4.11 Security structure and security rights of syndicate lenders
4.11.2 The security structure
The security structure typically used in a syndicated facility transaction governed by South African law is a Security SPV771 incorporated in terms of the Companies Act 2008.772 However, security rights can be held directly by a senior lender and a mezzanine lender in their names, although this is unlikely.773 The security rights and structure are typically effective prior to draw down because that is when the lender(s) will be at risk.
764 See the discussion in section 4.8 Pari passu ranking of security.
765 See the discussion in section 4.9 The realisation of security.
766 The LMA's User's Guide to the Recommended Form of Documents for Use in the South African Market (updated 21 December 2018) 51–53.
767 Ibid.
768 See the discussion in section 3.2.7 The contractual and economic relationship between the syndicate lenders.
769 See the discussion in section 3.3.2 English case law lessons regarding acceleration notices and the priority of claims, which explains the principles of subordination in South African law in the section Subordination.
770 Ex Parte De Villiers and Another NNO In Re Carbon Developments (Pty) Ltd (In Liquidation) 1993 (1) SA 493 (A) at 505.
771 The LMA, in its User's Guide to the Recommended Form of Documents for Use in the South African Market (updated 21 December 2018) 51–53, recognises that in South Africa in multiple lender transactions, the Security SPV structure is used and that its use is driven by the restrictions in the Deeds Registries Act 47 of 1937. It refers to s 54 whereby neither a mortgage bond nor a notarial bond can be passed in favour of an agent acting for a principal. As a result, obligors undertake principal commercial obligations in favour of the Security SPV as discussed in this section. See Locke Aspects of Traditional Securitisation in South African Law (LLD thesis, UNISA, November 2008) at 43 for an analysis of Security SPVs in the context of securitisation transactions, and Hatzilambros Determinants of the Cost of Credit for Project Finance Debt in Africa (MCom Finance (Financial Management), UCT, August 2016) for a broad non-legal discussion of Security SPVs in the context of project finance transactions. Major law firms in South Africa use the Security SPV structure in syndicated lending transactions;
I have used the Security SPV structure as lender's counsel in many transactions. The term 'Debt Guarantor' is often used in transactions instead of Security SPV. Apart from these referenced sources, and the Boshoff article in n 724, there is no South African academic or common-law authority for the use of the Security SPV structure in syndicated lending transactions.
772 The LMA's User's Guide to the Recommended Form of Documents for Use in the South African Market (updated 21 December 2018) 51–53; Boshoff 'One Way or Another' (2016) 35(9) International Financial Law Review 45–46.
773 See the discussion in section 6.7.1 The divisibility of personal rights regarding the senior lender and the mezzanine lender holding security directly in their names.
The Security SPV is mandated by the lenders to hold and realise their security interests if the borrower defaults,774 is placed under business rescue,775 or goes insolvent.776 The Security SPV is established as an insolvent remote entity by limiting its main business in its Memorandum of Incorporation777 to holding the security interests bonded, ceded and pledged in its favour. The LMA indicates that the Security SPV is (i) ring-fenced so as to ensure that it only acts as a special purpose vehicle company under the relevant transaction;778 and (ii) tax-neutral. If the Security SPV's business is restricted in this manner, it is unlikely to trade itself into insolvency by either its liabilities exceeding its assets or by being unable to pay its debts when they fall due. The lenders derive comfort from this security structure as their security rights are unlikely to be prejudiced by insolvency. The cost of setting up and administering the Security SPV is borne by the borrower.779
The shares in the Security SPV are owned and held by a trust established in terms of the Trust Property Control Act,780 known as the owner trust. The owner trust is managed by independent trustees781 who owe fiduciary duties to the beneficiaries to administer the trust property in their interests. The independent trustees are usually a fiduciary services company,782 whose business it is to manage Security SPVs. The owner trust's trustee enters into a management agreement with the Security SPV whereby the Security SPV appoints it to administer the Security SPV.783 The beneficiaries of the owner trust are the finance parties.
If the borrower defaults on its loan repayment obligations or goes insolvent,784 and the lenders have elected to take enforcement action, the agent on behalf of the lenders will claim against the Security SPV under the guarantee agreement. Simultaneously, the agent will instruct the Security SPV to in turn claim for a like amount under the borrower counter-indemnities.785 If the borrower fails to make payment thereunder, the Security SPV is entitled to realise its security rights held in the obligors' assets and property.786 The Security SPV will use the proceeds received from its claim under the enforced counter-indemnities or of its realised security rights to make payment due to the lenders under the guarantee, either directly or by paying these monies to the owner trust, which in turn, will distribute the monies to its beneficiaries, the finance parties (that
774 The mandate is sometimes an informal arrangement between the lenders and the independent trustees who manage the owner trust.
775 As defined in s 128(1)(b) of the Companies Act 2008.
776 As contemplated in the Insolvency Act.
777 Locke Aspects of Traditional Securitisation in South African Law (LLD thesis, UNISA, November 2008) at 43.
778 The LMA's User's Guide to the Recommended Form of Documents for Use in the South African Market (updated 21 December 2018) 51–52.
779 Ibid 53.
780 Trust Property Control Act 57 of 1988.
781 The LMA's Term Facilities Agreement, clause 1.1 (definition of Owner Trust); Boshoff 'One Way or Another' (2016) 35(9) International Financial Law Review 45–46 at 45.
782 Ibid. Fiduciary services companies commonly used in South Africa are GMG Trust Company (SA) Proprietary Limited or Maitland Group South Africa Limited.
783 The LMA's User's Guide to the Recommended Form of Documents for Use in the South African Market (updated 21 December 2018) 51–52; the LMA's Term Facilities Agreement, clause 1.1 (definition of Debt Guarantor Management Agreement). The term Debt Guarantor is often used instead of Security SPV.
784 As contemplated in the Insolvency Act.
785 The LMA's User's Guide to the Recommended Form of Documents for Use in the South African Market (updated 21 December 2018) 51–52.
786 Ibid.
includes the lenders). Such payment discharges the Security SPV's obligations under the guarantee agreement entered into with the lenders.787
A typical Security SPV structure that incorporates this structure is depicted schematically below.
The Security SPV Structure
An important aspect of the syndicate lenders' contractual relationship is the enforcement action that may be taken by the lenders against the obligors which arises from the borrower's default or insolvency.788 Enforcement action ordinarily includes accelerating the loan liabilities by demanding payment thereof; making a demand under any guarantees; realising any security, any composition or compromise permitted; and instituting any insolvency or analogous proceedings. As the focus of this thesis is on bilateral and syndicated loans and security, the enforcement analysis will be limited to the enforcement of security.
A distinction is made between the rights of senior lenders and those of mezzanine lenders to undertake enforcement action. A decision to take enforcement action is typically voted for by senior lenders holding a majority percentage of the value of loans, often 66,6 per cent.789 After the senior loans have been fully settled, the mezzanine lenders may vote for enforcement action by a majority percentage of the value of loans, often 66,6 per cent. Any intended enforcement action by mezzanine lenders may be made subject to contractual provisions in the facility agreement that oblige them to cure senior loan defaults before, for example, acquiring collateral.790 Payment by the
787 Ibid 53.
788 The term 'obligors' is defined in section 1.3 The research question as being, individually or collectively, the borrower or any third party who or which has given security for the borrower's loan obligations.
789 The percentage could be set higher by agreement between the lenders.
790 See the discussion of Bank of America, N.A. v PSW NYC LLC 918 N.Y.S.2d 396 (2010) under section 3.2.9 Tranche wars among syndicate lenders.
mezzanine lenders to cure senior loan defaults does in fact protect their interests in the loan and security structure because the senior lenders, having been repaid, will not need to realise their security rights.
Any enforcement action approved by a lenders' vote is implemented by the facility agent. Although the convention for sizeable financings in other jurisdictions may be to appoint a senior agent to represent the senior lenders and a mezzanine agent to represent the mezzanine lenders,791 the South African practice is to appoint one facility agent to represent both senior and mezzanine lenders.792 The appointment of separate facility agents for each class of lenders would occur if the lenders believe that their interests would be better served by separate, independent facility agents. The facility agent, despite exercising discretionary rights for the lenders, attracts no fiduciary duties to the lenders.793
Although bilateral loans and syndicated loans are transferable, the nature of security rights for these loans in South African law794 make transferring security rights, when the loans for which they offer credit support are transferred, rather complicated. South African debt security structures are, it is submitted, not ideally designed to facilitate the transfer of, and sharing in, security rights to new lenders, as demonstrated below. This scenario is unlike the scenario where a secured loan is sold and assigned in its entirety to a new lender. The security rights attached to that loan are, by virtue of the Pizani principle, automatically transferred to the new lender without the need for further action.795
If new lenders acquire portions of the loan796 through syndications, there are broadly two options available in South African law whereby the security can be shared between all the lenders. In the first option, if there is only one new lender, the original lender can retain the cession in securitatem debiti of the right of action797 in the principal debt and the new lender can take a cession in securitatem debiti of the reversionary interests798 therein.799 However, if there is more than one new lender, then the second option will have to be used where the original lender's existing security rights must either (i) be cancelled and new security rights created in favour of the Security SPV so that the lenders (original and new) can share in it pari passu through the Security SPV structure;
or (ii) be ceded out-and-out to the Security SPV, so that the lenders (original and new)
791 The LMA's Intercreditor Agreement for Leveraged Acquisition Finance Transactions (Senior/Mezzanine), 20 March 2020.
792 The LMA's Term Facilities Agreement.
793 Wright International Loan Documentation (2014) 272–277.
794 See chapter 4 Security for Loans, chapter 5 The Law of Cession and chapter 6 The Law of Cession in Securitatem Debiti.
795 The Pizani principle is analysed in section 4.12 Does cession of a principal debt automatically transfer security given for the principal debt to the new cessionary, or must the security be separately ceded?
796 As to the methods for acquiring portions of a loan, see section 3.2.4 The nature of syndication.
797 See section 6.6 The pledge theory for an analysis of the concept 'right of action' under the heading The theoretical nature of cession in securitatem debiti under the pledge theory.
798 See section 6.6 The pledge theory. However, pledge and cession security agreements often contain a standard clause that should it transpire that the initial pledge and cession in securitatem debiti in that agreement is invalid for whatever reason, such as there being a prior cession, the pledge and cession will then operate as a pledge and cession in securitatem debiti of the cedent's reversionary interest in the principal debt. See Lubbe Contract: General Principles (2020) 556.
799 See chapter 6 The Law of Cession in Securitatem Debiti.
can share in it pari passu800 with other secured lenders. The cancellation or out-and-out cession of existing security rights requires the parties to conclude agreements to that effect and comply with legislation governing certain types of security rights including, amongst others, the registration of bond cancellations or cessions801 or the cancellation or cession of pledged, listed securities that were flagged in the central securities account or the securities account in terms of section 39 of the Financial Markets Act.802 The out- and-out cession of existing security rights is a rather complicated matter because not only must there be a causa for such a cession,803 but moreover, if the original cession in securitatem debiti was defective, then its purported out-and-out (onward) cession will be invalid. In order to avoid these complexities, the cancellation of the existing security rights is, it is submitted, the preferred option. The creation of new security rights in favour of the Security SPV has to follow the same legal and statutory (if applicable) process originally followed, except that the beneficiary of the security will be the Security SPV.
Both the cancellation or out-and-out cession and creation of security rights come at significant legal and statutory (if applicable) cost. Furthermore, the new lenders must be made beneficiaries of the owner trust and parties to all the finance documents, including the intercreditor agreement. They will have to satisfy themselves that the terms and conditions of the finance documents protect their interests, and they may want to negotiate it before binding themselves.804
As the Security SPV holds all the security rights, the priority of claims is not a concern for the Security SPV since it does not compete with any lenders for security. The claims of the senior lenders rank and abate equally amongst themselves, as would the claims of the mezzanine lenders. Perfection of security rights would similarly not be a concern for the lenders because the Security SPV (not the lenders individually) is the only party holding security rights. Hardening periods only apply to mortgage bonds in limited circumstances. A general or special mortgage bond, passed for the purpose of securing the payment of a debt not previously secured, which was incurred more than two months prior to lodging the bond with the registrar of deeds for registration, or for the purpose of securing the payment of a debt incurred in novation of or substitution for any such aforementioned debt, confers no preference if the estate of the mortgagor (the debtor) is sequestrated within six months after lodging the bond document for registration, provided that a mortgage bond is deemed not to have been lodged if it was withdrawn from registration.805
800Donaldson Investments (Pty) Ltd v Anglo-Transvaal Collieries 1979 (3) SA 713 (W) 715B. See section 4.8 Pari passu ranking of security.
801 Deeds Registries Act 47 of 1937.
802 Financial Markets Act 19 of 2012.
803 See section 5.2 Legal requirements for a valid cession in securitatem debiti under the heading Causa or justa causa.
804 Banks negotiate terms and conditions with each other and the borrower when loans are syndicated, which forms part of the post-mandate phase, according to the LMA: see section 3.2.6 The phases of syndication.
805 Section 88 (Certain mortgages are invalid) of the Insolvency Act.