lender's risk of non-payment.277
3.2.5 The parties to a syndicate and their functions
The syndicate is led by a mandated lead arranger or mandated lead lender, often the initial lender. If the mandated lead arranger acts as principal, the syndicate members each place the lead lender in funds sufficient to advance the full commitment.278 If the mandated lead arranger acts as agent, the syndicate members each pay their loan portions into the agent's bank account, who in turn pays (or loans) the capital to the borrower.279 The syndication either takes place on a ʹbest efforts basisʹ, where the lender uses its best efforts to raise the capital required by the borrower, but is not contractually bound to raise such an amount, or the mandated lead arranger (or a group) underwrites the deal. In the latter structure, the mandated lead arranger assumes the risk, and invites other lenders to co-lend, failing which the mandated lead arranger advances the full amount committed.280
The book-runner manages the syndication process, manages the final composition of the syndicate, manages the primary distribution, sells the underwritten commitment or arranges the syndication on a ʹbest efforts basisʹ, and is also a lender.
The facility agent is appointed by the lenders as their agent,281 but its fees are paid by the borrower. Its function is primarily that of an administrator and facilitator, co-ordinator of the facility and the lenders, and the lenders representative.282 The facility agent represents the lenders, administers the facility, reviews the fulfilment of the conditions precedent, acts as the conduit for (i) all payments made283 and the facility agent then pays the amounts due to the lenders; and (ii) notices issued under the facility, receives and distributes borrower information, calculates interest rates, calls defaults, exercises the lenders' right to accelerate the loan due date, exercises the lenders' discretionary rights, and attends to the mechanics for loan transfers to new lenders.284 There are conflicting schools of thought as to whether the facility agent owes fiduciary obligations to the syndicate lenders. The one school contends that as the agent fulfils traditional agency functions and has wide discretion when doing so, it consequently has fiduciary obligations to the syndicate lenders.285 The other school contends that as the facility agent performs administrative duties on an arm's length basis, and as the facility agreement typically excludes any fiduciary relationship between the facility agent and
277 The methods for sharing security rights between lenders and the transferability of security rights are considered in section 4.11 Security structure and security rights of syndicate lenders.
278 Burgess Corporate Finance Law 2 ed (1992) 260 para 7.53.
279 Ibid para 7.53.
280 Loan Market Association 'LMA Syndicated Loans Workshop Bonds, Loans and Sukuk Africa' Cape Town, 15 March 2016;
Bratton Corporate Finance (2012) 304–305. At 304, Bratton defines syndication as '[a] very large loan made to one borrower by a group of banks'.
281 McKnight, Paterson & Zakrzewski The Law of International Finance (2017) 520 para 9.6.1.1.
282 Ibid at 520–521 para 9.6.1.1; Proctor The Law and Practice of International Banking (2015) 425–426 para 21.23; Wright International Loan Documentation (2014) 272–273; the LMA's Term Facilities Agreement, clause 25.3 (Duties of the agent).
283 See section 3.2.5 The parties to a syndicate and their functions.
284 McKnight, Paterson & Zakrzewski The Law of International Finance (2017) 520–521 para 9.6.1.1; Proctor The Law and Practice of International Banking (2015) 425–426 para 21.23; Wright International Loan Documentation (2014) 272–277.
285 Ajibo 'Syndicated Lending: Re-conceptualising the Role of the Managing Bank and Agent Bank' (2015) 30(9) Journal of International Banking Law and Regulation 476–486 at 2 (Westlaw version), who cites commentators such as Tennekoon at n 14 and Qu and Menges at n 15 as proponents of the position that agency implies fiduciary obligations to the syndicate lenders.
the lenders it represents, the facility agent has no fiduciary obligations.286 The better view, it is submitted, and which is in fact the view of the English court in Torre Asset Funding Ltd v Royal Bank of Scotland plc287 ('Torre') and the LMA,288 is that the facility agent's obligations are not intended to create a fiduciary relationship between the facility agent and the lenders289 if one considers the administrative and technical nature of the agent's duties, and the contractual exclusion of any such fiduciary relationship. In Torre, the facility agent in its capacity as agent for the junior lenders, discussed rescheduling the borrower's debt with the borrower not realising it constituted an event of default. The court limited the facility agent's role to what was stated in the agreement. It declined to extend the facility agent's obligations, and accepted that the agreement excluded a fiduciary relationship between the facility agent and the lenders.290 Facility agents are averse to attracting fiduciary obligations to lenders they represent because of the potential liability they would be exposed to. Facility agreements tend to exclude the facility agent's liability and responsibility that may be alleged the facility agent has within a duty of care, to protect the lenders' interests,291 in the performance of its obligations.
These obligations include exercising discretionary rights or ensuring the adequacy of documentation or information on which the lenders rely. The facility agent's discretionary rights in performing its obligations do not, in the LMA's Term Facilities Agreement, attract fiduciary responsibilities.292
The facility agent takes its instructions from all lenders if the matter requires an all- lender decision,293 and, in all other instances, it takes its instructions from the majority lenders.294 The types of matters requiring all-lender decisions and those requiring majority lender decisions can be highly contested areas as between the classes of lenders. Instructions given to the facility agent by the majority lenders bind all the finance parties, which include mezzanine and junior lenders, and override any conflicting instructions, unless that matter is reserved for decision by another lender.295 Majority lenders are defined as lenders whose commitments aggregate more than 66.6 per cent.296 If no instructions are forthcoming, the facility agent can exercise its discretion to act in the lenders' best interests.297 Contractually, the facility agent is obliged to execute the majority lenders' instructions regardless of the loan repayments at that time. So, for
286 Ibid. Ajibo cites commentators such as Clark and Farrar at n 16, Mugasha at n 17 and Skene at n 18 as proponents of the position that the agent has no fiduciary obligations to the syndicate lenders; McKnight, Paterson & Zakrzewski The Law of International Finance (2017) 524–525 para 9.6.2.1.4.
287 Torre Asset Funding Ltd v Royal Bank of Scotland plc [2010] All ER (D) 295 (Oct); [2013] EWHC 2670 (Ch).
288 The LMA's Term Facilities Agreement, clause 25.5(a) (No fiduciary duties).
289 Ajibo 'Syndicated Lending: Re-conceptualising the Role of the Managing Bank and Agent Bank' (2015) 30(9) Journal of International Banking Law and Regulation 476–486 at 2 (Westlaw version).
290 Torre Asset Funding Ltd v Royal Bank of Scotland plc [2010] All ER (D) 295 (Oct); [2013] EWHC 2670 (Ch); Proctor The Law and Practice of International Banking (2015) 426–427 para 21.25; Wright International Loan Documentation (2014) 273.
291 McKnight, Paterson & Zakrzewski The Law of International Finance (2017) 530–531 para 9.6.3.4.
292 The LMA's Term Facilities Agreement, clause 25.5(a) (No fiduciary duties) read with clause 25.7 (Rights and discretions).
293 The LMA's Term Facilities Agreement, clause 25.2(a)(i)(A) (Instructions); McKnight, Paterson & Zakrzewski The Law of International Finance (2017) 456–457 para 9.2.3.
294 The LMA's Term Facilities Agreement, clause 25.2(a)(i)(B) (Instructions); McKnight, Paterson & Zakrzewski The Law of International Finance (2017) 456–457 para 9.2.3.
295 The LMA's Term Facilities Agreement, clause 25.2(c) (Instructions).
296 The LMA's Term Facilities Agreement, clause 1.1, definition of 'Majority lenders'. Multiple lender transactions distinguish between senior lenders, mezzanine lenders and junior lenders. Each of these categories will then have its own majority lender thresholds for decision-making and voting purposes.
297 Ibid clause 25.2(e) (Instructions).
example, the facility agent must obey the majority lenders' instructions while the senior loans remain outstanding, even if second ranked security was created to secure the mezzanine and junior lenders' interests, unless that matter is reserved for decision by another lender or a lender group.
Then one has all the lenders, who may be categorised as senior, mezzanine and junior lenders. A syndicate can be as simple as consisting of one senior lender and one mezzanine lender, or as complex as consisting of multiple senior lenders, multiple mezzanine lenders and multiple junior lenders.
3.2.6 The phases of syndication
Godlewski and Weill298 provide an insightful analysis of the factors that affected a bank's decision to syndicate loans in emerging markets in Asia, Central and Eastern Europe, the Middle East and Latin America, during the period 1992 to 2004. In their analysis, they describe bank syndication as a sequential, three-phase process. In the pre- mandate phase, the borrower invites competitive bids from banks, chooses a lead bank, and mandates it to form a syndicate. The borrower and the lead bank, acting as the syndicate's agent, negotiate the preliminary loan terms. The syndicate is not a legal persona in that it has no capacity to contract, sue or be sued. Although the syndicate may have been formed, the syndicate members may not yet have subscribed for their portion of the loan. In the post-mandate phase, the lead bank initiates the syndication process, which includes preparing an information memorandum that contains information about the borrower, preparing a package for possible members, inviting them to participate in the syndicate, and drafting a facility agreement. The lead bank tries to manage the subscriptions to the loan so that it is neither over-subscribed nor under-subscribed, and then determines each bank's loan allocation. In the third phase, the loan becomes operational and the parties are legally bound299 in the manner contemplated in section 2.2 (The nature and genesis of loans in South African law).
The LMA describes the phases similarly, although somewhat differently.300 In the pre-mandate phase, the mandated lead arrangers and book-runners negotiate market terms with the borrower, obtain credit approval, and devise and execute a syndicate strategy (for example, on an underwritten basis or a ʹbest efforts basisʹ). In the post- mandate phase, the information memorandum is prepared, the syndicate is launched, legal counsel drafts the loan and security documentation, which are negotiated between the banks and the borrower, and participations in the loan are allocated amongst the syndicate members. In the last phase, the transaction is closed by the parties signing all the loan and security documentation and holding a closing meeting if needed. Once the transaction is closed, the facility agent is responsible for the transaction.
298 Godlewski & Weill 'Syndicated Loans in Emerging Markets' 2008 Emerging Markets Review 206.
299 Ibid 208 para 2.1.
300 Loan Market Association 'LMA Syndicated Loans Workshop Bonds, Loans and Sukuk Africa' Cape Town, 15 March 2016.
3.2.7 The contractual and economic relationship between the syndicate lenders In a syndicated loan, lenders agree contractually to rank the repayment of their loans pro rata and rank the enforcement of their rights and security interests, in the same order of priority. Any repayment or enforcement priorities that are not pro rata are dealt with either in an intercreditor agreement or by structural subordination. The lenders further agree on a payment waterfall or a funds flow waterfall, where incoming funds paid by the borrower in settlement of the loan are distributed between the lenders in stipulated amounts and in a specified order of priority to settle the borrower's debt.301 If incoming funds received by lenders exceed the amount due to them or are not repaid in the specified order of priority, but are repaid in a different order, unpaid lenders or lenders who were paid less than the amount agreed will have claims against the borrower or the other lenders for the repayment of their loans. The intercreditor agreement ensures the orderly and structured settlement of claims and the enforcement of security rights. Although an intercreditor agreement is, for these reasons, fundamental to a syndicated loan, its enforcement can be mired in controversy if it seeks to alter lenders' rights inter se on the borrower's insolvency.302
A facility agreement typically also contains a so-called sharing clause which facilitates the lenders being repaid equally from a payment made to a lender in preference to other lenders.303 The clause states that if a lender receives or recovers amounts directly from an obligor otherwise than in accordance with the agreed repayment structure, that lender is obliged to notify the agent who will determine if such payment exceeds the agreed repayments. If so, the recovering party is obliged, within three business days of the agent's demand, to pay such amount over to the agent who then redistributes such amount between the lenders in accordance with the contracted payment structure.304 McKnight et al contend, correctly so, that the sharing clause gives effect to the pari passu distribution of payments amongst the lenders.305
The lenders' respective commercial and legal positions are as follows. The capital required by the borrower and the associated risks are apportioned between the lenders.
The senior lender, typically a secured creditor, lends most of the capital, is repaid first in the payment waterfall from incoming repayments, and holds first ranked security. The mezzanine lender lends subordinated debt, with its claims and security ranking after those of the senior lender. The mezzanine lender usually charges a high interest rate.
301 Johns 'Financing as Governance' (2011) 31(2) Oxford Journal of Legal Studies 391–415 at 401 n 38. The payment waterfall typically distinguishes between pre- and post-enforcement scenarios. In the pre-enforcement scenario, as an example, the payment priority includes all debts of the borrower paid in this order (i) all costs, charges and fees due under the finance documents; (ii) operating costs; (iii) taxes; (iv) interest due under the loan; (v) capital repayments due under the loan; (vi) mandatory prepayments of the loans; (vii) voluntary prepayments of the loans, and so forth.
302 Morrison 'Rules of Thumb for Intercreditor Agreements' 2015 University of Illinois Law Review 721–734 where Morrison discusses the conflicting positions taken by US courts on enforcing intercreditor agreements that assign or waive creditors' bankruptcy rights.
303 McKnight, Paterson & Zakrzewski The Law of International Finance (2017) 455 para 9.2.2.1; Proctor The Law and Practice of International Banking (2015) 435 para 21.40.
304 The LMA's Term Facilities Agreement, clause 27 (Sharing among the finance parties). The clause contains related terms and nuances not relevant to this thesis. The origins, development and complexities of (applying) the sharing clause are not dealt with in this thesis. In this regard, see for example, Proctor The Law and Practice of International Banking (2015) 435–
437 paras 21.40–21.45.
305 McKnight, Paterson & Zakrzewski The Law of International Finance (2017) 455 para 9.2.2.1.
Amon and Dorfleitner,306 relying on information and statistics of the Directorate-General for Enterprise and Industry in 2007 and Henson's view,307 contend that, in Europe, with mezzanine lenders seeking returns of between 15 and 25 per cent on their loans, the overall costs of these loans are higher than senior debt. The mezzanine lender is repaid next in line in the payment waterfall, after the senior debt has been repaid. The junior lender lends the least, ranks last in the payment waterfall, and usually lends on an unsecured basis.
The economic relationship between senior debt and mezzanine debt, and by implication the relationship between senior lenders and mezzanine lenders, has been studied in Europe. In a limited study examining the influence of mezzanine financing on medium-sized European businesses, Amon and Dorfleitner308 reviewed 4,728 mezzanine transactions as at 31 December 2010, worth €64.4 billion, that were transacted in Europe between 1971 and 2010 as part of 28,400 private equity transactions. They found that, before the 2007 to 2008 international economic crisis, transactions comprised a higher senior debt proportion and a lower subordinated debt proportion, whilst during the crisis the proportions were inverted, with lower senior debt proportions and slightly higher subordinated debt proportions. Their hypothesis, factually proven by the data set analysis, was that senior debt and mezzanine debt are negatively correlated to each other.
Drawing on this conclusion, it is theoretically probable in the financing of medium- sized European businesses that the senior debt to mezzanine debt ratio was, during the 2007 to 2008 crisis, inversely proportional to each other. A similar study would have to be conducted in South Africa to determine the correlation between senior debt and mezzanine debt to understand the relationship between senior lenders and mezzanine lenders.
The syndicate lenders may, however, not require security for the loan if the borrower's balance sheet is strong, the borrower is classified as 'investment grade',309 or the lenders are satisfied that the risk of non-payment or borrower insolvency is remote. In such instances, the lenders' interest rates are usually higher than if they had security, to compensate them for not having security.
3.2.8 Insolvency considerations
South Africa's insolvency laws rank syndicate lenders' rights inter se against the borrower's insolvent estate and distinguish between secured, preferent and concurrent creditors, which categories apply equally to syndicate lenders regardless of their title as
306 Amon & Dorfleitner 'Financial Crisis' 2013 Journal of Small Business & Entrepreneurship 173.
307 Henson 'The Pros and Cons of Using Mezzanine Capital' (August 2010) Denver Business Journal 6–12.
308 Amon & Dorfleitner 'Financial Crisis' 2013 Journal of Small Business & Entrepreneurship 174, 175 and 178.
309 According to Investopedia, investment grade is the quality of a company's credit rating, and a company must have a credit rating by Moody's or Standard and Poor of 'BBB' or higher. A rating of below 'BBB' is considered to be non-investment grade.
See https://www.investopedia.com/ask/answers/what-does-investment-grade-mean.
315 For example, if the lender as a secured lender had subordinated its claims in favour of other secured lenders, the subordinating lender's claim will be paid only once all other secured lenders' claims have been paid in full.
316 Ex Parte De Villiers and Another NNO In Re Carbon Developments (Pty) Ltd (In Liquidation) 1993 (1) SA 493 (A) at 505.
317 Ibid. See Morrison 'Rules of Thumb for Intercreditor Agreements' 2015 University of Illinois Law Review 721–734 for an exposition of the controversy regarding the enforceability of intercreditor agreements in the USA where such agreements assign or waive creditors' bankruptcy rights.
318 The concursus creditorum is analysed in section 3.3.2 English case law lessons regarding acceleration notices and the priority of claims under the heading Subordination.
319 Section 48 of the Insolvency Act; Meskin Insolvency Law and its Operation in Winding-Up (1991) para 9.3.
320 Section 48 of the Insolvency Act.
321Donaldson Investments (Pty) Ltd v Anglo-Transvaal Collieries 1979 (3) SA 713 (W) 715B. See section 4.8 Pari passu ranking of security.
322 Ibid. For example, secured lenders may agree in an intercreditor agreement that their claims rank pari passu.
323 See section 4.11 Security structure and security rights of syndicate lenders.
324 See ss 96(3) (death-bed expenses), 97(2)(c) (costs of sequestration) and 99(2) (preference in regard to certain statutory obligations) of the Insolvency Act.
no statutory application of the pari passu principle generally to all creditors of an insolvent estate.325 At common law, the principle paritas creditorum (equality of creditors) applies to all unsecured creditors whereby each creditor will be paid an amount proportionate to its claim, without any creditor being advantaged over other creditors.326 Subordination alters the pari passu ranking of claims because the subordinated claim will be paid after the other claims are paid, not equally with and when such claims are paid. The type of risk that the syndicate lenders are willing to undertake in relation to repayment and security rights determines their ranking. In turn, the syndicate lenders can then determine their pricing for such risk.
3.2.9 Tranche wars among syndicate lenders
If the borrower defaults on repaying the loan to both the senior lender and the mezzanine lender, the lenders, in seeking to enforce their competing claims to repayment and security, may engage in litigation aptly described as a tranche war.327 Although intercreditor agreements may contain contractual mechanisms to manage the competing lenders' claims, tranche wars may still arise if parties interpret such mechanisms differently. This occurred in 2010 in a New York court decision by Judge Lowe in Bank of America, NA v PSW NYC LLC,328 which strengthened the position of senior lenders in relation to mezzanine lenders in a structured or tiered loan.329 The court found in favour of the senior lenders that the mezzanine lenders had to cure all senior loan defaults committed by the borrower, and dismissed the mezzanine lenders' arguments, as did the Court of Appeals.
In South Africa, tranche wars have not yet come before our courts, and it remains to be seen if our courts will follow the approach and rationale of the New York courts. The South African courts will most likely give effect to the parties' intentions set out in an LMA-styled intercreditor agreement. The nature of the remedy afforded by South African courts to lenders will be determined by inter alia the terms of the intercreditor agreement, and considerations of fairness and public policy. The probabilities are reasonably strong that, in a similar dispute, the South African courts may enforce a mezzanine lender's obligation to cure senior loan defaults prior to allowing it to realise its security rights.
Such enforcement will most likely occur because both legal systems recognise the hierarchical ranking of senior, mezzanine and junior claims.330 The position under English law is similar. In South Africa, whether senior, mezzanine and junior lenders are
325 There is no such principle cited in the Insolvency Act other than in respect of ss 96(3), 97(2)(c) and 99(2). The seminal insolvency works of Meskin Insolvency Law and its Operation in Winding-Up (1991) and Sharrock 'Secured Creditors and Realisation of Secured Property' LAWSA vol 11 2 ed (2008) make no mention of such a general pari passu principle.
326 Brits Real Security Law (2016) 2.
327 Bobbit 'Mezzanine and Mortgage Lenders' 2012 Columbia Business Law Review 240–283. The term 'tranche war' arose in the context of real estate finance but can be extended to disputes between lenders of all types of finance.
328 Bank of America, N.A. v PSW NYC LLC 918 N.Y.S.2d 396 (2010); Stangland & Ferguson 'Intercreditor Case Law Update' (2012) 129(3) Banking Law Journal 280 at 283.
329 In Bank of America, N.A. v PSW NYC LLC 918 N.Y.S.2d 396 (2010) the court adjudicated a dispute between senior lenders with loan claims aggregating $3 billion and 11 separate mezzanine loans aggregating $1.4 billion arising from the borrower defaulting on both senior and mezzanine loans.
330 South African courts acknowledge the distinction between senior, mezzanine and equity/junior funding even though these have not been accepted into South African law as forms of funding. See for example, Maleth Investment Fund (Pty) Limited v Paget 2014 JDR 0968 (GSJ) and Structured Mezzanine Investments (Pty) Ltd v Davids and Others 2010 (6) SA 622 (WCC);
[2011] All SA 583 (WCC) where the court inter alia acknowledged the existence of mezzanine funding as a form of funding.