Banks have become very active in recent months selling off large portfolios of loans. For example, it has been widely publicised that RBS and its subsidiary Ulster Bank are currently offering for sale large portfolios of loans as part of RBS’s “Capital Resolution” project which aims to reduce the size of its non-performing loan book. Lloyds Banking Group has also undertaken similar loan sales in recent months.
Concerns for borrowers
The prospect of having their loan sold to a third party often creates concerns for borrowers, these include:
- Their loan being sold to a third party with whom they have no existing commercial relationship, and with whom they would not have chosen to have a lender/borrower relationship.
- The interests/strategy of the purchaser in dealing with the loan may be very different from that of the original lender. The objectives for funds investing in distressed loan portfolios can vary significantly, sometimes they are interested in investing in loans for the long term, alternatively, the fund’s objectives may be to make a profit by taking enforcement action. This could include taking possession of the property that is providing security for the loan, and selling it on (or holding the property rather than the loan as an investment, perhaps as part of a wider portfolio of similar/connected assets). It is also possible that the purchaser may not be in the business of lending money, but of acquiring assets.
- Some borrowers may be able to agree a restructuring at a profit for the purchaser which in fact provides a better outcome than they had been able to negotiate with their original lender; whether the purchaser is open to such an offer, will depend on its commercial objectives for acquiring the loans in the first place. Whether the borrower has the means/funding capability to agree terms that provide the purchaser with an acceptable return when compared to other options available to the purchaser will also be a factor. It may be that the purchaser wishes to hold the loan/asset on the expectation of increased value in the future. If this is the case any hope of the borrower restructuring the loan by agreeing a reduced redemption figure will be lost, even if such discussions had already commenced with the original lender.
- If the loan being sold is in default (whether by way of missed payments, breach of covenants or other facility terms) or becomes in default after the sale, the purchaser will usually have the same rights as the selling bank under the terms of the loan facility. The borrower’s concern is that typically this will include the ability to demand repayment of the loan, put the borrower into administration or bankruptcy, send receivers in to sell property, increase interest payments and fees, and generally impose less favourable terms on the borrower.
- Loans are usually purchased with the benefit of all the security available to the original lending bank. This will include any cross company or personal guarantees as well as debentures or charges over shareholdings in associated companies. If the loan relates to a company which is part of a wider group of companies, enforcement action or insolvency proceedings taken against one company by a new lender may have serious knock on implications for other companies in the group. This is due to common provisions which allow other lenders to the group to treat any such enforcement action as an event of default, thus triggering rights to call in their own loans and/or apply increased rates of interest/fees.
It is easy to see why the prospect of such a loan sale can be worrying for borrowers who may have spent several years negotiating through a difficult financial climate and investing time and money in their banking relationship to try to keep their business afloat pending a recovery in property values and trading conditions. Many borrowers will also have invested substantial time and money progressing projects to enhance the value of their property (e.g. ongoing complex and expensive planning applications). The borrower may be concerned that this investment will be lost if their loan is purchased by a fund intent on enforcement action which then prevents the borrower from being able to recover the initial equity which they had invested in the project/business.
What action can borrowers take?
There are a number of steps that borrowers can take to protect their position in circumstances where they are notified (or suspect) that their bank is intending to sell their loan to a third party. These include:
1. Know your rights. Check your loan agreement/facility letter– can the bank sell the loan to a third party? Or are there restrictions/conditions the bank must comply with?
The most common contract terms relating to the transfer/sale of loans (usually referred to as “assignment” and/or “novation”) are as follows:
- Bank can transfer without any restriction or requirement to notify the borrower in advance; or
- Bank must notify the borrower of its intention to transfer the loan; or
- Bank is required to consult the borrower in advance of any transfer; or
- Bank can only transfer to certain types of purchaser e.g. only to another financial institution providing loan facilities as part of its business; or
- Borrower’s consent is required to any transfer. (The terms may or may not say that such consent cannot be unreasonably withheld).
The transfer of a loan by novation will have different effects to transfer by assignment. The main difference between the two procedures is that whereas an assignment transfers all the seller’s rights under the loan to the buyer, a novation transfers both the seller’s rights and their obligations (such as an obligation to provide further lending to the borrower). A novation involves the creation of an entirely new loan which, if the loan is secured, has the effect of discharging the existing security, resulting in a need to take new security (which can affect its priority and vulnerability in the event of an insolvency).
As a novation creates a new loan, all the parties (i.e. including the borrower) are required to consent to it (while an assignment only requires the signature of seller and buyer, subject to any restrictions created by terms in the facility agreements which give the borrower a say). From a borrower’s point of view, the facility agreement and all security documents should be checked to see whether or not they contain a clause whereby consent to a novation has already been given in advance.
Another means by which a bank can transfer its interest in the loan is by way of sub-contracting or sub-participation to a third party rather than assignment or novation. Both assignment and novation involve the initial lender transferring its interest outright so that it no longer has any involvement in the lender/borrower relationship. Sub-contracting and sub-participation, however, leave the initial loan agreement in place between the lender and borrower but bring in the third party by way of a contractual arrangement with the lender. Typically, such an arrangement requires the lender to pass on the economic benefit of the loan to the third party sub-contractor (i.e. interest payments or capital repayments whether on a performing basis or recovered by way of enforcement over security).
This means that the borrower still deals with their original bank, but the financial benefit of the loan has been sold on to someone else and the lender becomes a conduit for payments between the borrower and the third party. Usually the third party purchaser of the economic interest will have negotiated terms giving it the ability to control the lender’s management of the loan account and to require the bank to take enforcement action if it appears necessary to protect the financial interest it has acquired. It is less common for restrictions to be placed on the Bank’s right to sub-contract/offer sub-participation in loans but the wording of the loan agreement should be checked carefully in each case because such restrictions may exist.
2. Can the benefit of any associated security or finance documents be transferred without the consent of the borrower or any guarantors?
Borrowers should check the terms of all security documents and associated contracts, for example, guarantees and interest rate hedging products, to see whether these can be sold on with the loan without the borrower’s consent or if there are any other restrictions regarding transfer.
3. Make sure that any ongoing disputes or agreements reached with the bank about amendments to terms on your facility, or waivers of the bank’s rights are recorded in writing.
Consider sending a letter reminding the bank of all the points you would like a potential loan purchaser to be made aware of. This makes it less likely that any disputes will arise later between you and the new lender because the bank will have to consider carefully now what representations it makes and how to answer the potential purchaser’s queries during the sale process to avoid allegations that the bank has misled the purchaser if a dispute arises later.
4. What confidential information about your business has the bank disclosed to potential purchasers with the sale memorandum or in the data room? Does the loan agreement allow the bank to disclose such information?
The bank will not be allowed to disclose the confidential information it holds about your business and/or personal financial circumstances unless the loan agreement provides for this or you have subsequently agreed to it. A borrower may not be able to control who views information provided by the bank to potential purchasers in a “data room” (a facility which enables a purchaser to carry out “due diligence” before deciding whether to proceed). So, you could find that information has been passed to other parties which may assist them in their own dealings with you, if you happen to have a commercial relationship with them unconnected to the loan being sold (e.g. the potential purchasers may include lenders with whom you have other loans, or even competitors or parties with whom you are in dispute about unconnected matters).
5. Be vigilant. A bank planning a loan sale in the short to medium term may check in advance for terms which restrict its ability to do so and try to achieve (in the course of other discussions/restructuring) amendments to your facility terms to remove any restrictions or other clauses which might present obstacles to selling the loan.
It is strongly advisable to take legal advice on any proposed changes to facility terms, even if they appear straightforward or if you think you know what they are intending to do, because there may be implications or consequences, not apparent to non-lawyers, which could be important in the context of your rights in the event the bank decides to sell your loan.
6. Apply to Court for an order restraining the bank from selling your loan.
If, having considered the points above, you believe that the bank is selling your loan in breach of the provisions in your loan agreement or there is a risk of disclosure of confidential information in the process that could damage your business, then consider applying to Court for an order restraining the bank from either selling your loan without complying with the required procedure or from wrongfully disclosing your confidential information. This usually takes the form of making an urgent application for an injunction.
An application for an injunction must be made very quickly if it is to have practical effect (no point closing the stable door after the horse has bolted!), and also because the Court will take into account how promptly the application has been made when deciding whether to grant the application.
The application is complex and specialist legal advice is strongly recommended. This should be obtained as quickly as possible after you realise that there is a problem with a proposed loan sale.
An injunction, if awarded, usually provides interim relief to “preserve the status quo” pending a full hearing, usually some months later, to decide whether the bank is able to sell the loan, or not, or any other points in issue between the parties.
You will need to show (amongst other things) that you have a reasonably strong case, that your position is correct, and that damages would not be an adequate remedy should the bank proceed to sell your loan and you were to make a claim thereafter for losses suffered.
It is likely that you will also have to provide an undertaking to compensate the bank for any losses suffered if you obtain an injunction and if, at a full hearing of your case, you are ultimately unsuccessful in establishing that the bank was in the wrong. Depending on the circumstances these damages can vary significantly (from minimal to very substantial) and so it is important to seek specialist legal advice.
Injunctions can be a useful tool in these circumstances and in certain cases might lead to a negotiated deal but they must be approached with caution so that you have a full understanding of their pros and cons and of the other options that may be available to you.