2022 Lending & Secured Finance - 10th Edition - Morgan Lewis
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Practical cross-border insights into lending and secured finance Lending & Secured Finance 2022 10th Edition Contributing Editor: Thomas Mellor Morgan, Lewis & Bockius LLP
Table of Contents
Editorial Chapters
Loan Syndications and Trading: An Overview of the Syndicated Loan Market
1 Bridget Marsh & Tess Virmani, Loan Syndications and Trading Association
Loan Market Association – An Overview
7 Hannah Vanstone, Loan Market Association
Asia Pacific Loan Market Association – An Overview
13 Andrew Ferguson & Rosamund Barker, Asia Pacific Loan Market Association
Expert Analysis Chapters
An Introduction to Legal Risk and Structuring Cross-Border Lending Transactions
16 Thomas Mellor, Marcus Marsh & Jasmine Badreddine, Morgan, Lewis & Bockius LLP
Global Trends in Leveraged Lending
21 Joshua Thompson, James Crooks & Bryan Robson, Sidley Austin LLP
Looking Back at the Year in SPACs
32
Michael Steinberg & Alain Dermarkar, Shearman & Sterling LLP
The Increasing Use of Preferred Equity in Financing Acquisitions
39 Meyer Dworkin, Scott Herrig, Randy Dorf & Phoebe Jin, Davis Polk & Wardwell LLP
2022: A Regulatory Perspective
43 Bill Satchell & Elizabeth Leckie, Allen & Overy LLP
Acquisition Financing in the United States: A Strong Recovery
49 Geoffrey Peck & Mark S. Wojciechowski, Morrison & Foerster LLP
A Comparative Overview of Transatlantic Intercreditor Agreements
55 Miko Bradford & Benjamin Sayagh, Milbank LLP
A Comparison of Key Provisions in U.S. and European Leveraged Loan Agreements
63 Tracey L. Chenoweth & Clive J. Wells, Skadden, Arps, Slate, Meagher & Flom LLP
Fund Finance: The Transition to 2022
81 Michael C. Mascia, Cadwalader, Wickersham & Taft LLP
Recent Developments in U.S. Term Loan B
84 Denise Ryan & Kyle Lakin, Freshfields Bruckhaus Deringer LLP
The Continued Prevalence of European Covenant Lite
93 Jane Summers, Daniel Seale, Karan Chopra & Robert Davidson, Latham & Watkins LLP
Analysis and Update on the Continuing Evolution of Terms in Private Credit Transactions
98 Sandra Lee Montgomery & Michelle L. Iodice, Proskauer Rose LLP
Trade Finance on the Blockchain: 2022 Update
108 Josias Dewey, Holland & Knight LLP
Financing Your Private Debt Platform
115 Global Finance Group, Dechert LLP
Developments in Midstream Oil and Gas Finance in the United States
125 Elena Maria Millerman & Derrik Sweeney, White & Case LLP
More Money, More Problems: Considerations for Perfection and Control of Virtual Currency
134 Kalyan (“Kal”) Das, Anthony Tu-Sekine, Gregg Bateman & Y. Daphne Coelho-Adam, Seward & Kissel LLP
2022 Private Credit and Middle Market Update: Key Trends and Developments
140 Jeff Norton, Sung Pak, Jennifer Taylor & Adam Longenbach, O’Melveny & Myers LLP
Core-Plus Infrastructure and Leveraged Financing: The Continued Convergence of Terms
144 Ben Thompson, Travers Smith LLP
Recent Trends in Sustainable Finance
148 Lara M. Rios, Kevin L. Turner & Allison N. Skopec, Holland & Knight LLPTable of Welcome
Contents
Expert Analysis Chapters Continued
SONIA: Transitioning to a New Era
156 Tim Rennie, Darren Phelan, Katharine Tuohy & Sarah Curry, Ashurst LLP
Hedging the Refinanced Cross-Border Credit Agreement
162 Felicity Caramanna, Credit Agricole Corporate and Investment Bank
Q&A Chapters
Argentina Italy
165 Marval O’Farrell Mairal: Juan M. Diehl Moreno & 326 Allen & Overy Studio Legale Associato:
Diego A. Chighizola Stefano Sennhauser & Alessandra Pirozzolo
Austria Japan
176 336 Mori Hamada & Matsumoto: Yusuke Suehiro
Fellner Wratzfeld & Partners: Markus Fellner,
Florian Kranebitter & Mario Burger
Jersey
344 Carey Olsen Jersey LLP: Robin Smith, Kate Andrews,
Belgium
188 Astrea: Dieter Veestraeten Peter German & Nick Ghazi
Luxembourg
Bermuda 355 SJL Jimenez Lunz: Antoine Fortier Grethen &
195 Wakefield Quin Limited: Erik L Gotfredsen &
Iulia Gay
Jemima Fearnside
Malawi
Bolivia 364 Ritz Attorneys-at-Law: John Chisomo Kalampa,
203 Criales & Urcullo: Luis Valda Yanguas, Adrián Chifundo Ngwira & Lozindaba Mbvundula
Barrenechea Bazoberry & Andrea Mariah Urcullo
Pereira Mexico
373 Chevez Ruiz Zamarripa: Ana Sofía Ríos, Jimena
Brazil González de Cossío & María Martínez Escobar
211 Pinheiro Neto Advogados: Ricardo Simões Russo &
Leonardo Baptista Rodrigues Cruz Netherlands
383 Freshfields Bruckhaus Deringer LLP: Mandeep Lotay
British Virgin Islands & Tim Elkerbout
220 Maples Group: Michael Gagie & Matthew Gilbert
Nigeria
391 Famsville Solicitors: Dayo Adu, Woye Famojuro,
Canada
228 McMillan LLP: Jeff Rogers, Don Waters, Maria Sagan Adeyemi Ayeku & Elu-Ojor Okoka
& Christina Kim
Singapore
401 Drew & Napier LLC: Pauline Chong, Renu Menon,
Cayman Islands
239 Maples Group: Tina Meigh & Bianca Leacock Blossom Hing & Ong Ken Loon
South Africa
Chile 413 Allen & Overy (South Africa) LLP: Ryan Nelson &
247 Carey: Diego Peralta, Fernando Noriega & Cynthia Venter
Alejandro Toro
Spain
Croatia 425 Cuatrecasas: Héctor Bros & Manuel Follía
256 Macesic and Partners LLC: Ivana Manovelo
Sweden
England 437 White & Case LLP: Carl Hugo Parment &
265 Allen & Overy LLP: Oleg Khomenko & Jane Glancy Magnus Wennerhorn
Finland Switzerland
276 445 Bär & Karrer Ltd.: Frédéric Bétrisey, Lukas Roesler &
White & Case LLP: Tanja Törnkvist & Henna Viljakainen
Micha Schilling
France
285 Orrick Herrington & Sutcliffe LLP: Carine Mou Si Yan Taiwan
455 Lee and Li, Attorneys-at-Law: Hsin-Lan Hsu &
Germany Odin Hsu
295 SZA Schilling, Zutt & Anschütz
United Arab Emirates
Rechtsanwaltsgesellschaft mbH: 464 Morgan, Lewis & Bockius LLP: Amanjit Fagura &
Dr. Dietrich F. R. Stiller
Tomisin Mosuro
Greece USA
305 Sardelas Petsa Law Firm: Panagiotis (Notis) 480 Morgan, Lewis & Bockius LLP: Thomas Mellor,
Sardelas & Aggeliki Chatzistavrou Katherine Weinstein & Rick Denhup
Ireland Venezuela
314 Dillon Eustace LLP: Conor Keaveny, Jamie Ensor & 493 Rodner, Martínez & Asociados: Jaime Martínez
Richard Lacken Estévez480 Chapter 57
USA
USA
Thomas Mellor
Katherine Weinstein
Morgan, Lewis & Bockius LLP Rick Denhup
demonstrate maximum employment levels. Although, against
12 Overview the backdrop of rising inflation in 2021, Federal Reserve poli-
cymakers began signaling that they anticipated raising interest
1.1 What are the main trends/significant developments rates during the course of 2022.
in the lending markets in your jurisdiction?
Certain trends in loan documentation
The corporate lending markets in the US are broad and deep rela- One of the most vibrant and innovative segments of the loan
tive to other jurisdictions. Market trends are often associated with markets in the US is the fast-paced leveraged loan market. “What
certain segments of the lending markets, and market segmenta- is market” on a variety of points, including leverage levels, spreads
tion in the US is based on a number of factors. These factors and covenants changes from month-to-month. Drivers of these
include: the size of the borrower (from so-called “large-cap” changes include the demands of determined and resourceful
borrowers, to those in the “middle-market” to “small-cap”); the borrowers and sponsors, the ebb and flow of the demand for
credit profile of the borrower (from investment-grade to below leveraged loans, ambitions to command greater market share, due
investment-grade or “leveraged”); the type of lender (banks, versus regard for credit risk and the other factors described below. Some
non-bank lenders, please see the discussion regarding “Direct broader trends in the market in recent years can be identified.
Lenders” below); the number of holders of the debt (from syndi- Convergence. The same investors often invest in leveraged
cated loans, to “club” and bilateral facilities); whether the loan loans and high-yield bonds. Leveraged loans typically have
is secured, and the relative positions of the lenders vis-à-vis one more restrictive covenants than high-yield bonds (although the
another (from senior unsecured, to senior secured, mezzanine gap has narrowed substantially) and are generally secured, so
and second-lien loans); the basis on which the loan is made and recoveries on leveraged loans after default are generally better.
repayment is (hopefully) assured (from a company’s general credit Investors judge the relative values of each of these instru-
rating, to cash flow loans, to asset-based loans); and the purpose of ments on a company-by-company basis. With each of these
the loans (from acquisition finance and venture finance to general asset classes “competing” with the other, over the years many
working capital loans, the development of specific projects and leveraged loans have taken on more bond-like characteristics,
the purchase of specific assets). While there are trends within including incurrence-based covenants, no caps on dispositions,
each of these market segments, there are also some broad trends and greater flexibility for restricted payments.
which impact multiple segments. For example: Covenant-Lite Loans. When demand for leveraged loans is high
(and borrowers have more leverage in negotiations) the trend
Sustained low interest rates (for now) is toward “looser” bond-like covenants, otherwise known as
The trend of decreasing interest rates that began in late 2019 “covenant-lite.” In covenant-lite loans, the borrower generally
continued through 2021, as the Federal Reserve maintained pays a premium in exchange for less restrictive covenants and no
the federal funds rate at the target range of 0–0.25% (effec- financial maintenance covenants (similar to high-yield bonds).
tively zero) first set on March 16, 2020. The Federal Reserve’s While financial maintenance covenants test the borrower on
decision to maintain the low benchmark rate stemmed from a periodic basis, covenant-lite loan agreements typically only
general concerns about the continued risk to economic activity include “incurrence” tests (which test the borrower upon
posed by the COVID-19 pandemic, including new variants. a specific activity such as the incurrence of liens or debt, the
This sustained low interest rate from the Federal Reserve is making of acquisitions or restricted payments, etc.). Covenant-
intended to further certain goals set by the Federal Open Market lite loans are viewed as having a greater risk of loss after default;
Committee, including promoting the maximum level of employ- with a covenant-lite loan, the first default is often a payment
ment, fostering price stability and maintaining a stable inflation default, occurring long after a financial covenant default would
rate of no more than 2%. In December 2021, the Federal Reserve have occurred. By that time, the borrower’s financial condition
announced that it expects to maintain the target range for the is likely to have deteriorated substantially. Covenant-lite loans
federal funds rate at 0–0.25% until labor market conditions were popular before the financial crisis, dried up during the crisis
Lending & Secured Finance 2022Morgan, Lewis & Bockius LLP 481 and its aftermath, but have made a comeback in recent years and and acquisitions, and often for equity distributions and volun- are now seen with greater frequency, including in middle market tary repayment of junior debt (subject to leverage governors). deals. The frequency of covenant-lite loans increased in 2019 Uncommitted incremental facilities also remain common fare and continued through the early part of 2020. However, the in loan agreements, permitting capped or, in an increasing COVID-19 pandemic and resulting volatility in the US economy number of cases (including in middle-market credit facilities), chilled enthusiasm for such borrower-friendly agreements and an uncapped amount of additional debt (so long as certain pro raised concerns about the future of covenant-lite loans. This forma leverage ratios are satisfied) together with a “free and reversal accelerated during the second quarter of 2020, when clear” basket that is not subject to pro forma leverage ratio tests. the issuance of covenant-lite loans virtually halted due to the Borrowers are also requesting that negative covenant baskets market’s reaction to the COVID-19 pandemic. Late in 2020, include “builders” based on a percentage of EBITDA, as well the loan market saw a bounce-back in covenant-lite loans as the as the ability to first utilize fixed dollar baskets in the context of economy began to stabilize during the third quarter of 2020, certain negative covenants (for instance, debt, lien, investment contradicting predictions from earlier in the year as borrowers and restricted payment negative covenants) and, if the borrow- once again were able to secure favorable terms in the midst of er’s financial condition later improves, to subsequently reclas- the pandemic. Despite the ongoing pandemic, the trend toward sify amounts incurred or paid under a fixed dollar basket such covenant-lite loans in the leveraged finance market remained that these amounts are deemed incurred or paid under a lever- fundamentally intact through 2021. age-based basket instead. The result of such a reclassification is The Power of Equity Sponsors. Equity sponsors drive much of the that the borrower’s fixed dollar basket for a negative covenant is volume of leveraged loans and continue to exercise their market then freed up, so that the borrower can then incur or pay addi- power and push the market towards more borrower-favorable tional amounts under the fixed dollar basket, even if the borrow- terms. “SunGard” provisions continue to be standard in er’s financial performance should subsequently decline. commitment papers. SunGard provisions allow equity spon- sors who require acquisition financing to compete with strategic The regulatory environment buyers who do not need such financing, by aligning closely the While the Federal Reserve had kept interest rates low to boost conditions in financing commitments to the conditions in the economic activity in the wake of the financial crisis, it and other acquisition agreement. Equity sponsors typically require loan federal regulators with a mandate to protect the US economy arrangers to use the sponsor’s form of commitment letter (or a from excessive risk-taking associated with the financial crisis commitment letter from the sponsor’s favored precedent trans- tightened regulations that arguably had the effect of increasing action) so the sponsor can more easily compare the proposals the cost of making loans. Under the previous administration, of different financing sources. It has also become common however, federal regulators had begun to take steps to relax such for sponsors to prepare initial drafts of loan documentation. regulations. For example, both the Chairman of the Federal Another development unwelcome to many lenders is sponsors Reserve Board and the head of the Office of the Comptroller of requesting the right to “designate” counsel for arrangers. the Currency announced in February 2018 that the “Leveraged The Borrower’s Desire for Flexibility: Unrestricted Subsidiaries, Equity Lending Guidance” issued by federal regulators, which became Cures, Builder Baskets, Incremental Facilities and Reclassification. Equity effective in May 2013, is not legally binding on federally super- sponsors and borrowers desire flexibility in their financing docu- vised financial institutions that are substantively engaged in ments. This comes in many forms. The “unrestricted subsid- leveraged lending activities. The guidance outlines high level iary” concept is consistent with features seen in bond indentures principles designed to assist institutions in establishing safe and this feature has become common in leveraged loan docu- and sound leveraged finance activities. The guidance also had mentation. These provisions exclude specified subsidiaries from the effect of increasing lending costs as lenders re-evaluated coverage in the representations, covenants and events of default, their internal policies and programs and tightened their under- thus allowing a borrower to use an unrestricted subsidiary to writing standards to comply. In light of this shift away from incur indebtedness and liens or make investments without being the Leveraged Lending Guidance, federally supervised finan- subject to loan agreement restrictions. In effect, the lender loses cial institutions showed a renewed willingness to make loans at the ability to monitor or restrict the unrestricted subsidiaries. A leverage levels higher than the Leveraged Lending Guidance trade-off is that financial attributes of the unrestricted subsidi- allows, beginning in 2018. Similarly, the “Volcker Rule” had aries are excluded from the loan agreement provisions (including been facing increased scrutiny since its inception, and, as a result, any benefit the borrower may have otherwise realized from cash federal regulators issued a final rule in 2020 amending aspects of flow generated by such subsidiaries for purposes of loan agree- the Volcker Rule that impacted CLO managers and banks that ment financial ratios). “Equity cure” rights remain common. An structure, warehouse and make markets in CLOs. The initial equity cure allows a borrower’s shareholders to make an addi- Volcker Rule regulations were released on December 10, 2013, tional equity investment in the borrower to cure breaches of implementing the statutory Volcker Rule’s limits on trading its financial covenants. Loan agreements also continue to give operations, and private fund sponsorship and investment activ- borrowers more flexibility around so-called “builder baskets” ities, of banking entities. The final rule amending the Volcker (also known as “available amount” or “cumulative credit” Rule, which became effective October 1, 2020, modifies it by baskets), which provide the borrower with more flexibility in broadening the scope of permissible transactions by covered complying with certain negative covenants. Builder baskets will funds, curbing the risks associated with extraterritorial treat- often include an initial starter basket amount, which is in turn ment of foreign funds and allowing federally supervised insti- increased by either a borrower’s retained excess cash flow or a tutions to participate in certain fund activities. Notably, under percentage of a borrower’s consolidated net income or EBITDA. the amended Volcker Rule, CLO managers are permitted to Builder baskets may then be further increased in amount based purchase and hold non-loan assets; debt securities are no longer on the occurrence of certain events, including certain equity considered to be an ownership interest solely because they contributions, proceeds from the sale of (or other returns relating contain the right to remove or replace a manager for cause; and to) unrestricted subsidiaries and declined proceeds from manda- CLOs may now hold a certain amount (up to 5%) of their value tory prepayments. Typically, borrowers are permitted to use in debt securities, allowing for the return of the “bond bucket” builder baskets for capital expenditures, permitted investments feature which was common to pre-Volcker Rule CLOs. While Lending & Secured Finance 2022
482 USA
the amended Volcker Rule arguably loosens compliance require- December 31, 2021, and that the remaining US dollar LIBOR
ments, market observers predict that the Biden administration settings would permanently cease immediately after June 30,
will resurrect the Leveraged Lending Guidance by codifying 2023. In late 2020, US banking regulators had already issued
it as a rule rather than mere guidance, thereby reimposing its a statement encouraging US banks to cease entering into new
compliance requirements once more; however, with the Biden LIBOR contracts as soon as practicable but no later than
administration more focused on other matters during 2021, December 31, 2021. US banking regulators further clarified in a
including the ongoing COVID-19 pandemic, such a resurrec- statement on October 20, 2021 that a new LIBOR contract would
tion of the Leveraged Lending Guidance has yet to occur. include any agreement that “(i) creates additional LIBOR expo-
Sanctions and Anti-Corruption Laws. Federal regulators have in sure …. Or (ii) extends the term of an existing LIBOR contract.”
recent years increased their enforcement of sanctions, anti-ter- In response to these announcements and in preparation for the
rorism and anti-corruption laws, meting out record fines. In addi- start of 2022, US lenders began documenting a greater number
tion to being more strident in their due diligence of borrowers, of new loan originations with alternative interest rates to LIBOR,
lenders are requiring stronger provisions in loan agreements to with the Secured Overnight Financing Rate (“SOFR”), which is
try and address these issues (and to demonstrate to regulators calculated based on the overnight rates offered on the Treasury
that they are doing the same). These provisions typically require repurchase market, being the most prevalent such alternative
the borrower and its affiliates to comply with sanctions regula- rate in US lending markets during late 2021. In addition, many
tions enacted by the US and other applicable authorities, to not US lenders, during 2021 (and especially during the latter half of
use any borrowed proceeds in restricted countries or in doing 2021), worked to amend their existing loan documentation to
business with restricted entities, and to comply with and have either remove or replace with an alternative rate LIBOR settings
policies to comply with anti-bribery laws. Borrowers sometimes that would cease after December 31, 2021.
attempt to negotiate these provisions, including by adding mate- During 2021, US banking regulators also continued to empha-
riality or knowledge qualifiers, with some limited success. size that existing loan agreements entered into before the end of
Federal Income Taxes. The Tax Cuts and Jobs Act of 2017 (the 2021 that continue to use LIBOR should have adequate interest
“2017 Act”) and the CARES Act enacted numerous and in some rate fallback provisions that provide for a clearly defined alter-
instances sweeping changes to the Internal Revenue Code of 1986, native interest rate after LIBOR’s discontinuation. In March of
as amended (the “Code”), including numerous provisions that 2021, the Alternative Reference Rates Committee (“ARRC”) in
may impact the US federal income tax treatment of participants in the US published supplemental recommended fallback interest
the US lending markets. These changes have impacted consider- rate provisions for LIBOR-referenced US dollar denominated
ations surrounding the tax treatment of credit support provided by loans. In connection with the cessation of LIBOR, these supple-
non-US subsidiaries, as more fully described in question 2.6 below. mental provisions provide for a “hardwired” fallback to two
The Foreign Account Tax Compliance Act (“FATCA”), which SOFR-based rates (with the first such alternative rate being Term
became effective with respect to interest payments on July 1, SOFR and if Term SOFR cannot be determined, the second
2014, was a major revamp of the US withholding tax regime. alternative rate being Daily Simple SOFR). As 2021 progressed,
FATCA imposes a 30% gross withholding tax on certain US lenders further migrated towards incorporating ARRC’s
amounts, including interest, paid by US borrowers to a foreign suggested hardwired fallback provisions in their LIBOR-based
lender unless that lender (i) enters into an agreement with the loan agreements (either at the initial documentation stage or via
IRS to identify and report specified information with respect amendments of existing loan agreements).
to its US account holders and investors, or (ii) is resident in a Whereas historically US leveraged loans used primarily
jurisdiction that has entered into an intergovernmental agree- LIBOR as a reference interest rate, looking ahead, 2022 will
ment (an “IGA”) with the US pursuant to which the government be the year in which the US lending markets become a truly
of that jurisdiction agrees to report similar information to the multi-rate environment. There will be many legacy LIBOR loan
US. This sweeping law has significant impact on loan payments agreements in the market (with interest rate fallback provisions)
and receipts where it applies and has prompted loan parties to and then there will be the ever-increasing number of new loan
manage FATCA risk (express allocation of risk set forth in loan agreements in the market using either SOFR or another alterna-
documentation, operation of gross-up clauses, etc.). In the US tive rate to LIBOR, such as Bloomberg’s BSBY. While SOFR
loan market, for example, loan agreements now almost univer- appears to be the leading contender to replace LIBOR in US
sally contain provisions whereby any FATCA withholding is lending markets, it will take time during the course of 2022 to
exempt from a borrower’s gross-up obligation, and a borrower see if this in fact remains the case.
may request information from a lender to determine whether
such lender is in compliance with FATCA. (It is worth noting Continued innovations and ongoing trends in the loan
that while current provisions of the Code and Treasury regula- markets
tions that govern FATCA also treat payments of principal on, Given the depth and breadth in the loan markets in the US,
or the gross proceeds from a sale or other disposition of, debt many loan market innovations originate or are further devel-
obligations of US borrowers as subject to FATCA withholding oped here (consider, for example, the development of a sophisti-
beginning with dispositions on or after January 1, 2019, under cated secondary trading market, certain mezzanine and second-
proposed Treasury regulations, such principal payments and/or lien structures, the securitization of loans and CLOs). Some
gross proceeds would not be subject to FATCA withholding. In innovations include the following:
the preamble to such proposed regulations, Treasury and the The Unitranche Facility. One innovation that has grown in popu-
US Internal Revenue Service have stated that taxpayers may larity in recent years (and which is now firmly established in
generally rely on the proposed Treasury regulation until final middle-market lending in the US and is also prevalent in European
Treasury regulations are issued, which is yet to happen.) markets) is the so-called “unitranche” facility. Unitranche loans
combine what would otherwise be separate first/second-lien or
Replacement of LIBOR as the benchmark rate senior/mezzanine facilities into a single debt instrument, where
In March of 2021, the UK’s Financial Conduct Authority all the debt is subject to the same terms, and with a blended
(“FCA”) announced that sterling, euro, Swiss franc and Japanese interest rate. Lenders in unitranche facilities typically enter into
yen LIBOR settings and one-week and two-month US dollar a so-called “agreement among lenders” (“AAL”) which legislates
LIBOR settings would permanently cease immediately after payment priorities, voting rights, buyout rights, enforcement
Lending & Secured Finance 2022Morgan, Lewis & Bockius LLP 483
rights and rights in bankruptcy among lenders in a manner that in exchange for a portion of the fees the law firm may receive
may (or may not) be visible to the borrower. One advantage of from its contingency cases. Such financing is typically limited
unitranche loans for a borrower is speed and certainty of closing recourse, meaning the investor is only repaid if the plaintiff
(important in a competitive acquisition process), since negotia- (or law firm) wins an award. Investors can realize significant
tion of an intercreditor agreement typically is not a condition to returns, usually based on “multiples” of their initial investment
funding. Another potential advantage for the borrower is the or a “percentage” of the overall proceeds realized. Litigation
simplicity of decision-making during the life of the loan since finance has its share of critics: some lament “turning the court
there is no “class voting” from the perspective of the borrower system into a stock exchange,” while other observers argue litiga-
(though the AAL may impact voting issues in ways not visible to tion finance provides “access to justice” by “leveling the playing
the borrower). Lenders of unitranche loans are more typically field” when parties in litigation have unequal financial positions.
Direct Lenders (as defined below) than banks. In recent years, The law surrounding litigation funding is unsettled and changes
the US loan markets have continued to see increased complexity rapidly. While regulatory scrutiny is on the rise, the asset class
in unitranche structures and in the terms of AALs. Borrowers seems destined for continued growth for the foreseeable future
and their equity sponsors have had some success in requiring given the surge in investment and the fact that it has established
disclosure of terms of AALs, especially with respect to voting, itself as a very useful tool for a variety of market participants.
and in some instances the borrower now executes the AAL by
signing an acknowledgment to the document. The United States 1.2 What are some significant lending transactions
Bankruptcy Court for the District of Delaware implicitly recog- that have taken place in your jurisdiction in recent years?
nized the court’s ability to construe and enforce the provisions of
an AAL (to which the borrower was not a party) in March 2015 Given the large number of transactions in the US corporate loan
in the In re RadioShack Corp. bankruptcy, signalling to lenders that markets, it is difficult to differentiate certain lending transactions
AALs should be enforceable in bankruptcy. as being more significant than others. Any such comparison
Bank Lenders Versus Direct Lenders. Non-bank lenders, often necessarily excludes transactions for which documentation is not
referred to as direct lenders or alternative lenders (“Direct publicly available and therefore favors large corporate deals filed
Lenders”), are typically speciality finance companies, some- with the SEC compared to those in the middle-market, where
times organized as business development companies (“BDCs”) much loan product innovation takes place. One recent notable
or funds, and also include the direct lending business of large transaction that has garnered attention in the US corporate loan
asset managers. Unlike traditional banks, Direct Lenders have market is the Serta Simmons Bedding, LLC recapitalization.
greater flexibility than banks to hold leveraged loans on their This is an example of a distressed liability management trans-
balance sheets, which provides borrowers with greater deal action involving “uptiering,” in which certain creditors in the
certainty, since Direct Lenders, unlike banks, may not need to capital structure of a business amplify their lien and/or payment
condition deal terms based on their ability to syndicate a loan. priority position relative to other creditors in a manner that is
Direct lenders also often invest at different levels of a borrow- not consensual across all constituents, but within the parame-
er’s capital structure, such as by making an equity investment ters of provisions that may not implicate formal amendments
at the same time as providing a credit facility, which provides to the pro rata sharing provisions in the loan documents. This
added benefit to equity sponsors and borrowers seeking to raise trend goes along with other recapitalizations or transactions
capital. While traditional banks and Direct Lenders compete involving “downtiering,” in which certain assets are contributed
for market share, especially in the middle-market leveraged to an unrestricted subsidiary, which may be separately financed,
lending space, some market participants point out that the rela- thereby similarly resulting in certain creditors benefiting from an
tionship is actually more symbiotic in nature; for example, banks amplified lien position relative to other creditors.
provide debt financing to Direct Lenders and underwrite equity
issuances by Direct Lenders and also have analysts that “follow” 22 Guarantees
equity securities of BDCs. Some banks have developed Direct
Lender businesses. The introduction of the Leveraged Lending 2.1 Can a company guarantee borrowings of one or
Guidance mentioned above provided a competitive advantage more other members of its corporate group (see below
to Direct Lenders. The Guidance helped to open the door for for questions relating to fraudulent transfer/financial
Direct Lenders to become a “go to” source of capital for equity assistance)?
sponsors and borrowers in the leveraged-lending markets, espe-
cially for middle-market borrowers, given that such Direct Generally, yes. In the US, guarantees are commonly referred
Lenders were not subject to the same regulatory constraints. to as one of three types: (a) “downstream” guarantees, whereby
However, the pull back of the Leveraged Lending Guidance did a parent company guarantees the debt of a subsidiary; (b)
not shift the needle back in the direction of traditional banks “upstream” guarantees, whereby a subsidiary guarantees the
in 2021, as Direct Lenders continued to grow market share as debt of a parent; and (c) “cross-stream” guarantees, whereby a
compared to traditional banks throughout the course of the year subsidiary guarantees the debt of a “sister company.” Generally,
on middle-market deals. For example, in the third quarter of “upstream” and “cross-stream” guarantees may be subject to
2021, US-sponsored middle market direct lending loan volume increased scrutiny given enforceability issues in the context of a
reached a quarterly record high of $35.7 billion and middle bankruptcy, as further described below.
market leveraged buyout direct lending volume reached a quar-
terly record high of $16.3 billion.
2.2 Are there enforceability or other concerns (such as
Litigation Finance. While originally developed in Australia director liability) if only a disproportionately small (or no)
and the United Kingdom, the business of litigation finance has benefit to the guaranteeing/securing company can be
gained significant traction in the US. Investors are drawn to shown?
this asset class given its attractive returns that are “not corre-
lated to the market.” The two most common types of litiga- First, as a matter of contract law, some “consideration”
tion finance include (a) providing funds to a plaintiff in exchange (bargained-for contractual benefit to the guarantor) must
for a commitment to receive a share of the award or settlement be received for the guarantee to be enforceable, though this
resulting from litigation, and (b) providing funds to a law firm contract law threshold is typically easy to meet.
Lending & Secured Finance 2022484 USA
As a matter of insolvency law, certain types of enforceability of a corporate parent or a sister company, and a guarantee may
issues arise in the context of a bankruptcy. These issues are anal- be ultra vires if not in furtherance of the guarantor’s purposes,
ogous to, but not the same as, contractual concepts of “consid- requiring analysis of the purpose of the guarantee and the
eration.” With downstream guarantees, there is typically little benefit to the guarantor. If the benefit to the guarantor is
concern, since the parent will indirectly realize the benefit of a loan intangible or not readily apparent, this may provide additional
through the value of its equity ownership of the subsidiary (unless concern. Many corporate power statutes, however, provide safe
the subsidiary is already, or is rendered, insolvent). However, harbors for certain types of guarantees, irrespective of corpo-
“upstream” and “cross-stream” guarantees should be subject to rate benefit, including if the guarantor and the borrower are part
increased analysis since the benefit to the guarantor is less evident. of the same wholly owned corporate family, or if the guarantee
For example, a guarantee or other transaction may be voided is approved by a specified shareholder vote, for the guarantor
by a bankruptcy court in the US if it is found to be a “fraud- entity. For limited liability companies, state statutes are usually
ulent transfer.” Very generally, under the federal Bankruptcy more generous, with a limited liability company generally able to
Code, a guarantee may be considered a fraudulent transfer if, at engage in any type of legal activity, including entering into guar-
the time the guarantee is provided, (a) the guarantor is insolvent antees, unless the charter provides otherwise.
(or would be rendered insolvent by the guarantee), and (b) the In lending transactions in the US, the analysis that a company
guarantor receives “less than reasonably equivalent value” for has the corporate or other requisite power to enter into a guar-
the guarantee. (Note that both prongs of the test must occur antee is often provided in a legal opinion provided by the guar-
in order for the guarantee to be voided as a fraudulent transfer; antor’s internal or external counsel (though these opinions will
if the guarantor receives “less than reasonably equivalent value” typically assume away the tough factual issues, such as the level
though is nevertheless solvent at the time the guarantee is of corporate benefit).
provided (after giving effect to the guarantee), then the guar-
antee will not likely be voided as a fraudulent transfer.) Solvency
2.4 Are any governmental or other consents or filings,
will be determined by the application of a variety of tests, such or other formalities (such as shareholder approval),
as the cash flow test, which examines the guarantor’s ability to required?
meet its projected debt obligations as such obligations fall due,
and the balance sheet test, which examines whether the guar-
In addition to having “corporate power” (or equivalent power
antor still has enough assets to cover its liabilities at a fair valua-
for other types of entities) to enter into a guarantee, the guar-
tion. As mentioned above, in a downstream guarantee context,
antee must be properly authorized, which generally means that
the parent would more likely receive “reasonably equivalent
the procedural rules of the corporation, as set forth in its charter
value,” and therefore fraudulent transfer is less of a concern for
or by-laws, must be followed and that the stockholders or the
these types of guarantees. In addition to the federal Bankruptcy
governing board take the proper measures to authorize the
Code fraudulent transfer test, under state laws there exist similar
transaction. These procedures are customary and also typically
fraudulent transfer statutes and a federal bankruptcy trustee may
covered in a legal opinion provided by the guarantor’s counsel.
also void such guarantees under state law in a bankruptcy.
One situation that requires special attention in a guarantee
Loan documentation will often provide for solvency
context is when a guarantor is providing an upstream or cross-
representations from borrowers and guarantors in order to
stream guarantee, and the guarantor has minority shareholders.
address fraudulent transfer concerns. In some high-risk trans-
In this context, often the consent of the minority shareholders
actions (such as acquisition loans or loans provided so the
would be required in order for the guarantee to be provided in
borrower can make a distribution to shareholders), a third party
order to address fiduciary duty concerns.
is required to provide a solvency opinion in order to provide
Generally, no governmental consents, filings or other formal-
protection from fraudulent transfer attack, though the more
ities are required in connection with guarantees (though, as
common practice today is for lenders to do their own analysis
noted above, certain special purpose companies and regulated
given the expense of such outside opinions.
entities may be subject to additional requirements).
Under relevant corporate law, if a guarantee or similar trans-
action is structured in such a way that it would be tantamount
to a distribution of equity by a company while the company is 2.5 Are net worth, solvency or similar limitations
insolvent (or is rendered insolvent), or would impair the compa- imposed on the amount of a guarantee?
ny’s capital, the transaction may be improper under the corpo-
rate law and could result in director liability. See also question Yes, please see question 2.2.
2.3 below for a general discussion of corporate power issues.
2.6 Are there any exchange control or similar obstacles
2.3 Is lack of corporate power an issue? to enforcement of a guarantee?
Entity power to enter into a guarantee is generally governed Generally, no. Though there are a few other issues worth
by the corporation (or equivalent) law in the state in which the mentioning that do not relate to “enforcement” per se. For
company is organized, as well as the company’s charter and example, there may be withholding tax issues if the payment is
bylaws (or equivalent documentation). to a foreign lender (please see question 6.1).
For corporations, the corporation law of most states provides In addition, there are important tax issues to consider when
a broad range of permitted business activities, so few activities structuring a transaction with credit support from foreign
are considered to be ultra vires or beyond the power of a corpo- subsidiaries of US companies, and the rules in this regard have
ration (note that certain special purpose or regulated entities, been changed within the past several years. For example, there
such as banks, insurance companies, and utility companies, may may be adverse US federal income tax consequences for certain
be subject to additional statutes which impact corporate power). US borrowers resulting from the involvement of any non-US
In a lending context, however, many state corporation statutes subsidiary guaranteeing or otherwise providing credit support
limit the power of subsidiaries to guarantee the indebtedness for the debt of that US borrower. Under US tax rules, such a
Lending & Secured Finance 2022Morgan, Lewis & Bockius LLP 485
guarantee could be construed to result in an income inclusion, a financing statement in the appropriate state filing office. The
similar to a “deemed dividend,” from the non-US subsidiary to UCC provides specific rules for where to file a financing state-
the US parent in the full amount of the guaranteed debt, and ment, with the general rule that the filing takes place in the juris-
this deemed dividend would generally be subject to US tax. The diction where the borrower is located. A borrower organized
same result could apply, under US tax rules, if collateral at the under a state law in the US as a corporation, limited partner-
non-US subsidiary is used to secure the loan to the US parent, or ship, limited liability company or statutory trust is considered
if the US parent pledges more than 66% of the voting stock of a to be located in the state in which it is organized. The filing
first-tier non-US subsidiary. contains only brief details including the name of the borrower,
Changes to the Code pursuant to the 2017 Act impacted the name of the secured party and an indication of the collat-
the scope of taxpayers affected by these aforementioned US eral, and the filing fee is generally fairly nominal. Security inter-
tax rules (the “Guarantee Rules”). For example, the class of ests in some collateral may be perfected by “possession” or
non-US subsidiaries potentially subject to these Guarantee “control” (including directly held securities, securities accounts
Rules was broadened to include certain non-US subsidiaries of and deposit accounts). A security interest in certain collateral
certain non-US parents. However, the enactment of a “partici- may be perfected by more than one method.
pation exemption” with respect to dividends received by corpo- If two or more lenders have perfected security interests in the
rate US owners of wholly owned non-US subsidiaries, and the same collateral, the UCC provides rules for which lender has
extension of this exemption to the income inclusions that are “priority” over the other security interest. This is usually deter-
triggered by the application of these Guarantee Rules via US mined by a “first-in-time” of filing or perfection rule, but there is
Internal Revenue Service and Treasury regulations (the “956 a special rule for acquisition finance (“purchase-money”) priority
Regulations”), which were proposed in 2018 and finalized with and special priority rules also apply to certain collateral (e.g.,
certain changes in 2019, may reduce or eliminate the impact of promissory notes, investment securities and deposit accounts) if
these Guarantee Rules for certain corporate US borrowers that a security interest is perfected by possession or “control.”
own non-US subsidiaries. Moreover, given the 956 Regulations, In addition, security interests in certain types of personal prop-
lenders may now be more inclined to require non-US subsidi- erty collateral may to some extent be governed by federal statutes
aries to provide a guarantee and asset pledge as credit support in and pre-empt the UCC rules. For example, the perfection of a
respect of loans to a US corporate parent borrower (and likewise security interest in an aircraft is governed by the Federal Aviation
require the US corporate parent borrower to pledge 100% of its Act and the perfection of a security interest in a ship above a
equity interests in its non-US subsidiaries). certain tonnage is governed by the federal Ship Mortgage Act.
The requirements for taking a security interest in real prop-
32 Collateral Security erty (referred to as a “mortgage” or “deed of trust” in the US)
are determined by the laws of the state where the real property
3.1 What types of collateral are available to secure is located. Typically, the office in which to file the mortgage
lending obligations? or deed of trust is in the county of the state where the land is
located. These statutes are fairly similar from state to state, but
A wide variety of assets (including land, buildings, equip- less consistent than the rules for personal property. As a result,
ment, inventory, accounts, contract rights, investment prop- mortgage documents from state to state appear quite different,
erty, deposit accounts, commercial tort claims, etc.) are available while security agreements with respect to personal property
for use as security for loan obligations with many of the most (governed by the more consistent UCC of each state) are more
common types of collateral described more fully below. Assets uniform. Lenders often obtain a title insurance policy in order
used as security are often divided into two broad categories: (a) to confirm the perfection and priority of their security interest
“personal property” which generally refers to property other in real property.
than real property (land and buildings); and (b) real property. A security interest in fixtures (personal property that perma-
The Uniform Commercial Code (“UCC”) provides a nently “affixes” to land) is generally perfected by filing in the
well-developed and predictable framework for providing secu- place where the real property records are filed. A security
rity interests in a wide variety of personal property assets. The interest in fixtures may be perfected under the UCC or under
UCC is a state law statute rather than a federal one, but the the local real estate law.
UCC has been adopted by all 50 states in the US, the District of
Columbia, Puerto Rico and the US Virgin Islands, with only a 3.2 Is it possible to give asset security by means of a
few non-uniform amendments of significance. general security agreement or is an agreement required
Under the UCC, when a security interest “attaches,” it becomes in relation to each type of asset? Briefly, what is the
enforceable as a matter of contract by the lender against the procedure?
borrower. “Attachment” typically occurs when credit is extended
to the borrower, the borrower has ownership or other rights in the In general, a single security agreement can cover all UCC
collateral in which to grant a security interest, and the borrower personal property that is taken for security as a loan, no matter
signs and delivers to the lender a written security agreement where the personal property is located.
describing the collateral. With respect to real property, generally a separate mortgage
After attachment, the security interest must be “perfected” or deed of trust document is used for each state where real prop-
by the lender in order for the lender’s security interest to have erty is located, given that the mortgage document is typically
priority over the rights of an unsecured creditor who later uses governed by the laws of that particular state.
judicial process to obtain lien on the collateral. Since a federal
bankruptcy trustee has the same status as a state law judicial lien
creditor under US law, a bankruptcy trustee will be able to set 3.3 Can collateral security be taken over real property
aside the security interest if the security interest is not perfected. (land), plant, machinery and equipment? Briefly, what is
the procedure?
The method of perfecting a security interest under the
UCC depends on the type of collateral in question. The most
common method of perfecting a security interest is by “filing” Yes. Please see question 3.1.
Lending & Secured Finance 2022486 USA
3.4 Can collateral security be taken over receivables? 3.7 Can security be taken over inventory? Briefly, what
Briefly, what is the procedure? Are debtors required to be is the procedure?
notified of the security?
Yes. Please see question 3.1. A security interest may be granted
Yes. Receivables are considered personal property, and a secu- under the security agreement and may be perfected by the filing
rity interest in the receivables granted under a security agreement of a financing statement in the appropriate UCC filing office.
would typically be perfected by filing a financing statement in Perfection may also be achieved by possession, though this
the appropriate filing office. If the receivable is evidenced by method is seldom practical from a secured lender’s perspective.
a promissory note or bond or by a lease of or loan and security The security agreement can grant a security interest in future
interest in specific goods, the receivable may also be perfected inventory. An already filed financing statement will be effec-
by the lender’s possession or “control.” Debtors on the receiv- tive to perfect a security interest in a future inventory when it is
ables are not required to be notified of the security interest in created or acquired.
order for perfection to occur.
The security agreement can grant a security interest in future 3.8 Can a company grant a security interest in order
receivables. An already filed financing statement will be effective to secure its obligations (i) as a borrower under a credit
to perfect a security interest in a future receivable when it arises. facility, and (ii) as a guarantor of the obligations of
other borrowers and/or guarantors of obligations under
a credit facility (see below for questions relating to the
3.5 Can collateral security be taken over cash giving of guarantees and financial assistance)?
deposited in bank accounts? Briefly, what is the
procedure?
Yes to both (i) and (ii). Note that with respect to item (ii), a
guarantor would be subject to the same fraudulent transfer anal-
Yes. A security interest granted under a security agreement in ysis discussed in question 2.2.
a deposit account as original collateral must be perfected by A security agreement may also secure obligations relating to
control (not by filing). To obtain control of the deposit account, future loans. An already filed financing statement perfecting
a secured lender typically enters into a control agreement with a security interest securing existing loans will be effective to
the borrower and the institution that is the depositary bank by perfect a security interest in a future loan when the loan is made.
which the bank agrees to follow the lender’s instructions as
to the disposition of the funds in the deposit account without
further consent of the borrower. Many depositary banks have 3.9 What are the notarisation, registration, stamp duty
forms of control agreements that they will provide as a starting and other fees (whether related to property value or
otherwise) in relation to security over different types of
point for negotiations. (However, if the secured lender is also assets?
the depositary bank or the lender becomes the depositary bank’s
customer on the deposit account, control is established without
the need for a control agreement to perfect the security interest.) With respect to personal property governed by the UCC, and
the filing of financing statements, there are typically no material
costs and UCC filing fees are usually minimal.
3.6 Can collateral security be taken over shares in With respect to real property, there may be significant
companies incorporated in your jurisdiction? Are the recording taxes and fees. These taxes and fees will depend on
shares in certificated form? Can such security validly the state and local laws involved. A number of practices are used
be granted under a New York or English law-governed
in loan transactions in an attempt to minimize such costs. For
document? Briefly, what is the procedure?
example, in the case of refinancings, lenders may assign mort-
gages rather than entering into new mortgages; and in the case
Yes. Companies are typically incorporated under the laws of of mortgage tax recording states, lenders may limit the amount
individual states in the US, and usually not under federal law. secured by the mortgage, so that the mortgage tax payable is
Shares may be issued in either certificated or uncertificated form. set at a level commensurate with the value of the property as
A security interest may be created by either a New York law or opposed to the overall principal amount of the loans.
English law-governed security agreement. If the security agree-
ment is governed by English law, the UCC in New York requires
3.10 Do the filing, notification or registration
that the transaction bear a reasonable relationship to England
requirements in relation to security over different
for the choice of law clause to be enforceable. (Please also see types of assets involve a significant amount of time or
question 7.1 as to the extent a court in New York will enforce a expense?
contract that has a foreign governing law.)
In general, a security interest in such directly held shares can
Please see question 3.9. In terms of a time-frame, UCC personal
be perfected either by filing or by control, though perfection by
property security interests may be perfected in a matter of
control has priority. The law governing perfection of such secu-
days (or on a same-day basis in US states that allow for elec-
rity interest in certificated securities depends on whether perfec-
tronic filing of UCC financing statements). Real property secu-
tion is achieved by filing (location of debtor) or by control (loca-
rity interests typically take longer, though they can usually be
tion of collateral). completed in a couple of weeks.
If the shares are credited to a securities account at a bank or
broker and are therefore indirectly held, a borrower’s interest
in the securities account can be perfected either by filing or 3.11 Are any regulatory or similar consents required
control. Once again, perfection by control has priority. The law with respect to the creation of security?
governing perfection of a security interest in a securities account
depends on whether perfection is achieved by filing (location of Generally no, except in the case of certain regulated entities
debtor) or by control (location of bank or broker as usually deter- where consent of the regulatory authority may be required for
mined by the law governing the securities account relationship). the grant or enforcement of the security interest.
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