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von Holger Langer, LL.M.

Loan transfers / Sale of loan assets

Usually an inter-bank transaction which enables a bank to transfer an asset on its balance sheet consisting of its participation in a syndicated loan

 

 
Assignment Sub-
participation
Novation
Restri-
ctions in the loan agre-
ement
  • either express or implied restrictions on assignability possible
  • unless the loan agreement or the borrower authorises the selling bank to disclose the loan agreement and information about the borrower to prospective buying banks, the assignment may contravene the banker’s duty of confidentiality
  • unless the loan agreement or the borrower authorises the selling bank to disclose the loan agreement and information about the borrower to prospective buying banks, the sub-participation may contravene the banker’s duty of confidentiality
  • a clause permitting disclosure to an assignee (see left) would not cover disclosure to a sub-participant
 
Benefit of the loan agreement
  • participant acquires direct rights against the borrower under the loan agreement and therefore has the benefit of the whole loan agreement
  • however, the assignment may not increase the burden of obligation of the borrower (Durham Bros v Robertson)
  • buying bank is not an assignee and therefore does not obtain the benefit of the loan agreement (tax grossing-up, increased costs, illegality, voting rights etc.)
  • buying bank has all benefits of the loan agreement
Transfer-
ability of bank’s obligations
  • selling bank does not transfer obligations, notably obligations to make further loans under a revolving facility, cf. Tolhurst v Portland Cement (contractual rights may be assigned, contractual obligations cannot)
  • buying bank will in this case agree to pay its share against a deemed assignment of the new loan
  • selling bank is not released from any of its obligations owed to the borrower, notably obligations to make further loans
  • all continuing obligations of the selling bank, e.g. the advancement of further loans, are transferred to the buying bank, without any underwriting commitment if the buying bank fails to perform
Set-off position
  • buying bank as assignee may set off a deposit of the borrower held by it as against the assigned debt once notice has been given
  • selling bank as assignor may not exercise the right of set-off, since payment is owed only to the assignee
  • borrower may set off certain claims against the assignor, but will generally have agreed in the loan agreement not to raise set-offs, which will usually also be effective against the assignee
  • the selling bank should warrant to the buying bank that there are no set-offs and should agree to compensate the buying bank for set-offs by the borrower
  • assignment destroys set-off mutuality between the selling bank and borrower (as against the assigned part of the loan), but mutuality usually exists between the borrower and the buying bank for the assigned portion
  • buying bank is not a creditor of the borrower, so there is no set-off mutuality as between the buying bank and the borrower
  • selling bank remains creditor of the borrower for the whole amount and hence there is set-off mutuality between the selling bank and the borrower
  • each set-off should however expressly trigger an obligation of the selling bank to treat the set-off as a payment of the borrower and pay the buying bank an amount equal to the buying bank’s share
  • normal set-off mutuality between the buying bank and the borrower as if the buying bank were an original bank
Recourse to seller
  • although assignors are not liable for the payment of the debt assigned, the agreement should specifically exclude any recourse of the buying bank to the selling bank if the borrower fails to pay
  • however, direct contractual rights of action against the borrower - buying bank may sue the borrower for interest and principal
  • Bank of England requires for capital adequacy purposes
  • that the selling bank must have given notice to the buying bank that it is under no obligation to support any losses suffered by the buying bank and
  • buying bank has acknowledged such absence of obligation
  • buying bank may not sue the borrower for interest and principal (no privity of contract)
  • Double risk: buying bank takes the risk of default of the borrower and the selling bank
  • buying bank has no recourse to the selling bank
Appro-
priation of payments
  • partial payments by the borrower to the selling bank should be expressly appropriated pro rata between the selling bank’s retained portion and the buying bank’s assigned portion
  • partial payments by the borrower to the selling bank  should be expressly appropriated pro rata between the selling bank’s retained portion and the buying bank’s portion
  • partial payments should also expressly be appropriated in a specific order, e.g. costs, interest, principal
  • point of appropriation does not arise, since the agent bank pays the buying bank directly in place of the selling bank

Manage-
ment

  • buying bank should aim to control its portion of the loan
  • selling banks usually exclude responsibility for continuing disclosure and monitoring, but they are in the position of a fiduciary or trustee
  • of selling bank’s implied duties to buying banks is unsettled but common sense indicates that wherever one person has the power by contract to alter the economic position of another, the person with the power is subject to an implied duty of due diligence (application of agency principles by analogy)
  • selling banks usually exclude responsibility for continuing disclosure and monitoring
  • buying bank becomes a bank for the purpose of syndicate voting, the right to recover direct from the borrower and the right to manage its portion
Resche-
duling
  • if the assignment is notified, the buying bank should normally be the lender of record for new money on rescheduling
  • allocating rescheduling risks on the buying bank is a Bank of England requirement for capital adequacy purposes, so that even in the case of no initial notification of the assignment, such notification should be given in the case of rescheduling
  • in the absence of express clauses a buying bank would have no rights in the event of rescheduling (consultation, participation in negotiations etc.)
  • where the rescheduling takes the form of a waiver of the maturity date or a release, no payment by the borrower took place, hence no payment obligation of the selling bank would be triggered
  • the agreement should if possible commit the buying bank to a corresponding rescheduling which matches the rescheduling agreement between the selling bank and the borrower and should oblige the buying bank to advance its share of new moneys to the selling bank
  • problem may arise when the lead bank agrees to convert its debt into equity, i.e. set-off of the loan against subscription of shares ’ could trigger a pro rata payment obligation towards the buying bank
  • great weakness of sub-
    participations is that the basic purpose of passing the insolvency risk of the borrower to the buying bank can be threatened by the fact that the refusal of a buying bank to allow a rescheduling might lead exactly to liquidation of the borrower
  • the buying bank is lender of record for rescheduling purposes

Secured loans

  • if the loan is secured, it should be made sure that the security is assignable, too (and should consequently also be assigned)
  • since the transaction is not an assignment, any security is not transferred to the buying bank
  • Problem: novation operates as the creation of a new debt in favour of a new creditor, the old debt is cancelled, hence any security might lapse
  • Solution: can be avoided by granting the security in favour of a trustee to secure a parallel obligation from the borrower to the trustee to pay the debt and on terms whereby the trustee holds the benefit of the security for a class of beneficiaries which includes the original banks and any persons who may become banks pursuant to the novation procedure
  • no objection in Anglo-
    American law to a trust for a class of future unascertained persons provided that the identity of the beneficiaries can be ascertained when the trust property vests
 

A. Purposes of loan transfers

  • Reduction of exposure to default – the lender wants to get out
  • Capital adequacy
    • the capital adequacy limits under the Basle Agreement are reached, but the bank wants to enter into a new loan agreement
    • the transfer of loan assets with a high risk weighting could therefore reduce its capital requirements
  • Improvement of profitability ratios

B. Methods of loan transfers

  • Asset which is sold is the right of the lending bank to interest and principal, which is a form of intangible property (chose in action)
  • Such asset cannot be sold in the same way as goods are sold under English law, because the Sale of Goods Act 1979 excludes “money” and choses in action from its definition of goods, s 61
  • Three traditional methods
    • Assignment

The selling bank transfers a loan to the buying bank by assigning its rights against the borrower to the buying bank, which would then be able to recover interest and principal from the borrower

    • Legal assignment (s 136(1) Law of Property Act 1925)

      • Prerequisites
        • in writing under the hand of the assignor
        • absolute; assignment of a part of a debt does not fall within s 136(1) (Forster v Baker)
        • express notice in writing to the debtor
      • unattractive in practice since
        • parts of a loan cannot be assigned
        • selling bank might not wish the borrower to know that rights have been assigned to another bank
        • advantage is that a legal assignee can sue the debtor without joining the assignor as a party to the action whereas an equitable assignee must join the assignor as party to the action, but this is in practice only a formality
    • Equitable assignment
      • effective without notice
        • however, where a creditor has made a number of assignments of the same debt, priority of assignments is not determined by priority in time of each assignment but by priority in time of notice (Dearle v Hall)
        • notice might nevertheless be advantageous
          • to bind the debtor to pay the assignee
          •  to preserve priority (see above)
          • to exclude new set-offs
          • to convert assignment into a legal assignment
          • to prevent the debtor and the assignor from agreeing variations without the consent of the assignee
      • possible to transfer only a part of a debt
  • Novation

Substitution of creditors by an agreement with the consent of all parties by which a contract between the borrower and the lending bank is rescinded in consideration of a new contract being entered into on the same terms between the borrower and the purchasing bank

  • difficult in practice, because it requires not only the consent of the borrower but of all syndicated banks, since the loan agreement creates rights also between the banks (e.g. pro rata sharing)
  • therefore rarely used in practice
  • Sub-Participation

Not a transfer of rights and obligations (from the legal point of view) of the original loan agreement, but a second loan agreement with the buying bank by which the buying bank transfers an amount to the selling bank equivalent to the selling bank’s participation in the primary loan

  • right to repayment is wholly conditional upon the extent of payment of interest and principal by the borrower to the selling bank
  • risk of non-payment is thus transferred to the buying bank as well as the entitlement to interest and principal
  • if the borrower defaults wholly or partially in the payment of interest or principal the buying bank would not receive payment to the extent of such default
  • legal structure is that of a back-to-back loan which provides the selling bank with a non-recourse funding arrangement

C. Supervisory treatment

  • Basle Agreement 1988 on capital adequacy
    • banks must maintain capital (equity + disclosed reserves + some types of subordinated debts) of at least 8% of their assets and exposures
    • various categories of assets are given a risk-weighting
      • bank claims on OECD central banks 0%
      • residential mortgages 50%
      • ordinary loans to the private sector 100%
      • e.g. for each 100$ lent in an ordinary loan to the private sector the bank must at least have 8$ capital
  • Bank of England’s Notice on Loan Transfers 1989 (amended in 1993)
    • sets out rules for the capital adequacy treatment of loan transfers to meet the requirements of the Basle Agreement
    • main object is to see that the selling bank legally and commercially has effectively transferred the risk (both rights and obligations) to the buying bank so that the loan is no longer a loan by the selling bank (risk no longer exposed to the borrower)
    • General main conditions
      • Transfer does not contravene the terms and conditions of the underlying loan agreement and all necessary consents have been obtained
      • buying bank has no formal recourse to the seller for losses and the seller is not obliged to repurchase the loan
      • the documented terms of the transfer are such that, if the loan is rescheduled or renegotiated, the buyer and not the seller would be subject to the rescheduled and renegotiated terms

D. New Methods of Transfer

  • Transferable Loan Certificate (TLC)
    • a document issued by the agent bank on behalf of the borrower and the syndicated banks, which contains an offer by the borrower, the agent and other syndicated banks to any transferee of the TLC that the transferee will be accepted by all parties to the syndicated loan as a party to syndicated loan agreement in substitution for the transferor of the TLC
  • Transferable Loan Instrument (TLI)
    • a debt instrument or debenture (as understood in English law), which acknowledges the indebtness of the issuer of the TLI to the registered holder
    • contains an unconditional promise by the borrower to pay a sum specified on the face of the TLI to any registered holder thereof on surrender of the TLI
  • Transferable Participation Certificate (TPC)