With the economy in tatters and an everincreasing number of questionably solvent banks, the prospect of a bank failure in your syndicate increases.
Because we are facing the first bank crisis since Congress added the automatic stay to the Federal Deposit Insurance Act (“FDIA”) in October 2006, lenders have little guidance as to how to address the potential impact of a Federal Deposit Insurance Corporation (“FDIC”) receivership of one or more members of its lending group. In particular, lenders are unsure of how an FDIC receivership would affect the rights and remedies of nondefaulting lenders under loan documents.
Given this uncertainty, the time for lenders to act is now.
Lenders should take a close look at their loan documents to ensure that the defaulting lender provisions addressing loan fundings, payments, voting and the like, are applicable to insolvent lenders. In addition, lending syndicates should consider various options for pre-insolvency termination of a troubled lender to avoid the impact of the FDIA automatic stay.
Once an automatic stay goes into effect, nondefaulting lenders will be unable to amend the documents in instances in which such an amendment would affect the contractual rights of an insolvent lender, or the insolvent lender’s vote is required to pass the amendment.
FDIA Automatic Stay
Congress added the automatic stay to the FDIA for the first time in 2006. Specifically, Section 11(e)(13)(C)(i) now provides:
[N]o person may exercise any right or power to terminate, accelerate, or declare a default under any contract to which [a depository institution in conservatorship or receivership] is a party, or to obtain possession of or exercise control over any property of the institution or affect any contractual rights of the institution, without the consent of the conservator or receiver, as appropriate, during the 45-day period beginning on the date of the appointment of the conservator, or during the 90-day period beginning on the date of the appointment of the receiver, as applicable.
A lending syndicate may make meaningful revisions to its loan documents affecting an insolvent lender’s relationship with the administrative agent (the “Agent”) and the non-defaulting lenders in the context of funding loans and applying payments.
Most loan documents already provide that if a lender fails to fund its share of a requested advance, such lender is considered a “Defaulting Lender.” However, to provide certainty as to which lenders are required to fund in the event of a lender takeover by the FDIC, the definition of a “Defaulting Lender” should be expanded to include lender insolvency and instances in which a lender is placed under FDIC receivership or conservatorship.
Special attention should be paid to loans that provide for swingline advances and letters of credit. Since swingline loans and letters of credit are funded by the swingline lender and the letter-of-credit issuer (the “Issuer”) on behalf of the lenders, and later reimbursed by the lenders, both the swingline lender and the Issuer will want to limit their funding exposure to the Defaulting Lender.
The loan agreement should state that the swingline lender is not obligated to fund the Defaulting Lender’s portion of any swingline loan. Furthermore, nondefaulting lenders should be required to reimburse the swingline lender based on the nondefaulting lender’s share of the requested amount, rather than the funded amount (which already has been reduced by the Defaulting Lender’s share), so the swingline lender is reimbursed in full.
The Issuer should not be required to issue the Defaulting Lender’s portion of any requested letter of credit unless the borrower posts cash collateral for the Defaulting Lender’s portion. If there is a drawing under the letter of credit, the Agent can apply the cash collateral to the Defaulting Lender’s share and seek reimbursement from the nondefaulting lenders, based on their share of the issued letter of credit.
Lenders should check the definitions that govern the allocation of interest and principal payments to the lenders so that a Defaulting Lender isn’t entitled to receive interest and principal relating to advances it did not make. A lender’s share of a requested advance should be calculated based on the percentage a lender’s commitment bears to the aggregate commitment of all lenders (frequently called, the “Pro Rata Share”).
On the other hand, a lender’s share of the principal and interest payments received from the borrower should be calculated based on the percentage such lender’s loans bears to the aggregate loans funded by all lenders (the “Percent Outstandings”).
The loan document should provide that interest payments received by Agent will be apportioned to each lender based on its Percent Outstandings and not its Pro Rata Share. The loan document should further provide that principal payments received by the Agent will not be paid to a Defaulting Lender until the nondefaulting lenders have been reimbursed for advances such that the Percent Outstandings of all lenders, including the Defaulting Lender, is equal to their Pro Rata Share.
Lender Action During Stay
The automatic stay restricts the nondefaulting lenders from taking action to “affect any contractual rights of” the Insolvent Lender. Although there is scant precedent as to how the FDIC will exercise this new power, we know from other bank receiverships that the FDIC has taken a broad view of its power under the FDIA.32
The FDIC likely would consider prohibitions on voting by an Insolvent Lender to be in contravention of the automatic stay. Similarly, the agency likely would view provisions that provide a threshold for lender consent during the automatic stay that does not include the Insolvent Lender as an unallowable restriction that prevents the Insolvent Lender from enforcing its contractual rights during the automatic stay period.
So how can nondefaulting lenders continue business as usual under the loan documents without violating the automatic stay? One approach would be to make changes to the documents that otherwise would not require the consent of the Insolvent Lender. Amendments that only require the consent of requisite lenders, as opposed to all lenders, should be valid so long as they have enough support without the Insolvent Lender’s vote.
Another approach is to move away from taking action against the Insolvent Lender based upon the insolvency or the lender’s resultant inability to fund, to the extent applicable, and instead focus on events prior to the take-over by the FDIC. These could include a ratings downgrade, placement on the FDIC’s watch list, or stock price volatility, all of which indicate the lender is headed for trouble.
This approach represents a significant shift in the treatment of troubled lenders. Yet obtaining a prior agreement from a lender to transfer or suspend its voting rights based upon the occurrence of certain “bad” events would create a plausible argument that actions taken by the other lenders pursuant to loan document provisions, and prior to insolvency, do not violate the automatic stay.
The lending syndicate also should focus on preserving the ability to take action if the FDIC becomes receiver of the Agent. Without such precautions, the operation of the automatic stay would render the loan documents unworkable in such an event.
Similar to the discussion concerning voting rights, the most obvious solution to the dilemma of an insolvent Agent is to act before the Agent is declared insolvent. The syndicate should identify early warning signs of an impending insolvency as triggers for removing the rights the lenders seek to preserve during the automatic stay. The loan documents could provide for termination of the Agent upon events similar to those set forth above for the voting rights .
Upon termination, the Agent automatically would assign its rights and duties to a successor Agent to be selected by the nondefaulting lenders. Collateral such as bank accounts held in the name of the Agent would be moved prior to the receivership. A power of attorney in favor of the lender group could permit any one of the nondefaulting lenders to act as successor Agent and move the accounts.
It is difficult to predict the impact the new FDIA automatic stay will have on lending syndicates. There are exceptions to the automatic stay, one of which is that the provision does not allow the FDIC as conservator or receiver to fail to comply with otherwise enforceable contractual provisions. The legislation, nonetheless, could be interpreted to prohibit lenders from taking certain actions to implement contractual provisions.
It appears likely that funding obligations in revolving facilities will be impacted in ways that may be detrimental to credit facility co-lenders and Agents. The potential impact can be mitigated, however, by proactively reviewing and amending loan documents. Lenders and Agents should review provisions addressing the definition of a defaulting lender, funding mechanics, payment mechanics and voting to ensure as much flexibility as possible should one of the lenders become an Insolvent Lender.