Anyone who has been involved in the negotiation of loan documentation in recent years – not just in the project finance arena but in the wider syndicated debt markets – will be well aware of the greatly increased attention banks place on sanctions clauses in loan agreements. These clauses are there to protect the banks, and entitle them to default the borrower, if a member of the borrower group – and very often its officers, employees, agents and sometimes others connected with the borrower group – become the subject of sanctions.
Following Russia's invasion of Ukraine and the resultant sanctions on Russian banks and also against the backdrop of heightened political tensions between Russia and China, an issue that has not previously been focused on in loan negotiations is starting to attract some attention: what are the consequences for the borrower, the agent bank and the wider syndicate if a lender becomes sanctioned? Historically, loan agreements have been silent on this, and this silence can result in outcomes that are not just very problematic for the borrower but may also be very problematic for the agent bank and the rest of the syndicate.
This article examines the issue of lenders becoming sanctioned as it has historically been dealt with, or perhaps more accurately overlooked, in loan documentation and considers how documentation could be adjusted to ensure there is a fairer risk allocation as between the parties and greater clarity on what should happen if a lender is sanctioned.
Imagine the following scenario: prior to the commencement of Russia's war with Ukraine, a borrower incorporated outside of Russia and which has no business interests in Russia enters into a financing to develop a project. The facility agreement, as is typical, includes various sanctions representations and covenants to be given by the borrower – with an event of default for any breach of these. The facility provides for a staggered drawdown period to fund the development, depending on certain project development milestones being reached. The facility has a broad international syndicate of lenders backing it. The first milestone is reached, and the borrower has nearly achieved the second milestone, following which it will submit a utilisation request to draw funds for the next stage of the project development. Russia then invades Ukraine and one of the Russian banks lending to the project is sanctioned. Depending on the drafting of the facility agreement, some or all of the following consequences could occur:
- The borrower and the agent bank would be prohibited from
receiving from the sanctioned lender that lender's committed
portion of further loan drawdowns.
- The payment by the borrower of any amount interest or principal
to the sanctioned lender would be prohibited. Yet refusal by the
borrower to make a payment required under the terms of the facility
would result in a non-payment event of default.
- The now illegal performance of the borrower's obligation to
pay the sanctioned lender and the sanctioned lender's
obligation to fund the borrower would quite likely create breaches
of representation by the borrower if the facility includes typical
representations that all authorisations required for the exercise
of rights or performance of obligations under the finance documents
have been obtained and that the performance of the transactions
contemplated by the finance documents will not violate any
sanctions and other transactions. Breach of these provisions would
result in an event of default.
- There would likely be additional events of default on the basis
of unlawfulness/ unenforceability of the facility agreement in
relation to payment obligations from or to the sanctioned
lender.
- The occurrence of the events of default referred to above would
give every lender a right to drawstop further drawings by the
borrower of its facility.
- Even if no event of default occurred as a result of the
relevant lender becoming sanctioned, and the borrower was able to
submit further utilisation requests, the borrower and the agent
will not be able to receive funds from the sanctioned lender
thereby creating a project funding gap. This is problematic for the
borrower, as its project will not be fully funded, and
non-sanctioned lenders as they are lending to a non-fully funded
project.
- To rub salt in the borrower's wounds, the fact that it
would be illegal for the sanctioned lender to fund the borrower
would trigger the illegality provisions in the facility agreement
entitling the sanctioned lender to cancel its commitment and call
for immediate repayment of all amounts owed to it with which the
borrower would not be able to comply even if it had the funds to do
so because payment to the sanctioned lender would breach
sanctions.
- Failure by a sanctioned lender to fund a utilisation would result in the sanctioned lender being deemed to be a defaulting lender under the standard LMA drafting, which could also result in the borrower being required to provide cash cover to any relevant fronting bank of standby letters of credit issued under the facility in relation to that lender's participation in such letters of credit.
Obviously, the consequences set out above are not in the interests of the borrower – who is the unwitting victim of a lender being sanctioned – nor in the interests of the rest of the lenders of the syndicate or the facility agent (or any other relevant agents of the lenders, such as any security agent). Therefore, all parties would benefit from mechanics being built into the facility agreement from the outset that address the risk of a lender becoming sanctioned by ensuring that:
- The borrower would not be in breach of the facility agreement
by virtue only of a lender becoming sanctioned;
There is a regime in place to modify payment/ payment transfer obligations for the borrower and the facility agent to take account of what is and is not permitted by law when a lender is sanctioned; and - The borrower has a right to replace a sanctioned lender to avoid any funding gap on account of the sanctioned lender's commitment to fund not being performed.
There are a number of different provisions that could be written into a facility agreement to implement these principles:
- The ideal for the borrower would be to negotiate a blanket
overriding clause that provides that: (i) notwithstanding any other
provision of the facility agreement, no representation by the
borrower will be breached and no event of default will occur as a
result only of a lender becoming sanctioned, and (ii) the borrower
will not be obligated to perform any obligation that would breach
sanctions. The alternative, which would arrive at the same place
though with more precision, would be to specifically address all
the relevant provisions – ie representations, covenants,
events of default, drawstop etc – and ensure that the fact of
a lender being sanctioned would not result in breaches or default
by the borrower.
- Provisions addressing the borrower's obligation to pay
interest and repay principal to a sanctioned lender could be
adjusted. Clearly such payments cannot lawfully be made but equally
it would be an odd result if the borrower did not at least have to
provide for the payment. There are a variety of ways this could be
addressed such as providing that the borrower should pay amounts
owed to a sanctioned lender into a blocked account and that payment
will discharge the relevant payment obligation. If and when the
relevant lender ceased to be sanctioned then amounts from that
account would be transferred to that lender.
- If there is a project funding test that is run at intervals
during the tenor of the facility, the parties may agree that there
will be a grace period if there is a funding gap as a result of a
lender becoming sanctioned before any breach of the funding test
occurs. During that grace period no event of default would occur,
and further utilisations would not be drawstopped.
- The right of a lender who becomes sanctioned to rely on
standard illegality mandatory pre-payment clause to cancel its
commitment and require its loans to be pre-paid could be
disapplied.
- A right to designate a sanctioned lender as a defaulting lender
could be introduced, which would then permit the borrower to
require that lender to transfer its commitments to a new lender, if
this is practically possible, which it may well not be, or
otherwise cancel that lender's available commitments and
appoint a new lender to assume that lender's cancelled
commitments. If there is a revolving credit facility that forms
part of the facility, the sanctioned lender/ defaulting
lender's loans would be termed out. In addition, the sanctioned
lender/defaulting lender would be disenfranchised from
voting.
- If the facility includes a standby letter of credit component, and the borrower would otherwise be required to provide cash cover to the fronting bank as a result of a sanctioned lender/defaulting lender, the parties may consider including provisions for a negotiation period between the borrower and the fronting bank before any such cash cover is demanded in order to identify an alternative solution.
Recent events have served to remind us all that the issue of sanctions can apply as much to lenders as to borrowers and provisions in facility agreements should recognise that. The consequences of a lender becoming sanctioned could be (at best) highly disruptive and at worst catastrophic for the borrower and the non-sanctioned lenders.
To answer the question "Sanctioned Lenders: Whose problem is it?" the answer is that it is everyone's problem and therefore the parties to a loan agreement should recognise that their interests are aligned in including provisions that address the risks associated with sanctioned lenders. There are a small number of facilities that have done just this, but general awareness of the issues and problems for all parties that come with a lender becoming sanctioned is low.
Article originally published by Project Finance International on January 17 2024.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.