1 Legal framework
1.1 Beyond general commercial and contract laws, what other specific laws and regulations govern secured finance in your jurisdiction?
Security interests: Article 9 of the Uniform Commercial Code (UCC) governs the creation, perfection and enforcement (outside of bankruptcy) of security interests in personal property. The UCC – which is state law, rather than federal – has been adopted by all 50 states in the US and the District of Columbia, with fairly limited differences between jurisdictions. Security interests in real property collateral, on the other hand, are governed by the laws of the state in which the real property is located.
Borrowers that operate in regulated industries (eg, the energy, communications and cannabis industries) may be subject to certain restrictions or may require regulatory approval in order to pledge their assets and/or for lenders to enforce on their security interest.
Usury: State law also regulates the amount of interest that can be charged by lenders. Usury limitations differ from state to state, but generally depend on:
- the purpose of the loan;
- the amount of the loan; and
- the type of borrower and lender.
For example, in New York, secured business loans in excess of $100,000 that are made to corporations are exempt from criminal usury laws as long as the interest rate is not greater than eight percentage points above the prime rate when the interest is charged or accrued. In addition, under the criminal usury statute in New York, the maximum interest rate that can be charged is 25%, but this limit does not apply to loans in excess of $2.5 million.
Use of proceeds: Federal law (Regulations T, U and X of the Board of Governors of the US Federal Reserve System) regulates loans made for the purpose of purchasing or carrying publicly traded securities, which are secured by such securities (ie, margin loans). Generally, margin loans may not exceed 50% of the purchase price of the securities.
Anti-money laundering and trade sanctions rules: A number of federal laws, including the Bank Secrecy Act and the USA PATRIOT Act of 2001, require financial institutions to assist the US government with detecting and preventing money laundering. These laws oblige financial institutions to maintain customer identification programmes, such that the financial institution forms a reasonable belief that it knows the true identity of its customers. In addition, US sanctions laws prohibit US persons from engaging in or facilitating specified transactions with foreign persons and entities specified by the Office of Foreign Asset Control. Violations of anti-money laundering and US sanctions laws can result not only in reputational risk and risk of non-payment (eg, if a borrower becomes a target of sanctions), but also in penalties and fines, civil or criminal liability and even revocation of an institution's banking charter. Further information can be found here.
1.2 Do any bilateral and/or multilateral treaties or trade agreements have particular relevance for secured finance in your jurisdiction?
There are no treaties or trade agreements that have particular relevance for secured finance in the US.
1.3 Beyond normal governmental institutions, are there regulatory or tax bodies that play a particular role in secured finance your jurisdiction? What powers do they have?
Some states in the US require the licensing and regulation of non-bank lenders, but such laws are more common and are generally stricter with respect to consumer loans and small loans, as opposed to corporate and commercial loans. New York, for example, has a commercial lending licensing requirement, but it is applicable only to loans of $50,000 or less. California is a notable exception, however: it has a broad commercial lending licensing requirement.
Other than general tax oversight by the Internal Revenue Service and state and local tax authorities, there are no tax bodies that play a particular role in secured finance in the US.
1.4 What is the government's general approach to secured finance in your jurisdiction? Are there government guarantee/support schemes available to lenders, and if so what are the qualifications to that support?
As a general matter, the US government takes a free market approach with respect to secured finance in the US. Despite this, there are some government guarantee and support schemes available to lenders under limited programmes, which typically support small businesses or a certain industry. Examples include loan guarantees by:
- the US Department of Agriculture to support loans to rural farmers;
- the US Department of Energy to support loans to develop new energy-efficient technologies; and
- the Export Import Bank of the US to support foreign buyers that purchase capital goods and services from US companies.
Such financings may be in the form of traditional instalment loans funded by commercial banks or in the form of finance leases.
During economic downturns, the federal government will often develop new guarantee and support programmes to incentivise bank lending. Recently, in response to the COVID-19 pandemic, the federal government created loan and guarantee programmes under the Coronavirus Aid, Relief and Economic Security Act. Under one of those programmes, the Paycheck Protection Program, the Small Business Administration guaranteed loans made to small and medium-sized businesses.
2 Secured finance market
2.1 How mature is the secured finance market in your jurisdiction? Are the majority of the transactions purely bilateral and domestic, or is there an international syndicated market for secured financing under your domestic law?
Given the size and diversity of the US corporate loan market, it is difficult to make overarching characterisations of the types of US corporate transactions. The US market is very robust and arguably is the most developed market for lending globally. Deals in the market include:
- secured and unsecured lending first/second lien transactions;
- unitranche asset-based lending;
- mezzanine lending;
- subordinated lending;
- securitisation and structured finance;
- ‘true sale' transactions;
- project finance;
- bond and note issuances and placements; and
- many other products and combinations and hybrids of the foregoing.
Additionally, the US loan market is primarily private and only a small percentage of the deals are publicly available.
2.2 Are there any bodies in your jurisdiction/region that promote the use of standard documentation and best practices in secured finance transactions? If so, are these widely used and followed?
While certain bodies in the US provide standard forms and provisions for US loan documentation (eg, Loan Syndications and Trading Association and the Alternative Reference Rates Committees), there is no agreed-upon documentation that serves as the basis for loan documents. Rather, loan documents are typically negotiated on a deal-by-deal basis. Model credit documents and arrangements are readily available in the US to use as a guide, but most transactions start from an agreed upon precedent applicable to the borrower and its structure or generally comparable to similar recent deals in the marketplace. Each lender in the US also typically has internal guidelines that also impact key terms and arrangements.
2.3 What significant secured finance transactions have taken place in your jurisdiction in recent times?
For the same reasons set forth in question 2.1, it would be a disservice to label one transaction as more significant than another. As detailed further in question 1.1, loan documentation is constantly evolving to adapt to changing precedents and developments in the market.
3 Secured finance providers
3.1 Who are the key providers of secured finance in your jurisdiction? Is there a thriving alternative credit market (beyond bank lenders)?
The key lead arrangers of secured finance in the US remain traditional bank lenders, especially for larger (eg, loan value above $500 million), broadly syndicated loan transactions. The alternative or ‘direct lending' credit market is robust and growing each year. Direct lenders – including investment and hedge funds, business development companies, mezzanine debt funds, pension plans, life insurance companies and others – all offer competitive lending terms in the middle market and have increasingly competed with traditional bank lenders for larger loan transactions at the upper end of the market. We expect this trend to continue into the foreseeable future as borrowers seek out flexibility, speed and certainty of execution and other favourable deal terms on offer from alternative credit providers. Alternative credit providers also account for a significant portion of lender syndicates, primarily for term loans in the US market. The liquidity that alternative credit providers add to the US lending market has fuelled much of the growth of syndicated lending in recent years.
3.2 What requirements and restrictions apply to secured finance providers in your jurisdiction? Do these vary depending on (a) the type of entity; (b) whether the lender is domestic or foreign?
Generally, US federal law imposes no licensing requirements on non-bank entities that wish to extend commercial loans to US borrowers. Some states within the US, however, may impose licensing requirements depending on different factors such as:
- the size of the loan;
- the type of borrower (ie, commercial or consumer); and
- the type of collateral securing the loan (eg, a mortgage on real property).
Any non-bank entity looking to transact business in the US should be sure to verify requirements and restrictions not only at the federal level, but also at the state level.
In addition to state-level licensing requirements, some states may require entities to register or qualify as a foreign business entity with the state to ‘transact business' within the state. Many state laws exempt or exclude creating or acquiring indebtedness and related lending activities from the definition of ‘transacting business', and thus exempt entities from registration or qualification; but this should be verified on a state-by-state basis.
Foreign bank lenders are subject to an extensive bank regulatory regime that is similar to the regulatory regime in place for domestic bank lenders. Domestic entities and persons are subject to broad restrictions with respect to doing business with individuals, entities, geographic regions and governments in accordance with US policy, sanctions and embargoes administered by the US Treasury Department's Office of Foreign Assets Control.
Foreign lenders should also be aware that their ability to take security interests in collateral that implicates certain regulated industries or industries deemed important to national security may be limited.
Lastly, the amount of interest that may be legally charged by lenders is subject to state usury laws. As these laws vary by state, it is important for a lender to carefully examine the state law of each relevant state to determine:
- whether the usury laws apply to the size and type of loan and lender implicated in the subject transaction; and
- how interest for a loan is calculated for purposes of determining compliance by a lender with any applicable usury law (eg, whether fees or other charges paid to the lender are deemed to be interest under the law).
Most US transactions elect to be governed by the laws of New York. While this choice is generally enforceable for the broader issues under a loan transaction, the granting of security and guarantees can still be subject to applicable local state rules and regulations.
4 Secured finance structures
4.1 What secured finance structures are most commonly used in your jurisdiction?
The most common secured debt finance structures are loans and debt securities, which are the focus of question 4.
Loans: Borrowers may borrow loans from a single bank or other lending institution (a bilateral loan) or a group of lenders (a syndicated loan). Secured loans can come in many different forms, several of which are briefly described below:
- Term loans: These are typically drawn all at once at execution of the loan documents and cannot be reborrowed once they are repaid. ‘Delayed draw' term loans may be available for some period after execution, subject to various conditions and limitations on the number of draws. Term loans can be further categorised into Term A loans, Term B loans and Term C loans, the terms of which vary based on interest rate margins, maturity and amortisation.
- Revolving loans: Revolving loans are available to be drawn over a period of time (subject to certain conditions precedent) and can be reborrowed once repaid. Swingline loan facilities and letter of credit facilities are often subsets of revolving credit facilities. Swingline loans are short-term loans that are generally available on short notice (often same day). Letter of credit facilities allow borrowers to have letters of credit issued to support various obligations (eg, obligations related to leases, workman's compensation or the purchase of inventory).
- Asset-based loans: Asset-based loans, which are typically revolving loans, are structured such that the maximum amount that may be borrowed is based on the value of certain of the borrower's assets (a ‘borrowing base'). A borrowing base is usually calculated based on the borrower's eligible accounts receivable and eligible inventory, but sometimes also includes eligible real estate and/or other assets.
- Subordinated debt: Subordinated debt, which is often in the form of subordinated notes, is junior debt that is repayable only after senior debt has been repaid to the senior creditors. There are different ways to subordinate debt; structural subordination results from the structure of the transaction, while contractual subordination arises from an agreement between parties. The terms of subordinated debt vary and may allow junior creditors to receive regularly scheduled payments of interest, so long there is no ongoing default by the borrower under the senior debt. Given the increased risk to subordinated lenders, interest rates on subordinated debt are typically higher compared to senior debt.
- Intercreditor agreements and first/second-lien loans: Different lenders (or groups of lenders) may extend loans to a borrower, which are secured by the same collateral, but the obligations owing to the second lien lender are secured on a junior basis. In this case, the different lenders enter into an intercreditor agreement, which sets out the rights of each lender with respect to the shared collateral should the borrower default or file for bankruptcy. Upon such an event, the first lien lender is repaid in full with the proceeds of the collateral before the second lien lender is repaid. Given the increased risk to second lien lenders, interest rates on second lien loans are typically higher compared to first lien loans.
- Unitranche loans: Unitranche loans – which are usually term loans provided by a single lender – are traditional first and second loans that are documented under a single loan agreement and are subject to the same terms. Borrowers may prefer the unitranche structure, as they deal with a single counterparty, avoid intercreditor issues and comply with a single set of covenants. A unitranche loan may have a revolving component, in which case it will rank pari passu with any term loans under the unitranche facility. It is possible to have more than one unitranche lender; in that case, the lenders enter into an ‘agreement among lenders', pursuant to which they agree to create ‘first out' and ‘last out' tranches within the unitranche loan.
Debt securities: A debt security is an instrument that evidences a debt (and the promise of its repayment) and may be traded. Debt securities can be divided into several categories, including:
- bonds (which are typically long-term debt instruments); and
- notes (which typically have a shorter maturity of between one and 10 years).
Securitisation: Securitisation is another more complex debt finance structure in which assets that generate cash flow – such as loans, mortgages or receivables – are pooled; and asset-backed securities, which represent interests in the pool, are sold to investors. The securitised assets and the cash flows generated by such assets are pledged to the holders of the asset backed securities as collateral. The cash flow generated by the securitised assets is used to pay interest and principal to the investors.
Finance leases: A finance lease (or capital lease) structure is a type of financing transaction pursuant to which a lender (lessor) buys an asset (eg, an aircraft) and leases it to a borrower (lessee). Over the term of the lease, the lessee makes rent payments that equal the full value of the asset, plus a return on capital. At the end of the lease term, ownership of the asset is transferred to the lessee.
Project finance: Project finance is another complex financing mechanism that is generally used to finance the construction of an energy, infrastructure or industrial project (eg, power plants, renewable power projects, pipelines, railroads and airports). Project finance structures can vary widely, depending on many factors, and may include many sources of capital (eg, equity financing and tax credits) in addition to various types of secured debt, including senior loans, subordinated loans and/or bonds. The debt issued in connection with a project financing is largely repaid from the revenue generated by the underlying project once it is complete. Interest rates on project finance related debt is generally higher as compared to corporate debt.
4.2 What are the advantages and disadvantages of these different types of structures?
Covenants: Generally, debt securities contain fewer covenants with which issuers must comply, as compared to loans. In addition, high-yield notes typically have incurrence covenants rather than maintenance covenants, which are more common in loans. Incurrence covenants require an issuer to pass a financial ratio test in order to take a certain action (eg, incur debt or issue dividends), while maintenance covenants require borrowers to comply with financial ratios at regular intervals or maintain the ratios at all times.
Term: The term of a loan is typically three to seven years. Terms of debt securities are generally longer and average eight to 10 years. A longer term helps to improve a company's debt maturity profile.
Interest rates: Syndicated loans tend to have lower interest rates than debt securities. However, debt securities usually have more flexible interest rate options for an issuer, as debt securities can be fixed rate, floating rate or zero coupon. Syndicated loans usually only have a floating rate of interest.
Compliance with US securities laws: Securities offerings, including offerings of debt securities, must be made in compliance with the Securities Act of 1933. Under the Securities Act, any offer or sale of securities must be registered with the Securities and Exchange Commission, such that investors receive financial and other important information regarding the securities being offered for sale (unless an exemption to registration applies). There may be exemptions to registration available based on the value of the securities being offered or the investors to which the securities are being offered, among others. Loans are not subject to compliance with the Securities Act.
Transferability: Debt securities that are issued in registered offerings are generally freely tradable and there may be a liquid market to trade such securities, such as through bond dealers or on a securities exchange. Debt securities issued in unregistered offerings may be limited as to transferability under the Securities Act. While there may be a market for transferring syndicated loans, it is unlikely to be anywhere near as liquid as the market for registered debt securities and will often require some form of consent, whether from the borrower or the agent under the relevant loan documents.
Repayment and pre-payment: A syndicated loan is likely to be more flexible regarding repayment of principal, which may be done in instalments. In addition, a borrower can often optionally pre-pay a loan at any time, subject to payment of London Interbank Offered Rate or other fixed interest breakage cost, and sometimes subject to payment of a pre-payment premium. Revolving loans can be repaid and then reborrowed during the life of the loan without restriction. Debt securities, on the other hand, usually provide for a single payment of principal at maturity (although the principal of some bonds can be repaid in instalments). In addition, typically, an issuer of debt securities is not permitted to pre-pay the debt for some period of time after issuance; and thereafter, the issuer can pre-pay the debt, subject to payment of a premium or a make-whole amount. In some cases, however, the issuer of debt securities may not be able to optionally pre-pay such debt at all.
4.3 What other factors should parties bear in mind when deciding on a secured finance structure?
The appropriate structure of a secured debt financing depends on a variety of factors, including:
- the size and creditworthiness of the borrower;
- the amount of money to be borrowed; and
- the use of proceeds.
5.1 What types of security interests are available in your jurisdiction? Which are most commonly used and which are recommended (if different)?
There is no shortage of assets that can serve as security for loan obligations in the US. Broadly speaking, assets that serve as collateral can be divided into two categories:
- personal property (eg, equipment, inventory, accounts, contract rights, general intangibles, intellectual property, investment property, deposit accounts and commercial tort claims); and
- real property (eg, land and buildings).
Of the two groups, personal property serves as the most common form of security.
5.2 What are the formal, documentary and procedural requirements for perfecting these different types of security interests (ensuring that they are enforceable against debtors and third parties)?
With respect to personal property, the Uniform Commercial Code (UCC) provides a well-developed and predictable framework for providing security interests in personal property assets. While the UCC is a not a federal law, it has been adopted by all 50 states in the US and the District of Columbia, with limited deviations of significance.
Under the UCC, a security interest becomes enforceable once it ‘attaches' or is ‘created'. Generally, attachment occurs when the debtor has ownership or other rights in the assets that it seeks to grant a security interest, and the secured party and the debtor enter into an enforceable agreement that includes a grant of a security interest and sufficiently describes the collateral.
Once attached, the security interest must be ‘perfected' by the secured party to ensure that the security interest will be effective against third parties. Depending on the type of collateral in question, the steps to properly perfect a security interest under the UCC are dependent upon the type of collateral. The most common method of perfecting a security interest is done by filing a UCC-1 financing statement in the appropriate public office. This filing serves to provide notice to third parties of the secured party's interest in the assets of the debtor. However, certain types of assets (eg, securities accounts and deposit accounts) require that the secured party be in possession of, or have control of, the assets in question in order to be properly perfected.
In the event that security interests are granted by a debtor to multiple secured parties, the priority of the security interests as between each secured party becomes an issue. While each secured party will have priority over unsecured creditors, the UCC prescribes that the rule for determining which secured party has priority vis-à-vis each other is the ‘first-in-time' rule. With some exceptions, the secured party that was first to perfect its security interest in the collateral will have priority over the competing security interest.
Inter-creditor arrangements and agreements among lenders are commonly used in the US to override and reallocate lien and guaranty priorities to allow for financing to be implemented across a debtor's balance sheet and capital stack. Many debt transactions in the US accommodate multiple layers of financing both on and off-balance sheet for debtors.
The UCC is applicable to a large portion of personal property, but not all. In some instances, state law is pre-empted by federal statutes. For example, the Federal Aviation Act governs the perfection of a security interest in aircrafts and the Ship Mortgage Act governs the perfection of a security interest in ships that are above a certain tonnage.
Except to the extent that fixtures are present on real property, the UCC is inapplicable to real property. ‘Fixtures' are personal property that permanently ‘affixes' to land. A security interest in fixtures may be perfected under the UCC by filing a financing statement in the place where the real property records for the real property is located or under local real estate law. With respect to real property, the creation, perfection and priority of security interests in real property are governed by the law of state where the real property is located. How to perfect in new developing assets such as cryptocurrencies is a developing issue in the US. Further information on the UCC for the state of Texas recognising cryptocurrencies can be found here.
5.3 What are the main types of collateral used as security in your jurisdiction and what specific points should be borne in mind regarding each?
Please see questions 5.1 and 5.2.
5.4 Can security be taken over property, plant and equipment in your jurisdiction? If so, how?
Yes; please see question 5.2.
5.5 Can security be taken over cash (including bank accounts generally) and receivables in your jurisdiction? If so, how?
A security interest may be granted in a deposit account. With respect to perfection of this security interest, the secured party must establish ‘control' of the deposit account. This is one of the few exceptions in the UCC where the filing of a financing statement is insufficient to properly perfect the security interest. In order to obtain control of the deposit account, a secured party will typically enter into a tri-party agreement with the debtor and the depositary bank, which is commonly referred to as a deposit account control agreement. The deposit account control agreement will require that the depositary bank follow the secured party's instructions regarding the distribution of cash in the deposit account without further consent of the debtor.
Receivables are considered personal property under the UCC and a security interest may be granted in them by the debtor. Once created, the security interest is perfected by filing a financing statement in the appropriate office. Additionally, the security interest in receivables can encompass future receivables and the filed financing statement will be effective when the future receivable arises.
5.6 Can security be taken over company shares in your jurisdiction? If so, how?
Yes. Company shares may be issued in either certificated or uncertificated form and both can serve as security for loan obligations in the US. In general, a security interest in such shares can be perfected by either filing or control. With respect to certificated shares, perfection by control or possession will have priority. The law governing perfection of such security interest in certificated securities depends on whether perfection is achieved by filing (location of debtor) or control (location of collateral).
5.7 Can security be taken over inventory/moveables in your jurisdiction? If so, how?
Yes. Inventory is considered personal property under the UCC and a security interest may be granted in it by the debtor. Once created, the security interest is perfected by filing a financing statement in the appropriate office. Additionally, the security interest in inventory can encompass future inventory and the filed financing statement will be effective when the future inventory is created or acquired by the debtor.
5.8 What charges, fees and taxes (including notary and similar fees) arise from the perfection of a security interest? Do these vary depending on the type of assets used as collateral?
For personal property, there are typically only nominal filing fees required by each state in connection with the filing of financing statements.
For real property, each state has its own fee and tax structure for the filing and recording of real property mortgages or deeds of trust. Typically, these are based on a percentage of the amount of the debt or the value of the property.
5.9 What are the respective obligations and liabilities of the parties under the security documents?
While the obligations and liabilities of a debtor and secured party are too numerous and detailed to discuss here, one common provision regarding security interests is the ‘further assurances' provision. Briefly, the debtor agrees to take any and all actions that are reasonably requested by the secured party that are needed to ensure the creation, perfection and priority of the security interests granted in favour of the secured party.
5.10 What other considerations should be borne in mind by all counterparties when perfecting a security interest in your jurisdiction?
While the UCC provides a generally straightforward framework for perfecting security interests in personal property, attention to detail is key and should be left to professionals with expertise in the area. A simple error (either in how a security interest in perfected or in the perfection process itself) can lead to devastating consequences if not done properly.
6.1 What types of guarantees are available in your jurisdiction? Which are most commonly used and which are recommended (if different)?
Group company guarantees of all types are generally available in the US, subject to certain limitations and considerations outlined below. Guarantees may generally be categorised as:
- ‘downstream', in which the parent company guarantees the obligations of its direct or indirect subsidiary;
- ‘upstream', in which a subsidiary guarantees the obligations of its direct or indirect parent company; or
- ‘cross-stream', in which a company guarantees the debts of a sister company that shares a common parent company.
Each type is commonplace in the US secured loan market, with many transactions utilising all three types as credit support for a borrower's obligations. In such cases, the guarantee is structured as joint and several obligations of the guarantors, with each guarantor liable for repayment in full of the borrower's loan obligations.
While guarantees are generally commonplace, lenders should be aware that a US domestic parent may resist providing guarantees from its controlled foreign subsidiaries and certain domestic subsidiaries whose sole assets are equity interests in such controlled foreign subsidiaries (‘Domestic HoldCos'), as such guarantees may give rise to adverse tax consequences for the parent. Under applicable regulations, stock pledges of greater than two-thirds of the voting equity of a controlled foreign subsidiary or a Domestic HoldCo when coupled with other restrictive covenants are deemed to be a guarantee. Although recent changes in US tax law have reduced the impact of such guarantees, market practice in the US is to forgo or limit guarantees from controlled foreign subsidiaries or Domestic HoldCos of a US domiciled parent's loan obligations.
For commercial real estate loans in the US, lenders typically only have limited recourse to a guarantor for repayment of the loan obligations. These so-called ‘bad boy' guarantees are limited in terms of both:
- liability, with the guarantor liable for only a portion of the loan amount; and
- the events that give rise to recourse to the guarantor, with the guarantor only liable for certain ‘bad acts', including, but not limited to, fraud, bankruptcy and misappropriation of funds.
6.2 What are the formal, documentary and procedural requirements to perfect a guarantee?
A guarantee must satisfy generally applicable contractual principles to be enforceable against the guarantor – namely, there must be:
- sufficient consideration or value given in exchange for the guarantee; and
- a ‘meeting of the minds' between contracting parties over the terms of the guarantee.
In addition, in some states, a guarantee must be concluded in writing and duly executed by the guarantor to comply with so-called Statute of Frauds requirements. A guarantee need not be notarised or apostilled; however, it is common practice in the US to have a personal guarantee given by an individual notarised, to provide comfort as to the identity of the person executing the instrument.
It is also critical to examine state corporate law governing the corporate entity providing the guarantee and the documents governing such corporate entity, as both may restrict certain types of guarantees or require director or shareholder authorisation with respect to the making of a guarantee. Under Delaware law, for example, applicable law permits a corporation to make "contracts of guaranty and suretyship which are necessary or convenient to the conduct, promotion or attainment of the business" of the contracting corporation.
6.3 What charges, fees and taxes (including notary and similar fees) arise from the perfection of a guarantee?
There are no mandatory charges, fees or taxes that arise from the making of a guarantee in the US. If notarisation of a guarantor's signature is desired by a lender group, which is more typical where a personal guaranty is concerned, the fees for notarisation are de minimis.
6.4 What are the respective obligations and liabilities of the parties under the guarantee?
Typically, in the US, a guarantee provides that a guarantor guarantees the timely repayment in full and performance of all obligations of the borrower plus all costs incurred by the lender group in enforcing the guaranty. Furthermore, the beneficiary of the guarantee may seek to enforce the guarantee:
- without first exercising remedies or obtaining a judgment against the borrower;
- against any single guarantor or all of them while simultaneously pursuing remedies against the borrower;
- without resorting to recourse to any collateral for the loan; and
- without provision of any notice as to any default or other event with respect to the loan.
A guarantor's obligations under a guarantee usually terminate concurrently with the repayment in full of the loan obligations, but are subject to reinstatement if any portion of the repayment amount is voided or is returned upon the bankruptcy of the borrower.
Some guarantees may require financial reporting on the part of the guarantor to provide lenders with comfort that the guarantor remains sufficiently creditworthy to support the repayment of the loan obligations. This is less common for intercorporate guarantees, as the relevant financial reporting will be customarily required under the loan documentation.
6.5 What other considerations should be borne in mind by all counterparties when taking the benefit of a guarantee in your jurisdiction?
Guarantees may be subject to revocation by a guarantor; or the guarantor could even be automatically released from its obligations upon the occurrence of certain events. Furthermore, many defences are available to a guarantor that believes it should not be required to pay amounts guaranteed by it. For example, a guarantor may assert as a defence that the borrower did not provide accurate information to it regarding its financial condition and prospects, and that it was misled into providing its guarantee. In most forms of guarantee, however, the guarantee provides for a myriad of waivers on the part of a guarantor to mitigate risk of revocation and release. The governing law of the applicable jurisdiction must be carefully examined to ensure that necessary waivers are included and that they are enforceable under state law.
A small number of US states – most notably California – have so-called ‘one action' rules that, in the context of real property mortgage loans, may restrict the ability of a lender to enforce a guarantee in a separate action from another commenced against the borrower to exercise the lender's remedies.
Lastly, a lender should always be aware of and carefully consider fraudulent transfer risk in structuring guarantees for a loan transaction. Guarantees may also be challenged as fraudulent transfers under US bankruptcy law and state laws whose relevant statutes are, for the most part, modelled on the Uniform Fraudulent Transfer Act. A fraudulent transfer, simply put, is a transfer of property that is an actual or constructive fraud on the transferor's creditors. If a court determines that a guarantee constitutes a fraudulent transfer, the guarantee will be rendered unenforceable and payments, if any, made thereunder may be subject to recovery by the bankruptcy estate of the guarantor. In the absence of actual intent to defraud, which is difficult to prove, challenges to guarantees typically allege constructive fraud. Constructive fraud is found where:
- the guarantor received less than ‘reasonably equivalent value' in exchange for the guarantee; and
- the guarantor:
- was insolvent at the time or result of making the guarantee;
- was engaged or about to engage in a business or transaction with insufficient capital; or
- intended to incur, or believed it would incur, debts beyond its ability to pay as and when due.
Questions of ‘reasonably equivalent value' typically arise in the context of ‘cross-stream' and ‘upstream' guarantees, as it is less apparent what direct and indirect benefits accrue to a borrower's sister companies and subsidiaries in the absence of receipt of any of the loan proceeds by such entities. A ‘downstream' guarantee typically raises no fraudulent transfer concerns, as a parent entity directly benefits through the value of its equity interests. Documentation for ‘upstream' and ‘cross-stream' guarantees typically includes limitations on collection of amounts that would give rise to a fraudulent transfer. This may operate to limit the amount a lender may collect under the guarantee.
Because of fraudulent conveyance concerns, ‘upstream' and ‘cross-stream' guarantees commonly contain fraudulent conveyance ‘caps' that limit the guaranteed amount to what the entity can pay without being rendered insolvent. Contribution and consolidated group sharing arrangements are also used to provide credit support across a related group of companies to further support guaranty obligations. Solvency representations and certificates are common for US debt transactions.
7 Financial assistance
7.1 What requirements and restrictions apply with regard to the provision of financial assistance in your jurisdiction? What specific implications do these have for secured finance transactions?
Unlike some other jurisdictions, the US does not have the concept of ‘financial assistance' laws, which prohibit the provision of guarantees or security to support the financing of the acquisition of a target company, its direct or indirect parent, or any related company. See questions 6.1–6.5 for more information.
8 Syndicated lending
8.1 Is the concept of an agent or trustee recognised in your jurisdiction? If not, how is security taken for multiple lenders?
Yes. US loan documentation typically uses an administrative agent and a collateral agent. The administrative agent is responsible for the day-to-day administration of the facility (including making payments, sending and receiving notices and reports, and other communications between the debtor and the other lenders). Payments, notices, reports and other communications between the borrower and the lender syndicate are made through the administrative agent. The collateral agent, which often is the same bank that serves as the administrative agent, is responsible for collateral-related items. With respect to bond and note documentation, a ‘trustee' typically serves these functions. In addition to core agents and trustee responsibilities, large US debt transactions have marketing titles such as syndication or documentation agent, co-arranger and so on. These additional titles apply to fees and marketing credit, not to any substantive responsibility under the credit documentation on an ongoing basis after closing.
8.2 What requirements and restrictions apply with regard to syndicated lending in your jurisdiction?
The US takes a free market approach to syndicated lending and as long as the participants are sophisticated investors or qualified institution buyers, there are no restrictions on investing in, or trading, syndicated loans. Many US funds have internal guidelines that prohibit them from directly making a loan. For those participants, the lead agents usually ‘front' the funding of the debt by making the cash advance to the debtor on the closing date. Shortly after these loans are made, they can then be resold to those funds. Other restrictions apply to foreign lenders making loans in the US; usually, as long as the lender has established a registered US lending office, it can participate. Some loan structures use offshore tax havens, such as the Cayman Islands, to domicile the borrower so that a wider range of lenders can participate in the transaction. The rules on all these issues are complex and expert counsel should be consulted to ensure compliance for these transactions.
8.3 What other considerations should be borne in mind by all counterparties when engaging in syndicated lending in your jurisdiction?
In addition to the credit quality of a transaction, syndicate participants should be focused on how to protect their investment from ongoing changes through existing exceptions to the covenants or changes by a vote of the lenders. Most modifications to US credit agreements can be accomplished by a vote of the lenders holding a simple majority of the loans and commitments. It is also common to have what are called ‘sacred rights' that require all affected lenders to approve changes to those terms. The sacred rights usually include:
- extensions of final maturity;
- delays or waivers of any scheduled payment requirements;
- decreases in interest rates and fees;
- changes to pro rata sharing provisions;
- increase in any lender's commitment without its consent; and
- releases of material guarantors or all or substantially all of the collateral (in the case of a secured loan).
Other provisions, such as subordination of the loan or lien priorities, have recently started being added to the sacred rights, along with other fundamental changes to the loan or lending structure.
Understanding the amendment, pro rata sharing and transferability provisions of a loan transaction is fundamental to evaluating a participant's rights and protection within the syndicate. In the US, the Loan Syndications and Trading Association (LSTA) is the leading advocate for US loan syndication protections and procedures. Many publications are available from the LSTA that detail participation in, and trading of, syndicated loans. As always, however, each transaction depends on its particular terms, as the parties are free to agree to whatever they want and are not bound by staying within customary guardrails. Expert advice should always be consulted before participating in or acquiring syndicated loans.
9 Taxes, charges and fees
9.1 What taxes and similar charges are levied in the secured finance context in your jurisdiction? Do these vary depending on whether the lender is a domestic or foreign entity?
Lenders in a secured finance transaction may be subject to US withholding taxes. Domestic lenders may be subject to US federal back-up withholding, but most entities domiciled in the US are exempt from back-up withholding requirements; provided that such lenders provide certain forms or evidence certifying their non-US status. Foreign lenders, however, are generally subject to:
- US gross basis withholding tax on any fixed, determinable, annual or periodical income (FDAP) not effectively connected with the conduct of a trade or business within the US by the foreign lender (or, if a tax treaty applies, not attributable to a US permanent establishment maintained by such foreign lender); and
- US income tax with respect to income that is effectively connected with the conduct of a trade or business in the US (or a US permanent establishment, in the case of a treaty eligible lender).
For many foreign lenders, interest income would likely be subject to FDAP withholding on the gross amount of such income at 30% without any offsetting deductions, assuming that such lenders are not engaged in a US trade or business (or, if an income tax treaty applies, has a US permanent establishment). Any such FDAP withholding may be reduced or eliminated if the foreign lender qualifies for a lower rate under an applicable income tax treaty. Additionally, payments to foreign lenders may be exempt from FDAP withholding under the portfolio interest exemption.
In addition to the FDAP withholding regime, foreign lenders are subject to the Foreign Account Tax Compliance Act (FATCA), which requires certain foreign entities to provide information to the US federal government regarding US persons that hold foreign assets and accounts. To incentivise compliance with this reporting regime, the US imposes withholding taxes on FDAP payments made to foreign lenders that do not comply with FATCA reporting and/or other requirements. The aggregate withholding tax on FDAP income for FATCA non-compliance, combined with FDAP withholding discussed above, will not exceed 30%.
Back-up withholding generally will not apply to payments made to foreign lenders. Payments from guarantees and proceeds from collateral may also be subject to withholding taxes; and tax experts should be consulted in advance of a secured lender exercising remedies against a borrower, guarantors and collateral to ensure they are exercising remedies in a tax-efficient manner.
Unlike in many foreign jurisdictions, the US and states generally do not impose documentary stamp taxes; but certain states or locals may charge recordation fees or taxes for recording mortgages against real property. Such recordation fees or taxes may be substantial in certain jurisdictions, as they are calculated based on the amount of the obligations secured by the mortgage.
Outside of the context of mortgages on real property, fees and charges incurred in connection with the filing and recordation of security interests in personal property are minimal, except for certain states and locales. It is customary in the US that any fees and charges incurred by a lender in connection with a secured lending transaction, including costs and fees of legal counsel, are reimbursed by the borrower.
9.2 Are any exemptions or incentives available?
While the US generally does not provide direct tax incentives for lenders, payments to foreign lenders that would otherwise be subject to FDAP withholding may qualify for an exemption from FDAP withholding under the portfolio interest exemption. The portfolio interest exemption is generally available to a foreign lender if:
- the loan or promissory note is in registered form (ie, not bearer form);
- interest on the loan is not subject to contingencies – for example, borrower performance metrics;
- the lender is not a bank ordinarily engaged in extending credit;
- the lender does not own 10% or more of the borrower's equity;
- the lender certifies that it is not a US person (via an applicable Internal Revenue Service Form W-8); and
- the interest income is not income effectively connected to a US trade or business.
Foreign lenders may also benefit from and seek reduced withholding taxes through any double income tax treaty to which such lender's country and the US are party.
9.3 What other significant costs will be incurred by the counterparties in entering into a secured finance transaction? Do these vary depending on whether the lender is a domestic or foreign entity?
We are not aware of any other significant costs generally applicable to counterparties to a secured finance transaction.
9.4 What strategies might the counterparties consider to mitigate their tax and other liabilities in the secured finance context?
For loan obligations secured in part by a mortgage on real property, a strategy that is commonly employed to limit recordation fees and taxes that are calculated on the amount secured by such property is to limit the secured amount to a portion of the total loan obligations. This is especially critical if the amount of the loan obligations far exceeds the value of the property securing it, in which case you could end up with recordation taxes and fees in excess of the value of the property. Legal counsel and title companies are good resources for determining taxes and fees that will be due and how to structure transactions secured by real property.
For any foreign lender that is looking to collateral for repayment of loan obligations, it is important to consider whether foreclosing on the assets will unwittingly subject not only the assets to US taxation, but also the entire business of the foreign lender. A foreign lender that is not otherwise engaged in a US trade or business may be able to avoid such adverse tax consequences using a so-called ‘blocker' corporation that holds the assets and is taxed in place of the foreign lender.
10 Judicial enforcement
10.1 In the event of default, what options are available to enforce a security interest or guarantee? Is self-help available in your jurisdiction in connection with the enforcement of security (if so, in what circumstances) or must enforcement action be pursued through the courts?
Several options are available to a lender upon an event of default, including rights and remedies that may be exercised against the collateral. As an initial matter, upon an event of default, a lender may:
- refuse to extend additional loans to the borrower;
- raise the interest rates to a default rate;
- terminate any remaining loan commitments;
- accelerate the maturity of the loans; and
- demand immediate repayment of all outstanding loans and any other amounts owning under the loan documents from the borrower.
A lender can sue the borrower and any guarantors in court to obtain a judgment for the amounts that it is owed. To avoid a possible counterargument by a guarantor that the lender did not pursue the borrower first, a lender should generally first make demand on the borrower prior to bringing an action against a guarantor. As part of its action, a secured lender may also seek judicial foreclosure of the collateral under state law. Alternatively, a secured lender may exercise ‘self-help' remedies available to it under the Uniform Commercial Code (UCC), but only if it can do so without breaching the peace.
As part of the remedies available to a secured party under Article 9 of the UCC, a secured lender may sell, dispose of, lease or license the collateral in a commercially reasonable manner. Any sale or disposition of the collateral may be through a private or public sale. In addition, subject to limited exceptions, a secured party must notify certain parties (including the borrower, any guarantors and any other secured parties) prior to a proposed sale of collateral; generally, 10 days is considered commercially reasonable notice. After a sale, the secured party may pursue the borrower for any amounts that remain unpaid under the loan documents (ie, in a deficiency action).
Alternatively, a secured lender can retain the collateral in full or partial satisfaction of the debt (also known as strict foreclosure). The borrower, any guarantors and any other secured parties that are entitled to notice may object to strict foreclosure and prevent exercise of this remedy. Another possible remedy is collection: a secured lender can collect payments directly from account debtors and other parties that owe money to the borrower and apply such amounts to the debt. If a secured lender has a perfected security interest in a deposit account or a securities account (pursuant to an account control agreement), the lender may direct the bank at which the account is held to pay the amounts in the account to or for the benefit of the lender.
A secured party's remedies are mostly cumulative and can be exercised simultaneously. Further, in enforcing its rights under the UCC, a secured party must act in a commercially reasonable manner. While the determination of what is commercially reasonable is not specifically defined in Article 9 of the UCC, generally, using commercially reasonable efforts to maximise the proceeds of a collateral sale will be considered commercially reasonable. A borrower cannot waive the UCC requirement for the lender to be commercially reasonable when disposing of collateral.
The requirements with respect to enforcement of a security interest in real property collateral are governed by state law and can vary significantly. Some states allow a secured lender to take possession of a collateral property following an event of default. Most states, however, require the secured lender to sell a collateral property through judicial foreclosure, where the foreclosure sale is conducted under court supervision; while others permit foreclosure by power of sale, which is a non-judicial sale of collateral property through an auction. The proceeds of any such sale of a collateral property are applied to the outstanding debt of the secured lender; any excess proceeds go to junior lien holders or are returned to the borrower. Certain states, including California, have a ‘one action' rule, which requires a secured lender to judicially or non-judicially foreclose on real property collateral before commencing a lawsuit against, or taking other action to collect from, a borrower or its assets.
10.2 How long does the enforcement process generally take and what steps does this typically involve? Do these vary depending on any applicable requirements or restrictions (eg, requirement for public auction or regulatory consents)? Do these vary depending on whether the lender is a domestic or foreign entity?
Depending on the type of collateral and the applicable state law, the timing and requirements that apply to the enforcement process can vary significantly. The UCC is relatively flexible as far as the rules governing enforcement of a security interest are concerned; the only real limitations are that the secured party must "act in good faith" and "in a commercially reasonable manner". As such, in reality, the enforcement process can take anywhere from a few months to significantly over a year. In addition, certain regulatory approvals may be required with respect to enforcement of a security interest in collateral of regulated entities, which may further delay the process.
Generally, foreign and domestic creditors are treated the same in enforcement proceedings.
10.3 What other considerations should be borne in mind when enforcing a security interest or guarantee in your jurisdiction?
If a borrower files for bankruptcy protection under chapter 11 of the US Bankruptcy Code, an automatic stay goes into effect, which prevents any creditor from taking actions to enforce its rights or remedies against the borrower and its collateral. In certain limited circumstances, a secured party may be able to seek relief from the automatic stay, by showing cause, including based on the lack of adequate protection of its interest in the collateral. To show a lack of "adequate protection," a secured party must show a lack of security to protect against the diminution in value of the secured party's collateral during the pendency of the borrower's chapter 11 case.
It is important to keep in mind that sometimes the best option for a lender may be to cooperate with the borrower in structuring a workout or a restructuring of its debt.
10.4 Are direct agreements with contractual counterparties well understood in your jurisdiction?
Direct agreements with contractual counterparties are well understood and are particularly common in project finance transactions with respect to the material project documents, such as construction contracts and operation and maintenance contracts. Under such direct agreements, the contract counterparty gives certain consents (eg, explicit consent to the lender's security interest) and agrees to certain undertakings in favour of the secured lender (eg, notifying the lender of any default by the borrower/project company under the relevant project document). Such agreements also provide the secured lender with step-in rights in the event that the project company fails to fulfil any of its obligations under the relevant agreement, in order to prevent the counterparty from terminating the agreement. This direct relationship between the secured lender and the contract counterparty facilities continuity of the project document and eventual completion of the project.
10.5 What other avenues are available to a lender to safeguard its position in connection with security or guarantees?
Taking the appropriate perfection actions is extremely important for a secured party to safeguard its position as to its security interest. If there is more than one secured party with a security interest in the same asset, the general rule is that the first lender to perfect has priority. A secured party that has validly perfected through possession or control over the applicable asset generally has priority over one that previously only filed a financing statement. Priority among secured parties can be modified by entering into intercreditor agreements or similar arrangements, which set forth how control is shared and exercised between different secured parties.
11.1 How (if at all) do bankruptcy proceedings impact on the enforcement of security by a creditor?
Under US federal law, upon the filing of a bankruptcy petition (whether voluntarily by the debtor or involuntarily by the creditors of the debtor), the ‘automatic stay' goes into effect. The automatic stay is an order that prevents any creditor from taking, or continuing to take, any actions to enforce its rights against the debtor or any of the debtor's property. In certain circumstances, a secured creditor may seek relief from the automatic stay from the bankruptcy court. In addition to federal bankruptcy laws, there are state laws relating to a secured creditor's enforcement rights.
11.2 In what circumstances can antecedent transactions be unwound for preference? What other similar measures apply in this regard?
Generally, two types of transactions can be voided by a bankruptcy court:
- a preferential transfer; and
- a fraudulent conveyance.
If a bankruptcy court determines that a preferential transfer has occurred, a secured party's security interest will be voided. Generally, a bankruptcy court may set aside a transfer made by a debtor that:
- is to or for the benefit of a creditor;
- is for an antecedent debt that existed at the time of the transfer;
- was made while the debtor was insolvent;
- was made within 90 days before the filing of the bankruptcy petition (or one year, if the transfer was to an insider); and
- enabled the creditor to receive more than it would have in a hypothetical liquidation.
Under the umbrella of fraudulent conveyances, there are two types:
- constructive fraud; and
- actual fraud.
Under either type, a bankruptcy court can unwind the transaction. Constructive fraud involves a transfer made in exchange for inadequate consideration; while actual fraud occurs when the debtor makes a transfer with intent to hinder, delay or defraud the other creditors.
Because of fraudulent conveyance concerns generally applicable to borrowers, guarantors and grantors of security, US loan documentation usually provides for representations and warranties as to solvency as well as solvency certificates (from a key financial officer or a third-party advisory firm). The solvency representations are made at the initial funding at closing and usually at the time of any subsequent credit advance under a revolver, delayed-draw or incremental facility. The solvency certificate is usually delivered at closing and may also be required at the time of funding of any significant incremental or delayed-draw facility. Most transactions rely on a solvency certificate from the chief financial officer of a debtor; but for larger and more complex transactions, it is common for the lenders to require an independent evaluation of solvency from a reputable third-party advisory firm.
11.3 Are any types of entities excluded from the bankruptcy regime in your jurisdiction? If so, what alternative regimes apply?
Certain banks, insurance companies, railroads, commodity brokers, stockbrokers and governmental entities and municipalities are excluded from the general US Bankruptcy Code and are subject to either special legislation or special provisions of the US Bankruptcy Code. Bankruptcy practice in the US is very complex and nuanced, and depends on the facts and circumstances of each proceeding. As a result, the general impact of US bankruptcy issues is outside the scope of this Q&A. Expert bankruptcy advice is usually sought by lenders at the structuring stage of transactions, particularly for more complex lending and intercreditor arrangements.
12 Governing law and jurisdiction
12.1 What law typically governs secured finance agreements in your jurisdiction? Do any specific requirements apply in this regard?
New York law typically governs secured finance transactions in the US, due to New York's role as a premier financial centre in the world and its substantial, well-developed and predictable body of commercial law. Lenders also view New York as a lender-friendly jurisdiction for adjudicating disputes. New York allows for parties in any jurisdiction to elect New York as the governing law for a transaction involving $250,000 or more, regardless of whether the contract or parties bear a reasonable relationship to New York. Furthermore, if a contract involves $1 million or more, a party may elect to enforce the contract against the other party thereto in New York courts.
While New York law is the most typical governing law for the parties' contractual rights, the making, perfection and priority of security interests in personal property are governed by a body of law called the Uniform Commercial Code (UCC). Each state in the US has adopted a version of the UCC and it is generally uniform across all states. Generally, the UCC of the state in which the relevant property is located or in which the grantor is organised should be consulted to ensure that a valid and enforceable security interest has been obtained by a lender. For real property, the laws of the state in which the property is located will govern the making of security interest in such real property and these laws vary from state to state.
12.2 Is a choice of foreign law or jurisdiction valid and enforceable? In the case of a choice of foreign law of jurisdiction, will any provisions of local law have mandatory application? Are submission to jurisdiction provisions that operate in favour of one party only enforceable?
Under US and state law, the parties to a contract are generally free to elect any law to govern their agreement and such election will be respected with limited exceptions – for instance, if a court finds insufficient contacts or no reasonable relationship with the jurisdiction, or that the application of foreign law would constitute a violation of a fundamental state or public policy. As it relates to the making of security interests in personal and real property in the US, local law will generally govern regardless of any foreign governing law elections made by the parties to a contract.
Generally, a contract which provides that only one party and not the other submits to a particular jurisdiction is enforceable subject to the contacts that such party has had with that jurisdiction and relevant law in the jurisdiction. For the most part, however, US transactions use mutual waivers of, and consent to, choice of law and jurisdiction.
12.3 Are waivers of immunity enforceable in your jurisdiction?
Yes, a waiver made by one party for the purpose of allowing another party to bring an action against the waiving party in a US or state court is generally enforceable.
12.4 Will foreign judgments or arbitral awards be enforced in your jurisdiction? If so, how?
The US is not a party to any treaties for reciprocal recognition of foreign judgments and enforcement of a foreign judgment cannot be accomplished through a letter of rogatory addressed to a US or state court. Foreign judgments, however, may be enforced in state courts. Most states, including New York, have adopted the Uniform Foreign Money-Judgments Recognition Act, which provides for recognition and enforcement of any foreign judgment that is final, conclusive and enforceable in the jurisdiction in which it was rendered. A court may elect not to enforce a judgment if, among other things, it is found that the foreign court:
- is not impartial;
- did not offer due process of law; or
- did not have personal jurisdiction over the defendant.
Even those states that have not adopted the relevant uniform statutes perform a similar analysis for the enforcement of foreign judgments under common law principles of international comity. An entity or person that wishes to enforce a foreign judgment in the US must file suit with a court of competent jurisdiction and that court will determine, in accordance with the applicable law, whether and to what extent to recognise the foreign judgment and order its enforcement.
Arbitral awards are generally enforceable in the US, as the US is a member of both the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards and the Inter-American Convention on International Commercial Arbitration. An entity or person that wishes to enforce an arbitral award in the US must present an authentic copy of the award to the court, which will recognise and enforce it unless the party against which enforcement is sought can establish a basis for non-recognition. Article V of the New York Convention, for example, allows a court not to recognise an arbitral award if:
- the arbitration agreement was invalid;
- the non-prevailing party was not properly notified of the proceeding;
- the award "deals with a difference not contemplated by or not falling within the terms of the submission to arbitration, or it contains decisions on matters beyond the scope of the submission to arbitration";
- the tribunal composition was improper;
- the award "has been set aside or suspended by a competent authority of the country in which, or under the law of which, that award was made";
- the "subject matter" of the dispute is not "capable of settlement by arbitration" under that country's law; or
- award enforcement would be contrary to "public policy."
13 Trends and predictions
13.1 How would you describe the current secured finance landscape and prevailing trends in your jurisdiction? Are any new developments anticipated in the next 12 months, including any proposed legislative reforms?
London Interbank Offered Rate (LIBOR) replacement: LIBOR is scheduled to be phased out completely by 30 June 2023. Legislation has been introduced in the US Congress to address contracts that are based on LIBOR but do not have provisions providing for an alternative interest reference rate to LIBOR (the Adjustable Interest Rate (LIBOR) Act of 2021 (HR 4616)). The legislation, which provides for federal pre-emption of state laws, would provide a uniform, nationwide framework for LIBOR replacement. Notably, it would rely on the Secured Overnight Financing Rate (SOFR), which is calculated based on the overnight rates offered on the Treasury repurchase market. The Alternative Reference Rates Committee, convened by the Federal Reserve Bank of New York, has recommended hardwired fall-back language, which relies on SOFR as the benchmark replacement rate.
Erroneous payments to lenders: The finance world's ‘Revlon' case, In re Citibank (having nothing to do with board duties in the context of a sale of control), shocked the lending community in 2020. The Southern District of New York ruled that erroneous payments totalling $900 million made to the lending syndicate by the administrative agent for Revlon, Inc's credit facility did not need to be returned because the lenders did not have actual or constructive notice that the payments were erroneous. As a result, lenders are seeking to address how to claw back accidental payments made by an administrative agent to its syndicate of lenders. The Loan Syndications and Trading Association put out model language to address this and it is expected that similar provisions will be incorporated in most loan agreements going forward. Some parties are requesting amendments to existing loan agreements solely to address this issue.
Environmental, social and governance (ESG) lending: Following the rising popularity of ESG funds, loans with ESG-like performance metrics are also becoming more popular. Sustainability-linked loans and loans linked to ESG tests typically provide for a lower interest rate in the event that a borrower achieves certain performance metrics. This is unlike previous ‘green' loans, which sought to restrict the use of loan proceeds to environmentally friendly activities. Given the central focus of climate change and social justice in the Biden administration, there may be pricing incentives and other favourable borrowing terms on the horizon for borrowers looking to incorporate ESG goals into their credit facilities.
14 Tips and traps
14.1 What are your top tips for the smooth conclusion of a secured finance transaction in your jurisdiction and what potential sticking points would you highlight?
The United States (US) loan market is large and complex, with total volume last year estimated at close to $1 trillion. The investor base is broad, including commercial banks, hedge funds, mutual funds, insurance companies, private equity and others. Direct lenders, which are non-commercial banks such as funds, are the fastest-growing base for both the primary and secondary markets in the US.
The US corporate lending market is split generally into three categories:
- investment grade;
- leveraged lending (all loans not falling into the middle market); and
- the middle market (usually loans of less than $500 million, to debtors with revenues of less than $500 million annually).
Within these broad bands are a myriad of credit products and repackaged investments that cover the entire capital stack of corporate financing.
The market is constantly evolving, whether it is adapting to anticipated London Interbank Offered Rate replacement, new regulations or changing market terms and lending structures. For instance, over the last year, with the COVID-19 pandemic impacting businesses across sectors, many debtors looked to buy time and find more room in their capital structures to refinance and reorganise their liabilities. At the same time, investors sought to protect the value of their positions. The result was an increase in aggressive lending practices and structures that saw existing debt ‘primed', as it was essentially subordinated without consent to new financing by outside and/or inside investors. Terms of documentation going forward are attempting to defend against non-consensual priming. For more information on these developments, please see the 2021 Private Credit Overview and Middle Market Update: Pandemic Priming Shifts Debt to Defence, and New York Court's Ruling Could Have Broader Implications for No-Action Clauses, which can be found here and here, respectively, on the O'Melveny & Myers website.
This Q&A provides a general overview of the US lending market. It is by no means comprehensive or exhaustive of the issues that need to be navigated in US debt transactions. No guide can ever act as substitute for bespoke direct advice from expert counsel. This is not an arena where a little knowledge can go a long way. Nonetheless, hopefully the guide provides a better understanding for the overall scheme in which US lending operates.
As a rule, expert advice should be sought at the earliest stages of a potential structuring of a US debt transaction. Bankruptcy, tax, regulatory and other specialist advice is usually required, in addition to general lending and debt product expertise. The earlier that potential issues can be identified and dealt with upfront, the smoother the transaction will go. The US market is extremely complex to navigate, so having a clear map outlined at the start of any transaction is key to a successful investment.
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.