Archive for October, 2015

LSTA trading documents commonly in use in the secondary loan market offer three different conventions to allocate unpaid interest between buyer and seller. Each of the conventions allocates to buyer interest accruing from and after the parties’ closing date, but the conventions differ on whether seller or buyer gets the benefit of interest accruing up to and including the closing date, and whether one party is obligated to front to the other at closing the unpaid interest the other party is entitled to in anticipation of borrower’s payment of same.

Under the “settled without accrued interest” convention, seller generally keeps (if and when paid by borrower) all interest accruing through the earlier of the actual closing date or the “Commencement Date”¹ for “delayed compensation”², but buyer has no obligation to front such interest to seller at closing³.  Loans generally settle on a “trade flat” basis, entitling buyer to receive any pre-closing accrued interest, once the loans are non-performing—including where borrower has become the subject of a Chapter 11 proceeding in which borrower is no longer paying interest on the loans post-petition.⁴

The least commonly used convention, “paid on settlement date”, mirrors seller’s obligation in “settled without accrued interest” trades to front post-Commencement Date accrued interest to buyer at closing by requiring buyer to front to seller at closing all accrued unpaid pre-Commencement Date interest.⁵  Unlike in the “settled without” situation, however, buyer in a “paid on settlement date” trade traditionally did not have the right to claw back such interest from seller in the event borrower defaults.⁶ This has effectively transferred from seller to buyer the risk of borrower’s nonpayment of such interest.

Revisions to the LSTA par/near-par and distressed confirmations, and related trading documents, currently under review by the LSTA’s Trade Practices and Forms Committee propose to reverse this imbalance.⁷ Under the proposed revisions, the same clawback rights granted to seller to recover, in the event of a borrower default, post-Commencement Date accrued interest paid as delayed compensation will be extended to buyer to recover “paid on settlement date” interest fronted to seller at closing that is in fact never paid by borrower.

The net effect of these revisions will be to change the “paid on settlement date” convention from a credit risk reallocation to a rule of administrative convenience—assuming, of course, that buyer succeeds in getting its seller to repay the fronted interest payment in the event borrower does not  reimburse buyer for the payment.  Whether this equalization of the interest-fronting rules increases use of the “paid on settlement date” interest convention in the secondary loan market remains to be seen.

No set date for the effectiveness of the new rule has yet been announced.

1. 1  A specified number of business days after the Trade Date—seven (7) in the case of a par/near-par trade, and twenty (20) in the case of a distressed trade. See LSTA Standard Terms and Conditions for Distressed Trade Confirmations (published April 24, 2014), LSTA.ORG, http://www.lsta.org/legal-and-documentation/secondary-trading#secondary-trading (last visited October 23, 2015) (“Distressed Confirms STC”), §6; LSTA Standard Terms and Conditions for Par/Near Par Trade Confirmations (published April 24, 2014), LSTA.ORG, http://www.lsta.org/legal-and-documentation/secondary-trading/secondary-trading (last visited October 23, 2015), (“Par Confirms STC”), §6. ↩
2. 2  Generally, “delay compensation” includes all interest accruing from and after the Commencement Date.  Frequently-Asked Claims Trading Questions: Delayed Compensation, www.kieselaw.com/claims-trading-faq/delayed-compensation (last visited October 23, 2015). ↩
3. 3  Conversely, seller is obligated to front accrued interest comprising delayed compensation at closing, but seller has the right to claw it back if such interest it represents is not timely  paid by borrower.  See Distressed Confirms STC, §6; Par Confirms STC, §6. ↩
4. 4  By contrast, where the subject loans are perceived to be fully secured and the lenders and borrower enter into a cash collateral order that provides for interest to be paid post-petition on an ongoing basis, interest is generally allocated in a manner consistent with the “settles without accrued interest” convention that applies outside of Chapter 11. See Distressed Confirms STC, §5; Par Confirms STC, §5. ↩
5. 5  See Distressed Confirms STC, §5; Par Confirms STC, §5. ↩
6. 6  See Distressed Confirms STC, §; Par Confirms STC, §5; cf. n.3 above. ↩
7. 7  See LSTA Standard Terms and Conditions for Distressed Trade Confirmations (proposed draft dated August 31, 2015), LSTA.ORG, http://www.lsta.org/legal-and-documentation/secondary-trading#secondary-trading (last visited October 23, 2015); LSTA Standard Terms and Conditions for Par/Near Par Trade Confirmations (proposed draft dated August 31, 2015), LSTA.ORG, http://www.lsta.org/legal-and-documentation/secondary-trading#secondary-trading (last visited October 23, 2015). ↩