In many cases, a single bank can provide the financing required to bring a massive infrastructure or energy project to life. The sums required (and provided) can flow into the hundreds of millions. However, there are several instances where multiple banks come together to lend money to a borrower, at the same time and for the same purpose, in order to cover the loan commitment. This is called a syndicated loan.
Outside of the project risks that a bank needs to be aware of, when syndicating there are a host of other legal risks presented to the bank assuming the role of lead bank or agent bank (in so far as their duties to lending banks are concerned); and an even more unique question arises for the bank that takes on both roles. This will be the focus of the article.
This article will start by briefly identifying the syndication players and give an overview of the syndication process, for context. It will then identify the legal risks that the lead bank is exposed to when drafting syndication documentation and useful mitigation techniques. Then it will identify the legal risks that the agent bank is exposed in its fiduciary capacity and useful mitigation techniques. This article will then conclude by answering the question: Is transitioning from the role of lead bank to the role of agent bank a worthwhile endeavour?
The syndication process is sequential and is broken up into three phases. The pre-mandate phase, the post-mandate phase, and the post-completion. In order to adequately move through this process, it is essential to identify the key players that make up this process, namely; the lead bank, The Agent bank and The Lending/Participating banks. [If you are already familiar with these terms and the syndication process, you can skip to the section: ‘Duties of the arranging bank to the lending banks in the post-mandate phase’]
2.1. Key Players
Also known as the lead bank, this bank advises and negotiates terms with the borrower. Based on the negotiated terms, the lead bank obtains a mandate from the borrower authorizing it to arrange financing on its behalf. The bank then prepares the syndication documentation and solicits other banks to participate in the syndication and provide financing to meet the lending commitment.
The agent bank’s primary role is to relieve the lending banks of the administrative burden that come with executing the mechanical aspects of the loan, such as paying out the drawdowns and keeping track of the borrowers condition. It is not uncommon for the agent bank role to be assumed by the arranging bank.
Sometimes called the participating banks depending on how the syndicate was formed. This is a one of the banks that the arranger enlisted to provide part of the financing and form part of the syndicate.
2.2. Pre-mandate Phase
At this stage, the borrower solicits offers from banks to take the role of arranging bank. The borrower selects the lead/arranging bank and sings a mandate letter that instructs the bank to form a syndicate and negotiate tentative loan terms.
2.3. Post mandate Phase
Once the borrower signs the mandate, the arranging bank attempts to pitch the loan to other financial institutions. During this phase, the arranging bank will be responsible for drafting and circulating three specific documents necessary for the formation of the syndicate:
Firstly, a term sheet that outlines the core terms of the proposed financing is drafted and circulated to potential lending banks.
Secondly, an information memorandum that presents relevant information about the borrower. Information surrounding its political, economic and financial positions to ascertain the borrower’s bankability. This memorandum is prepared with the borrower and is often modified by the arranging bank.
Lastly, the arranging bank prepares a draft loan agreement in the case of direct syndication. This draft will be assessed by the interested lending banks and will be used as a template for the final loan agreement.
2.4. Post-Completion Phase
In this phase the loan becomes operational, and all the parties involved (borrower and syndicate members) are now bound by the debt contract. The lenders receive a closing fee, participant banks receive their participation fee, and the arranging bank obtains its arranging fee. Drawdowns commence shortly afterward. It is during this phase that the agent bank and becomes responsible for the administration of the loan.
3. Duties of the arranging bank to the lending banks in the post-mandate phase.
As outlined before, the arranging bank plays a unique role in pitching the loan to prospective participating banks. This bank drafts essential syndication documentation, such as the information memorandum and draft loan agreement, and provides it to other members in the syndicate. This job function comes with particular risks of liability. This part of the article will look at some of the duties and risks that come with being the party that drafts the Information Memorandum and the Syndicated Loan Agreement.
3.1. Information Memorandum
When deciding whether or not to participate in a syndicate, prospective lending banks rely upon the arranging bank to accurately relay the borrower's circumstances (as a measure of their bankability). Therefore, as the party that prepares and distributes the information memorandum, the arranging bank may be liable for any incorrect statements.
Even if the arranging bank expects that other bank will conduct their own credit analysis of the borrower without depending on the arranging bank, the arranging bank may still be held responsible for any omission or material misrepresentation.
This liability may stem from local legislation or from non-statutory duties that may be imposed by common and civil law. This article will briefly go over these two factors.
If the loan transaction can be defined as a security under the legislation, then the information memorandum of the arranging bank will fall under the scope of local securities legislation. The arranging bank may need to go through rigorous registration requirements that require a duty of disclosure. Breaching this duty by virtue of incorrect statements would open the bank to liability for misrepresentation.
3.1.2. Non-Legislative Duty.
A non-legislative duty to disclose may exist at common law, it would be rooted in the legal theory providing for fraudulent or negligent misrepresentation. This creates an environment where an arranging bank would be held liable whether it distributed the memorandum in its own name or on behalf of the borrower. If a participating bank alleges negligence, a claim for damages may be instituted, and various circumstantial factors will come into play including the extent to which the arranging bank contributed to the preparation of the information memorandum and how heavily the lending bank relied on the memorandum.
3.2. Limiting the arrangers’ Liability for Information Memoranda.
There are obvious risks that the arranging bank takes on in fulfilment of its duty. Although liability in the case of incorrect information in a memorandum seems automatic and unavoidable, there are ways to limit liability. The following are techniques to do that.
3.2.1. Due Diligence Defence
This defence allows an arranging bank to negate the application of non-statutory duties prescribed by the securities legislation. This is done by strictly conforming to due diligence standards that local securities legislation provides in relation to the memorandum and further insisting all banks in the syndicate do the same.
Additionally, the arranging bank may involve independent analysts and experts when reviewing information from the borrower. This due diligence process can be restricted to only verifiable sources of information and written confirmation of accuracy of all used information. This combination of preparatory elements should create a protective cushion around the arrangers' liability.
3.2.2. Dealing With Conflicting Duties of Disclosure
In the instance that the arranging bank obtains information about the borrower, from another source on a confidential basis (creating a duty of non-disclosure), but it has a duty to disclose such information to prospective bank lenders (by legislative or non-legislative obligation). This scenario would create conflicting duties of disclosure if the information is material.
The arranging bank would need to ask the borrower to either disclose the information or allow the bank disclose. This disclosure can be made through various media such as a separate letter or syndicate meeting informing relevant parties, as long as the disclosure is made before the closing of the transaction in order to allow parties to have enough time to incorporate this new information into their decision making.
3.2.3. Exculpatory & Indemnity Disclaimers
An arranging bank may attempt to use exculpatory clauses in either the information memorandum or the loan agreement to protect itself from misrepresentations that are actionable in law. An arranging bank might use the following contractual techniques to evade liability for a misrepresentation.
Firstly, the arranging bank may want to negate a lending banks’ ability to claim that it had been induced by misrepresentation to enter into the transaction. This can be done by getting all the lenders in the syndicate to confirm that they had not relied on the arranging bank for accurate and whole information in the memorandum.
Secondly, the arranging bank would procure a written statement from the borrower, which states that: (1) the borrower claims that the information is true and whole and also assumes responsibility for the information; and (2) the memorandum was drafted and distributed by the arranging bank as an agent of the borrower. This has the effect of shifting responsibility for the information memorandum from the arranger as a co-principle to the borrower, with the arranger being its agent.
Lastly, the arranging bank would obtain an indemnity from the borrower in relation to any legal action relating to misrepresentation and the arranging bank.
This combination of factors should adequately mitigate the arranging banks’ liability regarding the information memorandum.
3.3. Loan Agreement Negotiation
Before the formal loan agreement is executed, the arranging bank distributes a draft loan agreement to the parties in order to obtain commentary on its adequacy. There are instances when, because of pressures to complete the transaction on time, the loan will be executed before there is enough time to fully discuss any commentary on the draft loan agreement. The lending banks will have relied on the statements in the term sheet that the final loan agreement will contain the standard provisions…
However, if substantial changes are made in the draft loan documentation by the arranging bank and borrower, and these changes do not provide adequate protection to the lending banks, there is room for liability to be attached to the arranging bank.
For a lending bank to successfully institute its claim for damages, it must prove not only that the arranging bank was negligent in negotiating the loan documentation with the borrower, but also that its negligence caused a loss.
3.3.2. Limiting liability for the loan agreement
The arranging bank may claim that the draft loan agreement contained the standard exculpatory disclaimers as a defence. Moreover, the arranging bank may also argue that the financial commitment of the banks to the syndicated loan without finalized documentation gives rise to a form of contributory negligence, barring any form of recovery.
The arranging bank may seek to avoid legal troubles in several ways. Suffice it to say that one of the most transparent ways would be to give the lending banks enough time to review and discuss with queries with the arranging bank.
4. End of the Lead Bank, Start of the Agent Bank
The arranging bank's role in the syndication ends with the signing of the loan agreement. The arranging bank typically undertakes the roles and responsibilities of the agent bank. In this discussion on the agent’s duties, this article will not address the more mechanical functions of the role such as disbursement of funds, monitoring the condition of the borrower and informing syndicate members of borrower default. This discussion will focus more on the over-arching fiduciary duties that govern and drive the more mechanical ones.
4.1. Duties of Agent bank in the post-completion phase
In many jurisdictions, the agent bank exists as a true agent and holds a fiduciary relationship, inclusive of fiduciary duties, with the other banks. The specific functions that the agent bank takes up will determine the nature of its obligations and agency, but the inclusion of an agent clause would further solidify the relationship. The clause would stipulate that each bank appoints the agent bank to act on their behalf with regards to this syndicated loan and confer the powers that allow it to exercise its function. The following are some of the fiduciary duties that come with the role of agency.
4.1.1. Duty to act in the interest of the syndicate
The agent should, in so far as is reasonably possible, avoid any conflict between its own interests and the interests of the parties it represents. In many cases, the borrower is frequently a client to the agent by virtue of the agent providing, e.g. a lending arrangement outside of the syndicated loan at hand.
In this instance, the agent bank must balance the interests of the borrower and the lending banks, which can be considered to be its two principals. Thus, in disclosing borrower information to the lending banks, the agent bank may be considered in breach of its duty of confidentiality towards the borrower. This circumstance is difficult to navigate, but contractual provisions can relieve an agent from disclosing confidential information if such full disclosure shall amount to a breach of confidentiality.
It is also important to note, this duty is tied into the agents’ discretionary powers in instances where the agent bank must act on behalf of the syndicate without the lending banks' prior instruction or knowledge. Typically the agent bank can only act on instruction from the lending banks, and the power to act freely is only used when necessary. This power unlocks a host of risks when an agent bank acts independently in a crucial time, and the result is negative. This can bring about claims of negligence and breach of contract.
In order to provide some form of protection, a discretionary clause can be worded as follows:
“…In the absence of any such instructions, the agent may act or refrain from acting as it shall see fit. Any such instructions shall be binding on all the Banks."
The broad wording of this clause allows the agent to act swiftly to protect the financial viability of a project for the benefit of the lending banks. However, if that action is not successful, the lending banks are still bound by it and cannot hold the agent bank solely responsible.
4.1.2. Duty of skill, care, and due diligence
In the enactment of its duties, the agent bank is expected to act with reasonable care and due diligence and shall be accountable for any negligence. Particularly negligence that negatively impacts on the financial elements of the loan and any other mechanical issues in the loan agreement.
It appears that the positive act of thorough due diligence exists as an arranging bank provides an extra layer of defence against legal action. However, as an agent, that same positive action is simply the required work, and thus extra care is taken to give the agent bank enough freedom to operate.
When designing any provisions that address skill and due diligence, the agent is typically only held at fault for actions that constitute gross or wilful misconduct. The agent bank would not solely be responsible for actions that constitute mere negligence. All parties will take responsibility in that instance.
This approach recognizes the high-risk position that being an agent entails. There is a level of scrutiny and legal exposure that an agent bank undertakes in fulfilling that function. Provisions that take this approach exist to incentivize the agent bank to take this position. Flexibility is crucial, and thus a broad definition of 'wilful misconduct’ will give the parties the legal room to manoeuvre.
4.1.3. Duty to disclose information
The agent has access to key information of the borrower and has a duty of disclosure of any material fact pertaining to the financial status of the borrower to the Lending banks. This is especially important when there are signs of default. The main aim of such a duty is to allow the Lending banks to institute their default procedures to accelerate repayment and actions of that nature.
4.1.4. Exculpation Disclaimer
The exculpation approach of the lead bank vs. agent bank differs slightly. While the lead bank attempts to shift the burden to the lending banks for the accuracy of the information or to the borrower for any misrepresentation, the agent bank denounces responsibility entirely. An exculpation clause would indemnify the agent, any of its directors, officers, employees, and would relieve agents of any liability or responsibility to any of the banks.
5. Concluding Remarks
There is undoubtedly a core difference in the mechanical functions and duties of an arranging bank and an agent bank. However, their over-arching duties remain relatively similar: There exists a consistent duty to act in good faith by accurately representing information to the other banks involved, practicing thorough due diligence and disclosing necessary information. Albeit regarding different subject matter the driving principles are the same.
These duties carry with them certain risks, the question being, does the arranging bank take on more risk by becoming an agent? In order to establish this, the duties must be viewed through this lens: The scope of risks.
It appears that the scope of an arranging banks’ exposure is limited to the time it takes to complete the syndication process and to the two key documents it drafts: The information Memorandum and the Loan agreement.
On the other hand, the agent bank is exposed to risk for the duration of the financing, which would typically take over 10 years. The agent bank is further exposed though the multiple transactions it has to carry out over this period and constant monitoring of the borrower’s circumstances. On a long enough timeline anything can go wrong, and this fact only multiplies the number of administrative/clerical/political/economic risks that could impact an agent banks’ abilities. It’s clear that more risks lie with the agent bank duties, nonetheless, the role provides fees for the bank to make revenues from.
As far as limiting liability is concerned, the role of the arranging bank has a wide arsenal of defences and techniques to avoid liability for defective documentation. A big part of why an arranging bank has so many options is because the lending banks are involved in the process in their own separate capacity. What this means is, the lending banks are not “in the same boat” as the arranging bank and must thus take responsibility for their due diligence or can be estopped from retrieving commitments to the syndication. This same layer of separation can exist between the borrower and the arranger, and it is the key to limiting liability. This is what makes this role less risky to take on in any circumstance.
This separation does not exist for the agent bank. The agent bank derives its power from the lending banks and acts as an extension of them, thus its missteps are directly attached to the lending banks. Limiting liability for the agent bank revolves around creating flexible duties through creative contract wording or the inclusion of an exculpation clause. Banks would be reluctant to take on the agent position in any circumstance and would explicitly insist on these measures being taken.
From a legal perspective, this transition from lead bank to agent bank is not worth it. Although the lead bank signs up for new risks and new ways to mitigate that risk, it also signs up for more complicated risks and less certain ways to mitigate that risk.
However, this transition still takes place because the legal risk is not the only consideration. The revenue and control gained from providing agent bank services is surely an attractive feature. Other financial, operational and economic factors also weigh into the decision making process. Although those factors exist outside the scope of this article, it can be deduced that they are well worth the risk.
About the Author
Zach Kauraisa obtained his LLB from the University of Namibia and is currently a 2019/2020 Candidate for an LLM in International Oil and Gas Law and Policy at the Centre for Energy, Petroleum, Mineral Law and Policy. For inquiries, email: firstname.lastname@example.org