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Banks borrow short to lend long. Loans are assets but unusual deposit withdrawals involves high
insolvency risk.


Anglo American common law group

Napoleonic group

Roman Germanic

Criteria to help position legal systems. 5 indicators. 3 in terms of risk reduction. 4 economic
importance and 5 a critical ideological test.

1- The availability of insolvency set off (where a person goes into bankruptcy or a company
goes into liquidation mutual debts are automatically set-off.) and netting because there are
counterparties with mutual claims. Fundamental for payment and securities settlement
systems and derivatives. Insolvency set off pays the creditor, its absence pays the debtor.
Financial markets are the most visible exponents of set off.
2- The availability and scope of security interests (A security interest is a type of property
interest created by agreement or by operation of law over assets to secure the
performance of an obligation, usually the payment of a debt).
3- The availability of the commercial trust. A trust involves the holding by an intermediary of
title to property for the benefit of the real owner but so that the property is immune from
the private creditors of the intermediary. The trust arises whenever there is a need for an
intermediary or manager of assets. Settlement systems (Cede and Co, Euroclear)
holds investments
4- The marketability of contracts: receivables and claims (crditos por cobrar y otros
derechos similares): wether notice to the debtor is necessary for the validity of a transfer
if the transferor becomes insolvent as opposed to mere desirability in order to procure
that the debtor pays the transferee or in order to obtain priority. The author considers
needing the notifification a sign of an obsolete formality whose non performance
invalidates the transfer and reduces marketability.
5- The availability of tracing delinquent money through transformations and mixtures on the
insolvency of the final holder eg the recovery of money by virtue of a claim for
embezzlement of assets by a director or other fiduciary

All of these are based on insolvency law because is when law has to make difficult choices between
colliding principles.

Other indicators:

- Legal and political infrastructure, whether the courts enforce the law as stated, the capacities of
the legal infrastructure the degree of bureaucracy the time taken to form a company or collect a
debt, the competence of authorities.

- Codification: in most commercial states important areas of the law are codified.

-Doctrine of precedent not useful in this area most of advanced states the courts pay regard to the
decisions of higher courts although not strictly bound by them.
Cultural style: if the legal system is despotic liberal logical over regulated left wing right wing..

Contract law and property, both foundations of insolveny law. Works well outside insolvency law
too. Literal contract interpretation..


Term loans are loans for a fixed term, cancellable only if certain conditions are satisfied and
repayable prematurely only on an event of default and certain others. By contrast, overdrafts or
lines of credit are cancellable and repayable on notice from the bank.

Bilateral banks between a borrower and a single bank. Large loans lend themselves to syndication
amongst a number of banks that agree to make loans to a borrower on common terms by a single
agreement between all parties. The borrowing company mandates a bank or a group of banks to
arrange the loan on the outlined terms agreed between them. The arranging bank assist the
borrower in preparing an information memorandum about the borrower and setting out the terms
of the loan for despatch to potential bank participants, solicits expressions of interest from these
potential participants and negotiates the loan documentation. Once the loan documentation is
agreed, all of the banks sign up the syndicated credit agreement with the borrower and in the
agreement appoint one of their number, usually the lead arranging bank as their agent to administer
the credit.


The borrower, the guarantors, the arranging banks which benefit from exculpations from liability eg
in relation to the information memorandum and the sufficiency of the documentation and to benefit
from indemnities from the borrower, the lending banks, the agent bank.

Mandate to arrange a syndication

Authorising the arranging bank to arrange syndication and confirming that the mandate is exclusive.
The financial terms are set out in a term sheet with> the amount, term, repayment schedule,
interest margin, fees, any special terms and a general statement that the loan will contain
representations and warranties, covenants, events of default and other usual clauses.

The offer set out in the mandate is usually subject to conditions

Satisfactory negotiation and documentation to the syndicate, no material adverse change in the
opinion of the arranger in the syndication market, no concurrent syndication by the borrowers
group, final credit approval by the bank and for a takeover bid financial and legal due diligence by
the banks.

THE MARKET FLEX CLAUSE> a provision that the arranger may revise the pricing terms or structure of
the credit if it thinks that this is advisable in order to achieve syndication. Typical of very large
financings under committed mandate letters where the arrangers assume a massive underwriting
risk. The bank may agree in the mandate letter to underwrite the whole loan if they are unable to
find other participants although this is usually expressed to be subjet to material changes in market
conditions prior to the signing of the formal loan agreement and is a non legally binding
commitment. But on normal principles of contract law there is a presumption that commercial
arrangements are intended to be legally binding so the mandate has to be expressed as non legally
binding commitment


To assist the borrower in preparing an information memorandum about the borrower and the loan
for despatch to potential participants, and to solicit expressions of interest from banks, and to
negotiate the loan documentation.

The arranger is in a different position from the agent bank appointed although often the arranger is
appointed as the agent bank. The arrangers position is commonly not documented in detail, it is not
usually stated who the arranger is acting for, the arranger is closely involved in structuring and
organising the loan and the arranger receives a significant fee for its services.

In the normal case It is considered that the arranger is in the position of an independent contractor
and is not an agent or fiduciary of either the borrower or the banks. If the arranger were an agent
then this may attract the usual range of draconian fiduciary duties> due diligence, full discosure, not
to put itself In conflict of interest and not to benefit personally from the agencythe letter from the
borrower to the arranger authorising the arranger to organise the loan is expressed to be a mandate
but this should not itself characterise the arranger as agent of the borrower. In negotiating the term
sheet and then negotiating the documentation it would seem to act for the benefits of the bank. So
first for the borrower and then of the banks, the solution the arranger is the agent of nobody. But
the precise relationship depends on the facts, including the language used in the mandate letter, the
language used by the arranger in soliciting participants and any clear assumption of responsabilites
as agent we will do this on your behalf look after this for you well look after your interests.. In
English case law the courts are slow to find that a bank has undertaken fiduciary duties to advise a
customer unless there is clear assumption of responsibility by the bank.

Commonly the arranger is also a party to the credit agreement so as to benefit from provisions for
the payment of its fees and also to benefit from exculpations of liability in the agent bank clause. It is
usually stated in the agency clause that the arranger has no duties or liabilities to any of the parties.


SEVERAL COMMITMENTS each bank agrees in the loan agreement to make a separate loan to the
borrower up to its stated commitment. The commitments are several, the banks do not underwrite
each other in normal syndication practice. Contributions to loans are made by the banks in
proportion to their commitments and payments by the borrower are divided between the banks in
the same proportion. However, all the loans are made on precisely the same terms.

SYNDICATE DEMOCRACY the banks may agree between themselves to delegate limited decisions to
majority control.

PRO RATA SHARING clause designed to ensure that receipts by syndicate members arising from set
offs, litigation proceeds and the like are shared proportionately without discrimination.

Common practice is for banks who express interest to be sent an information memorandum giving
financial and other information about the borrower which has been prepared in conjunction with
the borrower by the arranging bank. With the term sheet, details of the history and business of the
borrower, details of the management of the borrower and the borrowers financial statements.

Most commercial jurisdictions have introduced legislation regulating prospectuses offering securities
to the public. Assuring that the participations in the loan agreement do not constitute securities or
debentures within the securities legislation or the circular constitutes a private offering and not an
invitation to the public or it is issued only to sophisticated investors.


LOAN MARKET ASSOCIATION an association of international banks active in the London syndication
market. Objectives to harmonise certain provisions of the documentation for syndicated credits with
a view to enhance the tradeability of these credits and reducing the time and const of negotiation.
But not to standardise deal specific terms covenants events of default..

Agreement to lend> The bank will make loans up to its specified commitment during the
commitment period. Usually express in minimum and rounded amounts with an expiry date the
commitment period. A REVOLVING LOAN the borrower can borrow, repay and reborrow up to the
stated maximum commitment of the bank.


These are to ensure that all legal matters are in order and that the security is in place. By this clause,
the bank is not obliged to make any loans until the bank has received such items as constituonal
documents of the borrower and its authorisations. EG the bank is not obliged to make a loan unless,
at the time of the request for the loan and the borrowing of the loan, and immediately after the loan
is made/ the representations and warranties are true on an updated basis, no event of default or
event with giving of notice, lapse of time or other conditions that would constitute an event of
default has occurred, there has been no material advere change in the borrowers financial condition,
and borrowers certificates are made available as to the above, if the bank so requests.

The conditions ensure that all legal and financial matters are still in order prior to each separate
borrowing and that the bank is not obliged to lend if it is only a matter of time before a default

NOTE that the condition precedent suspends the obligation to make the loan *a draw stop but does
not cancel the facility because cancellation requires a full event of default.


For example if the borrower is in difficulties and it is unclear whether the bank is obliged to lend, it is
not clear if the borrower can obtain specific performance if the bank fails to lend. English case law:
or pay solely for damages or in excepcional circumstances the specific performance of an unsecured
loan agreement might be awarded.
The damages payable by the bank are determined in accordance with ordinary contract principles so
the party suffering the loss is in the same position as it would have been in had the contract not
been broken and comprises two elements:

- Reasonably foreseeable losses as extra interest and costs incurred by the borrower in
arranging another loan, it may include a higher rate of interest if he cannot obtain the
money from other source except at a higher rate of interest or through a shorter term of
years. The burden of proving the amount of the loss sustained rests on the plaintiff. The
lender is not responsible for extra costs of a new loan which are attributable to a decline in
the borrowers credit in the meantime uless specifically contemplated at the time of
contract EG the credit was specifically intended to be an emergency stand by credit to
protect the borrower in the event of a downturn in its financial fortunes, then the lender
might be liable for extra costs of a new loan attributable to the foreseen decline in the
borrowers credit.
- Specially contemplated losses EG inevitable default by the borrower on a contract being
financed by the loan or loss of profit on that contract, BUT ONLY if the bank knows at the
time the loan agreement is entered into that the loan is to be used for that contract and of
the potential consequences. EG a case where the bank defaulted in making a loan needed
for the purchase of an interest in a business, the bank knew it the borrower was unable to
buy it, the customer was entitled to the loss of profit from the business. In another case, a
party may be liable for loss of business profits for failure in breach of contract to open a
confirmed credit to finance a transaction which the claimants could not otherwise

Where a loan is to the lenders knowledge to be applied towards the repayment of other
maturing obligations, the repudiation of the obligation to lend might result in substantial
damages if the borrower was unable in the time to arrange alternative finance and thereby
defaulted on the repayment of the other loan which in turn crystallised cross-default clauses in
the borrowers debt instruments generally, but only if these consequences were within the
contemplation of the parties at the time of contract.

EG an engineer went to a bank for a loan to finance a project, the local branch manager said that
head office approval was required but this was just a formality. The engineer increased his
overdraft because he thought the loan was to be made for sure but the head office turned down
the credit approval and the engineer went bankrupt. The bank should pay the engineer.

EG a bank wrongfully terminated substantial facilities in favour of a company which was forced
into administration and eventual closure. The company claimed that the business was basically
healthy, the bank maintained that the business was bound to fail. The lower court and the court
of appeal awarded interim damages.

So, consideration should be given as to whether the crystallisation of cross default clauses have
been in contemplation of the bank resulting from a wrongful failure to make a loan. The
implementation of cross default clauses could lead to the demise of the borrower and the issue
would be whether these results were or were not too remote in the particular circumstances.
The borrower then should try to mitigate its losses EG by borrowing elsewhere. Another
question is if the drying up of finance in the market generally, as opposed toa self inflicted drop
in the credit of the borrower is to be taken into account in the damages. EG the bank in breach
of contract set an upper limit to a facility which had not been agreed and the borrower was
unable to find new finance. The court: the losses caused by the borrowers inability to refinance
were losses arising in the ordinary course of things (credit is sometimes easier to obtain and
sometimes more difficult) and were so recoverable. There were good reasons why other
companies in the group who could have supplied the finance did not do so and this was not a
failure to mitigate. The borrower did not have to approach the possible hundreds of banks in the


The clause provides: the borrower will apply the proceeds of the loan towards---- a credit
purpose, often general (working capital purposes) or specific (to finance a construction contract
or the purchase of an asset) and then the bank may be liable for damages for loss of the bargain
if the bank defaults in making the loan.


May be by instalments or in a single amount bullet. Often instalments are by equal semi-
annual amounts commencing after a grace period and a larger final instalment balloon

In bank floating rate loans, prepayments are generally permitted at the end of interest periods.
Can be applied against the repayment instalments in the inverse order of their maturity so as to
shorten the life of the loan. In syndicated credits, voluntary prepayments are prorated amongs
the banks.

BORROWER CANCELLATIONS of bank commitments are normally permitted. They may not be in
project finance if there are insufficient funds to complete the project or it may be compulsory if
the purpose of the finance fails. Generally the borrower must pay a COMMITMENT FEE ON THE
UNUSED AMOUNT of the banks commitment during the commitment period.


If it becomes illegal for a bank to make the loan or fund the loan in the market as contemplated
or have the loan outstanding, the bank can cancel and the borrower must prepay the bank. EG
by a change of law in one jurisdiction


-The borrower will pay interest at a percentage margin, EG 1% above LIBER; the rate at which
the bank is offered deposits matching as to currency and maturity in the London interbank
market as shown on a market providers screen service (usually at 11am local time in the funding
market two business days before the interest period concerned)

-The borrower chooses interest periods of generally one, three or six months

-Interest is calculated on a 365 day a year basis for sterling 360 for all other currencies

-Interest is payable at the end of interest periods and at least six-monthly

-The borrower will pay default interest at usually 1 per cent plus normal margin plus higher of
existing rate and new LIBOR.

-Default interest is payable as well after as before judgment and overdue interest is capitalised.

IN FLOATING RATE LOANS: the interest rate changes periodically. The bank funds the loan by a
short-term deposit in the inter-bank market for the chosen period and on-lends to the borrower
plus the margin or spread, which is the banks gross profit. At the end of each interest period,
the bank repays its funding deposit in the inter-bank market and borrows another deposit for
the next interest period. The borrower does not repay. The bank borrows short to lend long. In
practice the banks do not match fund but fund from their aggregate resources. In substance
floating rate loans are cost of funds loans, plus the spread and anything which increases the cost
of funds to the bank or reduces the interest is for the account of the borrower EG increased
costs due to reserve requirements or other regulatory or tax costs.

Libor is usually provided by a rate provider via a screen service EG REUTERS based on the rates
of named banks EG british bankers, Europeans bankers, hong kong Singaporeif a screen rate is
not available there is usually a fall back to the arithmetic mean of rates quoted to the agent bank
by named reference banks.

Margin: the spread or margin, generally expressed as basis points. One basis points is one-
hundredth of 1 per cent so that 50 basis points is per cent.

Interest may by stepped up or down in stages, this is called MARGIN RATCHET. The rate may be
stepped according to the length of credit, with the higher margins later, or it may be stepped if
there is a change in the borrowers credit rating by a recognised rating agency or if there is a
breach of financial covenantA downgrade in the borrowers credit rating might for example
increase the capital adequacy costs to the bank in respect of the loan pursuant to the basel


The borrower and the bank will make all payments in the specified currency in immediately available
funds, to the specified bank account in the country of currency, without set-off or counterclaim.
Bank and borrower are invariably required to make payments in the financial centre in the country
of the currency. Euros are payable in the principal financial centre of an EU participating state or
London. Normally, large payments are made through a clearing system in the country of the

In syndicated loans, the borrower makes payments to the agent bank who distributes them to the
banks pro rata. Payment to an agent is payment to the principal so the borrower is discharged after
paying the agent.

REASONS FOR A PROHIBITION ON SET OFFS BY THE BORROWER: the maxim pay now, litigate later
the cash flow principle the bank uses payments to repay underlying deposits, and because the clause
improves the transferability of loans by the banks.

Clauses designed to protect the margin or spread payable to the bank which is the banks gross
profit or the whole of the interest.

- Tax grossing-up: if the borrower must deduct taxes, the borrower will pay extra so that the
bank receives the full amount and the borrower may prepay that bank. Thus, the bank is
protected against withholding taxes on interest and ensures that the bank receives 100%.
The borrower will pay extra so that after all tax deductions the bank receives the full amount
on the due date as if there had been no deduction. Even if the bank will obtain a tax credit
for the deduction, this will take time and the bank in the meantime suffers a cash flow loss.
- Increased costs: If any law or official directive increases the banks underlying costs, the
borrower must compensate as certified by the bank and may prepay that bank. The
weakness of this clause is the practical difficulty of allocating certain costs to particular loans
and commercial acceptability of passing some costs: EG the cost of compulsory increases in
the banks equity base because of capital adequacy rules imposed pursuant to basel accords.
Many banks take current capital adequacy costs into account when fixing the margin, even
though the risk-weight may change during the currency of the loan. In international loans
claims for increased cost are proably unusual. For domestic loans or loans in euros it is
common to add reserve or other mandatory costs to the margin. RESERVE COSTS are the
cost of depositing a percentage of each deposit it raises in the market with the central bank
at nil interest so that his is an extra cost of funding the loan. Some central banks however
pay a market rate on these reserve deposits. Reserve costs are intended to provide a liquid
reserve for banks to meet bank runs, to implement official policy on money supply and to
finance the central bank. It is highly standardised ant the clause is not usually heavily



Credit agreements contain an elaborate series of mainly standardised representations and

warranties by the borrower. Banking practice distinguishes between legal warranties and
commercial warranties. Legal deal with the legal validity of the agreement. EG legal status of
borrower powers and authorisations of borrower and the legal validity and enforceability of the
borrowers obligations. Commercial deal with the borrowers financial condition and credit-standing.
EG if the accounts are correct, the information memorandum the projections no changes or


- The warranties set out the contractual basis on which the loan is made IE the obligations are
valid and the borrowers financial and business condition is as stated in the warranties
- The warranties are investigatory in practice to flush out problems in advance
- There is an express event of default if a warranty is incorrect this is because the loan is made
on the basis of validity of the documents and the borrowers disclosed financial condition.
This doesnt mean that a warranty will validate a loan which is legally invalid. However the
bank remedy of acceleration under the events of default clause gives the bank bargaining
power to readjust the documentation to meet the problem if possible
- The bank can suspend drawdowns under the conditions precedent clause
- A breach of warranty may suspend other rights of a borrower EG in secured loans a right to
substitute collateral may be suspended. In project loans the right of the borrower to pay