Loan agreements: Navigating the complexities of sanctions in a time of conflict
What will the recent sanctions placed upon Russia by the United Kingdom, European Union, and the United States mean for existing and prospective financing transactions? In South Africa, these implications should be thought through in the context of facility documentation and how it documents sanctions regimes.
Sanctions are temporary limitations implemented by governments to regulate how their citizens and businesses interact with sanctioned countries and regimes. Sanctions are an important tool in foreign policy. Countries, regimes, organisations, companies, and individuals can all be sanctioned. Sanctions are also grouped into four categories: trade, financial, transportation, and immigration.
In most circumstances, the main goal of penalties is to change the behaviour of the sanction's target.
Sanctions can be used to apply pressure on a target country to enforce compliance with certain objectives, and to enforce measures where diplomatic efforts have failed.
Lenders will want to ensure that any transaction they enter into complies with all relevant sanctions regimes, because:
- a breach of sanctions legislation may result in them being liable for civil and/or criminal penalties; and
- a breach of any sanctions regime can lead to serious damage to their reputation.
These risks can lead to sanctions clauses that are more restrictive and broader than the sanction laws application to the borrower, or even to the lender itself. Sanctions legislation is especially difficult to navigate intra-financial institution, without clear policy guidelines regarding which regimes apply and when. This is partly due to the complex, and ever-changing nature of sanctions regimes.
In order to ensure that lenders are compliant with applicable regimes, it is vital for lenders to initially carry out a thorough due diligence process on the borrower, any relevant group company, and the jurisdictions in which they operate. The details will be transaction specific, but should generally address the following:
- whether a transaction involves a sanctions target (either a country, individual or corporate entity) either directly or indirectly,
- whether a transaction involves a non-sanctioned entity with substantial business interests with a sanctions target, and
- details of any other business the borrower (or any member of the borrower's group) may have with any sanctions target and a description of the particular activities, any financial sums involved and the proportion of the business activities that relate to the sanctions target.
It is vital that in a continuing borrower-friendly market, lenders recognise that the most impactful transaction requirements are those that have been uniquely tailored to the specific borrower the lender is assisting, regard being had to the lenders own policies.
Broad sanction clauses that are too restrictive may hinder the borrower and prevent it from carrying out its ordinary course of business, which could lead to an increased risk of default. However, borrowers should also be mindful of the rigorous compliance requirements that lenders must comply with.
It is for this reason that the sanctions clauses should be personalised to the transaction at hand – applying stringent requirements merely because they have applied in previous transactions is not considered best practice. Where a borrower is not a politically exposed individual nor associated with outside influences, there is no reason to impose especially stringent international measures that the borrower may or may not be able to comply with.
Whether sanctions provisions need to be included in a facilities agreement will depend on the nature of the transaction and the outcome of the lenders’ due diligence on the borrower. In a purely South African context, there are many transactions in which compliance or otherwise with international sanctions regimes is highly unlikely ever to be an issue. In these situations, the lenders are likely to be happy to rely on standard illegality provisions as well as the usual representations and undertakings relating to compliance with, and no conflict with, laws and regulations.
The “illegality” clause sits front and centre of the mandatory pre-payment section of the South African Loan Market Association ("LMA") documentation. In the ordinary course, the illegality provisions developed by the LMA may adequately cover the lender in relation to its own sanctions compliance obligations. The lender is protected, and the borrower is satisfied that it does not have to comply with overly onerous provisions that often go much further than it is able to contemplate in its daily dealings and checks to the business.
The LMA takes a conservative approach to sanctions, and highlights that this is a complex area for lenders. The laws and regulations in this area are widely drawn and subject to different interpretations. Amendments to sanctions regimes are also common, and so lenders and borrowers alike must be dynamic and fleetfooted in their approaches. The LMA believes that the most suitable approach for obtaining appropriate protection for lenders is to require sanctions representations, undertakings and related provisions to be agreed separately for each transaction rather than starting with a recommended set of substantive provisions in this respect.
The LMA also provides general sanctions guidance. Members can find this information on the LMA website. LMA's publications for developing markets provide a number of optional sanctions-related definitions that mirror those most typically seen in those markets. These can be utilised by the parties as a starting point in their negotiations on this complicated problem. When allocating the risks connected with sanctions, the definitions would aid in the design of any transaction-specific substantive representations, undertakings, and associated remedial clauses that the parties might agree on. These definitions are not specific to developing market transactions and might be altered for use in other sorts of transactions, according to the LMA's User Guide for the suggested form of facility agreements for use in developing market jurisdictions.
In each transaction where sanctions provisions are included, the parties will need to agree on what the consequences of a breach by the borrower will be. A breach of these provisions may trigger some, or all, of the following provisions in the facility agreement:
- a drawstop;
- a mandatory prepayment of the loan to any affected lender;
- an unrestricted right for any affected lender to transfer its interest; and
- an event of default.
Whether a breach triggers an event of default is a key issue for a borrower. A key benefit for the lender in making a breach of these contractual provisions an event of default is that if the borrower fails to comply the lender can accelerate the loan and take enforcement action. This has traditionally been the position taken by lenders, although borrowers have increasingly argued that this goes too far because of the extensive consequences that arise, such as triggering cross-defaults.
A more suitable approach would be for any breach of a sanctions clause to be considered a mandatory prepayment event. This is particularly so in syndicated transactions, where each lender will want to determine for themselves whether to exit the loan agreement in the event of such a breach occurring. However, even bilateral transactions will benefit from a breach being a mandatory prepayment event since such events will still enable the lender to be prepaid and to cancel any outstanding commitments if it would be unlawful to continue to participate in the loan. Ultimately both the borrower and lender will benefit – for a borrower, the risk of cross-default is limited, and for lenders there will be no requirement for majority lender instruction as is often the case when enforcing events of default.
Although sanctions clauses have become a standard component of the LMA loan documentation, the content thereof has not yet been agreed on. Often lenders include broad and restrictive provisions because there is no standard market practice, especially intra-financial institution where each has its own policy guidelines regarding which regimes apply and when.
As such, both parties should take particular care when negotiating their loan documentation to ensure that the ultimate outcome is a set of documents reflecting the actual transaction at hand. It is thus imperative that the wording of the sanctions is reviewed and negotiated, and agreement is reached, preferably in the term-sheet phase.
Banking and Finance | Executive
Monhé van der Walt
Banking and Finance | Candidate Legal Practitioner