Regulation

Capital and liquidity requirements

Describe how capital and liquidity requirements impact the structure of bank loan facilities, including the availability of related facilities.

As a result of the capital requirements imposed on US banks by the Basel III guidelines with respect to confirming letters of credit and maintaining swingline loan commitments, US banks face internal pressures to provide only a portion of the total letter of credit fronting commitment and swingline commitment, in particular where the commitment levels are sizeable.

One approach is to provide in the bank loan documentation that each of the lenders under the revolving credit facility (or, at least, those lenders that are joint lead arrangers for the revolving credit facility) accept a pro rata share of the letter of credit fronting commitment and swingline commitment, based on their respective shares of the aggregate commitments under the revolving credit facility.

Another approach is to cap the aggregate exposure of the financial institution serving as the letter of credit issuing bank and the swingline lender such that the outstanding face amount of the letters of credit issued by the financial institution, when taken together with the aggregate principal amount of swingline loans and revolving credit loans held by such financial institutions, cannot exceed the financial institution’s commitment under the revolving credit facility.

Disclosure requirements

For public company debtors, are there disclosure requirements applicable to bank loan facilities?

Under the US Securities Exchange Act of 1934, as amended, public company debtors must disclose on a current report on Form 8-K, within four business days, the entry into a material definitive agreement or the creation of a direct financial obligation. The entry by the debtor into a bank loan facility triggers a public disclosure requirement under both of these current report categories.

Use of loan proceeds

How is the use of bank loan proceeds by the debtor regulated? What liability could investors be exposed to if the debtor uses the proceeds contrary to regulations? Can investors mitigate their liability?

Debtors are prohibited by the terms of the bank loan documentation from using bank loan proceeds in violation of US and foreign anti-corruption laws (such as the Foreign Corrupt Practices Act), anti-money laundering laws (such as the Bank Secrecy Act) and antiterrorism laws (such as the USA PATRIOT Act, as restored by the USA FREEDOM Act, and the regulations administered by the Office of Foreign Assets Control of the US Department of the Treasury (OFAC)). In addition to the reputational harm to the lenders, a violation of these regulations by the debtor could expose the lenders to sanctions, disgorgement of profits, challenges to the priority of the lenders’ security interests in the debtor’s collateral, monetary fines and criminal penalties, depending on the regulation violated and the scope of the violation. In certain circumstances, the lenders may be able to mitigate their liability by showing that they have performed adequate diligence on the debtor’s operations and that the bank loan documentation contains certain safeguards, such as requirements that the debtor maintain and enforce internal policies concerning compliance with such regulations.

In addition, the bank loan documentation prohibits the debtor from using the bank loan proceeds in violation of the margin regulations promulgated by the Board of Governors of the Federal Reserve System. In particular, Regulation U prohibits banks from extending any credit for the purpose of financing the purchase or carrying of publicly traded equity securities (‘margin stock’) in an amount that exceeds the ‘maximum loan value’ of the collateral securing such credit. The maximum loan value of margin stock is 50 per cent of its market value, meaning that a bank can only lend up to US$50 to a debtor to purchase margin stock having a market value of US$100 if such margin stock secures the loan, unless other non-margin stock collateral also secures the loan. Violations of Regulation U can result in criminal liability to the lenders as well as a rescission of the bank loan. To provide the lenders with an argument in defence of a rescission claim, the bank loan documentation includes a representation by the debtor that it will not use the bank loan proceeds in violation of Regulation U.

A violation of the use of proceeds provisions of the bank loan documentation almost always results in an automatic event of default, allowing the lenders to accelerate any outstanding loans, terminate unused commitments and exercise remedies against the debtor and the collateral.

Cross-border lending

Are there regulations that limit an investor’s ability to extend credit to debtors organised or operating in particular jurisdictions? What liability are investors exposed to if they lend to such debtors? Can the investors mitigate their liability?

Sanctions administered by OFAC prohibit US persons (including financial institutions) from engaging in transactions in certain targeted foreign countries or involving persons or entities listed on OFAC’s Specially Designated Nationals List. The blocked transactions include the making of loans to OFAC sanctions targets and raising money for OFAC sanctions targets. OFAC regulations provide that a US person that enters into a transaction with an OFAC sanctions target may be unable to enforce their rights under the applicable agreement, may be unable to enforce their rights on any collateral, and may be subject to fines and other sanctions by OFAC. However, OFAC sanctions do not impose strict liability on US persons. A US person can mitigate their liability in respect of OFAC infractions by:

  • showing that they did not wilfully violate OFAC regulations;
  • showing that they had no reasonable cause to know or suspect that the transaction violated the OFAC regulations; and
  • upon discovery of the infraction, promptly reporting the infraction to OFAC.

 

For this reason, the bank loan documentation will include a representation by the debtor that neither it nor its subsidiaries nor any of its respective directors, officers or employees are on OFAC’s Specially Designated Nationals List nor are operating, organised or resident in any targeted foreign country. Depending on the debtor, this representation may extend to economic or financial sanctions or trade embargoes administered under foreign law, including the laws of the European Union and Her Majesty’s Treasury of the United Kingdom.

Owing to the regulations passed under the EU’s Bank Recovery and Resolution Directive (effective 1 January 2016), which was designed to avoid burdening taxpayers with the cost of a future bank bail-out in the event of a banking crisis, credit agreements and ancillary documents should now include contractual provisions recognising the authority of certain European regulators to write down or write off essentially any obligations, subject to certain exceptions, of regulated European financial institutions. Such provisions are being included in all loan documentation, whether or not a regulated European financial institution is an original lender, in order to give flexibility in syndication and secondary trading of the loans.

Debtor’s leverage profile

Are there limitations on an investor’s ability to extend credit to a debtor based on the debtor’s leverage profile?

Guidance released in March 2013 (and supplemented in November 2014 and further clarified in February 2015) by certain US financial institution regulators (the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency) described expectations for the sound risk management of leveraged lending activities. Among other items, the guidance called for financial institutions engaged in leveraged lending to adopt a risk management framework that implements ‘an intensive and frequent review and monitoring process’ with respect to loans to leveraged debtors. In particular, the guidance indicated that leveraged financing resulting in a debtor having a ratio of total indebtedness to EBITDA in excess of six times raises supervisory concerns and that those transactions are far more likely to be criticised by the regulators. More recent pronouncements (in particular, those from September 2018) from the aforementioned US financial institution regulators have clarified that such supervisory guidance does not have the force and effect of law and, further, that the regulators do not take enforcement actions based on supervisory guidance. In particular, the regulators indicated that they would limit the use of ‘bright-line’ tests and would not criticise an institution for a ‘violation’ of supervisory guidance.

Interest rates

Do regulations limit the rate of interest that can be charged on bank loans?

State usury laws limit the amount of interest that can be charged for money loans. Failure to comply with the usury laws could result in both civil and criminal penalties for the lending institution. While the usury laws in each state differ, it is generally the case that the maximum rate of interest that can be charged by a lending institution to an individual differs from the maximum rate of interest that can be charged to a business institution. Furthermore, the maximum rate of interest will often depend on the size of the loan in question. For example, in the state of New York, the laws of which govern many corporate loans, the maximum rate of interest that can be charged for a money loan having a principal amount below US$2.5 million is 25 per cent; however, if the loan has a principal amount of US$2.5 million or more, then the usury laws do not apply to the loan.

Currency restrictions

What limitations are there on investors funding bank loans in a currency other than the local currency?

US law does not impose any limitations on US banks funding bank loans in a currency other than US dollars.

Other regulations

Describe any other regulatory requirements that have an impact on the structuring or the availability of bank loan facilities.

Certain additional regulatory requirements that impact the structuring and availability of bank loan facilities include the following:

  • The Investment Company Act of 1940 (the 1940 Act): an entity that is an investment company as defined in the 1940 Act is prohibited from engaging in a variety of business activities, including borrowing on bank loans, unless that entity registers under the 1940 Act. If a lender makes a loan to an unregistered investment company, then the bank loan documentation may be unenforceable.
  • Anti-tying regulations: the anti-tying regulations promulgated under the Bank Holding Company Act Amendments of 1970 prohibit US banks from conditioning the availability or price of a bank product (eg, an extension of credit) on the requirement that the customer also purchase a non-bank product (eg, capital markets underwriting services) from the bank or one of its affiliates. These regulations do not apply in cases where the US bank’s customer is not a US person.

Law stated date

Correct on

Give the date on which the above content is accurate.

27 May 2020.