Different Legal Complications in The National Communication Corp - Case Study Example

Introduction Raising funds from the international market is always a challenge because it involves multitude of factors which need to be taken care of in order to successfully achieve the desired objectives. One of the most important aspects of raising the funds from international market are the legal complications associated with such an action. Since the laws from country to a country differ therefore international organizations have to comply with diversified set of legal laws and procedures before they can start to promote their cause of raising the funds. This is also because there is a general lack of standardized or uniform set of rules which can facilitate the international organizations to raise funds without any significant legal or administrative bottlenecks. The legal complications do not include only with providing accurate and correct information to lenders/investors but it also raises certain tax related issues and other matters which need to be taken care of before a firm formally approaches lenders and investors for raising funds. It is also critical to understand that the principles governing the international syndications are more or less same as that of the domestic syndication loans however there are added elements of managing different currencies, risks as well as taxes and government regulatory requirements. (Lajoux and Weston). Normally, an international syndication involves a group of lenders who pool their funds to offer to anyone who is willing to borrow and fulfil the requirements. Normally, an international syndication would require formation of only one agreement with the lead financial institution and all other members become signatories to this agreement along with the borrower. It is because of this reason that the associated legal complications are riskier than in a normal loan agreement. International organizations normally prefer to go for international syndication because they can raise larger sums of money from the market at lower cost besides exposing themselves to the international market so that future funding requirements can be easily met. The increases in the visibility of the borrowers in international market also provide more confidence to the lenders and as such future borrowing requirements of the borrowers can be easily met. From the perspective of the financial institutions, it is also important to note that through international syndications, financial institutions often get diversification of their risk by properly sharing the risks in different markets along with different other players who share the same risk. Similarly, the legal risk of the financial institutions as well as the international firms also reduces because of the risk sharing. International firms with no or very low credit history may therefore, also need to provide certain covenants or guarantees in order to secure funding from the international market. However, such covenants have legal consequences for the firm and failure to comply with them may result into legal complications. The situation provided in the given case study indicates that there are different legal complications involved in completing this transaction. This paper will provide legal analysis of how The National Communication Corp (NCC) can respond to such complications in order to successfully complete the transaction. Information Memorandum Information memorandum is prepared by the borrower to outline some of the financial, economic as well as political and other historical factors which can affect the current and future credit worthiness of the borrower. This information memorandum is always prepared with the collaboration of lead manager i.e. ABN in this case. The information memorandum is increasingly important because together with the term sheet of the loan, this document is sent to all the participating lenders/investors and serves as one of the most important tools for decision making purposes for them. (Smith and Walter). It is also important to note that checking the accuracy and completeness of the information memorandum is the responsibility of the lead bank and as such the lead bank may not be absolved of its responsibilities under normal course of business. It is because of this reason that the lead banks often insert protection clauses in the main agreements of the syndications in order to provide themselves a cushion against the future damages. Protective clauses in Information memorandum, therefore, serve as one of the most important shields against the potential future litigations arising due to incomplete or inaccurate information presented in the memo. It is important to note that the protective clauses are considered as the indemnity clauses under which the participants are assigned of different indemnities to be fulfilled. This is important in the sense that under this clause a lead banker can often avoid responsibilities and obligations which are not directly due to the misconduct on the part of the borrower. If we analyze this case, it would come to notice that the ABN is reluctant as to the accuracy of the information presented in the information memorandum. In order to protect itself, ABN therefore has to insert certain clauses which allow it to protect itself against any future claims of the lenders for wrong or inaccurate information presented in the document. In a multi-bank financing, it is also important to note that there may arise from different legal requirements for each of the players involved in the process, and as such it becomes the responsibility of the lead bank to sort out any differences arising due to such legal differences. In this case, a company from Finland has hired a bank from France to arrange the financing from international market under the English Law. The involvement of three different countries in this transaction automatically requires that the each entity have to follow the certain specific rules and regulations pertaining to their own home countries and therefore, may not be applicable to other participants. It is because of this reason that it has become really critical to clearly define the exact relationship between the participating i.e. whether they will be acting like a group, joint venture, partnership etc. due to this complexity of the legal relationship between the member banks of the syndications, it really becomes more important to insert the protective clauses by the lead bank in a bid to safeguard itself against any potential future liabilities. (Mugasha) ABN therefore can take following actions to protect itself against inaccurate information presented in the information memorandum: 1. One of the most important aspects of preparing the information memorandum is to include the information disclaimer at the start of the agreement in order to set things straight and define at the outset that the information presented in the memorandum is from the NCC and ABN does not bear any responsibility for any misinformation presented in the document. 2. ABN may include/attach the personal guarantees of the sponsoring directors of the NCC too in order to provide a protection to it. The inclusion of personal guarantees of the sponsoring directors may further provide the required security and assurance to the various participants as to the accuracy and completeness of the information presented in the memorandum. 3. It is also important to understand that, as a part of the agreement, there are certain affirmative as well as negative covenants which the borrowing firm has to fulfill. These covenants, therefore, also serve as strong protection to the lenders and put a check onto the borrowing entity. However, in case of defaults, it is certain that few of the participants may raise their objection over the quality of information presented in the memo and may question the information memorandum itself. In order to avoid such situation, ABN may include protection in the default clauses of the main agreement. In doing so, ABN, at the outright, will spell out the conditions under which its liabilities due to default of the NCC may be limited. ABN also needs to take into account any assignment of rights and as such information presented in the memo must not be in direct contravention to the main lending agreement. This is important because if participant banks assign certain obligations to the lead bank under certain pre-defined as well as explicit conditions therefore as a lead bank, ABN must ensure that the disclaimers which it has provided in the information memorandum as a part of protective clauses must therefore, do not directly coincide with the clauses outlined in the main agreement. The above protective clauses, therefore, may serve as a strong indemnity for ABN in case of any future liabilities arising due to misrepresentation of information into the information memorandum. Negative Pledge Clause At the time of formation of an agreement, lenders often restrict the borrowers by placing negative as well as affirmative covenants. Affirmative covenants are those clauses which basically force a borrower to perform certain action during the currency of the finance- for example; lenders may specify the amount of dividends to be paid during the currency of the finance, the extent to which certain ratios should be maintained etc., On the other hand, negative covenants are those covenants which basically restrict a borrower to perform certain actions. This is done in order to secure the interests of the existing lenders and provide them efficient allocation of resources in the event of any default at the future date. The term negative pledge is also one of the negative covenants which basically restrict the borrowing firm not to pledge its assets given as a security for this particular loan. A negative Pledge clause is also considered as the standard provisions in the syndication loan agreements which basically regulate the security interests in the collaterals held as security for any particular loan. There are generally two of situations which arise while dealing with the negative pledge clause in the master loan agreement. One, the clause may explicitly restrict the borrower from encumbering the assets by creating either charges, mortgages, liens or even sell the assets. Secondly, the negative pledge may allow the borrower to place the assets under encumbrance however, the clause may explicitly define that the right of each lender will stand equal to all other lenders or would be superior to them. (Asiedu-Akrofi). The major purpose of having such clauses are to protect the future revenue generation capability of the assets and as such restrict the rights of other lenders and gain an exclusive excess to a particular class of assets in case of liquidation of the company. It is also however, critical to understand that there are certain vehicles or schemes which run parallel to the negative pledge clauses and technically allow borrowers to threaten the built in security function of the negative pledge clauses. Such schemes are considered as quasi-security devices and are widely used by the shrewd and technically superior organizations to their fullest use. The major transactions which can be performed under the disguised of the quasi security devices include sales and lease back arrangements between the borrower and the other potential lenders, set- aside provisions included in the Master loan agreements as well as title retention transactions which may potentially allow the borrowers to take advantage of such devices. It is therefore, really important for the ABN to insert a very robust and flexible negative pledge clause in the agreement which not serves the interests of all the banks but also provide NCC a necessary room to further utilize its own assets. As discussed above that there are two situations which can arise for inserting the negative pledge clause in the agreement. Firstly, if there is a mutual agreement between all the participants and the borrower than ABN may restrict the further encumbrance of the assets given under collateral. For this purpose, it has to therefore create a fixed charge over the assets of the firm by first identifying which assets to be pledged and then creating a fixed charge over them so that their future encumbrance is restricted. Secondly, ABN with the mutual agreement of all the participants may allow the encumbrance of assets however, it can restrict by seeking a joint pari-passu charge ranking equally with all other lenders. In this way, ABN and the syndication members may be able to secure their interests through an effective creation of charge over the assets of the firm. Cross- Default Clause A cross default clause triggers when a borrower fails to meet any of the stipulated conditions and the lender declare the default on such a transaction. This clause is also considered as one of the most critical clauses of the general agreement and as such maintains the equality among the lenders. This clause generally inserted into the general agreement in two forms i.e. in one condition, the lender may accelerate the loan and cross default clause is automatically triggered. In another condition, lenders simply exercise the remedies available under the agreement in case any event of default occurs. It is therefore, also critical to note that to insert a very potent and strong cross default clause, it is necessary that the default events are properly and accurately identified and clearly mentioned in the agreement. Failure to do so may allow the borrower to take advantage of legal loopholes in the general agreement between the syndication members and the borrower. (Klein) Whatever the form of such cross default clauses, the basic purpose served by this clause is to protect the legal rights of all the lenders and explicitly outline the rights and obligations under any of the described events of default. One of the remedies available to the member banks of the syndication is to negotiate for getting preferential treatment under any given default condition. However, this can only be achieved, if the lenders have been able to insert the negative pledge clauses and have technically restricted the borrower to put the assets under pledge in order to secure funding from other sources. Secondly, the lenders may exercise their loan accelerating agreement which allows them to trigger the cross default clause and as such bring the borrower within legal ambit to pursue legal course of action. However, as given in the case, most of the sovereign or large groups tend to avoid providing the standard cross default clause and as historically there have been very little agreement between the borrowers and lenders on this issue. It is also critical to understand that the cross-default clause may not necessarily mean the wholesale default by the borrower on all the payments but may also include a default on other conditions or covenants mentioned in the agreement. For ABN, it is therefore really important that it must first define the scope of the cross default clause and as such must find an agreement on this also. Further, ABN must also need to decide whether what type of alterations can be made to the standard cross default clause. The alteration to the standard cross default clause, therefore, can be varied by inserting certain threshold levels for default, the degree and extent of the material change i.e. the extent of change which may potentially dilute the ability of the borrower to pay etc.. However, even after that NCC is not agreed to insert the customized standard clause then members of the syndicate may be running a legal risk. One of the most critical legal risks in the absence of a cross default clause is the mutuality of the obligations under which courts, mostly attempt to distinguish the entity from the government and as such may not allow the lenders to seize the properties of the government entity. However, there is an alternative to this also where if it can be proven that the government entity is the altered ego of the government and in such cases, the lenders may have the certain remedies available even if a standard cross default clause is not included. Restricting the cross default clause only to the public indebtedness may further create risks for the members of the syndicates because of the related legal complications. As discussed above that in most of the cases courts often take into account the separate legal status of the government and its entity and as such make a very clear distinction between the two at the time of making any judgment. However, if the public indebtedness clause is explicitly inserted into the loan agreement, it may therefore, become obvious for the courts to treat the NCC as an altered ego of the government therefore may allow NCC to get away with its default by shifting the responsibility to pay on the government. In such situation, ABN and other lender banks have to ensure that such syndication agreement is properly backed up by the guarantee of any of the government agencies so that in case of default by NCC, that guarantee can be invoked against the government. (Gooch and Klein). Novation One way to participate into providing funding to the firms is to enter syndication where banks form a group to provide funding to the various borrowers under different stipulated conditions. In a syndicated loan agreement, one or more banks often agree to form one single loan agreement with the borrower and as such a lead bank often , on the behalf of all other members, negotiate with the borrower on major terms and conditions of the loan. However, there is another option available to the lenders also in which they usually do not have to enter a single agreement with the borrower. Such arrangement is often called loan participation. In the loan participation type of agreement, a lead bank enters separately into an agreement with the borrower, and then it forms a separate agreement with all the participating banks into the loan participation. In this type of loan participation, therefore, there are two layers of documentation which a lead bank has to arrange in order to complete the transaction. In first layer, a major loan participating agreement is mutually agreed between all the participating banks including the lead bank. This agreement broadly defines the modus operandi of the whole agreement besides outlining any negative or affirmative covenants which the borrower has to perform. In second layer of agreement, the lead bank enters into the general agreement with the borrower outlining the terms and conditions under which the loan will be governed besides outlining clearly certain exceptions which may be allowed under this agreement. (Schroeder and Tomaine). Under the English Law of contract, novation describes an act which replaces an earlier obligation or replacing the party to the contract. Novation is one of the most important aspects of business law and governs the international syndications also. A novation, however, also jointly and mutually agreed by all the parties to the contract and must give their explicit approval of allowing the novation in order to avoid certain conflicts of interests. It is also important to understand that in order to perform the novation, a new contract must be formed between the parties and the clause of novation must be inserted into the earlier agreement in order to facilitate such an action to be taken. It is also important to note that novation is different from assignment or ratification of a contract and as such must be seen as a separate legal event by all the parties to the contract. Under the existing laws, the clause of novation therefore allows all or any of the parties to the contract to perform certain actions which may have otherwise render the contract as legally invalid. In order to perform the objective of inserting the loan participation and the novation, it is therefore, critical for the ABN to develop a mechanism which can permit it to allow actions without involving into the novation by consent. One of the options available to ABN is to include a clause within the participating agreement which may allow the participating banks to sell their participating amounts without increasing the overall liabilities of the ABN i.e the new agreement which may be formed between the bank and the new purchaser of debt swap therefore must clearly indicate that all the rights and obligations will be as they are and will not incur any further liabilities for the ABN towards other members or to the borrowers. Further, the general agreement between the ABN and the NCC must also explicitly mention that any act of selling the loan participation amount must not be objected by the NCC and as such NCC will not ask for any indemnity from ABN. Secondly, it is also important for the ABN to include into the agreement a clause which can allow it to restrict the selling rights of the participating members and as such both the parties must agree to an amortization schedule and any call options which can subsequently allow the participating members to sell their participating amount to third parties. Further, ABN can also stipulate the conditions under which such action can be taken without going through the formal process of novation by consent. This also means that the member banks must first adhere to certain conditions before they can enter any such action. Finally, ABN may out-rightly reject any such arrangement and restrict the participating banks to sell their participation amounts to any third party. Works Cited 1. Asiedu-Akrofi, Derek. "Negative Pledge Clauses in International Loan Agreements." Law and Policy in International Business 26 (1995): 1-10. 2. Gooch, Anthony C. and Linda B. Klein. Documentation for loans, assignments and participations. London: Euromoney Books, 1996. 3. Klein, Thomas Martin. External debt management. New York: World Bank Publications, 1994. 4. Lajoux, Alexandra Reed and John Fred Weston. The Art of M&A Financing and Refinancing. New York: McGraw-Hill Professional, 1999. 5. Mugasha, Agasha. The law of multi-bank financing. Torontto: McGill-Queens Press, 1997. 6. Schroeder, Gilbert J. and John J. Tomaine. Loan Loss Coverage Under Financial Institution Bonds. New York: American Bar Association, 2007. 7. Smith, Roy C. and Ingo Walter. Global banking. Oxford: Oxford University Press, 2003. Read More