CORPORATE FINANCE FINANCIAL INSTITUTIONS ENERGY AND INFRASTRUCTURE. Undertakings. Norton Rose LLP June PAR-# v1 1

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1 CORPORATE FINANCE FINANCIAL INSTITUTIONS ENERGY AND INFRASTRUCTURE Undertakings Norton Rose LLP June

2 UNDERTAKINGS What is an undertaking? 1 In general terms, an undertaking is simply an enforceable promise by a person to do, or not to do, something. 2 It need not be in writing. But, like all contractual obligations, it will not be enforceable unless supported by consideration (or executed as a deed). Undertakings in loan agreements 3 In a loan agreement, an undertaking is a promise by the borrower to the lender to do, or refrain from doing, something while the loan is outstanding. 4 A borrower s undertakings set out the agreed parameters within which it may operate. These parameters form a key assumption in the lender s credit assessment. 5 The key distinction between a borrower s representations and its undertakings is that representations deal with existing facts, while undertakings are essentially promises about conduct in the future. Since a loan agreement forms an ongoing relationship between lender and borrower, in most cases undertakings are more significant. 6 The terms undertaking and covenant tend to be used interchangeably in loan agreements (despite the traditional meaning of covenant - an undertaking under seal). Purpose 7 In general, the purpose of undertakings in loan agreements is to monitor and protect: the borrower s financial performance and solvency (and, therefore, its ability to service and repay the loan); in secured financings, the secured assets; the ranking of the lender s claim on insolvency (e.g. negative pledge/pari passu clause). 2

3 Classification 8 Conventionally, loan agreements split the borrower s promises into four categories: positive undertakings - what the borrower must do (e.g. comply with laws, obtain licences and authorisations, maintain insurance); negative undertakings - what the borrower must not do (restrictions on, for instance, borrowing and other debt, security and transactions similar to security, paying dividends and redeeming shares, making loans, disposing of assets, making acquisitions and changing its business); information undertakings - what information the borrower must provide to the lender (e.g. audited and unaudited accounts, details of disputes, details of any default and the steps being taken to remedy it); financial covenants - specified financial thresholds and ratios the borrower must comply with, tested regularly (link to information undertakings - financial covenants can only be tested with the right information). Striking a balance 9 In negotiating undertakings, a borrower will seek to: exclude some undertakings altogether; limit the scope of others by, for instance: (i) (ii) (iii) including materiality thresholds; providing for specific exceptions ( carve-outs ) and general sweep-up exceptions ( baskets ); if they are to apply to other members of its corporate group, restricting their application to its material subsidiaries only (carefully defined). 10 Negotiating the undertakings can be tricky. Lenders want to have sufficient control consistent with the credit risk they are taking, but there is no point in putting in provisions which are unworkable - the result is an endless stream of requests for consent/waivers which distract management from the business and lead to extra cost and work for both parties.

4 11 A balance is required, with the end result differing from one transaction to the next. Judgement and common sense are needed - the loan agreement has to govern the relationship between the parties for the life of the loan. 12 At the very least, the borrower must be given sufficient flexibility to pursue: its ordinary day-to-day business activities; any strategy (e.g. acquisitions/disposals) agreed in the business plan. 13 In general, the degree of control imposed depends on a number of factors, including: (e) (f) (g) (h) the credit standing of the borrower and its guarantors/sponsors; the type of business, event, asset or project being financed; the jurisdiction; the level of debt; whether the loan is secured or unsecured and (if secured) the extent of coverage; the pricing (i.e. the margin and fees) and market conditions - can the borrower go elsewhere for the money? the commercial rationale (lending against assets or cashflow?); market conventions, especially if the loan is to be syndicated. Consequences of breach of undertaking 14 The most commercially significant remedies for the lender are those which are specified by the loan agreement itself, rather than those which might be available under the general law. 15 Conventionally, a breach of undertaking is a specified event of default, entitling the lender to accelerate (or refuse to make) the loan (or cancel the facility). These rights are broader than those which exist under the general law, because the general law may not recognise every breach of undertaking as a repudiatory breach. 16 As a last resort (but rarely), a lender might look to remedies under the general law, which could include:

5 being able to terminate the loan agreement, although this depends on the way in which the court classifies the contractual term in question (i.e. condition or warranty?), as well as the nature and consequences of the breach; specific performance or (in relation to threatened breach) an injunction (both at the discretion of the court); in theory, a claim for damages, although this will not be an adequate remedy if repayment is not due (and if repayment is due, damages are unlikely to add anything to the debt claim); possibly (but unlikely), a claim for damages against a third party in the tort of inducing a breach of contract (e.g. if the third party has taken security from the borrower knowing that, by granting that security, the borrower has breached the lender s negative pledge). Disclaimer The materials in this pack contain information confidential to Norton Rose LLP. Copyright in the materials is owned and retained by Norton Rose LLP and the materials should not be copied or disclosed to any other person without the express authorisation of Norton Rose LLP. The materials have been prepared for training purposes only and not to give legal advice and, accordingly, they should not be relied upon. They are intended only to provide a general outline of the material covered. They should not be regarded as a comprehensive statement of the law and practice relating to this area. Readers should take specific legal advice on any particular matter which concerns them. If you require any advice or information, please speak to your usual contact at Norton Rose LLP. No individual who is a member, partner, shareholder, director, employee or consultant of, in or to any constituent part of Norton Rose Group (whether or not such individual is described as a partner ) accepts or assumes responsibility, or has any liability, to any person in respect of this presentation. Any reference to a partner or director is to a member, employee or consultant with equivalent standing and qualifications of, as the case may be, Norton Rose LLP or Norton Rose Australia or Norton Rose Canada LLP or Norton Rose South Africa (incorporated as Deneys Reitz Inc) or of one of their respective affiliates.