Types of Lending and Facilities PDF

Types of lending and facilities

This note:Outlines various types of lending (categorised by the number of lenders) and considers the advantages and disadvantages of each of them.Outlines various types of lending facilities (categorised by the duration of those facilities) and considers the advantages and disadvantages of each of them.Includes a section on forward start facilities (a type of syndicated loan).Links to a multi-jurisdictional guide to finance (which covers issues relating to secured lending) and a detailed note on corporate loan facilities and bank loans in the United States.
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Introduction
Loans or facilities (the terms are used interchangeably in this note) made by lenders to borrowers tend to be categorised by various features relating to the terms and conditions on which the money is lent. Features which are typically used to categorise loans are: Number of lenders. A loan may be by a single lender (in which case it will be a bilateral loan) or a multi-lender facility (either by way of syndication or sub-participation). Duration. A loan may be a term, revolving, overdraft, swing-line, bridging or standby facility. Security and quasi-security (or commercial security). A loan may be a secured, unsecured or guaranteed facility. Lenders obligation. A loan may be committed or uncommitted. Repayment structure. A loan may be repayable on demand, scheduled or amortised. The different features of a loan can be combined to produce different types of facility. For example, it is possible to have an unsecured, guaranteed, syndicated, term loan with an overdraft facility, or a bilateral, secured, revolving loan depending on the borrowers needs. There are also a series of specific forms of financing designed to provide finance for companies involved in specific trade transactions. These include letters of credit, factoring agreements and trade finance bonds (see Practice note, Bonds, guarantees and standby credits, overview). An alternative to bank lending is the issue of capital markets instruments such as bonds (see Practice note, Bond issues: overview), medium term note programmes (see Practice note, EMTN Programmes: overview) and euro commercial paper programmes (see Practice note, ECP: overview). For a comparison of the advantages and disadvantages of syndicated loans and debt instruments see Practice note, Methods of raising debt finance. Loan financing can be combined with other types of financing within a single transaction. Project financing often draws on a combination of loan and capital market financing (for more information see Practice note, Project finance, overview), while acquisition financing (see Practice note, Acquisition finance: funding sources for acquisitions) usually combines loan finance with equity and vendor financing. The greatest benefit of loan finance is its flexibility.
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Types of lending
There are three main types of lending and these are categorised by the number of lenders. Bilateral loan. Syndicated loan. Sub-participated loan. Bilateral loan A bilateral facility is where a single source lends to a company. It involves two parties: the lender (usually a bank) and the borrower. Small term loans and overdraft facilities are usually bilateral. The larger the sum to be advanced, the more risk it carries for an individual bank, so banks often group together in a syndicate to lend very large sums of money. Advantages of a bilateral loan For both parties, the advantages of a bilateral loan include that: The transaction is private for both parties. The documents are simpler and the fees will be lower because the bank plays a less complex role and there is usually an existing relationship between the parties. The private nature of a bilateral loan may enable the borrower to negotiate more flexible terms. Bilateral loans usually arise out of long-term banking relationships. A bank will therefore rarely assign a bilateral loan to another bank. This may be a further advantage for the borrower. Disadvantages of a bilateral loan A high value bilateral loan may be disadvantageous to a borrower (relative to a syndicated loan). This is because the larger the sum to be advanced, the more risk it carries for an individual bank. An individual lender will therefore need to charge a higher margin than a syndicate. The sum of money available to the borrower as a bilateral loan may be much smaller than the sum a syndicate would be prepared to lend. Syndicated loan In a syndicated loan, several banks act together and each provides a proportion of the loan on a several basis. If one bank drops out of the syndicate for any reason, the other banks are under no obligation to increase their shares of the loan to cover the lost amount. All banks in the syndicate lend on the same terms and conditions (under one agreement) and the banks deal with the borrower as a group, through an agent rather than on a one-to-one basis. Syndicated loans are a common source of acquisition finance for large deals as lending through a syndicate reduces the risk to each individual bank. In the current economic climate, a syndicated loan which refinances (that is, repays) an existing syndicated loan on maturity may be a forward start facility, see Forward start facilities for further details. The general rule is that the size of the syndicate grows with the size of the loan.
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Advantages of a syndicated loan It is difficult to generalise about the differences between a syndicated and a bilateral loan because the term of a bilateral loan will depend on the relationship of the bank to the borrower and, in some cases, may offer preferable terms to those offered by a syndicate. The advantages to the borrower of a syndicated loan over a bilateral loan are usually that: Amount. Syndicated loans generally allow the borrower to access a larger amount of money than bilateral loans. Cost. Syndicated loans usually charge lower rates of interest than bilateral loans. This is because the more lenders there are to a borrower, the smaller the risk to each individual lender, and the less the lender can justify charging for the loan. A syndicated loan will therefore usually cost less than a bilateral loan (just as the interest charged on a bond or note issue will usually be less than that charged in a syndicated loan). However borrowers should be aware that fees charged will be higher than for a bilateral loan. Regulatory. A syndicated loan may be advantageous to a bank lender as it may enable a bank to be involved in a wider rage of deals than it might otherwise be able to because of regulatory requirements. For example, banks are restricted from lending 10% or more of their assets to one borrower under the Large Exposure Directive (Council Directive 92/121/EEC), so a bank may not be able to lend on a bilateral basis but may be able to lend as part of a syndicate. Currencies. A syndicate can be a more effective way of borrowing in different currencies than a bilateral loan. Disadvantages of a syndicated loan A syndicated loan may be disadvantageous to a borrower as: Syndicated loans involve more complex documentation than for a bilateral facility as, for example, it will deal with inter-bank arrangements. Fees for the arranger, agent, underwriter and lawyers can be substantial. Market precedent needs to be followed in order to secure the agreement of the syndicate to lend. As deals are often very public, lenders will be less willing to deviate from their credit control policies. The secondary market in syndicated loans has become extremely important over the last few years and this has increased the pressure on both banks and borrowers to conform to the market standard terms set out by the Loan Market Association (LMA) standard documentation. (For information on the secondary market, see Understanding the syndicated loan market: The secondary market.) Borrower confidentiality is much more difficult to maintain in a syndicated loan than a bilateral loan because information provided by the borrower will go to a number of banks. Sub-participated loan Another way for banks to spread the risk of a large loan is sub-participation (the term is used interchangeably with "participation"). The term "sub-participation" has no strict legal meaning and it is used in the market to mean two different types of structure:
Funded participation. This is where a number of participating banks lend a proportion of the loan to the principal bank (a form of sub-funding). This can only be used for funds that have been drawn down and where there is no undrawn commitment. The principal bank pays a fee to the sub-participants, but passes interest and capital repayments down to those banks only when it receives them from the borrower. The sub-participants position is vulnerable because it has no direct contractual relationship with the borrower. Its return is conditional on receipt of capital and interest payments by the principal bank and it is only a creditor of the principal bank, not the borrower. In this structure the sub-participants are taking a double credit risk: one against the principal bank and another against the borrower. The sub-participants are also vulnerable because they do not benefit from any security that the principal bank may have negotiated with the borrower, unless specifically agreed between the principal bank and the sub-participants. The advantage of a funded participation for the principal bank is that the risk of the loan is removed from its balance sheet. Risk participation. This is where the participating banks do not lend money to the principal bank but merely guarantee a specified sum (being a portion of the capital sum) to the principal bank in return for a fee. This form of participation can be used where there are undrawn funds, for example, tranches outstanding or revolving credit facilities. The sub-participants receive no funds from the principal bank other than the fee and are only obliged to provide funds to the principal bank if and when the borrower defaults and the guarantee is called in. Again, there is no direct contractual relationship between the sub-participant and borrower. However, once the guarantee has been called in, the sub-participant will acquire rights against the borrower by way of subrogation (that is, the participant will be substituted for the principal bank and may pursue the borrower accordingly). A risk participation enables the principal bank to lay off its credit risk to a borrower but not its funding commitment. The LMA has published: Standard form funded sub-participation and risk sub-participation agreements. A standard form termination and transfer agreement (novation) (par). This provides for the simultaneous termination of a funded sub-participation and the novation to a buyer of the previously sub-participated commitments, see Legal update, LMA publish new Termination and Transfer Agreement (Novation) (Par). A paper on grantor (that is, principal bank) credit risk in the context of funded sub-participations, see Legal update, LMA grantor credit risk paper published. Advantages of a sub-participated loan A sub-participated loan may be advantageous to a principal lender as: Sub-participation allows a principal bank to reduce its risk to the borrower without the need for assignment or novation. (Assignment and novation may be unsuitable or impossible because of restrictions in the facility agreement and/or adverse tax consequences (the principal bank may wish to remain the beneficial owner of the loan to obtain tax credits)).
Both types of sub-participation (as well as novation and assignment) can be used to lay off risk as part of the syndication process, and to sell loan assets altogether. Disadvantages of a sub-participated loan A sub-participated loan may be disadvantageous to participants as: The borrower may require further funds, which will result in the rescheduling of the loan. The risk of rescheduling is not automatically passed to the participant but, the agreement can provide that it is passed on. The LMA standard form sub-participation and risk participation agreements make this provision. The sub-participant does not become a party to the facility agreement and, therefore, cannot take the benefit of any direct rights under the facility agreement (such as withholding tax gross up or increased costs). The sub-participant takes a double credit risk in either form of participation. In sub-participation, the borrower may not pay the principal bank and, even if it does, the principal bank may not pass on the funds. In risk-participation, the risks for the sub-participant are that, the principal bank does not pay the sub-participants fee and that the borrower does not pay the principal bank (if the principal bank is only liable to pay the sub-participants fee out of sums received from the borrower and the borrower does not pay the relevant sums up front). The benefit of any security is not automatically transferred on participation and there would need to be specific agreement to achieve transfer. A sub-participated loan may be disadvantageous to a principal bank as: In a risk participation, there may be the risk that the principal bank has not successfully removed the loan from its balance sheet as intended. In order to successfully remove the loan from the principal banks balance sheet, the agreement between the principal bank and the participating bank must oblige the participating bank to provide the funds to the principal bank, in time for the principal bank to pass them on to the borrower by the expiry of the drawdown notice. It may breach its confidentiality undertaking if details of the loan are disclosed to the sub-participant without the borrowers consent. For more information on transfer and risk sharing mechanisms of law see Practice note, Understanding the syndicated loan market. Option to elevate A number of (funded) sub-participation agreements (including the LMA standard form sub-participation agreement) contain an elevation provision. In general, this provision will permit (subject to, among other things, the terms of the original facility agreement, applicable law and regulation and due completion of all necessary documentation) a sub-participant to become a lender under the original facility agreement or, alternatively, provide for the loan to be transferred to a third party (with the intention that the sub-participant enter into a new sub-participation with such third party). Once the elevation is perfected, the relevant funded participation is terminated, although any rights and liabilities of the principal bank and the sub-participant which have arisen before the termination date will remain. Whilst elevation
might be helpful if the sub-participant were concerned about principal bank credit risk, it may not be an option (even where a clause is included in the sub-participation agreement), for example, if the underlying facility agreement includes transfer restrictions.
Types of facilities
There are various types of facilities and these are categorised by their duration. Term loan This type of facility allows a borrower to draw an agreed lump sum for a set period (the term) requiring repayment at or by the end of the term. Repayment will be agreed in a predetermined repayment schedule. The duration of a term loan is generally between one and five years (this can increase to seven years in a strong borrowers market). Under a term loan, a borrower is usually permitted a short period after execution of the documents during which it can draw a specified amount of the loan. This is known as the availability or commitment period. After this, additional funds may be drawn in stages or "tranches" as agreed under the loan facility and at the borrowers discretion (subject to the borrower complying with certain pre-agreed conditions). Each tranche has its own availability period. If monies are not drawn down during the availability period, they become uncommitted and the lender is no longer obliged to lend the money. The borrower will pay commitment fees in respect of committed amounts during the availability period. When the borrower decides to exercise its right to draw down during an availability period, it must give notice to the bank so that the bank can ensure that it has the funds. The notice period is usually two or three days, depending on the currency this will be less for sterling, but more for currencies held outside their country of origin. The borrower must choose the first interest period. At the end of the interest period, the borrower pays interest and chooses the next interest period. Interest periods are commonly one, three or six months long. In addition, it may be possible for the borrower, to pre-pay all or part of the loan before the dates specified in the repayment schedule, on giving sufficient notice in a situation where, for example, it finds it no longer needs as much money as it first borrowed. It may have to pay a fee to the bank to compensate it for the interest it would have received, had the money still been outstanding. Advantages of a term loan A term loan may be advantageous to a borrower as: This type of facility provides the borrower with the certainty of a pre-determined repayment schedule. This contrasts with the on-demand nature of an overdraft. The use of tranches provides the borrower with some flexibility, which may be further increased if the term loan allows the borrower to draw money in different currencies. Interest on a term loan is likely to be lower than that paid on an overdraft and will either be at a standard fixed rate or, more commonly, set at a small margin above the banks base rate or the London Interbank Offered Rate (LIBOR). Disadvantages of a term loan.
A term loan may be disadvantageous to a borrower as: Once a term loan has been repaid, it cannot generally be re-borrowed, unlike a revolving credit facility. A term loan usually has a term of no more than five years (although in a strong borrower market terms as long as seven years have been negotiated). If a longer maturity date is required, other forms of raising capital may be more appropriate, such as through a bond issue (see Practice note, Bond issues: overview and Practice note, Methods of raising debt finance). Revolving credit facility This is very similar to a term loan because it is a committed facility that provides for a specified maximum amount of capital that may be borrowed over an agreed period. However, it is also similar to an overdraft as the availability period extends for almost the entire life of the loan (except at the end, when a repayment schedule operates). The borrower may draw and repay tranches up to the specified maximum amount of capital whenever it chooses (subject to complying with certain pre-agreed conditions) throughout the term of the loan. The borrower may take a tranche for an interest period and, at the end of the interest period, decide whether to repay that tranche or "roll-over" into the next interest period (provided that no event of default has occurred). Further funds can be drawn down at any time (subject to complying with certain pre-agreed conditions), with interest periods running in parallel. As with term loans, the borrower must give the bank a draw-down notice and the borrower must specify its chosen interest period. Revolving facilities tend to be used if a borrower requires a substantial advance rather than a temporary and relatively small cash injection to solve short-term cash flow problems. Advantage of a revolving facility A revolving credit facility may be advantageous to a borrower because although a revolving facility is usually a committed facility and as such the borrower will have to pay commitment fees, it gives the borrower maximum flexibility. It can draw as much or as little as it requires at any time and, if cash flow is sufficient, it can repay outstanding tranches that are no longer required. Disadvantages of a revolving facility A revolving facility may be disadvantageous to a borrower as : It is likely to include more restrictions than an overdraft. For example: there may be minimum notice periods before a sum is advanced; the bank may set upper and lower limits on the amounts which may be drawn at any one time and/or on the number of interest periods that may exist in parallel at any one time (in order to reduce its administrative burden; and the bank may impose a repayment schedule.
Because the commitment period is so long, commitment fees will be high. 364 day facility
Some revolving loans (bilateral or syndicated) are structured as 364 day facilities. Under Basel I, undrawn 364 day facilities were popular with banks and borrowers as the capital adequacy requirements for those facilities were often favourable. Generally 364 day facilities were zero-risk weighted, meaning that banks did not need to set aside regulatory capital for their commitment under such facilities. However, under the revised risk weighting regime of the Basel II rules, commitments to lend under 364 day facilities are no longer generally zero-risk weighted. 364 day facilities must now satisfy far stricter conditions, if a bank is to avoid increasing its capital reserves to account for this type of loan. Therefore, 364 day facilities tend to be more expensive for banks to provide than under the Basel I regime and, for this reason, they are likely to be less common in the market. For more on Basel II, see Practice Note, Basel II: an overview. As a result of the financial crisis, regulators have agreed a series of amendments to Basel II. This project (unofficially known as Basel III) includes a substantial strengthening of capital requirements. For more information on Basel III, see Legal updates, G20 endorse Basel III and draft legislation expected March 2011 and BCBS publishes text of Basel III rules. For additional background information, see PLC Financial Services, Practice notes, Hot topics: Proposals relating to the quality and quantity of capital and Basel III: an overview. One benefit of a 364 day facility is that borrowers may generally make interest payments free from withholding tax. For more information on withholding tax generally, see Practice note, Withholding tax. Overdraft facility An overdraft, whether used for personal or business purposes, has the basic function of solving short-term cash flow problems. It is sometimes referred to as a "working capital facility", because it provides cash in a readily accessible form to meet any temporary shortfalls in working capital. An overdraft is usually evidenced by limited documents in the form of the banks standard terms. For more information on documenting an overdraft, see Standard document, Overdraft facility agreement and its accompanying drafting note. Advantages of an overdraft facility An overdraft facility may be advantageous to a borrower as: An overdraft is a simple form of finance and is therefore generally quick to arrange. It is usually available from a borrowers existing bank. Interest rates on an overdraft are generally higher than those on a term loan, but may be cheaper overall because interest is calculated at the end of each day on the basis of the amount actually borrowed rather than the maximum of the overdraft limit. Because it is uncommitted, there are no commitment fees to pay. Because the documentation is simple there will be few (if any) legal fees. Disadvantages of an overdraft facility An overdraft may be disadvantageous to a borrower as: An overdraft will generally be an uncommitted facility and must be repaid on demand. This makes it an unsuitable form of borrowing in some commercial settings. For example, it would not be appropriate to use an overdraft to fund a major acquisition.
The on-demand nature of an overdraft makes it a current liability for the borrowers balance sheet. The requirement to repay on demand is not as onerous as it may first appear because there will generally be an understanding that the bank will not call in the overdraft unless and until the borrowers financial position or activities give the lender cause for concern. Because a standard-form agreement is usually used, there is little scope for amendment by the borrower. The basic flexibility of an overdraft is limited in two ways: it will always have an upper limit; and it usually includes a "clean-up" provision, which states that the borrower must bring the overdraft down to a specified sum for a specified period and for a particular number of consecutive days. This ensures that the overdraft is used as intended (that is, to solve seasonal cash flow problems).
The bank charges and interest rates are relatively high. This reflects the administrative burden of an overdraft and its on-demand nature. Swing-line facility This is a committed facility used for short-term bridging purposes, generally by companies involved in the issuing of commercial paper (see Practice note, ECP: overview). The swing-line facility will generally be part of a larger revolving credit facility and can be activated very quickly (often by a telephone call). It is a type of loan designed to be used in an emergency. Normally commercial paper issues will be arranged to occur back to back, so that as one issue matures a new issue is made and the maturing commercial paper is repaid with the money raised by the new issue. If the ECP market is disrupted by an event (an earthquake, terrorist attack, or financial collapse and so on) or if the issuers financial condition suddenly deteriorates so sharply that its commercial paper is unsaleable, then the issuer will need immediate bridging finance to repay the maturing ECP. A swing-line facility is designed to provide this for up to a week until the issuer is able to put alternative arrangements into place. Swing-line facility interest periods tend to be extremely short (not more than five days) and the swing-line will be repaid from the main facility very quickly. A second swing-line cannot be used to repay the first. Swinglines are needed because of the speed with which they can be drawn down. Under most facility agreements, notice must be given one business day before drawdown. In many cases the ECP is in a different currency to the main facility in which case two business days notice are needed before the borrower can draw down in another currency under the facility. Advantage of a swing-line facility A swing-line facility may be advantageous to a borrower because it provides almost immediate access to funds in a given currency. Disadvantages of a swing-line facility A swing-line facility may be disadvantageous to a borrower as: It is a very short-term form of financing. The margin is much higher than on longer-term forms of finance. Standby or bridging facility
A standby or bridging facility is designed to be used only in very limited circumstances. It is usually a revolving credit facility, and therefore committed, to provide guaranteed funds if another method of raising cash falls through. Standby facilities are common where a borrower is planning to raise money on the capital markets by issuing short-term instruments, such as medium term notes (see Practice note, EMTN programmes: overview), and are occasionally used to temporarily support transactions for which the financing has been delayed. If the market in the instrument a company plans to issue collapses, or the financing for a transaction is temporarily delayed, then the borrower can use the standby facility instead. Advantage of a standby or bridging facility A standby or bridging facility may be advantageous to a borrower because it can provide short-term finance to support a transaction that might otherwise collapse. Disadvantages of a standby or bridging facility A standby or bridging facility may be disadvantageous to a borrower as: It only provides a short-term solution. The margin charged will be much higher than on longer-term forms of finance. Multiple option facility A multiple option facility has two stages. First, a formal, committed facility agreement (often a revolving facility), will be provided by a syndicate of banks up to a specified figure. The syndicate then provides options for the borrower to use the agreed figure. These options include issuing debt securities, bills of exchange or short-term loans. The second stage of the facility is uncommitted. The syndicate members offer their best priced options when the borrower requests the facility. The borrower may take up one of the offers or continue to use stage one of the facility. This is a solution that emerges when borrowers are in a strong negotiating position, but decreases in popularity in a lenders market. A multiple option facility allows a borrower to mix and match different methods of borrowing within one agreement. Advantage of a multiple option facility A multiple option facility is advantageous to a borrower because it provides flexibility to chose the cheapest option available when it requires funds. Disadvantage of a multiple option facility A multiple option facility may be disadvantageous to a borrower as they only tend to appear during a borrowers market. In times of recession, when events of default have become more likely, these facilities are unpopular with the banks.
Forward start facility

A new loan may refinance (that is, repay) an existing loan on maturity (including if the borrower is unable to repay the existing loan). In an economic climate where credit may be difficult to obtain, borrowers may look to a syndicated forward start facility (FSF) to refinance an existing syndicated loan. Key features of a FSF include: It is a new syndicated loan agreement that sits alongside an existing syndicated loan agreement.
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It is only available on the existing syndicated loan maturity date (which ensures the lenders under both facilities do not have a double exposure) and for the purpose of refinancing the existing syndicated loan. It is signed long before the existing syndicated loan maturity date, between several months to over a year before that date. Its lenders include some of the existing syndicated loan lenders (but not all, as in that case the existing syndicated loan could simply be amended, including to extend its maturity date, and a FSF would not be required). Its terms are based on the existing syndicated loan terms, subject to certain exceptions such as availability period, purpose, conditions precedent, pricing and maturity date. FSFs have been used to refinance UK investment grade loans (in the first half of 2009 around US$39 billion of FSFs were entered into). This is partly because to extend an existing syndicated loan typically requires unanimous lender consent, which may be extremely difficult to obtain in a market where lenders are reluctant to commit to lend. The main advantages of a FSF are: The borrowers future borrowing arrangements (including the terms and conditions on which those borrowings will be made) are certain and for a fixed price. Lenders who participate in the FSF and the existing syndicated loan receive, overall, a higher return than they would have done if the borrower had refinanced the existing syndicated loan close to its maturity date. The borrowers view is that the benefit of certainty of funding outweighs the burden of higher pricing. Higher pricing may also reflect the perceived under pricing of the existing syndicated loan. In relation to pricing, FSF lenders typically receive: Up-front fees for entering into the FSF; and/or Fees for the period from the FSF signing date to the start of its availability period. (FSF lenders who are not also lenders under the existing syndicated loan typically do not receive fees under the FSF for the period from its signing date until the start of its availability period.) As a condition to the grant of the FSF, the margin and fees payable under the existing syndicated loan are also typically increased. This price increase is documented in the FSF and benefits the FSF lenders only (the existing syndicated loan remains unamended and continues until its maturity date). As well as pricing, when structuring a FSF the parties will need to consider various other issues including: The FSF covenant package. This may be more restrictive than the existing syndicated loan covenant package, and the parties may agree the borrower should be bound by it from the FSF signing date. If so, they will need to consider if breach of the FSF covenants should constitute an event of default under the existing syndicated loan.
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Cancellations or prepayments of the existing syndicated loan. These should generally result in a proportionate reduction of the FSF. Amendments in favour of the lenders under the existing syndicated loan. The FSF lenders may require the right to make corresponding amendments to the FSF. Transfer provisions. The parties will need to consider whether the FSF and the existing syndicated loan can be separately traded or whether commitments under the two facilities can only be traded together. Care should be taken to consider the effects of the transfer provisions, particularly on the pricing payable by the borrower if the facilities are traded separately. Security. Investment grade loans tend to be unsecured, but a FSF may also be entered into in relation to a secured syndicated loan. Usually it will be necessary to release and retake the security on execution of the FSF. For more on security, see Security and quasi security. FSFs can be contrasted with "amend and extends" in the United States syndicated loan market. This term refers to amending a syndicated loan agreement, including so that certain lenders agree in advance to extend the maturity date of their loans. In return, the extending lenders typically receive a higher margin on their existing loans than non-extending lenders. Amend and extends are more likely to occur in the US syndicated loan market as typically they only require majority lender approval. For more information on amend and extends, see Article, Amend and extends: are they gaining traction in the UK? and PLC US Finance, Practice note, Whats Market: Amend & Extends.
Security and quasi security

Secured loan Loans can either be secured or unsecured, but it is common for lenders to require a comprehensive security and guarantee package from the borrower (and, in acquisition financing, the target itself) as well as any material subsidiaries. Material subsidiaries will usually be defined as trading companies with assets. The security will attach, where possible, to all the assets of the borrower and its material subsidiaries. In acquisition finance, the security will include the target company assets as well as the purchasers assets and any equity funding agreements. Assets commonly used as security include land, buildings, machinery, intellectual property, trading stock, book debts, cash held in bank accounts, shares in the borrower and shares in its subsidiaries. Advantages of a secured and guaranteed loan Secured and guaranteed loans can be advantageous for the lender as: The security protects the lender on the borrowers insolvency, giving the lender priority over other creditors in accordance with applicable priority rules and allowing them to maximise their recoveries in such circumstances. It provides the lender with some control on a restructuring. See Practice note, Taking security.
Disadvantages of a secured loan A secured loan may be disadvantageous to a borrower as, in order to give security, the borrower needs to check that giving the security would not breach the covenants in existing loan and security documents that the borrower might already have entered into. The borrower also needs to check the security is not prohibited financial assistance in acquisition finance. The Companies Act 2006 (2006 Act) changed the law on financial assistance. The prohibition on a private company giving financial assistance for the acquisition of its own shares (including the whitewash procedure) was repealed by the 2006 Act on 1 October 2008. The prohibition continues to apply to public companies. For more information, see PLC Corporate, Practice note, Financial assistance: Companies Act 2006 and PLC Corporate, Practice note, Financial assistance: 1 October 2009. Taking effective security usually involves entering into legal documentation in the jurisdiction in which the assets are held. It may therefore involve using several different sets of lawyers and the costs may outweigh the benefits. For more detail on security issues, see Practice note, Taking security. Unsecured loan When it gives an unsecured loan, the lender has no recourse to specific assets if the borrower fails to repay the loan. The lender must therefore rely entirely on its knowledge of the borrowers financial condition when assessing the risk of lending. Smaller loans, such as freestanding overdrafts, will often be unsecured, but not all unsecured loans are for small amounts. All the LMA precedents for syndicated loans are unsecured and most investment grade loans made in the European and US markets are unsecured. For an introduction to the LMA standard form documents for investment grade loans, see Practice note, LMA investment grade primary documents. Advantages of an unsecured loan An unsecured loan may be advantageous to a borrower as the borrower will be free to use assets that would be subject to security in a secured loan with little or no interference from the lender. Disadvantages of an unsecured loan An unsecured loan may be disadvantageous for a borrower because the lender will either charge a much higher margin for the loan, to take account of the higher risk the lender will be taking, or may not be prepared to lend at all. Guaranteed loan A number of loans are unsecured but have the benefit of a guarantee, which is usually provided by the borrowers parent company. The guarantor promises that if the borrower fails to repay the loan or the interest the guarantor will pay it instead of the borrower. See Practice note, Guarantees and indemnities. Guarantees are also used to support secured loans and may include guarantees from other companies in the group. Advantages of a guaranteed facility A guaranteed facility may be advantageous to a lender as:
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The guarantee provides the lender with another (potentially solvent) party from whom it may recover the debt if the borrower fails to pay. The borrowers parent company may make a number of significant financial decisions about the borrower, and a guarantee from the parent company will ensure that the parent remains aware of how any decisions taken will affect the loan. Taking guarantees from all the members of the group (a cross guarantee) can protect the lender in a situation where assets are moved out of the company that has taken the loan and transferred to group companies with no obligation to the lender (and so put beyond the reach of the lender if the borrower defaults). If the lender has a cross guarantee it will be able to recover the money from whichever company in the group has the most assets (and the least debt). Disadvantages of a guaranteed facility A guaranteed facility may be disadvantageous to a lender or guarantor as the guarantee may be prohibited financial assistance in acquisition finance. The Companies Act 2006 (2006 Act) changed the law on financial assistance. The prohibition on a private company giving financial assistance for the acquisition of its own shares (including the whitewash procedure) was repealed by the 2006 Act on 1 October 2008. The prohibition continues to apply to public companies. For more information, see PLC Corporate, Practice note, Financial assistance: Companies Act 2006 and PLC Corporate, Practice note, Financial assistance: 1 October 2009.
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Boxes
Corporate loan facilities in other jurisdictions
Multi-jurisdictional guide For a multi-jurisdictional guide to finance, including issues relating to secured lending, see PLC Cross-border Finance Handbook 2010. United States For an introduction to the common types of corporate loan facilities and bank loans in the United States, including an explanation of the key features of each, and a brief outline of the steps of a syndicated bank loan transaction in the United States, see PLC US Finance, Practice note, Lending: Overview.
Further reading
For further reading and resources on lending, see Practice note, A guide to PLC Finances lending resources.
15
Article Information
RESOURCE INFORMATION
The fulltext is available at http://www.practicallaw.com/8-202-0672

General
Article ID: 8-202-0672 Document Generated: 23-Dec-2010 10:13:53

Jurisdiction
England http://www.practicallaw.com/topic9-103-0624 Wales http://www.practicallaw.com/topic4-103-1070

Subject
Asset finance http://www.practicallaw.com/topic5-201-5200 Structured finance http://www.practicallaw.com/topic8-103-1105 Property finance http://www.practicallaw.com/topic1-201-5202 Lending: general http://www.practicallaw.com/topic1-103-2033 Trade finance http://www.practicallaw.com/topic0-103-1109 Project finance http://www.practicallaw.com/topic3-201-5282
References
Basel II: an overview (http://www.practicallaw.com/0-201-7169) Euro commercial paper: overview (http://www.practicallaw.com/0-201-8102) Project finance: overview (http://www.practicallaw.com/0-202-3293) LMA investment grade primary documents (http://www.practicallaw.com/0-205-6580) Overdraft facility agreement: drafting note (http://www.practicallaw.com/0-366-8008) Lending: Overview (http://www.practicallaw.com/0-381-0295) LMA grantor credit risk paper published (http://www.practicallaw.com/0-384-7623) 364 day facility (http://www.practicallaw.com/0-503-3496) Novation (http://www.practicallaw.com/1-107-5796) Assignment (http://www.practicallaw.com/1-107-6442) Sub-participation (http://www.practicallaw.com/1-107-7333)
Several liability (http://www.practicallaw.com/1-200-1403) Taking security (http://www.practicallaw.com/2-107-4032) Financial assistance: Companies Act 2006 (http://www.practicallaw.com/2-202-4475) Overdraft facility agreement (http://www.practicallaw.com/2-366-8007) Investment grade loan (http://www.practicallaw.com/2-384-7453) Amend and extends: are they gaining traction in the UK? (http://www.practicallaw.com/2-501-2577) LIBOR (http://www.practicallaw.com/3-107-6318) EMTN programmes: overview (http://www.practicallaw.com/3-201-6446) Bonds, guarantees and standby credits: overview (http://www.practicallaw.com/4-107-3649) Bond issues: overview (http://www.practicallaw.com/4-201-8058) G20 endorse Basel III and draft legislation expected March 2011 (http://www.practicallaw.com/4-500-9116) Margin (http://www.practicallaw.com/5-107-6812) Withholding tax (http://www.practicallaw.com/5-201-9175) Understanding the syndicated loan market: The secondary market (http://www.practicallaw.com/5-204-3000) BCBS publishes text of Basel III rules (http://www.practicallaw.com/5-504-2790) Capital adequacy (http://www.practicallaw.com/6-107-5845) Loan Market Association (LMA) (http://www.practicallaw.com/6-107-6779) LMA publish new Termination and Transfer Agreement (Novation) (Par) (http://www.practicallaw.com/6-381-1824) Acquisition finance (http://www.practicallaw.com/7-107-3756) Condition precedent (http://www.practicallaw.com/7-200-1382) Hot topics: Proposals relating to the quality and quantity of capital (http://www.practicallaw.com/7-381-7707) Availability period (http://www.practicallaw.com/7-382-4213) A guide to PLC Finance's lending resources (http://www.practicallaw.com/7-500-3009) Basel III: an overview (http://www.practicallaw.com/7-504-1959)
Secondary market (http://www.practicallaw.com/8-107-7216) Withholding tax (http://www.practicallaw.com/8-107-7508) Financial assistance: 1 October 2008 (http://www.practicallaw.com/8-382-5504) Event of default (http://www.practicallaw.com/9-107-6565) [Guarantees and indemnities] (http://www.practicallaw.com/9-200-1437) [Methods of raising debt finance] (http://www.practicallaw.com/9-201-8490) What's Market: Amend & Extends (http://www.practicallaw.com/9-385-9683)
Practical Law Publishing Limited, Practical Law Company 1990 - 2010. http://www.practicallaw.com. Subscription enquiries +44 (0)20 7202 1210 or email [email protected] Please read our Terms of Use (http://www.practicallaw.com/9-103-0884), Trade Marks (http://www.practicallaw.com/9-265-9958) and Privacy policy (http://www.practicallaw.com/jsp/privacy.jsp)
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