THE MECHANICS OF A SYNDICATED LOAN AGREEMENT

I used to think that the word ‘syndicate’ was invariably evil. I don’t recollect where I first came across the word, but it was apparently used in the context of drug cartels coming together.

Here is a funny story, I used to think that the word ‘syndicate’ was invariably evil. I don’t recollect where I first came across the word, but it was apparently used in the context of drug cartels coming together to do some terrible stuff. I think it must have been from one of these action movies I watched when I was too young.

So you can imagine my surprise the first time I ever came across a ‘Syndicated Loan Agreement’. I thought to myself, ‘oh, this must be interesting!’ Well, it was interesting, but not for the reason I was anticipating. Needless to say, there were no drug cartels involved. Bummer!

Turns out that a ‘syndicate’ is a group of persons or businesses coming together for the purpose of a common business interest. Well, I still convince myself that a syndicate can be made up of drug cartels. Hold on, have I mentioned that this is not legal advice and that all references to drug cartels are purely for the purpose of entertainment? Well, what I said.

A Syndicated Loan Agreement is used when a group of lenders come together to provide a loan pool to be used by one borrower. In simpler words, you use a Syndicated Loan Agreement when there are multiple lenders and one mutual borrower. So the question is, why would there be multiple persons loaning a single borrower money? Good question!

There are some projects that require heavy financing, running into hundreds of millions and possibly trillions of dollars, so it makes more sense to split the loan across multiple lenders. Note that it is not merely that the amount itself cannot be raised by one lender. There are additional factors like risk management. You see, every loan given out by a lender holds the risk of going bad i.e. the borrower is unable to repay it. When that happens, it could be really bad, really really bad.

Really bad, because the lender is usually a bank, that has taken deposits from customers and used a part of it for loans. If the loans and the risks are not carefully managed and loans fail, then depositors could lose money. This has actually happened in Nigeria where some banks failed in 2008 - 2009 due to bad loans and 53.3 billion naira was owed by just 40 borrowers. Yup, you read that right!

So to manage risks, different banks and financiers come together, offer individual loan amounts that they can safely provide without running at risk of failing if the borrower fails to repay the loan. These individual amounts are then pooled together until they arrive at the total amount that the borrower needs for the project.

Of course, this already sounds like a mess. So there is a need for an arrangement that manages the whole situation. And it is in the Syndicated Loan Agreement that the masterful art of lawyering comes to play. One of the few times when the law is truly, truly beautiful. So let’s look at it.

I once said that if you understand the financial arrangement of a scheme, it becomes incredibly easy to point out matters that need to be handled. This is why I started by explaining what a Syndicated Loan Agreement is. So, if you are one lender in a group of lenders, what matters do you want to settle, financially and legally?

Firstly, you want to appoint an ‘Arranger’. This would usually be the bank that brought on the deal and convinced other banks to join in. The Arranger would be the one to handle all communications between the borrower and all the banks. So in general all communications from the borrower goes to the Arranger who then forwards it to all the banks. Each bank in the loan would also send communications to the Arranger, who is obligated to ensure every other bank and the borrower receives the communication. The Arranger also ensures that all documentation and legal matters are settled, so it engages a legal consultant on behalf of everyone. Same goes for accountants, auditors etc as may be needed. For its role as an Arranger, the Arranger charges and receives an Arranger Fee to be borne by borrower. When the loan starts to roll out, the Arranger receives the money from all the banks and then passes it on to the borrower as a whole sum, as opposed to the different lenders sending individual payments to the borrower directly. What this means is that the Arranger is also the record keeper for the loan being the one in full knowledge of the different moving parts of the loan. When repayments are made by the borrower, the borrower pays to the Arranger who then shares it to the lenders.

Next, each bank commits an amount towards the total loan amount. In a syndicated loan, you do not send out the loan amount immediately. You merely commit to provide money up to a particular amount. If the loan was a 150 billion naira project, for instance and there were 10 banks in the syndicate, then the loan commitment could be 15 billion naira from each bank. or it could be 20 billion naira from 5 banks and 10 billion naira from the other 5 banks. What matters is that the ratio of the commitment of each bank is calculated against the total loan. This is important as we would see.

The borrower is allowed to access the total loan amount in a fixed number of withdrawals, technically called Drawdowns. Taking our 150 billion naira loan example, the borrower can be allowed to request the loan in a total of 4 Drawdowns. So it can request 50 billion naira 3 different times or it can mix the Drawdowns up as it may want. Generally, the agreement would set a minimum amount that can be requested in each withdrawal because of the costs that would be incurred in processing the movement of money. Dividing the loan into drawdowns also serves to protect the banks and lenders. If the borrower is unable to meet the requirements of the loan, the bank would not send more money over to the borrower. If I open up a 150 billion naira facility, I do not expect you to request to withdraw just 1 million naira. I am expecting to make profit of the interest to be accrued, so there is a minimum that I would expect you to withdraw where the interest you have to pay back would start to make sense to me.

When the borrower requests to make a Drawdown, the requested amount is divided into the ratio of the banks commitment. So if the 10 banks had equally committed to 15 billion naira each, and the borrower wants to make a drawdown of 50 billion naira, then each banks would send 5 billion naira each to the Arranger who would then forward it to the borrower. If 5 banks committed 20 billion each and 5 banks committed 10 billion each, when the borrower request 50 billion naira, then the first 5 banks would send in about 6.66 billion naira each and the last 5 banks would send in 3.33 billion naira each. This ratio would apply for every drawdown made by the borrower. The same goes for every repayment made by the borrower.

Now to some legal matters in the syndicated loan. There are a couple of rights to be sorted out in a syndicated loan arrangement.

One such right is the right to accelerate the loan repayment if a cross-default should occur. The right to what what what if what should occur? It is just a fancy term to say that if the borrower should fail to make its scheduled repayment to any other lender in a different loan outside the syndicate, then I can assume that they would fail to pay us in the syndicate. This is a cross-default. They defaulted with another lender, but I will carry it across to me. Then I will ask that they immediately repay me everything I have lent them, i.e accelerating the loan. This makes sense of course; if a borrower fails to pay a lender, it is not because they hate that lender, it is because they probably no longer have money!

Of course, if a cross-default happens, then the borrower probably doesn’t have money to give me if I try to accelerate the repayment. So it would mean there would possibly be a need to liquidate the borrower and share whatever is left of the value. Usually, there would not be enough to repay everyone: While negotiating this, all the lenders would try to negotiate a clause that no loan outside the current syndicate loan would rank higher than the syndicate loan itself. Of course, this provision is subject to the provision of laws such as the bankruptcy laws, which may provide for a specific order of ranking repayments of creditors during a bankruptcy. But you, generally, want to ensure that outside the law, the syndicate loan gets repayment first. Unfortunately it not usually this smooth, because every other loan probably has this same arrangement, so at best you all end up ranking pari passu i.e. ranking similarly. This is better than not having this clause, which would mean you could rank lower than others with the similar clause. If this happens, then you may not regain any amount at all.

You also generally want to make some provisions restricting any changes to the capital of the company, its management or shareholders without the permission of the syndicate. So things like entering a merger would require the permission of the syndicate. Or reducing the share capital of the borrower. Things that generally mean that the company has a lesser source of funding to repay the loan.

Needless to say, you may have noticed that a lot of the rights really have to do with recouping money if things go awry. I mean, that is kind of the point of a loan, you would agree. So when I think of Syndicated Loan Agreements, I still think of cartels fighting and that way, I find a lot of fun in it. But that may be just me.

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Post-credits: Today’s episode was edited by Feyisekemioluwa Akande who is the resident editor for this newsletter. Thank you so much.