General structuring of financing
Choice of law
What territory’s law typically governs the transaction agreements? Will courts in your jurisdiction recognise a choice of foreign law or a judgment from a foreign jurisdiction?
Loan and intercreditor agreements are typically governed by English law. However, there has been an increase in New York law-governed term loan debt provided by US lenders. High-yield bond documents are governed by New York law in nearly all cases. Security documents are generally governed by the law of the jurisdiction where the assets are located, except in the case of security over claims, which is often governed by the law of the place of the debtor.
Recognition of parties’ choice of law will not change drastically if or when the UK leaves the EU. The European Union (Withdrawal) Act 2018 provides for EU regulations in force in the UK on exit day to be transposed into UK law. The draft withdrawal agreement agreed between the UK government and the EU (if signed in its current form) will provide for a transition period, during which EU laws (including Rome I and Rome II Regulations - see below) will continue to apply to the UK.
Subject to certain exceptions, the English courts will apply the Rome I Regulation ((EC) No. 593/2008) on the law applicable to contractual obligations to determine the governing law of a contract. The general rule under Rome I is that a contract is governed by the law chosen by the parties. An English court would also generally uphold an agreement made in advance to submit non-contractual obligations (eg, a claim in respect of a misrepresentation made in the course of contractual negotiations) to the law of a particular country, in accordance with the terms of the Rome II Regulation ((EC) No. 864/2007). Rome I and Rome II Regulations do not require reciprocity, so their incorporation into UK domestic law means that the choice of governing law will continue to be recognised post-Brexit.
The recast Brussels Regulation ((EU) No. 1215/2012) currently provides for the recognition and enforcement by the English courts of judgments obtained in other EU member states within the scope of the Regulation. In addition, certain judgments for a specific sum of money obtained in uncontested proceedings can be recognised and enforced by the English courts under the European Enforcement Order Regulation ((EC) No. 805/2004) and, apart from where conflicting judgments exist, the defendant has very limited grounds to object. The Lugano Convention on Jurisdiction and the Enforcement of Judgments in Civil and Commercial Matters applies to the enforcement of judgments as between the EU and Iceland, Norway and Switzerland and is very similar to the recast Brussels Regulation. Following Brexit, recognition of choice of forum will not be as straightforward as choice of law: the UK becoming a signatory to the recast Brussels Regulation and the Lugano Convention will require the agreement of the other contracting states.
As a member of the EU, the UK is also currently party to the Hague Convention on Choice of Court Agreements, which provides for mutual recognition of exclusive jurisdiction clauses in civil and commercial matters and recognition of resulting judgments between contracting states (currently the EU member states, Mexico, Montenegro and Singapore). In preparation for the UK leaving the EU, the UK unilaterally ratified the Hague Convention in its own name on 28 December 2018. Under the terms of the UK’s accession, the Hague Convention will enter into force in the UK on 1 April 2019 in the event of a no-deal Brexit; however, if the draft withdrawal agreement becomes effective between the UK and the EU prior to Brexit, the UK will withdraw its accession in order to rely on the status quo during the transition period until 31 December 2020. A judgment given in proceedings started before the end of the transition period will, therefore, continue to be enforceable in accordance with the recast Brussels Regulation. At the end of the transition period, the UK would again accede to the Hague Convention to become a party in its own right.
The UK is party to various other treaties for recognition of foreign judgments, which are incorporated in statute. The main ones are the Administration of Justice Act 1920 and the Foreign Judgments (Reciprocal Enforcement) Act 1933, which apply as between the UK, Commonwealth countries and certain others with which the UK has historical links. Foreign judgments from the courts of countries with which the UK does not have any applicable treaty (such as Brazil, China, Russia and the United States) are not directly enforceable in the UK; recognition and enforcement will, therefore, be subject to English common law principles. In these cases, a foreign judgment will generally be treated as having created a contract debt due from the defendant and the claimant will need to bring a new action in the English courts to enforce it.
In 2017, the High Court upheld an asymmetric jurisdiction clause under the recast Brussels Regulation, pursuant to which a bank could choose jurisdiction but the borrower was tied to the jurisdiction of the English courts. There had previously been doubt as to whether such clauses were effective.
Restrictions on cross-border acquisitions and lending
Does the legal and regulatory regime in your jurisdiction restrict acquisitions by foreign entities? Are there any restrictions on cross-border lending?
The acquisition of UK companies in certain sectors by foreign entities is restricted and sanctions may restrict other acquisitions and financings. There are also disclosure requirements and antitrust laws.
Entities that are subject to financial markets supervision are usually subject to change of control restrictions. For example, acquisitions of qualifying holdings in banks, regulated financial services, insurance undertakings and certain regulated investment funds require prior regulatory approval pursuant to the Financial Services and Markets Act 2000. Similar restrictions apply to the acquisition of other financial sector businesses, including investment exchanges and e-money institutions. A prior notification requirement applies to the acquisition of a qualifying holding in a payment service provider authorised pursuant to the Payment Services Regulations 2017. Acquisitions involving UK companies exceeding certain thresholds may trigger the merger control powers of the UK Competition and Markets Authority or the European Commission.
The Takeover Code applies to acquisitions of listed UK companies and certain European Economic Area companies listed only on a UK regulated market. The Takeover Code regulates the way that an offer is made for such a company and conduct during the takeover after the offer is made. Changes to the Takeover Code became effective in January 2018 to extend certain restrictions and requirements under the Takeover Code to certain asset disposals - generally where ‘significant’ assets of a target are being acquired by an offeror which is prevented under the Takeover Code from making an offer for the target’s securities. There are also detailed notification requirements - both ‘opening position disclosures’ and ‘public dealing disclosures’ - with respect to bidders, targets and others who hold or, during an offer period, acquire interests in relevant securities of parties to an offer.
The Alternative Investment Fund Managers Directive (2011/61/EU) imposes further disclosure obligations on managers of certain private equity and other unregistered funds that acquire major stakes in certain EU-based non-listed companies (including UK companies) carrying 10 per cent or more of the voting rights in the relevant company. Reporting obligations are also imposed on funds that acquire ‘control’ of EU-based non-listed companies and issuers whose securities are admitted to trading on a regulated market. Such funds are subject, for a period of 24 months following acquisition of control of the relevant company, to anti-asset-stripping rules.
Acquisitions involving a change of control of targets in oil and gas, electricity, telecommunications and broadcasting, defence and certain other sectors are subject to additional consents or other regulatory requirements. In May 2018 the UK government introduced the first stage of reforms with respect to national security concerns raised by certain investments and takeovers (particularly foreign) of UK companies or businesses. These reforms reduce the thresholds for review of mergers in certain ‘sensitive sectors’ (eg, dual military/civilian use and advanced technologies sectors). As a result, more transactions in these sectors are likely to be assessed by the UK government on national security grounds and by the Competition and Markets Authority on anti-trust grounds. A second stage of reforms is proposed that will have a national security focus on protecting national infrastructure-related businesses or assets. The proposals include circumstances in which a loan relationship and/or an associated enforcement of collateral might lead to concerns that a lender who is hostile to the UK might gain ‘significant influence or control’ over assets of national security interest.
The United Nations, EU or UK may, from time to time, impose trade or financial sanctions or other similar measures on cross-border payments, including exchange control restrictions (pursuant to the International Monetary Fund Act 1979 and the Bretton Woods Agreement Order in Council (SI 1946/36)). In July 2014, in response to Russia’s actions in the Ukraine, the EU passed ‘sectoral’ sanctions targeting Russia’s finance, energy and defence sectors, which have been extended until 31 July 2019. They are similar to the sectoral rules published by the Office of Foreign Assets Control (OFAC) in the US. Although the EU’s sectoral rules, generally, do not restrict the sale of UK companies to entities designated under the sectoral rules, there are implications for cross-border lending, as lenders must ensure that they are not providing loans or credit to entities designated under the sectoral rules or their subsidiaries or agents.
The UK has an international law obligation to implement UN sanctions. In practice, the EU will implement UN regimes through directly effective regulations, which immediately form part of UK law when adopted and are enforced through domestic regulations. The Sanctions and Anti-Money Laundering Act 2018 introduced a new framework for the implementation and enforcement of international sanctions in the UK post-Brexit.
Lenders will wish to ensure that cross-border transactions they enter into are compliant with applicable sanctions regimes for a number of reasons, including liability under civil and/or criminal penalties for failure to comply with applicable laws and regulations, ability of the lender to receive payments from the borrower and to enforce a guarantee or security, in addition to reputational damage. In view of this, credit agreements often contain a representation and undertaking relating to the borrower’s use of loan proceeds to address compliance with sanctions. It may be difficult in certain cases for a bank to identify whether it is transacting with a sanctioned entity, particularly where a counterparty is acting as an agent of a designated entity. In addition to EU rules, US banks making loans booked in the UK must comply with OFAC rules as a result of being ‘US persons’.
In May 2018 the US announced its decision to reimpose extraterritorial sanctions against Iran simultaneously with its withdrawal from the Joint Comprehensive Plan of Action. In response to this development the EU updated its Blocking Statute in August 2018 to mitigate the impact of these sanctions on the interests of EU operators conducting legitimate business with Iran. The updated Blocking Statute allows EU operators to recover damages arising from the extraterritorial sanctions and nullifies the effect in the EU of any foreign court rulings based on them. It also forbids EU persons from complying with those sanctions unless exceptionally authorised to do so by the European Commission in case non-compliance seriously damages their interests or the interests of the EU.
For further detail on the regulatory restrictions applicable to certain types of lending in the UK, see question 6.
Types of debt
What are the typical debt components of acquisition financing in your jurisdiction? Does acquisition financing typically include subordinated debt or just senior debt?
The typical components of debt financing vary depending on the size of the deal. Financing can include senior term and revolving loans, first and second lien debt in the form of loans or notes, mezzanine term debt, payment-in-kind (PIK) loans or notes, vendor financing, unitranche facilities or high-yield bonds.
Subordinated debt (eg, second lien debt) is usually guaranteed by, and secured on, the same assets as senior debt. Intercreditor arrangements ensure that payments on the second lien debt are subordinated to the senior debt and the ability of subordinated lenders to enforce their guarantee and security package is subject to a standstill in certain circumstances. While a significant amount of the senior debt may be borrowed by the same holding company as the second lien debt, some senior debt may be borrowed at a structurally senior level to refinance existing debt within the target group at closing or for working capital. In cross-border financings, senior debt that is borrowed at operating company level and which is used to refinance existing debt may benefit from an enhanced guarantee and security package due to corporate benefit and other legal considerations. A second lien facility usually matures one year after the latest dated senior debt.
PIK debt and vendor financing are the most junior pieces of debt finance in the capital structure. They tend to be lent to, or be issued by, holding companies of the borrowers of the senior and second lien debt and tend to have limited, if any, recourse in the form of security and guarantees from the obligors in respect of the senior or second lien debt. They mature after all the other debt in the structure. Interest on PIK facilities capitalises, or there may be an option for the borrower to pay part in cash, if permitted under the terms of the other debt in the structure.
Subject to prevailing market conditions, acquisitions may also be financed with the proceeds of issues of secured bonds, combined with a revolving credit facility to finance working capital (often with priority over the realisations of security enforcement), or term debt (ranking pari passu). Bond issues are suitable for larger transactions where the debt will not be repaid quickly (due to the cost and non-call features), although the size of deals being financed with high-yield bonds has become smaller in recent years.
For mid-market transactions, borrowers have been able to finance acquisitions with unitranche facilities. Such facilities are priced with an interest rate that is a blend of rates that would have applied to a senior term loan and a second lien loan. A unitranche lender will often enter into a participation agreement with a pool of investors behind the scenes, allowing the borrower the relative ease of dealing with only one lender of record under the unitranche facility. The advantages of a unitranche facility include simplicity of documentation and speed of execution, as no syndication is required. A disadvantage may be that the borrower has no direct relationship with investors, who may be critical to pass certain consents and waivers. The borrower will also need to find a separate provider of working capital facilities and hedging arrangements.
Are there rules requiring certainty of financing for acquisitions of public companies? Have ‘certain funds’ provisions become market practice in other transactions where not required?
The UK Takeover Code requires that an announcement of a firm intention to make an offer for the acquisition of a UK company subject to the Takeover Code should only be made after the most careful and responsible consideration and when the offeror has every reason to believe that it can and will continue to be able to implement the offer. The announcement of an offer with any element of cash must include confirmation by the financial adviser (or other appropriate third party) that sufficient resources are available to the offeror to satisfy full acceptance of the offer (the ‘cash confirmation’ requirement). This generally means that the acquisition financing must only be subject to conditions that the bidder is sure it can satisfy or which are conditions to the offer (ie, the ‘certainty of funds’ requirement).
Certainty of funding has also become market practice for acquisitions of private companies. A lender will typically only be entitled to withhold funding at closing in respect of representations, undertakings and events of default relating to the actions or omissions of the acquiring group companies (and not the target group) and any failure to satisfy the conditions to the acquisition. In competitive auction processes, an ‘interim facility agreement’ is often submitted by bidders in place of fully negotiated long-form documents to save time and expense. The interim is a short-form loan agreement that is attached to the commitment letter and which the lenders agree to execute on short notice from the bidder, to allow the bidder to show availability of funding to it to finance the acquisition. That said, the expectation of all concerned is that it will not be used, and the long-form facility agreement will have been put in place prior to closing.
Restrictions on use of proceeds
Are there any restrictions on the borrower’s use of proceeds from loans or debt securities?
Loan agreements usually include a purpose clause specifying how the loan proceeds are to be used. One reason for this is to attempt to create a trust over any monies advanced but not used for the specified purpose, particularly if the borrower becomes insolvent. In addition, if the proceeds are used to fund an acquisition of a UK public limited company, it and its subsidiaries will not be able to provide financial assistance (see question 15).
The purpose clause will also give lenders some comfort that the loan will not be used for an illegal purpose. Under the Proceeds of Crime Act 2002, various types of arrangement involving the proceeds of crime are criminal money laundering offences. For businesses in the regulated sector, failure to disclose knowledge or suspicion of money laundering may be a criminal offence. Businesses in the regulated sector include financial and other higher-risk businesses, including banks and other lenders. The Money Laundering, Terrorist and Transfer of Funds (Information on the Payer) Regulations 2017 (SI 2017/692) (as amended) require such businesses to implement anti-money laundering and terrorist-financing controls, including customer due diligence, monitoring and record-keeping.
It has become commonplace to add express restrictions in a credit agreement on the use of the proceeds of a drawdown which would breach sanctions or anti-corruption laws. As the UK’s laws on anti-money laundering and terrorist financing derive from EU law, the Sanctions and Anti-Money Laundering Act 2018 (passed in May 2018) and Draft Money Laundering and Transfer of Funds (Information) (Amendment) (EU Exit) Regulations 2018 (published in November 2018) will enable the UK to update existing domestic laws on anti-money laundering and terrorist financing following Brexit.
What kind of indemnities would customarily be provided by the borrower to lenders in connection with a financing?
There are numerous indemnity provisions contained in a credit agreement covering various matters, including:
- stamp duty;
- loss to the lenders arising from an obligor’s failure to pay and various other defaults;
- the costs of conversion of a payment from one currency into the currency that was due under the finance documents;
- yield protection and costs and expenses arising from executing and documenting the transaction;
- amendments to the documentation;
- enforcement and preservation of security; and
- certain regulatory costs.