In continuing with its efforts to promote greater liquidity and certainty in the US secondary loan trading market, on April 24, 2014, The Loan Syndications and Trading Association, Inc. (the "LSTA") ofﬁcially released revised forms of its suite of secondary market loan trading documentation, including the Participation Agreement for Par/Near Par Trades (along with the LSTA Standard Terms and Conditions for Participations for Par/Near Par Trades, the “PPA”) and the Participation Agreement for Distressed Trades (along with the LSTA Standard Terms and Conditions for Participations for Distressed Trades, the “DPA”, and together with the PPA, the “Participation Agreements”), which revised forms are effective for LSTA trades entered into on or after that date.
The bulk of the revisions are technical, and include updating the Participation Agreements to conform with recent amendments to related LSTA form agreements, such as the Purchase and Sale Agreement for Distressed Trades and the Collateral Annex for Participations.1 We brieﬂy summarize below the more substantive changes to these LSTA secondary market loan trading forms: (1) the addition to each document of provisions addressing the Foreign Account Tax Compliance Act (“FATCA”) and (2) modiﬁcations to the Participation Agreements to clarify “true sale” treatment for participations and the impact of a grantor’s insolvency or bankruptcy on a participant’s right to elevate its participation to a lender of record position.2
FATCA was enacted in March 2010 to combat offshore tax evasion by US taxpayers through a new reporting and withholding regime and, when effective, will impact both the primary and secondary loan markets. FATCA requires a foreign ﬁnancial institution (“FFI”) to ascertain whether or not its account holders are US taxpayers and, if so, to disclose certain information to the Internal Revenue Service (“IRS”) about those US accounts (or to disclose such information to their governing jurisdiction, if such jurisdiction has entered into an intergovernmental agreement with the US). An FFI that does not comply with FATCA, in turn, will be subject to a 30 percent withholding tax on certain incoming US-source payments, including interest payments on loans, and on principal repayments and gross sale proceeds of loans that produce US-source interest payments. Loans outstanding on July 1, 2014 are grandfathered (i.e. not subject to FATCA) unless the loan is subsequently “materially modiﬁed” (such as through an extension of maturity or a spread change of 25 basis points or more).
Although FATCA withholding on principal repayments and gross sale proceeds does not begin until January 1, 2017, withholding on interest payments takes effect on July 1, 2014.
The revised LSTA form agreements generally make FATCA a receiving party (the “Payee”) risk, as has been the case with respect to previous tax withholding language in the LSTA trading documents.3 With respect to standard payments between a buyer and seller, the remitting party (the "Payor") has the right to withhold any amounts required under law, including FATCA. However, in certain situations, such as where payments originate from a borrower or agent and pass through a Payor under a participation agreement, the new LSTA language imposes a gross-up obligation on the Payor to the extent that such pass-through amounts were previously subject to FATCA withholding prior to the payment from the Payor to the Payee (e.g., on the payment to the Payor). The Payor’s gross-up obligation falls away only if the Payee (i) is non-compliant with FATCA or (ii) would otherwise have been subject to FATCA withholding if it had received the payment directly from the borrower or the agent. Finally, the FATCA forms provision in the revised LSTA agreements requires the Payee to agree to provide to the Payor any additional documentation reasonably requested by the Payor to ascertain the Payee’s FATCA compliance. A Payor may refrain from making any payments owed to a Payee thereunder until it receives the necessary FATCA documentation from the Payee.
“True sale” Treatment of Loan Participations
Affording “true sale” treatment to loan participations provides comfort to the grantor and the participant from both an accounting and credit risk perspective. If the participation qualiﬁes for “true sale” treatment, rather than as a loan from the participant to the grantor, then (i) the grantor no longer has to account for the loan as its asset and (ii) to the extent the grantor becomes a debtor in a US bankruptcy proceeding, the participated loan and its proceeds would not be considered part of its bankruptcy estate, but rather an asset of the participant. While the LSTA form participation agreements were drafted with the intent of effecting “true sale” treatment of a participated loan, the revised LSTA Participation Agreements now say this more directly. Speciﬁcally, Section 2 of the Standard Terms and Conditions states that the participation interest granted to the participant shall be treated for all purposes as a “true sale,” as opposed to a debtor-creditor relationship. In addition, Section 8 of the Standard Terms and Conditions includes language that payments or distributions made to either buyer or seller for the beneﬁt of the other party "shall for all purposes constitute property" of the other party.
Participant’s Elevation Rights
In the aftermath of the Lehman bankruptcy, many participants sought to elevate participation interests held under Lehman to lender of record positions to prevent proceeds from being caught-up in or distributed from the Lehman estate. Notwithstanding this desire to elevate, participants were faced with two obstacles: (i) underlying participation agreements that either prohibited or did not contemplate elevation under any circumstances and (ii) the grantor’s bankruptcy ﬁling and the resultant automatic stay. Although Lehman voluntarily agreed to permit elevations without the need to seek court authorization, there arose a concern that, in other cases, court relief from the automatic stay to allow the elevation of participations would not help those parties to participation agreements that required grantor consent for an elevation. In Section 15 (Elevation), the revised LSTA Participation Agreements remove any contractual obstacle to elevation that a grantor/debtor might wish to invoke, while also strengthening a participant’s argument for the bankruptcy court to lift the automatic stay. If a grantor (or its direct or indirect parent) seeks protection under the applicable bankruptcy or insolvency laws, (i) the DPA provides for deemed seller consent to a request from the buyer to elevate, and (ii) the PPA allows the participant to make an elevation request, irrespective of whether or not the parties agreed at the time of trade that elevation was applicable.
We anticipate that the LSTA will continually update and revise their suite of secondary market loan trading documentation. We will endeavor to continue to provide updates on these developments. If you would like more information on FATCA or the revised LSTA forms of secondary market loan trading documentation or have any questions on the foregoing, please contact us.