While the collapse of Silicon Valley Bank on Friday 10 March 2023 is not being described as another Lehman event, it serves as a timely reminder for borrowers in Australia to consider the implications of a non-performing or insolvent finance party.
For CFOs and Treasurers, it is crucial to understand the relevant provisions in their loan documentation and the options available to them in circumstances of distress or default of of one of their lenders.
The key items we will consider include the implications for borrowers where they experience insolvent/non-performing:
- Facility agents and security trustees; and
- Hedge counterparties.
1. Defaulting lenders
First and foremost, even if an insolvency or similar event has occurred with respect to a lender, this does not relieve a borrower of its obligations to make interest and other payments under its finance documents.
There are a number of provisions in any syndicated loan agreement which are relevant to insolvent or non-performing lenders. Using the template APLMA Australia Multicurrency Term and Revolving Facilities Agreement as a reference point, the concept of ‘Defaulting Finance Party’ is particularly relevant.
A lender may be a Defaulting Finance Party for a number of reasons but in particular where it:
- has failed to make a payment due by it under the loan agreement (save where there is an administrative error or a systemic market disruption event);
- rescinds or repudiates the loan agreement (which might be relevant where a lender has been seized by the relevant regulator and the regulator has the power to do so); or
- is insolvent.
While not necessarily standard in all loan arrangements, borrowers will also often negotiate to add to the above list any lender who is the subject of a ‘Bail-In Action’ (see paragraph 1(e) below) or which is an issuing bank that has failed to issue a letter of credit.
The implications for borrowers where they have a Defaulting Finance Party are summarised below but it is very important to note that these provisions are all negotiable and so may not be present in all loan agreements. It is therefore vital that borrowers review their own loan arrangements to identify whether the positions set out below apply. To the extent they do not apply they could be incorporated as a standalone amendment or as part of any refinancing process.
- Replacement of a Defaulting Finance Party: Probably the most useful tool available to a borrower who has a Defaulting Finance Party is the right to replace the Defaulting Finance Party (which forms part of the ‘yank-the-bank’ protections) and this may be particularly relevant for Defaulting Finance Parties who hold available but undrawn commitments, letter of credit facilities or ancillary facilities (for example, overdraft, bank guarantee, credit card facilities etc).
If Defaulting Finance Parties have already funded and have no ongoing funding obligations then borrowers may be more relaxed about leaving them in the lender syndicate and not replacing them, although ideally they would ensure they do not have any continuing consent rights. A replacement can be effected by providing written notice requiring that Defaulting Finance Party to transfer their rights and obligations, or only their rights and obligations in respect of any revolving facility, to another existing or new lender. The transfer is required to be at par and the Defaulting Finance Party is not required to accept a consideration which is sub-par.
Borrowers should also note that the Defaulting Finance Party is not required to transfer any fees it has received to the replacement lender – this would mean that any upfront fees or fees paid in advance remain with the Defaulting Finance Party and the replacement lender will not benefit from them.
Borrowers may also have negotiated in their loan documents the right to selectively prepay Defaulting Finance Parties without having to repay lenders pari passu. If so, such prepayment will have to be at par and the borrower cannot discount the prepayment. It is likely that as a condition of lenders agreeing to this right in loan documents, they will have required such selective prepayment to be made from the proceeds of equity or distributable cash so the borrower is not impoverished and other lenders are not disadvantaged by the prepayment.
Frequently a time limit will be imposed on a borrower’s right to replace a Defaulting Finance Party, often 90 days or similar, and as such borrowers should not assume any decision to replace is something they can delay until issues arise with the Defaulting Finance Party. This may not be the case for more sophisticated borrowers though, who we would expect to have disapplied any time limitation in relation to Defaulting Finance Parties.
- Disenfranchisement of Defaulting Finance Parties: It is important to note that Defaulting Finance Parties may still have voting rights under loan documents – the standard position is that their voting rights are only disapplied in relation to available commitments (that is, loans which remain available but undrawn).
However, as is the case for more sophisticated borrowers, the better negotiated position is for Defaulting Finance Parties to be disenfranchised entirely, not just in respect of available commitments.
- Term out of revolving loans: If the Defaulting Finance Party is a lender under a revolving credit facility, the APLMA documentation provides for any existing drawn revolving loans to extend to the end of the availability period or the maturity date.
Interest will still have to be paid on the loans but this provides the borrower with protection against the normal position where revolving loans are required to be repaid and re-drawn at the end of each interest period (since a Defaulting Financier will unlikely be in a position to provide a re-draw of the loan). The borrower is not required to repay the affected loan but has the option to elect to do so.
- Commitment fees: Borrowers are not required to pay commitment fees for available but undrawn loans of a Defaulting Finance Party.
- Bail-in clauses: Importantly, if a lender is not technically insolvent but has been seized by a regulator, then provided it continues to perform under the loan agreement it should not constitute a ‘Defaulting Finance Party’. However, dealing with the regulator may be of concern for a borrower as it may adversely affect timing and responses to requests for consent.
Provisions which are particularly relevant in the context of lenders which are the subject of action by a regulator are ‘bail-in’ clauses. In Australian syndicated loan agreements the bail-in clauses most commonly seen are those applicable to the EU and more recently Hong Kong, given the active participation of lenders from those jurisdictions in the Australian debt market. A detailed consideration of ‘bail-in’ clauses would require a separate article but in very broad terms, bail-in clauses provide the relevant regulator with powers to facilitate the rescue of failing financial institutions including by writing-down and/or converting into equity a failing financial institution’s liabilities.
This is particularly relevant where that financial institution is an issuer or borrower for debt, or party to other financial indebtedness arrangements, but in the context of it being a lender under a syndicated loan it is also relevant such as for example in respect of debt commitments, indemnities to other finance parties and sharing/turnover obligations.
2. Defaulting facility agents and security trustees
(a) Facility agent
There are risks for both borrowers and lenders if a facility agent becomes insolvent. These include:
- moneys due to lenders or a borrower could get trapped (at least for some time) in the insolvent estate of the facility agent, resulting in the borrower not receiving requested loans or lenders not receiving payments due to them, other than at some point in the future under an insolvency process with respect to the facility agent;
- consents, waivers or amendments may become difficult to implement, as the facility agent is no longer managing the syndicate. This issue also relates to general communications between lenders and obligors; and/or
- amendments that require the consent of the facility agent may be frustrated.
Fortunately, as a result of developments since the global financial crisis, in facility documentation there is often a right to force a facility agent to be replaced where it is insolvent (frequently on an expedited basis) – see for example the APLMA provisions in relation to a facility agent being a Defaulting Finance Party (which, in addition to their application to insolvent lenders as discussed further above, also apply when a facility agent is insolvent). The standard provisions also allow both borrower and lenders to make payments and communications directly between themselves rather than via the facility agent.
Where such provisions are not present in existing loan documents, it should be possible for borrowers and lenders to by-pass a facility agent and agree a position directly between themselves. However, this could require some work.
While an insolvent facility agent may seem like a remote possibility, the prudent approach is to include provisions from day one to address this unlikely circumstance.
(b) Security Trustee
Again, there are certain risks for borrowers and lenders if a security trustee becomes insolvent. At first blush, these could be seen as similar to those in relation to an insolvent facility agent.
However, the assets of a properly constituted security trust cannot form part of the security trustee's estate (except potentially in respect of any rights the security trustee may have as a beneficiary of that trust and/or in respect of indemnities or similar for fees owing to, or costs incurred by, the security trustee).
In the case of a security trust, the relationships are among the security trustee, the trust property of the security trust (being the security over all or the relevant assets of the obligors) and the beneficiaries of the security trust. The security trustee holds the security for the benefit of the secured creditors of that trust.
Given the above, the replacement of the security trustee should effectively deal with the issue of an insolvent security trustee. Well drafted security trust deeds should facilitate a speedy replacement of an insolvent security trustee. Even absent that, nearly all security trust deeds will have provisions giving (majority) beneficiaries a general right to replace a security trustee after a notice period (e.g. 30 days). (If beneficiaries are unable to remove a security trustee under an express power in the security trust deed or the trust legislation, the court may well be able to do so.)
Regardless of how replacement is effected, one issue that may need to be addressed is tripartite arrangements to which an insolvent security trustee is a party. Typically, on replacement of a security trustee such arrangements would be transferred to the new security trustee either: (i) because replacement is automatically permitted pursuant to the terms of the tripartite agreement or (ii) with the written agreement of both the outgoing and the new security trustee and the other parties to the arrangements. This may not be feasible or may be difficult in relation to an insolvent security trustee. A work around could be replacement arrangements with the new security trustee and the other parties involved, except the insolvent security trustee.
Borrowers enter into hedge transactions for a number of reasons including typically to manage their foreign exchange and interest rate risks.
Hedge transactions usually contain various events of default and termination events. In the context of a collapse such as that for Silicon Valley Bank, the following Events of Default may be applicable to hedge agreements entered into by hedge counterparties exposed to such a hedge counterparty:
- failure to pay or deliver;
- breach of agreement;
- credit support default;
- cross-default, and;
Under the ‘bankruptcy’ limb, the ISDA documentation contains a list of insolvency events which are broad in nature. For example and perhaps most pertinently, a hedging party which “becomes insolvent or is unable to pay its debts or fails or admits in writing its inability generally to pay its debts as they become due” would be within scope.
Upon the occurrence of an Event of Default, the Non-defaulting Party (in this case being the borrower) may designate an Early Termination Date in respect of all outstanding Transactions. In respect of certain bankruptcy Events of Default, where “Automatic Termination” is specified, and is triggered, all outstanding Transactions will be terminated without any election being made by the Non-defaulting Party. This may come as a surprise to a borrower if they first become aware of this because of a claim by a receiver or insolvency practitioner in relation to automatic termination of hedges where they are out of the money.
Depending on which vintage of ISDA documentation is used for a hedge transaction, the payment to be made on the early termination of a hedge may be calculated differently. Importantly, regardless of the ISDA documentation used, the calculation of an early termination payment may result in a payment being owed from the Non-defaulting Party to the Defaulting Party (or vice versa). To put this in context in respect of the current Australian interest rate market as an example, if general consensus is that we are close to peak interest rates and a borrower enters into an interest rate swap then it is possible in the future if interest rates have dropped they could have a substantial liability should there be an automatic termination event. If the payment is to be in the opposite direction, then the borrower could be due a payment from a hedge counterparty who is insolvent.
As events transpire in respect of Silicon Valley Bank over the coming days, it will be interesting to monitor if any Events of Default under their hedging agreements are caught and whether hedges are (or could be) terminated early and to evaluate the impact of any such early terminations on the hedging operations of the affected hedge counterparties.
In summary, borrowers who have carefully negotiated their loan documentation should be sufficiently protected from materially adverse consequences arising from the insolvency of a single lender in their bank syndicate. While what has happened to Silicon Valley Bank is hopefully just a single occurrence, not symptomatic of broader issues in the debt markets and not giving rise to contagion effects on other lenders, borrowers should nevertheless use this opportunity to review their loan documents to ensure they are sufficiently robust to deal with such circumstances.
This publication is introductory in nature. Its content is current at the date of publication. It does not constitute legal advice and should not be relied upon as such. You should always obtain legal advice based on your specific circumstances before taking any action relating to matters covered by this publication. Some information may have been obtained from external sources, and we cannot guarantee the accuracy or currency of any such information.