New provisions in U.S. loan agreements are quickly becoming a
common market practice to address swaps-related rules issued by
U.S. regulators in the wake of the Dodd-Frank Act.
Under Dodd-Frank and the new rules, it is "unlawful" for
any person other than an "eligible contract participant"
("ECP") to enter into a swap unless the swap is entered
into on, or subject to the rules of, a board of trade that the
Commodity Futures Trading Commission ("CFTC") has
designated as a contract market. The ECP requirement applies both
to swap providers and their counterparties. In addition, the CFTC
has stated that guarantees of swaps are themselves swaps, which
means that guarantors of swaps must themselves be ECPs in order to
avoid the burdensome board of trade requirements otherwise
necessary to ensure the guarantees are not unlawful. The definition
of "swap" in the Commodity Exchange Act is lengthy and
includes many instruments commonly used to hedge risks associated
with lending transactions.
The good news is that, if you're reading this, there is a very
good chance that your company or institution is an ECP. Broadly
speaking, ECP status is determined based on an entity's status
and assets. Many regulated institutions (such as banks, insurance
companies, employee benefit plans, governmental entities, and
broker-dealers) are ECPs, as are entities (i) that have total
assets exceeding $10 million, (ii) whose obligations are guaranteed
or otherwise supported by an ECP with total assets exceeding $10
million, by certain regulated or governmental entities, or by a
person that the CFTC deems to be eligible based on its financial or
other qualifications, or (iii) that have a net worth exceeding $1
million and that enter into an agreement in connection with the
conduct of their business or to manage risk associated with an
asset or liability. High net worth individuals (i.e., those with
amounts invested on a discretionary basis that exceed $10 million
or, if they have an agreement in place to manage business conduct
or risk, $5 million) are also ECPs. ECP status is measured each
time parties enter into a swap, regardless of when the primary
transaction, such as a credit facility, is consummated.
Borrowers and guarantors do not need to be ECPs to enter into
lending agreements or to guarantee loan obligations. However, many
lending facilities include swap obligations, as well as loan
obligations, in the obligations guaranteed and secured in
connection with the facility. Additionally, loan facilities often
involve multiple borrowers and guarantors, as well as
cross-guaranteed or cross-collateralized obligations. As a result,
the parties need to be mindful about drafting loan documents to
minimize the risk that a borrower or guarantor that is not an ECP
becomes obligated in respect of swaps. Possible measures to address
the new rules include conferring ECP status on an entity that is
not otherwise an ECP through the use of a cross-guaranty, keepwell
agreement, or other credit support document, as well as adding
language to loan documents to carve out non-ECPs from any
swap-related obligations. Some examples are provided below.
New Definitions to Carve Out Non-ECPs
"Commodity Exchange Act" means the Commodity Exchange
Act (7 U.S.C. § 1 et seq.) and any successor statute, and any
rule, regulation, or order promulgated thereunder, in each case as
amended from time to time.
"Excluded Swap Obligation" means, with respect to any
Credit Party, any Swap Obligation if, and to the extent that, all
or a portion of the Loan Documents to which such Credit Party is
party with respect to, or the grant by such Credit Party of a
security interest to secure, such Swap Obligation (or any Guarantee
thereof) is or becomes unlawful under the Commodity Exchange Act or
any rule or regulation promulgated thereunder (or the application
or official interpretation of any provision thereof) by virtue of
such Credit Party's failure for any reason not to constitute an
"eligible contract participant" as defined in the
Commodity Exchange Act at the time any such Loan Document becomes
effective with respect to such related Swap Obligation.
"Swap Obligation" means, with respect to any Credit
Party, any obligation to pay or perform under any agreement,
contract, or transaction that constitutes a "swap" within
the meaning of section 1a(47) of the Commodity Exchange Act.
Terms utilized in the loan documents, such as
"Obligations," "Guaranteed Obligations," and
"Secured Obligations," to identify the obligations
guaranteed or secured should specifically exclude all Excluded Swap
Obligations. The term "Credit Party" includes Guarantors
as well as Borrowers.
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.