As commercial borrowers struggle to plan in uncertain times, many are drawing down on revolvers, putting stress on bank and non-bank lenders. Efforts by non-bank lenders to raise funds by calling committed capital from investors that are similarly stressed takes time and creates a bottleneck that can impair lenders’ ability to timely advance funds to borrowers under credit facilities. Lenders that face this problem need to understand their legal and economic exposure.
1. Key Credit Agreement Provisions
A. Conditions Precedent to Funding
Lenders are only required to fund if the borrower has satisfied conditions precedent to funding set forth in the credit agreement. A lender that may find itself unexpectedly unable to fund an advance should first confirm whether the borrower is in compliance with its obligations under the credit agreement and whether there is any basis to refuse to fund the advance because the conditions precedent laid out in the credit agreement have not been satisfied by the borrower.
B. Defaulting Lender Provisions
If the conditions to funding have been met, a lender who fails to fund will likely be considered a “Defaulting Lender.” “Defaulting Lender” provisions vary by agreement but generally provide that defaulting lenders lose the right to vote on most amendments and waivers; go to the bottom of a waterfall for repayment on previously extended drawdowns; and may cure, with the consent of other parties to the credit agreement, by funding (or buying back) at par the portion of the loan they did not fund, potentially with interest from the time of default and fees expended by the administrative agent. Curing may not preclude claims by other credit agreement parties arising from the failure to fund by defaulting lenders.
2. Potential Legal Exposure
At a minimum, defaulting lenders may have legal liability to the borrower and other lenders for failing to fund under breach of contract theories. Borrowers may also bring claims for fraud, tortious interference, or under other extra-contractual theories if the defaulting lender has engaged in conduct that arguably harms the borrower over and above the simple failure to fund a loan.
Many credit agreements contain lender-friendly provisions prohibiting indirect, consequential or punitive damages (as opposed to direct or actual damages). Stressed lenders should check their credit agreements for such language. They should also confirm that defaulting lenders do not lose the protection of such provisions.
Damages for breach of an obligation to fund will usually be the cost of alternative funding, if available, over the borrower’s cost of funding from the defaulting lender. Courts may also permit restitution damages (for example, refunding of commitment fees paid by a borrower), even with damages limitations provisions.
The question of whether other types of damages (for example, lost profits or harm caused to a borrower’s business resulting from the failure to fund) may be recoverable will depend upon the strength and specificity of contractual damages limitations provisions, if any, and additional analysis of the contract.
3. Communicate Carefully and Preserve Cure Options
Communications with borrowers and/or administrative agents in response to drawdown requests should be carefully considered to ensure that lenders do not concede that they are “defaulting lenders” if there may be failures of conditions to fund. Lenders should expressly reserve all rights and remedies. Borrowers and administrative agents will appreciate lenders providing facts about what steps lenders are taking to try to satisfy funding requests, and lenders may be tempted to respond to buy time. Any such communications, however, should be strictly factual and crafted to avoid any misunderstanding regarding lenders’ future capacity to fund that could cause a borrower or administrative agent to delay steps to mitigate a lender’s default. Such a misunderstanding could result in claims for increased contract damages and potential tort liability.
4. Lenders Will Consider Legal and Economic Exposure Across All Facilities
As lenders prioritize which funding requests to satisfy, all parties potentially affected by lender defaults should be aware that stressed lenders will assess the legal and economic issues for each credit facility within the context of their entire portfolio of lending obligations. Lenders will be evaluating their total exposure by borrower if there are multiple facilities with that borrower and the degree to which any of those have already been drawn down. Lenders will be considering the relative size of their commitment in each revolver facility. Lenders will also be determining whether agents and other parties may be the lenders’ counterparties in other transactions in the credit markets. Stressed lenders communicating with such entities about particular credit facilities may be more circumspect in an effort to avoid complications and confusion concerning the lenders’ other commitments.