It has been a long but fruitful day. The borrower has just managed to settle the tricky commercial issues that have been the subject matter of long negotiations. Admittedly, there have been quite a few give and takes with some heated arguments but all in good spirit. Everybody wants a good bargain. But the deal has been sealed in that ten page odd signed term sheet. Now all that is left is for the lawyers to reproduce it in a short (say 30 page) document to be signed anytime this week.
Finally after much coaxing the document has arrived. Rather longish (150 page odd!) and verbose but then we are dealing with lawyers. It starts with familiar territory (drawdown, interest and like) but then goes on to be rude, trying to teach how to run one’s own business (representations, covenants and like). Hang on! No the borrower has not been outright called a thief, but the agreement at some length describes the miseries (events of defaults) that will befall the borrower if it were to turn into one. It is not too kind on fellow lenders either, rather it portrays a complete mistrust between them-no body is responsible for the acts of others nor is liable to the others! Whatever happened to the spirit of camaraderie?
Such reactions are not common from the uninitiated. When faced with irate borrowers, it might be helpful to explain some underlying principles that might get lost in translation.
History Repeats Itself
The basic principles of a facility agreement have remained much the same since 1970s. Various experiences since have helped to refine and elaborate the provisions. These include, bank collapses (e.g. the spectacular collapse of Franklin National Bank and Herstatt Bank in June 1974 which for the first time resulted in international banking crisis and impeached the sanctity of inter-bank deposits), sovereign crisis (the LDC crisis of 1980s), wars and hostilities spilling over to commercial sphere (the Iranian and the Falklands crisis which raised concerns relating to sharing and set–off clauses) and allegations of misrepresentation against arrangers/agents. Bank failures have been rare in India but we had our share of experiences too (GTB being a case in point). In the context of derivatives, arguments of misrepresentation were also levelled against banks. The current loan documents, including the Indian ones, in some form or other encapsulate provisions resulting from the events outlined above. Addition of a few dozen pages, when viewed in the context of over 35 years of experience, does not seem unreasonable.
The current economic crisis, with failures of venerable financial institutions and the Euro- Zone crisis, suggests that the experiences that shaped the drafting of a facility agreement in the seventies are still relevant. In fact, the current financial crisis may make its own contribution of a few pages more to the already long facility agreement. Besides, the forward start and accordion facilities, there has been much debate surrounding clauses relating to material adverse change, market disruption, defaulting agent/lenders and even currency and place of payment clauses (in the context of Euro Zone Crisis). If the facility agreements seem to be an esoteric exercise in pessimism gleefully prophesising a mini financial apocalypse, little blame lies on the lawyers. Hasn’t the world just witnessed a financial Armageddon?
Mind your own Business
In comparison to an equity investor, the lenders have little appetite for risk, limited visibility over the affairs of the borrower and still less idea about the running of the various businesses that the borrowers are engaged in. The lenders are happy to let the borrower run his own business in the best possible manner and are content only to prescribe dos and don’ts in the form of covenants and just to keep the lender in the loop about things (in the form of information covenants). It is backed up with certain representations to ensure that there are no skeletons in the cupboard. Therefore, detailed representations and covenants are a necessity, a negative list is bound to be bigger than a prescriptive list of things (such as affirmative rights and management clauses). Best perhaps to characterise it (for the borrower) as just enforceable guides of good moral and business conduct.
The borrower can also take comfort from the fact that the lenders are wary of invoking events of default except in extreme instances. Distressed assets result in NPAs provisioning and in most jurisdictions, protracted litigations. There is also the issue of keeping the business running, a task lenders are ill equipped to handle. If the business is fundamentally sound, renegotiations and restructuring are more likely.
There are no gentlemen!
The question of liability of arrangers/lead bank/ agents has been a well litigated matter. Banks have not shied away from suing their counterparts when things have gone wrong. In the context of syndication, the issues of fraud, fiduciary duty and misrepresentation have arisen from time to time. These have contributed substantially to the length of provisions relating to inter-se obligations of lenders. The provisions relating to independent credit appraisal, information memorandum, and the Finance Parties and or the Lenders’ Agent for the most part fall in this genre. Whatever be the efficacy of these clauses (and there clearly are limitations, such as, fraud), the market has evolved long exculpatory clauses in an effort to minimise the obligations of these entities.
Further, any syndicated/club deal has to address the issue of syndicate democracy and achieve a semblance of balancing of rights of minority and majority lenders. The democratisation of syndicates and the increase in propensity to sell down and securitise the loans has changed the landscape of finance. These provisions assume importance in light of different interest and profiles of lenders and participants. There are clauses requiring majority, supermajority and all lender decisions. One also encounters provisions relating to replacement of lenders and automatic consent in Indian as well as LMA documents (colloquially called ‘yank the bank’ and ‘snooze you loose’ provisions in the London market) in certain circumstances (notably, in case of increased costs, illegality, non-funding or non-consenting lender). These are helpful from the perspective of both, the lenders that wish to continue in the deal and the borrowers.
I want my cake and with icing please!
A substantial chunk of provisions (e.g. cure periods, day count convention, Interest Periods, Quotation Day etc.) of a facility agreement have more to do with market practice and commercials rather than law. A finance lawyer can do little but capture these faithfully.
The inarticulate major premise of a lender is that he will get a particular rate of return on his capital during the term of the facility and at the end of the tenure get his principal back. As a result besides, the usual repayment and interest clause, a number of ‘margin-protection’ provisions are found in the loan agreement. These are meant to safeguard the returns of the lender from all kinds of eventualities- taxes including withholding tax (tax gross-up and indemnity), regulatory charges or costs that result in less return on capital or reduction in amount payable for example due to reserving requirements or changes in Basel norms (mandatory cost and increased costs), currency fluctuations (currency indemnity), increase in cost of funding along the lines of ‘Japan Premium’ (market disruption clause) and costs and liabilities from documentation to enforcement (indemnity and expenses). Some prepayment clauses also piggy back on these provisions and the borrower is typically allowed to prepay in certain instances (such as increased cost). Admittedly on account of base rate based lending in India, not all margin protection clauses are required in Indian context as the cost of funds will be captured by fluctuation of base rate by the lender.
Yet another string of provisions in the facility agreement (prepayment premium, break costs, interest periods etc.) flow from the concept of ‘matched funding’- the idea that a lender borrows from the inter-bank market to lend to the borrower. Whatever be the economic reality (and lenders often do use their own deposits for funding) but the interbank rates do reflect the opportunity cost of lending. Payments during an interest period will attract breakage costs (or prepayment premium) on the analogy that lender will have to pay the interest on inter-bank deposit.
The Legal Twist
The international (and to some extent US) regulations relating to money laundering, terrorism funding and sanctions against specific countries have contributed their own to the shaping of financing documents. Therefore, it is not unusual to come across references to (or to clauses modelled on the basis of) Patriot Act (in case US obligors are involved), Office of Foreign Assets Control and UN 1267 resolutions in cross-border financing documents. Also the size and shape of covenants relating to environment has changed in line with international treaties and national legislations. One can also come across parallel debt structures when dealing with jurisdictions that do not recognise trust mechanism.
Post script: The Never Land of finance
In light of above, one may naively assume that lending is very safe. A reference to assumptions and qualifications in most financing legal opinion will, therefore, make a most instructive reading. In the end the promises in the documents are just that – promises of good conduct, and one does have to rely upon people keeping their promises. In view of the time consuming restructuring and recovery proceedings, it is best that the parties live happily thereafter. However, if things do go wrong, lawyers are always around.
Piyush Mishra, is a Partner at Luthra & Luthra Law Offices. The views expressed in this article are the personal views of the author and do not represent the views of the firm. It is informational and not an expression of opinion or advice.
NB: For the purposes of the article, references have been made to LMA/APLMA (Asian) and Indian project finance loan documents. Drafting, legal requirements and issues may be different in US, Continental and other jurisdictions.
 UBAF Ltd. v. EABC (1984) ALL ER 226; IFE Fund SA v. Goldamn Sachs  EWHC 2887 (Comm); Rajashree Sugars and Chemicals Ltd. v. Axis Bank Ltd., AIR 2011 Mad 144.
 The interests of bond holders and vulture funds may be radically different from that of traditional lenders.
 The LMA documents have a separate ‘mandatory cost’ formula. Certain borrowers did successfully manage to negotiate out costs associated with Basel II, and now in a few instances Basel III, from increased cost clause in LMA document based lending. LMA has also issued a note on Basel II carve out and its implications with respect to Basel III.
 Due to perceived weakness of Japanese economy in 90’s Japanese banks have had to pay a premium on Eurodollar and Euroyen interbank loans relative to their U.S. and U.K. competitors. Probably they made a reappearance for a short while in 2001. Doubts were also expressed on the reliability of LIBOR during the current financial crisis.
 In Indian loan documents the borrower is generally not allowed to prepay, without prepayment premium/ liquidated damages, except sometimes on Interest Reset Dates (another unique feature of Indian loan documents allowing reset of margin/spread on specified intervals).