In this briefing we explore the risk that a lender might renege (voluntarily or involuntarily) on its funding commitments. We touch on the different types of lender entities in the market currently and examine why there are often different reasons behind such a failure to fund.

We also revisit market standard provisions designed to mitigate the risk posed by so called "defaulting lenders" and explore the options for a borrower faced with a lender that is unable to honour its lending commitments.

Who lends?

Traditionally most UK corporate lending was provided by banks. Indeed, the early Loan Market Association (LMA) templates were drafted on the assumption that lenders were banks or financial institutions. Non-bank investors began to emerge as lenders around the time of the millennium, with a gradual increase in the number of institutional investors and debt funds seen over the next two decades.

Part of this trend has been the increased role of debt funds either replacing, or lending alongside, traditional bank lenders. From a borrower's perspective, a debt fund can represent an attractive funding partner. Such funds will be less constrained by regulatory capital requirements, when compared with a bank. A debt fund may be more flexible in its approach and willing to deploy capital against certain types of credit risk, if the price is right. They may also be able to act very quickly, with speed of execution being a key feature required by borrowers on competitive auction processes in particular.

However, a debt fund will have very different sources of funding when compared with a bank. A fund is essentially an investment vehicle for a (potentially very wide) pool of underlying investors (limited partners). Hence, ultimately, the fund's ability to advance cash is dependent on the liquidity and creditworthiness of a pool of entities. To mitigate this, a fund may have a liquidity facility of its own, in order to guard against capital calls which are not promptly met. However, suffice it to say that the cashflows required to honour a bank's lending commitment are likely to be very different to that of a debt fund.

In the same way, the circumstances in which a bank may not fund (either because it can't or because it chooses not to) are typically very different to those applicable to a debt fund.  A bank, for regulatory, reputational and other reasons, is extremely unlikely to choose not to fund if it is contractually required to do so under a committed facility.  Equally, the circumstances in which it cannot fund are likely to be very limited and indicative of significant macro financial and economic pressures, which may of course lead to the relevant bank receiving governmental or other third-party support that may not be available to a debt fund. 

As we have noted above, a debt fund is reliant on different funding sources to that of banks and typically it is those investors which will determine whether it funds – if they fund it, it is very unlikely that it would not pass on the funds to its borrower, but the question then becomes whether they will fund.  Again, the reputational impact would be considerable if an investor – particularly an institutional one – were to fail to fund, but there may be other factors involved, including the investor's concern over the performance and management of the fund itself, the market in which the borrower operates and, of course, its own ability to fund.

LMA "defaulting lender" provisions

The Global Financial Crisis caused shocks across loan markets worldwide. One issue highlighted by this period was the risk that a lender could become insolvent; hitherto loan documentation had only sought to address a borrower's credit risk.

The LMA introduced Finance Party default clauses in 2009 following the collapse of Lehman Brothers into administration. "Defaulting Lender" and "Impaired Agent" provisions have since appeared in the LMA senior leveraged finance (LMA SFA) facilities and have been widely adopted by market participants. However, in the interests of brevity, these clauses do not appear in other LMA loan templates, such as the investment grade or real estate finance loan documents.

It is entirely possible, therefore, that borrowers will be exposed to loans or other debt instruments which do not protect them adequately against lender solvency or liquidity risks.

Consequences of lender default (in the absence of "defaulting lender" provisions)

An LMA-style Facility Agreement could prove inflexible without the LMA "Defaulting Lender" provisions. If a lender were unable to fund, a borrower might be able to voluntarily cancel unfunded commitments. Firstly, this would be irrevocable. Secondly, voluntary cancellation would typically reduce all lenders' commitments (including those lenders able to fund). This is because the right of cancellation and repayment in relation to a single lender is typically given a limited scope, applicable only to lenders that trigger tax indemnity or increased cost provisions.

In parallel, until the relevant facilities are cancelled in full, a borrower would not be allowed to incur additional indebtedness beyond certain prescribed limits.

Legal remedies - can't fund or won't fund?

A lender could, hypothetically, have many reasons to not fund its lending commitments. At times of market turbulence, cashflow constraints could require it to consider its own competing creditors. In situations where a lender remains solvent but (for whatever reason) is withholding funds, it may help to consider whether legal remedies available to the borrower could be deployed in order to compel a lender to fund. In theory, the issue of court proceedings may of itself be enough to encourage a lender to allocate what money it does have to the borrower. The most likely remedies to be sought in court proceedings are damages and (in rare circumstances) specific performance.

Damages would place the borrower in the same position as if the lender had fully performed its obligations and so might include compensation for increased funding costs, the consequences of a cross default and potentially other losses.

Could a borrower seek an injunction forcing the lender to make the funds available?

In theory, an interim mandatory injunction could be ordered against a defaulting lender, but there are significant legal and practical hurdles to consider. An obvious benefit is that the application can be made and an injunction granted very quickly. However, this is an expensive option; the application would entail a lot of preparatory work and, if made without notice to the lender, would require full and frank disclosure.

A significant hurdle is that an injunction would not be available if damages could be considered an "adequate remedy". This will turn on the facts and the documentation, but could be difficult to demonstrate. It might be possible to argue that an injunction should be granted if the borrower would otherwise be unable to complete an irreplaceable acquisition without immediate funds.

It is important to stress that there is no guarantee that a court would grant an injunction; there are few "precedents" in this area. Injunctions are discretionary and the court would need to decide whether such a grant would be "just and convenient". There are also hidden risks for a borrower seeking an injunction as an applicant would have to provide a cross-undertaking in damages, so that if it later turns out that an injunction was wrongly granted (for whatever reason), the borrower would have to pay damages to the lender.  This is no small risk for a borrower.

In some cases, forcing a lender to perform its positive obligations under a loan agreement might not provide a full solution. This might be the case if the borrower has already begun to incur losses that do not fall strictly within the lender's obligations. For instance, if the failure to fund has placed the borrower in default under other contracts, it could suffer losses indirectly as a consequence of a series of "cross defaults".

Assuming that an injunction is not a viable option for a borrower, it may only be possible for it to claim damages from a defaulting lender. Faced with a pressing funding requirement, is there any other way to accelerate the court process? A borrower could apply for summary judgment, where the court is asked to determine the case at an early stage and at a shorter hearing. This would save time and costs, if successful. However, it is still an onerous process; the timeframe is likely to be at least nine months from start to finish.

However, filing proceedings could be a useful strategy if, for instance, the threat of action could put the borrower at the top of the lender's list of people it should pay out to first. Ultimately a court will grant a summary judgment application if the lender's case has no real prospect of success, and there is no other compelling reason why the case should go to trial. Consequently, this is only appropriate in clear-cut cases where there is limited scope for a defaulting lender to "muddy the waters", countering with instances where the borrower could be said to have committed minor breaches of the loan agreement. The greater the complexity, the less likely the application for summary judgment will succeed.

When can a borrower walk away?

As we explore in section 6 below, the "Defaulting Lender" provisions in a loan document may give a borrower a more concrete roadmap in terms of exiting its contractual relationship with a lender. Outside that context, a borrower may ask whether it is possible simply to "walk away" from the loan agreement and seek funding elsewhere. This hinges on the English law concept of "repudiatory breach".

Repudiatory breach

For a breach to be a repudiatory breach, it must be sufficiently serious or must be a breach of a condition (which is a term that goes to the heart of the contract). In the case of a loan agreement, a failure to fund is likely to be a repudiatory breach. As a result, the borrower has two options:

1: Elect to accept the repudiation, which terminates the agreement, then sue for damages.

2: Elect to affirm the contract and sue for damages.

Whilst the first option might appeal (allowing the borrower to immediately seek funds elsewhere), the situation is more complex if loans are already outstanding. If a loan agreement is terminated for repudiatory breach, the borrower will have to repay the defaulting lender in full immediately. Furthermore if there are additional lenders under the same contract, termination will generally require the borrower to repay all lenders.

The borrower may therefore prefer to affirm the contract by making a clear and unequivocal representation (by words or conduct) that it is electing not to terminate. It can still sue for damages for breach of contract even if it affirms the contract.

A practical consideration when a borrower walks away from a loan agreement (assuming the debt is secured) is that security releases may require cooperation of the defaulting lender. Even if security is held by a separate security trustee, the borrower will need to show secured obligations are "irrevocably and unconditionally discharged".

LMA defaulting lender provisions - a worked example

In this section 6, capitalised terms reflect the corresponding LMA definitions.

What is a "Defaulting Lender"?

Under the LMA drafting the "Defaulting Lender" provisions are triggered in three scenarios:

  • A Lender "has failed to make its participation in a Loan available (or has notified the Agent or the Parent (which has notified the Agent) that it will not make its participation in a Loan available) by the Utilisation Date of that Loan".

  • A Lender rescinds or repudiates a Finance Document.

  • A Lender experiences an "Insolvency Event".

In cases where a Lender fails to fund, in order to trigger these provisions it may therefore be necessary for a borrower to submit a formal funding request and wait until Utilisation Date has passed.

Under LMA documentation, once the Defaulting Lender provisions are triggered, there are multiple consequences.

  • Firstly, any Revolving Facility Loans advanced by a Defaulting Lender will be automatically termed out and can be prepaid.

  • A Borrower also has the option to cancel the undrawn Commitments of a Defaulting Lender. Thereafter, the relevant Commitments can be revived if one or more willing "Increase Lenders" can be found to make up the shortfall. Under the LMA documents this "increase" option is subject to a time limit, so Borrowers need to be aware that there may only be a short time available to trigger this option.

  • Under the LMA templates there is no general right to prepay a Defaulting Lender (save in relation to "termed out" Revolving Facility Loans), but this option is often added in facility documentation.

  • A Defaulting Lender is not usually owed a commitment fee "for any day" on which it is a Defaulting Lender. However, this means that a Borrower may still have to pay a substantial sum by way of accrued commitment fee up to that point. In the case of an Acquisition/Capex Facility, it may have already paid out commitment fees for several months or years on the undrawn Facility.

  • A Defaulting Lender will be "disenfranchised", meaning that it is not permitted to vote on its undrawn Commitments. Likewise, under the so called "snooze and lose" provisions, it loses its vote on its outstanding Loans if it fails to respond in the specified time frame.

A Defaulting Lender can be forced to transfer its participation in the Facilities to a new Lender at par. However, this assumes that the Borrower is able to find a "Replacement Lender" willing to step into the Defaulting Lender's shoes. It might not be possible to find a new Lender prepared to fund in line with the existing Facility pricing. The LMA provisions do not, for instance, contemplate an additional fee payable to a "Replacement Lender". In order to bring in a new Lender it may therefore be necessary to revisit pricing (or other provisions) and open-up the Facility Agreement to amendments.

Under the LMA provisions, the transfer to a Replacement Lender is subject to a prescribed timetable. Firstly, the Borrower must give notice (typically five Business Days) to the Agent. Secondly, the outgoing Defaulting Lender is allowed to conduct KYC checks on the Replacement Lender, for which there is no time limit.

The LMA Defaulting Lender mechanism is arguably better suited to situations where there is a problem with one Lender in a larger syndicate, the assumption being that an existing Lender is likely to be willing to step in. The provisions are harder to operate in the context of a bilateral facility, for instance one made available by a debt fund. In between the two extremes lies the common mid-market scenario whereby debt is made available by a small 'club' of Lenders. Take the hypothetical example whereby three Lenders have equal obligations and one reneges on its Commitments. Neither of the remaining two Lenders may be willing to assume the Defaulting Lender's Commitments, potentially denying a Borrower the opportunity to fund a 'bolt on' acquisition or some other time-sensitive project. Given that the Lenders' obligations are "several", the Borrower will still be liable to pay commitment fees to the willing Lenders and yet there may be no practical value in requiring them to fund, if there would still be a shortfall in the overall funds required to complete the relevant transaction.

Another aspect to consider is that, if a 'rescue Lender' is brought into an existing facility by a route not contemplated by the original facility documentation, this risks compromising the security package. This is because a revival of the cancelled Commitments of a Defaulting Lender (outside the pre-agreed "increase" mechanism) might arguably be said to be outside the "purview" of third-party security. In such cases both the incoming Lender and any existing Lender(s) might be advised that new security should be taken.


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