Syndicated loan transactions are a common feature in the South African loan market. As the agreements underlying the transaction are often English law governed, a need arises to reconcile the diverging systems of law (and practices) between the UK, other jurisdictions and South Africa and, where that is not possible, to find alternative means of arriving at the same result so as to ensure consistency, predictability and commercial viability of such transactions. This is particularly true for the provision of security under the loan transaction.
Providing security in other jurisdictions
In the UK, a trust is used to hold security over the assets of a debtor for the benefit of the lenders in a syndicated loan transaction. The lenders (not as named individuals but as a category of persons) are then appointed beneficiaries of the trust. In practice, a specialised trust company is used for this purpose. Often, the security interest held by the security trustee originates from multiple jurisdictions. In jurisdictions where a trust is not commonly used or is wholly a foreign concept, a security agent is appointed to perform the same function as the security trustee. The security agent and security trustee are almost always the same entity.
Providing security to an entity separate from the lenders negates the need to establish and re-establish security every time the lenders change in the syndication. In addition, a trust is relatively simple to establish – and facilitates the commercial pressures associated with this type of loan effectively.
The challenges with the trust/agency structure in South Africa
At the heart of the matter is the fact that the English law security trust structure is not recognised under South African law. Therefore the structure cannot be used without variation. It is widely accepted that, in order for a person to provide security to another, there must be a primary obligation owed by the security provider to the other party – it is unlikely that provision of security to a party other than that which advanced the loans would be recognised as an acceptable arrangement under South African law.
In addition, there are legislative prohibitions to arrangements similar to those found in English law. Section 50(5) of the Deeds Registries Act, 47 of 1937 (Deeds Registries Act) provides that debts or obligations to more than one creditor arising from different causes may not be secured by one mortgage bond or notarial bond. Section 54 of the Deeds Registries Act provides that no mortgage bond or notarial bond shall be passed in favour of any person as the agent of a principal. Therefore, a borrower cannot provide a mortgage bond or notarial bond as security for debt obligations owed to multiple lenders and a borrower cannot provide security to the agent of the lenders – in this case, the security trustee/agent.
Various securitisation structures have been developed which seek to avoid the challenges associated with implementing the security trust/agent structure where a local borrower is involved, but which are still able to maintain the benefits of having an independent security holder.
Special purpose vehicles: patchwork solution
The use of a special purpose vehicle (SPV) as security holder and guarantor of a syndicated loan is common when a South African borrower is involved.
In simple terms, the security is structured as set out below:
- An SPV and a trust are established.
- The trust becomes the holder of shares in the SPV.
- The SPV provides a guarantee to the security agent (acting on behalf of the lenders) for debts owed by the borrower to the lenders.
- The borrower indemnifies the SPV for any payments which may be made pursuant to enforcement of a claim by the security agent. The borrower provides security to the SPV under the indemnity.
- The trust would generally pledge its shares in the SPV to the security agent.
The benefit of the SPV structure is that it creates a result similar to that of the English law trust structure – a separate entity from the lenders which holds the security and allows for trading in the syndicated loan without affecting the security. In addition, this structure does not violate any established legal principles.
The SPV structure is not without its problems.
The structure is, relative to its English counterpart, complicated. The introduction of two further entities and a host of other agreements is a convoluted way to achieve securitisation in the transaction.
Setting up a trust and a company takes time – while establishing a company is a straightforward task, often taking approximately two weeks (even less in other circumstances), the establishment of a trust can take between six and eight weeks. Timing becomes crucial when closing looms and there is pressure to establish security.
As this structure takes time to put in place and looks different from the security trust structure, it is unfamiliar to foreign parties participating in the syndicated facility transaction. It may be challenging for the South African borrower to buy in from the foreign participants.
The SPV is a company which is subject to the Companies Act 71 of 2008. Issues such as corporate governance (normal considerations of a company such as the directors being obliged to act in the best interest of the company and not in the best interest of the security holder) must be given due regard. In addition, the SPV must be structured so as to avoid inadvertently incurring tax obligations.
Parallel debt structure
The parallel debt structure resolves the primary concern with the security trust/agent structure, namely the absence of a primary obligation upon which the borrower can validly provide security to the security trust/agent. This is resolved by creating an additional obligation on the borrower owed to the security agent.
The borrower and the security agent agree that the borrower has an additional debt obligation to the security agent, which exists alongside (in parallel to) the original debt owed by the borrower to the lenders. This is not an actual debt arising from an advance in monies by the security agent, but simply an acknowledgement of an obligation to pay the security agent amounts equalling the debts owed to the lenders. As the borrower pays the debt to the lenders, its obligation to the security agent is proportionately decreased, and vice versa.
As a legal obligation (through an acknowledgement of debt) has now been created, it is then possible to provide security in respect of such obligation to the security agent.
The main concern with the parallel debt structure is that it has not been tested by the South African courts. Therefore its validity in law remains uncertain. The structure has been received well in many other jurisdictions (such as France and Poland), where conscious and deliberate steps have been taken towards the recognition of parallel structures in local laws. Devoid of such certainty, there may be the risks that the regulators or courts take a view on the true nature of the structure, which may affect its usability. In South Africa, the general trend is to move towards using this structure, as it is simpler than the SPV structure, is expedient, and suits the commercial requirements of the participants in the transaction.