Proactively to the point.
Kieselstein Law Firm was recently noted in The Deal Pipeline1 for its involvement as distressed debt counsel to Clearlake Capital Group in connection with Clearlake’s recapitalization of Globe Energy Services.
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.
When a borrower has deleveraged its balance sheet, distressed investors that received both new loans and enough shares to designate a director of, or otherwise exercise control over, the borrower can find themselves in the uncomfortable role of fiduciary to the borrower’s other creditors if the borrower subsequently becomes insolvent. A recent bankruptcy court decision suggests that such insider lenders’ fiduciary duties may actually require them to preserve litigation rights against themselves simply to avoid having the right to repayment of their loans equitably subordinated.
For the past few months, a working group of the LSTA’s Trade Practices and Forms Committee has been debating changes to the form of Collateral Annex. Sellers of loans on the secondary market use this form when their inability to obtain agent or borrower consent to a pending sale of loans requires them to close the sale on a participation basis. The purpose of the form is to collateralize any ongoing funding obligations the purchasers may have. The realities of transacting in a post-Lehman world have contributed to an increasingly vociferous call by buysiders for seller segregation, or third-party custody, of any cash collateral posted by purchasers under the Annex.
Below, my preliminary notes from the LSTA’s 16th Annual Conference on November 2, 2011.
4:47 PM
Breakout session on Material Non-public Information in the Syndicated Loan Market. Best practices are under pressure due to occurrences in the market, including especially the desire for increased transparency. History of LSTA involvement on MNPI. Sophisticated party expectation of unequal information of parties trading loans. Syndicate Level Information discussed. Sources of authority: state asset protection rules, federal securities laws. Big boy provisions as “contractual disclaimers of reliance” that operate by reverse engineering a fraud claim. Limits on effectiveness of same: securities transactions (SEC not require to prove reliance); prohibition against circumventing securities laws; ineffectiveness against breach of fiduciary duty claims unaffected by CDRs; “blockbuster” information (read, Borrower Restricted Information on material issues) arguably unprotectable.