Security reviews:
It's never too late to act

ALEX INNES* continues to provide insights into how banks can manage their risks of lending

When providing funding, it’s vital to consult an experienced professional. Anything else often proves to be a false economy. Ideally, the consultation will occur before entering into a commitment. However, if that’s not possible, it is still worth obtaining advice before the commitment requires to be enforced, in case any remedial action is possible.

This is particularly relevant to facility letters and the related security documents. In our experience, these are constantly under review by both banks and borrowers.

The bank seeks to ensure that the facility letter has been effectively drafted so that the relevant borrower is due to repay the bank loan. If required, all the relevant securities (particularly third party securities) may be called upon to assist with the debt repayment.

If an ambiguity or other issue is uncovered at an early stage, there may be a remedy – say, by using a further assurance clause – before enforcement when it may be too late.

The borrower’s objective is to accurately assess its negotiating strength if discussions with the bank are imminent.

While there’s clearly a conflict between the interests of a bank and a borrower, it is essential to consult with a professional who is familiar with the requirements of both, as that experience will provide the best perspective and advice.

The review will often reveal a position that is not definitive, and it may be a combination of minor issues. The advice you then need is whether or not there’s a material risk and, if there is, what’s the best way to reduce that risk.

Another problem area is when a facility letter is amended. Is it a genuine amendment which can be captured by the existing security documents and would have been reasonably envisaged at the time of the original facility? Or is it a new loan for an entirely different purpose that may not be covered by existing security?

One bank’s practice was to declare that any new facility letter superseded and cancelled the original one. The risk to the bank is that, if the security referred specifically to a cancelled facility letter, then it might not secure the new facility letter.

A security will often cover “all sums due” and won’t be limited to a particular loan. However, if it’s a third party security, and the bank debt has been materially altered since the third party granted the security, the bank ought to consider ensuring that the third party is aware of the alteration to reduce the risk of challenge. And if it’s a corporate entity, can the third party avoid the obligation if it did not receive any commercial benefit when it granted the security?

A third party will often argue that a bank ought to enforce all other forms of security before calling on the third party security. However, a recent case confirms that, where a lender holds more than one source of payment for a debt, it is entitled to make its own decision about which source of payment it pursues. So, unless the documentation specifically provides for an enforcement order, there will be no implied duty or obligation on the bank to do this.

All these points are arguable, so it’s worthwhile for a bank to ensure that its loan documentation and securities are all in order well ahead of any enforcement. Remember, it’s highly likely that the borrower is also instructing the same documentation to be reviewed – but hoping for an entirely different outcome!

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