If you know anything about syndicated loan trading, you probably know the basics of transfer restrictions.
New term lenders typically need the consents of the administrative agent and the borrower in order to be admitted to the syndicate. New revolving lenders usually need those consents, plus the consents of any banks that issue letters of credit or swingline loans. In many syndicated loan deals, that’s the entire universe of transfer restrictions.
But that isn’t always the case. Transfer restrictions vary from deal to deal. They may stay the same over the life of the loan or change over time. Debt exchanges, rights offerings, and other restructuring events can introduce new sources of transfer restrictions outside of the credit agreement.
Overlooked or misunderstood transfer restrictions can result in settlement delays, unexpected costs, and potentially litigation. That’s why it’s critical to do your diligence before you trade. In order to perform this task efficiently, you need to know where to look for transfer restrictions.
Where to Find Transfer Restrictions
The Credit Agreement
Most syndicated loan transfer restrictions can be found in the credit agreement, but there are several places within the agreement where transfer restrictions are most likely to be found. The most important of these is the successors and assigns provision. Consent requirements, minimum transfer amounts, and any notice requirements are usually set forth at or near the beginning of the section. In many credit agreements, those provisions will be the only restrictions on transfer. But there are many exceptions. For example, the successors and assigns provision often imposes limitations on assignments to the borrower, the sponsor (if there is one), and their respective affiliates. The credit agreement may prohibit assignments to such entities altogether, or it may require the parties to follow a special process or use a separate form of assignment and assumption to complete the transfer. Some credit agreements grant a right of first refusal to certain lenders. These provisions can be particularly troublesome because the LSTA standard terms do not address what happens to a trade if a third party exercises its right of first refusal. If the loans are convertible into equity, the successors and assigns section may set out additional requirements based on applicable securities laws. Pre-trade due diligence should always include a thorough review of the successors and assigns section.
The credit agreement’s definitions section may also contain transfer restrictions. Most notably, credit agreements often limit transfers to potential assignees that meet the definition of an “Eligible Assignee.” The definition may simply state that an “Eligible Assignee” is an assignee that satisfies the requirements set forth in the successors and assigns section. But in some cases, the “Eligible Assignee” definition will impose additional restrictions of its own. For example, the definition may require that the assignee be a commercial bank or a financial institution with assets in excess of a certain threshold. Eligible Assignee definitions also sometimes set forth the consent requirements for new lenders or describe the level of discretion the borrower or the administrative administrative agent may have in deciding whether to admit new lenders. Similarly, the definition of “Disqualified Lender” may exclude certain named entities or types of entities from becoming lenders. As Eligible Assignee and Disqualified Lender definitions often set forth restrictions that apply to certain entities and their “Affiliates”, the definition of “Affiliate” (or the lack of such a definition) may complicate things further. To the extent the definitions section contains transfer restrictions, it’s important to harmonize those restrictions with the ones set forth in the successors and assigns section and to resolve any ambiguities before trading.
Transfer restrictions may also appear elsewhere within the credit agreement. For instance, some credit agreements require borrowers to comply with a Dutch auction process when repurchasing loans. These requirements may be set forth in the definitions or in the successors and assigns sections, but they may also appear in other parts of the credit agreement or in the exhibits. In rare cases, ancillary credit documents like security agreements or intercreditor agreements may impose additional transfer restrictions beyond what is set out in the credit agreement.
Other Agreements
Restructuring support agreements (“RSAs”) are an increasingly common source of transfer restrictions outside of the credit agreement. RSAs are agreements under which a subset of lenders agrees to support a proposed plan of restructuring, often in conjunction with the borrower, sponsor, and other groups of creditors. To prevent dilution of the debt controlled by RSA parties, lenders who sign on to RSAs are usually prohibited from transferring loans unless the assignee is or becomes a party to the RSA. One common exception is that a “qualified marketmaker” (i.e., a broker-dealer or similar entity that is acting as a marketmaker) that is not a party to the RSA may buy and sell loans that are subject to the RSA, provided that the qualified marketmaker transfers the loans to an assignee that is or becomes an RSA party. In either case, one or both of the parties to a trade of RSA paper is usually required to notify the borrower, the sponsor, the other RSA parties, or some combination thereof within a fixed period of time before or after the transfer. Although the LSTA published model RSA transfer provisions several years ago, the market has not adopted them, and transfer restrictions and notice requirements vary from one RSA to another.
Occasionally, loans are required to be traded in tandem with equity or other types of interests. These types of arrangements are most common in the post-restructuring context. If the loans are stapled to common stock, the parties to a trade will need to comply with any restrictions on transfer imposed by the issuer’s articles of incorporation, bylaws, and shareholders’ agreement (if any). If warrants are stapled, the parties will also need to consider restrictions imposed by the warrant agreement. Bonds or litigation trust interests may also be stapled to loans and their governing documents may impose further restrictions.
Why Transfer Restrictions Are So Important
Failing to identify the applicable transfer restrictions before entering into a trade can have serious consequences. Settlement delays are the most likely result. And while settlement delays are common in the loan market, the risks they create should not be overlooked. The longer a trade remains unsettled, the longer each party to a trade is exposed to the other party’s credit risk. For the seller, settlement delays also mean additional exposure to the credit risk imposed by the borrower. Price fluctuations can change the parties’ economic incentives, making disputes and litigation more likely. When a trade is entered, the parties’ economic incentives are aligned in that they have chosen to enter into the transaction at the agreed upon price. If the market price changes significantly before the trade settles, the party that stands to realize a loss will have a greater incentive to find a way out of the transaction.
In some circumstances, missing a transfer restriction can give third parties the right to unwind a transfer. Most credit agreements do not include provisions that make a transfer done in violation of the credit agreement void or voidable. While a lender or credit party that is damaged by such a transfer may have a claim for breach of contract, the transfer itself would stand.
However, RSAs and certain other agreements among lenders routinely include language that makes a transfer void if it does not comply with all applicable transfer restrictions. The right to unwind such a transfer is often bestowed upon every party to the agreement, thereby creating a large pool of potential challengers to the effectiveness of a transfer. A transfer that is retroactively voided could create significant liability for the original seller and buyer because the unraveling could negate the buyer’s and/or its downstream purchasers’ rights to participate in a rights offering, vote on a plan of reorganization, or receive distributions. As the transfer restrictions contained in RSAs vary from agreement to agreement and often contain multiple notice requirements, the parties to a trade should take special care to understand and observe the applicable restrictions and procedures.
Takeaways
- Perform your due diligence before you trade. The secondary loan market functions on the principle that a “trade is a trade.” In other words, if two parties agree to the material terms of a loan trade, then they have made a legally binding commitment to one another to settle the trade on the agreed terms, regardless of whether there is a signed agreement and regardless of what happens after the trade is entered. Discovering after the fact that the loans cannot easily be transferred is unlikely to excuse either party’s obligation to settle the trade under an LSTA trade confirmation. Traders need to know upfront which restrictions apply so they can make informed decisions about whether to enter into a trade and which terms should apply if they do trade.
- Consider the drafting implications. If your pre-trade diligence identifies transfer restrictions that are not adequately addressed by the LSTA standard terms, those restrictions should be taken into account upfront when the parties agree to trade terms. Knowing which terms to include requires a mastery of the LSTA standard terms, as well as the credit documents and other applicable sources of transfer restrictions. Getting those terms into the agreement often requires close coordination among traders, closers, and legal counsel.
- Periodically refresh your diligence. Credit agreement amendments, events of default, bankruptcy filings, updates to internal policies, and even the simple passage of time can affect which restrictions apply. Lenders and prospective loan purchasers should stay on top of developments that may affect a particular loan’s transferability. If you haven’t traded a credit recently, consider performing a fresh round of diligence before trading again.