Using a traffic light approach, we consider the sorts of amendments which might impact on "day one" security.
WHEN MIGHT AMENDMENTS PRESENT A PROBLEM?
We are frequently asked to advise parties to loan finance transactions on the steps to take when secured debt is amended or extended. In our experience, loan facility extensions are becoming increasingly common in the mid-market, as lenders will often commit to a loan with a specified term with a view to extending the scheduled maturity at a later date. This may be because the origination or credit team at the relevant lending institution was not willing to initially extend credit for the longer period or that such team may have been willing to do so, but with the credit made available after the initial period being on different terms – a term out facility replacing a revolving credit facility, for example. Alternatively, it may be because the borrower did not want to incur the cost of upfront fees on longer-dated debt which it may or may not ultimately use.
It is equally common for the quantum of a facility to be increased over time as the borrower's needs evolve. To a greater or lesser extent, this may have been part of the initial "plan". Provisions regarding additional advances may be pre-baked into the facility agreement (by way of an uncommitted / accordion facility). Alternatively, the additional debt may require amendments to the documentation. This may entail a logical "scaling up" of the same project (e.g. increasing the quantum of a subscription facility to reflect an increased borrowing base as a result of further fund closes or continuing to fund the construction of an office block under a development finance facility). Equally however, it could be that funds are required for an entirely different purpose which was unlikely to have been contemplated by the parties when the original documentation was signed.
Often amendments will be made simultaneously to other commercial terms, such as the margin and/or fees or the purpose of a facility. Financial covenants may be reset or an amendment may be required to permit an action that might otherwise have been prohibited under the terms of the original documentation.
If secured debt is amended substantially, there is a risk that the original guarantee and security package will not extend to the amended debt and so there is increased risk of challenges by competing creditors. Understanding that risk and deciding how to act on it appropriately in the commercial context is critical for lenders and borrowers alike. For lenders, a proportionate response is also a key client care issue when the topic is broached with a valuable borrower client.
THE EXTENT OF THE SECURED OBLIGATIONS
At the smaller scale of corporate lending, it is common to see "all monies" guarantees or security which typically cover all a borrower's present and future indebtedness to a particular institution. This is distinct from guarantees or security where the guaranteed / secured obligations are defined by reference to the original facility documentation, as amended from time to time. Where all monies guarantees and security have been taken, amendments or extensions to the underlying indebtedness are unlikely to pose a problem. This is because, by their nature, they cover "all monies" owing to that institution rather than being tied to a particular debt obligation which is now the subject of an amendment or extension.
However, such all monies security is likely to be unattractive to borrowers – not least, because convincing a lender to release it upon repayment of the facility it was initially intended to secure can be problematic. Likewise, security agents will not want to be responsible for collateral realisations relating to debts outside the main credit facility, nor will they (or other creditors which benefit from the same security package) want to find out that debts outside the main credit facility are secured by the security granted to support amounts owing under the main facility agreement.
Consequently, on larger scale financings (such as those documented using Loan Market Association documentation) all monies security is rarely seen. By definition, this means that the security will not extend to a substantially different debt obligation.
FIRST PARTY AND THIRD PARTY SECURITY
It is important to distinguish "first-party" security (i.e. security granted by a borrower solely for its own debt) and "third-party" security. The latter can include security granted by an obligor both for its own obligations and for the obligations of other obligors (i.e. not simply security granted by an entity that is not itself an obligor). First-party security is, generally speaking, more likely to be found to extend to subsequent amendments. On the other hand, third-party security (in the wide sense used here) is more likely to either be discharged by variations to the principal debt or, as a matter of interpretation, found not to apply to the loan documentation as amended. The legal principles at play here are complex and derive from long standing caselaw. A key point to note, however, when seeking to establish whether third party security remains intact is that there are two separate considerations. It is necessary to consider both:
- the scope of a surety's1 obligations (i.e. do the words used in a guarantee or security contract demonstrate sufficiently clearly that the parties intend the surety to be bound by the amended obligations?) and
- the possibility of discharge (on the basis that even where a guarantor / chargor appears to have already consented to all manner of variations, this may not cover amendments which go beyond the parties' reasonable contemplation).
The so-called "purview" doctrine may limit the extent to which it is possible (even with state of the art drafting) to avoid the need to re-take security. There is considerable debate both in caselaw and in textbooks as to the nature and effect of this doctrine and it remains a grey area.
RELYING ON BOILERPLATE PROVISIONS
Both guarantees and security documents typically contain copious boilerplate wording which purports both to define the scope of the surety's obligations and to ensure (so far as possible) that future events will not cause those obligations to be avoided. The latter are often referred to as "savings" or "indulgence" provisions.
Whilst the transaction documentation may, on its face, appear to extend credit support to a loan facility as amended or varied from time to time, there are limits on how far facilities may be amended or varied without the need for guarantees to be confirmed and security retaken. The law in this area is uncertain and it may not be possible to entirely contract out of the purview doctrine referred to above.
THE IMPACT OF 'CAPS'
It is common for recoveries under a guarantee or a charge to be capped. For example, a director's exposure under a personal guarantee could be capped at £100,000. Alternatively, a third party chargor might insist that its exposure be limited to the proceeds of sale of the charged assets. One might assume that, given this limited exposure, the credit support might less likely be affected by variations to the underlying debt. This would be incorrect, as material changes to the secured or guaranteed obligations could increase the possibility of a default thus putting the surety in a worse position.
DOES CASELAW PROVIDE A USEFUL PRECEDENT?
It is helpful when considering the effect of an amendment to debt documentation to look for a legal precedent. Unfortunately, most of the cases on this topic simply do not relate to corporate borrowing with credit support provided by a stack of operating company subsidiaries. Instead, cases involve credit support for a wide range of commercial enterprises including property developments, construction contracts or vessel charterparties. Some of the core cases date from the nineteenth century and few are based on LMA-style documentation. One of the lead cases frequently quoted in legal analysis of this topic relates to a guarantee for the safe return of a flock of sheep! Cases frequently turn on unusual facts and disputes often relate to poorly documented amendments to small bilateral facilities or defects in the boilerplate, which LMA-style documentation should – to a large extent – avoid. Nevertheless, they are often quoted out of context.
When secured debt is amended, each deal is different and there is no one size fits all approach to preserving the security package. It is difficult, for instance, to derive a rule of thumb as to the amount of additional debt which may be incurred without impacting on security.
UNDERSTANDING THE RISK – THE TRAFFIC LIGHT SYSTEM
Using a traffic light approach, we consider the sorts of amendments which might impact on "day one" security. There will not always be a clear cut answer to the question of whether new security is required. Note also the assumption here is that the guarantee and security package is not "all monies" and that it adopts the boilerplate currently used in LMA facility documentation.