The number of syndicated loans signed in EMEA in the first quarter of 2012 was less than half the number seen in the same period last year and the pipeline for the remainder of 2012 remains thin, bar any uptick in M&A activity. Banks are operating under tighter capital constraints and are increasingly selective on deals. For as long as market volatility persists, this seems set to continue. For those borrowers embarking on any form of financing in the current market, they are likely to find themselves treading a fine line between protecting their banking relationships (and locking in available liquidity) and signing up to a facility that is overly or unduly restrictive and that potentially prevents them from carrying out their day-to-day business without seeking bank consent. The aim of this article is to provide finance directors, treasurers and in-house counsel with an overview of some of the key issues they may face when negotiating a syndicated loan agreement in the current market and to highlight those areas where borrowers may wish to focus their efforts when negotiating with their banks.
The starting point
Loan documentation has evolved considerably since the late 1990s and market standard documents published by the Loan Markets Association (LMA) are now widely used and accepted as a starting point by all key players in the syndicated loan market, lenders and borrowers alike.
The recommended form of investment grade facility agreement was first published in 1999, having been settled by a group consisting of representatives of the LMA, the British Bankers’ Association, the Association of Corporate Treasurers (ACT) and several major City law firms. It was produced in response to demand from the syndicated lending market to provide a standard form of facility agreement. But while the investment grade agreement was designed initially for ‘plain vanilla’ loans to UK investment grade rated corporates, the market has evolved considerably since then with banks now using this agreement for a much wider range of types of financings and for borrowers across the credit spectrum operating in a variety of different sectors and jurisdictions. For any borrower entering into a syndicated facility agreement with its banks, it is worth remembering that the LMA agreement is purely a starting point and all commercial terms of the transaction can and should be negotiated on a case-by-case basis.
So what are the advantages and disadvantages for a borrower of using the LMA document?
Advantages
The main aim of the LMA was to promote greater standardisation of documentation and ultimately result in less time-consuming negotiation of ‘boiler plate’ parts of the loan agreement. For the most part, this objective has been achieved, and there is generally widespread acceptance of the boilerplate provisions among the borrower community.
As a general rule, use of the LMA agreement should save time and costs, avoiding lawyers having to spend time negotiating the finer details of clauses relating to areas such as notices, mandatory costs, and governing law for example. This leaves the borrower with the time to focus on the business/commercial aspects of the agreement, which will need to be negotiated for each and every deal.
In a bank market driven by ‘relationship lending’, any borrower that can save its negotiating fire power for those aspects of the agreement that are the most important to it, can take comfort from using a document with standard boilerplate provisions that should require little to no negotiating.
Finally, use of the LMA agreement is considered important for those borrowers seeking to maximise liquidity, in particular where they are looking to attract liquidity from non-relationship banks. Some retail banks in particular may require, and others will take comfort from, the use of the LMA document when considering whether to participate in a syndication.
Disadvantages
It is worth remembering that the form of LMA agreement assumes, among other things, a solid investment grade borrower, a facility being provided on a guaranteed but unsecured basis, with all obligor companies being incorporated in England and Wales. How many transactions fit this exact mould? A ‘one size fits all’ approach does not work for all borrowers and the agreement should be reviewed and negotiated taking into consideration the type of borrower and its business, the type of financing being provided and perhaps most significantly, the wider market conditions under which we are all now operating.
The LMA agreement provides only a starting point for the commercial aspects of any financing with a recommended set of representations, undertakings and events of default. Though borrowers should be mindful of the challenges that banks are facing with inflated funding costs, restraints on capital and an overall requirement to be more selective in the relationships it supports, they should not feel obligated to accept terms that unduly restrict it from conducting its day-to-day affairs and pursuing management’s overall business strategy. Lenders should (and for the most part do) acknowledge that the business terms of any financing require a high level of negotiation, even in today’s challenging market, and that borrowers require a certain degree of operational flexibility to run their business.
Finally, while no commercially astute lawyer would suggest spending any degree of time negotiating the boilerplate provisions, borrowers are advised to spend some time reading through the mechanics of a syndicated facility agreement to ensure they are familiar with the administrative aspects of a syndicated loan. It is also advisable, and is in fact market practice, that where the LMA form of agreement has been used, borrowers and their counsel should request a mark-up to show the changes that lenders’ counsel have made to the LMA. This should expedite the borrower’s review of the draft agreement and allow for time to be spent negotiating the more substantive business provisions of the agreement.
It goes without saying that borrowers regularly find themselves faced with the argument from banks and their counsel during negotiations that ‘it’s LMA’. It can prove tricky to negotiate a document that is presented by lenders as a market standard and, while the objective of designing this market standard was to balance the interests of borrowers and lenders, there are a number of features that are unattractive to borrowers and that borrowers should consider putting on the table for discussion (see ‘Points to watch out for’ below).
What are the alternatives?
Use of the LMA form of agreement is not mandatory for borrowers, it is non-binding and is intended to be used purely as a starting point for negotiations. However, the use of the LMA agreement is widespread and borrowers should not underestimate the importance that banks (and their credit committees) attach to the use of this document, in particular in a market where banks’ lending books are under increased scrutiny.
However, there are certain circumstances where borrowers may wish to refinance using their existing documentation. This is most likely where the lender is providing a bilateral loan to a borrower but may also be where the same club of banks are renewing a ‘plain vanilla’ working capital facility on substantially similar terms. In this scenario, redocumenting the facility using the LMA could be viewed as both unnecessary and inefficient.
Another approach more frequently seen in the market is where a borrower agrees to use the LMA form of agreement, but with the representations, covenants and events of default substituted with the borrower’s existing loan documentation. This may be where the loan or loans are being refinanced with the same groups of lenders and perhaps where the covenant package has undergone extensive negotiations previously. The obvious advantage of this approach is that it reduces the time spent negotiating the boilerplate provisions of the agreement. However, this may not be appropriate if the risk profile of the borrower has changed significantly or where market practice has evolved since the original facility was signed.
Points to watch out for
The degree of market volatility witnessed over the last few years has led banks and borrowers alike to re-examine their relationships and this has been highlighted in the way many successful financings have been negotiated and agreed.
Borrowers have been forced to accept that lenders’ risk appetite is somewhat lessened from previous years and they are more sensitive to sector and/or geography. In addition, the credit analysis that lenders are required to undertake is more thorough, all of which has in part translated into less ‘borrower-friendly’ terms and conditions for some borrowers. For others however, the borrower/lender relationship looks quite different. With deal volumes at an all-time low, driven in part by low demand from borrowers, some banks now find themselves under-lent and, in an attempt to retain and support their key relationships, may be prepared to lend on more favourable terms.
So what does this mean for documentation?
As highlighted above, the LMA leaves plenty of scope for negotiation on the more business specific provisions of the loan agreement, with a number of provisions left blank or where optional or alternative drafting is suggested. While this article is not intended to be a comprehensive review of the terms of a facility agreement, some of the key areas for negotiation are identified below.
- Representations, covenants and events of default: the investment grade precedent contains a set of suggested representations, covenants and events of default, which lenders’ counsel will use as their starting point when producing a first draft of the facility agreement. However, these will usually be heavily negotiated in light of any deal or borrower-specific provisions.
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- Borrowers should focus on the scope of the representations (ie do they apply to all members of the group or just the obligors and/or the material companies); whether any should be qualified by materiality or knowledge; and when they are to be given/repeated. While all lenders will argue that these representations cover risks that they are not and should not be in a position to take, any borrower will need to ensure it has the appropriate systems in place to check the accuracy of any representation it is being asked to make.
- Undertakings remain in force continuously for the duration of the facility. Post credit crunch, lenders are seeking tighter restrictions generally, with particular scrutiny given to any specific carve-outs, thresholds, baskets and grace periods. However, this has to be balanced against the need for the borrower to have the required operational flexibility to run its day-to-day business. Consideration should also be given to the strategic plans of the group (for example, regarding acquisitions and disposals) and how much control a borrower is willing to concede the lender group.
- The main focus of negotiation on the events of default will be similar to the representations, namely scope and materiality. In addition, all but the strongest rated borrowers, are having to concede to a Material Adverse Change event of default in the current climate. There is no definition suggested by the LMA so this is usually negotiated alongside the definition of Material Adverse Effect, a term that features extensively in the document to qualify representations, undertakings and events of default.
- Financial covenants: the investment grade agreement does not contain any financial covenants. Historically, not all investment grade facilities included financial covenants, although post credit crunch, lenders have become more likely to require them. While these need to be tailored to the circumstances of the borrower and should undergo a detailed review by the finance director/treasurer, the starting point is very often those set out in the LMA precedent for leveraged transactions (a precedent designed primarily for use on European leveraged buy-out financings). Alternatively, some borrowers may wish to rely on the covenants set out in their existing documentation where a facility is being refinanced.
- Tax: as bank liquidity remains restricted for certain borrowers, consideration needs to be given to the impact that wider and more diverse lending groups may have on the borrower’s tax burden under a loan agreement. In general, the market expectation is that the borrower will pay gross (ie without withholding tax) and will take the risk of a change of law. However, particular attention should be paid to the definitions of Qualifying Lenders (which will include Treaty Lenders) as the function of these definitions is to identify those lenders that the borrower would have to gross up if there were a change in law. Equally, the greater the flexibility afforded to lenders to transfer their participations post signing, the greater the tax risk taken on by the borrower.
- Market condition provisions: more recently, and as a result of the market volatility that has impacted the loan markets post Lehmans, the LMA has introduced a number of market condition provisions, which now appear in documentation as a matter of course. These include ‘defaulting lender’ and ‘impaired agent’ provisions and a change to the market disruption provisions. While the ACT was not involved in the settling of these provisions, for the most part, these clauses have improved the borrower’s position by addressing the consequences of a finance party being in financial difficulty and also reducing the likelihood of lenders being able to charge the borrower interest at their individual costs of funds. As such, most borrowers will spend little time negotiating these clauses.
- Transferability: while the LMA position requires borrower’s consent for most transfers, some lenders will push for free transferability or restrict the borrower to a right of consultation only and they will do so on ‘policy’ grounds. Banks’ policies have undoubtedly become more stringent in response to the tighter regulatory regime; however, exceptions can be sought and it may be wholly inappropriate for a borrower to allow the facility to be transferred to a non-bank lender or even a non-relationship bank where the financing is otherwise provided by a small club of banks who understand the borrower’s business and have a genuine interest in a long-term relationship.
In summary, some of the key ingredients for a borrower to ensure a successful financing in today’s environment are:
- agree at any early stage the basis upon which the facility is to be documented (ie LMA versus existing document and, if LMA, which precedent is to be used);
- provide banks with a comprehensive information package (including for example, latest financials, group structure chart, corporate documents);
- identify the key areas where operational flexibility is necessary and make banks aware of these up front;
- avoid negotiating ‘boilerplate’ provisions where possible;
- remember that the LMA is only a starting point and you will have to monitor and operate under the provisions of this facility for a significant period of time; and
- recognise that the attitudes and capabilities of some banks are likely to change for so long as the market volatility persists, which is likely to translate into more ‘strained’ negotiations that both borrowers and banks may have experienced previously.