Professional Documents
Culture Documents
The authors examine the defaulting lender provisions typically found in syndi-
cated credit agreements and risks faced by administrative agents, issuing banks,
and swing line lenders, which are becoming of particular importance during
this time of increasing financial instability.
A
s the financial crisis has unfolded and a wide array of financial insti-
tutions have faced deteriorating financial stability, concern has
increased that lenders participating in syndicated loans may become
unable to honor their funding obligations. Most syndicated credit agree-
ments contain some language dealing with the consequences of a lender’s
failure to fund. Until recently, however, defaulting lender provisions have
not been the subject of much attention. Most syndicated credit agreements
assume solvency of the lenders and their ability to fund. In the current mar-
ket environment, borrowers and financial institutions that take on partici-
pation or funding risk from other lenders (such as administrative agents,
issuing lenders and swing line lenders) have begun to focus serious attention
on the risks imposed by defaulting lenders. The defaulting lender provisions
typically found in syndicated credit agreements and risks faced by adminis-
trative agents, issuing banks, and swing line lenders are of particular impor-
tance during this time of increasing financial instability.
165
Published in the February issue of The Banking Law Journal.
Copyright ALEXeSOLUTIONS, INC.
BANKING LAW JOURNAL
166
Published in the February issue of The Banking Law Journal.
Copyright ALEXeSOLUTIONS, INC.
SYNDICATED LENDING UPDATE
ment lender will probably also request indemnification from the defaulting
lender and assurances from the parties to the credit agreement that no claims
will be asserted against the replacement lender as a result of the defaulting
lender’s failure to honor its obligations.
As an alternative to the traditional “yank-a-bank” remedy, there may be
provisions added to syndicated credit agreements that permit the borrower
to terminate a defaulting lender’s existing commitments and repay its out-
standing loans in lieu of finding a replacement lender. The reduction would
be to the defaulting lender’s commitment only, not a pro rata reduction of
each lender’s commitment. This remedy would be appropriate in a situation
where a borrower is unable to find a replacement lender, but still desires to
remove a defaulting lender from the credit facility. The borrower would
need to have sufficient availability to pay off any outstanding loans by the
defaulting lender.
Voting Rights
Some syndicated credit agreements already provide that a defaulting
lender forfeits its right to vote on amendments and waivers of the loan doc-
umentation. The voting rights that a defaulting lender loses can include
issues that would otherwise require a unanimous vote of the lenders, such as
reductions of principal, interest and fees. However, a defaulting lender gen-
erally retains its right to approve any increase in its commitment.
167
Published in the February issue of The Banking Law Journal.
Copyright ALEXeSOLUTIONS, INC.
BANKING LAW JOURNAL
and that the borrower is relieved of its waiver of the right of setoff because
of the defaulting lender’s breach.
If the borrower desires to not pay the defaulted lender’s commitment
fee, it should enlist the support of the administrative agent. Some agents
have been willing to allow the short paying of the commitment fees. If the
credit agreement provides, as some do, that commitment fees are payable on
the aggregate unused commitments, and the fees are to be divided pro rata
to the lenders based on their individual commitments, the agent will be less
likely to cooperate.
Breach of Contract
A borrower could elect to sue a defaulting lender on a breach of contract
claim. In order to prevail, the borrower would need to demonstrate dam-
ages resulting from the defaulting lender’s failure to fund, such as a higher
cost of obtaining alternate financing. A borrower should consider that a suit
for breach of contract can be costly and time-consuming and that it may be
difficult to successfully enforce a monetary judgment against a defaulting
lender that is on unsure financial footing or insolvent.
168
Published in the February issue of The Banking Law Journal.
Copyright ALEXeSOLUTIONS, INC.
SYNDICATED LENDING UPDATE
Issuing Lender
Each lender acquires a pro rata risk participation in each letter of credit
issued under a syndicated credit agreement. After a draw on a letter of cred-
it, each lender is responsible for reimbursing the issuing lender by making its
pro rata share of a revolving advance available or by funding its risk partici-
pation in respect of the letter of credit. The issuing lender faces the risk that
a defaulting lender may fail to honor these obligations. Some credit agree-
ments contain language providing that an issuing lender is not required to
issue a letter of credit where a defaulting lender is participating in the facili-
ty unless cash collateral is provided to protect the issuing lender against the
fronting risk imposed by the defaulting lender. This language is not stan-
dard in the marketplace, but issuing lenders are beginning to request it with
more frequency. The provision can place significant hardship on the bor-
rower, which would be forced to post cash collateral in order to have any let-
ters of credit issued while a defaulting lender is participating in its credit
169
Published in the February issue of The Banking Law Journal.
Copyright ALEXeSOLUTIONS, INC.
BANKING LAW JOURNAL
facility. Another protection for issuing lenders that may be included more
frequently in the marketplace is reducing letter of credit availability by the
defaulting lender’s pro rata share of the letter of credit sublimit. This would
protect the issuing lender against fronting risk imposed by a defaulting
lender, but would allow the borrower to continue to rely on the letter of
credit facility to the extent of non-defaulting lenders’ participation.
Issuing banks in synthetic letter of credit facilities also have been taking
borrowers to task for exposure to defaulting lenders. Under a synthetic let-
ter of credit facility, each lender prefunds its risk participation in the letters
of credit and the issuing bank holds a deposit of the prefunded amounts in
a deposit account in which the borrower and the lenders hold no claim or
interest. These accounts were designed to be bankruptcy remote from the
lenders and the borrowers, but we have experienced the issuing banks taking
the conservative view that the defaulting lender may have a right to the
deposit, notwithstanding the express terms of the documents. If the default-
ing lender is in bankruptcy, these issuing banks also seem to believe the auto-
matic stay would prevent the issuing bank from using the defaulting lender’s
share of the deposit to reimburse letter of credit draws. As with traditional
letter of credit facilities, issuing lenders taking this position are attempting
to require borrowers to cash secure the defaulting lender’s share of the letters
of credit if the credit agreement gives the ability to require the borrower. At
some point the rights to these deposits will need to be addressed in the bank-
ruptcy proceedings to validate whether the deposits are not property of the
bankrupt lender’s estate.
170
Published in the February issue of The Banking Law Journal.
Copyright ALEXeSOLUTIONS, INC.
SYNDICATED LENDING UPDATE
required to fund swing line loans even when a defaulting lender is partici-
pating in the credit facility. In some instances, credit agreements provide
that swing line loans are made at the swing line lender’s discretion. This pro-
tects the swing line lender against fronting risk, but is burdensome to the
borrower because the borrower cannot be certain that swing line loan
requests will be honored. An alternative protection to the swing line lender
that may emerge in the marketplace is reducing swing line availability by the
defaulting lender’s pro rata share of the swing line commitment. This solu-
tion would protect the swing line lender against the fronting risk imposed
by a defaulting lender but would allow the borrower to continue to rely on
the swing line facility to the extent of non-defaulting lenders’ participation.
This language has not traditionally been included in credit agreements but
may begin to be more common going forward.
Resignation
Where a defaulting lender is participating in a credit facility, the issuing
lender and the swing line lender may attempt to resign to avoid taking on
future fronting risk with respect to the defaulting lender. Although credit
agreements generally contain language allowing an issuing lender and a
swing line lender to resign their positions, it is typically necessary for a
replacement issuing lender or swing line lender to be located before the retir-
ing issuing lender or swing line lender is relieved of its obligations. Also, a
retiring issuing lender is typically required to remain an issuing lender with
respect to letters of credit issued before its resignation.
171
Published in the February issue of The Banking Law Journal.
Copyright ALEXeSOLUTIONS, INC.
BANKING LAW JOURNAL
172
Published in the February issue of The Banking Law Journal.
Copyright ALEXeSOLUTIONS, INC.