2008 v. 2020: What Secondary Loan Market Participants Should Consider Now | Sullivan and Worcester

Similarities and distinctions are already made between the impact on our economy of the 2008 subprime mortgage-induced financial crisis and the current global COVID-19 pandemic. With the shutdown of non-essential businesses, social distancing and a resulting volatile market, it’s unclear how COVID-19 is going to scare our economy. Participants in the secondary loan market are simultaneously fighting to preserve their health and that of their families while striving to keep the business of the business under pressure with work-from-home mandates. The lessons learned from 2008 can help us weather this storm and weather these unprecedented times. Since the secondary loan market intersects with bankruptcy and business issues, it is important to keep in mind the following major legal issues, which were tested in 2008, and are likely to be tested again in the weeks to come. and the months to come.

Counterparty risk: In secondary loan market transactions, secondary loan market (“PM”) participants should consider the possibility and implications of seller or buyer insolvency. In June 2008, the Loan Syndication and Trading Association (the “LSTA”) issued an LSTA Legal Notice, Counterparty credit risk assessment in the secondary loan market in the United States[1]. The lessons learned from 2008 and summarized in the LSTA opinion underline the importance of paying attention to counterparty risk. Unlike real estate transactions, for example, a transaction to buy or sell bank loans is enforceable as a verbal agreement, provided the material terms of the trade are evident. The requirement to reduce the transaction to writing is carved out in the New York Statute of Frauds[2] but best practice dictates reducing an oral agreement to writing in a business confirmation (“Confirm”). Members of Parliament who have just executed a Confirmation are in a precarious position in the event that their seller files for bankruptcy. Article 365 of the Bankruptcy Code treats a Confirmation as an enforceable contract which can then be rejected, assumed or assigned by the debtor. MPs are already examining how a borrower’s business is affected by the pandemic, but MPs should also assess how the pandemic is affecting their counterparty’s operations.

Documentation on trading in distress: The stress of the global pandemic on borrowers will impact whether or not a loan trades in the secondary market on the par or distressed trade documents of the LSTA[3]. With default rates looming, MPs should consider the benefits of closing on troubled business documents at this time. The decision to negotiate at par or troubled negotiating documents is made by MPs at the time of negotiation[4]. In a peer LSTA transaction, there is a Confirmation, the contract form of assignment of the credit agreement (“AA”) and a finance note. The AA transfers legal title to the loan from the seller to the buyer and contains standard representations and guarantees. These are basic protections offered to the buyer in the context of a loan that is negotiated at or near par. Transactions are expected to be settled within 7 days of a trade date (T + 7). There is less risk when a borrower fulfills his obligations under the credit agreement and the credit is trading at or near par. In a troubled LSTA transaction, there is a confirmation, the AA, a purchase and sale contract (the “PSA”) and a financing note. In a troubled transaction, the risk is naturally greater because the borrower is in restructuring or in bankruptcy proceedings. Transactions are expected to be settled within 20 days of a trade date (T + 20). There are major differences between LSTA business documents and troubled business documents. The troubled business documents include a supplemental agreement, the PSA. The PSA contains strong representations and warranties from seller to buyer. These additional protections relate to predecessors in title, previous holders of bank loans, and actions of the seller while holding the bank loans. This means that the seller transfers additional rights to the buyer which allow him to exercise recourse against the previous owners. The buyer is able to identify and control the previous owners as the chain of title is provided in an appendix to the PSA. The seller also provides the buyer with copies of previous transfer documents (AAs and PSAs) that follow the loans throughout the chain of ownership. The chain of title established, as well as some representations like the “absence of wrongdoing representation”, where the seller declares that he has not committed any act or conduct that would cause the buyer to be treated differently from other lenders, offer additional protections to a buyer[5]. The PSA also contains enhanced indemnities and one of the indemnifications relates to the seller’s declaration of no wrongdoing. Overall, troubled business transactions allow the buyer to sue their immediate seller and upstream parties in the ownership chain. Problems arise for MPs when loans have been purchased on au pair business documents and then sold on distressed business documents. However, not all transactions are settled on troubled documents. Indeed, some credits are negotiated at par and others are negotiated in difficulty. The LSTA uses a market consensus among concessionary banks, buyers, and sellers to determine whether a credit has gone from par to distressed. MPs can ask the LSTA to publish a change date for a specific credit. Liquidity in the market is key for MEPs. Whether a credit is rated or in difficulty, loan transactions continue electronically on platforms like ClearPar and with the electronic signature of documents. MPs should continue to assess their positions and close deals with the help of a lawyer.

Disposals and shareholdings: Transfer clauses and eligibility criteria for new lenders and participants are essential even if a borrower’s creditworthiness declines. Whether or not an MP can take out credit as a new lender is a threshold issue and a key element of diligence. Members of Parliament should pay particular attention to issues relating to new lender requirements, borrower consent, transfer minimums and withholding tax issues.

Material adverse effect clauses: Provisions relating to significant adverse effects may be considered in light of this global pandemic. If triggered, these clauses can trigger an event of default under a credit agreement and affect a borrower’s ability to borrow money. However, as we are in the middle of this storm, it is too early to say how successful such claims will be. What constitutes a material adverse effect is often a carefully crafted and highly negotiated arrangement, most often designed to be triggered in response to an event that causes a material adverse effect on a company’s business or operations, except events that have an impact on the economy as a whole. There are exceptions to this exception which allow the claimant to assert that a material adverse effect has occurred, however, it then becomes an exercise in careful consideration of the facts and circumstances. The laws of Delaware and New York require a company making this claim to show that a material adverse effect significantly threatened its overall profits in a significant way over time (i.e. a company should show that it has suffered years – not months – of indirect impact). With this type of information needed to be able to make such a claim, it is difficult (at least to this day) to assess COVID-19 through this lens.

Fault events and cross faults: Credit agreements provide detailed default provisions that identify how the borrower can initiate an Event of Default and remedy an Event of Default. With declining income, a borrower is exposed to breach of certain financial covenants which are most often calculated using EBIDTA. The pandemic is forcing borrowers to face unprecedented costs. These new costs include increased clean-up costs to ensure employee safety and costs associated with closing and reopening business operations. Since cross-defaults can occur between financial documents, it is imperative to review the sequence of documents in a transaction.

On the horizon: In the future, borrowers will negotiate forbearance agreements and defaults will continue to increase. MPs should also pay close attention to provisions in credit agreements that allow borrowers to buy back debt while corporate bank debt continues to trade below par. Useful analysis was provided on the Coronavirus Aid, Relief and Economic Security Act (CARES Act), which is available here.


In these uncertain times, it helps to understand the mechanics of business documents, the key provisions of credit agreements, and the lessons of the past financial crisis.

[1] Legal advice LSTA. Counterparty credit risk assessment in the secondary loan market in the United States, June 6, 2008.
[2] New York State General Obligations Act Section 5-701.
[3] Most of the secondary loan market uses LSTA forms to settle transactions.
[4] LSTA: Use of normal or distressed documentation, August 16, 2007.
[5] LSTA purchase and sale contract for trades in difficulty – General conditions, March 16, 2020.

Priscilla C. Carnegie