In the financing world, side deeds (sometimes also referred to as tripartite deeds, consent deeds or direct agreements) are frequently the source of robust negotiations between parties. This article briefly explores when a lender needs a side deed and the key elements that a lender should require when obtaining one.

What are side deeds?

Side deeds create a direct contractual relationship between the lender and a third party to a financing. That third party would be the counterparty to a key contract or arrangement with a borrower. Generally, that contract or arrangement is essential to the borrower's business or the project being funded by the lender.

The most common examples of key contracts where a lender may require a side deed are:

  • leases or agreements to lease: the premises upon which the borrower's business is trading or the project is being built, or if the borrower is a landlord, a lease or agreement for lease for a major tenant that constitutes a bulk of the borrower's rent revenue. Side deeds relating to leases are known as rights of entry (where the borrower is the tenant) or tenant side deeds (where the borrower is the landlord);
  • building contracts: for the construction of the project that is being funded by the lender. Such side deeds are known as builder side deeds;
  • supply agreements: for core materials, services, or other inputs that are needed for the operations of the borrower or the project;
  • offtake agreements: relating to the purchase of the goods or services produced by the borrower or the project; and
  • licences or other rights to use: property or rights such as intellectual property or physical access to a site or resource.

When is a side deed required?

A lender should obtain a side deed where any of the above arrangements are difficult or expensive to replace, are unique or of limited supply, or where the termination of the contract would be materially adverse to the going concern of the borrower's operations or the project.

For example, the leased premises for a retail business such as a restaurant may rely on its unique location as a large part of its goodwill, and if the lease is terminated and the restaurant forced to move, a new location may prove to be less successful (in addition to the obvious significant costs relating to physical fit-out). A side deed can assist to prevent the unexpected termination of such a lease. On the other hand, the lease for a generic storage facility for non-perishable goods may be readily replaceable with an alternative lease on comparable terms, and therefore a side deed may not be necessary.

What are the key terms of a side deed?

The content of a side deed can vary depending on the type of contract involved, but there are a few key elements which a side deed should cover:

  • Consent to security: the underlying contract will usually contain a provision expressly requiring the counterparty's consent to any assignment or granting of security over the borrower's rights under the contract. Where the lender is taking all assets security (or specific security over that contract), the consent of the counterparty should be obtained to avoid inadvertent breach of the terms of the contract. The side deed should contain a clause acknowledging the counterparty's consent to the lender's security;
  • Notice of default: whilst the borrower will likely be obligated under the finance documents to notify the lender of a default under the contract, where the borrower (either wilfully or inadvertently) fails to do so, the lender will be unaware of a default and therefore unable to take steps to remedy or protect the contract before it is terminated. For this reason, a direct obligation for the counterparty to notify the lender of a default, prior to termination, is an essential part of a side deed;
  • Cure rights: the lender should seek a direct right to cure defaults to ensure the contract is kept on foot and the counterparty continues to perform its obligations under the contract. Where possible, the lender should insist on extended cure rights over and above the cure period available under the contract itself. This gives the borrower the opportunity to cure the default itself (without interference from its lender) within the original contractual cure period, and the lender only intervening after the borrower is unwilling or unable to do so. Cure rights may include the option for the lender to 'step in' and perform the obligations of the borrower to preserve the contract;
  • Enforcement powers: an acknowledgment from the counterparty that an enforcement of the lender's security (by the appointment of a receiver to the borrower or otherwise) does not constitute a default under the contract, and that the counterparty will continue to perform under the contract notwithstanding that enforcement; and
  • Sale and transfer: an agreement on the conditions upon which the lender (or its receiver or appointed representative) can transfer or assign the borrower's rights under the contract pursuant to a sale of the borrower's business or the project. Counterparties may be reluctant to give the lender an unfettered right to transfer the contract to an unknown third party buyer, and may include conditions relating to the financial worthiness, reputation, or standing of any potential assignee.

A side deed can also include bespoke provisions to 'fix' any deficiencies in the underlying contract that the lender discovers during its due diligence. For example, expired milestones or sunset dates, material changes to scope or obligations, or breaches that have not been formally waived or cured, can be dealt with in the side deed between the parties.

Why would a counterparty agree to a side deed?

A significant source of difficulty in obtaining a side deed relates to the borrower having not prepared the counterparty for the possibility of signing up to a side deed during negotiations. Ideally, prior to signing the relevant contract, the borrower should discuss the requirement for a side deed with the counterparty and include an obligation to execute one as a condition to entering into the contract.

Acknowledging that prior negotiation may not be a realistic possibility, the general argument for a counterparty to accept a side deed is that without one, the lender will not provide financing and therefore the borrower will not have the financial resources to continue to make payments or fulfil other obligations under the contract. Additionally, the counterparty should gain some comfort that the borrower is backed by a significant lender, who by executing a side deed has a vested interest in the contract and may later cure and remedy defaults.

In some sectors, such as for building contracts, side deeds are standard market practice and most sophisticated builders will be familiar with them (some may have their own accepted standard form). Certain powerful counterparties, such as listed retailers, may refuse to enter into side deeds or provide simple consent letters with basic cure rights. In both cases, lenders should seek legal advice before agreeing to accept a document produced by a counterparty.

When should a lender start the process of a side deed?

Early engagement is the best approach to procure the best result for a lender on a side deed. From our experience, when timing becomes an issue the lender may be forced to compromise or make significant concessions to the counterparty to meet a looming borrower deadline. In those circumstances, or where there are a significant number of counterparties (e.g. for a large retail borrower with numerous premises), it may also be necessary to have the side deed or deeds as a condition subsequent to funding.

During first discussions with a borrower, lender's counsel can usually provide a pro forma or example side deed that a borrower can socialise with a counterparty. The initial response can guide the lender on whether there is appetite for a side deed, or if approvals need to be sought for a compromise that may fall short of some of the key side deed elements.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.