This article is written by Arushi Agarwal, pursuing Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from LawSikho. The article has been edited by Zigishu Singh (Associate, LawSikho) and Ruchika Mohapatra (Associate, LawSikho).
Table of Contents
Introduction
Banks provide loans to various corporations, start-ups, proprietors and even the Government on a very large scale. Oftentimes the loan amount is so huge that even the bank is unable to lend the same, in such cases two or more banks (lenders) enter into a loan agreement and lend money to one borrower. Such an agreement is called a syndicate loan agreement.
The syndicate loan, also known as a syndicated bank fund, is offered by a group of lenders called syndicates, that comes together to provide funds for one borrower. The borrower can be a corporation, a project or a government. The agreement has a lead bank that lends a large share of the loan. The lead banker also ensures that there is a set order of cash flow in the agreement and the other lender banks are aware of the said order. In July 2019, Power Finance Corporation took a three-year syndicated loan from the State bank of India, Hong Kong and MUFG (Mitsubishi UFJ) Bank Limited in Singapore.
The loan may include a fixed amount of funds, line of credit (continuous transfer of amounts over a period), or a combination of the two, the interest rate can be fixed or floating, depending on the benchmark rate as decided by MIBOR (Mumbai Interbank Offer Rate) in India. A benchmark rate is a standard rate against which other interest rates are calculated. The rate is regularly updated and publicly accessible as calculated by an independent body.
These syndicates can be banks, mutual funds, angel investors. A large corporation or government can borrow a huge loan to finance large scale mergers and financing large scale projects in mining, energy, transportation, telecommunications, petrochemicals etc.
What is the main purpose of a syndicate loan agreement?
The amount involved in a syndicated loan agreement is much higher than that of a regular loan. In such a case it is not possible for one single lender to have such money thus, more than one lender is the right choice. Even if a single lender has the means to lend such a huge amount it is not advisable for him to do so. The main purpose of such an agreement is to ensure that the burden to bear the risk should not be on one lender if the borrower defaults his payments, then one single lender should not be subjected to such a huge loss, Since the amount of this loan far exceeds the amount of a standard loan, multiple lenders help in spreading the risk evenly.
Moreover, different lenders specialise in different types of assets, loans, and projects. It is advisable to have lenders in the agreement that are aware of the risks involved in the loan, various methods of the valuation of the assets pledged as the security against the loan and any other details related to the syndicated loan. The expertise of a lender in a specific area also encourages the borrower to go for a syndicated loan agreement.
What are the different types of syndicate loans?
There are majorly three different types of syndicated loan agreements that are used around the world. They are:
Underwritten deal
In this type of loan, the lead banker, or the underwriter syndicates the entire amount of the loan, under this deal, the lenders guarantee that if the entire loan is not subscribed then the remaining amount will be underwritten/ absorbed by them, and they shall then ensure that the entire loan is subscribed.
Underwriting as a concept is very commonly used in the corporate world. Shares of a company are often underwritten. This ensures that if all the shares are not subscribed by the public, then the remaining shares are bought by the underwriters and then it is their responsibility to sell those shares.
Club deal
Under this type of loan, the loan amount is generally small. The lower cap is usually $25 million and the higher the amount can go up to $150 million. The lead banker and the other lenders share the fees and earned from the loan facility, equally.
Best efforts syndication deal
Under this deal the lead banker does not guarantee the entire loan amount, insisting the undersubscribed portion of the loan is used keeping in mind the changing market conditions. If any part of the loan remains undersubscribed, the borrower will be forced to accept a loan of a lower amount or cancel the loan agreement entirely.
What are the essential clauses of a syndicate loan agreement?
Definition and interpretation
Every agreement has a section that contains the basic information to identify the parties to the agreement. This section mentions the details of the borrower and the lender. Details such as names of their organisation, addresses of the registered offices, occupation, company identification number. Any changes in any of these details of either of the parties should be notified to the other party in the manner mentioned in the notice clause.
Terms that have meanings specific to this agreement should also be defined in this clause. This ensures that the terms are interpreted correctly throughout the agreement and it is read smoothly.
Facilities
This clause is one of the most important clauses in the agreement, this clause contains the amount of loan that is to be given to the borrower by the lenders, the purpose for which the loan has been taken, the number of advancements the lenders are willing to make and the conditions that must be satisfied before and after the loan has been advanced, the clause should be precise and verified properly.
Some of these conditions are:
- No advancements will be made by the lenders unless they receive all the necessary documents that they have demanded.
- The representations made by the borrower are all true.
Utilisation
Under this clause, the borrower makes timely requests to the lender to extend their line of credit towards the borrower. This request is known as the utilisation request. It is an elaborate yet simple clause.
It contains the details such as the mechanism in which the utilisation request should be sent, the procedure after the utilisation request has been received by the lenders, the medium through which the amount will be transferred to the borrower, etc.
Repayment, prepayment and cancellation
It is one of the most essential clauses in a loan agreement. This clause specifies how and when the loan is to be repaid by the borrower to the lender. It’s a simple clause that contains many details. The repayment can be a lump sum or on a periodical basis. In the case of periodical payments/ equated monthly instalments (EMI), it should specify the number of instalments, period of which when the instalment becomes due, modes of payment and the undertaking of the borrower stating that he shall pay all the dues of the lenders.
It is important that a loan agreement allows the borrower to repay the loan early. This is known as making a prepayment, it makes the loan more flexible. The word prepayment refers to making repayment more than the EMI that is specified in the agreement, generally, these excess amounts are adjusted against the outstanding principal amount when the payment is made, the borrower is required to pay prepayment changes when such prepayment is made, these prepayment charges are determined by the lender.
Under cancellation, the lenders agree to cancel all or part of the borrowed obligation to repay this and this becomes effective upon the occurrence of a specified event mentioned in the agreement.
Interest
In a loan agreement, the interest clause is crucial as it sets out the interest rate on the loan, there are two main types of interest rates: fixed interest rate and floating interest rate. This clause contains important details such as the method of calculating the interest rate, any changes in the said method, the period when the interest should be paid, the means of payment of the interest i.e., cheque/ bank transfer, details of default interest.
Obligations and undertakings
Loan agreements often provide that the borrower will indemnify the agent banks and lenders for losses, liabilities, and related expenses they incur from litigation or other claims related to the loan or the borrower, the borrower also ensure that he shall hold the lender, its officers, employees, advisors an agent harmless against all losses, claims and liabilities which are a result of the acts of the borrower.
The other obligations are paying the stamp duty on the agreement and various other ancillary documents, paying the taxes, paying for any additional costs that are incurred under the agreement.
An undertaking is a pledge that requires the borrower to fulfil certain conditions, or which stops the borrower from doing certain actions or which possibly restricts certain activities. Some of the undertakings are:
- The borrower shall inform the lender of any material circumstances affecting the ability to repay the loan or nay charges to the lender.
- The borrower shall comply with all relevant laws and obtain all authorization which are necessary for the borrower’s ability to enter and perform its obligations under the agreement.
- The borrower shall supply to the lenders such information relating to the financial condition, as the lenders from time to time reasonably require.
Representations of the borrower
A representation is an assertion that is made most likely to induce the other party to enter a contract or take some action. Some of the common representations made by the borrower are as follows:
- The borrower is competent to enter into this agreement.
- The agreement is binding upon borrower.
- The information provided by the borrower to the lender is true and fair.
Event of default
Different lenders have different definitions for default in their loan agreements, the definition of the event of default will change depending on the:
- Type of loan the party will enter,
- The positions of the parties,
The most common events of default across syndicated loan agreements are:
- Failure to make payment.
- Misrepresentations made under the agreement ‘Winding up/ Insolvency. Cessation or stopping of business.
- Cross default i.ee when the borrower defaults on any other loan provided by any other bank or the same bank.
- If the borrower uses the loan amount, or any part of it, for any purpose other than the purpose specified in the agreement.
Governing law
This clause states which rules, and laws are to be followed to govern the agreements if legal action is taken against either of the parties to the agreement, this clause contains the courts that have jurisdiction over the dispute matters of the agreement. Usually, all the agreements are governed in accordance with the laws of India and any competent court that has jurisdiction under the law where the lender is situated has jurisdiction over the matters of the agreement.
Miscellaneous
A miscellaneous clause is essential to every agreement. It contains various sub-clauses such as waiver, severability, survival etc. However, loan agreements contain two or more important sub-clauses which are as follows:
- Amendment clause: this clause gives the right to the financial institutions to amend any clauses in the loan agreement that they want without informing the borrower any amendment case should be read in detail and understood properly.
- Notification clause: the borrower must duly inform the lender of any change in address, change in primary business operations, any major change in the books of accounts that may or may not adversely affect the loan, etc. during the tenure of the loan. The tie frame within which this information must be notified and the mode of notification is specified in the clause.
Conclusion
Although the means of access to credit and finance has diversified and proliferated everywhere in the world, syndicated bank loans remain the preferred option for raising large amounts of funds. A large number of funds and stakes involved resultantly makes it imperative for all stakeholders to be absolutely thorough in their negotiations and agreements to avoid avoidable conflicts in future. A well-drafted agreement goes a long way in ensuring that.
References
- https://www.investopedia.com/terms/s/syndicatedloan.asp
- https://www.mondaq.com/unitedstates/financial-services/803634/syndicate-loan-agreement-and-relevant-clauses
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