Guarantees and collateralRelated company guarantees
Are there restrictions on the provision of related company guarantees? Are there any limitations on the ability of foreign-registered related companies to provide guarantees?
In general, unsecured affiliate guarantees are limited only by fraudulent conveyance issues (see question 22). If the affiliate at issue is a foreign entity, however, the provision of a guarantee by that entity of the obligations of a US borrower can have serious economic consequences for the borrower. Under the US tax code, subject to certain exceptions, income earned abroad by companies that are organised abroad generally is not taxed by the United States. However, if the assets of such a foreign company provide credit support for obligations of a US affiliate, then the undistributed earnings and profits of the foreign company may be deemed to be repatriated to the United States and may become subject to US taxation as a dividend. Recent proposed Treasury regulations would in many cases provide an exemption from such taxation, but there are several exceptions and limitations under those proposed regulations, and it is not entirely clear that the regulations have binding effect. In the US market, borrowers are typically not expected to take such a risk and guarantees from foreign subsidiaries are not commonly provided. In addition, borrowers often limit pledges of the equity of their direct foreign subsidiaries to 65 per cent of the voting equity (the US tax rules may treat pledges of 66.67 per cent of the voting stock of a foreign company as equivalent to the assets of the foreign company providing credit support). For these purposes, borrowers are likely to be reluctant to rely on the proposed Treasury regulations and offer expanded guarantees and pledges.
To the extent that an affiliate guarantee is secured, there may be some additional costs involved in providing the guarantee. State and local authorities do assess modest state filing fees and filing service charges for the filing of financing statements to perfect a secured guarantee. A few states impose a documentary stamp tax, intangibles tax or other filing tax on financing statements filed in their jurisdictions, although not all types of assets are subject to the tax. Federal taxing authorities generally do not require documentary, filing or other taxes payable in connection with the provision of guarantees or the granting of security, although there are fees charged for perfecting security interests in intellectual property by making filings with the US Patent and Trademark Office or the US Copyright Office.
Several states impose a mortgage recordation tax, intangibles tax, documentary tax or other similar tax on mortgages or deeds of trust filed in their jurisdictions. If such a tax is imposed, it is generally calculated in one of two ways. In some states, the tax is payable on the amount of the indebtedness secured by the mortgage or deed of trust. In these cases, in order to avoid having the borrower unnecessarily pay tax on the entire amount of the loans, the amount of the total indebtedness that is to be secured by the mortgage or deed of trust would be limited to a specified amount (typically the value of the subject property), and the tax is paid on that amount. Alternatively, some states use a formula that takes the ratio of the value of the real estate secured in the taxing state to the value of all of the real estate assets securing the indebtedness (some states use the value of both the real and personal property in this formula), and that ratio is multiplied by the total amount of indebtedness, with the tax being calculated on the resulting number. In some states, it is permissible to use both of these calculation methods and use the one that yields the lowest tax payment. Further, there are costs associated with title insurance insuring the lien of the applicable mortgage or deed of trust if it is required to be obtained pursuant to the terms of the transaction documents. These costs are generally proportionate to the dollar amount of the title insurance policy; however, in several states, title insurance rates are regulated, and in these states the costs tend to be much higher.Assistance by the target
Are there specific restrictions on the target’s provision of guarantees or collateral or financial assistance in an acquisition of its shares? What steps may be taken to permit such actions?
There are no specific restrictions on a target providing guarantees or collateral in a transaction pursuant to which its shares are acquired. In fact, the provision of these guarantees and collateral is common in US acquisition finance practice. There are, however, general limitations on fraudulent conveyance that should be evaluated in any transaction where upstream guarantees are contemplated to be provided by subsidiaries of the borrower (see question 22).Types of security
What kinds of security are available? Are floating and fixed charges permitted? Can a blanket lien be granted on all assets of a company? What are the typical exceptions to an all-assets grant?
Collateral that can be used as security falls into two general categories: real property and personal property. Real property (including fixtures constituting real property under applicable law) is governed by the law of the state in which the property is located, and a security interest in real property can be granted pursuant to a mortgage (or similar) agreement and perfected by filing the mortgage (or similar instrument) in the land records where the real property is located. The creation of security interests in most types of personal property is governed by the UCC, a form of which has been enacted in each state. Security interests in the personal property governed by the UCC can be granted pursuant to one omnibus security agreement and perfected (with certain exceptions) by the filing of financing statements describing the collateral in the jurisdiction of organisation of the party granting the security interest. Often, a description of ‘all assets’ or ‘all personal property’ will be sufficient to perfect a security interest in such assets.
A borrower or guarantor can grant a security interest in all of its personal property assets, including future acquired assets (other than commercial tort claims). A security interest in assets that will be acquired in the future does not attach (become legally enforceable) until the borrower actually acquires the assets; but in many cases, no new action will be required on the part of the lenders for the attachment to occur at the time of the acquisition. However, perfection may require additional action for certain assets, such as intellectual property, cash and cash equivalents and certain equity interests. In the case of real property, the security interest is typically granted on a specific parcel of property and in order to encumber additional real property, a new mortgage (or similar) agreement or an amendment to an existing mortgage (or similar agreement) would be needed. However, any improvements subsequently made on real property covered by a mortgage will become subject to the lien of that mortgage without the requirement that a new or amended mortgage be filed.
The terminology used for security interests in the United States is different from that used in certain other jurisdictions. The terms ‘fixed charge’ (where the parties agree to let the charged assets stand permanently as security for the discharge of the obligations) and ‘floating charge’ (where the parties agree that the grantor has freedom to use its charged assets unless and until the secured party is allowed to dispose of the assets, in priority to other creditors) are not commonly used in the United States, but security arrangements in the United States (with the exception, in certain circumstances, of cash and cash equivalents) are generally more akin to a floating charge.
Typical exceptions to an all-assets collateral package include, among others:
- assets for which the granting of a security interest would be void or illegal under any applicable law;
- voting equity interests of a foreign subsidiary in excess of 65 per cent (owing to tax implications discussed in question 14);
- leasehold real property (depending on the business of the borrower and the nature of the leasehold interest);
- immaterial fee-owned real property;
- equity interests in an entity that cannot be pledged without the consent of one or more third-party equity holders thereof;
- equity interests of immaterial subsidiaries; and
- assets, the pledge of which would require governmental or certain other third-party consents.
Are there specific bodies of law governing the perfection of certain types of collateral? What kinds of notification or other steps must be taken to perfect a security interest against collateral?
As with the creation of the security interest, the perfection of a security interest in most types of personal property is governed by the relevant state’s UCC. However, the perfection of certain types of assets are governed by other state laws (eg, vehicles), or federal laws (eg, aircraft, railroads, ships and intellectual property), which provide for a specialised filing or registration system. Perfection occurs through the filing of UCC financing statements with the relevant state office, intellectual property security agreements with the relevant federal office (either the US Patent and Trademark Office or the US Copyright Office), the execution of control agreements (with respect to cash and cash equivalents held in a depositary bank, or in certain circumstances, with a securities intermediary), the possession or delivery of certain personal property, the recording of mortgages with the relevant state office, and other filings or actions in the case of other special category assets such as those discussed above. The Hague Securities Convention, an international treaty that became effective in the United States on 1 April 2017, provides choice-of-law rules that pre-empt the choice-of-law rules in the UCC relating to perfection and priority of securities held with an intermediary. In most cases, application of these new rules will result in the same choice-of-law as under the UCC, but secured transactions involving such collateral must be carefully reviewed to ensure compliance with the Hague Securities Convention’s choice-of-law rules.Renewing a security interest
Once a security interest is perfected, are there renewal procedures to keep the lien valid and recorded?
Yes. Depending on the nature of the asset subject to the security interests. Continuation statements for UCC financing statements covering most types of collateral generally need to be filed every five years (there are certain types of financing statements covering special types of collateral, such as transmitting utilities, manufactured homes, and cooperative interests, that have an extended or no expiry date). In addition, changes in the granting entity’s name or jurisdiction of organisation will require amendments to (or new) financing statements. Renewal requirements for recorded mortgages over real property are state-specific, and, in certain jurisdictions, mortgages will eventually expire if not renewed. There are no renewal requirements for control agreements over deposit and securities accounts or for filings with the US Patent and Trademark Office or the US Copyright Office. Finally, collateral perfected by possession remains perfected while it is in the possession of the secured party.Stakeholder consent for guarantees
Are there ‘works council’ or other similar consents required to approve the provision of guarantees or security by a company?
No. There is no concept of a ‘works council’ or analogous body in the United States.Granting collateral through an agent
Can security be granted to an agent for the benefit of all lenders or must collateral be granted to lenders individually and then amendments executed upon any assignment?
Yes. A collateral agent is typically granted the security interests for the benefit of all lenders, whether or not the initial lenders transfer or sell their interests to others. Typically, the trustee also acts as a collateral agent in the case of securities issuances and the administrative agent acts as a collateral agent in the case of bank loans. If there is shared collateral between groups of lenders with the same lien priority there may be an independent collateral agent appointed to hold the security on behalf of all lenders.Creditor protection before collateral release
What protection is typically afforded to creditors before collateral can be released? Are there ways to structure around such protection?
The circumstances under which collateral may be released are specified in the credit agreement or indenture and collateral documents, as applicable. To the extent that the relevant provision does not permit the automatic release of collateral, the consent of the lenders or holders will be required to release the collateral. The threshold for the release of collateral varies and is a negotiated provision.
If the indenture under which the securities are issued is qualified under the TIA (see question 11) or imports provisions of the TIA, in order to release collateral, the trustee must receive a certificate or opinion from an engineer, appraiser or other expert as to the collateral’s fair value and stating that the proposed release ‘will not impair the security under the indenture in contravention of its provisions’. The expert must be independent if the fair value of the collateral to be released and of all other collateral released in that calendar year is 10 per cent or more of the principal amount of the collateralised securities then outstanding, unless the fair value of the collateral to be released is less than US$25,000 or less than 1 per cent of the principal amount of the collateralised securities then outstanding.
There are several SEC no-action letters providing some relief from these requirements, including exceptions for certain ordinary course dispositions and if the release of the security is dictated by a party other than the trustee or the security holders (eg, if the securities have a second-priority lien and the first-lien holders control decisions on collateral releases). An issuer relying upon the ordinary course of business exemption must deliver to the trustee a semi-annual certificate that collateral dispositions in the prior six-month period were in the ordinary course of business and that all the proceeds were used as permitted by the indenture.Fraudulent transfer
Describe the fraudulent transfer laws in your jurisdiction.
Under US federal bankruptcy law and comparable provisions of state fraudulent transfer or conveyance laws, which may vary from state to state, the incurrence of debt, the guarantee thereof or the grant of a security interest in collateral in connection therewith could be avoided as a fraudulent transfer or conveyance if the borrower or guarantor:
- incurred the debt or guarantees with the intent of hindering, delaying or defrauding creditors; or
- received less than reasonably equivalent value or fair consideration in return thereof and, in the case of (ii) only, one of the following is also true at the time thereof:
- the borrower or any guarantor was insolvent or rendered insolvent by reason of the incurrence of the debt or the guarantee;
- the incurrence of the debt or the guarantee left the borrower or the guarantor with an unreasonably small amount of capital or assets to carry on the business;
- the borrower or guarantor intended to, or believed that it would, incur debts beyond its ability to pay as they mature; or
- the borrower or guarantor was a defendant in an action for money damages or had a judgment for money damages docketed against it if, in either case, the judgment is unsatisfied after final judgment.
If a court were to find that the incurrence of the debt or guarantee or the grant of security was a fraudulent transfer or conveyance, the court could avoid the payment obligations under the debt or guarantee, avoid the grant of collateral, subordinate the debt or guarantee to the presently existing and future indebtedness of the borrower or the guarantor, or require the lenders to repay any amounts received with respect to that debt or guarantee.
Under the Bankruptcy Code, the look-back period for fraudulent conveyances is two years. The Bankruptcy Code also incorporates, by reference, the fraudulent conveyance law of any applicable state jurisdiction. Each state has a similar (although not identical) fraudulent conveyance course of action, with look-back periods ranging from three to six years.