The Legal Position and Responsibilities of the Lead Bank - Essay Example

Syndicated Loans and the Lead Bank’s Legal Position and Responsibilities in the Pre-Contract Stage Introduction The legal position and responsibilities of the lead bank in arranging a syndicated loan can be complicated and ambiguous particularly since those responsibilities carry over to the post-contract stage. In the pre-contract stage, the lead bank’s takes an active role in the creation of the syndicate, preparing information and negotiating the loan’s terms and conditions. Once the syndicate loan is negotiated and finalized the lead bank continues to play an active role in the loan arrangements in that it coordinates loan payments and mediates between the borrower and the syndicate.1 It follows from this that the legal responsibilities of the lead bank is very important as it represents an important link between the syndicate and their individual relationships with the borrower.2 Even so, the lead bank’s legal position is ambiguous since it coordinates what can amount to conflicting obligations between the syndicate and the borrower. This paper examines the legal position and the responsibilities of the lead bank in arranging a syndicated loan and explains how both can be ambiguous. Syndicated Loans A syndicated loan is a multi-bank financing mechanism where a number of banks conjoin to advance a loan to a borrower based on a “single loan agreement.3 The legal complexity of this arrangement is explained by Mugasha as follows: “...the agreement is executed by more than one bank and there is privity of contract between the borrower and each of the banks. Legally, each of the banks has a separate contract with the borrower, even though for convenience, the separate contracts are printed in one document.”4 The lead bank’s tenuous position is set against this background in that it arranges the individual contracts between the borrower and each of the participating banks. In a typical case, a borrower requires a loan which a single bank is either unwilling or unable to advance. It could be that the loan required is large and the bank approached is not prepared to accept the risk for the entire amount.5 In any case, the reluctance of a single bank to advance a loan often gives way to a syndicated loan or a “multi-bank loan arrangement” in which at least two banks advance loans to a single borrower “on common terms based on a single document.”6 Despite the single document, each bank has a separate agreement with the borrower.7 The result is, the obligation of the individual banks involved in the syndicate loan is several rather than joint.8 The Lead Bank’s Role in the Syndicated Loan Arrangements The lead bank’s legal position and responsibilities with respect to the syndicated loan arrangements is divided into two intricately connected participatory roles. First and foremost, the lead bank, which is usually the bank approached by the customer is typically an agent or manager for the borrower.9 At this stage, the bank takes on the responsibility for forming the syndicate of lending banks, which invariably includes preparing an information memorandum and negotiating the terms of the loan. This part of the pre-contractual process is generally referred to as the “sourcing stage.”10 During the second stage of the syndicated loan arrangement, also known as the “post-contract stage”, the lead bank: “coordinates tasks associated with the loan payments and communications between the borrower and the syndicate.”11 The lead bank’s legal position and responsibilities however are far more pointed in the pre-contract stage. It is at this stage of the syndicate loan arrangement where the lead bank’s role is more involved and as such gives way to a number of legal obligations and responsibilities. In short the lead bank’s legal position and responsibilities at the pre-contract stage can give rise to the following liabilities: A breach of a common law duty of care. Breach of a fiduciary duty with respect to the other banks in the syndicate. Misstatement. Misrepresentation.12 Each of these possible liabilities speak to the potentially ambiguous nature of the lead bank’s legal position and responsibilities with respect to the syndicated loan. Each of these possible heads of liabilities will be discussed below. The Lead Bank’s Legal Position and Responsibilities at the Pre-Contract Stage In a typical case, a syndicated loan commences with a borrower approaching a bank which is the lead bank and persuades that bank to organize a loan on the borrower’s behalf. In most cases, the bank approached or the lead bank is frequently the bank with whom the borrower customarily conducts business.13 The lead bank responds by furnishing the borrower with an “offer letter” which ultimately offers to arrange the loan for the customer.14 The borrower then submits a “mandate letter” which not only accepts the offer, but also authorizes the lead bank to make arrangements for the loan.15 In addition the mandate will delineate the “financial terms of the loan.”16 The legal status of the mandate letter will depend on the nature of the lead bank’s commitment. There are essentially two types of commitments that a lead bank can undertake. One is a commitment to advance the entire amount of the loan requested regardless of other banks’ participation. This is referred to as “a fully underwritten credit or a firm credit.”17 A second lead bank commitment can also take the form of what is referred to as a “best efforts commitment.”18 By virtue of the best efforts’ commitment: “...the lead bank...is only obliged to use its best efforts to find participating banks and to advance the funds only if it succeeds in finding the banks.”19 The legal position and responsibilities of the lead bank with respect to the borrower is at this stage compromised by its obligations to safeguard against the credit risk to potential participating banks. When the lead bank’s legal responsibilities and position is examined at this juncture, the ambiguity of this relationship is revealed. Obviously, at this stage of the pre-contract process the bank is required to structure the loan transaction and implement it. Included in these duties is a duty to arrange for “counsel to prepare all the legal documentations” and to select participating banks.20 In doing so the lead bank is required to take into account the following: The borrower’s funding requirements. The borrower’s credit standing. The purpose of the loan. The collateral necessary for securing the loan. Setting an interest rate that is capable of inducing bank participation.21 Once offer and acceptance is dispensed with the lead bank, “in conjunction with the borrower” prepares an “information memorandum” which is provided to banks targeted to form the syndicate.22 In the event the borrower and the lead bank agree that the lead bank undertake to secure a syndicated loan in exchange for a fee, the bank’s legal position and responsibilities are aligned to that of agency for the borrower.23 The information memorandum typically contains all the information that is relevant with respect to the borrower, the terms of the loan and any other relevant information.24 It is commonly anticipated that the lead bank will conduct an orthodox investigation of the borrower’s “financial affairs prior to seeking participants.”25 Although it is generally expected that banks agreeing to join the syndicate would conduct their own investigations, the lead bank is accountable for the information contained in the information memorandum. To this end, the ambiguous nature of the lead bank’s legal position and responsibilities are obvious. On the one hand, the lead bank has a commitment to take a best efforts approach to securing the participation of other banks. On the other hand, the lead bank is also accountable to the participating banks if the information contained in the information memorandum misrepresents or misstates information calculated to ensure that the lead bank makes good on its commitment to the borrower. O’Sullivan however, explains that the lead bank does not in actuality act on behalf of the bank in preparing the information memorandum.26 Rather, the bank acts “in conjunction with” the borrower.27 As a result, the lead bank’s fiduciary responsibilities to the syndicate banks is not necessarily in conflict with the lead bank’s duty of care toward the borrower. The lead bank’s fiduciary relationship with the participating banks forming the syndicate was explained in UBAF Ltd. v European American Banking Corporation [1984] 2 WLR 508. In UBAF Ltd. v European American Banking Corporation [1984] 2 WLR 508, the information contained in an information memorandum falsely represented the purpose of the loan as well as the borrower’s financial status. When the borrower fell into arrears on the loan, the syndicate banks filed a suit against the lead bank. The court ruled that the lead bank’s responsibilities toward each of the participants was fiduciary in nature since: “it was the defendants who received the plaintiffs’ money and it was the defendants who arranged for and held, on behalf of the participants, the collateral for the loan.”28 In essence, UBAF Ltd. v. European American Banking Corporation is a manifestation of the ambiguous legal position and responsibilities of the lead bank. The lead bank ultimately acts as the borrower’s agent while simultaneously bound to a fiduciary responsibility toward the participating banks forming the syndicate. This position is fortified by the decision in Natwest Australian Bank Ltd. Tricontinental Corporation Ltd. [1990] Supreme Court of Victoria, BC9300770, 2493/1990. In Natwest Australian Bank Ltd. Tricontinental Corporation Ltd. [1990] Tricontinental was the lead bank in a syndicate loan transaction in which the plaintiff, Natwest participated.29 Tricontinental had failed to disclose in the information memorandum, the fact that the borrower had provided guarantees to Tricontinental and another financial institution in respect of loans advanced to the borrower’s subsidiary. This state of affairs had clearly compromised the borrower’s ability to discharge the loan in favour of Natwest. When the borrower defaulted Natwest sued Tricontinental. The court did not elaborate on the fiduciary duty imposed upon Tricontinental but did find that the latter breached its duty of care to Natwest.30 Some academics have taken a position against the imposition of a fiduciary duty on the lead bank in the context of syndicated loans.31 The most popular argument is that the banks forming a part of the syndicate are in a position to conduct their own investigations and it is therefore unfair to place the burden entirely on the lead bank as it relates to the information memorandum.32 Foy argues however, that some of the more relevant information is not publically available and as such may not be accessible by participating banks. Foy explains that: “The syndicate leader having structured the transaction is the only party with access to all the information. They have briefed the tax advisors, the lawyers, they did the cash flows, the sensitivity analysis, it is their client, their relationship, only they knew where the weaknesses lie, where the advice may have been different if the assumptions were changed even if only slightly.”33 Foy goes on to explain that participating banks do not generally have a comparable opportunity. Moreover, the applicable fees do not form a part of the participating banks’ expenses. It is therefore only reasonable that the participating banks’: “only assumption is that the syndicate leader has done his job. A risk assessment is made, but if the assumptions are fundamentally flawed the participant often goes the way of the ‘proverbial lamb.’”34 Mugasha, takes the position however, that the syndicated loan is no different from an arms’ length transaction and this fact alone dismantles the logic behind imposing a fiduciary duty on the lead bank with respect to its relationship with participating banks.35 An arm’s length transaction imposes upon all participants in the transaction a duty to perform individual assessments and foregoes the requirements of trust and confidence. 36 To start with a fiduciary relationship is said to exist when a fiduciary takes on the responsibility of acting in the interests of another party within the ambit of a discretionary power which impacts the interests of that other party in either a legal or practical manner.37 But as McPherson observes, not all fiduciary relationships can be characterized as one party undertaking to act in the other’s interest.38 The arms’ length transaction is just one such example as it typically involves parties of equal expertise. In this regard, there is very little difference between the fiduciary relationships between the lead bank and participating banks in a syndicated loan and the parties involved in an arms’ length transaction. Moreover, a fiduciary relationship also presupposes that the party entitled to rely on the other party’s expertise is vulnerable.39 The vulnerability test was explained by the Supreme Court of Canada in Frame v Smith [1987] 42 DLR (4th) 81 as containing the following elements: “(1) The fiduciary has scope for the exercise of some discretion of power. (2) The fiduciary can unilaterally exercise that power or discretion so as to affect the beneficiary’s legal or practical interests. (3) The beneficiary is particularly vulnerable to or at the mercy of the fiduciary holding the discretion or power.”40 Taking into account the relatively equal footing of the lead banks and the participating banks in a syndicated loan, it is difficult to accept that participating banks are at the mercy of the lead bank. Despite the vulnerability test with regard to the existence of a fiduciary relationship, there appears to be a departure from this key element when applied to the legal position and responsibility of the lead bank in a syndicated loan arrangement. At common law, the lead bank is held to the standard of the fiduciary regardless of the vulnerability test. The ambiguity of the lead bank’s legal position and concurrent responsibilities are further exemplified by the lead bank’s duty of confidentiality toward the burrower, its client. However, Banks LJ explains that the banks are required to disclose the customer’s information in circumstances where: “disclosure is under compulsion by law, where there is a duty to the public to disclose, where the interests of the bank require disclosure, where the disclosure is made by the express or implied consent of the customer.”41 The operation of common law principles of misrepresentation in English law requires a duty to disclose in certain circumstances. This duty confers upon the lead bank in conjunction with the borrower, an obligation to provide full and frank disclosure in the information memorandum. In Derry v Peek (1889) 14 AC 337 for instance it is mandated that in circumstances where false information is furnished with knowledge or furnished with reckless regard for its authenticity the recipient may found an action for fraudulent misrepresentation.42 It therefore follows that where misinformation is necessary for circumventing deceptive conduct, frank disclosure is required “under the compulsion of law.”43 In other words, the lead bank’s duty of confidentiality toward the borrower is compromised by its duty of full and frank disclosure. Kwaw explains that a misrepresentation is the offering of information that has the capacity to induce syndicate banks into a syndicate contract with the “person who makes the misrepresentation”.44 In general, it is the borrower that makes the misrepresentation and the lead bank that “actively assists the borrower in preparing the information memorandum” which is ultimately circulated among the syndicate banks.45 Wood puts the lead bank’s role in perspective by stating that: “A confidentiality letter between the arranger and the potential participants may cover information provided by the borrower to enable participants to decide whether to participate.”46 It therefore follows that should information contained in the information memorandum turn out to be false, both the borrower and the lead bank are equally accountable for the misrepresentation.47 Kwaw goes on to explain that: “Where the information in the memorandum is inaccurate, misleading, or untrue, and the other members of the syndicate are induced to participate in the loan arrangement on the basis or those misrepresentation, any member of the syndicate would have the right to rescind the contract.”48 The lead bank’s legal position and responsibilities at the pre-contract stage also places upon it a burden to ensure that statements made at this stage are not negligently inaccurate or insufficient.49 This principle of common law is known as negligent misstatement.50 Liability for negligent misstatement was articulated in and developed from the House of Lord’ ruling in Hedley Bryne and Co. Ltd. v Heller and Partners Ltd. [1964] AC 465. This case established that a duty of care will not arise on the mere basis of foreseeability that a statement can give rise to claim in negligence.51 A special relationship must exist between the parties in order for a duty of care to arise.52 The required special relationship was delineated in Capraro Industries Plc v Dickman [1990] AC 605. In this case it was held that in order for a duty of care to arise with respect to statements of fact, a special relationship must exist between the parties. That relationship is characterised by the following elements: The statement is required for a purpose and that purpose is either specifically or generally known to the person or party providing the information. The person or party providing the information either knows or ought to know that the recipient will rely on the capacity of the maker of the statement. The person or party making the statement knows or ought to know that the statement will be relied on without more.53 It can therefore be argued that since the lead bank is aware that the banks forming the syndicate will rely on the information proffered in the information memorandum, the lead bank is under a duty of care to avoid negligent misstatements. However, when one considers that it is very unlikely that the lead bank expects that the syndicate banks will not pursue their own investigation of the borrower and the facts offered in the information memorandum, a duty of care does not appear to arise. Lead banks, recognizing the ambiguity of their legal position and responsibilities have adapted a practice in which they seek to disclaim liability for negligent misstatements in an information memorandum.54 This practice includes the drafting of a disclaimer on the part of the lead bank.55 Even so, the courts have placed constraints on the extent to which a lead bank can exclude liability for negligent misstatement. The case of Natwest Australia Ltd. v Tricontinental Corp Ltd. 1990] Supreme Court of Victoria, BC9300770, 2493/1990 is one example. 56 In Youyang Pty Ltd. v Minter Ellison Morris Fletcher [2003] 196 ALR 482 it was likewise held that in circumstances where a lead bank was aware of specific relevant facts relating to a borrower but failed to disclose those facts in the information memorandum, the lead bank was not at liberty to exclude liability for failure to disclose that information.57 The duplicity and/or ambiguity of the lead bank’s role in the pre-contract stage of the syndicated loan arrangements is further exemplified by its dual role of agent to the borrower and the participating banks. For instance, at the time of negotiating the loan contract on behalf of the borrower, the lead bank acts as the borrower’s agent.58 During those negotiations, the lead bank also acts as an agent for the participating banks.59 As O’Sullivan explains, the mandate letter: “...not only constitute the manager the agent of the borrower for the purposes of procuring lenders but also constitute the manger the borrower’s agent to procure banks to lend to the borrower on certain terms, for example, as to amount, duration, pricing, security and other items dealt with in the mandate letters...”60 By this reason, the lead bank’s legal position and resulting responsibilities are rather ambiguous since it is impossible for the lead bank to act as an agent for the borrower and the syndicated banks simultaneously.61 Obviously a conflict of interest is unavoidable.62 Gabriel argues that the duplicity and/or ambiguity of the lead bank’s legal position and responsibilities are also encapsulated in the fact that the lead bank also acts in its own interest in the syndicated loan arrangements. Gabriel explains that: “So far as the participants only getting the benefit, or disadvantage, of the lead’s negotiation with the borrower, it is actually a matter extraneous to the lead manager.”63 Conclusion The lead bank’s legal position and responsibilities in the context of a syndicated loan arrangement is potentially ambiguous as a result of its multilayered relationship with the conflicting interests of the parties involved. On one side is the borrower’s interest, an interest which the lead bank seeks to procure. On the other side is the participant banks, whose interests the lead bank is required to be mindful of and at the same time cultivate their participation for the benefit of the borrower. Even so, the courts have held that the lead bank has a duty to act in good faith and cannot act arbitrarily.64 The fact is the lead bank is in a tenuous position with respect to each of the parties at the pre-contract stage. It’s legal obligations in relation to each of these conflicting interest is ambiguous by the very nature of the conflicting interests involved and the lead bank’s duty to act in good faith and not arbitrarily. It makes no difference that the pre-contract stage does not form a contract. Common law regards commercial transactions as legally binding.65 It therefore follows that the lead bank has an onerous and perhaps impossible task at the very onset of negotiations. The ambiguous nature of the lead bank’s legal position and responsibilities are dictated by its representation of conflicting interests in the procurement of the syndicated loan arrangement. Bibliography Bhattacharyya, G. “The Duties and Liabilities of Lead Managers in Syndicated Loans.” (1995) Journal of Banding and Finance Law, 172. Brooks, J. “Participation and Syndicated Loans: Intercreditor Fiduciary Duties for Lead and Agent Banks Under US Law.” (1995) Business Journal of Banking and Finance Law, 275. Capraro Industries Plc v Dickman [1990] AC 605. Clarke, L. and Farrar, S. F. “Rights and Duties of Managing and Agent Banks in Syndicated Loans to Government Borrowers.” (1982) Universtity of Illonois Law Review, 229. Derry v Peek (1889) 14 AC 337. Edwards v Skways Ltd. [1964] 1 WLR, 349. Foy, B.E. “Syndicated Lending – the Syndicate Participants’ Perspective.” (1992) Banking Law and Practice, International Business Communications, NSW 332. Frame v Smith [1987] 42 DLR (4th) 81. Gabriel, P. Legal Aspects of Syndicated Loans. London: Butterworths, 1986. Gott Insurance Co. Ltd. v Tai Ping Insurance Co. Ltd. (No.2) [2001] All ER 299. Hedley Bryne and Co. Ltd. v Heller and Partners Ltd. [1964] AC 465. Kwaw, Edmund, M.A. The Law and Practice of Offshore Banking and Finance. Greenwood Publishing Group, 1996. McPherson, B.H. “Fiduciaries: Who Are They?” (1998) Australian Law Journal 288. Mugasha, Agasha. The Law of Multi-bank Financing: Syndications and Participations. McGill-Queen’s Press, 1997. Mugasha, A. “A Conceptual Functional Approach to Mult-bank Financing.” (1995) 6 Journal of Banking and Finance Law and Practice, 5-28. Mugasha, A. “The Agent Bank’s Possible Fiduciary Liability to Syndicated Banks.” (1996) 26 SBLJ, 403. National Westminster Bank USA v Security Pacific national Bank, 20 F 3e 375 (1974). Natwest Australian Bank Ltd. Tricontinental Corporation Ltd. [1990] Supreme Court of Victoria, BC9300770, 2493/1990. O’Donnovan, James. Lender Liability. Sweet and Maxwell, 2005. O’Sullivan, J. “The Roles of Managers and Agents in Syndicated Loans.”(1992)3 Journal of Banking and Finance Law and Practice, 162. Phipps v Boardman [1967] 2 AC 46. Qu, Charles. “The Fiduciary Role of the Manager and the Agent in a Loan Syndicate.” (2000) 12(1) Bond Law Review, 85-105. Roberts, Graham. Law Relating to International Banking. Woodhead Publishing, 2005. Sin, K.F. The Legal Nature of the Unit Trust. Oxford: Clarendon. Slater, R. “Syndicated Bank Loans.” (1982) Journal of Business Law, 173. Tournier v National Provincial Bank of England [1927] 1KB 461. UBAF Ltd. v European American Banking Corporation [1984] 2 WLR 508. Witting, Christian. Libability for Negligent Misstatements. Oxford University Press, 2004. Wood, Philip. International Loans, Bonds, Guarantees and Legal Opinions. Sweet and Maxwell, 2007. Yoong, W.F. “Liabilituy of the Lead Bank for Erroneous or Inaccurate Information.” (1992) 22 Victoria University of Wellingtoon Law Review, 285. Youyang Pty Ltd. v Minter Ellison Morris Fletcher [2003] 196 ALR 482. Read More