We are likely to be heading into an era of economic uncertainty that few have ever experienced. It is therefore more essential than ever that clients undertaking cross border transactions be sure that their legal advisors are highly knowledgeable and experienced in matters arising outwith their own jurisdiction.
In a three part series of articles, we explore some common issues we have seen arise during the course of our extensive experience of working on cross jurisdictional finance transactions. In this first article we look at how some jurisdictions deal with the grant of security in syndicated finance transactions where the concept of security trustee is not recognised. In our second and in our final article in the series we look at the options and remedies that may be available to lenders when enforcing security over moveable assets and the cross jurisdictional considerations that lenders should take into account before deciding the most appropriate route of action.
Using Parallel Debt Obligations to solve Common Cross-jurisdictional Issues
Particularly in times of global economic unpredictability, it is essential for lenders that security rights granted in cross-jurisdictional finance transaction are valid and can be relied upon. A parallel debt obligation can make a security structure work in those jurisdictions where local laws do not recognise security trusts or the secured parties' ability to transfer their obligations. In this article we consider how an alternative security structure can work to overcome jurisdictional difficulties with security trusts in syndicated finance transactions.
What is the usual security structure in a syndicated finance transaction?
Typically, in a syndicated finance transaction lenders/finance parties will appoint a security trustee to hold the security granted under that transaction on trust on their behalf. The use of a security trustee in these transactions has two principal advantages:
- it provides a level of administrative ease to the lenders/finance parties; and
- it regulates priority and sharing of proceeds on enforcement.
What are the administrative benefits of having a security trustee?
In large syndicated finance transactions, where it is foreseen and documented that lenders may at some point transfer or assign their debt to an incoming lender, the appointment of a security trustee ensures that the security that was created in favour of an outgoing lender and which was held on trust by the security trustee in favour of all original lenders will not have to be discharged and "retaken" and registered by the incoming lender.
The security trust concept seeks to eradicate any exposure an incoming lender (and the remaining lenders) may have to the administrative burden and risks associated with retaking and re-registering security granted under the original facility. The security, which forms part of the trust property, in essence remains unchanged even if the profile of the creditors who have the benefit of it changes.
How does having a security trustee protect priority and proceeds?
The appointment of a security trustee also ensures that no one single lender can enforce the security granted under the transaction and thereby potentially prejudice the position of other lenders on enforcement.
Typically, the security trust deed under which the security trustee is appointed will state that a certain portion of the creditors will need to act collectively in order for an instruction of enforcement to be given and for the security trustee to act on such instruction.
We see then the creation of the security trust and the appointment of a security trustee strives to afford creditors a level playing field vis-à-vis their respective interests and rights in and to security whilst freeing them from the administrative burden of holding such security.
What happens when a jurisdiction does not recognise a security trust?
A jurisdiction's non-recognition of security trusts may be due to local laws:
- not recognising as valid security, that which is granted by a party (in this instance, a borrower as Grantor) in favour of another party (in this instance a security trustee as Grantee), where there is no underlying primary obligation owed by the Grantor to the Grantee or;
- governing real property i.e. only trusts in relation to real security, and not in relation to guarantees, being recognised (as was the case in France prior to 2017).
Whatever the reason, the creation of a parallel debt between a borrower and (typically) a facility agent seeks to rectify the problematic position in which lenders could otherwise find themselves in jurisdictions where security trusts are not recognised.
How does a parallel debt obligation work?
The inclusion of a parallel debt provision creates an additional or supplementary obligation upon the borrower/obligor. In addition to the primary debt obligation which the borrower/obligor will owe to its lenders under the facility agreement (Primary Debt Obligation), it agrees to also assume a parallel obligation of the Primary Debt Obligation (reflecting exactly the latter's terms and amounts) to the facility agent (Parallel Debt Obligation).
The Parallel Debt Obligation creates a primary obligation to the facility agent and in so doing, creates the right of the facility agent to demand payment of that Parallel Debt Obligation. The borrower/obligor will then grant security both to the facility agent (securing the Parallel Debt Obligation) and each of the finance parties/lenders (securing the Primary Debt Obligation) in parallel.
The facility agent typically will agree to hold on behalf of each of the finance parties/lenders both (i) the security granted and (ii) its benefit of its claim under the Parallel Debt Obligation.
The result of the insertion of a parallel debt provision should be that, for all practical purposes, the treatment of the security will be the same as that had a security trust been recognised.
Of course, when a parallel debt provision is used, provisions should then be inserted into the documentation which provide against double recovery, namely:
- upon receipt of amounts in discharge of the Parallel Debt Obligation from the borrower/obligor, the facility agent shall apply those amounts as per the waterfall provisions in the facility; and
- the receipt by the facility agent of such amounts shall pro tanto discharge a corresponding amount owed under the Primary Debt Obligation and vice versa.
Is parallel debt recognised in foreign law jurisdictions?
The concept of parallel debt has been developed under common law, due in part to English law often being the law of choice for parties to cross border financings. It is also a recognised concept under transactions governed by Scots law (a civil law jurisdiction).
Historically, some commentators in mainland European civil law jurisdictions questioned the validity and enforceability of parallel debt provisions. However, there have been instances in the recent past of parallel debt arrangements governed by common law (English law and the law of the State of New York) being tested and confirmed in major European civil law jurisdictions (e.g. France) which should provide a level of comfort to lenders that parallel debt provisions would be enforced. Indeed, in jurisdictions where the concept remains untested (e.g. Germany and the Netherlands) the concept is nevertheless generally, widely accepted.
However, any proposal to include parallel debt provisions in a cross-border financing should as with any other elements to a cross-border transaction, be subject to local law advice and be considered on a case by case basis.
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