In recent months, the settlements of many secondary bank loan trades have been thwarted or delayed because a borrower or administrative agent has denied the consent to assignment required under the applicable loan agreement. For instance, it has become common for consent to be denied merely because the assignment is being made to hedge funds or similar investment vehicles. For individual buyers and sellers of bank loans, the denial of consent can result in delay, increased cost and trade failure. For the market as a whole, such denials threaten to undermine the growing liquidity of the secondary bank loan market. This marks a movement away from the open and evolving model of liquid bank loan trading.1
Although a standard condition to the assignment of syndicated bank loans is the receipt of the borrower’s and the administrative agent’s consent to the assignment, the consent right is generally limited by the proviso that it may not be “unreasonably withheld.” In many cases, loan market participants that have been denied consent have been questioning whether such denial was actually “reasonable.”
The unreasonable refusal to grant consent can be costly to participants in the secondary market and market participants denied consent to assign a loan may have a basis to challenge such refusal. This memorandum briefly discusses the consent requirements, issues raised by the increasing number of consent denials, and the legal framework that might be used to analyze a challenge to such denials.
In general, agents and borrowers include consent requirements in their loan agreements to ensure that their lender syndicate consists of sophisticated, creditworthy institutions that will see “eye to eye” in connection with lender-group issues. To the extent the relevant loan facilities include revolving or delayed draw term loan commitments, the borrower and the agent also have an interest in insuring that each syndicate member has the ability to meet its future funding obligations. In addition, agents want to have confidence that new lenders are able to meet their obligations to indemnify the agent against any costs or liabilities they may incur on behalf of the lending group.
To address these concerns, most U.S. syndicated loan agreements drafted in recent years require that prospective assignees be “accredited investors” and have experience in making or purchasing bank loans. In addition, these loan agreements provide that an assignment is conditioned on receiving the consent of both the agent and the borrower, which consents will not be “unreasonably withheld.” This consent right provides an opportunity for agents and borrowers to review information concerning potential lenders’ financial and legal condition. The diligence process takes time, but consent is provided to the vast majority of proposed assignments.
INCREASE IN BORROWERS’ AND AGENTS’ REFUSAL TO PROVIDE CONSENT
In recent months, a substantial number of assignments have failed to garner approval because a borrower or agent has withheld consent to all or certain classes of prospective lenders. Borrowers and agents have pointed to the Lehman Brothers bankruptcy in the fall of 2008 to justify the increased refusal to consent to assignments. Lehman’s default on numerous obligations as a lender to fund syndicated loans resulted in great disruption for borrowers and agents alike. As a result, since that time borrowers and agents have demonstrated an increased fear of lender default risk and credit approval standards have risen.
In addition, there have been a number of total transfer “freezes” in situations where the borrower is in the midst of a restructuring or refinancing. Some borrowers have used their consent power to ensure that new lenders will be receptive to their requests for waivers or restructurings of the loans. These borrowers often contend that commercial banks are likely to be more receptive than other lenders to restructuring or refinancing and therefore reject any hedge fund or alternative investment vehicle that wants to join the credit facility. As a result, borrowers and agents that have already begun the process of gathering lender support for an amendment, waiver or restructuring of the loan agreement are often reluctant to admit new lenders to the syndicate that are not supportive of the deal.
Regardless of the explanation, the increased difficulty in obtaining consents to assignments has been disruptive to the secondary market for bank loans. In many cases, substantial amounts of time pass before the borrower or agent responds to the consent request, and lenders will often be required to submit large amounts of confidential diligence materials for review. Parties to a trade that have used a standard Loan Syndications and Trading Association trade confirmation that cannot get approval for an assignment are obligated to then settle by participation, a settlement mechanism that can have many disadvantages for both parties.
In recent months we have observed consents withheld (or conditioned) in the following circumstances:
- A borrower refused to consent because it was concerned that a potential lender may not vote to approve a proposed restructuring.
- A borrower conditioned consent on a buyer’s agreement to approve a restructuring.
- A borrower conditioned consent on the seller agreeing to more stringent consent standards with respect to the remaining loans held by the seller under the credit facility.
- Borrowers relying on internal policies (not provided in the loan agreement) of denying consent to all assignments being made to hedge funds or, in some cases, to specifically designated hedge funds.
DISPUTE BETWEEN BORROWERS AND LENDERS LIKELY
Lenders who are unable to assign their loans because of a borrower’s or agent’s refusal to provide consent are concerned, and we believe that legal disputes are inevitable. Unfortunately, courts have not yet established parameters for when consent may be reasonably withheld with respect to the transfer of syndicated loans. Case law developed in other contexts has given rise to the principle that where a party has promised not to unreasonably withhold its consent, it may do so only for a “legitimate business reason” exercised in good faith. But what constitutes a legitimate business reason in this context is not clear. Borrowers that establish blanket policies limiting the types of entities that are acceptable or that refuse to consent absent a buyer’s commitment to vote a certain way will argue that they are acting to protect a legitimate business interest and, thus, are acting reasonably in denying consent.
Lenders will likely respond that the only reasonable criteria that may be used to evaluate prospective lenders are their credit-worthiness and their ability to otherwise meet their obligations as lenders. They will argue that borrowers are improperly attempting to use their consent rights to add borrower-favorable terms that were not part of the original loan agreement. For instance, the refusal to consent to an assignment merely because the new lender may exercise its rights under the loan agreement in a manner adverse to the borrower’s interest is not reasonable. The borrower has already granted voting rights to lenders and should not seek to alter the terms of the loan agreement as a condition of assignment. Similarly, by selectively excluding certain entities as lenders based on their actual or perceived response to the borrower’s proposed loan agreement amendments or waivers, the borrower is, in essence, using its consent right to push through an amendment of the loan agreement. Thus, the categorical refusal to provide consent to an assignment to hedge funds, in this view, would violate the terms of the loan agreement.
Prior to the recent financial crisis, the secondary loan market seldom faced the types of obstacles to the assignability of a loan that have recently begun to emerge. As a result, the line between reasonable and unreasonable withholding of consent has not yet been drawn, and litigation over these issues can be expected. Until clear rules emerge, loan market participants, when assessing the risks associated with transactions in bank loans, should take into account the increased risk that necessary consents will not be obtained. They should consider in advance that they may not be able to purchase or sell their loans by assignment.