3.3 The Loan Market Association standard-form loan documents and English law lessons
3.3.2 English case law lessons regarding acceleration notices and the priority of claims
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.
simultaneously secured, preferent or concurrent creditors under our insolvency law is a matter of fact determined by the nature of the security rights held by them.
3.2.10 The origins of mezzanine finance
Mezzanine finance, which forms an integral part of syndicated lending, was initially used to fund only sector-specific transactions in South Africa, the UK and the USA. The 2007 to 2008 international financial crisis resulted in senior lenders being less willing to fund companies. Amon and Dorfleitner,331 for example, state that according to Standard &
Poor's third quarterly review of the European market for 2010, senior debt in Europe dropped from €165.5 billion in 2007 to €53.6 billion in 2008. It is submitted that because banks were cautious about advancing senior loans, mezzanine finance becoming an alternative and popular funding source.
Bobbitt332 contends that mezzanine lending in the US real estate sector arose out of the pitfalls of second mortgage financing, which came to light in the savings and loan crisis of the late 1980s. Pratt and Crowe333 note that mezzanine lending in the UK was introduced in the 1980s by US banks that funded management buyouts, whilst Amon and Dorfleitner334 cast the net wider by contending that it was in fact introduced into Europe in the 1980s to fund leveraged buyout transactions.
3.3 The Loan Market Association standard-form loan documents and English law lessons
Secured lending in South Africa, also referred to internationally as secured credit or secured loans,335 occurs in an international context. The LMA, headquartered in the UK, has standardised loan documentation for the South African market.
3.3.1 LMA standard-form loan documents for South Africa
The LMA has published different types of facility agreements for use in the South African market for investment grade financings.336 Some of the important aspects of the LMA's South African facility agreements are analysed in this thesis. However, the LMA has not produced any facility agreements for non-investment grade financings or security agreements for the South African market, in respect of which the risks faced by lenders will probably be different to investment graded borrowers. The facility agreements are standard-form agreements and are typically negotiated by the lender(s) and borrower(s), amended to reflect such negotiations, and then signed.
331 Amon & Dorfleitner 'Financial Crisis' 2013 Journal of Small Business & Entrepreneurship 170.
332 Bobbitt 'Mezzanine and Mortgage Lenders' 2012 Columbia Business Law Review 240–283.
333 Pratt & Crowe 'Mezzanine Finance' 1995 Bank of England Quarterly Bulletin 371.
334 Amon & Dorfleitner 'Financial Crisis' 2013 Journal of Small Business & Entrepreneurship 171.
335 See, for example, McCormack Secured Credit under English and American Law (2004) and Wright International Loan Documentation (2014).
336 These are (i) Unsecured Single Currency Single Borrower Term Facilities Agreement; (ii) Unsecured Single Currency Multiple Borrower Term Facilities Agreement; (iii) the LMA's Single Borrower Term and Revolving Facilities Agreement; (iv) the LMA's Multiple Borrower Term and Revolving Facilities Agreement; and (v) Single Currency Secured Term Facilities Agreement. The concept of investment grade is discussed in n 309.
In addition to standardising lendersʹ approaches to loans, the LMA standard-form loan documentation promotes the transferability of loans, thereby increasing liquidity in the markets.337 As Ivashina and Scharfstein put it, the significance of transferability is that it extends the credit cycle.338
3.3.2 English case law lessons regarding acceleration notices and the priority of claims While the UK body of case law in respect of disputes arising from bilateral and syndicated facility agreements and the related security agreements, and therefore disputes about secured lending, is developing, there is virtually no South African case law on syndicated lending and the related security. Two recent notable English judgments of the High Court of Justice of England and Wales dealing with acceleration notices, and the priority and subordination of claims can provide guidance to South African law on secured loans because the LMA's South African facility agreements contain acceleration rights.339 South African law has some jurisprudence on the subordination of claims.340
Acceleration notices
In English law in 2016 in African Export-Import Bank and Others v Shebah Exploration and Production Company Ltd and Others341 ('African Export'), the claimants (the lenders) sought summary judgment against the first defendant (the borrower) and the second defendant (the guarantor) for an amount of US$144.2 million plus interest, the principal debt having been borrowed pursuant to a syndicated loan facility.
When the first defendant breached the facility agreement by not repaying the loan, the claimant issued an acceleration notice on 6 September 2013, and contended that the notice took effect on 16 October 2013 (one month after the 16 September 2013 instalment was due) without the claimant having to issue any further notices. The defendants disputed the effectiveness of the acceleration notice as it was expressed to be effective at a future date, whereas the acceleration clause required the outstanding amount to be immediately due and payable. Judge Phillips granted summary judgment in favour of the claimants against the defendants and held that the acceleration clause did not entitle the claimants to pick a future date of their choice on which the loan was due and payable and that the loans must be immediately due and payable to fall within the clause. In other words, for an acceleration notice to be valid, it must set out that the loan is immediately due and payable, not that it will become due and payable at a future date if the borrower fails to repay the loan on maturity. The relevance of this judgment is discussed in section 3.3.3 (The consequences of an event of default).
337 See www.lma.eu.com; Hughes 'Transferability in Syndicated Lending' (2007) 1(1) Law and Financial Markets Review 21–
24. 338 Ivashina & Scharfstein 'Loan Syndication and Credit Cycles' (May 2010) 100 American Economic Review: Papers and Proceedings 57–61 at 57. See http://www.aeaweb.org/articles.php?doi=10.1257/aer.100.2.57.