The term ‘financial institution’ is widely used in the finance sector. This insight focuses on its use in facility agreements where it is common to permit transfers of the lender’s position to ‘banks or other financial institutions’.
A typical transfer clause in a facility agreement may state that: ‘the lender may at any time transfer, assign or novate all or any part of the lender’s rights, benefits or obligations under this agreement to any one or more banks or other financial institutions’.
There is a degree of uncertainty as to when exactly a transferee will be classed as a ‘financial institution’ and in a legal document involving the lending of money, nobody likes uncertainty.
The Court of Appeal partially addressed this issue in the Argo case, where the judge stated that for the transferee to be a financial institution it was sufficient for the transferee to be an entity:
- which is a legally recognised form or being;
- which carries on its business in accordance with the laws of its place of creation; and
- whose business concerns commercial finance.
This is a very broad definition, but the entity involved in Argo was a hedge fund and so the case did not help to remove the uncertainly relating to companies set up purely for the purpose of purchasing and holding debt. In addition, the facility agreement Argo was concerned with was a syndicated agreement.
Fortunately, further clarification has recently been provided in the High Court. This case considered whether a company that had not yet traded and which had only recently been incorporated, for the purpose of holding assets on trust for a third party, fell within the definition of ‘financial institution’.
Although not bound by the decision in Argo (because the Grant case involved a syndicated loan agreement) the High Court adopted the same view (and the same three point test from Argo), that the concept of ‘financial institution’ is widely drawn and will include, for example, ‘commercial trust corporations, primary and secondary lenders and those who act as trustees or fiduciaries either for buyers or borrowers on one side of a transaction or for the providers or users of financial products and services’.
Significance for lenders
The trading of debts (distressed or otherwise) is important to lenders as it assists in the management of risk. Primary lenders have an opportunity to recoup a potentially significant amount of ‘risky’ debt quickly and with more certainty than they may have should they have waited to try to recoup the debt through enforcement or other means available to them.
This decision should provide reassurance to lenders who seek to sell debts, and equally to parties seeking to purchase debts, that they can do so through special purpose vehicles (SPVs) provided that the SPV satisfies the three point test from Argo. It also means the Argo test has now been applied in cases relating to both syndicated and bilateral facility agreements.
Significance for borrowers
Borrowers should be aware that if they want greater restrictions on acceptable transferees and if they want to be able to exercise a degree of control over the identity of their lenders, perhaps to avoid the transfer of its financing to a more aggressive counterparty, then the borrower should seek to agree this in the facility agreement by insisting on a pre-approved list of assignees (normally referred to as a ‘white list’). The borrower’s consent will be required for any transfer to a party not included on the white list.
A welcome decision
Although not ground-breaking, this decision has been welcomed by those involved in the loan market as there is now clear direction as to what constitutes a ‘financial institution’ for the purposes of transfer clauses in both syndicated and bilateral facility agreements.
The case also delivers a reminder to those drafting loan agreements to ensure that the definitions, words and phrases used in the document are appropriate and work not only for the transaction itself but for the future requirements of the parties involved. Uncertainty can lead to dispute further down the line.