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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?
New York law is most commonly selected for financing agreements in international and other large financings. Under New York corporate law, a choice of New York law will be enforceable for commercial contracts having a value of at least US$250,000 without any requirement to prove that either the parties or the contract bear a ‘reasonable relationship’ to the state.
With respect to a choice of law other than New York law, New York courts generally uphold choice-of-law provisions in transaction agreements provided there is some ‘reasonable relationship’ between the parties or the transaction and the selected jurisdiction’s law at the time the agreement was reached and at the time the dispute arises. A reasonable relationship generally exists if one of the contracting parties’ place of business is within the selected jurisdiction or performance under the contract occurs in the jurisdiction. Where a dispute relates specifically to a letter of credit, the Uniform Commercial Code (UCC) requires application of the substantive law of the jurisdiction whose law is chosen to govern the letter of credit regardless of its relation to the transaction.
In the absence of a binding choice of law provision in the agreement, New York courts determine the ‘centre of gravity’ between the controversy and relevant jurisdictions by applying a multi-factor test for a contract dispute. These factors include:
- the place the contract was executed or negotiated;
- location of the parties;
- the place of performance;
- the location or the subject matter of the contract; and
- the domiciles or places of business of the parties.
Courts also consider which territory has the greater interest in having its laws applied to the particular dispute. Where a dispute specifically involves a letter of credit, and there is no choice-of-law provision, the dispute will be governed by the substantive law of the jurisdiction in which the issuer is located, considered to be the address from which the undertaking was issued.
New York courts recognise final money judgments entered anywhere in the United States. They will recognise a foreign money judgment that is ‘final, conclusive and enforceable where rendered’ unless there is a showing that the judgment was procured through a system that did not provide impartial tribunals or due process, or the foreign court lacked personal jurisdiction over the defendant. New York courts assess the foreign court’s personal jurisdiction by considering, among other factors, whether the defendant:
- was served personally in the foreign state;
- voluntarily appeared or agreed to submit to the jurisdiction of the foreign state with respect to the subject matter;
- was domiciled, had a principal place of business or acquired corporate status in the foreign state when the action was initiated; and
- maintained an office in the foreign state from which the action arose.
New York courts may choose not to recognise foreign money judgments if, among other factors:
- the foreign court lacked subject matter jurisdiction;
- the defendant did not receive sufficient notice of proceedings;
- the judgment was obtained by fraud;
- the cause of action was repugnant to New York public policy;
- the judgment conflicted with another final and conclusive judgment; or
- the proceeding in the foreign court was contrary to an agreement between the parties.
Finally, where jurisdiction was based only on personal service, the foreign judgment may not be recognised if the foreign court was a ‘seriously inconvenient’ forum for the trial.
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?
Generally, the United States does not restrict foreign acquisitions or cross-border lending. However, transactions that pose national security risks are subject to review, and transactions with sanctioned countries, persons or entities are prohibited. In addition, there are restrictions on foreign investments in certain regulated industries, such as US airlines (which are regulated by the Federal Aviation Administration) and telecommunication companies (which are regulated by the Federal Communications Commission), among others.
The Committee on Foreign Investment in the United States (CFIUS), which is a multi-agency committee chaired by the US Department of the Treasury, exists to review and address national security matters arising from foreign acquisitions or investments in US businesses. If there is found to be credible evidence that the foreign investor exercising potential control over a US business might take action threatening US national security, and other provisions of law, other than the International Emergency Economic Powers Act, do not provide adequate and appropriate authority to protect US national security, then the transaction in question can be suspended or prohibited by the US president or, in the case of a completed transaction, a divestiture may be ordered by the US president. In practice, this power is almost never exercised by the US president, although President Trump blocked Singapore-based Broadcom Ltd from purchasing Qualcomm, Inc in a hostile takeover in 2018 and blocked Chinese-backed Canyon Bridge in its proposed acquisition of Lattice Semiconductor in 2017. More commonly, national security issues are resolved by CFIUS, which has the authority to propose, negotiate and impose mitigation agreements on the parties to address and resolve any national security concerns identified by CFIUS during its investigation.
Under the recently enacted Foreign Investment Risk Review Modernization Act (FIRRMA), Congress expanded CFIUS’s jurisdiction to include investments that do not confer potential control by foreign persons over certain US businesses involved in critical infrastructure or critical technologies or that collect and store sensitive personal data of US citizens, as well as acquisitions of real estate and leaseholds near US military or other sensitive government facilities. Most of FIRRMA’s provisions will not be effective until final regulations are promulgated, which is not expected until late 2019 or 2020. CFIUS did announce a pilot program (the Pilot Program), effective 10 November 2018, which expands the scope of transactions subject to review by CFIUS to include certain non-controlling investments made by foreign persons, whether or not foreign government controlled, in US businesses involved in critical technologies related to specific industries and requires mandatory declarations for transactions that fall within the Pilot Program. All other filings with CFIUS are technically voluntary; however, CFIUS member agencies can initiate an investigation on their own (an ‘agency notice’) and there may be political, reputational and public relations considerations that lead a party to formally notify CFIUS. The content of a CFIUS filing is specified by regulation and includes detailed information about the parties, their proposed transaction and rationale, the US business, and the foreign investor’s plans for the US business. Personal identifier information about individuals serving on the board or in senior management positions at the acquiring foreign company and its parent entities is required to be submitted along with a CFIUS notice. CFIUS filings and submissions are confidential. If the parties to the transaction decide to file such a notice, CFIUS will have 45 days after formally accepting the filing to review and clear the acquisition or to initiate a further 45-day investigation, which may be extended by an additional 15 days in extraordinary circumstances. At the end of the review period, CFIUS could conclude the investigation or refer it to the US president, who would then have 15 days to make a decision. Any such decision would be final and could not be appealed.
The Office of Foreign Assets Control (OFAC) of the US Department of the Treasury administers and enforces economic and trade sanctions based on US foreign policy and national security goals. US economic sanctions generally prohibit US persons from doing business or otherwise dealing with:
- Cuba, Iran, North Korea, Syria or the Crimea region of Ukraine;
- the governments of, or any persons or entities organised or located in, Cuba, Iran, North Korea, Syria or the Crimea region of Ukraine;
- persons or entities listed on OFAC’s specially designated nationals (SDN) list and other restricted party lists; or
- any entity owned or controlled by any of the preceding.
US economic sanctions also prohibit lending and certain other dealings with certain Russian sanctions targets, including those entities listed on OFAC’s Sectoral Sanctions Identifications (SSI) list. OFAC also prohibits certain financial dealings with the government of Venezuela and with Petroleos de Venezuela.
Before entering into any transaction, it is important to check OFAC’s website for the most current SDN and SSI lists and restrictions affecting countries, territories and parties with which you plan to transact. In some cases, OFAC could issue a licence to permit a person or entity to engage in an otherwise prohibited transaction. OFAC issues both general licences, which are granted without the need for application, as well as specific licences, which require application and are evaluated on a case-by-case basis.
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?
Large acquisition financings would typically be composed of debt in the form of both traditional bank financing and financing through the capital markets. Most often, the debt would include a senior secured term loan facility, a senior secured revolving credit facility and senior unsecured notes. However, many variations on this combination are common, including:
- senior unsecured bank financings (most typically for higher grade credits);
- first lien and second lien bank financings;
- senior secured notes;
- senior subordinated notes;
- subordinated notes; and
- mezzanine financing.
To the extent that an issuance of debt securities is contemplated to fund the acquisition, the commitment papers will include a commitment by the bank lenders for a bridge loan in an amount equal to the principal amount of proposed debt securities. The bridge loan is not intended to be funded, but serves as a backstop in case the securities issuance (which is uncommitted) ultimately fails.
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?
Although there is no concept of ‘certain funds’ in US practice, sophisticated sellers will focus on conditionality in the financing commitments provided to potential purchasers and those conditions are highly negotiated, with purchasers pushing to align the conditions in their financing commitments as closely as possible to any conditions to purchase in the underlying acquisition agreement. Conditions are generally more fulsome than those found in a ‘certain funds’ regime, but far more limited than they have been historically in the United States. As a result, there is an increased focus on the terms of the underlying acquisition agreement on the part of the lenders because they are essentially forced to ‘piggyback’ off the terms in that agreement. As consummation of the acquisition in accordance with the terms of the acquisition agreement is a common condition precedent in commitment papers, lenders are ultimately forced to look to the protections built into the acquisition agreement itself for comfort on a number of matters (see question 28).
Restrictions on use of proceeds
Are there any restrictions on the borrower’s use of proceeds from loans or debt securities?
Yes. The margin regulations, which are intended to restrict stock speculation, regulate the extent to which borrowers may use loan proceeds to purchase or carry ‘margin stock’. In general, the amount of any loan provided by a bank that is for the purpose of purchasing or carrying margin stock (purpose credit), and that is directly or indirectly secured by margin stock, may not exceed the maximum loan value of the collateral that secures the loan. The maximum loan value of any margin stock collateral is half of its current market value, while the maximum loan value of other non-margin stock collateral is its current market value. Note that a loan will be considered ‘directly secured’ by margin stock if a lien is placed on the margin stock to secure the loan and ‘indirectly secured’ by margin stock if the loan agreement places any restrictions on the ability of the borrower to incur liens on (or dispose of) its margin stock. A loan that is not ‘purpose credit’ is not subject to these collateral requirements. For any loan over $100,000 that is secured by margin stock, whether or not the loan is purpose credit, the lender needs to obtain a form FR U-1 from the borrower (or a form FR G-3 in the case of a non-bank lender), which states whether the loan is purpose credit and which lists the margin stock that is provided as collateral.
The term ‘margin stock’ is defined to include any equity security trading on a US national securities exchange, debt securities that are convertible into margin stock, warrants to purchase margin stock and certain securities issued by investment companies registered under section 8 of the Investment Company Act of 1940, as amended.
Licensing requirements for financing
What are the licensing requirements for financial institutions to provide financing to a company organised in your jurisdiction?
Financial institutions (such as banks, insurance companies, broker-dealers and their holding companies) are subject to various US federal and state licensing requirements related to the businesses they conduct in the United States. US banks, for example, are generally chartered and supervised by US federal or state banking regulators and are authorised to engage in a host of banking activities, including making and syndicating commercial loans. Non-US banks may engage in banking business in the United States, including making commercial loans, by obtaining a licence for a branch or agency, either from a state that permits non-US banks to have a branch or agency or from the Office of the Comptroller of the Currency. Non-US banks must also obtain approval from the Board of Governors of the Federal Reserve System to establish a branch, agency or other office in the United States or to engage in activities in the United States.
Although state requirements to obtain licences for making commercial loans are less uniform, most commercially important states (such as New York and California) have some kind of licensing requirement for non-financial institution lenders, not otherwise subject to US federal or state supervision and regulation, that engage in commercial lending activities in the state.
Withholding tax on debt repayments
Are principal or interest payments or other fees related to indebtedness subject to withholding tax? Is the borrower responsible for withholding tax? Must the borrower indemnify the lenders for such taxes?
Interest payments made by a US borrower to a non-US lender will generally be subject to federal withholding tax at a 30 per cent rate unless interest on the loan qualifies for the portfolio interest exemption or the lender is domiciled in a jurisdiction that is party to a treaty with the United States providing for a reduced rate or an exemption (and the lender is eligible for the benefits of the treaty). Interest on a loan generally qualifies for the portfolio interest exemption if the lender properly certifies as to its foreign status (generally, on Internal Revenue Service form W-8BEN or W-8BEN-E) and the lender does not own, and is not deemed to own, 10 per cent or more of the borrower (although certain other conditions must also be met). In most cases, loans by non-US lenders are structured in order to qualify for the portfolio interest exemption and avoid any federal withholding tax. The withholding agent (typically the last US person in the chain of payment) has the legal obligation to make any required withholding. Principal payments are generally not subject to withholding tax.
Contractually, lenders typically bear the economic cost for any such federal withholding taxes in effect as of the closing date of the transaction (or the date they become a lender under the applicable agreement) and the borrower typically indemnifies or grosses-up the lenders for any such withholding taxes imposed thereafter owing to a change in the law. A borrower will gross-up the lenders by paying such additional amounts necessary so that the net amount received by the lenders after the payment of the withholding tax is not less than the amount the lenders would have received had there been no change in withholding tax.
In the case of a loan made to a non-US borrower, if there is withholding tax on interest paid to lenders, the issue of liability with respect to the cost of the withholding is a negotiated point and is fact-specific. In many of the jurisdictions more frequently involved in large global transactions, such as the United Kingdom and Luxembourg, the commercial agreement is likely to be the same as described above. Where borrowers have specific needs for money in jurisdictions where the tax laws are more burdensome, lenders will often try to negotiate to have the withholding tax paid by the borrower (even to the extent applicable at the time of closing).
A non-US issuer of securities is generally required to make interest payments free of any withholding tax by grossing-up interest payments, even if such withholding taxes are applicable on the issuance date of the securities. Typically, a non-US issuer has the right to redeem the securities if there is a change in tax laws that would require the issuer to pay any additional amounts pursuant to a gross-up after the issuance date and the payment of such additional amounts cannot be avoided by the use of reasonable measures available to the issuer.
Restrictions on interest
Are there usury laws or other rules limiting the amount of interest that can be charged?
In New York, charging interest of more than 16 per cent per year is considered civil usury. Interest exceeding 25 per cent per year is criminal usury. New York law defines ‘interest’ broadly to include anything a lender directly or indirectly charges, takes or receives in money, goods or otherwise in consideration for the amount of any loan or forbearance provided to a borrower. Loans of US$250,000 or more are generally exempt from civil usury statutes, but are still subject to the 25 per cent criminal usury laws. Loans in excess of US$2.5 million are not subject to civil or criminal usury laws in New York.
What kind of indemnities would customarily be provided by the borrower to lenders in connection with a financing?
The lenders and the agents are typically indemnified against all liabilities, losses, costs or expenses arising out of the negotiation, execution, delivery, performance, administration or enforcement of the transaction documents, including pursuant to any proceeding or in connection with the borrower’s use of proceeds of that financing. Indemnities typically cover reasonable fees and expenses of legal counsel but are sometimes limited to one principal legal counsel for all such parties and one local counsel in each relevant jurisdiction (with additional counsel permitted where there is a conflict of interest). Where appropriate, reasonable fees and expenses of one regulatory, or special, counsel may also be covered. Lenders and agents are generally not indemnified to the extent that any such losses or liabilities are caused by their own gross negligence or wilful misconduct (and sometimes, if caused by a material breach, by them, of the loan agreement) and contracts will typically provide that such finding must be made in a final and non-appealable determination by a court of competent jurisdiction.
Holders of securities issued initially to underwriters or initial purchasers are not indemnified by the issuers thereof, except for taxes for which a gross-up is payable, as discussed in question 7. Issuers of securities typically indemnify underwriters and initial purchasers against certain liabilities, including liabilities under US securities laws, or agree to contribute to payments that such parties may be required to make in respect of those liabilities. Trustees and collateral agents are typically indemnified by the issuer for any loss, liability, damage, claim or expense incurred by them without negligence, bad faith or wilful misconduct (or such similar provision as the parties may negotiate) on their part arising out of or in connection with the administration of the indenture or collateral documents under which the securities are governed and their duties thereunder. Before trustees and collateral agents will take certain actions requested by holders of securities, they are entitled to seek indemnity from those holders.
Assigning debt interests among lenders
Can interests in debt be freely assigned among lenders?
In loan agreements, restrictions on assignment are contractual and negotiated. Assignment provisions typically require the consent of the borrower and the administrative agent for any assignment, except that:
- the consent of the borrower is generally not required if there has been an event of default (sometimes limited to a payment or bankruptcy default) that is continuing;
- the consent of the borrower and the administrative agent are typically not required for assignments of any term loan to existing lenders or their affiliates or certain affiliated funds of the preceding; and
- the consent of the borrower is often not required for assignments of revolving loans and commitments to existing revolving lenders, their affiliates or certain affiliated funds of the preceding.
The borrower’s consent to assignments cannot be unreasonably withheld or delayed, and many agreements provide that the borrower shall be deemed to have consented to an assignment if it does not respond within a certain number of days. There are also limitations on the ability of lenders to assign loans or commitments to the borrower or its affiliates (including, in the case of an acquisition by a private equity sponsor, the sponsor). Such limitations are addressed in more detail in question 12. In addition, credit agreements often prohibit assignments to natural persons and competitors and may also contain a negotiated list of ‘disqualified institutions’ to which assignments are prohibited.
The ability to transfer securities depends on whether or not the securities were registered at issuance pursuant to the US Securities Act of 1933, as amended (Securities Act). If the securities were registered under the Securities Act, barring any other contractual restriction or limitation on resales by affiliates, the securities will be freely transferable pursuant to the registration statement. However, if the securities were not registered at issuance under the Securities Act, they may only be resold or transferred pursuant to an effective registration statement under the Securities Act or pursuant to an available exemption from registration under the Securities Act, such as the various exemptions provided by section 4(a)(2) of the Securities Act or Rules 144 and 144A or Regulation S under the Securities Act.
Requirements to act as agent or trustee
Do rules in your jurisdiction govern whether an entity can act as an administrative agent, trustee or collateral agent?
There are no specific rules that govern whether an entity can act as an administrative agent for a bank financing.
The Trust Indenture Act of 1939, as amended (TIA), provides statutory protection to bondholders. All indentures for securities registered under the Securities Act must be qualified under the TIA. For Rule 144A issuances (known as ‘private-for-life’ issuances), the most typical form of unregistered transaction, it is a negotiated point as to whether TIA provisions will be incorporated into the indenture; but typically, the trustee requirements conform to the TIA irrespective of whether other TIA provisions are included in the indenture. Pursuant to section 310 of the TIA, at least one trustee must be an independent US corporation, authorised under those laws to exercise corporate trust powers, and subject to supervision or examination by US authorities. The Securities and Exchange Commission (SEC) may, pursuant to the rules and regulations it may prescribe, or by order on application, permit a corporation or other person organised and doing business under the laws of a foreign government to act as sole trustee under a TIA-qualified indenture if the corporation or other person:
- is authorised under those laws to exercise corporate trust powers; and
- is subject to supervision or examination by an authority of that foreign government or a political subdivision thereof substantially equivalent to the supervision or examination applicable to US institutional trustees.
In addition, a trustee must have a combined capital and surplus of not less than US$150,000. In the case of secured securities, the same entity that acts as trustee typically also acts as the collateral agent or the collateral agent is an entity that would otherwise qualify to act as a trustee.
In addition, national banking entities must be licensed by the Office of the Comptroller of the Currency (an independent bureau of the US Department of the Treasury) to act as a trustee and non-national banking entities will need to obtain similar authority from the applicable US state regulator.
May a borrower or financial sponsor conduct a debt buy-back?
Buy-back provisions were a significant focus during the economic downturn, as many companies and private equity sponsors began buying back debt at below-par prices in the troubled economy.
There is some variation in buy-back provisions, but the most typical formulations in large global transactions with sophisticated investors permit purchases by both the borrower and a sponsor, subject to the following limitations:
- purchases by the borrower are sometimes limited to Dutch auctions open to all applicable lenders on a pro-rata basis;
- all purchases are limited to term loans;
- there is generally a cap on the amount of term loans that can be purchased by the sponsor;
- term loans acquired by the borrower must be retired and cancelled upon purchase;
- the sponsor, generally, will not have any right to attend lender-only meetings or receive lender information not provided to the borrower; and
- the sponsor will have limited voting rights.
There are many alternatives for an issuer to repurchase its securities, including:
- privately negotiated transactions;
- open-market purchases;
- cash-tender offers; and
- exchange offers.
Sponsors and issuers may purchase securities; however, under the indenture, issuers and affiliates are typically not permitted to vote debt securities owned by them.
Privately negotiated or open-market purchases are generally not subject to regulation and may be completed more quickly than a tender offer or exchange offer; however, depending on how a purchase is structured, it could be characterised as a tender offer and therefore subject to regulation. Tender offers and exchange offers are subject to the tender offer rules under the Securities Exchange Act of 1934, as amended (Exchange Act). In addition, the securities offered in an exchange offer will also be subject to the requirements of the Securities Act, unless the securities offered are exempt from registration. In essence, an exchange offer is a combined tender offer and securities offering. The level of regulation applicable to a tender offer or exchange offer depends in part on the character of the targeted securities, with offers for equity securities, including debt securities optionally or mandatorily convertible or exchangeable for equity securities, being subject to the most significant structural and SEC filing requirements. Generally, tender and exchange offers for any securities must remain open for at least 20 business days and at least 10 business days must elapse between notice of any change in the price to be paid or in the amount of securities sought in the offer and the expiry of the tender offer. However, pursuant to SEC staff exemptive relief, certain cash-tender offers and exchange offers for debt securities by issuers for any and all of the targeted securities may be conducted in periods of five business days, subject to satisfaction of a variety of structural and procedural requirements. US tender offer rules also require prompt payment following the completion of a cash tender offer or exchange offer.
Is it permissible in a buy-back to solicit a majority of lenders to agree to amend covenants in the outstanding debt agreements?
Yes. In the context of securities financings, such transactions are commonly referred to as consent solicitations and may enable a company to remove or relax covenants or events of default (either in respect of a particular contemplated transaction or permanently), which, if approved, will be binding on all holders regardless of whether they consent. Consent solicitations can be conducted either alone or in tandem with a tender offer (ie, holders deliver their exit consent). Tender offers coupled with consent solicitations are commonly used in the context of acquisitions when the target company’s outstanding debt is call protected but the covenants need to be modified to allow the acquisition.
A company that intends to solicit consents or amendments must carefully analyse the provisions it desires to amend. Under the terms of most loan agreements and indentures, provisions can generally be amended with the consent of a majority of the lenders, but certain provisions require the consent of a greater percentage of lenders, each lender or each affected lender. Furthermore, in a securities financing, if the provisions of the outstanding securities are amended to such a degree that there would be a significant change in the nature or fundamental economics of the investment to the remaining holders, the remaining securities may be deemed a ‘new security’, which would then require that the new securities be registered under the Securities Act or be subject to an exemption from registration. An important aspect of the ‘new security’ analysis is whether adoption of the proposed amendment would require a 100 per cent vote or whether it can be adopted with a majority of consenting bondholders, with the former more likely to be determined to be a new security.
Guarantees and collateral
Related company guarantees
Are there restrictions on the provision of related company guarantees? Are there any limitations on the ability of foreign-registered related companies to provide guarantees?
In general, unsecured affiliate guarantees are limited only by fraudulent conveyance issues (see question 22). If the affiliate at issue is a foreign entity, however, the provision of a guarantee by that entity of the obligations of a US borrower can have serious economic consequences for the borrower. Under the US tax code, subject to certain exceptions, income earned abroad by companies that are organised abroad generally is not taxed by the United States. However, if the assets of such a foreign company provide credit support for obligations of a US affiliate, then the undistributed earnings and profits of the foreign company may be deemed to be repatriated to the United States and may become subject to US taxation as a dividend. Recent proposed Treasury regulations would in many cases provide an exemption from such taxation, but there are several exceptions and limitations under those proposed regulations, and it is not entirely clear that the regulations have binding effect. In the US market, borrowers are typically not expected to take such a risk and guarantees from foreign subsidiaries are not commonly provided. In addition, borrowers often limit pledges of the equity of their direct foreign subsidiaries to 65 per cent of the voting equity (the US tax rules may treat pledges of 66.67 per cent of the voting stock of a foreign company as equivalent to the assets of the foreign company providing credit support). For these purposes, borrowers are likely to be reluctant to rely on the proposed Treasury regulations and offer expanded guarantees and pledges.
To the extent that an affiliate guarantee is secured, there may be some additional costs involved in providing the guarantee. State and local authorities do assess modest state filing fees and filing service charges for the filing of financing statements to perfect a secured guarantee. A few states impose a documentary stamp tax, intangibles tax or other filing tax on financing statements filed in their jurisdictions, although not all types of assets are subject to the tax. Federal taxing authorities generally do not require documentary, filing or other taxes payable in connection with the provision of guarantees or the granting of security, although there are fees charged for perfecting security interests in intellectual property by making filings with the US Patent and Trademark Office or the US Copyright Office.
Several states impose a mortgage recordation tax, intangibles tax, documentary tax or other similar tax on mortgages or deeds of trust filed in their jurisdictions. If such a tax is imposed, it is generally calculated in one of two ways. In some states, the tax is payable on the amount of the indebtedness secured by the mortgage or deed of trust. In these cases, in order to avoid having the borrower unnecessarily pay tax on the entire amount of the loans, the amount of the total indebtedness that is to be secured by the mortgage or deed of trust would be limited to a specified amount (typically the value of the subject property), and the tax is paid on that amount. Alternatively, some states use a formula that takes the ratio of the value of the real estate secured in the taxing state to the value of all of the real estate assets securing the indebtedness (some states use the value of both the real and personal property in this formula), and that ratio is multiplied by the total amount of indebtedness, with the tax being calculated on the resulting number. In some states, it is permissible to use both of these calculation methods and use the one that yields the lowest tax payment. Further, there are costs associated with title insurance insuring the lien of the applicable mortgage or deed of trust if it is required to be obtained pursuant to the terms of the transaction documents. These costs are generally proportionate to the dollar amount of the title insurance policy; however, in several states, title insurance rates are regulated, and in these states the costs tend to be much higher.
Assistance by the target
Are there specific restrictions on the target’s provision of guarantees or collateral or financial assistance in an acquisition of its shares? What steps may be taken to permit such actions?
There are no specific restrictions on a target providing guarantees or collateral in a transaction pursuant to which its shares are acquired. In fact, the provision of these guarantees and collateral is common in US acquisition finance practice. There are, however, general limitations on fraudulent conveyance that should be evaluated in any transaction where upstream guarantees are contemplated to be provided by subsidiaries of the borrower (see question 22).
Types of security
What kinds of security are available? Are floating and fixed charges permitted? Can a blanket lien be granted on all assets of a company? What are the typical exceptions to an all-assets grant?
Collateral that can be used as security falls into two general categories: real property and personal property. Real property (including fixtures constituting real property under applicable law) is governed by the law of the state in which the property is located, and a security interest in real property can be granted pursuant to a mortgage (or similar) agreement and perfected by filing the mortgage (or similar instrument) in the land records where the real property is located. The creation of security interests in most types of personal property is governed by the UCC, a form of which has been enacted in each state. Security interests in the personal property governed by the UCC can be granted pursuant to one omnibus security agreement and perfected (with certain exceptions) by the filing of financing statements describing the collateral in the jurisdiction of organisation of the party granting the security interest. Often, a description of ‘all assets’ or ‘all personal property’ will be sufficient to perfect a security interest in such assets.
A borrower or guarantor can grant a security interest in all of its personal property assets, including future acquired assets (other than commercial tort claims). A security interest in assets that will be acquired in the future does not attach (become legally enforceable) until the borrower actually acquires the assets; but in many cases, no new action will be required on the part of the lenders for the attachment to occur at the time of the acquisition. However, perfection may require additional action for certain assets, such as intellectual property, cash and cash equivalents and certain equity interests. In the case of real property, the security interest is typically granted on a specific parcel of property and in order to encumber additional real property, a new mortgage (or similar) agreement or an amendment to an existing mortgage (or similar agreement) would be needed. However, any improvements subsequently made on real property covered by a mortgage will become subject to the lien of that mortgage without the requirement that a new or amended mortgage be filed.
The terminology used for security interests in the United States is different from that used in certain other jurisdictions. The terms ‘fixed charge’ (where the parties agree to let the charged assets stand permanently as security for the discharge of the obligations) and ‘floating charge’ (where the parties agree that the grantor has freedom to use its charged assets unless and until the secured party is allowed to dispose of the assets, in priority to other creditors) are not commonly used in the United States, but security arrangements in the United States (with the exception, in certain circumstances, of cash and cash equivalents) are generally more akin to a floating charge.
Typical exceptions to an all-assets collateral package include, among others:
- assets for which the granting of a security interest would be void or illegal under any applicable law;
- voting equity interests of a foreign subsidiary in excess of 65 per cent (owing to tax implications discussed in question 14);
- leasehold real property (depending on the business of the borrower and the nature of the leasehold interest);
- immaterial fee-owned real property;
- equity interests in an entity that cannot be pledged without the consent of one or more third-party equity holders thereof;
- equity interests of immaterial subsidiaries; and
- assets, the pledge of which would require governmental or certain other third-party consents.
Requirements for perfecting a security interest
Are there specific bodies of law governing the perfection of certain types of collateral? What kinds of notification or other steps must be taken to perfect a security interest against collateral?
As with the creation of the security interest, the perfection of a security interest in most types of personal property is governed by the relevant state’s UCC. However, the perfection of certain types of assets are governed by other state laws (eg, vehicles), or federal laws (eg, aircraft, railroads, ships and intellectual property), which provide for a specialised filing or registration system. Perfection occurs through the filing of UCC financing statements with the relevant state office, intellectual property security agreements with the relevant federal office (either the US Patent and Trademark Office or the US Copyright Office), the execution of control agreements (with respect to cash and cash equivalents held in a depositary bank, or in certain circumstances, with a securities intermediary), the possession or delivery of certain personal property, the recording of mortgages with the relevant state office, and other filings or actions in the case of other special category assets such as those discussed above. The Hague Securities Convention, an international treaty that became effective in the United States on 1 April 2017, provides choice-of-law rules that pre-empt the choice-of-law rules in the UCC relating to perfection and priority of securities held with an intermediary. In most cases, application of these new rules will result in the same choice-of-law as under the UCC, but secured transactions involving such collateral must be carefully reviewed to ensure compliance with the Hague Securities Convention’s choice-of-law rules.
Renewing a security interest
Once a security interest is perfected, are there renewal procedures to keep the lien valid and recorded?
Yes. Depending on the nature of the asset subject to the security interests. Continuation statements for UCC financing statements covering most types of collateral generally need to be filed every five years (there are certain types of financing statements covering special types of collateral, such as transmitting utilities, manufactured homes, and cooperative interests, that have an extended or no expiry date). In addition, changes in the granting entity’s name or jurisdiction of organisation will require amendments to (or new) financing statements. Renewal requirements for recorded mortgages over real property are state-specific, and, in certain jurisdictions, mortgages will eventually expire if not renewed. There are no renewal requirements for control agreements over deposit and securities accounts or for filings with the US Patent and Trademark Office or the US Copyright Office. Finally, collateral perfected by possession remains perfected while it is in the possession of the secured party.
Stakeholder consent for guarantees
Are there ‘works council’ or other similar consents required to approve the provision of guarantees or security by a company?
No. There is no concept of a ‘works council’ or analogous body in the United States.
Granting collateral through an agent
Can security be granted to an agent for the benefit of all lenders or must collateral be granted to lenders individually and then amendments executed upon any assignment?
Yes. A collateral agent is typically granted the security interests for the benefit of all lenders, whether or not the initial lenders transfer or sell their interests to others. Typically, the trustee also acts as a collateral agent in the case of securities issuances and the administrative agent acts as a collateral agent in the case of bank loans. If there is shared collateral between groups of lenders with the same lien priority there may be an independent collateral agent appointed to hold the security on behalf of all lenders.
Creditor protection before collateral release
What protection is typically afforded to creditors before collateral can be released? Are there ways to structure around such protection?
The circumstances under which collateral may be released are specified in the credit agreement or indenture and collateral documents, as applicable. To the extent that the relevant provision does not permit the automatic release of collateral, the consent of the lenders or holders will be required to release the collateral. The threshold for the release of collateral varies and is a negotiated provision.
If the indenture under which the securities are issued is qualified under the TIA (see question 11) or imports provisions of the TIA, in order to release collateral, the trustee must receive a certificate or opinion from an engineer, appraiser or other expert as to the collateral’s fair value and stating that the proposed release ‘will not impair the security under the indenture in contravention of its provisions’. The expert must be independent if the fair value of the collateral to be released and of all other collateral released in that calendar year is 10 per cent or more of the principal amount of the collateralised securities then outstanding, unless the fair value of the collateral to be released is less than US$25,000 or less than 1 per cent of the principal amount of the collateralised securities then outstanding.
There are several SEC no-action letters providing some relief from these requirements, including exceptions for certain ordinary course dispositions and if the release of the security is dictated by a party other than the trustee or the security holders (eg, if the securities have a second-priority lien and the first-lien holders control decisions on collateral releases). An issuer relying upon the ordinary course of business exemption must deliver to the trustee a semi-annual certificate that collateral dispositions in the prior six-month period were in the ordinary course of business and that all the proceeds were used as permitted by the indenture.
Describe the fraudulent transfer laws in your jurisdiction.
Under US federal bankruptcy law and comparable provisions of state fraudulent transfer or conveyance laws, which may vary from state to state, the incurrence of debt, the guarantee thereof or the grant of a security interest in collateral in connection therewith could be avoided as a fraudulent transfer or conveyance if the borrower or guarantor:
- incurred the debt or guarantees with the intent of hindering, delaying or defrauding creditors; or
- received less than reasonably equivalent value or fair consideration in return thereof and, in the case of (ii) only, one of the following is also true at the time thereof:
- the borrower or any guarantor was insolvent or rendered insolvent by reason of the incurrence of the debt or the guarantee;
- the incurrence of the debt or the guarantee left the borrower or the guarantor with an unreasonably small amount of capital or assets to carry on the business;
- the borrower or guarantor intended to, or believed that it would, incur debts beyond its ability to pay as they mature; or
- the borrower or guarantor was a defendant in an action for money damages or had a judgment for money damages docketed against it if, in either case, the judgment is unsatisfied after final judgment.
If a court were to find that the incurrence of the debt or guarantee or the grant of security was a fraudulent transfer or conveyance, the court could avoid the payment obligations under the debt or guarantee, avoid the grant of collateral, subordinate the debt or guarantee to the presently existing and future indebtedness of the borrower or the guarantor, or require the lenders to repay any amounts received with respect to that debt or guarantee.
Under the Bankruptcy Code, the look-back period for fraudulent conveyances is two years. The Bankruptcy Code also incorporates, by reference, the fraudulent conveyance law of any applicable state jurisdiction. Each state has a similar (although not identical) fraudulent conveyance course of action, with look-back periods ranging from three to six years.
Debt commitment letters and acquisition agreements
Types of documentation
What documentation is typically used in your jurisdiction for acquisition financing? Are short-form or long-form debt commitment letters used and when is full documentation required?
At the time of signing of the acquisition agreement, the potential purchaser will typically have executed a set of ‘commitment papers’ with its financing parties. The commitment papers will usually consist of:
- a commitment letter;
- a term sheet;
- a fee letter; and
- to the extent that a capital markets transaction is contemplated as part of the acquisition financing, an engagement letter and often a fee credit letter.
The principal final documentation will typically consist of:
- in the case of a bank financing, a credit agreement, a guarantee and security agreement;
- in the case of a securities financing, an indenture, notes evidencing the securities, a guarantee (if not included in the indenture) and, if secured, a security agreement; and
- where applicable, an intercreditor agreement and other security-related documents.
Full documentation is not required upon signing of the acquisition agreement and is generally not required until the closing of the acquisition. In certain cases, loan documentation may be executed prior to closing, either to be effective upon closing or to fund into escrow prior to closing, but it is far more common to sign and close on the same day (the date of the closing of the acquisition). In the case of securities financings, a purchaser may choose to consummate an offering prior to closing the acquisition and fund into escrow in order to take advantage of favourable market conditions.
Level of commitment
What levels of commitment are given by parties in debt commitment letters and acquisition agreements in your jurisdiction? Fully underwritten, best efforts or other types of commitments?
It is rare to see anything other than fully underwritten commitments in connection with acquisition financings for purchasers requiring debt financing to complete the acquisition, because sellers have become much more active in the financing process and thoroughly examine and evaluate the quality of a potential purchaser’s financing package. Sellers look for certainty in the financing and anything less than a fully underwritten commitment will negatively affect a purchaser’s overall bid in a competitive process.
Conditions precedent for funding
What are the typical conditions precedent to funding contained in the commitment letter in your jurisdiction?
The conditions precedent to funding are some of the most important and negotiated provisions in commitment papers for an acquisition financing and there can be considerable variation in terms across different deals.
Some of the more typical conditions include:
- no business material adverse change;
- receipt of a minimum equity contribution;
- consummation of the acquisition pursuant to the terms of the acquisition agreement;
- no materially adverse modifications or consents to the acquisition agreement;
- receipt of historical audited and unaudited financial statements and of pro forma financial statements;
- completion of a marketing period;
- perfection of security interests;
- delivery of a customary offering document suitable for marketing any securities component of the financing;
- execution and delivery of documentation;
- payment of fees;
- receipt of information required by the US Patriot Act and other know-your-customer and anti-money laundering rules and regulations; and
- accuracy of certain representations made by the target in the acquisition agreement and other basic corporate and legal representations made by the borrower in the credit agreement.
Are flex provisions used in commitment letters in your jurisdiction? Which provisions are usually subject to such flex?
Flex provisions are typically included in any set of acquisition financing commitment papers. Flex provisions permit the lenders to change certain negotiated terms in the term sheet to the extent necessary to ensure a ‘successful syndication’ (which term is negotiated and defined in the commitment papers) or if a successful syndication cannot be achieved. Similar to conditions precedent, market flex is one of the most important and highly negotiated provisions of commitment papers and, consequently, there is significant variation in terms (though the provision most commonly subject to the flex provisions is the pricing of the debt).
Are securities demands a key feature in acquisition financing in your jurisdiction? Give details of the notable features of securities demands in your jurisdiction.
Yes. In the US market, the arrangers of any bridge financing typically have the right to force the borrower to issue permanent debt securities or, in limited cases, equity securities in lieu of funding all or a portion of the bridge facility at closing or to refinance all or a portion of the bridge facility after closing. The most common formulations of a securities demand will permit the issuance of such a demand at any time during the period commencing a few days prior to closing, provided that no securities are required to be issued before the closing date (however, requiring funding into escrow prior to closing is sometimes negotiated in situations where the commitment period may be longer than typical due to regulatory or other deal-specific circumstances), and ending on the first anniversary of the closing date.
There will typically be certain negotiated parameters with respect to the demands and the details of the issued securities including, among others:
- maximum number of demands;
- minimum issuance amount for each demand;
- maximum weighted average yield for all securities and often a maximum effective yield for any one tranche of securities;
- minimum tenor and maximum call protection for the securities; and
- form of offering of the securities (ie, SEC registered or private) and type of securities (eg, secured or guaranteed).
Key terms for lenders
What are the key elements in the acquisition agreement that are relevant to the lenders in your jurisdiction? What liability protections are typically afforded to lenders in the acquisition agreement?
The provisions in an acquisition agreement that are most relevant to lenders include:
- the definition of ‘material adverse effect’ or comparable term with respect to the target;
- the buyer’s representation that it has obtained requisite financing;
- the buyer’s covenant to obtain financing in accordance with the commitment papers;
- the seller’s covenant to cooperate with the buyer to obtain financing in accordance with the commitment papers;
- any provisions relating to a financing condition or the payment of break-up fees; and
- any provisions relating to the liability of lenders.
In addition, there may be several general representations and covenants that are relevant to the lenders either from a diligence perspective or from a practical perspective.
As a result of litigation that arose with respect to failed financings during the financial crisis, lenders generally insist on including language in acquisition agreements that:
- gives lenders the benefit of any cap on termination damages negotiated by the purchaser or otherwise limit their liability;
- designates New York as the exclusive jurisdiction for any actions against the lenders related to financing for an acquisition;
- requires buyer and seller to waive any right to a jury trial; and
- because lenders are not parties to the acquisition agreement, stipulates that lenders are third-party beneficiaries of each of the foregoing provisions.
Public filing of commitment papers
Are commitment letters and acquisition agreements publicly filed in your jurisdiction? At what point in the process are the commitment papers made public?
Issuers that are subject to the reporting obligations of the Exchange Act will typically file commitment letters and acquisition agreements for a transaction that an issuer believes is material. As a result, acquisition agreements for a ‘material’ transaction may be filed by either the buyer or seller and commitment papers may be filed by the buyer. Because it is possible that commitment letters would be publicly filed with the SEC, lenders are careful to keep sensitive pricing or interest rate details out of the commitment letter. The pricing or interest rate details are usually in a separate fee letter that an issuer may deem is not material and thus not required to be filed with the SEC.
Entering into a commitment letter for a material transaction is typically described in an 8-K filing shortly after entering into such agreement, but the commitment letter is not typically filed with the SEC until the issuer files its periodic report (either form 10-K or form 10-Q) for the applicable period in which the commitment letter was signed. An acquisition agreement that is deemed material is typically filed after entering into such agreement.
Enforcement of claims and insolvency
Restrictions on lenders’ enforcement
What restrictions are there on the ability of lenders to enforce against collateral?
Upon the filing of a petition for bankruptcy reorganisation (a Chapter 11 petition) or liquidation (a Chapter 7 petition) under title 11 of the United States Code (the Bankruptcy Code), an automatic stay arises that prohibits all collection and enforcement efforts, subject to certain exceptions for the right to close out most securities and financial contracts, criminal proceedings and the exercise of police and regulatory powers. Generally, all interest accruals stop as of the petition date, unless the secured creditor is oversecured or the debtor is solvent. Covenants are not enforceable once a petition is filed. Under certain circumstances, a secured creditor may be able to obtain relief from the automatic stay to enforce remedies against collateral.
Does your jurisdiction allow for debtor-in-possession (DIP) financing?
The Bankruptcy Code allows for a DIP (ie, the bankrupt entity) to obtain post-petition financing on either an unsecured or secured basis, subject in each case to bankruptcy court approval. If the DIP financing primes pre-petition liens on collateral, a debtor needs to either obtain the consent of the pre-petition secured creditor or, without such consent, prove that such pre-petition secured creditor has adequate protection in the applicable collateral. Priming pre-petition secured creditors without their consent is atypical in a Chapter 11 case.
Stays and adequate protection against creditors
During an insolvency proceeding is there a general stay enforceable against creditors? Is there a concept of adequate protection for existing lien holders who become subject to superior claims?
Upon the filing of a petition for bankruptcy under the Bankruptcy Code, an automatic stay arises that prohibits all collection and enforcement efforts, subject to certain exceptions (see question 30). For a debtor to use the cash collateral of secured creditors or pre-petition collateral, the debtor, subject to bankruptcy court approval, must provide such pre-petition secured creditors with adequate protection, which can include periodic cash payments, additional or replacement liens, super-priority administrative expense claims for any diminution in value of the collateral and information rights.
In the course of an insolvency, describe preference periods or other reasons for which a court or other authority could claw back previous payments to lenders? What are the rules for such clawbacks and what period is covered?
The Bankruptcy Code provides for the avoidance of certain transactions. Generally, a transaction may be preferential and therefore avoided if it:
- was a transfer of an interest of the debtor in property;
- was made to or for the benefit of a creditor;
- was for or on account of an antecedent debt owed before such transfer was made;
- was made while the debtor was insolvent;
- was made in the 90 days prior to the filing of the bankruptcy petition (or within one year prior to the petition date in the case of payments made to a lender that is a statutory insider); and
- enabled a creditor to receive more than such creditor would have received under a Chapter 7 liquidation.
If a secured creditor has received a transfer of collateral on account of its secured claim, such a transfer should not be capable of being characterised as a preference because a secured creditor can look to its collateral for payment in a Chapter 7 liquidation, which means that prong (vi) of the preference test cannot be satisfied. There are also various defences to preference claims, including an ordinary course and new value defence.
The Bankruptcy Code also provides for the avoidance of transfers or the incurrence of debt that are deemed to be fraudulent conveyances or transfers (see question 22).
Post-petition transfers made out of the ordinary course of business or without the approval of the bankruptcy court may also be avoided.
Ranking of creditors and voting on reorganisation
In an insolvency, are creditors ranked? What votes are required to approve a plan of reorganisation?
Unless a secured creditor consents to different treatment, secured creditors are entitled to look to their collateral for payment. Thereafter, the Bankruptcy Code provides for a ‘waterfall’ or ranking for the payment of claims whereby generally the highest-ranking claim is an administrative expense, which is an actual, necessary cost and expense of preserving the estate. These expenses generally include post-petition funded debt, wages and salaries, ordinary course of trade payables and taxes, and also include the value of goods received by the debtor within 20 days before the commencement of the case in which the goods have been sold to the debtor in the ordinary course of business. The next ranking claim is a ‘priority claim’, which generally includes pre-petition wages and salaries (up to certain limits) and taxes. Ranked next is pre-petition general unsecured debt, which includes trade debt, unsecured funded debt and pre-petition litigation liability. Thereafter, there are contractually or statutorily subordinated debt claims and then equity interests.
For a plan of reorganisation to be approved, each class of creditors must vote in favour of the plan by 66.67 per cent in amount and 50 per cent in the number of claims and each class of interest holders must vote in favour of the plan by 66.67 per cent in amount of interest. If there is at least one impaired accepting class (ie, a class that is having its legal, equitable or contractual rights against the debtor altered), the debtor can seek to confirm the plan over the objection of any rejecting class of creditors or interest holders, which is known as a ‘cram down’.
Intercreditor agreements on liens
Will courts recognise contractual agreements between creditors providing for lien subordination or otherwise addressing lien priorities?
Generally, bankruptcy courts will enforce the contractual subordination agreements between creditors. In certain circumstances, bankruptcy courts, as courts of equity, may not enforce certain provisions limiting the rights of junior creditors (eg, a junior creditor’s desire to be heard or to vote in the bankruptcy process).
Discounted securities in insolvencies
How is the claim of an original issue discount (OID) or discount debt instrument treated in an insolvency proceeding in your jurisdiction?
Generally, claims for unmatured interest are not allowed under the Bankruptcy Code. Bankruptcy courts generally have determined that OID, which is unamortised as of the bankruptcy filing, constitutes unmatured interest.
Liability of secured creditors after enforcement
Discuss potential liabilities for a secured creditor that enforces against collateral.
A secured creditor that forecloses on collateral outside of the bankruptcy process generally takes the collateral subject to any other potential liabilities against which the collateral is subject.
If a secured creditor violates the automatic stay applicable in bankruptcy proceedings, the secured creditor can be found civilly or criminally liable.
In a Chapter 11 reorganisation, a plan of reorganisation generally will discharge pre-petition liabilities (other than those unimpaired under or reinstated pursuant to the plan of reorganisation). In limited circumstances certain liabilities, such as environmental liabilities, may remain attached to the collateral. In a liquidation, a discharge is generally not available.