Syndicated loans are loans, offered by a banking group, that are organized by one or more banks. Several banks and financial institutions participate in the program on the terms and conditions of the same loan agreement from the same lender1. Since they were initiated in the 1960s, syndicated loans have demonstrated the obvious advantages2 of large financing amounts, long financing terms, a large number of participating banks and low financing thresholds. In China, most syndicated loans are used for the construction of major infrastructure projects such as the Beijing-Shanghai High-Speed Railway and the reconstruction of the Wenchuan area after the 2008 earthquake. After 50 years of development, syndicated loans are becoming increasingly mature in international capital markets, the legal norms that govern them are being perfected, and a comprehensive set of international conventions and contract models have developed.
1. Participating Lenders
Banks participating in syndicated loan programs are all members of consortiums. They can be generally divided into lead banks, correspondent banks and participating banks based on their function in a syndicated loan project.
- Lead Banks A lead bank is also known as Managing Bank. This term refers to a bank that, with the approval of the Borrower, creates and organizes the syndicate and takes responsibility for distributing shares in the loan to other participating banks. Based on the lead bank’s loan percentage, the business can be classified as exclusive underwriting, partial loan underwriting and aggressive sales promotion of the loan.
Correspondent Banks A correspondent bank can be either the lead bank or another bank or financial institution selected by the bank consortium. The correspondent bank disburses the loan to the borrower in accordance with the terms of the loan agreement, and manages the loan as entrusted by the consortium based on its prescribed duties. The duties of a correspondent bank include:
- Liaison: Contacting the borrower on behalf of the consortium for daily business and sharing information among consortium members;
- Manager: Acts as loan manager by supervising the disbursement of loan funds in accordance with contractual preconditions, supervising the use of the loan and dealing with breaches of loan terms.
- Mail Carrier: Receiving notices sent by the borrower on behalf of the consortium.
- Payment Agent: Disbursing and recovering loan amounts. If the syndication loan has a complicated guarantee structure, a guarantee agent can be appointed to take responsibility for the implementation of guarantees for syndicated loans, the registration of collateral (pledges) and management.
- Participating Banks Participating banks are the banks that accept invitations from the lead bank to syndicate the loan and make disbursements to the borrower based on their own committed credit lines.
2. Syndicated Loan Process and Required Legal Documentation
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- Selecting the lead bank and drafting the loan agreement. The borrower must locate a suitable lead bank and submit a Mandate Letter and an overview of the loan project. If the bank finds the project feasible after assessment and review, it will issue the borrower a conditional Commitment Letter; discuss the basic structure, methods and conditions of the loan with the borrower; and determine the preparatory steps to be taken. After receiving the Commitment Letter, the borrower must secure the approval of its Board of Directors and issue a Letter of Authorization. At this point the lead bank assumes legal liability for the loan and organizes a consortium.
Preparing Syndicated Loan Documents After receiving the Mandate Letter, the lead bank entrusts lawyers to prepare the legal documentation, which generally includes:
- An Information Memorandum The Information Memorandum is an important legal document drafted by the lead bank and the borrower. It details the legal and financial status of the borrower as well as basic loan conditions. Normally it is distributed to potential participating banks by the lead bank to help them decide whether or not to join the consortium. The accuracy of the Information Memorandum bears directly on the security of the capital of the participating banks. When drafting and distributing the information memorandum, the lead bank must faithfully disclose the borrower’s true financial, commercial and legal information to potential participants. It bears legal liability for any inaccuracies in the Information Memorandum.
- Term Sheet The Term Sheet is a basic legal document that lists the major conditions and parameters of the loan as determined by the borrower and the lead bank. It serves as a basis for drafting and negotiating the loan contract.
- Letters of Guarantee and Collateral Agreements The lead bank and the borrower reach an agreement on the major causes of the Loan Agreement. The borrower must obtain all necessary governmental approvals and permits, and must comply with all loan preconditions.
- Loan Marketing and Invitations The lead bank sends an invitation to potential participating banks in conformity with project demands. Interested banks then sign confidentiality agreements with the lead bank, which in turn provides them with the Information Memorandum on terms of confidentiality. After receiving an Invitation Letter, interested banks analyze project information and issue evaluation reports, upon which basis they will decide whether or not to accept the invitation. Banks that accept the invitation sign a Letter of Commitment to sign up for their loan shares and issue their conditions for participation in the project. The lead bank determines the loan shares of each bank, allocates risk and approves acceptable participation preconditions.
- Negotiating and Executing the Loan Agreement The lead bank negotiates with the borrower on behalf of the loan consortium for the terms of the Loan Agreement and related agreements. Usually the terms of the Loan Agreement are confirmed in advance, with only certain important market-sensitive terms (such as interest rate or its confirmation method) left for final confirmation.
- Enforcement and Follow-up Supervision After validating the Syndicated Loaning Agreement, the correspondent bank assumes responsibility for daily management -- arranging bank disbursements and the borrower’s withdrawal of funds; issuing notices of withdrawal; confirming the interest rate and loan extensions in accordance with the terms of the loan agreement; representing the loan consortium in collecting principal, interest and service fees and distributing these fees to the participating banks; reviewing guarantee clauses; supervising the borrower’s performance of the Loan Agreement and sending periodic reports to the participating banks. During the term of the loan, the lead bank or the correspondent bank is usually responsible for holding a Consortium Conference.
3. Major Characteristics of Syndicated Loans
Principle of Independent Obligation Banks disburse and collect their loans in accordance with the same loan agreement based on the independent relationships with the borrower (there is no joint legal liability between banks). This principle comprises three aspects:
- Lenders are subject to their own obligations on the disbursement of loans to the borrower. A lender’s failure to disburse its loan in accordance with the loan agreement will not influence the disbursement obligations of other lenders, and lenders do not act as guarantors of each other’s disbursement obligations.
- Under the Loan Agreement, creditors’ rights and obligations are separate and independent, and the borrower’s debts to each bank are also separate and independent.
- Unless otherwise provided in the Loan Agreement, all creditors are entitled to exercise their rights independently
- Principle of Democratic Decision-Making Profit conflicts can easily arise among members of a consortium. To operate effectively, a consortium adopts the principle of democratic centralism in its management. Consequently, the Loan Agreement usually provides that certain terms must be approved by all consortium members and others that must be adopted by a majority (or supermajority) of loan shares. Some model syndicated loan agreements require approval by consortium members holding no less than 2/3 of the total loan shares. With respect to terms that must be approved by a majority of loan shares, the banks holding those shares restrict the banks holding minority shares (i.e. the majority oppresses the minority). With respect to items that must be passed unanimously, each member has veto power over the entire consortium. Terms that can only be revised or eliminated with unanimous consent usually include matters concerning the currency of loan commitments, amounts, YTM, repayment dates or changes in maturity dates. Terms that require a majority or a supermajority vote include declarations of default, repayment acceleration, loan termination, and revision or termination of certain contract clauses.
Sharing Clauses In a syndicated loan, the lead bank is always a deposit bank of the borrower and is in possession of a large quantity of the borrower’ funds. If the borrower defaults, an issue of fairness will arise if the lead bank exploits its possession of the borrower’s deposits and thereby imposes a disproportionate share of the risk of default on other consortium members. Sharing clauses are drafted to insure that all consortium members share equally in the risk of default.
Sharing clauses are drafted in the loan agreement for the purpose of ensuring that all consortium members are fairly compensated, and to coordinate relationships among consortium members. Such clauses are drafted to ensure that lending banks are compensated in proportion to the amount they lent. A lending bank that received more than its pro rata share of returns from a borrower must share its returns with other consortium members through offset, litigation, disposal of collateral, return of the borrower’s principal or interest, or other methods.
Syndicated loans can trigger a wide range of legal issues. Compared to the rights and obligations of the parties to a general loan, syndicated loans involve complex issues related to coordinating the relationship between the consortium members consistently with the principles of independent obligation and democratic centralism. International syndicated loans also involve the foreign exchange management, currency policy, tax avoidance arrangements and conflicts of laws. Consequently, there is a huge market demand for legal services from professional legal teams to construct rigorous legal frameworks and to establish risk warning and prevention systems based on flexible information, rapid response and effective dispute resolution methods.