Syndicated loans: mechanisms and legal issues

Major property, industrial or infrastructure projects require colossal amounts of financing. A single bank is rarely able to take them on alone. That's where syndicated loans come in.

Definition and type of syndicated loans

Definition and legal framework

Syndicated credit refers to a transaction in which several banks join forces to grant financing to the same borrower. This technique dates back to the 1930s in France, but developed in the 1970s with the rise of euro loans.

The legal framework remains minimalist. To better understand the complexities of legal qualification Please refer to our detailed analysis of these operations. The decree of 18 February 1987 simply defines "tour de tables" as follows "the bringing together of different contributors of capital, without a public offering, for the purpose of distributing the capital contributed"..

CRBF Regulation 91-01 of 16 January 1991 specifies that a "syndicated transaction" exists when "when several reporting institutions decide to join forces to grant a loan by sharing the cash flow, the risk and the interest"..

Direct syndication: immediate risk sharing

Direct syndication organises the sharing of risk from the outset on the primary market. All the banks sign the joint contractual documentation. Each bank grants a loan directly for an amount expressed in nominal terms or as a percentage of the overall amount.

As stated by the Cour de cassation (1re civ., 2 October 2002, no. 00-10.675), "the joint obligation due to the plurality of creditors leads to a splitting of the obligation between the creditors without affecting the debtor's commitment"..

Conversely, sub-participation allows the subsequent transfer of credit risk. For an in-depth analysis of this hidden risk transfer mechanismSee our article on this subject. A signatory bank assigns all or part of its claim to other institutions.

Motivations of banks

There are three main reasons for using syndicated loans:

1. Compliance with prudential ratios Basel rules require banks to have capital in proportion to their risk exposure. The total risk on any one entity must not exceed a certain percentage of their net equity.
2. The risk division : The increase in the amount of loans is pushing banks to share the risk, even where there is no regulatory obligation to do so.
3. Tax optimisation : Sub-participation may make it possible to avoid certain taxes or to benefit from tax advantages, depending on the jurisdiction.

The key players in syndication

The arranger: role and responsibilities

The arranger sets up the transaction on behalf of the borrower. He performs several essential functions:

• Setting up a bank syndicate
• Negotiate and draw up contractual documentation
• Prepare the information memorandum in collaboration with the borrower

The arranger may be liable both to the borrower and to the participating banks. The Versailles Court of Appeal (12th ch., 2nd sect., 5 December 2002, no. 01/01203) ruled that an arranger is in breach of his duty of loyalty when he provides "erroneous information likely to mislead the banks on the decisive elements of the transaction"..

The signing of the credit agreement marks the end of its mission.

The credit officer: functions and limits

The agent administers the loan throughout its term, a task that requires a great deal of time and effort. crucial legal and operational issues. Its main responsibilities include :

• Centralisation of payments between banks and borrowers
• Transmission of information between parties
• Declaration of claims in the event of insolvency proceedings

In the absence of active solidarity, the agent must have a special written mandate to declare the overall claim (Cass. ass. plén., 26 January 2001, no. 97-15.943).

Unlike arrangers, agents are not always the banks' representatives. The Paris Commercial Court (1re ch., 29 May 1989) stated that "the obligations of the lead manager of a banking pool can only be those of an agent if the existence of an agreement entrusting it with such a task is demonstrated"..

Participating banks: rights and obligations

Participating institutions bear the risk to the extent of their contribution. Their rights include :

• Compensation
• Immediate payment of sums due
• Isolated realisation of securities in proportion to their claim

Case law reiterates their duty of care. The Montpellier Court of Appeal (13 October 1983) established that in the presence of uncertified balance sheets, "the banks were obliged, in order to avoid granting their loans indiscriminately, either to refuse their loans or to demand that they carry out an examination of the accounts"..

Syndication process

Initial phase (call for tenders, credit offer)

The borrower begins by approaching several banks, thereby creating competition. The banks present different types of offer:

• The firm offer (fully underwritten commitment): the bank guarantees the full amount
• A commitment to use our best efforts (best effort): the bank only undertakes to try to set up a syndicate

Choosing one of these offers gives the arranger a mandate to set up the syndication.

Formation of the banking syndicate

The arranger selects the participating banks according to several criteria:

• Financial area
• Renown
• Country of origin (for tax optimisation)
• Sector experience (particularly in project finance)

It sends them an invitation letter accompanied by the information memorandum. This document contains essential information about the borrower and the transaction.

The contractual documentation includes :

• Bank-borrower relations (credit agreement)
• Relations between banks (syndicate contract)

Arranger's liability

The arranger may be held liable for :

• Providing inaccurate information
• Lack of information on essential elements
• Failure to verify information

The Court of Cassation (22 May 2001, no. 98-22.430) ruled that the arranger had provided the sub-participant with incorrect information "by presenting them to him as if he had checked them".This was his obligation.

However, this liability is tempered by the duty of prudence of the participating banks. Case law emphasises that"in the case of relationships between professionals in the same speciality, the existence of a leader did not exempt the other participants from a duty of discernment". (CA Versailles, 12th ch., 2nd sect., 5 December 2002).

Specific legal issues

No solidarity between banks

The main feature of a syndicated loan is the absence of solidarity between lenders. Each bank commits its share without guaranteeing the commitments of the others.

Contracts generally include a non-solidarity clause. The Paris Court of Appeal (15th ch., sect. B, 13 June 1985) confirmed that "the formation of a pool [...] between several banks may not, in the absence of joint and several commitments, have the effect of extending to the other banks the obligations entered into by one or more of them"..

There are, however, substitutes for solidarity:

• The "replacement effort" clause in the event of a bank failure
• Increased contributions from the remaining members

Juxtaposition of loan contracts

A syndicated loan is a juxtaposition of individual loans granted under the same conditions. This structure has several consequences:

1. Individualised contractual protection Certain clauses protect each member individually (illegality clause, cost increase clause).
2. Payment sharing clause It obliges banks that have received a payment in excess of what they are owed to share it proportionally.
3. Qualified majority for decisions Major decisions require the agreement of a qualified majority (generally 66 2/3% to 90%).

The Paris Court of Appeal (15th ch., sect. B, 7 November 2002) ruled that the majority clause had "horizontal effects between lenders and vertical effects between lenders and borrowers"..

Transfer of shareholding and enforceability of rights

There are several ways in which banks can sell their holdings:

• Assignment in civil form (C. civ., art. 1689 et seq.)
• Novation (with the borrower's agreement)
• Sub-participation (hidden transfer)

For an assignment to be enforceable against the assigned debtor, it must be notified to him in accordance with article 1690 of the Civil Code. The Court of Cassation (1re civ., 4 March 2003) stated that "the failure to serve the assignment on the principal debtor does not affect the existence of the debt"..

The assignment of the benefit of security interests poses particular difficulties. According to Article 1692 of the Civil Code, "the sale or assignment of a claim includes the accessories to the claim, such as surety, lien and mortgage".. However, certain additional formalities are required to ensure that the contract is enforceable against third parties.

Are you setting up a project requiring complex financing? Syndicated loans require specialised legal expertise. Legal support from the pre-contractual stage is essential to avoid the risks of litigation. Our specialist team analyses your needs and helps you secure your financing. Contact us to discuss your project.

Sources

• JurisClasseur Droit bancaire et financier, Fasc. 505: SYNDICATED LOANS - Direct syndication, Last update: 1 February 2019
• JurisClasseur Droit bancaire et financier, Fasc. 506: UNION CREDITS - Sub-participation, Last update: 27 November 2016
• Ministerial Order of 18 February 1987 on the expansion of economic and financial vocabulary (JO 2 April 1987, p. 3654)
• CRBF Regulation 91-01 of 16 January 1991 (OJ 22 February 1991, p. 2660)
• Cass. 1st civ. 2 October 2002, no. 00-10.675
• Cass. ass. plen., 26 January 2001, no. 97-15.943
• Cass. com. 22 May 2001, no. 98-22.430
• CA Versailles, 12th court, 2nd section, 5 December 2002, no. 01/01203
• CA Paris, 15th ch. sect. B, 13 June 1985
• CA Paris, 15th ch. B, 7 November 2002
• T. com. Paris, 1st ch. 29 May 1989