Mechanisms of Secured Syndicate Debt Transfer - Essay Example

MECHANISMS OF SECURED SYNDICATE DEBT TRANSFER Introduction: Syndicated Loan Agreements Syndicated loan facilities constitute an arrangement where a borrower in need of a huge amount of funding engages a group of lenders in a single agreement involving the whole group of lenders. The element of security that is usually required of such loans as operated in secured syndicated loans enables investors to consider them as financial instruments that can exchange hands just like ordinary assets. Jurisdictions embracing common law and civil law have a different way of dealing with transfers of such instruments based on various mechanisms that allow full or partial transfer of obligations and rights. In certain circumstances, the lending group members may consider selling their loan commitment to a different party thereby transferring the lender consideration that the syndicate arrangement confers1. In this discourse, the mechanisms of common law and civil law jurisdictions pertaining to the transfer of secured syndicated debts are discussed and distinguished from each other. Security Trusts in Common Law Debt Transfers In common law jurisdictions, the syndicate loan facility arrangement is constituted under a separate trust agreement. A third party to the debt effectively replaces the role or roles of the exiting lender upon transfer of the commitment in common law. Secured syndicate loans are secured through an independent trustee who holds the security consideration over the debt in trustee on behalf of the syndicate group. An independent trustee is appointed and constituted through a provision of the loan agreement where the syndicate partners agree to enforce the security on the loan in a certain manner that is deemed fit among the lenders. In terms of the security enforcement, the trustee is guided by the loan agreement in the procedures to follow when called upon to distribute the proceeds of the loan security among the lenders with regard to their participation in the funding of the loan2. As a general rule, the constitution of the trustee is such that the credit risk involved in the agreement does not affect the trustee. According to several common law literature and sources, the role of the trustee also includes charge over the particular security given over the debt, which also becomes transferable once the lending parties decide to transfer their commitment through various ways3. The trustee holds certain clear interests over the security assigned to it by the syndicate and carries out any distribution of interest as guided. Parallel Debt in Civil Law Debt Transfers A parallel debt arises when the borrower engaged in a different contractual engagement with the security agency besides the contractual engagement with the lenders. A transfer transaction under civil law treats new entrants as different parties who must engage into the transaction through contractual procedures in a parallel arrangement. The agent treats the borrower as a creditor just as the lender treats the borrower and the transfer transactions must go through the two parties. The agent plays a lender’s role just as the lender does. However, in payments, one payment reduces the commitment equally for the two creditors. The right to the security by a new lender upon transfer of the commitment is not an issue since the agency is also an equal lending player as it regards the signing of the credit contract. Under civil law agreements, an agency is usually involved in holding the security on behalf of the syndicate group but the lender’s title of the agency under parallel debt makes transfers easier. The borrower has different contractual engagements between the lender and the agency unlike in the common law where the trust occurs as a single agreement for the syndicate group. However, transfer issues such as those observed in the common law mechanisms imply that the complete transfer of the debt commitment to another lender is not always possible. Partial transfers are therefore not envisaged in a majority of civil law systems that also happen to apply a different security protection. An illustration of such an arrangement is the Dutch fiduciary system that is based on the Dutch civil law4. Transferring Syndicated Debt There are a couple of mechanisms through which a transfer can be effected which include the following. Novation Under a novation transfer mechanism, the lender willing to transfer the debt transfers every right and obligation to the new lender willing to buy the commitment. In this mechanism, the initial lender cancels every commitment and identical commitment on the transaction is passed onto the new lender coming in. Generally, the exit of the old lender terminates the relationship held with the rest of the syndicate group of lenders and it implies that the new lender acts as a replacement. This mechanism effectively places the new lender in charge of the contractual part supposed to be respected by the exiting lender. Apparently, a direct relationship is established upon the transfer between the new lender and the borrower. To illustrate the implications of this transfer, a term lending arrangement imply that the lender would not be advancing any more credit to the borrower having effectively assumed the obligation of the former lender. However, in a revolving lending facility, the new lender will assume the responsibility of advancing the expected disbursements as the former lender would have continued with the facility5. Legal and Equitable Assignments A legal transfer mechanism does not transfer all the aspects of the commitment to the new lender, since only rights are transferred while obligations remain with the transferring lender. Three aspects must be fulfilled in order to enforce the legal assignment in entirety which must be; absolute in terms of the existing lender’s debt commitment, in writing and signed by the existing lender and notification made to borrower. All rights to the debt’s commitment are effectively transferred to the new lender despite the fat that the two lenders play different roles in the commitment6. When any of the three conditions in a legal assignment is not met, the transfer of the rights takes a different perspective under the equitable assignment. The new lender assumes the position of the equitable assignee and must act as a co-assignor with the existing lender for any action taken on the debt. The notification of the borrower as a fundamental condition is the main differentiating factor between a legal and equitable assignment and the relevant transfer of rights. Failure to notify the borrower implies that the equities on the debt are directed to the new lender. Other treatment mechanism under common law jurisdictions include the funded and risk participation. On such an agreement, the existing lender further agrees to pay all or an agreed portion of the principal as well as interest gained from the debt7. On the other hand, risk participation involves the introduction of the participant into the lending role as a guarantor to the existing lender. An agreement is enterer into to allow the participant to provide funds to the existing lender in case the risk of lack of funds poses before the execution. Participation involvement in either risk or fund agreements does not necessitate the alert of the borrower since the participant deals with the existing lender to assist in execution of the lending mandate. However, the risk participant may want to transform the engagement into a takeover of the lender’s position8. Legal systems formulate various interpretations on the manner to deal with the circumstances of the syndicate debt matter at hand using predetermined regulations. Such system provide for the treatment of transfer of rights and obligations in an automatic version which may fail in certain circumstances that complicate such a transaction9. Distinctions Common law and civil law jurisdictions have evolved to supply answers to the challenge found in distribution of the security among the syndicate parties as well as define the rights and obligations of the lenders and the borrower as the debt changes hands. As mentioned above, there are certain instances when one of the lenders in the syndicate group may be forced to consider withdrawing from the commitment of the loan agreement through the sale of the consideration thereon. While the various mechanisms of transfer such as assignment pose the difficulty in partial transfer of the commitment in that only the rights are transferred, it is possible to handle the transfer issues thereon through the trust system as discussed below. Alternatively, security is timed under a novation which may complicate the transfer achieved through this method where the common law offers solution of an independent trustee to take care of the trustee longer after the transfer has taken place10. Common law applies the trust system in transfer of the debt in syndicated facilities while the civil law relies on the parallel debt arrangement, but neither recognises the system used in the other. Other legal transfers may be considered outside the common law arrangement, for instance where trusts are not recognised. The dominant application in civil law is the use of what is referred to as parallel debt obligation where a security agent that involved in the management of the trust is separately considered from the lenders. In common law, the trust system defines the legal and beneficial ownership between the trust and the lender in order to distribute the security among the syndicate group parties. Civil law provision of equal lending capacity between the agency and the lender creates legal commitment but does not imply that the debt is increased. In understanding the trust system which has the trust and lender playing different roles, the civil jurisdiction gets confused. However, common law would not find it difficult too understand the role of the legal debt commitment in the separate contracts. In light of the need by the involved parties to protect their individual interests without feelings of preferential treatment on either party to the syndicate lending agreements, it is clear that the civil format of intervention is a weaker option for the business11. Whereas it is clear that non-compliance with a particular requirement of transfer in common law may translate into a different form of transfer for instance in legal assignment, civil law violations may translate into nullification of the entire transfer. It therefore implies that under the civil law system of debt transfer, more risks are involved than in the common law. To illustrate the risky aspect of the civil law, nullification of a faulty transfer process may result into further costs in determination of the appropriate alternative to employ in settling the anomaly. Alternatively, many civil law jurisdictions do not accommodate the assumption that a commitment can be stretched to involve more parties in a derivative version12. Whereas such a notion reduces ambiguities as intended, it blocks investors to take advantage of the opportunities that the common law jurisdiction avails13. Conclusion Syndicate debt transfer presents an opportunity for the business world to open up opportunities for more players to take advantage of the lending business. However, the applicable jurisdiction may determine whether this is opportunity is to be availed14. As indicated in the above discussion, various mechanisms of syndicate debt transfer pose certain challenges that are solved differently under the common and civil law jurisdictions. As illustrated, trust and agency systems applicable in both methods apply ownership definition and parallel debt for the clarification of likely uncertainty15. While the security trust under common law may not fit into the parallel debt in civil law, common law may adopt the functioning of the parallel debt system. Security trustee system in common law does not recognise the security agency system applied in the civil law jurisdiction to handle the mechanism challenges in syndicated debt transfers. Bibliography Law Market Association “Guide to Syndicated Loans” (12 January 2012) C Bamford Principles of International Financial Law (Oxford University Press Oxford 2011) Nieuwenhuijzen Financial Law in the Netherlands (Kluwer Law International Netherlands 2010) Moody’s Investors Service “Debt Financing of Projects in Emerging Economies: Lessons from Asia.” Project & Infrastructure Finance Sourcebook (December 2001) 45-49 P R Wood Comparative Law of Security Interests and Title Finance (Sweet & Maxwell London 2007) 11-16 J.J. 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