United States: Recent Credit Agreement Restricts Ability Of CLOs To Pledge Loans And Ability Of Lenders To Sell Participations On The LSTA Form

A broadly-syndicated U.S.-law credit agreement1 which closed recently includes language limiting the ability of lenders to grant pledges or sell participation interests in their loans. The language appears to be intended to prevent pledgees and participants from gaining direct rights under the credit agreement, but goes beyond provisions that are customary in the market by attempting to (i) prevent participants from gaining beneficial ownership of the participated loan and (ii) preventing participants and pledgees from obtaining direct ownership of the loan even in the event of the insolvency of the grantor or pledgor. Although this language may be ultimately unenforceable, by its terms it could prevent a collateralized loan obligation fund (CLO) from effectively pledging its loans to its trustee, and cause a lender that sells a participation interest using the forms promulgated by the Loan Syndications and Trading Association (LSTA), or any other form that effects a "true sale," to be in non-compliance with the credit agreement. Collateral managers of CLOs, and market participants intending to sell or buy participation interests, should review pledge and participation provisions of recent credit agreements closely to confirm that they do not contain language that could be breached by, or could frustrate, ordinary market practices and expectations.


A defining feature of a CLO is that it grants a security interest in its portfolio of loans and other assets to its trustee, for the benefit of the holders of its notes. Frequently, the collateral manager is contractually obligated to ensure that the trustee holds a perfected, first-priority security interest in the CLO's portfolio. The ability to effectively pledge may also be a requirement under the CLO's indenture in order for a loan to be eligible to be purchased by the CLO. To accommodate CLOs (as well as banks that pledge their loans to a Federal Reserve Bank), most credit agreements that are marketed to the U.S. loan market (and an increasing proportion of European credit agreements) include language explicitly permitting pledges without any consent or notice requirement.

The market-standard language permitting pledges states that a pledge does not substitute the pledgee for the grantor as a "Lender" with direct rights under the credit agreement. This language prevents the pledge provision from swallowing the consent, documentation, minimum-transfer, and other requirements for assignment under the credit agreement. The credit agreement in question, however, goes beyond this standard caveat by adding that the pledgee will not gain direct rights even upon the insolvency of the pledgor.

How exactly this language would play out in the event of a CLO insolvency is unclear. An applicable court could conclude that a properly-perfected pledge is effective and order the borrower and administrative agent to pay the trustee directly, notwithstanding the credit agreement language suggesting otherwise, particularly if the CLO is to be liquidated and will not be in a position to pass on payments. New York2 case law supports the conclusion that, unless an agreement explicitly states that non-complying transfers are null and void (which the credit agreement in question does not), such transfers are effective conveyances. Moreover, Uniform Commercial Code Section 9-406(d) arguably overrides contractual restrictions on the pledge or other transfer of loan interests, and any breach-of-contract claim arising from non-compliance with such restrictions. There is no guarantee, though, that a court would not conclude that the credit agreement provisions are enforceable or otherwise rule in a manner that effectively prevents the trustee from foreclosing on its pledge. In addition, whatever the outcome of the analysis with respect to payments and ownership, the question of whether the trustee would be able to exercise direct voting rights could be analyzed independently, and that analysis could yield a different result.

Even if the trustee might ultimately be able to take ownership of the loan, the language in question casts enough doubt that a collateral manager might reasonably question whether it can cause the CLO to purchase the loan and remain in compliance with its obligation under its collateral management agreement to ensure that the trustee maintains a properly-perfected security interest (as well as any analogous provisions of the CLO's indenture).


In the U.S. market, participation interests are usually structured to be "true sales" of the underlying loan. From a legal perspective, this means that the participant becomes the beneficial owner of the loan and can, in the event the seller becomes insolvent, extract the participated loan from the seller's insolvency estate, dollar-for-dollar. From an accounting perspective (which, under U.S. GAAP, generally depends on the legal conclusion), a true sale means that the seller can take the loan off its balance sheet. Most U.S. credit agreements accommodate participations by including language which specifically states that lenders may freely sell participations, subject only to minor restrictions (e.g., participants can only vote on matters that would require unanimous consent of all lenders or the consent of each affected lender, participations may not be sold to borrower competitors or affiliates). The LSTA forms of par and distressed participation agreement, which would be the market-standard forms of participation agreement for a New York-law, syndicated commercial loan facility such as the credit agreement in question, are structured so as to effect true sales of the underlying loans under New York law, as were the customary participation forms that preceded standardization by the LSTA.

This credit agreement, however, states explicitly that a participation may not convey to the participant any interest in the underlying loan, and must be structured as a debt obligation of the seller. This directly contradicts the language of, and would therefore by its terms bar the use of, the LSTA forms. The restriction may ultimately be unenforceable, both due to the absence from the credit agreement of language stating that non-complying transfers are null and void (which, as noted above, may be necessary to prevent a non-complying transfer from becoming effective under applicable case law) and due to the "override" provisions of UCC Section 9-406(d). Nonetheless, lenders who expect to be able to sell participation in broadly-syndicated U.S. commercial loans, but who have not reviewed the specific provisions of this credit agreement closely, may find themselves in the position of having violated the credit agreement as written by entering into an LSTA participation agreement.


CLO managers, and market participants that may sell or buy by participation, should be careful to ensure that they have not recently purchased any loans that match the description contained herein (or, if they have, that the language in question has been fully vetted by internal or external counsel). They may also wish to increase their diligence of the pledge and participation provisions of credit agreements going forward, in case the problematic language spreads to other deals.


1 Because the credit agreement in question is not public, we are not able to specifically identify it.

2 The credit agreement in question is governed by New York law.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.