Responsibilities and obligations of syndicated loan participants

As well as gaining the benefits of the syndicated loans market, the parties involved all have definite responsibilities and obligations to which they must adhere. These duties are described in the section on an introduction to syndicated loans of Chapter 1.

The borrower

The information memorandum

The information memorandum is prepared by the arranger in consultation with the borrower and possibly the borrower’s accountants and legal advisers. The borrower would trigger an Event of Default under the terms and conditions of the loan agreement – giving the participants the right to call for immediate repayment of the syndicated loan – if it were to make any statement or claim which it knew to be incorrect.

Representations and covenants

The loan agreement is likely to include representations, financial covenants, and restrictions. These will typically include:

If the syndicated loan is unsecured, there will probably be a covenant preventing the borrower from giving security for other loans (i.e. a ‘Negative Pledge’).

The borrower may not change its main type of business or dispose of significant subsidiaries without the prior written consent of the participants.

There will usually be financial covenants including various ratios concerning net worth, total borrowing, current assets, current liabilities, pre-tax profit, etc. and possibly a restriction on dividends paid to shareholders.

There may well be restrictions on the borrower taking on additional borrowing.

Many syndicated loans are structured as medium-term loans and the borrower must be certain at the time of signing the loan agreement that it will be able to full these covenants at all times without hindering the management of its business and therefore its ability to service the syndicated loan. Any breach of a covenant is viewed seriously and may lead to an increase in the interest margin (‘penalty interest’) or even an event of default being declared under which the participants may make demand for early repayment of the loan.

Each of the representations and covenants is deemed to be repeated by the borrower each time a loan is ‘rolled over’ and a new interest period begins.

Events of default

The loan agreement contains a list of events of default, any of which may allow the participants to ‘accelerate’ the syndicated loan, i.e. call for immediate repayments of all amounts drawn and cancel any undrawn portion. Events of default are typically designed to provide banks with advance warning of potential difficulties (e.g. technical defaults, such as a financial ratio requirement that is violated) to actual difficulties (e.g. financial defaults missing a payment on interest or principle). Other events of default can be defined for matters such as the entry or exit of directors, the acquisition or disposal of subsidiaries or assets, a ‘substantial change in the nature of the business’, or the contracting of new debt.

How the borrower chooses an arranger for the syndicated loan

A company which is interested in raising a large new syndicated loan is likely to approach more than one bank – or be approached by more than one bank – as potential arranger. Each of these banks will outline their particular strengths and abilities in what is sometimes known as a ‘beauty contest’ of contestants before the borrower decides which bank to appoint.

In coming to this decision, the borrower will take the following points into consideration:

Placing power

The ability of the potential arranger to attract participants into the syndicated loan. This can best be gauged by studying the recent record of the bank, both from details supplied by the bank and by its position over the last few years in the league tables published in the trade press.

Structuring ability

In certain circumstances, and particularly when the borrower is making an acquisition of another company, it may wish to repay the syndicated loan by issuing bonds or other capital market instruments at some time in the future. A bank which can demonstrate its ability to structure and manage this debt issue can be of enormous benefit to the borrower.

This is one of the reasons why the 1990s witnessed a spate of mergers and acquisitions between banks, such as the creation of the Citibank/Salornon/Smith Barney/Schroders agglomeration, in which banks with differing specialities have united so that they can offer a borrower a ‘one stop’ service which can ostensibly handle all the borrower’s different needs (if there are no mass defections due to internecine power struggles).

Sector

Some potential arrangers may specialize in particular sectors and concentrate their efforts in these sectors. A thorough understanding of the borrower’s sector of business by the arranger is important both to the borrower and to the participants.

Experience

If the arranger is also to act as agent, it should be able to demonstrate an experience and ability to carry out the various functions of the agent throughout the life of the syndicated loan. If it is not to act as agent, it should be able to propose another bank which can satisfactorily perform these functions.

Speed of action

The borrower will wish to be satisfied that the potential arranger can complete the structuring, syndication, documentation and finalization of the syndicated loan within a reasonably short-time scale.

Geographic location

If the borrower is located in a different country or region, it is important that the potential arranger has a thorough understanding of local laws and regulations which may affect the legality and repayment of the loan.

Margins and fees

The pricing of a syndicated loan is a fairly exact science, and it would be unusual for one potential arranger to be drastically out of line with its competitors. However, some banks may be more prepared than others to lower the overall cost to the borrower, particularly by reducing the fees payable.

Underwriting

If the proposed syndicated loan needs to be completed very quickly (and perhaps confidentiality is to be protected by restricting the number of parties having knowledge of the purpose of the proposed loan) the arranger may be asked to assemble a group of underwriters, i.e. a group of banks which will speedily advance the whole amount of the loan by taking very large participations which they will later reduce (usually to a prearranged minimum amount which they will retain in their loan portfolios) when the loan is launched in the syndicated loans market. Because of the size of the commitments which they will initially make, underwriters must have a large balance sheet capacity and be capable of acting quickly and aggressively. The ability of the proposed arranger to assemble a group of underwriters can therefore be vital to the borrower.

The participants and their responsibilities

The responsibilities and obligations of the participant in a syndicated loan are set out in the loan agreement and must be adhered to. They include the following.

Commitment

Once a participant has signed the loan agreement and committed to lend a certain portion of the loan, it must do so even if its own circumstances change. Only if a new law or regulation comes into effect preventing it from contributing may it advise the agent that it can no longer honour its participation.

If one bank is preventing from participating in this way, the other participants must still honour their own commitments unless they are similarly affected by the new law or regulation.

(N.B. In these circumstances the agent will attempt to find a replacement bank and if it is unable to do so within a certain time, the total amount of the syndicated loan will be reduced accordingly. The other participants will not have to raise their own participations to cover the amount lost.)

Event of default

The participant is committed to maintain its participation in the syndicated loan unless an event of default occurs. There may be occasions when a participant feels uneasy about a borrower or the sector or geographic region in which the borrower operates, but it is not possible for the participant to withdraw from the loan or even cancel any undrawn commitment unless a formal event of default has occurred and been announced by the agent.

Majority banks

If an event of default comes to the attention of the agent, it will notify the participants. A meeting of all the participants will normally be held at which the position will be discussed. The participants will then be asked to approve a course of action which may include accelerating the loan. The agent must act in accordance with the instructions of a majority of participants, as defined in the loan agreement and usually consisting of a minimum of 66⅔ % in terms of participations (‘majority banks’). All participants are then bound to act in accordance with the decision of the majority banks even if they do not agree with this decision.

Similarly, during the course of a syndicated loan the borrower may propose relatively minor amendments to the terms and conditions of the loan, and again the decision on whether or not to agree is made on the basis of the majority banks’ views and all participants are bound by this decision. (N.B. This does not...