Trends and regulatory climate
Trends What is the current state of the lending market in your jurisdiction and have any new trends emerged over the last 12 months? Most secured loans in the United States are made to sub-investment grade borrowers. Over the past 12 months, there has been a contraction in the leveraged lending market for such borrowers. The implementation of the revised leveraged lending guidance by the prudential bank regulators has caused banks to pull back from some credits that they had previously underwritten. While non-bank direct lenders have filled some of the void, there has still been a decline in sub-investment grade secured lending in the past 12 months. Investment grade syndicated lending, which is primarily unsecured, has remained robust.
Regulatory activity Is secured lending a regulated activity in your jurisdiction? With respect to borrowers, secured lending typically implicates both federal and state law. The terms of the loan documents are governed by state law. In most large transactions, lenders and borrowers choose New York law as the governing law due to New York being a centre of commercial activity and lenders viewing New York as a more favourable jurisdiction for adjudicating disputes. In addition, the creation and perfection of security interests in most personal property and enforcement of such security interests outside bankruptcy is generally governed by Article 9 of the Uniform Commercial Code. Depending on the types of non-personal property collateral included in the security package, other laws may apply (eg, real estate collateral is governed by non-uniform real estate laws of the state in which the real property is located).
Are there any specific regulatory issues which a prospective borrower should consider when arranging or entering into a secured loan facility? Borrowers should pay particular attention to any regulatory regimes applicable to the borrower. For instance, telecommunications providers, broker-dealers and casino gaming companies are subject to regulatory regimes that may limit their ability to provide collateral or require regulatory approval to grant security over certain assets. Additionally, borrowers should also carefully consider potential tax issues, particularly in instances where the borrower’s corporate structure includes non-US corporate entities. Section 956 of the Internal Revenue Code could result in undesirable US federal tax consequences if the transaction is not structured appropriately.
Are there any specific regulatory issues which a prospective lender should consider when arranging or entering into a secured loan facility? The regulatory issues applicable to a lender will depend on whether the lender is a regulated entity. Regulated financial institutions are subject to a number of regulatory requirements that typically do not apply to non-bank lenders. These regulatory requirements are extensive.
Are there plans or proposals for reform or significant changes to the regulatory landscape in this area? We are not aware of any such plans.
Structuring a lending transaction
General Who are the active providers of secured finance in your jurisdiction (eg, international banks, local banks or non-bank financial institutions)? International and domestic banks continue to be the primary arrangers and underwriters of secured financing in the United States. In the syndicated bank loan markets – in particular for sub-investment grade borrowers – the arranging banks often syndicate all or a portion of the loans that they arrange and underwrite to a variety of market participants, including collateralised loan obligations, debt funds and insurance companies. However, non-bank direct lenders (including business development companies, mezzanine debt funds and pension plans) have played an increasing role in the US secured financing market as direct providers of secured financing to sub-investment grade borrowers. The increased activity by non-bank lenders in recent years has resulted from a number of factors, including the prudential bank regulators placing increased restrictions on regulated banks through the implementation of the revised leveraged lending guidance.
Is well-established market-standard facility documentation used in your jurisdiction for secured lending transactions? Unlike, for instance, in the United Kingdom, there is no well-established standard documentation for corporate secured loan facilities in the United States. While certain provisions are typically included in loan agreements, loan agreements are typically negotiated on a deal-by-deal basis.
Syndication Are syndicated secured loan facilities typical in your jurisdiction? Yes, syndicated loan facilities are common in the United States. Almost all large corporates use the syndicated bank loan markets for their bank financings.
How are syndicated facilities normally structured? Does the law in your jurisdiction allow a facility agent to be appointed to act on behalf of other banking syndicate members? Typically, one of the financial institutions that is party to the loan agreement (usually the lead bank arranging the facility) is appointed to act as the administrative agent for the syndicate of lenders under the loan agreement. The administrative agent is responsible for the day-to-day administration of the loan facility. Payments, notices, reports and other communications between the borrower and the lender syndicate are made through the administrative agent.
In a secured loan facility, the lenders also appoint a collateral agent to:
- hold the collateral on behalf of the lenders;
- perform ministerial functions necessary to help to maintain a valid security interest in the collateral; and
- exercise remedies with respect to the collateral in the event of default.
Typically, the same bank acts in both the administrative agent and collateral agent roles. The agent bank is broadly exculpated and indemnified against claims by the lenders and the borrower.
Does the law in your jurisdiction allow security and guarantees to be held on trust by a security trustee for the benefit of the banking syndicate? In the United States, the security is effectively held in trust by the collateral agent for the benefit of the secured parties. The collateral documentation refers to the collateral agent and the collateral agent performs ministerial functions relating to the collateral. Guarantees are typically in favour of the collateral agent on behalf of the secured parties.
Special purpose vehicle financing Is it common in secured finance transactions for special purpose vehicles (SPVs) to be used to hold the assets being financed? Would security generally be given over the shares in the SPV or would lenders require direct asset security? Whether an SPV is used is dependent on the type of transaction. In typical secured corporate lending transactions, SPVs are generally not used. However, for more specialised lending transactions, an SPV may be used.
Interest Is interest most commonly calculated by reference to a bank base rate or a market standard variable reference rate (eg, LIBOR, EURIBOR or HIBOR)? If the latter, which is the most commonly used reference rate in your jurisdiction? Loan agreements in the United States often provide borrowers with the option to calculate interest by reference to either a base rate based on the bank’s prime rate or LIBOR. Selecting the LIBOR rate typically results in a lower total interest rate than the base rate, but requires advance notice to the lenders for borrowing under the loan agreement (usually at least two business days). In addition, a LIBOR ‘floor’ is typically included in the loan agreement setting a minimum LIBOR rate, which is typically between 0% and 1%. Base rate loans, in contrast, are typically available on shorter notice, sometimes on a same-day basis, and can be pre-paid at any time without incurring break funding fees.
Are there any regulatory restrictions on the rate of interest that can be charged on bank loans? Yes, the maximum rate of interest that can be charged on bank loans is limited by state law in many jurisdictions. The scope and amount of these limits differ significantly by state. Under Section 85 of the National Bank Act (12 USC § 85), federally chartered national banks are permitted to charge up to the maximum amount of interest permitted under the laws of the state in which the bank is located. As a result of regulatory guidance and case law interpreting Section 85, national banks with locations in multiple states have some flexibility in determining which state’s interest rate laws apply to their lending activities.
Use and creation of guarantees Are guarantees used in your jurisdiction? Yes, guarantees provided by subsidiaries of the borrower and its parent entities are a common feature of corporate secured loan transactions. In some transactions, sister company guarantees are also provided.
What is the procedure for their creation? Guarantees are created by contract, through either provisions included in the loan agreement or, more commonly, a separate guaranty executed by the guarantor. Generally, no filing is required in order to create an enforceable guaranty. However, if the guarantor is granting a security interest in its assets (which is typically the case in a secured loan transaction with guarantees), other actions will be required to perfect a security interest in the guarantor’s assets.
Do any laws affect or restrict the granting or enforceability of guarantees in your jurisdiction (eg, upstream guarantees)? In the case of a corporation or other business entity, the entity’s ability to provide a guaranty is governed by the business organisation law of the state in which the entity is organised. It is important to review the applicable state law of the relevant guarantor, as jurisdictions differ on the permissibility of certain types of guarantee and whether board or shareholder approval is required or provides safe harbour protection under state law. For instance, in Delaware, a popular jurisdiction for incorporating corporations, the Delaware General Corporation Law expressly permits a Delaware corporation to provide guarantees to its subsidiaries (‘downstream’ guarantees), its parent company (‘upstream’ guarantees) or companies under common ownership with the corporation (‘cross-stream’ guarantees), provided that the guaranty is “necessary or convenient” to the conduct of the corporation’s business. Delaware courts generally will not challenge a determination by a corporation’s board of directors that the corporation’s issuance of such a guaranty is necessary or convenient to the corporation’s business.
The enforceability of guarantees may also be limited by federal and state fraudulent conveyance laws. Under Rule 548 of the US Bankruptcy Code (11 USC § 548), a bankruptcy court is permitted to set aside as a fraudulent transfer the grant of a guaranty or security interest by the debtor if the grant was made within two years before the commencement of the bankruptcy proceeding and the court determines that the grant was a product of actual or constructive fraud. In addition, guarantees and security interests may also be voided outside of bankruptcy under similar state fraudulent conveyance statutes.
Because a guarantor receives no proceeds of the loan that it is guaranteeing, guarantees may be challenged in bankruptcy court as constructive fraudulent conveyances on the basis that the guarantor did not receive reasonably equivalent value in exchange for its guaranty. In the case of downstream guarantees, courts have generally held that there is no fraudulent transfer because the guarantor is deemed to benefit from its subsidiary’s receipt of the loan proceeds. However, upstream and cross-stream guarantees are more vulnerable to legal challenge because it is harder to demonstrate that the guarantor received reasonably equivalent value and there is conflicting case law on this point.
Subordination and priority Describe the most common methods of structuring the priority of debts and security. The most common type of subordination is lien subordination, in which a creditor’s claim is senior to another creditor’s claims based on the priority of their liens against the collateral. A creditor or group of creditors can also contractually agree to subordinate their right to payment of the loan obligations (‘payment subordination’). One way of achieving payment subordination is to include provisions in the loan document identifying the debt as subordinated debt, as applicable, and setting forth the terms of the subordination. However, in cases where both classes of creditor hold security interests in the borrower’s assets and intend for there to be lien subordination in addition to payment subordination (eg, in the case of first lien and second lien credit facilities), the creditors usually negotiate and enter into a separate intercreditor agreement setting forth the terms of the subordination in detail.
Debt claims may also be structurally subordinated to one another. This type of subordination occurs when one creditor has a claim against a parent company and the other creditor has a claim against a subsidiary of the parent company. The creditor of the subsidiary has recourse to the assets and cash flows of the subsidiary and, in the event of insolvency, must be paid in full before the parent company receives any payment on account of its equity interest. Because the creditor of the parent company must look to the value of the parent company’s equity interest in the operating subsidiary for repayment, and has no direct recourse to the subsidiary’s assets, the debt at the parent company level is structurally subordinated to all debt at the subsidiary level (including any unsecured debt).
Documentary taxes and stamp duty Are any taxes, stamp duty or other fees payable on the granting of a loan, guarantee or security interest, or on its enforcement? US federal law and New York state law generally do not impose any taxes or other fees in connection with the making of a loan or the granting of a security interest or guaranty. However, the filings required to perfect the lender’s security interest (eg, UCC-1 financing statement filings, filings with the US Copyright Office or the US Patent and Trademark Office to perfect security interests in US intellectual property and state mortgage filings) generally require the payment of a fee.
In some states (eg, Florida) a borrower’s entry into a loan document may give rise to a documentary tax under state law, in addition to any applicable filing fees.
Governing law Is it more common for local law to govern the terms of the facility documentation or is the law of another jurisdiction often elected by the parties (eg, English law or New York law)? In large syndicated loans, New York law is frequently chosen to govern the terms of the documentation.
Restrictions Are there any restrictions on the making of loans by foreign lenders or the granting of security or guarantees to foreign lenders? No, foreign lenders (other than lenders in jurisdictions that are the target of broad US economic sanctions) may generally make loans and hold security interests and guarantees in the same manner as US-based lenders.
However, for borrowers in industries where the transfer of assets to non-US persons is subject to regulatory restrictions (eg, in the defence or natural resource industries, where the transfer of certain assets may require the approval of the Committee on Foreign Investment in the United States), the grant of a security interest to a non-US lender may be subject to such restrictions.
Are there any exchange controls that restrict payments to a foreign lender under a security document, guarantee or loan agreement? Not as a general matter, although US anti-terrorism laws or other economic sanctions may prohibit payments to lenders in certain foreign jurisdictions.
Security – general
Security agreements Is it possible to create a security interest over all assets of an entity? If so, would a single security agreement suffice or is a separate agreement required for each type of asset? As a general matter, a security interest can be created in almost any type of asset (subject to limited statutory or regulatory exceptions). The laws applicable to the attachment, perfection and enforcement of a security interest vary depending on the type of asset and any special regulatory regime applicable to the borrower.
The attachment and perfection of security interests in most types of personal property are governed by Article 9 of the Uniform Commercial Code, a model statute that has been enacted in each state (with important variations among states). ‘Personal property’ generally includes tangible goods, accounts, general intangibles and commercial tort claims.
For assets within the scope of Article 9, a single security agreement can be used to grant a security interest in all of the borrower’s interests in such assets, including acquired property. The security agreement must:
- be in writing;
- be authenticated;
- expressly provide for the grant of the security interest; and
- include a sufficient description of the collateral.
The Uniform Commercial Code includes a set of rules describing what constitutes a sufficient description. The requirements for a sufficient description in the security agreement differ from the requirements for a sufficient description in a UCC-1 filing. Assuming that value has been given and the debtor has rights in the collateral, the entry into a written security agreement meeting the requirements outlined above is sufficient to create a security interest that is enforceable against the debtor. In order for the security interest to be enforceable against third-party creditors in a bankruptcy proceeding or other third parties with competing liens in the borrower’s assets outside of bankruptcy, the borrower and lenders must take certain additional steps to perfect the security interest. For assets within the scope of Article 9 of the Uniform Commercial Code, perfection can generally be achieved for certain assets by filing an appropriate UCC-1 financing statement. However, certain assets may be perfected only by taking specialised actions (eg, obtaining control). In addition, security interests in certain assets may be perfected by more than one method and the method chosen may result in a secured party having priority over another secured party.
Security interests in real estate are governed by non-uniform state real estate law. In addition, the perfection of security interests in certain types of personal property is specifically excluded from the Uniform Commercial Code and is governed by other federal or state laws, including aircraft and related assets, ships, railroad rolling stock and motor vehicles. In addition, perfection of security interests in intellectual property is governed by federal law in certain respects.
Release of security What are the formalities for releasing security over the most common forms of assets? The release of a security interest is typically effected either through a written agreement between the borrower and secured parties or, if the loan documentation so provides, automatically upon the satisfaction of relevant conditions. There are also provisions of the Uniform Commercial Code relating to the release of security interests in certain situations. In addition, a security interest typically attaches to the proceeds from sale of collateral.
Usually the security agreement contains a section describing the procedure for documenting the full or partial release of the secured party’s security interest, requiring the lender (or, in a syndicated deal, the collateral agent) to execute a written release upon the borrower’s payment in full of the loan obligations. Some security agreements provide for the automatic release of security interests upon the payment in full of the borrower’s loan obligations, although even in such cases, borrowers typically prefer to document the release of the security interest in writing, as acquirers and future lenders usually want written evidence of the release. The release of a security interest is often documented in a ‘payoff letter’ executed at the time of release.
If the security interest being released was perfected through the filing of UCC-1 financing statements, UCC-3s are filed at release to terminate the outstanding UCC-1s. In the case of perfection by possession (eg, for certificated securities perfected by control), the certificated securities are returned by the secured party to the borrower.
The procedure for terminating a security interest in real property varies by state, but typically involves the lender’s delivery to the borrower of a ‘satisfaction of mortgage’ document and the filing of a copy with the relevant real estate recording office.
In the case of security interests in intellectual property, the parties also typically enter into separate release agreements, which are filed with the US Copyright Office or US Patent and Trademark Office, as applicable.
Asset classes used as collateral for security
Real estate Can security be granted over real estate? If so, what are the most common forms of security granted over real estate and what is the procedure? Yes, security can be grated over most forms of real property, including partial interests (eg, leaseholds). The creation and enforcement of security interests in real property are governed by state law and vary significantly by state. Most commonly, the security interest is granted by the borrower’s signing and acknowledging a promissory note and a mortgage describing the property in sufficient detail. In order to perfect its security interest, the lender must file the mortgage with the local real estate recording office.
Machinery and equipment Can security be granted over machinery and equipment? If so, what are the most common forms of security granted over this kind of property and what is the procedure? Yes, machinery and equipment generally fall within the scope of Article 9 of the Uniform Commercial Code and the security interest can typically be perfected by filing a UCC-1 financing statement.
Receivables Can security be granted over receivables? If so, what are the most common forms of security granted over this kind of property and what is the procedure? Yes, the creation of a security interest in most receivables falls under the scope of Article 9 of the Uniform Commercial Code. A security interest in receivables is generally perfected by filing a UCC-1 financing statement.
Financial instruments and cash Can security be granted over financial instruments? If so, what are the most common forms of security granted over this kind of property and what is the procedure? Yes, the creation and perfection of a security interest in financial instruments fall under the scope of the Uniform Commercial Code. The procedure for perfecting a security interest in financial instruments depends on the type of financial instrument. Common ways to perfect a financial instrument include executing a control agreement, filing a UCC-1 and taking possession of the instrument.
Can security be granted over cash deposits? If so, what are the most common forms of security granted over this kind of property and what is the procedure? Yes, the creation and perfection of a security interest in deposit accounts are governed by Article 9 of the Uniform Commercial Code. A security interest in a deposit account is perfected by control, which is typically accomplished by the secured party, obligor and depository bank executing a tri-party deposit account control agreement.
Intellectual property Can security be granted over intellectual property? If so, what are the most common forms of security granted over this kind of property and what is the procedure? Yes, security can be granted over intellectual property in the United States. As best practice, most lenders both file UCC-1s to perfect the security interest in the intellectual property and make appropriate federal filings with the US Copyright Office or the US Patent and Trademark Office, as applicable. In transactions where intellectual property is an important part of the borrower’s business and a significant component of the collateral package, particular attention should be paid to evaluate legal issues surrounding the grant of security in the intellectual property.
Criteria for enforcement What are the common enforcement triggers for loans, guarantees and security documents? The conditions under which the lender (or, in the case of a syndicated credit facility, the administrative agent on behalf of the lenders) can enforce its rights under the loan documents are usually defined in the loan agreement and referred to as ‘events of default’. Typical events of default include:
- the borrower’s failure to make required payments on a timely basis;
- the borrower’s breach of a covenant in the loan documents;
- material inaccuracy of a representation or warranty in the loan documents;
- commencement of an insolvency proceeding against the borrower or guarantors;
- a default on other debt of the borrower or guarantors;
- a final legal judgment issued against the borrower above a certain threshold;
- changes of control of the borrower; and
- issues with the validity of the lender’s security interest.
Process for enforcement What are the most common procedures for enforcement? Are there any specific requirements with which lenders must comply? Upon an event of default, the lender or administrative agent acting on the instructions of the requisite lenders is typically entitled to accelerate the maturity of the debt. With respect to its security interest in the collateral, the secured party may either seek judicial foreclosure of the collateral or exercise ‘self-help’ remedies under the Uniform Commercial Code, such as selling collateral in the secured party’s possession. If the borrower has filed for bankruptcy protection, the ‘automatic stay’ provisions of the US Bankruptcy Code generally require the secured party to obtain permission from the bankruptcy court before exercising any remedies against the borrower or the collateral.
Ranking in insolvency In what order do creditors rank in case of the insolvency of a borrower? A creditor with a valid, perfected security interest has priority over unsecured creditors to the extent of the value of the collateral. If there are multiple secured creditors with a security interest in the same asset, the creditor with lien priority typically has priority.