Problem loans: Ten early steps to take

The recent collapse in the oil price has raised concerns for the ongoing viability of certain projects and companies within the oil and gas sector. This follows similar downturns in both the shipping and mining sectors.

When a company’s revenues are slashed, its continued ability to meet its financial commitments including those relating to loan repayments comes under pressure. Any bank with exposure to the oil and gas sector is likely to be currently examining its loan portfolio in order to identify loans which might give cause for concern.

Ten practical steps:

01 | Don’t panic

The earlier that a lender can identify a potential problem loan, the more options it is likely to have to deal with it. Once a problem loan has been identified, a lender should give priority to considering the pre-emptive and practical steps that could be taken to protect his position, so that should enforcement action become necessary, it is well prepared to take such action and the possibility of any impediments to such action is reduced.

02 | Identify the relevant documents

The loan agreement and associated security documents set out a lender’s rights against a borrower and its assets. The loan agreement, as originally executed by the parties, may have been amended, supplemented or certain rights may have been waived, and such changes could be captured in several other stand-alone documents. It is, therefore, important to identify as soon as possible all documents which form part of the loan agreement so as to establish a complete and accurate picture of the lender’s rights and when they are triggered.

03 | Locate original transaction documents

Original documents typically get filed in storage once a transaction has been completed. However, originals of certain transaction documents, particularly security documents, may be required in certain jurisdictions before rights are recognised and can be enforced. Accordingly, not only is it good document management practice to keep track of original transaction documents but it may also be an essential element of the enforcement rights that such documents create. A lender should carry out a check for all relevant original documents as early as possible upon the identification of a potential problem loan.

04 | Identify potentially relevant jurisdictions

Consider all potentially relevant jurisdictions, both in terms of enforcement and also in terms of borrower or guarantor insolvency. The location of incorporation of the borrower is usually the starting point for establishing which country’s insolvency laws may apply. However, jurisdictions where the borrower has a branch or significant assets could also provide a basis for local insolvency laws to apply, for example UK administration procedures or US Chapter XI which can allow insolvent companies to benefit from protection from creditor action, including mortgage enforcement.

In terms of enforcement, other relevant jurisdictions might include jurisdictions where charged assets (such as an FPSO for example) are located because local legal action may be required to enforce and realise the security held over them. Some jurisdictions may require security to have been registered at the relevant authority before it may be recognised and enforceable and this in itself can be a time-consuming process which is best commenced as soon as possible.

05 | Does any security need to be perfected?

For many types of loan security, it is necessary to make filings or registrations or serve notices in order for the rights created by the documents to be perfected, legally recognised and enforceable in the relevant jurisdictions. For example, before the local courts in Brazil will recognise the rights created under a mortgage over a vessel, the mortgage must be registered with the Registry of Title Deeds.

Similarly parties may agree not to serve notice of an assignment at the time the assignment is created but reserve the right to do so at a later date, usually with the intention that notice be served where there has been a default under the loan agreement.

When a problem loan is identified, a lender should establish what steps need to be taken to perfect any security because these necessary steps may have a critical effect on the timeline of any enforcement action.

06 | Reserve rights

In certain circumstances, for example where the borrower has breached a term of the loan agreement or an event of default has occurred, a lender should take active steps to reserve all its rights under the loan and security documents. Taking no action may put a lender at risk of waiving such rights. The wording of a letter to the borrower to reserve all relevant rights is of utmost importance and a lender and his legal advisors must take great care to ensure that all relevant rights are captured by the wording of the letter.

07 | Retain legal counsel

The earlier that legal counsel is engaged, the better. Legal counsel will not only be able to analyse and advise on the lender’s rights but will also manage and protect those rights through correspondence and communications with the borrower.

All correspondence regarding the loan, whether that be between lender and borrower or internal bank correspondence, may be required to be disclosed and made public if the matter ends up in litigation. With this in mind, it is important to ensure that all correspondence is reviewed and vetted by legal counsel and sent without prejudice to the lender’s rights. Correspondence between legal counsel (including, in most circumstances, in-house counsel) and clients for the purpose of giving legal advice will be protected by privilege under English law and will not be subject to disclosure.

08 | Engage with the borrower

Retaining the borrower’s cooperation during periods of financial difficulty can be invaluable. Heavy-handed threats and immediate enforcement action is likely to alienate the borrower and may even bring about its insolvency. It may also lead to the borrower taking evasive actions to avoid or prolong enforcement action by lenders, which will serve to increase the time and cost of the whole process. A negotiated and cooperative approach should always be considered by lenders early on and in most cases will afford the best outcome for all parties.

09 | Identify and engage with other creditors

A lender should try to obtain as much information as possible about other creditors of the borrower. This does not just involve identification of amounts owing by the borrower to other creditors, but also anticipating what action other creditors may take which may frustrate or affect either a workout or a security enforcement. Engaging with other creditors applies equally to large preferred or secured creditors of the borrower and small unsecured creditors because both have the potential to disrupt or prevent lenders plans to solve a problem loan situation.

10 | Clarify the decision-making process

For a bilateral facility the process is straight-forward. However, making decisions can present problems for a syndicate of lenders, particularly a large syndicate or a syndicate in which lenders have assigned, transferred or sub-participated their loans. In such circumstances, the lenders should consider establishing a steering committee which would typically consist of members of the largest lenders in the syndicate to which all syndicate lenders delegate specific decision-making powers.

Care must be taken in defining the steering committee’s decision-making powers – too little freedom defeats the purpose of having a steering committee, whereas too much discretion may lead to smaller lenders in the syndicate having no control or input in key decisions. Certain decisions are usually carved out as all-lender decisions, for example, amendment to the terms of payment of the loan or terms relating to the distribution of proceeds from charged property.

Conclusion

Many distressed loans are restructured and repaid without the need for expensive and protracted litigation, particularly when both lender and borrower are transparent with each other and realistic in terms of their expectations. Enforcement of security is usually a last resort but it pays to know all of your options when sitting down to negotiate with a borrower. Timing is often critical and being prepared invaluable. When reviewing your portfolios, it is worth bearing in mind the lessons set out above which in our experience have helped lenders achieve successful outcomes when faced with problem loans.