Defaulting finance parties: tips for borrowers in 2023

The recent SVB/Signature Bank failures and Credit Suisse/UBS merger revived GFC memories for some borrowers. In the current economic environment, borrowers should be aware of "Defaulting Finance Parties" provisions so that they can negotiate loan agreements and manage their loans and syndicates in circumstances where there are one or more defaulting/distressed finance parties in their syndicate.

APLMA's Australian Secured Term and Multicurrency Revolving Syndicated Facility Agreement (APLMA SFA) contains "Defaulting Finance Parties" provisions. These are appropriate for use on corporate, leveraged and other syndicated financings (and, as with any provisions, can be negotiated).

What is a Defaulting Finance Party?

Under the APLMA SFA, a "Defaulting Finance Party" is a finance party which:

• has failed to make a payment or issue an LC under the loan agreement (unless caused by administrative/technical error or market disruption with payment being made promptly, or unless the finance party is disputing in good faith whether it is contractually obliged to make the payment);
• has rescinded or repudiated a finance document; or
• is insolvent.

What happens if there's a Defaulting Finance Party?

It is important to note that a borrower is not relieved of its obligations (for example, payment of principal/interest) to a finance party while it is a Defaulting Finance Party.

The main consequences of a finance party being a Defaulting Finance Party are:

1. cancellation: the borrower may cancel undrawn commitments of a lender that is and continues to be a Defaulting Finance Party. We note that the APLMA SFA does not contain a general borrower right to repay a defaulting lender before other lenders;
2. "yank-a-bank": the borrower may replace a lender (but not the agent/security trustee) that is a Defaulting Finance Party. This is particularly important where the defaulting lender has undrawn commitments or provides ongoing transactional/LC facilities:
   • replacement is implemented by transferring all/all undrawn/only revolving credit facility (RCF) rights/obligations to a new or existing lender at par within an agreed period;
   • the agent/Defaulting Finance Party are not obliged to find a replacement lender. Finding a replacement lender may be difficult for the borrower; and
   • the replaced lender is not obliged to return any fees;
3. disenfranchisement: a Defaulting Finance Party becomes disenfranchised and cannot vote on amendments/waivers (although disenfranchisement is usually only regarding its undrawn commitments). Stronger borrowers may look to negotiate complete disenfranchisement;
4. RCF term out: if a Defaulting Finance Party is an RCF lender, an existing RCF loan will be treated as a separate loan and extended to the end of the RCF's availability period or the RCF's maturity date. RCF term out protects borrowers against the risk of the RCF lender not funding on rollover:
   • RCF term out may result in the RCF not being drawn pro rata (the APLMA SFA does not provide for RCF commitment reallocation among non-defaulting lenders);
   • the borrower is not required (but may elect) to prepay the term out loan;
   • on voluntary prepayment of the RCF, under the APLMA SFA the proportion of the term out loan being repaid may not exceed the proportion of the RCF being repaid (to avoid favourable treatment of the defaulting lender); and
   • the term out loan is not taken into account when determining the maximum number of loans allowed under a loan agreement;
5. commitment fee: no commitment fee is payable on a lender's undrawn commitments while it is a Defaulting Finance Party; and
6. disclosure: the agent may disclose the identity of a Defaulting Finance Party to the borrower/other finance parties (and must disclose it on the written request of the borrower or the majority lenders).

What about defaulting agents/security trustees?

An agent/security trustee that is a Defaulting Finance Party can present significant risks to borrowers and lenders. For example, an agent that is a Defaulting Finance Party might not pass on loans to the borrower or payments to lenders, and might not forward communications or facilitate amendments/waivers.

Where an agent is a Defaulting Finance Party, under the APLMA SFA:

• the majority lenders may require the agent to resign on short notice (at the defaulting agent's cost);
• a party required to make a payment to the agent may instead pay directly to the ultimate payee; and
• the parties may communicate with each other directly (instead of through the agent).

The same considerations apply when a security trustee is a Defaulting Finance Party (if not more so given the importance of security trust assets). For example, under APLMA's security trust deed the majority beneficiaries can require a security trustee that is a Defaulting Finance Party – or which has materially breached security trust deed duties – to resign on short notice.

Bail-in

We saw government bail-outs during the GFC, with governments injecting capital into failing banks/financial institutions. "Bail-in" refers to regulators helping to facilitate failing bank/financial institution rescues (for example, by enabling loan write-downs/conversions to equity).

Under APLMA's Australian bail-in provisions, parties acknowledge that finance document liabilities may be subject to government bail-in action. However, these provisions do not make a finance party which is subject to bail-in action automatically a Defaulting Finance Party (this could be negotiated). Bail-in provisions from other jurisdictions like Hong Kong are also frequently seen in Australian syndicated loan documents.

If a borrower has questions about bail-in, it should seek legal advice.