Originally published March 17, 2011

Keywords: Dodd-Frank, lenders, Basel III, credit agreements, yield protection, LSTA

The question of who will pay the additional costs that lenders are expected to incur as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) and the announced modifications to the Basel Framework of the Basel Committee on Banking Supervision (Basel III) has been a highly debated topic recently, as borrowers and lenders have been discussing and negotiating increased costs provisions in credit agreements. 

Credit agreements that include LIBOR based loans typically include provisions that allow the lender to pass on to the borrower increases in the lender's costs incurred as a result of a change in law occurring after the date of the credit agreement (e.g., imposition of a new or higher reserve requirement), in order to protect the lender's expected return on the loans.

The Dodd-Frank Act generally became effective on July 22, 2010, although many specific provisions contain delayed effective dates and others require regulatory implementation through a rule-making process that in many cases has not yet even begun. In addition, while the text of Basel III was published on December 16, 2010, its effect will not be fully known until it is transposed into country-specific laws and regulations, and various "observation" periods and transitional arrangements expire over the next several years. Therefore, whether or not the rules and regulations implementing the Dodd-Frank Act and Basel III would constitute a change in law under yield protection provisions has been the topic of much debate. 

Citing the unknown scope and costs of such rules and regulations (and the resulting inability of lenders to correctly price credit facilities to incorporate such costs), and in an effort to provide certainty that the yield protection provisions will apply to such costs, some lenders have sought to draft increased costs clauses so that they expressly provide that such costs are covered. Some lenders, however, have taken the position that expressly referencing the Dodd-Frank Act and Basel III is unnecessary because, in their view, any new regulations would be covered by more general language that is already typically included in their credit agreements. The Loan Syndications and Trading Association elected to include express language in its exposure draft of Model Credit Agreement Provisions distributed on February 7, 2011, as such provisions define "Change in Law" to include all requests, rules, guidelines and directives issued in connection with the Dodd-Frank Act or Basel III, regardless of the date enacted or issued.

Borrowers have generally held the opposite position, arguing that, because the Dodd-Frank Act and Basel III have already been passed, increased costs and yield protection provisions of credit agreements should not cover costs resulting from rules and regulations prescribed to implement them. Borrowers have, therefore, argued against expressly including such rules and regulations and, to the contrary, have attempted to expressly carve out such costs.

In light of such ongoing debates, parties to credit agreements should be cognizant of the developments surrounding such issues and should determine which formulation of the increased costs clause is the best expression of their common understanding.

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