The documentation of credit facilities and hedging agreements under Bulgarian law has in recent years become increasingly aligned with international market standards.
The type of documentation used in Bulgarian credit transactions largely depends on the specific circumstances. Short-form documentation is widely used by Bulgarian banks for the purpose of financing local businesses, where no syndication is envisaged. Syndicated and large-scale financings with an international element (eg, if the lenders are foreign banks) are usually documented by long-form agreements following the forms published by the London Loan Market Association (“LMA“) and subjected to English law and to the jurisdiction of English courts. In syndicated financings with no international element, however, the parties’ freedom to choose a foreign system of law is significantly restricted and, most importantly, the choice of a foreign court in such circumstances would not be enforceable in Bulgaria.
In this respect, Schoenherr Bulgaria was recently mandated by several different banks to prepare long-form agreements, based on LMA models but with a choice of Bulgarian law and Bulgarian courts, and with the Bulgarian language prevailing in case of discrepancies with the English version. In such a contract drafting various English law concepts needs to be adapted to or even substituted by appropriate Bulgarian legal mechanisms serving similar purposes. However following the LMA models brings many additional benefits to the lenders – for example regulating the powers of the agent in detail and making exhaustive arrangements on changes to the lenders may later facilitate a transfer of the loans.
In-house lawyers at top Bulgarian banks say that these are the only examples of such drafting on the market, but it may be expected that the practice will grow, even in cases with an international element where the agent is a Bulgarian bank. The benefits of preparing LMA-based agreements subjected to the law of the bank acting as the agent have already been recognised by other similar jurisdictions in CEE, where such drafting – fol-lowing LMA models but subjected to local laws, is widespread.
Over-the-counter (“OTC“) derivative transactions – mainly plain vanilla FX and interest rates derivatives – are popular on the Bulgarian market as a hedge against important financial risks, such as interest rate and currency rate risks. The market practice when only Bulgarian parties are involved, is to use various local master agreements governed by Bulgarian law (for reasons similar to those outlined with respect to credit facilities). In recent years, we have seen a tendency among the largest local banks that are subsidiaries of important EU credit institutions, to replace their local master agreements with new documentation that closely follows the key provisions of the 2002 ISDA Master Agreement (the “ISDA MA“), but is subjected to Bulgarian law. For cross-border transactions, market participants normally use the ISDA MA, usually governed by English law, while taking into account certain aspects of Bulgarian law. The most important issue for banks in both local and cross-border OTC derivative transactions is to receive a clear opinion on the enforceability of the close-out-netting mechanism under the ISDA MA, since the ability to net allows banks to allocate capital only against the net figure they would have to pay on close-out rather than the gross amount under the transaction. In this respect, however, apart from some special legislation protecting netting when banks are in default, Bulgaria has no general netting-friendly legislation.
An effective netting mechanism
Nevertheless, Schoenherr Bulgaria has found a method to make close-out netting arrangements effective which is acceptable both for local and foreign banks dealing with Bulgarian counterparties that are not financial institutions. The method consists in the provision of financial collateral which must be appropriately linked to the derivative transaction, thus bringing into play the netting mechanism under the EU Financial Collateral Directive as transposed in Bulgaria. That netting mechanism may be negotiated as applicable to any mutual obligations of the counterparties, including their obligations under the derivative with respect to which a financial collateral arrangement has been entered into. Thus, the mutual obligations under a derivative may be effectively netted in case of a termination event under the relevant derivatives agreement. We believe it would be sufficient to grant a small fixed amount of cash as financial collateral to secure the potential (and thus uncertain) future obligation of a bank’s counterparty to pay amounts (if any) under a derivative. The parties may agree that the financial collateral will be updated on certain dates (or only upon the bank’s request, at its discretion) to account for fluctuations in the underlying interest rates or foreign currency exchange rates, which would require the counterparty to provide additional financial collateral, if necessary. Alternatively, the collateral may secure only a portion of the bank’s exposure under the derivative (up to the amount of the collateral that was effectively provided), in which case there would be no need to update the amount of the financial collateral in the future.
It may be expected that aligning local financial documentation with international standards will become even more widespread, as it is associated with important benefits for financial players.