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Loan transfer
 

Loan transfer

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    Loan transfer Loan transfer Document Transcript

    • Loan TransfersMethods - novation, equitable and statutory assignment, funded and risk sub-participation,proceeds assignment and declaration of trust. Not all of these methods imply transfer ofthe rights and obligations arising under the loan contract.Reasons for transfer for the original lender: 1. To spread the risk involved in the loan 2. To release funds committed to the loan for further lending 3. To eliminate the risk of increased costs of the loan (e.g., if the borrower’s creditworthiness declined) 4. To generate income, i.e. a fee, or by retaining part of the interest payment due under the loan, while at the same time passing the risk to the new bank 5. To reduce exposure to a particular geographical area or industry or borrower 6. To comply with the requirements of the regulator, e.g., in connection with the fact that amount of loan assets of a bank has exceeded its capitalGenerally: 7. To provide access to this lending market to smaller banksthat couldn’t participate in the original loanNovationNovation doesn’t transfer rights and obligations, but is a cancellation of the old contractand its substitution by a new contract - the rights and obligations of the borrower, all of thelenders and other parties in relation to the old lender are discharged and replaced by thesame rights and obligations in respect of the new lender.Advantage: 1. enables the transfer of obligations which cannot be transferred byassignment (obligation to lend) - Tolhurst v Associated Portland Cement Manufacturers(1900) Ltd.; 2. it’s a clean break on a facility which is not fully drawn; 3. No stamp duty ispayable (as compared to statutory assignment);Disadvantage: requires the consent of all the parties to the original and the new contracts(Aktion Maritime Corp of Liberia v S. Kasmas& Brothers (The Aktion)). Solutions: 1. LMAloan contract obtains advance consent from all parties (provided that provisions onprocedures and restrictions are observed).Carlill v Carbolic Smoke Ball Co - an offer can bemade to the whole world and acceptedby the conduct of the offeree without notice ofacceptance to the offeror. In a loan agreement, the offer by all parties to an existing lenderand a prospective new lender to cancel the old contract is accepted by the lender’sfollowing the procedure in the contract.No changes in terms are allowed, which typicallyneeds the consent of the majority lenders and the borrower. 2. A form of novation -Substitution Certificate: the borrower signs the certificates evidencing his debt inconvenient denominations at the inception of the loan, including the borrowers consent tosubsequent novation.Novation vs variation: Substitution of one lender for another may merely be avariation.Distinction between variation and novation rests on the intention of the parties.Novation means complete extinction of the first and formal contract, and not merely thedesire of an alterationof the existing contract(Morris v Baron & Co.).Novation of a secured loan: termination of the original contract automaticallyextinguishes the security. If a new security is obtained, there will be a loss of ranking overother security interests created in respect of the same assets, since ranking is determinedby the date of creation. Also, in case of insolvency liquidators may challenge the securitywithin acertain periodupon its creation. Solutions:
    • 1. Use assignment to transfer the lender’s rights to which the security attaches, andnovation to transfer its obligations;2. More common - in the original loan contract the borrower grants security in favour of asecurity trusteefor the benefit of the current lenders, so the security is not affected by thechange of lenders (British Energy Power & Trading Ltd v Credit Suisse).This approach canalso be used for guarantees (Habibsons Bank Ltd v Standard Chartered Bank (Hong Kong)Limited). Security also attaches to a collateral obligation under which the borrower isobliged to pay the security trustee the same sums as are owed to the lenders – in case ofbreach by the borrower, the security trustee can enforce the security.AssignmentAssignment cannot be used to transfer obligations (Tolhurst v Associated Portland CementManufacturers (1900) Ltd). Advantages over novation: 1. Guarantee or security under theloan does not terminate; 2. No need for consideration (Re Westerton, Public TrusteevGray);3. Subject matter of the assignment doesn’t constitute insolvent assignor’s estate (Gorringev Irwell India Rubber &GuttaPercha Works). 4. Consent of the parties is not required (Olssonv Dyson), but the loan contract may stipulate for this. 5. Doesn’t require notice to thedebtor.Under English law assignment of future property (which doesn’t exist or hasn’t been vestedon the lender) is possible, provided there is consideration, intention to transfer proprietaryinterest and the assets are sufficiently identified.If an unassignable debt is assigned, under English law there is no assignment of the debtbut there is a contract between purported assignor and assignee.Important principle of assignment: the borrower cannot be made worse off by theassignment (Dawson v Great Northern & City Railway Co.). Market disruption clause(lender can charge cost of funds exceeding the one as per the loan agreement) andincreased costs clause (lender can charge for a reduction in the rate of return as a result ofchange in law). If the withholding tax grossing-up clause or other increased costs clauseentitle the assignee to demand more funds from the debtor than the original lender, theassignee is unable to claim the additional sum. The assignee assumes only the rightsagainst the debtor that the assignor had, so if the debtor had a counterclaim against theassignor, it will also have it against the assignee.An assignment is not invalid even if the necessity for litigation to recover it is contemplated(Lordsvale Finance v Bank of Zambia;Camdex International v Bank of Zambia).Applicable law - The governing law of the loan contract is used to determine whether theloan is assignable. The law governing the contract of assignment deals with matters such aswhether the requirements of the assignment have been met, what is the effect of theassignment and what rights the assignee acquires against the debtor.It is suggested thatpriority between different assignments is determined under the governing law of theoriginal debt.Equitable assignment (EA)No prescribed form (TailbyvThe Official Receiver), need not be in writing, unless it’s EA of asubsisting equitable interest (if assignee assigns its right) (Law of Property Act 1925,s.53(1)(c)). There should be some act of the assignor to assign and acceptance by assignee.There must be a clear intention to assign, the subject matter and the assignee must beidentifiable at the time of the assignment. EA can cover part of the debt (In re Steel WingCorpn Ltd [1921]).Reasons for use of equitable assignment - Lender may wish: 1. For the borrower not toknow about the assignment; 2.Not to transfer the whole loan; 3. Not to pay a high stamp
    • duty which is mandatory if the assignment is executed in the UK. However, unstampeddocument which requires stamping cannot be used in evidence in a court. The followingoptions are used: 1. The parties execute the documentin a jurisdiction which does not haveits own stamp duty, and bring it to England when it is necessary to sue on it (and pay thestamp duty only then); 2. Not pay the duty and face the penalty if it is necessary to sue onthe document. 3. Not have a written document of transfer, thus, legitimately not pay anyduty. The buyer will need written evidence – seller sends written offer to the buyer to sellthe loan, stating that it can be accepted by mere payment – the buyer pays. Parties shouldavoid a written document of transfer.Onsale of loan using assignment is to be in writing.Problems with EA:Claims: to make an action against the borrower, assignee should join the assignor, and if itobjects, name the assignor as co-defendant with the borrower. Solution: irrevocable PoAgranted by the assignor to the assignee at the time of EA.Lack of notification (also refers to statutory assignment before the time of the noticeto the borrower): 1. borrower will continue to obtain a good discharge by paying theoriginal lender(OL)– risk of losing funds in case of OL’s insolvency/dishonesty; althoughsuch funds are held by the OL on trust (International Factors Ltd v Rodriguez), they couldbe dissipated before the assignee is paid; 2. borrower may be able to set-off debts due fromthe assignor against claims under the loan contract – risk in case of the assignor’sinsolvency (also see “Notice-related issues” below).Statutory assignment (SA)SA creates direct relationship between the borrower and the assignee (s. 136(1) of the Lawof Property Act 1925)–borrower pays to the assignee; assignee may sue in its own name.The assignee obtains all the rights against the borrower.SA must be: 1. In writing; 2.Of the whole debt only; 3.Notice to the borrower – is to be givenprior to making an action on the assignment.If the assignment does not comply with these requirements, it may still take effect as EA.There are no mandatory requirements onhow the SA should be written, but presumably itshould be similar to the contents of EA, as specified above. The inaccuracy of theinformation on the notice to the borrower on the SA may render it ineffective (W.F.Harrison & Co Ltd v Burke), the notice should enable identification of the debt and of theperson to whom payment should be made.Notice-related issues1. The rule in Dearle v Hall: priority between competing assignees is determined by theorder in which they give notice to the debtor (i.e., the debtor will pay to the one of thecompeting assignees who is the first to give the notice to the debtor).2. The assignee takes subject to equities existing at the time of notice to the borrower - defects inthe title of the assignor or debt which accrues due before notice, or debt which arises out of thesame contract or is closely connected to it, may be set off against the assignee (BusinessComputers LtdvAnglo-African Leasing Ltd).So, after the notice is given, no new equities orcounterclaims may be established. Therefore an assignee mayrequire representations from thelender that no set-off exists.The assignee’s recourse is to the assignor for any shortfall in itsclaim against the borrower on the assigned debt arising from the set-off.Sub-participation (SP)The lender (the grantor, seller or lead bank) enters into a back-to-back agreement withanother party (the grantee, buyer, sub-participant or participant) whereby that other partyassumes all or part of the risk involved in the loan contract. SP gives the sub-participant no
    • rights under that contract: the sub-participant only acquires rights against the lender, notagainst the borrower (Lloyds TSB Bank plc v Clarke and Chase Manhattan Bank LuxembourgSA). Sub-participant may itself grant a sub-participation (Socimer International Bank Ltd vStandard Bank London Ltd (No 2)), assign or novate its rights under SP (BanqueFinancierede la Cite SA v Westgate Insurance Co.).SP allows trading in debt which has transfer restrictions (Lloyds TSB Bank plc v Clarke andChase Manhattan Bank Luxembourg SA) or if the borrower objects to the transfer (RoyalBank of Scotland plc v Highland Financial Partners LP), since it does not require theborrower’s consent. SP, unlike an assignment, permits the economic effect of an obligationto be transferred; allows to avoid tax liability arising in assignment or novation (due to thetransferee becoming the lender of record); avoids problems with security and guaranteessupporting the loan and with hardening periods in insolvency law; allows to remove theloan for the lender’s capital adequacy requirements; payments from sub-participantarenotnormally caught by the sharing clause in the loan contract.Funded SP - debtor-creditor relationship between the lender and the sub-participant: sub-participant pays the lender a sum equivalent to the loan, if the borrower defaults, thelender retains the equivalent amount from the funds received from the sub-participant.The lender pays to the sub-participant out of its own funds a sum equivalent to thepayments of interest and capital received from the borrower (Lloyds TSB Bank plc v Clarke),but only if the borrower makes a payment (Adolfo Altman v Australia and New ZealandBanking Group Ltd).Sub-participant cannot use the clauses of the loan agreement in connection with increasedcost of funds (MAC, market disruption clauses). The lender is not acting as an agent of thesub-participant in the loan contract.Funded SP removes the loan from the calculationoflender’s capital adequacy ratio (although it remains on the lender’s balance sheet).Risk SP–payment by the participantis contingent on the borrower’s default; the participantis paid: a fee irrespective of such default, and the equivalent of any payments received fromthe borrower after default. It is advisable that participant’s obligations terminate upon thelender’s insolvency, since payments from the participant and borrower fall into generalassets for unsecured creditors.Risk SP is less effective for removing the loan for regulatory purposes, because the sub-participant may fail to pay on the borrower’s default. In case of borrower’s default theparticipant, by virtue of having indemnified the lender, can make the same claims againstthe borrower as would have been available to the lender(Orakpo v Manson InvestmentsLtd).Problems with SP generally: 1. participant cannot bring an action against the borrower –depends on the lender managing and enforcing the loan. Solutions: 1). SP agreement maystate that the lender will not transfer/grant security over the right of action under the loan(lender may object to such solution); 2). Require the lender to give a PoA for theparticipant to enforce the loan in its own name – but such PoA will not be irrevocable, andthe lender may refuse (since the participant could thus be put directly in contact with theborrower).2. lender may be demotivated to protect rights under the loan contract if it isn’t interestedin it – e.g., the lender may fail to monitor the borrower’s compliance with the covenants.Protections for the participant - Promise of the lender to: 1. notprejudice the rights of theparticipant; 2. notify the participant of notices from other parties to the loan or any eventof default; 3. administer the loan with the same care as transactionson its own account (notvery clear and is usually limited by exclusions);4. Consult with or defer to the participantbefore amending the loan contract (Al-Bank Al Saudi Al-Alami Ltd v Arbuthnot Latham BankLtd) – problematic if the lender has granted several sub-participations (may create
    • difficulties with other participants)/ retained interest in the loan. To solve the problemwith other participants, the SP agreement can include a clause similar to the one dealingwith syndicate management in loan contracts;5. The SP agreement may state that upon acertain event the lender will procure that the participant is elevated to the lender, or rightsand obligations under the loan shall be transferred to a third party, which will be obliged toconclude the SP agreement with the same participant. Such clauses are difficult to draft, thelender may be reluctant to include them. If elevation was shortly after insolvency, it can beunwound by the liquidator (Insolvency Act 1986, s.239).Problems with funded SP: 1. Participant in a funded participation runs a double creditrisk (Lloyds TSB Bank plc v Clarke and Chase Manhattan Bank Luxembourg SA; Altman vAustralia and New Zealand Banking Group Ltd; Socimer International Bank Ltd v StandardBank London Ltd (No 2)): 1). Borrower’s insolvency means no payments to the participant.Borrower’s balance with the participant cannot be set-off against the borrower’s debt; 2).Participant doesn’t benefit from security/guarantee under the loan contract. 3). As per theSP agreement, if the loan is rescheduled, the SP interest is subject to the new terms.2.Upon payment from the borrower, lender may be restricted from paying the participant,or participant may be restricted from receiving it, or lender goes into insolvency beforepayment. In case of insolvency the participant will be an unsecured creditor; also, SPagreement can be set aside on the grounds of undervalue or preference in insolvencyproceedings.Solutions: 1. Lender declares a trust over the loan and the proceeds – better to documentit as proceeds assignment to avoid the lender being characterized as an agent. 2. Lendergrants security to the participant over the lender’s rights, payments and security under theloan – lender may be reluctant to do this, and such security may be unenforceable in case ofinsolvency1.3.If the underlying loan is refinanced and the funds come from new lenders, the OL shallpass them to the participant and the SP terminates. If funds come from OL – not clear if theparticipant should pay its share.Problem with risk SP: if the loanis syndicated, with a sharing clause obliging lenders toshare payments received from any source, payments from the participant are shared withthe other lenders – this means shortfall of the lender triggering further payment from theparticipant, which will also be shared, etc.Proceeds assignment (PA), AKA proceeds trustPA doesn’t involve any assignment, but involves a declaration of trust - beneficiary obtainsa proprietary interest in a contingent right to payments by the borrower as soon as theyare made to the lender. Plus - such funds are not available to the lender’s general creditors,the participant receives the funds paid by the borrower. No notice to the borrower isrequired. No requirements to the form, but there must be intention to hold funds on trustfor the benefit of the transferee as soon as they reach the lender (e.g., if as per theagreement such money is held on a special account).Problem: lender’s insolvency before the borrower pays – transferee cannot sue theborrower (lender’s right to sue is not assigned), liquidator is not interested in enforcing thedebt.Solution: lender retains a small part of the loan, or to agree that the lender acts as acollection agent for a fee. This will motivate the liquidator to enforce the debt.Transfer by way of trust, AKA benefits trust1Another option - transfer the lender’s interest in the loan to a third party, this party grantsSP – is not a viable one.
    • Effect similar to novation or assignment – declaration of trust over the benefit of thecontract (Milroy v Lord (1862) 4 De G.F. & J. 264; Re Turcan; Linden Gardens TrustLtdvLenesta Sludge Disposals Ltd).Lender has legal interest, but holds beneficial interest forthe transferee. In proceeds trust (see above), the subject is the payment received from theborrower, while in a benefits trust (BT) the subject is the rights the lender has against theborrower. Unlike assignment, in BT the borrower continues to pay to the lender (while in anotified assignment the borrower pays the assignee), and the beneficiary cannot bringaction against the borrower (while an assignee can).To confirm there is a trust, there must be intention to create it, clear subject matter andbeneficiary (Milroy v Lord; Re Turcan; Linden Gardens Trust LtdvLenesta Sludge DisposalsLtd).Don King Productions Inc v Warren: the contracts could not be assigned, so it was held theintention of the parties must have been to declare a trust over the benefits of it (althoughthis position was later criticized). Also held that non-assignment clause in the managementcontracts did not apply to a declaration of trust. However, the contractor under therelevant contract may be reluctant to be in a direct relationship with the beneficiary (i.e.,beneficiary may be allowed to enforce the obligation directly, wind up the trust and requirethe trustee to transfer the trust property). The court may modify the effect of trust law forcommercial reasons –in this case judges suggested the court would be hesitant to permit abeneficiary to sue directly by joining the trustee.General issues relating to transferNon-transfer clausesA clause may be included into the loan contract restricting transfers or requiring theborrower’s consent for a transfer. English courts broadly rejected the idea that restrictionson transfers are contrary to public policy.Reasons: 1. Borrower will not be able to set up new equities and set-offs against a transferee 2. Despite the notice of assignment, there is a risk that the borrower’s finance office might pay the wrong person (especially if parts of the loan are assigned to different persons – this risk can be diminished if the loan contract prohibits transfers below a certain amount) 3. Sovereign states or central banks may wish to restrict the categories of entities that can acquire their debts (Barbados Trust Co Ltd v Bank of Zambia) 4. The borrower may want to avoid becoming bound to a transferee dealing in distressed loansConsent to transferNon-transfer clauses can be absolute (less common) or qualifiedprohibition on transfer.LMA, clause 24.1 – assignment or transfer is subject to the borrower’s consent.Example of qualified restrictions – in Essar Steel Ltd v The Argo Fund Ltd, transfers werepermitted to “a bank or other financial institution”, and the court held that the transfereedid no have to resemble a bank; the Court of Appeal held that the transferee could be alegally recognized form of being doing business concerning commercial finance.Under the LMA, where the transfer requires the borrower’s consent, it must not be“unreasonably withheld or delayed” (as per LMA, the borrower is deemed to haveconsented 5 business days after the request),the request for the consent must be given asper the contract.Under the LMA, therequest for consent must go through the agent, so thedeeming period (5 days) begins when the agent delivers the request.
    • Where there is a transfer to an existing lender or its affiliate, consent is not required. Theborrower can refuse when the transferee falls within the list of entities to which a transfercan be made (the fact that it is included in this list does not constitute the borrower’sconsent).“Unreasonable refusal of consent”: 1. Narrow view: borrower can reasonably refusewhen the assignment would cause increased liabilities under a tax gross-up clause or anincreased cost clause. When applying this view one should consider the circumstances ofthe particular credit. Little authority to support this view.2. Broad view (J. Oldnall and M. Clark, “The Age of Consent”): refusal at the borrower’sdiscretion. Authority: 1). The right of a lessor to refuse consent to the assignment oftenant’s rights; 2). Discretion conferred by contracts.The approach states that a reasonable refusal is determined in each case by reference tothe borrowers position and the specific situation.Whether the borrower can refuse on the grounds beyond the subject matter of the loancontract (e.g., the type of the lender) – if the contract requires consent of the borrower, thiscan mean that issues beyond the subject matter can be taken into account. In the landlord-and-tenant cases, the courts have supported the idea that the landlord’s interest in theidentity of the tenant is a significant consideration. So, the broad view also supports thatthe borrower could reasonably refuse consent to a transfer to, e.g., a vulture fund.Criticisms of the broad view: reasonable refusal must relate to the contract and notextrinsic issues (British Gas Trading Ltd v Eastern Electricity).Besides, if the borrowerrefuses the transfer because of the new lender’s identity, it is generally difficult to persuadethe courts that the identity of commercial parties is of relevance.The borrower’s wrongful refusal from the contract has no effect, however, the borrower isnot in breach of the contract for this. Where the lender does not seek consent because itargues that the borrower could not reasonably have refused, the Court of Appeal seems touphold that the assignment would not be effective.Breadth of the prohibition – what types of transfers are restricted? Depends on thewording, but if properly worded can apply to all types. Non-assignment clause doesn’tprohibit a declaration of trust (Don King Productions Inc v Warren). The judge admittedthat it is possible to have a clause prohibiting declaration of trust, but restrictions in thecontract cannot be extended to other types of transfer (Barbados Trust Co Ltd v Bank ofZambia). If the lender breaches a non-transfer clause, the relevant transfer will beineffective (Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd).If the transfer isineffective, the transferee should still be able to bring an action against the transferor onthe transfer agreement (although there is a decision to the contrary - Helstan Securities Ltdv Hertfordshire County Council). In Linden Gardens Trust Ltd v Lenesta Sludge DisposalsLtdit was said that the assignment contract would not be affected by the breach of the no-assignment clause, so that the assignee could bring an action for a breach of the contract.Liability of the transferor – if the borrower defaults after a transfer, can the transfereeseek to recover its loss from the transferor?The transferor is unlikely to have fiduciary duties with respect to the transferor (New Yorkcourts have rejected the existence of a fiduciary duty in loan transfers in the absence ofsuch clear intention). Usually the transfer agreement states that the transferee has donethe due diligence and thus exclude the transferor’s fiduciary duties, and may exclude actionfor misrepresentation or negligence. E.g., in National Westminster Bank plc v Utrecht-America Finance Co.the court upheld that a transfer clause can exclude all potential liabilityof the seller to the purchaser.
    • Confidentiality – the lender must obtain consent of the borrower to disclosure ofinformation to the transferee, which is implied when the borrower consents to a transfer(but better to include the borrower’s confidentiality waiver for transfer purposes into theloan contract). The transferee is not bound to keep confidential the borrower’sinformation disclosed before the transfer. Partial solutions: 1) To argue that suchdisclosure to the transferee still creates confidentiality obligations; 2). To include into thetransfer agreement the transferee’s confidentiality obligations.