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Chapter 4 - International Term Loan Agreements

This is a chapter from the Bloomsbury Professional book The Law Relating to International Banking, which addresses the key legal issues associated with international banking and capital markets. The book analyses how to determine the forum and jurisdiction that apply to a transaction; legal issues in term loans, syndicated lending, debt transfers, bond issues, securitisation, derivatives and standby letters of credit; and remedies, exchange controls, legal opinions and sovereign risk. It is both practical, analytical and academic and is essential reading for banking lawyers and bankers themselves.

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Professor Andrew Haynes

Chapter 4 International Term Loan Agreements


4.1 The aim of this chapter is to provide a general overview of international term loan agreements. Many of the aspects commonly associated with such loans are dealt with elsewhere in this work and the remaining topics, many of which are of considerable importance in both a legal and practical sense, will be considered here.

4.2 Many different considerations affect the parties' decision to lend or borrow under a medium-term loan agreement. Some of these considerations give rise to common interests and others to legitimate differences which pre-contract negotiations must resolve. Those drafting the loan documentation must, therefore, fully appreciate the nature and purpose of each particular loan agreement and the interests of the parties who contract under it.

4.3 In practice many firms use or adapt the Loan Markets Association Primary Documents. Of particular relevance in this context is the Multicurrency Term and Revolving Facilities Agreement (referred to in this chapter as 'the LMA agreement') created by a working party of the LMA themselves, the British Bankers' Association and the Association of Corporate Treasurers. It provides a very useful guideline but the circumstances of term loans vary so widely that significant changes will normally be made. It can be found as an appendix to this book. Where the LMA Agreement differs from or adds to the information below the fact is highlighted.

The nature and mechanics of medium-term loan agreements

4.4 This chapter will concentrate upon medium-term loan agreements, that is to say, loans which have a term of between 1 and 15 years. Banks occasionally make corporate loans for more than 15 years but only in very special circumstances such as certain types of large scale project finance.

4.5 Governments as well as corporate entities borrow substantially and many favour the medium-term loan facility. One of the main reasons for the continuing popularity of this instrument lies in its inherent flexibility as a lending medium. Medium-term loan agreements can be advanced in all shapes and sizes, providing for drawdown to be made immediately, (the 'bullet' drawdown), or within a short period of the loan being executed, or in accordance with a fixed amortisation schedule. Alternatively, the loan agreement may provide the borrower with a longer period in which to drawdown the facility and may afford considerable flexibility as to both timing and number of drawdowns which may be made. The most flexible form is the revolving facility which allows the borrower repeatedly to drawdown the loan or a portion thereof and to repay any drawn amount either at the borrower's discretion or in accordance with a pre-determined schedule.

4.6 The flexibility of these instruments extends to the interest rate mechanisms under which they may operate. The interest rate may be fixed for the entire term of the loan, or occasionally for a shorter period in excess of one year. It is common, however, for loans to incorporate a floating interest rate mechanism, such a rate being tied to a short-term market indicator. The market indicator used in most loans is the displayed screen rate on a system such as Reuters for LIBOR[1] or Euribor[2] as the case may be, being the rate at which the lending bank is able, in accordance with its normal practices, to acquire the relevant currency from the markets in order to fund the loan with a margin included for default risk.

4.7 The rate at which banks in the market offer to lend the currency in question will obviously vary and some loan agreements specify the names of banks from which interest rate quotations must be obtained. LIBOR therefore reflects the cost of funding the loan from the lender's standpoint, this being a fundamental feature of lending. A margin is added to LIBOR and it this margin which compensates the lending bank for the risks and costs incurred. The margin also provides the bank with its operating profit on the loan facility. Another common example is 'x% above the base rate of …… Bank plc for the time being'. The interest rate charged is the aggregate of the margin + LIBOR (or if a euro loan Euribor) + mandatory cost. Where the figure for the relevant one of these two rates is not available from a reference bank on the quotation day, the applicable rate is calculated on the basis of the quotations from the remaining reference banks. This is payable on the interest period date or six-monthly if the interest rate period date is longer. Default interest on late payments is calculated at a higher rate and is also compounded with the overdue amount unpaid at the end of each interest rate period.

4.8 The interest rate period for a loan can be selected by the borrower from those available either in the utilisation request or in a selection notice. Once made the choice it is irrevocable. If no selection notice is given the contract sets out the relevant periods.

4.9 If a market disruption event occurs then the LMA Agreement adopts the approach that the rate of interest for that interest period is the margin + the rate notified by the lender as soon as practicable and in any event prior to the interest being due (the rate being that at which the lender can raise the funds to finance the loan from any source it might reasonably choose) + the mandatory cost. A 'market disruption event' is defined in the agreement as one where at noon on the quotation day the screen rate is not available and none or only one of the reference banks provides a rate to calculate LIBOR or Euribor for the relevant currency and interest period. Alternatively, it could occur because the lender gives notice prior to the close of business on the quotation day for the relevant interest period that the cost of obtaining matching deposits exceeds LIBOR or Euribor as the case may be. If there is a market disruption event the borrower has a 30-day period to try and negotiate a substitute rate of interest.

4.10 If the borrower does not pay any sum due under the LMA Agreement by the last date of the interest period for the loan or any unpaid sum, then they must within three business days pay the lender break costs resulting from the late payment. 'Break costs' are the interest which the lender would have received for the period ending in the late payment, less the amount they could have received by depositing the equivalent amount on deposit with a leading bank in the relevant interbank market.

4.11 There are limits to the lender's capacity to maintain freedom to reset interest rates during the term of the loan. Paragon Finance PLC v Staunton[3] determined that this could only be done where:

  • the capacity to increase the rate is not utilised for an improper purpose, capriciously or arbitrarily;

  • the rate is not increased on the basis of matters extraneous to the transaction and the surrounding events; and

  • the capacity to increase the rate must not be carried out in a manner that no reasonable lender would do.

4.12 The interest period will be stated and is normally monthly, quarterly or six-monthly. The interest calculation has one oddity. Sterling is calculated on a 365-day year and all other currencies on a 360-day year. There is usually also an interest rate default sub-clause inserted here stating the interest rate payable if the borrower goes into arrears. Interest will also be chargeable on overdue interest. In the case of an Islamic borrower interest may not be acceptable to them and if the case should end up requiring enforcement in a court in an Islamic jurisdiction it may prove unenforceable if interest is being charged. Alternative arrangements do however exist in which case appropriate clauses will need to be inserted explaining what sums will be repaid and how they will be calculated.

4.13 Due to the fact that the markets are unregulated they are considered vulnerable to external events and it is, therefore, common to incorporate specific clauses within the loan documentation to protect the banks against possible funding difficulties. The clause used is often referred to as the disaster clause and provides that if the markets are disturbed so as to affect the availability of funds or the determination of LIBOR the parties shall negotiate in good faith to agree new terms upon which the loan will operate. This is discussed below under force majeure clauses. If the parties fail to incorporate an alternative interest rate it is unlikely that an English court would imply one in the event of future market disturbance. In such a case, the court would most probably find an implied term that the original interest rate, applicable before the market disturbance would continue to apply. This may have serious consequences for the lending bank depending upon how the prevailing market rates have moved since the last occasion when the interest rate was determined.

4.14 Additional flexibility is provided by the multicurrency options which can be incorporated within the terms of the agreement. Lenders in the loan markets are able to offer borrowers a multicurrency option under which the borrower is permitted, subject to certain qualifications, to drawdown in any currency and in some cases convert at a later date to a different currency. The LIBOR rate attaching to such loans will obviously be the equivalent rate applicable to the currency chosen by the borrower.

4.15 The currency of payment by the borrower will be specified. Payment will be specified to be in immediately available funds paid unconditionally[4] to a specified bank account. Once it has been paid the bank has no power to revoke the transfer[5] , not that it is normally likely to want to. The payment will be required to be in the currency of the country of that currency except in the case of loans in other currencies. London is a major US dollar lending centre and euro loans are also common. Clarification on this is important as otherwise payment might be made in a jurisdiction where there are exchange control problems or some other obstacle or cost involved in the transfer.

4.16 In some instances there will also be a multi-currency clause where the borrower requires it. If the borrower requires to change the currency then he has to repay the loan and draw down the new currency. The exchange rate is normally the spot rate two business days before drawdown. This way no currency risk falls on the bank.

4.17 The alternative structures, interest rate mechanisms and currency options outlined above can be combined is a variety of ways, and most lenders are willing to consider any practical combination to meet a specific need. In addition, the loan may be secured or unsecured, guaranteed or not, or be syndicated (see Chapter 5). Whatever form the final note takes, there are certain fundamental legal issues which will undoubtedly arise, many of which have yet to be fully worked out.

Some problems caused by the flexible structures

4.18 Where the loan is advanced in the form of a revolving facility there is always a risk that a borrower may later exceed its own borrowing limits as it continues to repay and drawdown under the terms of the agreement. Similarly, the lending bank may experience difficulties with future funding because of lending limits which are imposed in respect of individual borrowers or for all borrowers within a geographical area. These lending limits are normally the result of other credit contracts, and they are becoming increasingly common at the time when failure by both lenders and borrowers in the markets is an everyday fact of life. Furthermore, banks which provide a facility imposing future obligations upon the bank, for example, the obligation to make funds available under a revolving loan or to convert currency under a multicurrency option, may find that their ability to assign the loan at some later date is prohibited since many jurisdictions, including England, prohibit the assignment of continuing obligations.[6] (See Chapter 6)

4.19 One final problem posed by the revolving facility is that any security taken over such loans may be discharged as the loan 'revolves', under the rule in Clayton's case.[7] This case is an application of the old equitable maxim that equity imputes an intention to fulfil an obligation. Therefore, the first payment into an account is taken to clear the first payment out. The impact of this is that a secured overdraft facility will lose the security once an amount equal to the original loan and any associated charges and interest have been paid into the account, even though sums have been paid out in the mean time. Fortunately, this problem can be avoided by appropriate drafting of a clause in the loan agreement.[8] However, this will cease to have effect on the insolvency of the borrower and in this instance the bank will have to freeze the secured account and open a second account into which to pay any further monies received.

The structure of a loan agreement

4.20 The structure of a loan agreement is based upon a very simple contract whereby the lender promises to advance a certain sum over a certain period of time to the borrower and the borrower promises to pay the loan with interest. Unfortunately, the legal difficulties and problems which are likely to arise if anything goes wrong in this simple contract are many and complex, and, therefore, a large number of additional provisions are normally included in order to protect the parties' respective interests.

4.21 As we have already seen the very fact that many transactions are cross-border will bring into play principles of private international law with all its associated legal complications, and where the borrower is a sovereign state or state entity, additional legal complications must be addressed.

4.22 Negotiations between lender and borrower may take many weeks, especially in the case of very large loans, and the loan documentation must correctly reflect provisions which have been agreed. In addition to setting out the terms of the loan, the documentation should also provide an agreed basis for the performance of the various terms in the contract and in so doing anticipate and deal with the typical problems that might arise.

4.23 We will now consider how the loan documentation may be structured to achieve its desired purpose.

The 'drawdown' period

What if the lender fails to lend or the borrower fails to borrow within the 'drawdown' period?

4.24 There are a number of reasons why the lending bank may, after executing the contract, decide not to make the funds available. The bank may erroneously believe that the borrower has failed to satisfy certain conditions precedent to the loan. Whatever the reason an English court is unlikely to compel the bank to lend even though it is contractually bound to do so, since specific performance is not normally available to enforce a lender's commitment to provide funds. However, an action is likely to be available in damages unless the bank has valid contractual reasons for not performing.[9] The borrower could also treat the failure to advance the loan as repudiatory beach of contract.[10] This would not however repudiate any rights the borrower had acquired prior to termination.[11] This is also important for the lender who is therefore able to enforce repayment of any sums already advanced.[12] There remains the possibility in such cases that the borrower would have an action in damages against the lender for any loss it might suffer as a result of any loan incurred in a transaction that was funded by the arrangement concerned.[13] It would seem reasonable to suppose that such potential loss would be in contemplation of the parties at the time the contract was entered into. This has proved to be a topical problem in the period mid-2008 to early 2010, as banks have in some cases tried to avoid fulfilling lending commitments because of their weakened capital position and increased caution as to the amounts they are prepared to lend and to whom.

4.25 The borrower's remedy in such a case would, therefore, lie in an action for damages. Damages for breach of contract are designed to give the borrower, as nearly as possible, what he would have received had the lending bank performed its obligations under the loan agreement. However, not all loss suffered by the borrower is recoverable, for there must be a sufficient connection between the bank's breach and the borrower's loss. In other words the loss must not be too remote. The loss must arise naturally from the breach itself or have been reasonably foreseeable by the parties at the time they entered into the contract, as the probable result of the breach.

4.26 The possible heads of damage would include:

  • (a) general damages, particularly where the borrower can only obtain a replacement facility upon more onerous terms; or

  • (b) damages for consequential or incidental loss, including expenses incurred by the borrower in procuring an identical loan elsewhere and any increase in the interest rate applied to the new loan.

Failure by the borrower to drawdown the facility

4.27 Foreign currency lending agreements in London do not normally commit the borrower to drawdown the facility, but instead confer an option to borrow. The borrower is normally required to give notice of its intention to borrow and is only bound once such notice has been given. If the borrower fails to draw down the loan after irrevocably committing itself, it is unlikely that specific performance will be available as a remedy to the lender. However, damages may be available in certain circumstances, although it is unlikely that the lender would be able to claim pre-contractual expenses, including administrative costs and legal fees, unless a clause has been included in the agreement providing that such expenses became payable upon execution of the loan. Such clauses are relatively common in loan agreements, as are those which cover the payment of certain fees, notwithstanding the fact that the loan is never drawn down. Insofar as damages for breach of contract are concerned it is likely, bearing in mind the funding mechanism employed in the markets, that the lender will be able to recover general damages, provided the conditions outlined above in relation to the lender's breach are satisfied. The lender will obviously be under a duty to mitigate its loss. In other words it must take all reasonable steps to minimise its loss, for example, employing the undrawn funds elsewhere.

Restrictions on the use or purpose of the loan

4.28 Generally speaking, loan agreements do not impose restrictions on the manner in which the funds are to be used, although restrictions are common in rescheduling and project finance agreements. Sovereign borrowers would, no doubt, consider such restrictions an unwelcome interference in domestic affairs, and in practical terms it will obviously be extremely difficult for a lender to police effectively any restriction which is imposed on the use of funds. This difficulty is reflected in the wording of clauses which do attempt to impose restrictions, eg:

'… without prejudice to the foregoing [restriction] none of the Agents, the Managers and the banks shall be bound to enquire as to the applications by the Borrower of the proceeds of the loan, nor shall any of them be, responsible for, or for the consequences of, such app1ication.'

4.29 Notwithstanding the enormous practical difficulty in restricting the use of funds, there are a number of legal considerations which may be of fundamental importance to the lender. In the most extreme case the borrower may utilise the loan proceeds for an illegal purpose, thus rendering the loan contract void under English law if both lender and borrower are aware of all the circumstances.

4.30 Even if the lender is unaware of the illegal purpose at the time the loan is executed, it must prevent any further drawdown once it becomes aware of the illegal purpose, lest it be implicated in the illegality and lose its right to enforce the loan. The lender may also be at risk where the loan has been advanced to a sovereign state or state entity and the loan is not commercial in nature. In such a situation the borrower will prime facie be entitled to immunity under English law, thereby preventing the bank from enforcing the loan unless appropriate measures have been included within the terms of the loan documentation. (This is considered in Chapter 3).

4.31 Where the loan is granted in favour of a corporate borrower it may be important to determine whether the borrower intends to use the proceeds for an ultra vires purpose. Under English law the ultra vires law is almost dead.[14] In the case of limited companies the normal rule is that contracts ultra vires the directors' powers may be prohibited by court order brought at the behest of a shareholder provided the contract has not yet been entered into,[15] but that beyond that such contracts are enforceable.[16] However, in the case of companies created by Royal Charter, by Act of Parliament, and in the case of certain collective investment schemes, ultra vires contracts will normally be unenforceable.[17]

4.32 Other restrictions may be imposed by the local laws of the borrower's own jurisdiction. Some, for example, place restrictions on loans which finance acquisitions and mergers. In every case, therefore, it will be important to obtain the advice of local counsel on issues similar to those highlighted above, and also to incorporate protective provisions within the loan documentation which enable the lender to bring effective enforcement proceedings should this prove necessary.

Restrictions imposed upon the borrower within the terms of the loan documentation

4.33 The lender taking the credit analysis decision in a term loan agreement usually bases his decision upon a series of assumptions and caveats. At the heart of these is the assumption by the bank that the borrower can repay, but that if they cannot the bank can enforce payment or rely on security. Should the need arise they would also want to be able to get out of the contract.

4.34 These assumptions and caveats are effectively given contractual force by the incorporation of certain restrictive clauses within the terms of the loan agreement known as conditions precedent, representations and warranties, covenants and events of default. The restrictive clauses, when taken together, fulfil three specific functions: first, they help to provide the lender with detailed information concerning the borrower; secondly, they provide for certain contractual remedies within the framework of the loan agreement; and thirdly, they give the lender the benefit of certain remedies available under the general law.

Financial terms

4.35 This will state the date by which the loan must be drawn down and the structure, ie is it a bullet loan, revolving, etc, and there will also be a clause setting out the currency and the type and length of notice that the borrower must give. It will normally also state the place of repayment of the loan. In some instances the bank will also insist on the use of the funds. However, if the borrower is well known to the bank and has a good credit rating the clause may just say that the loan is for 'working capital purposes'.

4.36 The first part of the agreement will deal with the loan facilities themselves. In some cases there will be a facility for syndicated lending (see Chapter 5) and/or the loan being made in more than one currency. This is normally followed by details such as the date when the loan will be drawn down, the applicable currency and the proposed interest period. In the case of a revolving facility there may be a minimum drawdown amount on each occasion. It is possible that the lender(s) may not be able to make the required amount available in the currency required on that date or cannot be made available for legal reasons (usually resulting from the imposition of exchange controls), in which case the borrower must be notified. In that case an equal amount must still be made available in the base currency of the loan. There is also sometimes a facility included for the loan currency to be changed between optional currencies denominated in the original agreement. There are requirements determining how the exchange rate will be calculated by making that calculation against the base currency spot rate at the relevant time.

4.37 Prepayments take place where the borrower decides to pay back some or all of the loan before it is due. A common reason for this is that the borrower has discovered a cheaper source of funds. This is normally allowed by the agreement but only at the end of an interest period. The reason for this is that the lending bank will have normally arranged its own funds on a parallel time basis.

4.38 The agreement then deals with issues resulting from repayment, prepayment and cancellation. Once a repayment has been made, no part of that repayment can be re-borrowed. In the event that the loan becomes illegal the lender has to immediately notify the borrower, the commitment is cancelled and the borrower must then either make repayments by the last day of the relevant interest period, or earlier if the lender so notifies the borrower, but this cannot be earlier than the last date of any grace period permitted by law.

The legal and practical significance of conditions precedent

4.39 The agreement will go on to include conditions precedent, which, as their name implies, are elements that must be in place before the loan can be drawn down. Where a large arrangement consists of a series of loans they fall into two groups: those that are conditions precedent to all the loans in an arrangement and those which are conditions precedent to each loan. Even after the loan has become operative the borrower is normally required to satisfy further conditions prior to any subsequent drawdown. These conditions are known respectively as conditions precedent and conditions subsequent.

4.40 The purpose of the conditions precedent is to suspend the lender's commitment until their security, if any, is perfected and satisfactory evidence has been received that all pertinent legal matters concerning both the borrower and guarantor, if any, are in order. They also seek to permit the lender(s) to withdraw from the agreement at any time before the conditions have been met. Insofar as English law is concerned, whether the conditions precedent manage to achieve this purpose will depend upon whether they are conditions precedent to the actual formation of the loan contract. If they are, the lender will be free to withdraw from the agreement at any time before the borrower meets the conditions.[18]

4.41 The precise working of the clause will obviously be crucial in determining whether or not the lender is free to withdraw. As Gabriel points out, the wording of the conditions precedent in many agreements places the emphasis upon the borrower's right to borrow, and the conditions precedent operate only upon the lender's obligation to lend once the agreement has been executed. This means that:

'… any withdrawal from its commitment to lend, even before the borrower has begun to satisfy any condition, would result in the lender breaching the contract and thus exposing itself to a suit at the instance of the borrower'.[19]

The danger in such a situation is that difficulties may arise after the loan has been executed, but before the conditions precedent have been satisfied, and these difficulties are not caught by other restrictive clauses. In such a case the lender would be unable to withdraw without breaching the contract as the agreement comes into place straight away but the loans are conditional on the conditions precedent. There is English authority which suggests that in such a case the lender cannot withdraw whilst the event can still be met.[20] It is, therefore, important for the lender to protect themselves by making sure the agreement expressly provides that a formally binding contract will not exist until the conditions precedent have been satisfied by the borrower, otherwise it will not be clear whether failure by the borrower to bring about the conditions precedent permits the lender to withdraw from the agreement, or merely suspends that agreement.[21] Since the banking crisis began in 2008 a large number of banks have withdrawn loan facilities at an advanced stage of negotiations, and such a clause has proved crucial.

Conditions precedent normally found in term loan agreements

4.42 The conditions precedent drafted into the loan agreement will vary accordingly to the particular circumstances of all parties who contract under the agreement but will often follow market standards, primarily those of the Loan Markets Association. First, any guarantees will have to be in place. These will usually be intra-group guarantees which may have associated security provisions and set off arrangements. Secondly, any authorisations by the board must be in place authorising named directors and/or the company secretary to sign the loan agreement and copies of this authority must be provided. Thirdly, where relevant official consents such as exchange control consents are needed because of the location of the borrower or guarantor, they must be in place prior to the loan agreement becoming binding. Fourthly, there will be an undertaking that the representations and warranties (see below) remain accurate at the time of signing. Fifthly, that there are no events of default pending and sixthly that there has been no significant adverse change in the borrower's financial position since matters were agreed.

4.43 In addition, where the borrower is incorporated it is usual for the lender to require copies of all relevant constitutional documentation. If the company was incorporated in England such documents would include the Memorandum and Articles of Association or, if it is a company set up after the coming into force of the Companies Act 2006, Articles of Association only. In addition copies of corporate authorisations such as board resolutions and, where required shareholders' sanctions would also be required. Where the borrower is a sovereign state or state-controlled entity a variety of declarations and authorisations from both the state's government and its central bank will also be required.

4.44 An additional, and very important, condition precedent is the requirement to furnish legal opinions, addressed to the lender, and drawn up by lawyers in the jurisdiction of the borrower and of the guarantor, where relevant. The legal opinions should address the legal implications of the loan documentation by examining the impact of the representations and warranties made by the borrower and any guarantor. However, it must be appreciated that legal opinions do not amount to a guarantee that the transaction is valid and binding, since this opinion will only relate to the laws of its own jurisdiction and will not cover any legal system which impacts upon the loan agreement.

Conditions subsequent

4.45 It is common practice when drafting loans to specify certain 'standard' conditions which must be satisfied at or before each subsequent drawdown. These include the condition that the representations and warranties made by the borrower at the time the loan was executed continue to be true, and that no event of default has occurred and is continuing or will result from the drawdown.

4.46 The aim of the conditions subsequent is to suspend any subsequent drawdown, unless the borrower's position, both financially and otherwise, is consistent with that as 'represented' in the agreement when the loan was originally executed.

4.47 It can be clearly seen that the conditions, both precedent and subsequent, described above are included for the benefit of the lending bank(s), and therefore can be waived by such bank(s) as if they were never included in the first place.

Representations and warranties

4.48 A golden rule in every form of bank lending, be it purely domestic or international, is 'know your borrower'.[22] This rule is obviously difficult to satisfy in some types of lending, eg foreign currency loans, since the close relationship which normally exists between bank and borrower, in domestic lending, is rarely evident. Nevertheless, there are certain fundamental facts about the borrower of which a lending bank must always assure itself, before granting any loan facility. It is principally in order to ascertain these fundamental facts that representations and warranties are incorporated within the loan documentation. In strict legal parlance representations are statements made, and warranties are undertakings given, by the borrower on the basis of which the lender makes the credit available.

4.49 Representations and warranties commonly fall into two categories: (1) Those clauses giving various assurances as to the legal validity of the obligations into which the borrower is entering ; (2) clauses relating to the financial condition of the borrower.

Representations and warranties commonly found in term loans

4.50 The representations and warranties clause usually commences with a number of statements concerning the valid existence and authorisation of the borrower, and include that the borrower is validly existing under the relevant foreign law (if it is a foreign company) and has power to borrow or enter into other obligations, such as the giving of a guarantee, required under the agreement. When considering the capacity of the borrower it is usual to incorporate a statement that the borrower's legal status is as stated, ie that it is a registered limited company. There have been problems with organisations based in some jurisdictions which appear to be companies but are not in the sense that English law understands it. There will also be a statement that the borrower's powers allow the loan. This is an issue because some companies' articles only allow them to borrow up to a certain multiple of fully paid up share capital. In such a case a vote by the shareholders would be needed to change the articles.[23] The borrower's authorisations must also be satisfactory. Thus, the director(s) or company secretary who signed the loan agreement must have been authorised by the board to so act. Also, the company must not be in contravention of any relevant laws or regulations, such as exchange controls or capital controls. There may also be statements to the effect that:

  • any necessary government or regulatory approvals have been obtained;

  • the loan is legally valid and enforceable and constitutes a binding obligation upon the borrower, enforceable in accordance with its terms;

  • no litigation, arbitration or other proceedings are, to the best of the borrower's knowledge, threatened against the borrower which might adversely affect the ability of the borrower to perform its obligations under the loan agreement or any security provided there under;

  • the borrower is not in breach of any of its other obligations which might materially affect its ability to perform its obligations under the loan agreement;

  • no default has occurred; and

  • the recent audited accounts of the borrower reflect a true and fair view of the borrower's financial condition and the borrower has no other material liabilities which are not disclosed in the accounts.

It is also common to incorporate an all-embracing material adverse clause which may read as follows:

'There has been no material adverse change since …in the financial condition of the Borrower or in the Borrower's ability to perform its obligations under this Agreement.'

The difficulty with this clause is that it begs the question: what is material? It could be argued that this question is answered by applying an objective test, and English authority certainly appears to support such a notion,[24] in which case the clause will operate in a most unpredictable manner. The lender should try to avoid such unpredictability, whenever possible, by incorporating either a materiality test or by making the test subjective, eg: 'material in the opinion of the lender.'

4.51 Where the borrower is a sovereign state or state-controlled entity it is also common to include a statement that the borrower is subject to civil and commercial law with regard to its obligations under the agreement, a statement that the borrowing constitutes a commercial, rather than a governmental act and that the borrower does not enjoy immunity from set-off, suit or execution in respect of its obligations under the agreement, and finally, a statement that the borrower is a member of the International Monetary Fund.

Evergreen representations and warranties

4.52 In many cases, the representations and warranties given by the borrower are isolated statements reflecting the circumstances at the time the loan agreement is executed. This, to a certain extent, contradicts the position as perceived by the lending bank, which normally assumes that the matters represented will remain so throughout the full term of the loan agreement. This particular problem can be resolved in a number of ways. First, the borrower may covenant to maintain the status quo as reflected by the representations and warranties, although in practical terms such a covenant will be virtually impossible to satisfy, since many of the matters covered by the representations and warranties are likely to be beyond the borrower's control. An alternative approach to the problem is to include an appropriate event of default clause linked to the representations and warranties. Such a clause is commonly adopted, notwithstanding that most borrowers, particularly sovereign states, resent the imputation inherent in its inclusion. An additional solution is obtained by including a rather artificial clause within the loan agreement, which provides that the representations and warranties shall survive the execution of the agreement and remain true throughout the full term of the loan. Many loans also provide that the representations and warranties shall be deemed to be repeated at various times, usually before any subsequent drawdown during the life of the loan.

The purpose and significance of representations and warranties

4.53 There are several purposes which representations and warranties seek to address: they endeavour to provide remedies for misrepresentation in the event of an inaccuracy; they may operate as an estoppel against the borrower; and they may enable the lender to cancel the commitment and accelerate the loan if they are linked to an event of default. On a more practical note, they provide a checklist which serves an investigative function for the lender.

4.54 Whether they achieve their desired purpose will depend to a large extent on how they are legally construed. There is a significant difference under English law between a representation and a warranty. A representation is a statement of fact, not of opinion or law, which is made before the loan agreement has been executed, and in reliance upon the truth of which the lender enters into the loan agreement. It is not, however, an integral part of the contract. A warranty on the other hand is a term of the contract itself. This distinction is of the utmost importance, since the availability of various common law remedies will be determined, to a large extent, by ascertaining whether the statement is a term of the contract. The key to discovering whether a statement is such a term lies in the intention of the parties and such intention is ascertained by applying an objective test.[25]

4.55 Appropriate drafting techniques can, however, avoid problems which arise out of the distinction between representations and warranties by expressly making all statements warranties and, therefore, terms of the contract. Such an approach is common in loan agreements where the borrower 'represents and warrants' in respect of every clause in the appropriate section of the documentation. The fact that all statements are made warranties is unfortunately, not the end of the matter, since under English law there is an important distinction between warranties and conditions in so far as the available remedies are concerned. Strictly speaking, a warranty is a contractual term which affects some relatively minor aspect of the contract, and therefore breach only entitles the innocent party to sue for damages. In general, there is no right to terminate the agreement for breach of warranty. A condition, however, is a term which affects an important aspect of the contract, and breach entitles the innocent party not only to claim damages but also to terminate the contract for the future. Cases also recognise an important group of intermediate terms which are neither conditions or warranties, breach of which justifies discharge if it amounts to a serious failure in performance.[26]

4.56 The distinction between conditions and warranties has in some cases been based on the intention of the parties as expressed in the contract, but more recent cases suggest that the use of the words 'condition' or 'warranty' will not be conclusive. Where no intention is expressed, the distinction may be based upon the seriousness of the failure to perform the contractual term at issue. In other words, where the term broken is so important that it would be unreasonable to expect the innocent party to fulfil its obligations under the contract, it is likely that the term will be construed as a condition.[27]

4.57 The distinction between conditions and warranties under English law has become overlaid with technicalities, and their classification is at the very least unpredictable; it will, therefore, be most important for the lender to avoid any future classification problems by expressly incorporating various remedies within the terms of the loan agreement which cover the eventuality of the representations and warranties being untrue. This is achieved in most loans by linking the representations and warranties to an event of default, ie:

'It shall be an event of default in the event that any representation and warranty of the Borrower or the Guarantor in this Agreement or any other document delivered in connection with this Agreement proves to have been incorrect, incomplete or misleading …'

Such a clause clearly indicates that the parties perceive the representations and warranties as fundamental to the contract, giving rise to the right to cancel the facility and accelerate in appropriate cases. In such a case the representations and warranties would be classified as conditions rather than warranties.


4.58 Term loan agreements invariably contain certain undertakings with which the borrower is required to comply throughout the life of the loan. Such undertakings are generally referred to as covenants. The scope and purpose of the covenants which are used by those who draft the loan agreement tend to be as wide as the variety of lenders and borrowers who participate in the lending market. Their primary objective, when taken together, is to ensure the continued soundness of the credit facility being advanced and to give the lender(s) certain inside information on, and limited control over, the business of the borrower.

4.59 The most important covenant made by the borrower is, of course, the borrower's promise to repay the loan either on a particular date or by a series of instalments. This promise to repay is reinforced by additional covenants, the scope of which will be a matter of detailed negotiation between the lender and the borrower. Negotiation of the covenants often proves a difficult exercise, since the parties often have sharply contrasting interests. The borrower will obviously endeavour to retain for itself the greatest possible freedom with regard to the management of its business, whereas the lender will endeavour to impose suitable restrictions over the borrower's operations in order to safeguard its lending. A balance must clearly be struck and much will depend upon the relative bargaining strengths of the parties. The covenants ultimately agreed upon, as with all clauses in the loan agreement, should be specifically tailored. It is, nevertheless, possible to consider certain 'fundamental' covenants which are commonly seen in term loans.

The financial covenants

4.60 The financial covenants are designed to protect the lender's position should the borrower's credit worthiness begin to deteriorate. They require a flow of financial information from the borrower to the lender which enables the lender to monitor the borrower's financial health, providing, of course, the lender is in a position to check compliance. Perhaps the most important covenant at the time of writing relates to a minimum level of earnings before interest, tax, depreciation and amortisation (EBITDA) over the next 12 months. The purpose of this is to make sure that the borrower has sufficient available profitable income to service its debts.[28] 'Earnings' in this context means net operating income after deduction of capital gains and losses from non-current asset disposals and one-off gains and losses, together with expenses. Pre-acquisition earnings from acquired companies should also be deducted. Sometimes the reference will be to EBIT and depreciation and amortisation will not then be taken into account.

4.61 Ratio covenants, which define certain acceptable requirements in relation to the borrower's financial condition, are also commonly employed in this monitoring process. Such covenants may define the acceptable financial condition of the borrower with reference to the value of its net assets, after deduction of net liabilities, the ratio between such assets and liabilities indicating the threshold above which the borrower 'covenants' to maintain its position.

4.62 An alternative approach is for the borrower to 'covenant' that it will maintain a minimum figure for net assets after the deduction of liabilities, commonly defined as the minimum net worth threshold. Similarly the borrower may be required to maintain a certain 'ratio' as between current liabilities and current assets or to maintain working capital above a predetermined figure.

4.63 Whatever form the ratio covenants take, the specific wording must always be clearly defined within the terms of the loan agreement. Most borrowers can easily arrange their financing and accounting procedures in such a way as to significantly change the value of 'working capital', 'liquid assets', 'minimum net worth', etc, as defined in everyday commercial life. The lender, therefore, must ensure that these and other key phrases are carefully defined in order to prevent accidental or deliberate avoidance of the financial covenants by the borrower.

4.64 Compliance with the ratio covenants, provided they are appropriately drafted, should indicate that the borrower's business is being conducted in a prudent fashion, whilst breach of such covenants may be an indication of future financial difficulties, thereby operating as an early warning device. It must be appreciated, however, that financial covenants will only be as good as the raw financial information supplied by the borrower. Accounting standards vary enormously from one country to another and it should never be assumed that the high standards applied in the lender's home jurisdiction will be similar to those applied in the borrower's jurisdiction.

4.65 The financial covenants are given teeth by linking them to an event of default clause which is intended to enable the lender to demand repayment as early as possible whilst there is still some prospect of the borrower being able to meet the demand.

How effective are ratio covenants?

4.66 Where realistic parameters and clear definitions are selected for the ratio covenants there can be no doubt that a significant degree of protection is afforded to the lender. However, their shortcomings must not be overlooked. The financial information required by the covenants will often take many months to prepare, and, therefore, it will be long after the event before any contravention is brought to the lender's notice. It has already been mentioned that accounting standards vary from country to country, and although the lender can partially overcome this by selecting appropriate auditors who will prepare the information, it must be appreciated that the ratio covenants will only be as good as the financial information supplied.

Material adverse change clause

4.67 The main alternative to ratio covenants is a continuing material adverse change clause, which will typically provides that it shall be an event of default:

'… if there is any material adverse change in the financial condition of the borrower which in the reasonable opinion of the bank may impair the ability of the borrower to perform its obligations under this Agreement.'

The legal difficulties posed by such a clause will be considered later, and suffice it to say, at present, that even when the clause incorporates a materiality test its language will invariably pose difficulties of proof, due to its discretionary nature. There can, therefore, be little doubt that where the financial condition of the borrower is at issue, well drafted financial covenants are far more suitable than an all-embracing event of default clause. Well defined covenants establish specific criteria, breach of which may be clearly identified by the lender, while at the same time guiding the borrower as to what must be done in order to avoid an event of default.

The negative pledge

4.68 The majority of very large-scale term loan agreements are unsecured, and, therefore, most lenders feel it is vital, whenever possible, to fetter the borrower's ability to create or maintain secured indebtedness. In such cases the lender will tend to rely on the borrower's credit rating as an indication of their capacity to repay. In the event of the lender failing to control the borrower in this way, it may ultimately transpire that the borrower's unencumbered assets are unable to satisfy the lender's unsecured claim. In addition, it is common where security it taken to add a negative pledge clause to cover non-secured and future acquired assets.

4.69 The mechanism adopted in most term loans to achieve this degree of control is the negative pledge clause, which typically provides that the borrower shall not create or permit to subsist any security, usually specified as:

' … any mortgage, charge, pledge, lien or other encumbrance; over its assets or revenues unless the loan covered by the negative pledge is "equally and rateably" secured.'

What does the negative pledge cover?

4.70 It will be noticed that the wording in the example given is very broad and without more would probably place too heavy a restriction on the borrower's business. It is common therefore to word the negative pledge very restrictively and then list a number of exceptions to its operation.

4.71 The most common relaxation relates to encumbrances granted to third party creditors which are 'equally and rateably secured.' The precise meaning of this phrase is unclear, but it would appear to cover the situation where security is granted to a third party, the proviso being that such security must also be used to secure the original lender's position on the term loan equally and rateably with the third party creditors. An alternative view is that where security is granted to a third party an equivalent security is to be granted in favour of the original lender. Much will obviously depend upon the precise wording of the clause, a typical example of which might read as follows:

'The Borrower will not create or permit to subsist any mortgage, charge, lien, pledge or other security interest on or over any of its present or future assets unless all the Borrower's obligations under this Agreement either:

  • (a) share (to the satisfaction of the lender) the security afforded by such mortgage, charge, lien, pledge, or other security interest, equally and rateably with the loan, debt, guarantee or other obligation secured thereby, or

  • (b) receive (to the satisfaction of the lender) the benefit of either a mortgage, charge, lien, pledge or other security interest, on other assets or revenues of the Borrower which the lender judges to be equivalent to that granted to such loan, debt, guarantee or other obligation.

    Notwithstanding the above, there shall be disregarded for the purpose of this clause:

    • (i) liens which arose or may arise by operation of law;

    • (ii) any mortgage, charge, lien, pledge or other security interest not exceeding £…… or …… per cent of [the] Borrower's tangible net worth;

    • (iii) any mortgage, charge, lien, pledge or other security granted with the written consent of the lender.'

4.72 The exemptions outlined in the above clause are only examples and their precise scope will be a matter for detailed negotiation between the parties – the Loan Markets Association for example has quite a brief clause.[29] The clause must not be too restrictive so as to effectively preclude the borrower from entering into normal commercial arrangements, and an ill considered clause may actually force the borrower into taking undesirable financial measures to raise funds, such as selling valuable assets which might otherwise be pledged. It is obviously in the lender's interest to keep the borrower's financial condition as healthy as possible and this should be borne in mind when the wording of the negative pledge is being negotiated.

To whom should the negative pledge extend?

4.73 Another important issue is whether the negative pledge should only cover security created by the borrower or whether it should encompass security created by related entities of the borrower. Where the borrower is a sovereign state, the clause may be drafted so as to extend over governmental agencies and instrumentalities, although most states would strongly resist any attempt to bring either central banks or state-owned enterprises within its parameters. Similarly, in the case of a corporate borrower the clause may extend over its subsidiaries, even though the lender will not, at least under English law, have a direct right of recourse against the assets of such subsidiaries, but only against the value of the borrower's interest in them.

The legal nature of the negative pledge

4.74 It has already been stressed that the primary purpose of the negative pledge is to prevent third party creditors being preferred to the original lender which advances the term loan. The intention in the majority of loan agreements is to provide a mechanism whereby the borrower is required to consult the lender should it wish to create any secured indebtedness to third party creditors. In the event of the borrower falling to consult, the creation of such indebtedness will trigger an event of default in the original loan. It is submitted that the clause will rarely provide any other remedy to the original lender, such as the ability to dislodge the security granted in breach of the clause, which security will consequently have priority over the original lender's unsecured claim.

4.75 It is now common to attempt to increase significantly both the scope and purpose of the negative pledge clause by incorporating within its terms an automatic security device. Such a clause basically provides that when the borrower grants third party security, in breach of the negative pledge, the borrower's obligations under the original lender's loan will be secured upon the same assets, equally and rateably, with the third party obligations which are being secured. There is clearly a problem in seeking to do this after the creation of the loan as there is no consideration. It seems unlikely that that this problem is solved by the mutual intention by the parties to create the charge, albeit at a future date, at the time the loan is made.[30] It seems likely that such a clause could not, under English law, give rise to a present equitable interest, which presumably is its primary intention, since the interest will only arise once the contingency in the clause is satisfied. In other words, it can only arise when the borrower breaches the clause and grants third party security, at which point an equitable interest is immediately created in favour of the original lender. This interest may be a present right for value, (value being an essential ingredient if a security interest is to be created) in appropriate circumstances, for example, where the original lender is able to suspend future drawdowns unless the security interest is created in its favour. Providing the ingredient of value is present, another caveat relates to the question of intention and the wording of the clause must clearly indicate that it was the borrower's intention to grant an equitable interest in favour of the lender.

4.76 If one accepts the foregoing argument, a further caveat which must be satisfied if the clause is to give rise to a security interest is that the clause must identify the assets over which the future security interest is being prospectively offered by the borrower. Where the wording of the clause specifically states that the original lender's security interest will attach to those assets over which the third party creditor is given security, equally and rateably, the problem of identification is removed. However, if the clause states that, upon the grant of such third party security, the original lender is to be given matching security, equal in value to the third party security, but over different assets, no security interest is created since the assets over which the original lender's security will attach have not been identified. Before the contingency is satisfied, by breach of the negative pledge, there seems little doubt that the lender is only entitled to an equity which is not an interest in any of the borrower's assets. However, as already indicated, once the contingency is met, and providing the conditions mentioned above can be satisfied, it would seem that the negative pledge can give rise to an equitable security interest, namely an equitable charge. One may argue that talk of equitable charges in relation to the negative pledge is all very well, but in the final analysis such arguments are purely academic, since negative pledge clauses, when drafted by English lawyers, do not usually attempt to create equitable charges. In practice, this may no longer be the case, and it has been evident that the technique of incorporating an automatic security device within the terms of the negative pledge clause is common. However, any equitable charge which may be ultimately created will only give priority if it is perfected by registration under s 869 of the Companies Act 2006.

4.77 An alternative equitable interest to which the clause may give rise is the equitable lien which is not based on possession of the relevant asset(s) and is enforceable in similar ways to a mortgage by equitable charge. In most commercial loans it would be difficult in practice to make this operate.

What protection does the negative pledge give the lender?

4.78 Even if one accepts the argument that the negative pledge may, in appropriate cases, give rise to an equitable interest, the fact remains that such interest may not afford any real protection in favour of the lender. This is because the lender's equitable interest will only relate to property which has been secured in favour of a third party in breach of the clause. It is difficult to imagine how such property could be 'equally' secured as between the third party creditor and the lender, and the negative pledge may, therefore, fail to create an interest in the property due to lack of certainty.

4.79 Since there is no doctrine of constructive notice with regard to negative pledge clauses contained in term loan agreements, the clause will become subordinated to a third party who breaches it by purchasing a legal interest in good faith without notice.[31] Only if the third party creditor has actual notice would he be bound by the terms of the clause. In such a situation the lender's only effective remedy would, therefore, be a contractual right to demand security equal to that given in favour of the third party. Alternatively, the lender could, of course, accelerate the facility and demand repayment, since breach of the negative pledge will invariably be an event of default under the loan.

4.80 However, there are fundamental weaknesses with the negative pledge clause. First, in the event of the borrower breaking it the lender can only either accelerate payment as discussed or bring court proceedings against the borrower for breach of contract. Should the lender win they would still be an unsecured creditor for the amount of the judgment. It may be possible for the creditor to appoint a receiver.[32] This would seem to be an option where the lender also has taken security but an unsecured negative pledge lender could also apply using the court's inherent power to appoint receivers. However, it seems that a court would not do this unless a normal debt action or injunction was inadequate.[33]

4.81 If it can be shown that the third party creditor took his security with notice of the negative pledge clause, it may be possible for the lender to bring a claim against the creditor in tort for interference with the term loan contract. However, this would depend to a large extent on the precise wording of the negative pledge and the manner in which it was breached. The key point is that it would be necessary to prove that the later secured lender knew of the negative pledge in the earlier loan document. It is very unlikely that this could be done. Some lenders who take security and a negative pledge clause seek to improve their position by tying the wording of the negative pledge into the security clause and so facilitate it being registered at Companies House (or its overseas equivalent). However, s 869 of the Companies Act 2006 only provides that the registration of the security is notice to the world at large, so the benefit will only arise where a second lender decides not to advance a secured loan on the basis of having seen the registered wording.

The pari passu covenant

4.82 The pari passu covenant is a companion of the negative pledge clause which covers only unsecured indebtedness. The pari passu covenant is normally worded in such a way that the borrower warrants that its obligations under the loan will not be subordinated to any unsecured creditor. In other words, that the rights of the term lender will always rank at least pari passu with the rights of the borrower's other unsecured creditors.

4.83 The pari passu covenant is normally expressed as a continuing covenant, hence the words, '… will at all times'. Furthermore, the obligations owed to the lender are expressed to rank 'at least' pari passu in order to provide for the possibility of the borrower incurring unsecured indebtedness which is subordinated to the lender's claim. Clearly, the lender would not wish to elevate such subordinated debt to the same position as its own.

4.84 Many jurisdictions provide that certain classes of unsecured creditors will rank in priority to others, and since the clause has no effect on third parties, it is common to qualify the scope of the clause in favour of those creditors who are thus afforded priority. The efficacy of the clause once again lies in the fact that it is invariably linked to an event of default which permits acceleration and the right to demand repayment, preferably before the borrower becomes insolvent. Whether the clause, therefore, achieves its desired purpose will depend upon how effectively it can be policed, and this should be borne in mind by those drafting the agreement.

Additional covenants commonly found in term loans

Use of proceeds

4.85 We have already seen that in certain circumstances it may be necessary to impose restrictions on the use or purpose of the loan. Whenever this is deemed necessary it is common to reinforce the purpose clause with a specific covenant linked to an event of default permitting acceleration in the event of any breach. Once again, however, it may be very difficult to police such a covenant.

Anti-merger covenants

4.86 Anti-merger covenants are relatively common where the borrower is a corporate entity and the primary purpose of such a covenant is to maintain the identity of the borrower. In rare cases the scope of the covenant may go much further than maintaining the identity of the borrower, and may require key management figures to remain in office or to be replaced by persons approved by the lender.

Anti-disposal covenants

4.87 Just as it may be important to maintain the identity of the borrower, it is likely that the lender will want to preserve the borrower's assets, which will be available for any future distribution. The clause may be drafted very widely to prevent any creeping disposals of all assets, or may relate only to a small number of assets which the lender perceives as fundamental to the borrower's credit worthiness. Where the covenant is very restrictive it is common to incorporate numerous exceptions which permit the borrower to carry on its day to day business. The clause may be reinforced by a covenant requiring the borrower to maintain a certain level of insurance over specified assets and against such risks as prescribed by the lender. The over anti-disposal covenant obviously operates hand in hand with both the financial covenants and the negative pledge, the general purpose being to prevent the depletion of funds to which the lender must look for eventual repayment.

Events of default

4.88 Certain clauses will give the lender the right to terminate the contract. Whether they would wish to utilise this right is another matter as were the contract to be terminated it might well force the borrower into insolvency. This would not normally be in the lender's best interests, however, it is useful in that it puts the lender into a position of power in being able to threaten termination and thus negotiate from a position of strength. Key examples of such clauses are as follows.


4.89 In the event that the borrower does not pay the due amount on the agreed place in the stated location in freely available funds and the agreed currency, it will normally be an event of default. It is common to include exceptions for failure to pay being the result of a purely administrative error, or a disruption event and provided it is paid within a certain number of business days of the payment date. Indeed the LMA terms take this approach.[34]

Financial covenants

4.90 Failure to satisfy the financial covenants discussed above will also be an event of default.


4.91 Misrepresentation, which is discussed elsewhere in this chapter, and also in detail in Chapter 5, will be an event of default if made by a borrower or guarantor in the lending agreement, guarantee or any connected document where it is material and misleading.

Cross default

4.92 This refers to the failure by the borrower to make a payment under another lending arrangement, an event of default or termination event arising in relation to another lending agreement, any creditor becoming entitled to seize property under another lending agreement will be typical examples of this. It is normal to include a minimum sum in this clause so that trivial breaches of other agreements do not trigger the activation of this clause.

Attachment of assets

4.93 Any attachment of the borrower's assets by creditors will be an event of default, although this clause is sometimes added to the insolvency clause in 'termination events' discussed below.

Obligor default

4.94 If a subsidiary of the borrower providing a guarantee or security ceases to be a subsidiary it will normally be an event of default.

Termination events

4.95 Whereas an event of default gives the lender the option to terminate the contract, a termination event is one that results in the contract coming to an end regardless of choice by the lender.


4.96 This is the most obvious example as were there not to be a clause rendering the contract terminated there is the danger that in certain circumstances the contract could be void. The issue could arise because the contract becomes illegal under the law chosen in the choice of law clause in the contract or that of the jurisdiction in the unlikely event that this is different. It could be an issue if the contract becomes illegal in another state connected with the loan, though here it will depend on the exact circumstances. Prima facie the English courts will not enforce a contract where it is against the law of a friendly state affected by that contract[35] but if it is a case of a loan agreement that is effective under English law being unacceptable elsewhere purely for what English law would see as technical reasons,[36] eg interest payments being prohibited under Sharia'h law where the borrower is located in an Islamic state but the loan agreement is covered by English law and the jurisdiction of the English courts, illegality would not be an issue.


4.97 It will normally be stated to be a termination event where the borrower becomes insolvent or where steps are taken against them by a creditor in relation to failure to pay or where there is a winding up case brought or one involving dissolutions, reorganisation, winding up or administration of the borrower or a guarantor or provider of security. The clause will also be activated by the borrower entering into a scheme of arrangement with their creditors or by any security provided by the borrower being enforced.

Force majeure

4.98 This is a clause which results in the parties' obligations under the contract being terminated or adjusted in the light of an unexpected event. It is a civil law concept and must, therefore, be contractually incorporated in common law jurisdictions should its benefits be wanted. Current market practice in London seems to be to not have a general force majeure cause. If, however, the parties do wish to have one, they must determine which events they will wish to have this effect, short of those events that would frustrate the contract anyway. In that instance the Law Reform (Frustrated Contracts) Act 1943 would lead to the contract being frustrated and moneys paid prior to that could be recovered. In the LMA document that clause crops up as a market disruption sub-clause,[37] It applies when the bank determines that further deposits are not readily available on the deposit market specified. It allows the bank and borrower to negotiate for 30 days and if they cannot agree by then the bank can determine the interest rate on the basis of its funding costs from whatever source it might reasonably select.

4.99 Other common versions are war, terrorist attacks, blockades, embargoes, breakdown of civil order and Acts of God. The burden of evidence rests on the party seeking to rely on the clause.[38] Notice provisions are also commonly included.

Payment mechanics[39]

4.100 Obviously a key element of any loan agreement is the obligation to make payments of interest and repayments of capital on time and in both cases in the contracted currency. This should be done without set-off or counterclaim. Should payment for costs, expenses or taxes be necessary then they should be paid in the currency in which they are incurred. This is the line adopted in the LMA Agreement.

4.101 In the event of a change of control at the borrower's company the lender, or where appropriate their agent must be promptly informed and after that date the lender(s) are not required to continue to provide funds except in the case of a rollover facility. A notice terminating the loan can then be given and a notice period for this purpose can be inserted at this point. Of particular concern to a lender will be a change of control resulting in a lower credit rating for the borrower. Here the lender(s) may not have been willing to make the loan, or if so, on such favourable terms.

4.102 The borrower also has the capacity to cancel the loan or any remaining part thereof. Prepayment is also possible although there is usually a minimum amount that can be prepaid and interest up until that point must be included. In addition, it can only be made after the end of the current availability period. This gives time for the lending bank(s) to make other arrangements to lend the money. Compulsory prepayment on change of control is sometimes phrased as an event of default which means the lender can cancel the commitments to lend and accelerate the loans. Alternately it can be inserted as a mandatory prepayment so as to avoid a reputation for default, should it occur.

Tax gross up

4.103 This clause is added on the assumption that any withholding tax that may be payable is paid under UK law. Essentially it states that the borrower must make any payments to the lender without any deductions for witholding tax. In the event of a withholding tax being introduced outside the United Kingdom the borrower must make the full payment to the lender regardless. There are certain exclusions and the notes to the LMA agreement state that:

'This is a complex area and in each case relevant treaties should be reviewed and, if appropriate, additional wording inserted to apportion risk as agreed by the Parties.'

Tax indemnities and credits

4.104 The following clause requires the borrower to indemnify the lender against any loss caused by taxation being paid in respect of a finance document, a tax credit or stamp duty. The LMA Agreement requires that in the case of VAT an appropriate VAT invoice must be provided. There are also provisions determining that where the borrower pays VAT on a supply goods or services pursuant to the loan agreement, the lender will be indemnified against any cost.

Provisional Treaty Relief Schemes

4.105 There are provisions dealing with syndicated loans (see Chapter 5) that determine the borrower must indemnify the agent of a syndicate where they have incurred costs managing the syndicate. They must also make provision to provide promptly any information that the Agent asks for and act in accordance with any notices from HM Revenue and Customs.

Increased costs

4.106 The LMA Agreement requires the borrower to pay within three business days any increased costs incurred by the lender arising as a result of a change in the law or relevant regulations made after the date of the lending agreement. This does not extend to tax deductions or indemnities, which as seen above have certain specific arrangements attributable to the borrower wilfully breaching a law or regulation.

Other indemnities

4.107 The LMA Agreement requires the borrower to agree that they will pay to the lender within three business days of it being demanded any costs arising from an event of default, failure to pay any amount due or not prepaid when required. They are also obliged to pay any costs necessarily incurred in investigating a default, entering into a necessary change of currency (see below) or where an agent has acted on an instruction. They must also pay promptly any costs incurred in preparing or amending the lending agreement.

4.108 As a counterbalance there is a requirement that the lender mitigates any costs that arise as a result of the illegality, tax gross up, increased costs and mandatory cost formula clauses. If this involves any costs the borrower must indemnify them.

4.109 There is a fairly standard guarantee/indemnity clause for any guarantor(s) of the loan together with a release provision in the event of a guarantor stepping down as a result of the terms of the lending documentation.

4.110 The LMA representations, undertakings and events of default contain no great surprises. The borrower confirms that it is validly incorporated in its jurisdiction and both it and its subsidiaries have power to carry on their business and to own their assets. It also confirms that the lending agreement does not put it in breach of any law, regulation, constitutional document or agreement applying to either itself or a subsidiary or any of their assets and that any necessary authorisations are in force. There are also representations stating that it is not necessary for the borrower to make any deduction from repayments for tax or for stamp duty or similar tax to be payable on the document or for the documents to be field with any authority in the borrower's jurisdiction.

4.111 There are also the standard type of clauses stating that the borrower has not committed an event of default nor that one might reasonably be expected. If it has notification should take place. Any factual information provided remains accurate as do the financial projections which are undertaken to have been carried out on the basis of recent historical information and on the basis of reasonable assumptions. The borrower undertakes that its financial statements have been prepared in accordance with GAAP and fairly represent its financial condition or if not this must be expressly disclosed. Any material adverse change since the date of the financial statements must also be disclosed as must any change in the accounting practices, financial reference periods or the auditors. The financial statements must be in sufficient detail to enable the lenders to determine whether the financial covenants have been complied with. In addition a compliance statement must be added, signed by two directors, stating in reasonable details what the computations are in the financial statements.

4.112 There is provision, as long as the lender agrees, for all information that must be provided to be done electronically together with provisions as to how this should be done.

Remedies for breach of covenant

4.113 As we have already indicated the loan agreement will normally provide specific remedies for any breach of covenant by linking the covenants to an event of default. The wording of such an event of default will typically read as follows:

'The Borrower defaults in the due performance or observance of any of its covenants, undertakings or obligations under this Agreement.'

4.114 Breach of the covenants will, therefore, normally permit the lender to suspend and/or cancel the facility and accelerate the borrower's obligation to repay. However, this may prove to be of little practical effect if the borrower's financial condition has deteriorated so badly that it is unable to repay. The lender's only hope is that the covenants will act as an early warning system which may enable the lender to recover its funds before the situation is completely lost.

Internal remedies

Set Off

4.115 As Philip Wood points out:

'Potentially one of the most useful remedies available to a bank lender on a default by the borrower is the ability to use deposits of the borrower placed with the bank to pay out the defaulted loan by a set off.'[40]

4.116 Set off is a remedy which bridges the gap between the internal and external remedies since a clause covering the lender's right to set off may be incorporated within the terms of a term loan agreement. Rights of set off also exist in equity, but only where given conditions are fulfilled.

4.117 Here the focus will be on the set off clause, which usually seeks to confer broader rights of set off than would be given in equity.

4.118 Such a clause may read as follows:

'The Lender may set off against any obligation of the Borrower due and payable by it hereunder any monies held by the lender for the account of the Borrower at any office of the lender anywhere and in any currency exchanges as are appropriate to implement such set off.'

4.119 It is debatable whether the courts in England would permit set off where the funds to be set off are in another jurisdiction or in a currency other than that specified in the agreement. Set off in such cases would certainly not be allowed in equity and the specimen clause serves to illustrate how the loan agreement may attempt to extend the lender's rights. The problem with such a clause is that, under English law, if not carefully worded it may constitute the creation of a charge over the borrower's deposits, and if so construed will be void under s 869 of the Companies Act 2006 unless it is registered.[41]


4.120 There are a number of different fees which may be payable by the borrower in a loan agreement, although most of these are only levied if the loan is being syndicated. Single lender medium-term loans often do not involve fees because of the competitiveness of the market and other potential sources of funds. Some borrowers, however, may be prepared to pay more in undisclosed front-end fees rather than higher spreads as that may imply a poorer credit rating. As we have already seen, some of these fees may be payable even though the borrower does not drawdown the facility, and may, therefore, operate as a significant disincentive against the borrower seeking alternative funding once it has become committed under the original facility. The following are examples of the fees which may be payable.

Commitment fees

4.121 In most loan agreements the lender will be committed to make the funds available as soon as the loan is executed, even though the borrower may not drawdown the facility immediately. In such cases the burden of risk rests heavily on the lender which may, as a consequence, require the borrower to pay a commitment fee on the undrawn portion of the committed facility, to compensate the bank for the risk it bears. The fee payable is usually expressed as a percentage of the undrawn facility on a day-to-day basis. Fees of less than 1 per cent are normally expressed in terms of basis points, and market practice recognises each basis point as referring to one-hundredth of 1 per cent.

Front-end fees

4.122 A variety of front-end fees may be payable by the borrower depending upon the type of facility being advanced. These fees are normally payable once and for all shortly after the loan has been executed, and relate to the entire facility, regardless of whether it is fully drawn, cancelled or pre-paid. Front-end fees are particularly valuable to the lender where there is a risk of early cancellation or prepayment, and they are commonly found in syndicated loan agreements where they are normally paid to each participating bank in proportion to the exposure being taken.

4.123 Front-end fees compensate the lending bank in two ways. First, the proportionate value of the fee levied will be greater if the loan is cancelled or prepaid by the borrower and will, therefore, to a certain extent, offset such cancellation. Secondly, the fact that such fees are levied, notwithstanding drawdown, may dissuade some borrowers from exploiting the market advantages of prepayment and may thus strengthen the negotiating position of the original lenders.

Legal fees

4.124 Medium-term loan agreements obviously vary in complexity, and this is reflected in the level of legal fees. While legal fees are rarely large in percentage terms, they nevertheless tend to be a major expense, and the lender should always provide for an express clause within the loan agreement whereby the borrower agrees to indemnify the lender in respect of such fees. Rather than make specific reference to legal fees, some loans incorporate an all embracing expenses clause, which requires the borrower to reimburse the lender for all expenses incurred in connection with the loan.

Stamp duty

4.125 In ascertaining which country's stamp laws will apply to the loan agreement much will depend on the nationality of the borrower and the law of the place where the loan is executed. The amount, if any, of stamp tax or duty payable will vary widely from one jurisdiction to another, and it is sometimes possible to avoid these taxes by executing the agreement in a jurisdiction which does not apply stamp taxes. Insofar as English law is concerned, loan agreements are not subject to stamp duty. Because different jurisdictions adopt a variety of stamp duty requirements, it is common for the lender(s) to insist that the loan documentation include a provision whereby the borrower agrees to indemnify the lender(s) against every eventuality covering:

'… all stamp, registration and similar taxes or charges imposed by law or by any governmental authority which may be payable or determined to be payable in connection with the execution, delivery, performance or enforcement of this Agreement.'

The importance of controlling the jurisdiction in which the loan is executed

4.126 The importance of ascertaining and controlling the jurisdiction in which the loan is executed has been highlighted in earlier chapters. In some cases the place of execution will be self-evident as the loan will be signed by all relevant parties in one place. Other cases, however, may be less clear, particularly where the agreement is signed by one party, say the borrower in one jurisdiction and then posted for signature by the lender in another jurisdiction. Under English law, such an agreement would be deemed executed in the jurisdiction where it is accepted, and where a postal method of acceptance is adopted this would be the place where acceptance is posted by the offeree. Under English rules of private international law, if there is a conflict on the question of execution, the issue would fall to be determined by the proper law of the contract.

External remedies

Specific performance

4.127 An English court will not normally grant an order for specific performance where damages would be an adequate remedy. Nor will the court normally grant specific performance where the loan agreement makes provision for a more suitable remedy, for example, termination and acceleration.

Prohibitory injunction

4.128 Although an English court would be reluctant to grant an order for specific performance which would require a positive act on the part of the borrower, it would be much more favourably disposed towards the grant of an injunction which restrains the borrower from performing acts which are in breach of its obligations under the loan agreement. Thus, the borrower may be restrained from breaching an undertaking or covenant, providing the lender can act quickly, before the breach occurs. This once again highlights the importance of incorporating undertakings/covenants within the loan agreement which can be effectively policed by the lender.

Other external remedies

4.129 There are a number of other remedies which may be available to the lender in the event that the borrower breaches the loan agreement, and most of these are considered elsewhere in this work. They include: the right to repudiate the contract and accelerate the sum outstanding; the right to sue the borrower for damages; the right to sue for outstanding amounts of interest and/or principal; the right to rescind the loan agreement and claim damages.

4.130 As we have seen, the availability of such remedies will depend upon the circumstances surrounding the borrower's breach, and although they may provide the lender with a number of important safeguards, their availability will normally be subject to significant limitations. They should never be relied upon as a substitute for express remedies, which must always be incorporated into the loan agreement in order to bring a degree of certainty and predictability to the rights of the lender in the event that the borrower subsequently breaches the agreement.



4.131 Where the borrower encounters difficulties so that it is no longer able to meet its liabilities as they fall due, the lender may agree to open restructuring negotiations in the hope that the borrower will pull through its present financial difficulties. Such a course of action may be perceived as being more attractive than winding up proceedings which, as has already been seen, will realise for the lender only a small proportion of the sums owed. Restructuring agreements are particularly common in so far as sovereign borrowers are concerned and such agreements tend to be even more complex than corporate restructurings.

4.132 Insofar as the lenders are concerned, the most important components of the restructuring process will be:

  • the rescheduling of the borrower's existing debt;

  • the provision of new money; and

  • the need to conclude formal arrangements for the maintenance of inter-bank lines of credit.

4.133 One of the main advantages of restructuring is that control stays with the lenders, but there are a number of major problems which such a course of action pose for the lenders, not least the need to provide new money. It is hardly surprising that many lenders resent the need to provide new money, seeing it as a case of throwing good money after bad. As a consequence, the documentation evidencing restructuring agreements tends to be drafted heavily in favour of the lenders.

4.134 Before considering some specific aspects of the restructuring process it must be pointed out that no two restructurings are ever the same and corporate and sovereign debt restructurings tend to be very different. There are no international guidelines governing the process of restructuring and discussion of this topic will, therefore, concentrate on general principles rather than specific examples. Many of the inherent difficulties in a restructuring exercise arise out of the sheer complexity of the negotiations which are necessary. A typical sovereign restructuring will involve tens, if not hundreds, of individual borrowers in both the public and private sector, with a corresponding number of separate credit instruments. The credits themselves will have been advanced in a multitude of different currencies at varying maturities, interest rates and margins. The documentation evidencing such credits will be equally diverse, ranging from one paragraph promissory notes to voluminous syndicated loan agreements. It is hardly surprising that the most difficult question is often the first: 'which of the borrowers' debts will be rescheduled?'

The restructuring process

Declaration of a moratorium

4.135 Insofar as sovereign restructurings are concerned the restructuring process has generally commenced following an announcement by the state of a specific cut off date upon which it proposes to suspend payment of its obligations, accompanied by an announcement of the opening of negotiations to reschedule. The major problem facing a corporate borrower, should it decide to commence restructuring negotiations by the declaration of a so called moratorium, is that individual creditors, with minimal exposure may feel that their interests are best served by taking independent legal action against the borrower to enforce the debts they are owed. Such a course of action may have serious implications for the borrower's prospects, since its major creditors may be disinclined to restructure in a case where many minor creditors are actively seeking to enforce their rights by means of attachment or otherwise. Nevertheless, many corporate borrowers do survive this vulnerable stage, and the bankruptcy laws of both England and many other states provide various procedures which may help to achieve a workable situation.

4.136 Rather than declare a moratorium the borrower, and likewise the lender(s), may prefer the restructuring to be conducted privately, as between an individual debtor and an individual lender, or syndicate of lenders. Such a procedure will be unrealistic, however, when the borrower has many different creditors with whom it must negotiate.

Administration of the restructuring

4.137 In most of the major restructurings the negotiations from the lending bank's side have been led by a so called 'steering committee.' The members of this committee are normally drawn from the leading bank creditors of the borrower and each committee is the product of the specific restructuring in question. No two steering committees have ever comprised the same banks, but although their members are appointed on an ad hoc basis, the manner in which these committees are formed and work on the restructuring has, to some extent, been formalised. In many of the sovereign restructurings, for example, the steering committee has comprised between 10 to 14 banks with a permanent chairman. A number of sub-committees have usually been appointed to deal with particular aspects of the rescheduling and these sub-committees have tended to work with the steering committee in supervising the drafting of the documentation for the rescheduling and new-money agreements, and generally, in implementing the restructuring itself.

Is there a duty upon any of the bank's creditors to take a role in the restructuring?

4.138 It has been suggested by at least one learned commentator[42] that certain banks may be under a contractual duty to assume a leading role in the restructuring negotiations. Those principally cited are the lead managers and/or the agent banks in syndicated loan agreements.

4.139 Professor Horn contends[43] that since both the lead managers and agent banks have acted for and on behalf of the other syndicate members in both the formation of the syndicate and thereafter during the life of the loan, one may conclude that in a crisis, for example in a restructuring exercise, such banks will be obliged to take leading roles on behalf of the syndicate. Horn accepts, however, that such a duty is remote, and would, in any event, be restricted to giving information about the crisis to the other syndicate members.

4.140 This conclusion is very probably correct, since if one closely examines the contractual relationships which exist between the parties to a syndicated loan agreement it is clear that no such duty can be found to exist. The duties of the lead manager/managers, for example, will be confined to forming the syndicate and drafting the loan documentation. Such banks will cease to occupy any special position in the syndicate unless they also act as agent banks once the loan agreement has been executed. Insofar as the agent bank is concerned, its duties will only commence once the loan has been executed and, as we have seen, the loan documentation will usually restrict its duties, largely to administrative matters. The agent bank will normally be bound to inform the syndicate members of the events which give rise to the need for a restructuring operation. Few loan agreements, however, will give the agent bank power to conclude restructuring negotiations on behalf of the syndicate and even if the agent bank is prepared to participate in such negotiations it may, before so participating, require the express approval of each syndicate member.

4.141 It will be most important for the members of the steering committee to ensure that they do not become agents of the banks on whose behalf they are acting in the restructuring negotiations.

4.142 A further problem for the steering committee is that it may come to acquire certain confidential or inside information concerning the borrower. If such information is material, the members of the steering committee should insist upon the borrower disclosing it to the other bank creditors. English law would also take a stern view towards any secret deals which may be agreed between the members of the steering committee and the borrower.[44]

Identifying the debts which are to be rescheduled

4.143 As we indicated earlier, the first, and perhaps the most difficult issue to resolve in a sovereign restructuring is precisely which of the borrower's debts are to be included in the negotiations. In most cases it will only be necessary to restructure part of a country's debt, the problem is: which part? The category of debt ultimately selected must be sufficiently broad to enable the sovereign debtor to re-establish itself, yet not so broad as to prejudice the cooperation of the banks which are to participate in the rescheduling. The state debtor will have additional motives for keeping the rescheduled package as small as possible, since margins and fees will generally be higher than those found in the credits originally advanced.

4.144 The restructuring negotiations will normally be restricted to the state's external debt; few sovereigns would countenance external interference over local currency obligations. External debt is generally recognised as debt payable in a currency other than the debtor's local currency, to creditors who operate outside the jurisdiction of the debtor.

4.145 Identifying the external debt will give a basis upon which the rescheduling negotiations can commence, although, as has already been indicated, no two restructurings are ever the same. Furthermore, although the external debt will provide a starting point, it will still be necessary to distinguish, amongst the external debts identified, those that will be rescheduled and those that will not.

4.146 A further criterion commonly applied is that of rescheduled maturity. In other words, the rescheduling is often limited to those credits originally scheduled to mature within a given period of time.

4.147 In many sovereign reschedulings a critical division has been made between those debts having a term of more than 12 months to run and those with less than 12 months remaining.

The new money agreement

4.148 An essential component of most large restructuring arrangements is the need to supply the borrower with new medium-term credits or, as it is often called, fresh money. The amount so required is often expressed as a percentage of the lending banks' current exposure to the borrower, although it should be emphasised that there is no legal obligation upon any of the creditors to provide funds for the new money agreement. Most banks recognise, however, that they will have to carry rescheduled debt for several years, particularly in the case of sovereign debt. In addition, they recognise the need to provide fresh credits to various state and corporate borrowers, until more stable repayment positions can be achieved. Without the new money agreements it is difficult to see how many of the recent rescheduling agreements could have been reached.

4.149 The fresh money is normally provided in predetermined stages and, for obvious reasons, a considerable degree of control is exercised over the borrower's ability to draw down the fresh money. For this reason the new money agreement is normally kept as an independent obligation, entirely separate from the old money documents.

Key provisions of the restructuring process

4.150 The documentation evidencing both the rescheduling and new money agreements will contain many of the clauses commonly found in international loan agreements, although the precise wording of the various clauses may differ to reflect the bargaining position of the respective parties. In most cases, therefore, the documentation will be drafted heavily in favour of the lenders.

4.151 A fundamental principle exposed by these agreements is that the lenders which acquiesce to the restructuring arrangement will, in return, be repaid on a fair and reasonable basis. In other words, they will be given parity of treatment vis-à-vis those creditors with comparable indebtedness whose debts have not been included within the rescheduling. Comparable indebtedness, therefore, encompasses any other debt which satisfies the criteria used to identify the debt being rescheduled, but which, for some reason, is not so rescheduled on similar terms. In addition, the borrower will be expected to meet its non-rescheduled obligations in the terms outlined during the restructuring negotiations. Preferential payment of such debt will obviously be disadvantageous to those lenders which agree to reschedule their own credits.

4.152 In order to promote parity of treatment, certain contractual provisions have become a common feature of the restructuring documentation. The precise wording of these clauses will obviously be tailor-made for each particular restructuring and, for present purposes, some general principles will be highlighted.

Comparable indebtedness covenants

4.153 One method of achieving parity of treatment for different categories of comparable indebtedness is to ensure that the debtor expressly undertakes, within the restructuring agreements, not to pay comparable indebtedness' without the consent of the lenders whose credits are rescheduled.

4.154 A major practical problem with this type of clause is that it will be difficult to monitor. Additionally, it may not be feasible for the debtor to comply with such a clause, since it may have the effect of disrupting its trading activities and thus be counter-productive insofar as the rescheduling lenders are concerned.

4.155 The clause may also pose legal problems in that any attempt to enforce such a covenant may, under English law, lay the lenders open to an action in tort for inducing the debtor to breach contractual obligations owed to third party creditors.

Mandatory prepayment provisions

4.156 Another method by which the lenders may attempt to impose parity of treatment is by incorporating mandatory prepayment provisions within the restructuring documentation. Such provisions are similar to the sharing clauses which are commonly found in syndicated loan agreements and require that a reduction in the exposure of third party creditors must be accompanied by a pro rata reduction in the exposure of those lenders whose credits have been rescheduled. The precise wording of the pro rata clause may vary and in some cases a mandatory prepayment will only be required if so requested by the lenders, or at least the majority of them.

4.157 Alternatively, a letter of priority could be drafted between the lenders whereby one party is given priority in repayment, normally in return for advancing further moneys. As there can be doubts as to whether the other banks will be receiving consideration for this a deed of priority may be used instead to guarantee enforceability.[45]

Other clauses which seek to maintain parity of treatment

4.158 In addition to the clauses already identified most restructuring agreements will contain, negative pledge clauses, pari passu sharing clauses and cross default clauses, the purpose of which will be to prevent discrimination and preserve equality as between creditors of the debtor. All of these clauses have been considered in detail elsewhere in this work and will not be dealt with any further here.

Availability of foreign exchange

4.159 In the case of most sovereign restructurings the crisis which led to the need to restructure will usually have been precipitated by an insufficient supply of foreign exchange to service the country's external debt. The immediate response of most governments when faced with a major debt crisis is to impose exchange control regimes with varying degrees of stringency. A sovereign state will obviously control the movement of foreign exchange following the introduction of such a regime and it will, therefore, be open to the sovereign to manipulate the allocation of foreign exchange to various state entity borrowers, for example, public corporations. It will be crucial in such a case for the lenders to inhibit the sovereign's power of discrimination with regard to foreign exchange, although in practical terms few sovereigns will be prepared to guarantee the availability of foreign exchange.

Importance of supra-national organisations

4.160 There are at least three supra-national organisations which play an important role in sovereign restructuring negotiations. The Bank for International Settlements is often called upon to provide bridging finance whilst the recovery plan is being worked out and the World Bank has over the years developed a high level of expertise in supervising sovereign restructurings. It is without doubt, however, the International Monetary Fund (IMF) which plays the most important role.

4.161 IMF membership will be vital to enhance a sovereign debtor's credit standing, and it is common for IMF membership to be a condition precedent in restructuring arrangements. Acceptance of any IMF recovery plan will also normally be a condition precedent and compliance with its terms a condition subsequent. The IMF will also play an important role in the dissemination of information concerning the debtor's financial condition, and its recovery scheme often becomes the cornerstone of the restructuring negotiations, with events of default in the new agreements commonly linked to the debtor's performance under its terms.

4.162 Despite all the criticisms which have been levelled at the IMF's role in the international debt crisis its importance within the restructuring process cannot be over-emphasised, and in many cases official creditors and commercial banks will simply refuse to commence restructuring negotiations until a recovery programme has been agreed between the IMF and the debtor country.


4.163 There can be little doubt that restructuring arrangements pose innumerable problems for those conducting negotiations on behalf of commercial bank creditors. This chapter has considered just a few of these difficulties, an extensive treatise being impossible owing to the ad hoc manner in which the arrangements are usually conducted. Each particular debtor, be it a corporate or a sovereign state, will have its own idiosyncratic problems, and it will be the job of the bankers, together with their lawyers, to address these problems in the restructuring agreements which are finally worked out.


4.164 In domestic transactions the taking of security is straightforward. In international transactions it is less common, in part because of the tendency for lenders to rely more on credit ratings, as discussed above, and in part because of the cost and inconvenience of enforcing cross-border security in many instances. In addition the borrower may have provided negative pledge obligations to a previous lender (see above). Security may be taken in specialised areas such as project finance, and ship or aircraft finance but the specifics of this are beyond the scope of this book. In the case of bond issues and syndicated lending (see relevant chapters) security may be taken and will in these instances be held by a trustee.

4.165 The reason for taking security is of course so that the lender can take priority over other lenders in the event of the borrower's insolvency and attach the assets that have been secured to take back the money owed to them. In the event of a Sovereign borrower (see Chapter 3) the lender may find a greater degree of reluctance to provide security to provide against the borrower's insolvency or a decision being taken not to repay the debt. In this event the lender will be able to enforce the debt against assets owned by the borrower provided an appropriate waiver of immunity clause was included. Typically these might be bullion, investments or trade receivables due to the borrower which are outside the borrower's state. Alternatively, security might be held simply to enable the lender to take control of and manage the property or even the business of the borrower. This could arise as a result of a floating charge, or where real property is concerned through the appointment of a Law of Property Act receiver.[46] Another reason for taking security may simply be to stop other lenders coming later and acquiring it. As seen this would be considerably safer than relying on a negative pledge clause.

Conflict of laws issues and security

4.166 If security is taken, the issue of which country's law shall apply may arise. This is a particular problem with movable assets such as ships and aircraft. With immovable assets such as land the problem is less common but may still arise where the security is provided in one jurisdiction for a loan in another.

4.167 Tangible movables are governed by the law of the place where the assets are at the time of the transfer[47] and the following key principles apply.

  • The validity of an expropriation or transfer of title – which would include the granting of a security interest – is governed by the law of the state in which the asset is situated at the time of the expropriation or other transaction, even if the asset is otherwise taken out of that state. The rule is subject to some exceptions such as where the foreign law is penal, oppressive or morally repugnant.

  • An English court will not recognise the validity of any expropriation, disposition or transaction affecting a proprietary interest in movables according to the law of one state if the asset is outside that state at the time of disposition unless that disposition also conforms with the law of the state in which the asset is at the time of the transaction.

4.168 In the case of ambulatory movables such as ships and aircraft the UK approach is to apply the law of the flag to issues relating to transfer and security. A problem however arises. If the lex situs of an asset originally determines its transfer and the validity of any security, and the asset then moves to another state, the state in which the asset is now located may treat its own law as having an overriding effect. Some states do this in relation to any creditor in their own jurisdiction while others only do so in the case of a bona fide purchaser of an asset there. In some states jurisdiction will be held to apply only in the case of further dispositions of the property. In many states the host state will not recognise charges over ambulatory assets unless the lender has taken possession subsequent to the charge. In some states the doctrine of constructive possession applies where the mortgage controls the indicia of possession such as the key to a building. It may also be recognised where a third party controls the movable and promises to hold it for the benefit of the mortgagee. Sometimes possession of documents of title is regarded as equivalent to possession, eg by possessing bills of lading.

4.169 In the case of intangible assets matters are more complex as in the UK security is usually taken by a floating charge or occasionally a bill of sale. The latter requires the assets to be specifically described and the details must be registered at the High Court within seven days of the bill's creation.[48] Attempts were made over a number of years by many lenders to take a fixed charge over intangible assets, primarily books debts owed to the borrower. This cause of this is that on the borrower's insolvency a lender holding a fixed charge is in a much stronger position than one holding a floating charge. However, in National Westminster Bank plc v Spectrum Plus Ltd[49] the House of Lords (with seven judges sitting) determined that this could not be done. This was because the charger had not been deprived of access to the proceeds of the debts when they were paid. It required a full denial of access to satisfy the final requirement in Re Yorkshire Woolcombers Association.[50] The requirements there were that for a floating charge to be successfully taken it had to be over a class of assets, which changed from time to time and which the borrower could not access. It was insufficient to impose a partial restriction[51] and also insufficient to divide them into debts and their collected state.[52] The account must effectively be blocked, with the option by the chargee to release them at their own discretion. Alternately a fixed charge could be taken by the charger assigning the proceeds to the chargee.

4.170 Floating charges remain, therefore, as the main source of security over book debts and future acquired property. It exists as an equitable interest and requires registration at Companies House in the same manner as a fixed charge. However, a fixed charge created after the floating charge will still take precedent as will any preferential debts and liquidator's costs. Problems arise in the case of overseas assets as many civil law jurisdictions do not recognise floating charges.

4.171 A detailed analysis of charges is beyond the scope of the book, however it is possible to isolate key problems that arise in the taking of security on an international basis.

  • Does the borrower have unencumbered title to the asset concerned? In the case of land the relevant registers should be checked. In the case of aircraft the Civil Aviation Authority register, or overseas equivalent, should be checked and in the case of ships the register in the port where they are registered. This is in addition to a search being done of the company which owns the asset at Companies House (or the overseas equivalent).

  • Has the borrower the power to grant security? Ultra vires is no longer generally an issue with UK companies, or a considerable number of foreign ones, but even in the United Kingdom such issues can arise with companies created by Act of Parliament, companies created by Royal Charter and companies where a statute may impinge on their contractual powers. In addition it should be considered whether the security been properly authorised by the directors.

  • Does the security contradict any negative pledge provided to a third party? There may be evidence of this in the wording of any charges registered against the borrower at Companies House. Breach of this could put the borrower in default of that agreement and potentially in cross default of other term loans and derivative contracts.

  • Is it property that can only be covered by a floating charge? Some countries do not recognise floating charges and some do not recognise charges over future acquired property. Others may recognise such a state of affairs as a contractual obligation but not as a property right conferring priority.

  • What are the registration procedures and what is the legal position if registration does not take place? Is the charge void or if not how does it affect priorities?

  • Should the security be held by a trustee? This may be necessary in the case of a bond issue or where there is a syndicated loan. If there is a trustee will all jurisdictions involved recognise his existence and if not will they view him as either the owner of the property or see it is an agent and principal relationship?

  • If there is a clause in the secured agreement prohibiting prepayments or limiting how they may be applied there may be problems in some jurisdictions where the borrower will still be able to pay the loan off as they wish. The choice of law and jurisdiction clause should however retain the contract within a known jurisdiction where possible.

  • Is stamp duty payable and if so by whom?

  • Will the court concerned have jurisdiction to enforce security? In the United Kingdom that is not likely to be a problem even with sovereign borrowers provided they have signed a contract with a suitably worded waiver of immunity and enforcement clause (see Chapter 3).

  • What remedies are available on default? Can the asset be sold and if so is there a limitation on how. In some states it must be sold by auction. Are any duties imposed on the party enforcing the charge when selling? Does the lender become the owner or do they just take possession and in the latter case do they keep any income or do they have to account for it? Are exchange controls going to be an issue when it comes to repatriating the money?

  • Maintenance of value clauses can be inserted so that additional property must be secured if the value of the collateral falls below a certain figure. Some states do not recognise these; some do but only if the class of assets concerned are defined. If an attempt is made to take the additional security too close in time to the borrower's insolvency there can also be problems.

  • Must the mortgage debt be expressed in the currency of the state local to the asset even if that is not the currency of the loan? If that is the case some type of indexation arrangement will be necessary associated with a maintenance of charged assets clause. There may also be issues with both in some states.

The obvious solution is to take legal advice from a firm of solicitors in the state where the assets are situated. Where large international legal practices are concerned such arrangements can be made internally.

Guarantees in international term loans

4.172 The matter of guarantees as a general issue is beyond the scope of a text on international banking law. However, certain issues arise. The obvious purpose is to cover the scenario where the primary debtor cannot repay and, therefore, a secondary one is sought to commit themselves to do so by the lender. This might be sought from another company in the group or more commonly an omnibus guarantee from all the companies in the group.[53] A second reason is to make sure that a parent company exercises close control over a subsidiary because they have given a guarantee on their behalf or that the directors do because they have given personal guarantees. In some cases a guarantee may be sought from a central bank to secure non-interference in the event of exchange controls being brought back in or to stop a change in that state's law to the detriment of the lender. In any of these events the guarantee is also needed to give the lender a right over any security that is taken from a parent company or director as otherwise there is no legal basis for claiming against it.[54]

4.173 Although the term 'guarantee' is widely used in practice many banks use a form of words that renders the so-called guarantor a primary obligor to settle the debt.[55] Such an arrangement is called an indemnity.[56] The third possibility is a letter of comfort where a non-legally binding quasi-guarantee is given. The attraction of this to the 'guarantor' is that the arrangement will not appear on their balance sheet as a contingent liability. Normally large companies will stand by such obligations due to the damage to their reputations if they do not. This is not always the case however.[57]

4.174 In some cases the guarantee may be a more complex document including some of the terms normally found in the term loan agreement itself. This would occur where the lender wished to keep a close eye on the guarantor. Typical clauses would be covenants, a negative pledge, an undertaking to provide financial and other information, representations, warranties and grossing up clauses. If it is a syndicated loan the guarantee should have pari passu and sharing causes. Normally the guarantee will be made subject to the same law and jurisdiction as the loan agreement so that a single action could be brought against the borrower and the guarantor.

4.175 If the guarantor is independent of the borrower and has not got the capacity to control him, additional terms will be included. A grace period is often provided so that the guarantor only has to pay a claim a set number of days after the maturity of any claim. This is to give the guarantor the opportunity to cure the borrower's default and thus the guarantor can be sure there is a genuine default before they pay. It is also not uncommon for the guarantor to object to being made liable for costs such as commissions, fees, liability under indemnities and grossing up clauses and in such cases the lender may agree to make the guarantee cover only the loan and interest. One possibility could be to get the guarantor to agree to adopt the loan in the event of it not being paid on schedule by the debtor. It is also a good idea to include a clause that prohibits the guarantor from applying sums received from the debtor to sums that the guarantor has not guaranteed. This can be extended to sums received by set off or from other security.

4.176 In addition, the lender may not be able to accelerate on the debtor's default without calling on the guarantor first and this may be coupled with the period of default referred to above. If there is a default it may be provided that the lender shall take all steps to minimise his losses and that he shall first proceed against the debtor perhaps on the guarantor's direction and only then against the guarantor. The guarantor may reserve the right to substitute himself as the creditor by purchasing the debt from the lender at any time, so that if there is evidence of a likelihood of the debtor defaulting, the guarantor can proceed against the debtor's assets immediately. Assignment of the debt by the debtor may also be prohibited as the identity of the debtor and their credit rating may be the very reasons the debt is being guaranteed.

4.177 A guarantor, and especially one with no control over the guarantor may wish to have a greater degree of control by requiring that the lender keep them informed concerning any matter that may affect his liability. This clause will of course require the debtor's consent because of the doctrine of banker-customer confidentiality.[58]

Legal problems

4.178 The formalities need to be observed, namely that a guarantee must be in writing. This is not the case with an indemnity but given the realities of international banking it always will be reduced to a written contract.

4.179 Capacity is also an issue. In some states this is more likely to emerge as an issue than in others and it should be remembered that capacity will be governed by the law of the state in which the company is domiciled not that of the loan agreement when this is different.[59] Where the primary debt cannot be enforced, someone accepting a secondary liability will not be liable either. This is another reason for having the 'guarantor' accept primary liability as an indemnifier.

Other considerations with guarantees

4.180 Key issues to be considered are as follows:

  • The governing law and jurisdiction should both preferably be the same as that governing the loan itself.

  • The consideration should be stated to avoid running foul of the rule against past consideration.[60]

  • The guarantee should be expressed to be a continuing obligation covering all liabilities of the principal debtor. This avoids the rule in Clayton's case[61] by preventing the guarantor's liability becoming fixed when the debtor becomes liable for a particular sum.

  • There should be protective clauses to allow the lender to modify the obligations of the debtor without discharging the guarantor. Without this any modification would discharge the guarantor.[62]

  • There should, when appropriate, be a clause enabling the lender to release a co-guarantor without discharging the other(s).

  • There should be clauses enabling the lender to release security or deal with it without releasing the guarantor, and so that the security continues to be security for non guaranteed debts even though the guarantor may have paid the non-guaranteed debts off. In effect the guarantor's rights of subrogation are excluded.

  • There should be a clause enabling the lender to pay sums received from the guarantor into a suspense account.

  • There may be a 'conclusive evidence' clause enabling the lender to state what the guaranteed debt is so that the guarantor cannot then challenge this.

  • The guarantee may be for a limited sum or the 'whole debt' or for the whole debt with a provision limiting liability.

  • The guarantee can be for a limited duration or for or a specific transaction, or it may be continuing.

Comfort letters

4.181 As already discussed these are given by a party who does not wish to become legally bound and it is often provided by a parent for a subsidiary or one company in a group to another. Generally speaking, they begin with a statement that the comforter is aware of and approves the proposed loan or transaction and then states that the parent agrees to maintain an interest in the borrower's share capital, and will give some financial support. They may promise to maintain good management and not to take assets or money from the subsidiary. Clearly such a state of affairs is not desirable from the lender's point of view.

4.182 In the United Kingdom, such letters are not normally binding but those drafting such an agreement for a firm providing the letter must be careful with the wording to make sure that, unintentionally, the agreement does not end up being unenforceable. Essentially in England and Wales a document clearly stated not to be legally binding will be treated in this way by the courts.[63]

4.183 It is wise to use terms such as 'this agreement is binding in honour only and does not constitute legally binding contract'. A common wording is, 'It is our intention (or policy) to do …', but this seems less safe. It should not however be assumed that if the term 'letter of comfort' is used in the heading or the document that this will stop it becoming legally enforceable. The content and the wording of any related documents could have the opposite effect.

4.184 There are additional legal issues that may help protect a party providing a letter of comfort, for example the English law requirement that the terms of a contract must be sufficiently certain for a court to enforce it. The vagueness of many letters of comfort could well result in this rule determining that they are not enforceable.

4.185 This is a more complex problem where an overseas jurisdiction may be involved and local advice will be needed by the comforter's solicitors to make sure it is not legally binding there.

[1] London inter-bank offered rate.

[2] Euro inter-bank offered rate.

[3] [2002] 1 WLR 685, 2 All ER 248.

[4] The Chikuma (1981) 1 AER 652.

[5] Libyan Arab Foreign Bank v Manufacturers Hanover Trust Co (No 2) [1988] 2 Lloyd's Rep 494.

[6] Law of Property Act 1925, s 136.

[7] Clayton's Case or Devaynes v Noble (1916) 1 Mer 259.

[8] Russell-Cook & Trust Co v Prentis [2002] EWHC 227.

[9] South African Territories Ltd v Wallington [1898] AC 309.

[10] Moschi v Lep Air Services Ltd [1973] AC 331.

[11] McDonald v Denny Lascelles Ltd [1933] 48 CLR 457.

[12] Bank of Boston Conneticut v European Grain & Shipping Ltd [1898] AC 1056.

[13] Hadley v Baxendale (1854) 9 Exch 341, Kipohraror v Woolwich Building Society [1996] 4 All ER 119 and Jackson v Royal Bank of Scotland plc [2005] UKHL 3.

[14] Companies Act 2006, s 39.

[15] Companies Act 2006, s 40(4).

[16] Companies Act 2006, s 40.

[17] In the case of a contract entered into by an overseas company, subject to English law, it is the law of the home state of that company that will determine whether it is enforceable. Merrill Lynch v Municipality of Piraeus [1997] CLC 1214.

[18] Pym v Campbell (1856) 6 E & B 370; Wood Preservation v Prior [1969] 1 WLR 1077, [1969] 1 All ER 364; North Sea Holdings NV v Petroleum Authority of Thailand [1997] 2 Lloyd's Rep 418.

[19] Gabriel, Legal Aspects of Syndicated Loans (Butterworths. London, 1986), p 44 .

[20] Smith v Butler [1900] 1 QB 694; Felixstowe Dock and Railway Co v British Transport Docks Board [1976] 2 Lloyd's Rep 656; Alan Estates Ltd v W G Stores Ltd [1981] 3 WLR 892.

[21] MacKay v Dick (1881) 6 App Cas 251; Re Anglo-Russian Merchant Traders [1917] B 679.

[22] Indeed, due to the requirements of rr 7 and 8 the Money Laundering Regulations 2007 in the United Kingdom and equivalent laws covering financial institutions in virtually all states, this is now obligatory.

[23] Companies Act 2006, s 21(1).

[24] Docker v Hyams [1969] 1 Lloyd's Rep 333, [1969] 3 All ER 808.

[25] Oscar Chess v Williams [1957] 1 WLR 370; Dick Bentley Productions Ltd v Howard Smith (Motors) Ltd [1965] 1 WLR 623.

[26] Hong Kong Shipping v Kawasaki Kisen Kaisha [1962] 2 QB 26.

[27] Ibid.

[28] For a more detailed discussion of this see P Wood International Loans, Bonds, Guarantees, Legal Opinions (Sweet & Maxwell, London, 2007) pp 88 -91.

[29] Multicurrency Term and Revolving Facilities Agreement, cl 22.3.

[30] National Provincial and Union Bank of England v Charnley [1924] 1 KB 431. P Watts, 'Guarantees undertaken without the request of the debtor' [1989] 1 LMCLQ 9, and Gabriel Legal Aspects of Syndicated Loans Vol II (1980) pp 85–90. J Stone 'Negative Pledge Clauses and the Tort of Interference with Contractual Relations.' [1991] 8 JIBL 370.

[31] Dearle v Hall (1828) 3 Russ 1, 38 ER 475 LC.

[32] Bond Brewing Holdings v National Australia Bank [1990] 1 ASCR 445.

[33] J Stone, 'Will the Court appoint a Receiver at the request of a Negative Pledge Lender?' [1991] 10 JIBL 405 and D Allan 'Negative Pledge Lending – Dead or Alive? How to reinvent the mortgage' [1990] JIBL 330.

[34] Clause 23(1)(a).

[35] Ralli Bros v Compania Naviera Sota, Sota v Aznar [1920] 2 KB 287; Foster v Driscoll [1929] 1 KB 470.

[36] Tekron Resources Ltd v Guinea Investment Co Ltd [2003] EWHC 2577 (QB), [2004] 2 Lloyd's Rep 26; Mahonia Ltd v JP Morgan Chase Bank (No 1) [2003] EWHC 1927 (Comm), [2003] 2 Lloyd's Rep 911; Mahonia Ltd v JP Morgan Chase Bank (No 2), Mahonia v West AG [2004] EWHC 1938 (Comm); Baros Mattos Junior v MacDaniels Ltd, Mattos Junior v General Securities & Finance Co Ltd [2004] EWHC 1188 (Ch), [2004] 3 All ER 299 & 2 All ER (Comm) 501; Marlwood Commercial Inc v Kozeny [2006] EWHC 872 (Comm).

[37] Clause 11.2.

[38] Mamidoil-Jetfoil Greek Petroleum Co SA v Okta Crude Oil Refinery AD [2003] 1 Lloyd's Rep 1.

[39] Clause 29 ibid.

[40] P Wood The Law and Practice of International Finance (1st edn, Sweet & Maxwell,1980) p 173.

[41] Morris and others v Rayners Enterprises; Morris and others v Agrichemicals Ltd also known as Re Bank of Credit and Commerce International SA (in liquidation) No 8 [1998] AC 214, [1997] 3 WLR 909.

[42] Clark 'Problems and Solutions to Sovereign debt Restructuring' (1984) IFLR (October) pp 4–8 and Horn 'The Restructuring of International Loans and the Debt Crisis' (1984) IBL 404–409.

[43] Horn ibid.

[44] Hirachand Punamchand v Temple [1911] 2 KB 330; Barrett v United-Island Records Ltd [2006] EWHC 1009 (Ch).

[45] Re SSSL Realisations (2002) Ltd [2004] EWHC 1760 (Ch).

[46] Section 109.

[47] Cammell v Sewell (1860) 5 H&N 728; Inglis v Robertson [1898] AC 616.

[48] Bills of Sale Act 1878, s 10.

[49] [2005] UKHL 41, [2005] 4 All ER 209.

[50] [1903] 2 Ch 284.

[51] Re Cosslett (Contractors) Ltd [1998] Ch 495.

[52] Re New Bullas Trading Ltd [1994] 1 BCLC 485.

[53] Often in the form of an omnibus guarantee and set off which will usually have security attached.

[54] Birkmyr v Darnell (1704) 1 Salk 27; Moschi v Lep Air Services Ltd [1973] AC 331; Argo Caribbean Group Ltd v Lewis [1976] 2 Lloyd's Rep 286; General Produce Co v United Bank Ltd [1979] 2 Lloyd's Rep 255.

[55] Davys v Buswell [1913] 2 KB 47.

[56] In practice bank documents are usually hybridised in that the guarantor both agrees to guarantee the borrower's debt and also to be primarily responsible for payment.

[57] Kleinwort Benson v Malaysia Mining Corporation [1989] 1 All ER 785

[58] Tournier v National Provincial and Union Bank of England [1924] 1 KB 461.

[59] Merrill Lynch v Municipality of Piraeus [1997] CLC 1214.

[60] Roscorla v Thomas (1842) 3 QB 234 subject to the limitations in Pao On v La Yiu Long [1980] AC 614.

[61] Devaynes v Noble, (Clayton's Case) (1816) 1 Mes 572.

[62] Marubeni Hong Kong & South China Ltd v Mongolian Government [2004] EWHC 472, 2 Lloyd's Rep 198, QBD.

[63] Jones v Vernon's Pools [1938] 2 All ER 626; Rose & Frank Co v Crompton & Bros Ltd [1923] 2 KB 657.

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