CROSS-BORDER FINANCING REPORT

OCTOB E R 2018 | I F LR .COM

USScott Forchheimer and Jennifer Kent, Latham & Watkins

Cross-border Financing Report

OCTOB E R 2018 | I F LR .COM | 1

SECTION 1: MARKET OVERVIEW

1.1 Please provide an overview of the market andenvironment for cross-border financing in yourjurisdiction.

Despite gradual increases in short-term interest rates over the pastcouple of years, interest rates in the US remain relatively low. That,combined with the flexibility found in covenant-lite loans, makes theUS loan market appealing to borrowers. The low risk of borrowerdefault and deep supply of loans makes the market appealing tolenders. Financings can take many forms: the size can range from large-cap

to middle-market to small-cap; the lenders can be traditional banks,funds, or other alternative lenders; the loans can be widely syndicatedor closely held. We continue to see a variety of financing structures,including bank/bond, first lien/second lien, stretch first lien, andmezzanine financings, all of which can involve cross-bordertransactions.

1.2 Have there been interesting changes in thestructure of the banking sector in your jurisdiction?

Recent developments include:

Leveraged lending guidance:In 2013, the Office of the Comptroller of the Currency of the USDepartment of Treasury (OCC) issued guidance on leveraged lending(the Guidance). The Guidance has been interpreted to limit pro formaleverage for loans to 6.0x, and until recently banks have viewed theGuidance as a hard rule and restricted their lending accordingly.

CROSS-BORDER FINANCING REPORT

USScott Forchheimer and Jennifer Kent, Latham & Watkins

www.lw.com

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CROSS-BORDER FINANCING REPORT US

In October 2017, the GeneralAccountability Office (GAO) stated that theGuidance was a rule under the CongressionalReview Act and thus could be reviewed byCongress, creating the possibility of reversal.In February 2018, the head of the OCCstated: ‘I am supportive of banks doingleveraged lending…as long as it does notimpair safety and soundness.’ Thesestatements have demonstrated to banks thatthe Guidance may be looser than previouslythought, and we are already seeing increasedleverage levels (eg 7.0x) becoming moreprevalent in large cap financings.

LIBOR Phase-out: In July 2017, the Financial Services Authority(FSA) of the UK announced concerns aboutthe future of Libor, stating that the ‘absenceof active underlying markets [for the Liborrate] raises a serious question about thesustainability’ and noting the rate’svulnerability to misconduct. For these

reasons, the FSA has recommended that analternative benchmark be implementedwithin the next several years. Borrowers andlenders have begun to incorporate Liborsuccessor provisions into new loandocumentation and amendments to existingloans to more readily allow for incorporationof a successor benchmark once chosen by themarket.

FinCen Customer Due DiligenceRule: The Financial Crimes Enforcement Network(FinCen) issued a new customer due diligencerule that took effect in May 2018. The rulerequires financial institutions to collect andverify identification information for beneficialowners of legal entity customers. Beneficialowners include certain individuals who (a)have significant responsibility to control,manage, or direct the entity or (b) directly orindirectly own 25% or more of the equityinterests thereof.

Determining who constitutes a legal entitycustomer is fact-specific and subject to anumber of exclusions, but ultimately couldinclude both borrowers and guarantors in anygiven financing. Practically speaking, this rulewill result in increased know-your-customer(KYC) requirements as well as the insertion ofadditional covenants and representations inthe loan documentation related to beneficialownership.

SECTION 2: FINANCINGSTRUCTURES

2.1 What have been the key trendsor developments in yourjurisdiction over the past 12months in terms of financingstructures, deal drivers and theway borrowers and creditors areparticipating in the market?

The US market continues to produce a largenumber of covenant-lite, term loan Bfinancings, often coupled with a revolvingfacility. All of the structures noted in Section1.1 are commonly utilised. In addition, non-bank lenders and direct lenders continue to bean increasing and reliable source of capital,both in the middle market and on second lienterm loans.The loan market has seen increased

volatility in Q3 of 2018. As a result, arrangershave been exercising flex rights more oftenand more broadly. Nevertheless, private equitysponsors are still generally successful innegotiating for borrower-friendly terms suchas increased restricted payment flexibility,exceptions from most favoured nation pricingprotection on incremental facilities, and assetsale prepayment exceptions.

2.2 Briefly outline some recentnotable transactions involvingyour jurisdiction, highlighting anyinteresting aspects in theirstructures and what they mightmean for the market.

The J Crew transaction from late 2016elicited renewed focus oninvestment/restricted payment capacity andflexibility with unrestricted subsidiaries. In acontroversial set of transactions, J Creweffectively transferred a significant amount ofintellectual property to an unrestrictedsubsidiary, resulting in a release of security in

Scott ForchheimerPartner, Latham & Watkins Washington, DC, UST: +1 (202) 637 3372F: +1 (202) 637 2201

E: scott.forchheimer@lw.comW: www.lw.com

About the authorScott Forchheimer is the local chair ofthe finance department in theWashington DC office of Latham &Watkins and is a member of thebanking and private equity financepractices. Scott has representedborrowers and private equity firms insecured lending and other financingtransactions, including acquisitionfinancings, cash-flow and asset-based loans, subordinated debtfacilities and secured bond offerings.In addition, he has worked for avariety of clients on matters involvingsecured finance issues and generalcorporate issues.

Jennifer M KentAssociate, Latham & Watkins

Washington, DC, UST: +1 (202) 637 2302F: +1 (202) 637 2201E: jennifer.kent@lw.com

W: www.lw.com

About the authorJennifer Kent is an associate in theWashington DC office of Latham &Watkins and is a member of thefinance department and the bankingand private equity finance practices.Her practice focuses on representingprivate equity firms and private andpublic company borrowers indomestic and cross-border securedlending and other financingtransactions, including acquisitionfinancings, cash-flow and asset-based loans, subordinated debtfacilities, and secured bond offerings.

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CROSS-BORDER FINANCING REPORT US

favour of its secured creditors. Whiletechnically compliant with the terms of theloan documentation, this transaction hascaused lenders to narrow in on looseinvestment carve-outs in order to limitunintended impacts on collateral.

SECTION 3: LEGISLATIONAND POLICY

3.1 Describe the key legislationand regulatory bodies that governcross-border financing in yourjurisdiction.

Regulatory bodies and laws governingfinancings in the US include:• Federal Reserve System: The central bankof the US, responsible for, among otherthings, regulating certain financialinstitutions and financial activities.

• Securities and Exchange Commission(SEC): Regulates the securities marketsand supervises the participants therein,including investment advisors andbroker/dealers.

• OCC: Supervises all national banks andfederal savings associations.

• State regulators: Each state has its ownregulatory agencies tasked with overseeingfinancial markets and the participantstherein.

• Dodd-Frank Wall Street Reform andConsumer Protection Act: A 2010 federallaw regulating banks and the financialindustry as a whole.

• Securities Exchange Act: A 1934 lawgoverning securities transactions.

• Uniform Commercial Code: A lawadopted by each state (with certain state-specific variations) that governs thecreation, perfection and priority of securityinterests in the US. In addition, while not a regulatory body,

the Loan Syndications and TradingAssociation (LSTA) is a non-profitorganisation that works to develop policiesand guidelines, promote equitable marketprinciples, and prepare standarddocumentation for the US syndicated loanmarket.

3.2 Have there been any recentchanges to legislation orregulations that may impact thecross-border financing market oravailability of funding in yourjurisdiction?

See Section 1.2. In addition, the US administers a variety

of sanctions programs which are subject toongoing update. To the extent a US financinginvolves a company with operations in anycountry subject to US sanctions programs,borrowers should expect a more stringentKYC process as well as narrowly-tailoredcovenants and representations and warrantiesrelated to use of proceeds and sanctions/anti-corruption.

3.3 Are there any rules, legislationor policy frameworks underdiscussion that may impactlenders or borrowers involved incross-border financing in yourjurisdiction? How can marketparticipants prepare?

See Section 1.2.

SECTION 4: LOCALMARKET NORMS

4.1 Are there frequently askedquestions from new marketentrants or often overlooked areasfrom parties involved in cross-border financings in yourjurisdiction?

In the leveraged buyout context, partiesshould be cognisant of the nuances of USacquisition agreements and their impact onfinancing terms and process. Two notableexamples are below:

Xerox provisions: These are provisions thatare inserted into the remedies, venue, waiverof jury trial, third-party beneficiaries andamendments sections of a purchaseagreement, intended to limit the recourse aseller may have against the buyer’s financingsources. Xerox provisions are commonplace inthe US market and so US lenders will expectthese, even in non-US purchase agreements,if there is a US financing.

Certain funds: The certain funds concept,while typical in Europe, is relativelyuncommon in the US market. Lenders whoprimarily participate in the US market maybe unfamiliar with the differences in processand documentation required in a certainfunds deal. If you plan to have a US financingin connection with a certain funds-styleacquisition, you should raise this with yourfinancing sources as early as possible to ensurea smooth process.

4.2 Please describe any commonmistakes or misconceptions thatexist about the financing marketin your jurisdiction.

Many of the relevant laws are state law, notfederal law, and thus are not uniform acrossthe US. In addition, lenders often assume thatin order to file a UCC-1 financing statementin the US against a non-US loan party, suchfiling must be made in Washington, DC. Inreality, the rule is a bit more nuanced and thecorrect jurisdiction may be elsewhere. As such,local counsel should be engaged in eachindividual state where a loan party is located,as well as in the state whose law governs theloan documentation. Moreover, on cross-border financings,

non-US banks may request US legal opinionsconsistent with what is regularly provided intheir non-US jurisdiction, including opinionson choice of law, submission to jurisdictionand stamp duty. These are not common in USopinion practice, and due to theaforementioned nuances in state laws canoften necessitate US local counsel in the statesof organisation of the relevant US entities.

4.3 Are there any classes of assetsover which security cannot betaken or regulations specific toyour jurisdiction governing thetaking of security over certainclasses of assets that lendersshould be aware of?

There are a few classes of assets for whichthere are regulatory, contractual or other legalrestrictions on granting security, such ascertain equipment leases, margin stock, assetsof gaming companies, and governmentallicences.Beyond formal legal restrictions, there are

assets with respect to which the creationand/or perfection of a security interest is not

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market, usually as a result of burdensomeperfection requirements or negative financialconsequences. Some examples include motorvehicles, certain intent to use trademarks, andreal property located in a flood zone. Themost prevalent example is with respect tocertain non-US subsidiaries of a US entity,and US subsidiaries that hold no substantialassets other than equity and/or debt of non-US subsidiaries. There can be material taxconsequences under Section 956 of the USInternal Revenue Code if these entitiesprovide guarantees or security in support ofan obligation of a US entity, or if more than65% of the equity interests of any such entityare pledged as collateral for the obligations ofa US entity.

4.4 What measures should betaken to best prepare for yourlocal market norms?

Security and perfection rules differ widelyamong states and market standards vary basedon the size of the transaction, the industry ofthe debtor, the structure of the loan and thecomposition of the lender group. As such,lenders and borrowers alike should consultappropriate US counsel as early as possible inthe financing process.In addition, there is often a distinction in

approach to security in bond financings,where a collateral agent/trustee will notexercise discretion in making exceptions to thesecurity package or granting deadlineextensions. Therefore, careful considerationshould be given when negotiating the termsfor security on bond financings, particularlyon cross-border transactions that may involvemore complex security.

SECTION 5: PRACTICALLEGAL CONSIDERATIONS

5.1 Briefly explain (i) the typicalsecurity package available atclosing and (ii) any downstream,upstream and cross-streamguarantees available in yourjurisdiction, in each case, withreference to any specificrestrictions or limitations.

The typical security package consists ofsubstantially all personal property, subject tocertain exceptions (as briefly discussed inSection 4.3 above). Owned real estate and

leaseholds over a certain threshold may beincluded as well. Security interests in personal property can

be granted in one universal securitydocument. However, ancillary filings, noticesand other documentation or actions may berequired to perfect the security interest incertain assets, such as US federally registeredintellectual property, deposit accounts andcertificated equity interests. The requirementsto grant a security interest in real propertyvary from state to state, but generally speakingat a minimum a mortgage or deed of trust willbe needed. The US does not have explicit financial

assistance or corporate benefit laws.Downstream guarantees are generallyunrestricted. Upstream and cross-streamguarantees are extremely common, but youmust consider the facts of the transaction toensure they are permissible under state law.Ultimately, guarantees will be subject tobankruptcy and fraudulent conveyance laws,as well as certain limitations (including withrespect to certain swap obligations).

5.2 Are there any specific issues orchallenges creditors should bemindful of regarding aninsolvency or restructuringsituation? Have there been anymajor judicial changes to theinsolvency system (or relatedjudicial decisions) in yourjurisdiction recently? How longdoes an enforcement processtypically take?

The federal insolvency regime is the USBankruptcy Code (the Code). The two typesof bankruptcy cases most typically applicableto debtors in the leveraged loan markets are(a) a liquidation under Chapter 7 of the Codeand (b) a reorganisation under Chapter 11 ofthe Code. Commencement of a bankruptcy case

creates an automatic stay against any creditor’senforcement, repossession or collectionactions against the debtor or the debtor’sproperty, regardless of whether such creditoris secured or unsecured. The bankruptcy courthas broad power, and could set aside transfersthat the debtor made when insolvent, or thatwere made within a certain period prior to thebankruptcy case being commenced.Additionally, security interests that areunperfected at the time the bankruptcy caseis commenced could be invalidated.

There is no hard rule for how long abankruptcy case will last – it depends on anumber of factors including whether the caseis brought under Chapter 7 or Chapter 11,the size of the debtor, the number of creditors,and the competing interests thereof.

SECTION 6: OUTLOOK

What are your market outlookpredictions for the next 12 monthsin cross-border financing in yourjurisdiction?

Barring any market or global disruptions, weexpect that we will continue to see active andborrower-friendly debt markets in the US.Interest rates remain relatively low, providingopportunity for refinancings, and privateequity sponsors and borrowers continue topush the envelope for favourable terms. Weexpect continued convergence of terms inbank debt financings and bond issuances, aswell as more consistency in provisions in USdeals and cross-border matters. Finally, weenvision the continued and increased use ofalternative lending products, includingunitranche and privately placed facilities, inorder to offload market and syndication risk.

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