The Loan Syndications and Trading Association (the "LSTA") published revised trading documentation on May 17, 2019 (the "Publication Date"). This revised documentation will govern all trades entered into on or after the Publication Date. The preceding form of LSTA documentation (effective from June 9, 2017) continues to govern open trades that pre-date the Publication Date.
The LSTA now requires that both parties to a trade either purchase a license or become a member of the LSTA to utilize the LSTA documentation. Previously, only one party to a trade was required to be an LSTA member. The LSTA has advised that it will enforce its copyright rights with respect to trades entered into after September 1, 2019. Each LSTA document in the updated suite bears a legend advising of the LSTA's copyright, and it should be noted that current LSTA members have no obligation to determine whether their counterparties are either LSTA members or license holders. LSTA membership fees range in price according to the preferred membership level and, as such, we recommend that you contact the LSTA directly to discuss.
Further key changes implemented in the revised documentation are as follows:
Voting provisions known in the market as "voting override" language are now included in (i) the standard terms and conditions for distressed purchase and sale agreements; (ii) the standard terms and conditions for par/near par participation agreements; (iii) the standard terms and conditions for distressed participation agreements; and (iv) the proceeds letter.
Voting language is most commonly seen in participations (both distressed and par). If the parties agree that voting rights will be granted by the seller/grantor, then this will be documented in the terms specific to the transaction. The seller/grantor will generally only follow the buyer's/participant's direction if either the vote is divisible or if the buyer/participant holds the majority position (and therefore controls the vote).
The language incorporated in the amended documentation allows the seller/grantor in certain circumstances to override the voting instructions of the buyer/participant or its majority holders (being the current holders (including the seller/grantor to the extent it holds debt for its own account) of more than 50 per cent of the aggregate principal amount of claims then outstanding in respect of which the voting action is to be taken by the seller/grantor). The circumstances are where the seller/grantor reasonably determines that the buyer's/participant's direction (i) exposes the seller/grantor to a material liability for which it has not been provided an adequate indemnity; or (ii) violates any applicable law, rule, order or the underlying credit documentation.
- Tax gross up obligations
The Receiving Party (as defined below) gross up provision is now expanded to any withholding, not just in respect of the Foreign Account Tax Compliance Act of 2010 ("FATCA"). For example, if either the buyer or the seller is required to make a payment (the "Remitting Party") to the other (the "Receiving Party") pursuant to the transaction, and the Receiving Party's distribution would not have suffered a withholding if it had received the payment directly from the borrower, then the Remitting Party will have to gross up the Receiving Party whether such withholding is due to FATCA reasons or otherwise.
This provision has been incorporated in (i) the par trade confirmation; (ii) the distressed trade confirmation; (iii) the standard terms and conditions for distressed purchase and sale agreements; (iv) the standard terms and conditions for par/near par participation agreements; (v) the standard terms and conditions for distressed participation agreements; and (vi) the proceeds letter.
The Employee Retirement Income Security Act of 1974 ("ERISA") language was modified to remove the Department of Labor's fiduciary rule that expanded circumstances under which a person would be considered a fiduciary under ERISA or the Internal Revenue Code which was incorporated into the LSTA documentation in 2017. This follows the fiduciary rule being vacated following a mandate issued by the Fifth Circuit Court of Appeals on June 21, 2018.
- Proceeds letter updated
The proceeds letter has been updated to include some standard language that was previously not incorporated. This includes (i) a no bad acts covenant for subsequent distributions; and (ii) a disgorgement provision where a seller suffers a claw-back by the bankruptcy court.
No bad acts
The no bad acts provision in the new Section 5(b) of the proceeds letter effectively provides that a seller has not taken action or failed to take action that will result in a buyer receiving reduced distributions or less favorable treatment than a creditor of a similar status. This amendment acknowledges that the no bad acts representation included in the purchase and sale agreement (for distressed trades) applies in respect of actions taken or not taken (as the case may be) up to the settlement date, but not for future actions. The covenant included in the proceeds letter now provides protection to the buyer for post settlement date actions. Pursuant to the proceeds letter, distributions will be made by a bankruptcy estate to a record-date holder of the loan (which is not necessarily the current holder of the loan). This covenant provides recourse for the current holder of the loan if the record-date holder receives worse treatment than creditors of a similar status due to any action or inaction by the record-date holder.
The disgorgement provision has been included in Section 7(c) of the proceeds letter. Prior to the inclusion of this language, if a bankruptcy court required a seller to return proceeds distributed to it by a bankruptcy estate and the seller had passed the economic benefit of such proceeds to the buyer, the seller would only be able to claw such proceeds back from the buyer that had been distributed by mistake. The inclusion of this disgorgement language provides the seller with an unfettered right to claw back proceeds from the buyer (to the extent that the seller delivered the economic benefit of such proceeds to the buyer).
How do the updated LSTA terms compare to the LMA documentation?
These LSTA updates reflect some of the provisions already contained in the Loan Market Association (the "LMA") secondary trading documentation.
- Tax gross up obligations
The amended LSTA tax gross up obligations reflect the current position under Condition 29 of the LMA standard terms and conditions (the "LMA Standard Terms") whereby the 'payer' is required to increase the amount to be paid to the 'payee' to ensure that the payee receives and retains a sum equal to the sum which it would have received and retained had no such deduction or withholding been made or required to be made.
The ERISA language in the LMA Standard Terms and forms of participation agreement was updated in October 2018 to take account of the revocation on June 21, 2018 of the ERISA fiduciary rule that was introduced in the US in June 2017, so the LMA documents already reflect this change.
The disgorgement provisions in the LSTA documentation reflect the claw-back language in the LMA Standard Terms (Condition 9 (Insolvency Proceedings) in respect of claims and Condition 15 (Interest Payment and Fees) in respect of interest and fees), which allows a seller to reclaim amounts paid to its immediate counterparty. As the LMA documentation works on a back-to-back basis, a buyer required to repay amounts to a seller will have the same right to claw-back from its downstream under the trade confirm and the LMA Standard Terms.
There are some notable differences between the LSTA and LMA documentation though.
There is no standard "voting override" language contained in any of the LMA documents, although most investment banks and broker-dealers will seek to include their own form of "voting override" language in LMA distressed participation agreements and LMA distressed and claims trades where voting has been agreed to be passed on to the buyer from the trade date. The language commonly included in English law governed trades often extends beyond the new LSTA market standard language by also referring to a right to override the voting instructions where the seller/grantor determines that such action may impact its reputation or prejudice its relationship with the borrower.
- Proceeds letter
There is no LMA standard form of proceeds letter (although the market does settle on similar terms as the LSTA letter from time to time). That said, the no-bad acts provision and obligation to pay distributions to onward buyers is already covered under the LMA Standard Terms (Condition 22.4(c) and Condition 9.5(c) respectively) and such terms could apply on a back-to-back basis in any chain of title.
The changes to the LSTA documentation are useful for both buyer and seller to ensure fairness in payments between the parties and afford the relevant party appropriate recourse where necessary. Since the LMA standard terms have always been drafted to allow parties to recover from their immediate counterparty for withholding and in disgorgement circumstances, it is not necessary for the LMA to make corresponding updates in respect of those particular terms of trade, although we may see European broker-dealers requesting similar amendments in negotiations concerning the "voting override" provisions.