Brexit – the top 5 loan documentation clauses to watch out for
As Brexit looms, Stuart Gillies highlights the top five clauses to consider when reviewing loan documentation.
At the recent Conservative Party Conference, Prime Minister Theresa May confirmed that Article 50 will be triggered in the first quarter of 2017, which will begin the two year exit process for Britain leaving the EU.
The impact of Brexit on financial transactions is yet to be fully determined, although it is unlikely to have a significant or immediate legal impact on current or future loan documentation. As a precaution however, we would still recommend that you review outstanding loan documentation and an open dialogue is maintained between parties to ensure any potential risks are caught and dealt with early.
1. Be aware of increased costs
Whatever route Brexit discussions take, they will undoubtedly result in the introduction of new laws and regulations which could potentially lead to lenders incurring increased costs. Lenders may look to recover these extra costs under the increased costs provisions in their facility agreements. LMA standard form documentation provides that borrowers compensate lenders for increased capital costs and the Basel Committee’s globally recommended standards for bank capital and liquidity related legislation is often referenced. It is likely that equivalent legislation would be enacted following Brexit and so we do not anticipate lenders incurring increased costs. Some lenders are looking to introduce ‘flexit’ clauses into facility documentation which provide for increasing interest rates in the event of Brexit but this is not something we have come across as yet.
2. Look out for events of default
Brexit specific or related events of default provisions are rare but if this is something that has been provided for, any such provisions should be reviewed carefully. Frequently found in LMA style facility agreements are ‘material adverse change’ (MAC) events of default. The effects of Brexit in the short term at least, specifically the uncertainties that surround it, such as currency fluctuations on non-hedged transactions, could constitute a MAC event of default. This will depend on the specific drafting of the clause, which normally takes one of two forms (or a combination of both):
1) The MAC clause is objectively determined and focuses on the borrower and their ability to meet payment obligations.
2) The MAC clause is determined in the lender’s ‘reasonable opinion’ and looks more broadly at the business operations, future prospects etc.
MAC events of default usually take the first form and are specific to the borrower and not the wider political and economic landscape. Having said that, facility documentation can often include drafting which provides for an event or series of events which in the lenders opinion, could constitute a MAC.
3. Consider Financial Covenants and Non Payment
It is wholly possible that Brexit could be the catalyst of financial losses to businesses. This could result in breaches of financial covenants or in a non-payment which would trigger an event of default. These should be looked at carefully and be the subject of open dialogue between parties.
4. Be conscious of Representations and Undertakings
Representations relating to a borrower’s authorisation to transact should be carefully reviewed as breach of such representations would be treated as an event of default. If a company’s business is particularly dependent on EU legislation and access to the Single Market, Brexit could be considered a MAC and lead to an event of default. A borrower may wish to address these risks by making changes to its business operations. The problem is that such actions could be restricted by the wording of any loan documentation. For example, a facility agreement may restrict (by way of a repeating representation) a borrower from changing its ‘centre of main interests’ (derived from European Insolvency Regulation) away from its jurisdiction of incorporation.
5. Highlight any references to EU
Standard form LMA documentation is unlikely to contain many provisions which rely, directly or indirectly, on EU legislation. Reference is often made to ‘a provision of law is a reference to that provision as amended or re-enacted’ which would cover any replacement legislation. Also, any reference to the European Union in the definition of Participating Member State only applies to any EU member state which has adopted the euro as its currency so is not affected by Brexit. However, the specific drafting should of course be checked.