Introduction
To harmonize EU member states’ approaches to managing failing European financial institutions, last year the European Parliament ordered European Economic Area member states to enact, no later than January 1, 2016, specific mechanisms to allow the private recapitalization of failing European banks. This collective legislation, commonly called the “EU Bail-In Regime,” gives European financial regulators broad authority to cancel, write down, convert to equity, or otherwise modify unsecured liabilities of EU-based financial institutions. Instead of using public funds to “bail out” failing financial institutions, the regime imposes a system of private recapitalization, forcing unsecured creditors of failing financial institutions to “bail in” to restore the institutions to fiscal health. This bail-in regime has significant implications for U.S. administrative agents and lenders that are parties to syndicated ABL credit facilities with failing European banks.
Technical Requirements
Among the bail-in regime’s technical standards is the requirement that certain contracts contain language expressly recognizing the authority of European regulators to carry out bail-in actions. Contracts affected by these bail-in rules include syndicated ABL credit agreements. European regulators now have the right to alter the obligations of failing European financial institutions in their roles as letter of credit issuers, pro rata lenders under revolving and term loan commitments, and risk participants in letters of credit and swing line loans under syndicated credit facilities. If any affected European institution becomes obligated under an agreement governed by non-EU law, that institution is now required to ensure that the agreement contains appropriate notifications regarding bail-in liabilities and consent from all contract counterparties as to the regulators’ bail-in authority. Although this requirement applies principally to agreements entered into after January 1, 2016, existing agreements are likely subject to the requirement to the extent (i) they are materially amended, (ii) new obligations or liabilities arise under the agreements, or (iii) an affected European entity subsequently becomes party to the agreements.
Model Trade Association Provisions
Both the Loan Market Association (the “LMA”) and the Loan Syndications and Trading Association (the “LSTA”), the respective trade associations for syndicated loans in Europe and the U.S., have published draft model provisions addressing the new bail-in requirements. The LMA provisions, drafted for use in agreements governed by European law, focus principally on the consent and notification requirements. The LSTA’s provisions, tailored for agreements governed by New York law, also include suggested revisions to the definition of a “defaulting lender” to include lenders subject to bail-in actions. Lenders in both Europe and the U.S. normally follow the trade group model provisions, so we expect the LMA and LSTA model bail-in provisions to be widely followed.
Implications for ABL Market Participants
Lenders in ABL syndicated credit facilities should expect to see bail-in provisions included in all new credit agreements and in material amendments to existing credit agreements. Even in U.S. “club” syndicated loans for which the parties initially expect that only domestic lenders will comprise the syndicate, the bail-in provisions will be necessary unless the agreements flatly prohibit assignments to foreign lenders –- an approach not yet commonly embraced by the market.
The new bail-in regime has implications for all participants in syndicated ABL transactions. Borrowers with European lenders in their syndicates may have access to less funding than they desire, may be required to post cash-collateral for risk participation obligations of the defaulting bank, and may even be forced to take an unwanted equity stake in the defaulting European lender.
And the downside risk for lenders in ABL syndicated credit facilities may be even more significant. Because the technical requirements of the bail-in regime affect both contractual and non-contractual liabilities, the range of obligations falling within its ambit is potentially quite broad. For example, the LMA has identified the following obligations, in addition to general financing obligations, as potentially being subject to write down, cancellation or other modification: (i) indemnities typically given by lenders to administrative agents, (ii) requirements to share or turnover recoveries a failing European bank receives from the borrower, (iii) confidentiality duties; (iv) requirements to obtain borrower consent; (v) restrictions on creditor actions; (vi) administrative obligations, such as notifications of tax status or requirements to supply information; and (vii) contingent tort liabilities, such as claims for negligence or misrepresentation.
Market Reaction
It remains to be seen whether U.S.-based syndicated ABL market participants (including borrowers, administrative agents, letter of credit issuers and syndicate member lenders alike) will become more assertive in negotiating the loan assignment provisions of syndicated credit agreements or whether they will be resigned to living with the bail-in rules as the price of ensuring sufficient access to syndicated loans. Stated another way, we are uncertain whether there will be a mass “on-shoring” of syndicated ABL credit facilities in response to the bail-in rules. We are also awaiting the outcome of the industry’s lobbying efforts to narrow the scope of liabilities covered by the bail-in rules. The only certainty is that LMA or LSTA model bail-in provisions will be common features of credit agreements and amendments thereto for the foreseeable future.
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