TOOL K2
In structured lending transactions, the bank will often rely for part of its protection on commercial contracts between the borrower (or another credit base) and third parties. Whenever this is the case (whether the contract is assigned or not) the following points should be addressed as part of putting the structure under stress.
If any of the issues outlined below are not relevant for the particular contract under consideration then the points may be ignored.
| Issue | Key Considerations | Answer |
| Legal Issues | – Do the contracting parties have the contractual capacity and legal authority to enter into the contract and can it be assigned? – Which law governs the contract? – Which court has the jurisdiction? – Is the contract easily legally enforceable? | |
| Volume / Price | – Are the volumes achievable? – How do they relate to capacity and existing commitments? – Are volumes / price variable? – Can reductions in price be offset by increase in volume? | |
| Tenor | – Is it fixed term or open ended subject to notice (see termination events below)? – How does the tenor relate to the term of our exposure? – Do we have a safety margin to cover variations in price, volume, interruptions etc? | |
| Cash Flow Timing | – Do we need to control the payment we are financing (e.g. suppliers, pre-export finance) and the receipts? – Are the cash receipts likely to be in a regular pattern or ad-hoc basis? – Can the repayment schedule (including grace periods and balloon repayments) closely related to the anticipated timing of receipts? – Do we need a debt service reserve account or cash sweep to mitigate fluctuating receipts? – How can we maintain priority over the cash receipts? | |
| Quality / Performance Standards | – What are the criteria by which performance under the contract to be measured? – Are they measurable or open to dispute? – What is the probability that they will not be consistently achieved and cause an event of default? | |
| Penalties / Liquidated Damages | – How are they linked to the quality performance standards? – Is there a repair period before they become payable? – Are the damages our client is entitled to receive likely to be sufficient to compensate for potential losses and interruption to cashflow and debt service capacity? – In what circumstances is the liability for our customer likely to crystallise? Is there a cap? How will it impact debt service capacity? | |
| Termination Events / Notice Periods | – Can the contract be terminated only by an event of default or also by giving of notice by either party? – How probable are the events of default? – How sustainable is the commercial interest that both parties have in the contract? | |
| Ability to Change the Terms | – What provisions are there for the terms to be changed? – Does the bank have the power to veto or at least be informed? | |
| Step In Rights | – Do we have or want this right? – What triggers this right? – What can the bank do when triggered? Is it easy legally and operationally to exercise our right? – What additional responsibilities and lender liability would be incurred? | |
| Dispute Procedures / Arbitration | – How strong is the commercial interest to prevent disputes? – Is there a clear procedure? Will it be legally binding and not subject to delay? – Can we exercise step in rights during a dispute? | |
| Insurance Contracts | In addition to commercial contracts, the bank very often relies on insurance contracts to protect collateral, country risk exposure and interruption of cash flow. The following issues are particularly relevant for these contracts. – Who is the insurer? Is the insurer acceptable to the bank? – What does the insurance policy cover? Are there any significant exclusions or conditions? – Who pays the premium? Does the bank control these payments? – What specific conditions have to be maintained to keep the policy valid? Will they be adhered to during our exposure? – Does the bank have an assignment of the contract? Is the bank the loss payee? – Is the contract revoked on default? Consider the bank being named as the insured party in addition to loss payee – When does the insurance contract expire? |
