Loan buy-backs
It makes good press to express doubt over the legality of borrowers buying back their borrowing cheap. There has been a flurry of articles about debt buy-backs. “Debt” in the language of our trade journals - really “loan buy-backs”: to distinguish them from the practice in the securities world which raises no eyebrows.
The discussion has arisen because of the cheapness of secondary debt available for purchase. The pricing has been driven by the crisis in liquidity and not by the credit status of the borrower. Yesterday afternoon, the LMA’s (Loan Market Association) seminar on the problem was packed out. What it boils down to is that buy-backs might be in breach of the terms of the original loan agreement on the facts of the particular transaction. There is, too, a principle in syndicated lending that lenders should be treated equally by the borrower. Perhaps as a result of the buy-back, the lenders will not receive a pari passu distribution.
Does a buy-back amount to a “prepayment”? Does it matter? Yes, if prepayment is prohibited by the loan agreement or if very specific conditions are imposed on prepayment. Has a covenant been breached? Does it affect the financial covenants? All these questions are matters of basic contract law and specific to the transaction and its documentation. Counsel’s advice has been sought as to whether by implication a buy-back is a prepayment and understandably, Counsel has sat very firmly on the fence (”it’s too close to call”). he suggests that only the House of Lords will be able to decide. Some pointers though: the greater the discount, or the non-cash consideration, the more likely it is not to be a prepayment. If it is not a prepayment and the contract only permits prepayment, the contract is breached.
Alternatives to buy-backs that don’t carry these anxieties are funded participations or total return swaps.
The Loan Syndications and Trading Association (in America) prohibits buy-backs outright. The LMA proposes instead to amend its standard form loan documentation so that parties have a choice either to prohibit buy-backs or to permit them provided specific conditions are met and processes are followed.
A storm in a tea-cup?
