CORPORATE FINANCE FINANCIAL INSTITUTIONS ENERGY AND INFRASTRUCTURE. Events of default. Norton Rose LLP June 2012.

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1 CORPORATE FINANCE FINANCIAL INSTITUTIONS ENERGY AND INFRASTRUCTURE Events of default Norton Rose LLP June

2 EVENTS OF DEFAULT Events of default in loan agreements 1 Loan agreements normally specify the consequences of the borrower s default. These consequences include certain rights which, in most cases, would not be available to the lender under the general law. 2 If there are other obligors (e.g. guarantors/additional borrowers), the loan agreement will specify the consequences of their default too. 3 Consequences of a lender s default are not usually specified (except, in syndicated loans, to make it clear that lenders are not responsible for each other s performance). What are events of default? 4 Events of default are events and circumstances which the parties agree are sufficiently serious as to justify the lender being able to terminate the financing. Not all involve fault as such. 5 It is up to the parties to decide what to include as events of default, and how they should be drafted. 6 There is, however, a fairly typical core list which includes: (a) non-performance of the loan agreement and other finance documents (e.g. breach of obligations, misrepresentation, illegality and unenforceability); credit events affecting the borrower and (if appropriate) its corporate group (e.g. cross-default in relation to other transactions, insolvency and insolvency proceedings, creditors process, change of control and material adverse change). Pending events of default / mandatory prepayment events 7 As well as defining Events of Default, loan agreements often include a separate definition of Potential Event of Default (or just Default ). 8 The purpose of this definition is to give the lender certain rights before an event of default has occurred, for instance the right to suspend drawdown. 2

3 9 When drafting the definition, the intention is to capture events and circumstances which would be events of default but for an unexpired grace period or some other requirement such as the giving of a notice or the making of a determination - i.e. pending, rather than actual, events of default. 10 The definition must be drafted (or reviewed) carefully. Borrowers will want to define it as narrowly as possible - it should not pick up the mere possibility of an event of default. 11 Certain events (e.g. change of control of the borrower) are often designated mandatory prepayment events rather than events of default. Their commercial purpose is similar to that of pending events of default. They are used to give the lender rights which are similar to acceleration rights even though an event of default has not occurred. The borrower s approach 12 The borrower will seek to: (a) (d) delete events of default which are outside its control (e.g. change of control by its shareholders), or designate them as mandatory prepayment events instead (which might reduce the risk of triggering cross-default clauses in agreements with other creditors); if the events of default are to apply to other members of its corporate group, restrict their application to its material subsidiaries only (carefully defined); incorporate grace periods, allowing time for remedy (so that the event of default does not occur if the event or circumstance in question - i.e. the pending event of default - is remedied within the grace period); provide that the lender cannot do anything unless the event of default in question is continuing at the time it takes action. 13 Grace periods are only appropriate for events of default which are capable of being remedied. When drafting grace periods, be sure to make it clear when the clock starts ticking. Consequences of an event of default 14 The following consequences are normally specified by the loan agreement itself:

4 (a) (d) The borrower s right to draw down any unused part of the facility is suspended (a pending event of default may be enough for this) and, if the lender wishes to do so, it can exercise its right under the acceleration clause to cancel its obligations completely. In relation to borrowed and outstanding amounts, the lender can exercise its other rights under the acceleration clause (and consequently enforce guarantees and security). The borrower will have to indemnify the lender against any loss the lender suffers as a result of the event of default. The indemnity is included because (unless the event of default consists of misrepresentation or breach of obligation) damages and other relief will not be available under the general law. If the lender s set-off right is expressed to arise only when an event of default occurs, the lender will be able to exercise that set-off right. 15 There may be other consequences for the borrower. For instance, an event of default under one loan agreement is likely to trigger cross-default provisions in agreements with other creditors. Suspension of the borrower s right to borrow 16 It is usually a condition precedent to the borrower s right to draw down the loan that no event of default or pending event of default has occurred (or has occurred and is continuing), both on the date of the drawdown notice and on the proposed drawdown date. 17 Normally, the condition is extended to include an element of looking forward, so that drawdown is also suspended if an event of default or pending event of default would result from the proposed loan. 18 With a revolving loan facility, the condition applies to not just initial drawdown, but loan rollovers too. On rollovers, the borrower will want the suspension to apply to actual events of default only (i.e. not to pending ones). It will argue that (a) the level of debt is not being increased on a rollover and a revolving facility should not be suspended in circumstances where a term loan facility would not be suspended (with a term loan, the condition only applies on initial drawdown). This is normally acceptable. Acceleration 19 Acceleration clauses usually entitle the lender to:

5 (a) bring forward (accelerate) repayments of principal which are not yet due so that they becomeimmediately due (with accrued interest); demand repayment of amounts due, or place them on demand - which means the lender can call for repayment at any time (useful in a restructuring); cancel any outstanding commitments to lend money or provide any other form of credit. 20 Acceleration is not automatic. The lender must take positive steps to exercise its rights (although usually a notice to the borrower is all that is needed). Wrongful acceleration 21 What rights does a borrower have if the lender purports to exercise its rights at a time when in fact (a court later decides that) no event of default has occurred? 22 In relation to amounts committed to be lent, but not yet actually lent, the lender is clearly in breach of contract, giving the borrower the right to claim damages and pursue other remedies. 23 In relation to amounts already lent, the position is not so clear: (a) If the lender is subject to an express obligation not to serve an acceleration notice unless an event of default has occurred, there is clearly a breach of contract, and the borrower can claim damages accordingly. If not, case law suggests that no such obligation will be implied, and that the lender has no liability in tort either (Concord Trust v Law Debenture Trust Corporation plc ([2005] UKHL 27; [2005] 1 W.L.R. 1591); BNP Paribas S.A. & others v Yukos Oil Company [2005] EWHC 1321 (Ch); Jafari- Fini v Skillglass Ltd & others [2007] EWCA Civ 261) - i.e. the borrower has no basis on which to claim damages, and the acceleration notice simply has no effect. The wisdom of this has been questioned, and not all possible arguments have been fully tested, so we do not rely on it (nor do we overlook the potential damage to a lender s reputation if it serves an acceleration notice without the grounds to do so). Consider the borrower s position. It can ignore the notice and dispute its validity in a defence to a debt claim; but service of an acceleration notice is a serious matter, valid or invalid. Even an invalid notice might trigger cross-default clauses in agreements with other creditors (depending on

6 how those clauses are drafted), and might result in serious damage to the borrower s reputation and credit standing with e.g. suppliers, customers and other creditors. (d) (e) (f) (g) A borrower who knows that its lender is planning (wrongfully) to exercise its rights might be able to get an interim injunction to restrain service of an acceleration notice until its validity is settled, but this is not failsafe - borrowers will not always have advance warning, and such relief is not available as of right. The only safe course of action for a lender is to be certain that an event of default has occurred before taking any steps to accelerate. (In practice, this is not so easy - most events of default are not clear-cut.) Concord Trust might provide a defence to a damages claim if a court subsequently disagrees, but it must not be relied on at the time of acceleration if there is any doubt about the existence of the event of default. The only safe course of action for a borrower is to include an express obligation on the lender not to serve an acceleration notice unless an event of default has occurred (and is continuing). What is clear is that, if the lender enforces security and it later transpires that it was not entitled to do so, it (and any receiver or administrator appointed by it) will be liable for substantial damages in tort (trespass and conversion). Syndicated loan facilities 24 In a syndicated facility, it is the agent who serves the acceleration notice. 25 Conventionally, it is specified that the majority lenders may instruct the agent to do so, and that those instructions will bind all the lenders. Majority is usually defined by reference to percentage of either amounts committed to be lent or amounts actually lent. 26 It is unusual for any single lender, or a minority of lenders, to be able to force the agent to accelerate. On the other hand, a requirement for unanimity is likely to be impracticable where the syndicate needs to act quickly. Majority discretion provides the most effective system for syndicate democracy.

7 27 The agent is normally given discretion to accelerate without any instructions. This is included in case of emergency. In practice, it is very rarely used because the agent will be wary of incurring any liability (to the borrower or to the lenders). Events of default in practice 28 Commercial lenders do not exercise these rights lightly. Most events of default which occur in practice are waived (expressly or impliedly). Acceleration is a measure of last resort, and usually means the end of the road for the borrower. 29 But that is not to say that events of default are without purpose. It is the lender s entitlement to exercise its rights which is the real sanction. Anything other than a minor event of default will force the borrower to the negotiating table and will put power in the hands of the lender to instigate a variation of terms, a restructuring or a refinancing. 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.