This article first appeared in Corporate Rescue and Insolvency journal, April 2014. It was co-written by Ben Jones and Eva Holden of BLP's Restructuring & Insolvency team.
The economic interests of syndicate lenders are increasingly disparate. Where original lenders have traded their debt at a discount, those lenders who bought in below par will see value in a recovery which is inadequate to repay the debt in full, provided the recovery is sufficient to clear their acquisition cost. Enforcement may be attractive to a lender who has bought into the debt at a discount where it delivers a swift and profitable exit or creates the option for taking ownership interests. An original lender may however be prepared to take a longer term view if that will enhance its overall recovery and avoid crystallising current losses. Even if the debt has not been traded, variations in lender policy on an institutional basis in response to factors such as increased cost of capital, appetite for risk and the level at which each institution has provided for any anticipated shortfall will influence a lender’s commercial position. The disparity between lenders’ interests has exacerbated the difficulty in reaching agreement amongst the syndicate, sometimes leaving lenders deadlocked; an uncomfortable position for both lenders and borrowers, particularly in an already distressed scenario. It was particularly a common feature of real estate re-financings in 2007/8 for facilities to be prepared on a syndicated basis for flexibility, with the original lenders taking 50:50 commitments. Based on the LMA standard syndicated loan agreement, this effectively renders all decision-making unanimous.
The LMA approach
The standard approach to voting in syndicated loan agreements centres around a majority lender concept, typically set at two thirds of the total commitments. Subject to a number of specific entrenched rights which require agreement of all lenders to amend or vary, this majority will be able to agree amendments and waivers, or to exercise any powers contained in the finance documents in the lenders’ favour, without having to obtain unanimous agreement.
As original debt participations have increasingly changed hands in the secondary debt market, investors have sought a greater degree of flexibility in relation to voting arrangements. To minimise the likelihood that a small minority will be able to frustrate the objectives of the majority, an increasing number of decisions can be made on behalf of all lenders by the majority.
Trends in facility documentation
These clauses are designed to enable the agent to disregard for voting purposes the commitment and participation of any lender whose consent it seeks but who does not reply to the agent within a specified timeframe following notification of the relevant request. The LMA has provided suggested optional wording in its recommended form of leveraged loan agreement, most commonly applied in relation to amendments or waivers. However this is only of help if a lender does not or is not able to respond to a request (e.g. a CLO). It will not assist in circumstances where lenders are actively opposed to a course of action and respond on that basis.
Yank the bank
These provisions allow borrowers or other lenders to force a lender to transfer its commitments or to accept prepayment in certain circumstances, such as if that lender did not agree to a requested amendment or waiver. The LMA standard language provides for forced transfer in prescribed circumstances but this is commonly applied as a class action, such that it would require support of the majority of a lending class before a lender could be ‘yanked’. The lender that is ‘yanked’ will typically be paid the face value of its debt. Where the borrower is in distress and lenders may not get a full recovery on their debt, the cost/benefit of using this provision to remove a disruptive or non-aligned lender will need to be considered carefully and balanced against the cost of any alternatives, such as using a scheme.
The concept of permitted structural adjustments allows the majority lenders to approve certain amendments to the finance documents which would usually be entrenched and require all lender consent, such as provision of an additional tranche of debt or increase in existing (usually senior) commitments. This will usually require an additional economic outlay, which may be unattractive if a lender is already facing a shortfall on their existing exposure, but can be useful to bridge a temporary cash flow shortfall during restructuring negotiations and may enable a lender to get the upper hand if the documentation allows for creation of a voting super-senior tranche. As majority lender agreement is likely to be required in order for a lender to access these provisions however, they will typically be of limited value in a deadlock scenario.
Schemes of arrangement
A scheme of arrangement under Part 26 of the Companies Act 2006 permits a company to make an arrangement or compromise with its creditors (or any class of them) which will be binding on all of them if approved by the requisite majority and sanctioned by the court. Increasingly this procedure has been used to amend loan terms where unanimous consent is needed but cannot be obtained. A scheme proposal will require the approval of 75% by value and 50% by number of each class of creditors. In the context of a scheme targeted at amending the terms of the finance documents, the lenders will be grouped into classes based on their legal rights. Lenders whose rights are sufficiently similar such that it is not impossible for them to consult together with a view to their common interest will form one class, irrespective of their economic interests or motives, which may differ widely. In a 50:50 ‘club’ loan where the lenders have equal rights, they will together form a single class and a scheme of arrangement will not break the deadlock. Where however there has been significant trading of debt in the secondary markets and the debt is held widely, a scheme can be a very useful tool for borrowers who have the support of the majority of lenders to cram down minority ‘hold outs’ and drive a restructuring forward although numerosity issues can arise if a lender of record has divided its larger participation into multiple lots which have been acquired by multiple secondary debt investors.
Where does this leave lenders
Hedging arrangements do not typically carry voting rights, except where amends are proposed which directly affect or prejudice the hedge provider’s rights under the hedging arrangements. Hedging liabilities often rank super senior in the waterfall and therefore hedge providers may have leverage in negotiations if they are entitled to terminate the swaps and crystallise a substantial mark to market position ahead of the senior lenders. This can be particularly divisive where the hedge provider is also a participant in the debt.
A typical LMA leveraged loan agreement will provide that the agent (and security trustee) is obliged, unless otherwise provided, to exercise any right, power, authority or discretion vested in it as agent in accordance with any instructions received from the majority lenders. In a loan which is participated 50:50, consent of both lenders will be required in order to amend the facilities or take steps to accelerate or take enforcement action in respect of outstanding indebtedness.
In the absence of majority lender instruction, the agent will commonly retain discretion under the documentation to act (or refrain from taking action) as it considers to be in the best interests of the lenders. However, in the absence of an express obligation to do so, in practice it would be unusual for an agent to rely on this discretion to accelerate a loan or to commence enforcement of security held in respect of a loan without majority lender instruction, especially if there is no immediate risk of value dissipating through inaction (ordinarily the case where the underlying asset is real estate). Whilst the agent commonly benefits from extensive exculpatory provisions as well as an indemnity from the lenders absent any gross negligence or wilful misconduct on its part, to exercise its discretion without a clear mandate from the lenders would expose the agent to increased risk of criticism or challenge from a dissenting lender.
The duties of an agent to the finance parties that it represents is increasingly being tested, perhaps influenced by the growing number of US investors entering the UK secondary debt market accustomed to the concept of a universally implied ‘good faith’ obligation.
Whilst recent case law has resisted an extension of the agent’s duty on a wider fiduciary basis beyond that expressly set out in the relevant finance documents, the exercise of an agent’s discretion will be subject to established principles which limit the parameters within which that discretion should properly be exercised. Although not specifically considered in reaching their decision, the most recent case considering an agent’s duty included judicial commentary to the effect that omission by an agent to act in exercise of its judgment or discretion could potentially amount to gross negligence if to take the action it omitted to take was the only rational course. Whilst these comments indicate that it may not always be appropriate for an agent to take a completely passive role, they will not sit comfortably alongside the currently accepted position that an agent’s duties are restricted to the express contractual obligations imposed upon them. Increased scrutiny and the perception of any shift, however slight, will do little to encourage agents to adopt anything other than a conservative view regarding their obligations.
Winding up petition
Whilst liquidation is a collective procedure for the benefit of all creditors, secured and unsecured, and not simply a debt collection method, this does not mean that winding up is not available as a means of seeking repayment of debt which is properly due and payable and is not the subject of a bona fide substantial dispute. If a debt due from a company to a creditor is due and payable, the fact that the creditor is secured in respect of that debt does not prevent the creditor from petitioning for the company to be wound up. A statutory demand can be served by a secured creditor and a secured creditor does not ordinarily have to decide until after the winding-up order is made whether to rely on their security or whether to place a value on their security and participate for any balance on an unsecured basis. It is a matter of construction of the finance documents whether the individual lenders are restricted from presenting a winding up petition, bearing in mind that an application by a secured creditor to wind up a company is not technically an action to enforce the security, unless expressly included in the definition of enforcement action in the finance documents.
A standard LMA leveraged loan agreement does not contain express provision restricting a lender’s ability to present a winding up petition against the borrower. Typically majority lender instruction to the agent on an event of default will be required in order to accelerate or demand repayment of the loan. The winding up petition would need to demonstrate an inability to pay. A debt may become due and payable such that it could form the basis of a winding up petition without the need for acceleration and/or demand, for example on expiry of the term or following failure to make scheduled repayments of principal or interest. Restrictions on enforcement action as between the finance parties are most commonly contained in an intercreditor deed. An intercreditor agreement will typically restrict junior/subordinated creditors from interfering with the interests of senior lenders, so is not likely to regulate the position between individual lenders in a 50:50 single class loan. Often the security documents themselves will contain a requirement for demand to be made prior to enforcement rights becoming exercisable, but this will not prevent a lender seeking repayment by means other than enforcement of the security.
The court has a discretion in all cases whether to make a winding up order or not and it is an abuse of process to present a winding up petition for an improper purpose. Depending on whether a petition is threatened or has already been presented, an aggrieved party could seek an injunction restraining presentation or advertisement of the petition, could seek to have an advertised petition struck out pre-hearing or could ask for petition to be dismissed at the substantive hearing. Should a petition be opposed, the court will consider the opposing views and in reaching its decision will give less weight to fully secured creditors on the basis that they would have a limited interest in the liquidation.
Whilst the ability of an individual lender to precipitate insolvency of a borrower on a unilateral basis may appear to be inconsistent with the majority lender principle enshrined in the finance documents, a creditor may bind himself contractually not to present a petition so that, as between sophisticated lenders, the court will be reluctant to assist if the parties have failed to include express ‘no action’ language between themselves. If the contractual documentation is inadequate to restrict the presentation of a winding up petition by a lender, this may provide one lender with significant leverage over the other. Given the public nature of a winding up petition, it may not be necessary for a lender to proceed with presentation. Indeed a lender should be mindful of the risk that a 3rd party creditor could take carriage of their petition if advertised, preventing the lender from withdrawing the petition pre-hearing if agreement is reached within the syndicate and their objective is achieved. Additionally, the practical implications of presenting a winding up petition should be considered, as the borrower will be restricted from making dispositions from the point of presentation. In an otherwise deadlocked scenario, the threat of unilateral action by an individual lender may be sufficient to elicit engagement towards a collective enforcement strategy. Alternatively, this could assist a lender in negotiating the purchase of the other lender’s commitment at a mutually acceptable discount, paving the way for an exit controlled by a single lender which affords greater flexibility and may maximise recovery further. In addition to providing leverage within the syndicate, the threat of presenting a winding up petition will exert significant pressure on directors of a borrower, particularly in circumstances where there is a risk that the position of any creditor or class of creditor may be worsened by the company continuing to trade. The directors will be cognisant of their duties and the danger of personal liability should their decisions be scrutinised at a later date by an insolvency practitioner with the benefit of hindsight.
Other potential obstacles
A dissenting lender will look to the documentation to resist an unwelcome enforcement.
If the documentation fails to contain a mechanism by which the security trustee can release security following enforcement without seeking all lender consent, this will allow an unhappy lender to fetter the ability to realise value. Where enforcement will be inadequate to repay the debt in full, the equity of redemption will not operate to restrict a lender’s right to refuse to provide a release in respect of their security.
Similarly, if the documentation fails to provide a mechanism by which any balance of debt outstanding post enforcement will be released, the existence of an outstanding debt post enforcement could prove problematic (even if no longer secured) if, for example, a lender’s strategy involved the purchase of the underlying assets at a discount or by way of credit bid higher up the holding structure to minimise tax leakage.
Contractual consultation obligations pre-enforcement would provide the syndicate with forewarning of a lender’s intentions, although failure to consult will generally not invalidate action taken without consultation. This affords the syndicate the opportunity to take defensive steps and/or marshal an alternative strategy and may obstruct the ability to deliver a pre-pack, resulting in their being exposed to market and the practical issues associated with a competitive bidding process.
What does this mean
The terms of the contractual arrangements which govern a loan relationship remain fundamental to determine the options available to lenders. With the traditional approach to voting in syndicated loan agreements typically of little assistance in a distressed situation, particularly if the loan is participated 50:50 and one lender is actively opposed to a course of action, what is left unsaid may provide leverage in an otherwise deadlocked situation.
 Torre Asset Funding Limited and another v Royal Bank of Scotland plc  EWHC 2670 (Ch)
 Socimer International Bank Ltd (In Liquidation) v Standard Bank London Ltd (No.2)  EWCA Civ 116; Redwood Master Fund Ltd v TD Bank Europe Ltd  EWHC 2703 (Ch)
 Torre Asset Funding Limited and another v Royal Bank of Scotland plc  EWHC 2670 (Ch)
 Moor v Anglo-Italian Bank (1879) 10 Ch. D. 681; Re Lafayette Electronics Europe Ltd (2007) B.C.C. 890
 Re Cushing Sulphite Fibre Co Ltd (1905) 37 NBR 254
 Re Carmarthenshire Anthracite Coal and Iron Co (1975) 45 LJ Ch 200
 s.122 and s.125 Insolvency Act 1986
 s.127 Insolvency Act 1986