Cash Secured line of CreditSecured cash credit line
Before the recent turmoil, very much liked and beginning to reappear, is a credit line that provides a mutual trust (a "fund", in particular a so-called "opportunity fund") with cash on a quicker footing than the demand for principal injections by the fund's own shareholders - usually state and privately owned retirement plans, insurers, endowment trusts and other institutions that enter into significant obligations to repay the issued principal.
A determining characteristic of this kind of credit facilities (a "facility") is the kind of collateral: the obligation of the fund's providers of capital (the "investors") to make the payment to the fund of the outstanding subscription amount is the guarantee of the fund's obligation under the facilities (whether as borrowers or guarantors).
In the event of failure of the facility, it is envisaged that the creditor (or a representative of the creditors and all the credit granting institutions as a whole, the "creditor") will be able to demand and obtain repayment of these outstanding sums to apply for the loan.
Significantly, despite the recent financial difficulties, there have been very few reported failures by investors to make investments in such investment vehicles for the purposes of repaying a facility. When subscribing to the provision of own resources (as distinct from borrowed capital), which is typically the case for investment trusts organised as US through-put corporations such as Kommanditgesellschaften or Gesellschaften mit beschränkter Haftung, these investors' commitments are often called " principal commitments ".
As the lender relies on continuous unsecured capital commitments as a means of repaying, mutual investment trusts with reimbursement facilities that allow the investor to cover and remove potential financing commitments are not normal beneficiaries of these facilities (although it would not be possible to set up a facility for such a car if appropriate reserves were included in the documentation).
Given that the Facility's security mainly comprises investor commitment related securities, the lender's legal adviser will examine the Fund's suggested Memorandum of Association, Memorandum of Association or similar documents (the "Founding Document"), its signature contract format and the increasing number of subsidiary major investor documents (with the result that the Founding Instrument will be amended).
It has clear benefits to arrange for this document verification at the early stages of the procedure so that problem rules can be adapted before an investor is accepted into the fund and, in an ideal case, before prospective investor reviews the document they are required to produce. As soon as the investor has completed the signing of the document, the fund sponsor is naturally hesitant to request an audit.
Nevertheless, the change of incorporation document procedure, after it has been verified or even implemented by an investor, has taken place in a significant proportion of these investments, and those who have participated in similar investments vehicle (as is the case with many opportunities funds investors) have often already gone through the review procedure.
Financing a call for funds to reimburse loans granted under a facility should not be considered by the investor as an additional asset - without this prior lending, the fund would have drawn down funds and investors would have contributed the same amount at the same times and for the same purposes for which the loan granted was used.
If an investor fails to make its contributions, whether as a result of a contractually agreed policy choice or defaults, the impact on a fund will be different from that on a lender. Therefore, similar to the issuer entity of a credit to which a drawdown must be repaid, the lender should not be implicated in or hindered by disputes between investors and the general counterparty or any other fund managers (the "managers") of the fund.
Thus, if the Fund has taken out loans under the Facility and has used the revenues from the loans for a poor return on investments or has made an initial transaction that contravenes an obligation under the Constitutional Document, these are issues the risk of which should be shared exclusively between the investors and the manager and accounted for by the latter on a separate basis.
Since the lender cannot be placed in the position of monitoring the fulfilment of the manager's contractually agreed commitments to an investor, it is not an appropriate means of allocating risks so that the lender's claims for reimbursement are affected by such events. Where a fund is calling for principal rather than resorting to a facility, non-payment by an investor may burden the fund's sponsors or even affect the completion of a planned return but it is not as serious as in the case of a lender who has made loans and relies on the principal commitments as the main redemption resource.
Lenders should have at their disposal capital commitments without defence, counter-claim or set-off (a mantras that appear in practically every fund with a facility in the founding document). Underwriting facilities always have a limit on the amount of credit available, which can take many different form. An almost universally accepted constancy is that only the uncovered capital commitments of certain select shareholders (the "Included Investors") are eligible for entry into the credit basis (usually at a discount that can be staggered according to rating or other characteristics).
The lender's collateral right, however, comprises the commitments of all shareholders, not just the commitments of the included shareholders. Since the incorporation document generally demands that call for funds be made to all depositors at the same moment, usually in proportion to the amount of each commitment, it would not be practicable for the lender to have the right to call only funds from the included depositors.
General credit documents. As a rule, the credit document basis pack comprises the following: A revolving credit agreement that provides for credit (and a letter of credit) in an amount not exceeding the lower of the lender's credit obligation or the credit basis. the right to draw down principal from investors, the right to do the same for commitments under the Facility, and the right to assert those interests of the Fund and/or the Manager in relation to the principal commitments and the use of principal injections for commitments under the Facility.
Any of the Funds and the Manager (and any other parties having the right to demand or exercise any contribution of capital) should participate in the arrangement and the granting of a surety in all their relative interests which may be exercised by the cedant (subject to certain obligations in the credit documentation) in the event of no failure of the Facility.
Underwriting Subscription Agreement Collateral which gives the Lender a right of collateral on a specified investment or custody account controlled by the Lender and used exclusively to secure payment under the Capital Commitments, with all payment requirements set out in the Memorandum of Association being directly payable to that investment or custody bank or custody bank or custody bank or custody bank or custody bank or custody account controlled by the Lender and used exclusively for the receipt of payment under the Capital Commitments, with all payment requirements set out in the Memorandum of Association being payable directly to that investment or custody bank or custody account or the " Underwriting Subscription Agreement ".
As a rule, investor prepayments to the subscription account are credited to the fund as long as there is an adequate credit basis. Thus, the lender is protected from the situations where funds could be drawn down and the contribution could be used for any purpose other than repayment of the facility, which could cause the lender to be undercollateralised after the reduction of the amount of uncovered commitments resulting from the repayment of the call.
Irrespective of whether asset values earned with the income from a call for funds improve the fund's financial position, each deposited US Dollars of principal is one US Dollars less security in the shape of uncovered commitments. Due to the great impact of investors and the fund's interest in meeting them, the investor letter is often a delicate negotiation deed.
Empirical evidence shows that the most effective way to achieve the intended goals is to have the appropriate rules for the facility included in the incorporation memorandum, so that recognition by the investors to the lender can be done through a direct link to the incorporation memorandum. While the lender cannot reasonably forbid the fund to admit an investor who declines to provide this documentation (and an obligation that requires an economically justifiable outlay to effect supply by any investor is usually included in the loan agreement), the provision of an investor letter is almost always a requirement for the investor's amount of uncommitted capital to be included in the loanbasis.
Statement by the investor advising the investor and directly addressing the lender on the investor's commitments in relation to his capital commitment. Often this is only necessary for included investor and does not constitute an incriminating expert report. Questions of fund documentation, general. Favourable facility prices depend on the lender being reimbursed without investor disagreement.
Therefore, their prerogatives with regard to capital commitments should be express, not only vis-à-vis the Fund but also vis-à-vis investors. As has become customary, the constituent document contains an integral section which specifically provides for the facility and its collateral and which sets out various credit-related characteristics, such as the commitment to make capital commitments for the purpose of fulfilling facilities without defence, counter-claim or set-off (and in particular without waiver thereof), inter alia, where this is due to a violation or misrepresentation by the manager or another investor, an alleged loss of authority by the fund or the manager, a breakdown of the fund or the unsuccessful outcome of its investment.
Issues that should be dealt with in such a section or elsewhere in the constitutional document include: terms clarifying that the creation of a facility with raising of credit (or surety) by the Fund will be considered, and safeguarding the credit in a way compatible with the Pledge and Collateral Agreement and the Subscription Account Collateral Agreement, as well as the lender's right to demand repayment of principal obligations if there is a failure under the facility. The provision of power to raise credit in the event of a failure under the facility.
It should also not be eligible if the power to raise credit under the Facility arises from a general credit approval requirement. That does not mean that the incorporation document should not contain any restriction on the activity of the fund, but that such restriction (including limits on leveraging, concentration rules and the like) should be included in discrete agreements obliging the manager to redeem loans per se by means of specified principal and not to restrict or restrict the right to secure the facility in the way intended.
"Managers are entitled to take up debts on the Fund's account provided that the total amount of debts does not exeed x% of the Net Asset Value" and the reasonable alternative: "Managers are entitled to take up debts on the Fund's account". "Whether or not the taking out of a loan violated an obligation between the investors and the manager, the lender should not be able to discuss whether the fund was primarily empowered to take out loans.
While it is customary for the founding document to contain a number of listed sections, which list the objectives for which capital commitments may be specified (which surprise many in early designs by failing to include the reference to repaying debts as such), it is of course prudent that the fulfilment of the Facility's commitments is for the stated objectives (in particular when other specified objectives are listed), it also contains clauses which may lead to a shortening of the planned duration (usually between two and five years) during which the commitment of capital may be necessary.
Premature closure (or suspension) of the payout term is often provided for when the manager finds that he has reached the viable investing possibilities, when a certain percent of the total amount of the capital commitments has been committed, when the investor finds that the manager has violated the incorporation document, when certain questions of regulation can be presented, or just when a certain percent of the investor has found that they wish to close the term.
Obviously, this contradicts the lender's need to call on funds if necessary to reimburse the loan granted. However, the easiest way is for the founding document to stipulate that in the case of requests to make payment of principal commitments applicable to commitments under the facility (including requests from the lender as assignee), the contribution time must not end before a specified date (set later than the planned due date of the facility by a specified amount of time enough to retrieve and maintain any principal contribution).
Insofar as notice of cancellation is under the manager's supervision, it is not unusual for the lender to base its decision not to complete the deposit term on the manager's obligations (contained in the credit documentation) in the case of a manager with whom the lender is satisfied. From time to time, the incorporation document will contain terms that allow the payout term to end by designating investors who make up a certain percent of the capital commitments.
However, although more challenging, such a mechanism may, in general, be taken into account if the constituent document contains guarantees for the lender, such as a requirement that such cancellation shall not be enforceable in the case of a call for repayment of principal on facilities, unless the lender has been given advance notification in writing and in any case does not cover loans granted before receiving such notification.
Naturally, the credit document must stipulate that the lender's duty to renew further loans must also end upon receiving such notification. It is not enough to have a contract requiring the lender to obtain a termination that is under the investor controlling authority alone, as non-compliance with the termination could lead to the lender receiving an unsecured appeal.
Rather, the validity of the end of the paying-up horizon (which should in any case not be applicable to premiums for credit renewals due at the time) should be made conditional on the lender receiving the notification. As a general rule, any restriction on the conditions under which call for funds may be made or on the amount of funds which may be drawn, whether due to a particular use of the call for funds, to particular times when the call is made, to the features of investors or to other factors, must be carefully considered.
Given that the security for the loan is composed of privileges deriving from the incorporation document and given the many rules foreseen for the lender under the Facility and included in the incorporation document, this type of script is just not compatible with the Facility. Simplified outsourcings into the main terminology (e.g. "with the exception of clauses referring to the creditors under the Underwriting Facility referred to in Section X....") are often used to re-establish coherence. The way in which disputes are resolved may be incompatible with the funding terms and serious thought should be given to rewriting or, if possible, deleting these clauses thoroughly.
Specific credit issues. The handling of certain enforcement agreements in the event of insolvency is potentially pertinent to the situation in which the fund or lender attempts to obtain the capital commitment from an investor. For example, if the fund is a bankrupt, it may concern a treaty on the "issuance of collateral by the debtor".
There is no practice for pass-through companies to "issue" transferable securities in the usual use of this notion at any point after the investor's first inclusion in the Fund. Rather, the investment owned by the investor is generally a "taxable" instrument (i.e. it is not "fully funded and not taxable"), with the usual balance sheet mechanisms taking into account the provisions of § 704 EStG.
In some cases, however, the Company "issues" interest when principal is paid in, although the offering usually comprises only a constituent document which provides that the Company "issues" new "shares" so that investors ultimately agree with the appropriate number of their particular interests, combined with the act of making an inscription in the Company's registers stating that the principal has been paid in without a stock deed or equivalent security being issued to investors.
These issues have often been tackled by the lender acting as a representative of the Prime Minister in accordance with an arrangement operating in accordance with the pertinent Article 8 of the UCC. In addition, the Facility rules in the founding document often contain a special exception in Section 365(c) to the degree that it applies in the event of the Fund's bankruptcy.
While there is a case history that rejects the renunciation after the filing of 365 Section petitions, it is hard to discern a good political rationale why the insolvency proceedings would be challenged by a renunciation of 365(c) by an own capital investors before the filing, in particular by an own capital investors with the commercial potential and complexity of the typically investors subscribing shares in a fund with a facility.
uses a disqualification investor-event approach, whereby the uncovered tie-up of the investor's equity is no longer considered an option for raising the credit basis. Apparent parodigms of such occurrences are failures in response to call for funds, investor bankruptcy petitions, and rejection of the investor's commitment of funds.
Although the spectrum of redress available to the manager under the constitutional document in the event of an investor failure is usually wide, the use of some of these redress mechanisms (e.g. the investor's right to terminate contribution after default) may be incompatible with the lender's continuing interest in its security, whether or not the unsecured capital commitment in question remains in the creditbasis.
There should be no danger for the lender of being hampered by the administrator's exercising of such legal means and it is customary for the constituent document to expressly stipulate that the exercising of such legal means requires the lender's agreement. Exercising these legal means is normally at the manager's discretion, in which case it may be dealt with in the credit documents, but any clause in the founding document providing for compulsory withdrawal of the right to contributions should be repealed.
Compromises, disbursements, transfers and loan defaults. If an investor is exempted from its residual capital commitment or is otherwise exempted, the investor is removed from the loanbasis. Furthermore, the credit facility documents usually exclude the capital commitment of an investor who has contributed its shares to the fund.
While the investor may remain accountable for prospective premiums, the lender will usually not be happy with an "absent" debtor who has wound up his initial investments and does not have the usual incentive to make further premiums (although the lender may arrange to borrow the capital commitment of an eligible recipient). For the purpose of obtaining a loan, disqualified, retired and transferring borrowers will be considered in the same way as borrowers who withdraw due to a rating downgrade or non-compliance with other criteria, provided that an inadmissible claim from the loan is precluded from the receivables funding.
Importantly, if removing an investor from the credit basis results in an overrun of credit risk over the remainder of the credit basis, a proportional call of principal to all depositors in the amount of that overrun is not sufficient to resolve the inconvenience. In the event that an investor makes the contribution in this total amount, the debt basis is further reduced by the amount disbursed by the residual lenders (due to the resulting reduction in the amount of their uncovered commitments).
The following correcting call for share premium in the amount of this new deficit would also lead to a further (albeit smaller) deficit and so on. Assuming that endless batches are not complicated, the point is that the amount of money requested in the Facility's credit documents must be an amount higher than the initial deductible, which is reasonably extrapolated to take into consideration the extra credit basis decrease as a consequence of the correction contribution.
In particular, this begs the question whether (i) the fund's ERISA asset should be considered a'plan asset' and (ii) whether an element of the operation (including the service of the investor letter) would otherwise lead to a 'prohibited operation'. Others may be regulated by other systems.
Frequently, the incorporation document provides that an investor covered by ERISA or any other such arrangement shall make a statement to the Council that he should not comply with a particular call for funds or a particular category of call for funds, then the incorporation document does not require him to comply with such call or call.
This type of clause is not analytical, despite a cursory remedy, if the commitment of such an investor is to be incorporated into a credit basis. If the investor can successfully claim (even if he may win a lawsuit) that the current legislation forbids him to comply with a call for funds for the purpose of redeeming a facility, the lender must eventually address that result.
However, the risks of objectively realities should not be associated with a discrete contract termination that would be possible even though the investor would have missed the lawsuit (e.g. if the lawyer's view was just wrong and the investment could have been reimbursed under current law).
Legal advice as a protective screen for a premium may make good business if the fund calls for a purpose other than repaying a facility, but if the lender relies on the capital commitments, their justification is doubtful. The problem has been successfully tackled by introducing in the founding document rules whereby all advance payments necessary under the Facility must be made as a precondition for the validity of the investor's waiver under the contract (including a waiver triggered by an expert opinion).
To the extent that these exemptions are not lifted (either in the relevant documents, by law or otherwise) or found not to be appropriate to the Capital Commitment, it is challenging to warrant the incorporation of such Capital Commitment by the investor in the borrowings, as those with significant Capital Commitments often have collateral to the Fund, in particular overriding consistent terms of the Constitutional Document.
Rules may also exist to adjust the amount of the investor's capital commitment upon the materialisation of certain occurrences, as well as occurrences related to other investors. Since the subsidiary documents change the constitutional document in an effective way, it is imperative that the subsidiary documents are examined by the lender's council.