved in making specialized loans and can also earn attractive management fees at the same time (M.A.L., 1978). Syndicated loans could include multiple term loans in multiple currencies, with multiple arrangers and multiple lenders who also participate in it, but in general, one “lead” bank performs the primary functions associated with the loan, i.e., sourcing, structuring, selling and servicing.(M.A.L, 1978). The lead bank retains overall control of the loan and forms a more intense syndicate when higher levels of monitoring are required. The burden of monitoring the loan and ensuring moral diligence necessarily falls upon the bank that is geographically closer to the borrower and/or has a prior lending relationship, especially when there is potential for information asymmetry between the borrower and other lenders in the syndicate. In the case of loan syndication, the need to transfer a loan may arise for various different reasons, notably, the need to spread risk, to restructure the banking group, scrutinise loans and transfer non performing ones to a government agency or central bank, among other reasons. The three major methods of participation are (a) assignment, i.e, transfer of a proprietary interest by way of a trust (b) sub participations – agreements wherein the existing bank receives payments from the borrower and pays it out to the new participating banks in proportion to their participation and (c) novation, wherein the participatory share is allotted to the new bank on the basis of an agreement between all the banks and the borrower. Research proposal: This research study proposers to focus on the methods of transferring of loans and the financial arrangements that can exist between the lead bank and the associated banks involved in the transaction. Major aspects to be taken into consideration in each of the three arrangements would be (a) existing restrictions on the transactions (b) transferring the benefits under the loan agreements and (c) transferring the existing bank’s commitments to lend (Wood, 2008). This study will present an examination of all these aspects as they relate to all three methods of loan transfers. Methods of transfer of loans: Assignment of loans: Under an assignment of loans arrangement, the existing bank which has the transaction assigns all or a part of its rights under the arrangement to the new bank, matical percentages which may or may not be notified; in the latter case, the earlier bank remains the legal trustee of the sold portion as well, with the new bank having a beneficial ownership in proportion to the shares whose ownership has been transferred. This arrangement is necessitated including the concomitant pro rate benefits (Wood, 2007:9-018). In terms of legal ownership however, the assignment is generally expressed in terms of mathematical percentages because the amount in question is advanced on credit and is thus an intangible amount. One of the important aspects to consider in the case of loan assignment is whether any restrictions exist. An express restriction would generally be more difficult to circumvent, but this does not necessarily exclude the assignment of the proceeds, because the beneficiary of a related trust stands to benefit, even in the presence of a legal restriction on assignment1. Nevertheless, as Wood (2007:9-020) points out, the assignment of proceeds does not carry with it all of the benefits associated with a typical syndicated loan agreement, i.e, the right to sue the borrower for the entire debt. Dolvin et al (2007) have examined the relationship between the characteristics of the loan and abnormal returns to the borrower, applied in the case of 1472 syndicated loans. They found that under conditions where there were constraints on loan resale, this was generally an indication of short run abnormal returns. Under an assignment arrangement, it is also vital that consent for transfers are not unreasonably withheld. If parties entering to a trade arrangement do not obtain consent, then they will need to enter into a different arrangement, i.e, a funded sub participation, which does not generally require consent. Other aspects to be taken into consideration include set offs and mutuality agreements. Sub participation: Under this form of loan participation agreement, the new bank expresses its participation through a deposit and the existing bank pays “amounts equal to the new bank’s share of receipts from the existing bank” (Wood, 2007:9-038). The difference between this arrangement and an assignment is that payments under the former are due and payable only if the existing bank is able to receive corresponding amounts from the borrower. In the case of Lloyds TSB Bank plc v Clarke2, a sub-participant arrangement was found, which meant that the risks arising from the insolvency of the bank feel upon the existing bank. The major purpose of entering into this kind of an arrangement is to ensure that an existing or lead bank does not have to bear all of the risks associated with a default by the borrower. In the case of a sub participation agreement, only the traditional contractual provisions are likely to apply; the banker’s duty of confidentiality also would be capable of being over ridden only if the loan agreement on sub participation authorizes it (Wood, 2008). Where guarantees for loans are concerned, the existing bank would not be obliged to transfer them to the new bank, since it is not an assignment arrangement. Appropriation of payments would occur in a specified order. Novation: The word “novation” is derived from the legal concept of ancient Rome and it literally means substitution. Novation differs from assignment in that the existing bank opts to transfer all or part of its rights and obligations to a third party, i.e, a new bank, which effectively becomes liable for and the owner of those rights and obligations (Wood, 2008). There are two forms in which notation can occur; first, all the rights and obligations of the existing bank are cancelled and replaced by the new bank. This method is common practice in England because of the stamp duty payments involved; however in the case of the United States, the more common novation arrangement is the assignment of the rights to the new bank, coupled with the release of obligations of the existing bank which are transferred over to the new bank. Novation agreements differ from the two methods mentioned above because a substitution certificate needs to be issued. In some cases, for the payment of some nominal consideration, the borrower agrees to accept new banks that may be involved in a novation arrangement. This would ensure that any restrictions on transfer of rights and obligations under the loan are dealt with. One important issue arising specifically in the case of novation agreements is the question of transfer of securities and guarantees associated with the loan is that once an existing agreement is cancelled, the associated guarantees will cease to apply (Wood, 2007:9-056). To protect borrowers against the lapses of security, the guarantee is assigned to a trustee, who undertakes the obligations of the lender while a parallel obligation is also established for the borrower to pay off the debt. References: *Dolvin, Steven D, Pyles, Mark and Woodside, Perry, 2007. "The Effect of Resale Constraints on Abnormal Returns of Borrowers in Syndicated Loans" Academy of Banking Studies Journal 6.1/2: 81-96. *Wood, Philip R, 2008. “The Law and Practice of International Finance”, Sweet and Maxwell Ltd. *Wood, Philip R, 2007. “International Loans, Bonds, Guarantees and Legal Opinions”, Sweet and Maxwell Ltd. Read More