Introduction

Pursuant to the Commodity Exchange Act (the “CEA”), as modified by Title VII of the Dodd-Frank Act and interpreted by the Commodity Futures Trading Commission (“CFTC”), it is “unlawful” for any person other than an “eligible contract participant” (“ECP”) to enter into most swaps, including any over-the-counter interest rate derivative, such as a fixed-for-floating swap or cap (“Swap”). This prohibition applies not just to counterparties to a Swap (“Counterparties”), but also to all guarantors (“Guarantors”) of the obligators under such Swap (the “Swap Obligations”). Any lender (a “Lender”), or agent for a group of Lenders (an “Agent”), that is party to a Swap must verify that each Counterparty and each Guarantor (each a “Swap Obligor”) of the Swap Obligations is an ECP.

Timing of Verification

A lender should verify the ECP status of each Swap Obligor at the time that:

  1. The swap is entered into by the parties;
  2. The swap is amended; and
  3. A new Swap Obligor is added to Swap or Credit Documents (as hereinafter defined).

Verification of ECP status should not be controversial for most borrowers, though during the short term, as transition to rules addressing ECPs occurs, some customers may be concerned about provisions in other existing agreements which may require related existing agreements and related Swap and Credit Documents to contain identical sets of obligors. In addition, the inability to have Swap Obligations guaranteed by certain parties could, in certain instances, change a credit profile of an obligated group and lenders should be aware of those possible incremental risks.

Limits of Verification

Verification will often be achievable by conducting diligence, but, if an Agent or Lender expects that there will be additional Swaps or Guarantors over the term of a transaction, diligence is not always going to be sufficient and the addition of certain protective contract provisions will be needed to assure that the Swaps and the related guarantees are enforceable. Diligence is typically easiest in smaller single bank deals where a Lender will have more control through tighter covenants and where the structure and credit needs of the borrower are typically less complicated. Syndicated transactions, however, often make verification difficult with the ability of some customers to regularly enter into Swaps with any number of Lenders, and to add additional Swap Obligors without the need for consent of any Lenders or Agents.

Compliance for Single Bank Deals

Notwithstanding their relative simplicity, single bank deals sometimes have all encompassing definitions of “Obligations” intending to cover all obligations of any kind to a Lender, even when they don’t include specific inclusions of Swap obligations as part of the “Guaranteed Obligations” and/or “Secured Obligations”. Compliance with the ECP rules should include the following steps, depending upon the triggering event.

A. New or amended Swap

Where a Lender is to amend or enter into new a Swap and/or related documents (“Swap Documents”), the Lender’s ECP compliance steps should include the following:

  1. Confirm the ECP status of each Counterparty at the time a Swap is amended or entered into;
  2. Confirm whether each Counterparty is or will be a borrower, guarantor, surety or applicant on any loan, letter of credit, equipment lease or other obligation to the lender (each a “Credit”) and identify any documents describing obligations covered thereby (“Credit Documents”);
  3. Confirm whether the Swap Obligations are included as direct, guaranteed or secured obligations of any coborrower, guarantor or pledgor (each an “Obligor”) under the Swap Documents themselves or with respect to any Credit Documents through review of Swap Documents and Credit Documents, including main loan agreements, any guaranty and each collateral document delivered to determine if Swap Obligations are covered and, if so, which entities are Swap Obligors with respect to the Swap Obligations;
  4. Determine if each Swap Obligor is an ECP;
  5. If any Swap Obligor is not an ECP (or cannot be verified to be an ECP), verify that terms excluded non-ECP Obligors (“Exclusionary Terms”) and/or terms conferring ECP status on non-ECP Obligors (“Keepwell Terms”) from Obligors that meet the CEA keepwell requirements (each a “Keepwell Obligor”) are in the existing Swap Documents and/or Credit Documents already or are added (ISDA Exclusionary Terms and Keepwell Terms can be added to Swap Documents and/or LSTA Exclusionary Terms and Keepwell Terms can be added to Credit Documents);
  6. Add additional representations as to ECP status and/or covenants as to maintenance of ECP status and/or notice of failure to maintain ECP status and may be agreed; and 
  7. Verify that any existing Keepwell Obligor provider currently qualifies for such status.

B. New Obligors under Swap Documents

Where a Lender or customer seeks to add new Obligors under existing Swap Documents, the Lender’s ECP compliance steps should include the following:

  1. Verify that each Swap Obligor is an ECP;
  2. If any Swap Obligor is not an ECP (or cannot be verified to be an ECP), verify that Exclusionary Terms and/or Keepwell Terms are in the existing Swap Documents already or are added;
  3. Add representations as to ECP status and/or covenants as to maintenance of ECP status and/or notice of failure to maintain ECP status; and
  4. Verify that any Keepwell provider currently qualifies for such status.

C. New Obligors under Credit Documents

Where a Lender or a customer seeks to add new Obligors under existing Credit Documents, the Lender’s ECP compliance steps should include the following:

  1. Determine whether any such Obligors will be Swap Obligors under the related Credit Documents;
  2. Verify that any such Swap Obligor is an ECP;
  3. If any Swap Obligor is not an ECP (or cannot be verified to be an ECP), verify that Exclusionary Terms and/or Keepwell Terms are in the existing Credit Documents already or are added;
  4. Add representations as to ECP status and/or covenants as to maintenance of ECP status and/or notice of failure to maintain ECP status; and
  5. Verify that any Keepwell provider currently qualifies for such status.

Compliance for Syndicated Deals

General Concerns

Unlike single bank deals, syndicated deals have specifically identified “Obligations” that typically will be limited to the credit extensions made under the Credit Documents and related obligations thereunder, and also, in secured transactions, in addition to these Obligations a broader category of “Secured Obligations” often picks up obligations under non-speculative Swap Documents with Lenders and to cash management obligations provided by Lenders. In these transactions it is possible that the Agent and/or the other Lenders will not have control over certain matters that require compliance under the ECP rules, including: (a) when an Obligor amends or enters into a Swap with a Lender that will be treated as a “Secured Obligation”; (b) when an existing Obligor will guaranty or grant security for Swap Obligations; and (c) when an additional Obligor will be added (i.e. as a co-borrower or guarantor), causing such Obligor to become a Swap Obligor for Swap Obligations (which, in some instances may be at the sole discretion of the existing borrower(s) who may be entitled to create or acquire subsidiaries and/or add other Obligors).

A. New Syndicated Deals (as Agent or Lender)

Whether acting as Agent under or joining as a Lender to a new syndicated deal which includes Swap Obligations as part of “Guaranteed Obligations” or “Secured Obligations”, because it is difficult for each ECP requirement to be fully addressed going forward, it is recommended that the Exclusionary Terms and Keepwell Terms promulgated by the LSTA each be added to such syndicated facility.

B. Existing Syndicated Deals (as Agent)

While it may be impractical to insist that Obligors amend existing Credit Documents immediately, when amending an existing syndicated facility which includes Swap Obligations as part of Guaranteed Obligations or Secured Obligations, it is recommended that the LSTA Exclusionary Terms and Keepwell Terms each be added to such facility as part of the amendments otherwise being entered into.

C. Existing Syndicated Deals (as Lender)

As a non-agent Lender in an existing syndicated facility which includes Swap Obligations as part of Guaranteed Obligations or Secured Obligations, there will generally not be an ability to direct amendments to the Credit Documents, but if amendments are being proposed it is recommended that an inquiry be made to the agent about including LSTA Exclusionary Terms and Keepwell Terms to such facility as part of the amendments otherwise being entered into.

Language Changes

While revisions to documents addressing ECP compliance are still evolving and will likely continue to evolve for a while, two proposals, one from ISDA and one from the LSTA, have already started to serve as a basis for revisions being made by many Agents and Lenders.

A. Changes to Swap Documents (ISDA Provisions)

The recently proposed ISDA language is set up in standard ISDA format to be incorporated by reference in any agreement, amendment or other writing (such as the trade confirmation of the swap or, alternately, in the schedule to the master agreement) and includes both Exclusionary Terms and Keepwell Terms.

The ISDA Exclusionary Terms are designed to remove non-ECP entities as Guarantors of Swap Obligations, but are not intended to affect pledges of collateral from non-ECP entities that are not Guarantors. In addition, the ISDA provisions treat any entity as an ECP if it has made a written representation to the effect that it is qualified as an ECP on the “Eligibility Date” (as defined in the ISDA Exclusionary Terms) in question (such a representation would need to be added separately). These provisions do not address instances where joint swap counterparties exists as co-obligors and not providers of a guaranty.

The ISDA Keepwell Terms are designed to identify specific “Qualified Keepwell Providers” (or if none are specified, to treat all qualified Guarantors as such). These Qualified Keepwell Providers lend their ECP status to Guarantors of the Swap Obligations in question (but not to the actual counterparties) by agreeing to provide funds necessary to support the Guarantor’s obligations with respect to the related Swap Obligations (subject to fraudulent transfer limits).

B. Changes to Credit Documents (LSTA Provisions)

The recently proposed LSTA language is set up as additional definitions and provisions to add into Credit Documents and also includes both Exclusionary Terms and Keepwell Terms.

The LSTA Exclusionary Terms are designed to exclude Swap Obligations with respect to the Obligations supported by any guaranty or pledge of collateral made from non-ECP entities (whether or not a Guarantor), to the extent such guaranty or pledge would not be permitted to secure the applicable Swap Obligations under the ECP rules. They also clarify that not all Swap Obligations arising under a “Master Agreement” (as defined in the LSTA Exclusionary Terms) are automatically excluded merely because some Swap Obligations must be excluded. Adding the LSTA’s “Excluded Swap Obligation” definition will also require changes to any “Guaranteed Obligation” or “Secured Obligation” definitions which appear in any of Credit Documents (i.e. in any guaranty or security document).

The LSTA Keepwell Terms are designed to automatically treat as “Qualified ECP Guarantors” all Obligors in the transaction that otherwise qualify as in such capacity as being able to “share” their ECP status as a Keepwell Obligor.

These Qualified ECP Guarantors lend their ECP status to any Guarantor of the Swap Obligations in question (but not to the actual counterparties) by agreeing to provide funds necessary to support the Guarantor’s obligations with respect to the related Swap Obligations (subject to fraudulent transfer limits). These keepwell definitions and provisions are intended to be added to the applicable guaranty and/or collateral security documents.

In addition to the above changes, there has been discussion about the need to adjust waterfall provisions in Credit Documents to account for the need to apply certain funds in a non-pro-rata manner (i.e. where Swap Obligations are not the last payment in a waterfall). One mechanism being used is a “Collateral Allocation Mechanism” which provides for the sharing among Lenders of proceeds of guaranty payments and/or collateral in order to achieve a pro rata distribution among obligations under Swap Documents and Credit Documents. While such a mechanism would be dependent upon the agreement of the various parties, one method used is to add language similar to the following to the end of a waterfall provision: “Excluded Swap Obligations with respect to any Guarantor shall not be paid with amounts received from such Guarantor, but appropriate adjustments shall be made with respect to payments from other Obligors to preserve the allocation to Obligations otherwise set forth above in this Section.”