Guidance on Revisions to LSTA Secondary Loan Trading Documentation Effective June 9, 2017

On June 9, 2017, the Loan Syndications and Trading Association, Inc. (“LSTA”) published, in final form, its most recent revisions to the LSTA secondary loan trading documentation for both par/near par loan trades and distressed loan trades. The changes made govern all LSTA secondary loan transactions entered into on or after June 9th. This client alert is intended to summarize the material modifications effected by the revisions.

I. Paid On Settlement Date.

One material change made to the suite of trading documentation relates to the terms and conditions governing the “Paid On Settlement Date” (“POSD”) interest convention.

Typically for performing credits where the borrower is currently paying interest and ordinary course fees timely (or making current adequate protection payments to the extent the borrower is in bankruptcy), the loans will trade on a Settled Without Accrued Interest basis (“SWOA”). Under the SWOA convention, Buyer will be credited at the closing of the trade for any accrued interest (whether paid or unpaid) relating to the period between (i) either T+7 for a par/near par trade or T+20 for a distressed trade and (ii) the settlement date of the loan trade (such period of time referred to as the “Delay Period”).¹ However, the SWOA convention does not achieve the intended economic result if the Agent is paying out interest entirely to the lender of record on the interest payment date. Under such circumstances, Seller would be obligated, at the time of settlement, to provide a credit to Buyer for all unpaid interest relating to the Delay Period, despite the fact that such interest would ultimately be paid to Buyer on the next interest payment date. Accordingly, in such a scenario, Buyer would receive a “double payment” on account of the interest allocable to the Delay Period, in addition to possibly receiving certain interest that would relate to Seller’s Retained Interest.²

The POSD convention provides a solution to the foregoing by modifying the mechanisms for the crediting of interest. The election of POSD would generally only be made when (a) interest (or adequate protection payments) are currently being timely paid and (b) such payments are being made to the lender of record on the applicable interest payment date. Under a POSD convention, Buyer will generally be required to pay Seller, at the time of closing, an amount equal to all accrued but unpaid interest and accruing ordinary course fees (on the loan amount being traded) that relates to the period prior to T+7 (for par/near par trades) and T+20 (for distressed trades).³ Effectively Buyer fronts the expected interest payment relating to Seller’s Retained Interest on the closing of the trade, and Seller does not provide a credit to Buyer for all unpaid interest allocable to the Delay Period.

Prior to the modifications to the terms of POSD, both the LSTA par/near par and distressed confirmations provided that, to the extent the borrower on the next interest payment date failed to make the interest payment to the lenders, Seller would have no obligation to reimburse Buyer for the interest amount that had been fronted by Buyer to Seller at the closing of the loan trade.⁴ The revisions to POSD now alter the standard so that, to the extent the borrower “fail(s) to pay all or a portion of the Paid on Settlement Date Amount” on or prior to the due date (taking into account any grace period), then “Seller shall be required to promptly reimburse Buyer” upon Buyer’s demand for the unpaid amount of interest that had previously been fronted to Seller.⁵

To the extent parties desire to utilize a POSD approach for par/near par trades, the parties will need to memorialize such agreement in the “Trade Specific Other Terms of Trade” section of the par/near par trade confirmation. However, for distressed trades, the POSD approach is now available as a check the box option in addition to both Trades Flat and SWOA.⁶

II. Non-Recurring Fees.

The LSTA has also modified the rights of Seller and Buyer to “Non-Recurring Fees” under both the par/near par and distressed trade confirmations. “Non-Recurring Fees” relate to any amendment, consent, waiver and other similar non-ordinary course fees remitted to the lenders pursuant to the credit documents. Prior to publication of the June 9th documentation, both the standard terms of a par/near par trade confirmation and the standard terms of a distressed trade confirmation provided that Buyer was entitled to the benefit of any “Non-Recurring Fees” that were paid with respect to the loans being purchased from and after the Trade Date. The revised standard terms and conditions for both a par/near par trade confirmation and a distressed trade confirmation now provide that Buyer is only entitled to “Non-Recurring Fees” that are payable with respect to the loans from and after the Trade Date.

This modification from a “paid” standard to a “payable” standard means that, to the extent a one-time amendment fee was paid after the Trade Date but was actually due and payable on a date prior to the Trade Date, Buyer would not be entitled to the benefit of such “Non-Recurring Fee.” Hence, to the extent a Buyer, at the time of trade, would like to receive the economic benefit of an “amendment fee” that was “payable” prior to the Trade Date but not yet “paid” as of the Trade Date, Buyer must have that term specifically agreed upon at the time of trade.

III. Adequate Protection Payments.

In the standard terms and conditions for par/near par trades, the SWOA and POSD conventions were both broadened to expressly include the concept of “Adequate Protection Payments” therein.⁷ The most typical scenario where this language would apply is in a situation where, between the Trade Date and the Settlement Date, a borrower files for bankruptcy and an adequate protection order, providing for adequate protection payments to be paid to the lenders is entered. Under such a scenario, to the extent the debtor/borrower timely pays amounts owed under the adequate protection order, Seller will generally be entitled to the economic benefit of such payments up until T+7 (such time period could be extended to the Settlement Date if Buyer fails to comply with the Par DC Requirement Based Rules). The new modifications to the par/near par trade confirmation make clear that Seller will be entitled to adequate protection payments (and not just ordinary course interest payments and fees) that have accrued to but excluding T+7 (or the Settlement Date, to the extent Buyer fails to satisfy the Par DC Requirement Based Rules).

IV. Credit Documents.

Revisions were made throughout the secondary loan trading documentation to harmonize the use of the term “Credit Documents” versus “Credit Agreement”. For example, prior to the June 9th revisions, the term “Credit Documents” had been used in the definition of “Interest and Accruing Fees” in the LSTA standard terms and conditions to the distressed purchase and sale agreement whereas, in the LSTA distressed trade confirmation, the definition of “Interest and Accruing Fees” solely related to the “Credit Agreement.” The trade confirmation and the purchase and sale agreement now consistently employ the definition of “Credit Documents.” In certain other instances the use of the term “Credit Agreement” in the secondary loan documentation was broadened to utilize the term “Credit Documents”.⁸

V. ERISA.

On June 9, 2017, the Department of Labor’s final “fiduciary” rule, which expanded the definition of who is an investment advice fiduciary under ERISA and the Internal Revenue Code, became effective. Since the fiduciary rule may affect secondary loan trading documentation, the LSTA revised its suite of documents to take into account the changes under the fiduciary rule with respect to the purchases and sales of loans and any related investment advice. The revisions are intended to cover an exception to the fiduciary rule known as the “transactions with independent fiduciaries with financial expertise,” which provides that if certain entities (including US regulated banks, US regulated insurers, federal and state-registered investment advisors, registered broker-dealers, and independent fiduciaries managing or controlling at least $50 million in assets) meet the requirements set forth in the revised LSTA documents, then such entities will not be treated as providing “investment advice” and will be outside the scope of this rule.

This memorandum is intended to be a general summary of the revisions to the LSTA’s form of secondary trading documentation. Parties are strongly encouraged to review the revisions made by the LSTA independently and consult with their own advisors.

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1. The basic construct behind this methodology is that the trade should have closed no later than the applicable Commencement Date and, to the extent the trade has not closed by the applicable Commencement Date, the Buyer should be entitled to interest (or adequate protection payments) on the purchase amount of the loan from and after such date as if Buyer had closed the trade and become the legal and/or beneficial owner of the loans on the Commencement Date. The “Commencement Date” is generally T+7 for par/near par trades and T+20 for distressed trades.

2. The “Seller’s Retained Interest” relates to interest and ordinary course fees accrued with respect to the purchase amount of the debt for the period of time prior to T+7 for par/near par trades and prior to T+20 for distressed trades. The Seller’s Retained Interest period can be expanded beyond T+7 to all interest and ordinary course fees accrued prior to the settlement date of the trade. This occurs in situations where the Buyer fails to comply with the delay compensation requirement based rules (the “Par DC Requirement Based Rules”) set forth in Section 6 of the Standard Terms and Conditions of the LSTA Par/Near Par Trade Confirmation (the “Par ST&C’s”).

3. To the extent the Buyer does not satisfy the Par DC Requirement Based Rules, the Buyer would be required to pay to Seller (at time of closing) an amount equal to all accrued but unpaid interest on the loan amount relating to the interest period prior to the settlement date (and not limited to T+7).

4. As noted above, a POSD election would typically only be made for performing loans and, at the time of closing, the parties’ expectation would be that, on the next interest payment date, the borrower would satisfy its payment obligations.

5. The revised documentation also contemplates that the POSD approach should not be utilized between the parties to the extent a transaction was to settle by participation and not assignment. The reason for this nuance is that, under such circumstances, even if the Agent is paying interest entirely to the lenders of record on the interest payment date (without cleaving among the lenders who held the loans for a portion of the time during the interest period), the Agent would still pay interest to Seller (as the grantor of the participation) since Seller would remain the lender of record. Hence, to the extent the parties do not anticipate an immediate elevation of a participation after settlement, the regular SWOA convention would be more appropriate in achieving the intended economic results.

6. The election of Trades Flat is typically only utilized by market participants when the loan is non-performing and neither interest payments nor adequate protection payments are being remitted by the borrower.

7. Additionally, the concept of “Adequate Protection Payments” was likewise expanded into the standard terms and conditions of the distressed trade confirmation relating to POSD.

8. For example, note Section 12 of the Par STC’s relating to Participations whereby it is now clarified that elevation rights of a participant are subject to the terms of the “Credit Documents” and not necessarily just the “Credit Agreement.”