The Foreign Account Tax Compliance Act (FATCA) requires foreign financial institutions (FFIs) to enter into a reporting agreement with the United States Internal Revenue Service (IRS) with respect to their US account holders, or else be subject to a 30 percent withholding tax on US-source payments of interest, dividends and other fixed income. In July 2012, the Loan Market Association (LMA)—the authoritative voice of European primary and secondary syndicated loan markets in Europe, the Middle East and Africa—published riders (FACTA Riders) to help borrowers and lenders handle the various risks associated with FATCA.
The FATCA Riders are aimed solely at loan agreements that are subject to the proposed grandfathering rules under FATCA, or, in a nutshell, payments committed and/or made under loan agreements entered into prior to January 1, 2013, provided that those loan agreements are not materially modified after January 1, 2013 and that payments made thereunder are not, for US tax purposes, treated as equity (Grandfathered Loans). Note that uncommitted facilities, e.g., ancillary or accordion facilities, are unlikely to be grandfathered if they become committed only on or after January 1, 2013, even if the main loan documentation was signed in 2012.
Background—Problems With FATCA Risk Allocation Outside of the US
In the US market, lenders usually bear the FATCA risk because they are not FFIs, they can comply with FATCA and thus become participating FFIs, or they can sell to participating FFIs or those who can comply. However, many market participants outside of the US are FFIs and thus may face complex legal issues under their respective domestic laws, including data protection laws, privacy laws, bank secrecy rules and other local laws that conflict with FATCA (Conflicting Local Laws).
In Europe, for example, personal data can normally only be transferred outside of the European Union if the country to which data would be transferred has adequate data protection in place, or if an exemption is available. A country like the US does not, for instance, have adequate data protection from a European perspective, and thus the FFI would likely be required to obtain the consent of each account holder, or the US Department of the Treasury (Treasury) would have to abide by European data protection laws. Moreover, various jurisdictions outside of the US prohibit FFIs from withholding monies from their clients’ accounts without client consent.
Model Intergovernmental Agreement
To counter these and other non-US conflicts between the FATCA regime and Conflicting Local Laws, the Treasury, after consultation with the governments of France, Germany, Italy, Spain and the United Kingdom (FATCA Partner Jurisdictions), recently published the long awaited model intergovernmental agreement. The model agreement establishes a framework for reporting by FFIs in the FATCA Partner Jurisdictions to their local tax authorities followed by an automatic exchange between those local authorities and the IRS. This should allow the IRS to take the position that each relevant FATCA Partner Jurisdiction FFI is FATCA-compliant and eliminate the need to subject these FFIs to FATCA withholding. The FATCA Partner Jurisdictions have endorsed the model agreement and called for a speedy conclusion of bilateral agreements based on the model; still, it is expected that each FATCA Partner Jurisdiction also needs to enact local legislation to fully implement this intergovernmental approach and there thus remains some uncertainty about how exactly this approach will be implemented and what how it will impact FFIs.
Against this background and in light of the current approaches to FATCA in Europe, the FATCA Riders consider both possible risk allocations: to borrowers and to lenders.
FATCA Riders—Borrower Risk
The borrower will bear any FATCA risk on account of Grandfathered Loans when (1) the arrangement is a commercial deal between the parties or (2) the borrower/parent is either considered able (a) to control amendments and/or changes to the group of obligors under the loan agreement so that grandfathering will not be lost, or (b) to control the status of each obligor, i.e., control that no obligor is (or becomes) a US entity whose payments are (or would be) considered a US source or an FFI (each a FATCA Obligor).
In the latter case, where the borrower/parent is considered able to prevent any obligor from becoming a FATCA Obligor, the FATCA Riders require each obligor (and the parent in the case of additional obligors) to adhere to the following FATCA Loan Clauses:
- Represent and covenant that it is not and will not become a FATCA Obligor.
- Represent and covenant that no withholding will arise on payments made by it or an agent on its behalf.
- Resign as an obligor if so directed by an agent prior to the earliest date on which FATCA withholding may arise (for example, on January 1, 2014 with respect to interest payments and other payments from US sources, each a Relevant FATCA Application Date).
Where an obligor is in breach of one or more FATCA Loan Clauses and a finance party suffers a loss, the FATCA Riders may refer the affected finance party to its contractual rights to receive damages for any such losses suffered or:
- Provide for a gross-up obligation on the part of the obligors.
- Permit the finance parties to make FATCA deductions themselves.
- Require the parent to compensate any finance party that has suffered a shortfall.
- Allow the parent to prepay or replace any lender that potentially triggers a FATCA withholding (Option 1B).
Note that the FATCA Rules also envisage use of Option 1B on a stand-alone basis where it would not be appropriate to include the FATCA Loan Clauses in the loan documentation; for example, in cases where one or more obligors are FATCA Obligors and it is the commercial understanding that the borrower/parent will bear all FATCA risk.
FATCA Riders—Lender Risk
In some instances, however, lenders may wish to take FATCA risk in relation to Grandfathered Loans because (1) they want protection if the Treasury does not take into account Conflicting Local Laws in the final FATCA rules and they are unable to comply with FATCA, or (2) in the more likely event that the
final FATCA rules will take into account Conflicting Local Laws to prevent a borrower’s credit from being impaired by having to gross up a lender who is not a participating FFI.
In these circumstances, the FATCA Riders allocate risk to lenders, but at the same time provide for the following:
- Lenders have the right to veto any amendment to the loan agreement or any change in the group of obligors that would result in the Grandfathered Loans losing their grandfathering. Consequently, any amendment, waiver, obligor accession/resignation, etc., may effectively become subject to all lenders’ consent.
- A borrower can override a lender’s veto by agreeing to either (1) replace that lender or (2) mandatorily prepay or cancel that lender’s participation if a FATCA withholding has to be made subsequently on a payment to that lender. Note, however, that the right to override a lender’s veto must expire prior to a Relevant FATCA Application Date as prepayments would otherwise themselves become subject to FATCA withholding, thus rendering this mechanism moot.
FATCA Riders—General Provisions
The FATCA Riders contain supplemental provisions, including information-sharing clauses aimed at facilitating FATCA compliance, as well as provisions in relation to the replacement of the non-compliant agents.