The Commodities Futures Trading Commission (the “CFTC”), pursuant to its rulemaking authority under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”)1, has interpreted guarantees of swap agreements to fall under the definition of a swap,2 which means that any swap guarantor must be an “eligible contract participant” (“ECP”) at the time a swap is entered into (which may occur after the date on which the guarantee and related credit facility documents are entered into).3 To qualify as an ECP, the guarantor must meet certain minimum requirements, the most commonly-relied upon in credit facility-related hedge transactions being either (i) total assets exceeding $10 million or (ii) net worth exceeding $1 million if it is executing the swap to hedge commercial risk.4
Because it is common for one or more subsidiaries or affiliates of a borrower in a commercial lending transaction to provide guarantees of, or provide other support for, such borrower’s obligations, such subsidiaries or affiliates would also need to qualify as ECPs where such guaranteed obligations include swap obligations owed to the lenders or other hedge providers. Subsidiaries or affiliates of borrowers who may be relying upon anticipated proceeds of a loan to constitute a significant part of their initial capitalization must meet certain specified requirements in order to satisfy such requirements.5 In addition, it is possible that such entities may have difficulty making representations based upon their capitalization to the extent they do not prepare separate financial statements. Should a swap guarantor fail to meet the ECP threshold, that guarantee under the loan agreement becomes illegal and unenforceable upon entry into a guaranteed swap, and could lead to regulatory problems.6
Market participants and trade groups initially attempted to address the consequences of the CFTC’s interpretation by proposing to amend the loan documentation to incorporate “keepwell” provisions and carve out swap guarantees by non-ECPs (by way of “exclusionary terms”).7 Recently there has also been discussion among practitioners in this area of effecting amendments to the swap documentation itself, and a working group of swap dealers and other market participants within the International Swaps and Derivatives Association, Inc. may soon propose a template for amendments that may be incorporated by reference into swap documentation or any other document.
Incorporating these amendments directly into swap documentation would be a convenient solution, but this approach may not be a complete replacement for amending loan documentation. First, it is unclear to what extent the borrower, the guarantor and the swap counterparty can rely upon an amendment of the swap documents to modify a guarantee without the signature of the guarantor, who is typically not a party to such swap documentation.
Second, such an amendment to the swap documentation may not amend the waterfall provisions of the loan documents, which provisions may require all payments to be shared pro rata among the lenders and hedge providers. A guarantee exclusion provision in the swap documents would likely seek to preclude any payments by non-ECPs from being shared with swap providers, but this could conflict with waterfall provisions in the loan documents unless the waterfall is also amended.
Third, it is unclear what effect, if any, an unenforceable swap guarantee might have on other guarantee obligations under the loan facility. Amending the loan documents, however, mitigates the risk that an unenforceable swap guarantee could render other guarantee obligations under the loan facility unenforceable (although it is likely that parties would seek to insert clear severability language stipulating that the exclusion of the swap obligations from the guarantee will not affect non-swap guarantee obligations).
Lenders, borrowers and swap market participants should continue to monitor developments in this area.