Syndicate Loan Agreement and Select Clauses
Almost every day, we witness the birth of several new innovative projects, worth billions of dollars of investment. Many often ponder the origins of such investment. Banks play a crucial role in lending these funds to clients, ranging from corporations to large projects, and even governments. However, there are cases where the required amount of funding is highly excessive, and in such cases, two or more lenders may combine resources to cover the total loan.
Syndicate loans, also referred to as Syndicated Bank Facilities, are debts issued by a group of lenders to a single borrower. Succinctly stated, it is the practice of providing a loan by a group of lenders- known as the syndicate- to fund an individual borrower. The investment can be for a fixed amount, a credit line or a combination of both. Under a syndicated loan, lenders are typically big banks, though financial institutions such as mutual funds and insurance companies sometimes also fill these roles. There shall be a single lender appointed as the lead, and they will be responsible for arranging the syndicate group. They shall also have further duties beyond funding a substantial portion of the loan, as the lead agency shall also be responsible for the facilitation and allocation of the cash flows to the other lenders.
The primary objective of a syndicated loan is to spread the risk that would ordinarily be present for a single borrower. Since the value of these types of investments far exceeds regular loans, the risk is that default by the borrower could have a catastrophically crippling effect on a single lender.
Types of Syndicated Loans
- Underwritten Deal
This type of loan is a common variation used in Europe. In this arrangement, the lead agent or underwriter guarantees or syndicates the entire amount.
- Club Deal
These are syndicate loans involving smaller amounts, typically ranging from between $50 to $150 million. The unique feature of a Club Deal is that the lead agent along with the other members of a Club Deal consortium shares equal or nearly equal parts of the fees earned from the loan facility.
- Best-Efforts Syndication Deal
Most commonly used in the United States, this deal doesn't commit the lead agency or guarantee the entire loan. Any unsubscribed portion will become completed by taking advantage of the conditions of the market, and if any part remains unsubscribed, the borrower will be forced to accept a loan of a lower amount or cancel the loan agreement in its entirety.
Syndicate loans help in meeting the customer’s demand for large long-term loans. They are generally used to fund new projects, the leasing of large equipment, mergers and acquisitions in petrochemicals, transportation, telecommunications, power, and other industries.
Once the recipient and arranger have negotiated and agreed upon the loan term, it is generally the responsibility of the arranger to do the preparation work of creating the syndicate or cluster; this saves time and energy in financing.
The same syndicates will embrace different kinds of loans, such as fixed-term loans, revolving loans, and a standby L/C line according to the need of the purchasers. The receiver, meanwhile, may select the currency portfolio required to meet their needs.
Borrowing money from a syndicate implies the participant members of the Syndicate fully recognize the borrower’s financial and operational performance which will help in building the name and goodwill of the borrower.
The syndicates can use a wide variety of currencies in their loans, depending on the needs of the clients. The advantage of syndicated loans is that multiple currencies can be used in the group if the borrower demands it.
The usual duration of syndicated loans for a short-term is three to five years; seven to ten for medium length loans, while long-term funding usually extends for ten to twenty years.
Interest Rate: The profit of the lender is calculated based on interest and fees. The setting of the interest rate shall take place according to the different borrowers, in line with the lending rate policies, regulations, and provisions of the loan contract.
Before entering into a syndicate arrangement, the parties, that is the lenders and the borrower, agree to a contract which designates the structure, rules, and time period of the syndicated loan; this contract forms the underwriting agreement and is similar to a subscription agreement.
Clauses in a Syndicate Agreement
The syndicate agreement may be provided in different forms, and could contain numerous provisions depending upon the circumstances. However, they typically involve enormous amounts of money and a credit relationship between multiple parties. Subsequently, it is necessary to take utmost precaution by carefully wording the agreement. This involves negotiating and examining the clauses added so that it maintains a sufficient balance between protecting the interests of the lenders and the freedom of the borrower. Some of the select elements which are essential to a syndicate agreement include:
There are usually two types of covenants contained in a syndicate agreement:
- Financial Covenants
These are covenants inserted into syndicate agreements to ensure borrowers meet the necessary standards, and their primary purpose is to safeguard the interest of the borrower. This ensures the borrower possesses the ability to service the loan at all points of time. The business will be capable of repayment only if it maintains a certain amount of equity, cash flow, or profit which correlates to its expenses or loans. If these expenses or investments were disproportionate, it would adversely affect the ability of the business to meet its obligations.
These covenants are, simply put, financial or accounting ratios which enable the lenders to specify the metrics. Borrowers are required to ensure that the business remains within the specified limits at all times for the duration of the loan. Failure to do so can lead to an “event of default,” invoking the lender’s right to claim the entire loan with interest repaid. This right of the lender is known as “acceleration”. The covenants may also include a system of periodic reporting by the borrower to the lenders to keep the latter informed about the compliance status of the business with these covenants.
Depending on circumstances such as the financial condition of the borrower and the nature and value of the transaction, the components of these covenants will vary from one agreement to another. However, some of the most common types are:
Debt to Equity Ratio: this ensures that the borrower does not exceed a certain multiple of its equity represented by its share capital, accumulated profits, and reserves. It is inserted to prevent the borrower from borrowing more than its stake.
Minimum Net Worth: this requires that the borrower ensure, excluding its outstanding liabilities, that the value of all its tangible assets is no less than a specified limit, ensuring the security of the revenue-generating assets.
Current Ratio: to ensure that the borrower has sufficient liquid assets to make payments, the enforcement of a specified ratio is established to maintain a balance between its current liabilities and assets.
Minimum Working Capital: the syndicate specifies the minimum level of liquid assets to be more than its current liabilities to guarantee the payment of interest by the borrower.
Debt Service Ratio- to ensure that the profits of the business exceed the obligations for repayment of the loan, a proportion of the annual profits, interest, and credit repayments will find themselves inserted into the agreement.
- Negative Covenants
Negative covenants are similar to those stipulations in the investment agreement, where on particular issues, affirmative voting rights are giving to the financial investors. In simple terms, for those actions specified in the contract, the company will have to obtain the permission of the lenders. Failure to do so triggers an “event of default” obligating the company to make repayments to the lenders.
- Mandatory payment clause
Though generally the prepayment of the loan is left to the option of the borrower, the lenders tend to discourage this since they lose out on interest payments as the principal reduces affecting their predicted cash flows. The syndicate agreement enforces with it additional fees where prepayment is allowed, or even prohibits advance payment for particular periods. However, there may be situations where there is compulsory prepayment such as when the holding company has taken the loan, or sells out its subsidiaries or assets; further, a change in the law which renders the transaction illegal, or a downgrade in the creditworthiness of the borrower, may also trigger this clause.
- Negative Pledge Clause
Typically, a lender agrees to provide the loan after an assessment of the borrower’s creditworthiness, which is their ability to repay; this includes the total assets of the borrower. In case of a default by the borrower, the lender can proceed against the borrower to liquidate his assets and recover his dues. However, to protect these assets from being alienated, the lender places restrictions on the borrower’s powers to create security, transfer, or sell assets.
- Change of Control Clause
If there is a change in control of the company after the execution of the loan agreement, the lenders can cancel the loan facilities and initiate prepayment of the principal and the interest of the amount already disbursed. Since the actual control of the company lies with the shareholders, the clause usually identifies that if a particular person or group of individuals ceases to have control over the company, the provisions will come into effect. This clause, like the Material Adverse Effect Clause, can be negotiated by the borrowers on points such as: the cancellation and repayment of the loan only to the lenders who wish to exit the loan arrangement, or a more extended notice period to arrange new lenders. Carve-outs and exceptions can also be included, for example: cancellation and repayment will only be triggered via control change resulting in a downgrade of the credit value of the business.
- Material Adverse Effect Clause
If the business operations, property, financial, or other conditions of the borrower or company group undergoes any significant change, the Material Adverse Clause enables for the discharge of the lender(s) to prevent the dispersal of any further loan amounts. This clause is generally negotiated by the borrowers to avoid ambiguity and prevent it from being used as a safety net by the lender to circumvent its lending obligations.
- Event of Default Clause
In the case of defaults in syndicated loans, this clause is to be triggered. Situations where this will be the case, include: the non-payment of the amount due, breach of the financial covenants, representations or warranties, insolvency or initiation of liquidation, and insolvency proceedings and others. Should this clause be triggered, there are potentially graver implications for the borrower as their creditworthiness may be negatively impacted, which could cause trouble for the obtainment of potential future loans. In such an event, the lenders have the right to accelerate the repayment, terminate the agreement, and permit further disbursement of the loan, amongst other remedies.
- Right to Accelerate
This clause, along with the cross-default, can be said to be the ancillary rights of the lenders (should the borrower default). In the event of default, the lenders have the right to accelerate or altogether cancel further loans, and demand repayment of the outstanding loan. The lenders usually try to restructure the investment in the event of defaults, and the right to accelerate is used more as leverage for the negotiation of the restructuring deal.
The Cross-Default is present to protect the interests of lenders under other loan agreements. If the borrower defaults in a loan agreement, it will subsequently trigger a default in all other loan agreements. This ensures that all lenders will get their dues from the borrower. In reality though, as we have already stated, the default clause and the cross-default is used as more of a negotiation tool for the restructuring arrangement, rather than to push the borrower into bankruptcy.