With interest rates rising and credit tightening, there’s a chance that lenders may become more risk-averse. They may limit how much they will lend in total or to a particular borrower or within a specific industry. Lenders may also look to spread some of their risk with other financial institutions through a loan participation offering. Sometimes loan participants may be smaller banks, credit unions, or other financial institutions that join together for group representation to save money, time, or resources.
Participation loans have layers of complexities, however. Lenders who are not taking the lead, and are considering purchasing an interest in a participated loan, will want to retain their own counsel rather than relying on the lead lender (or the lead lender’s counsel) or otherwise pooling legal resources with other participants. Here are a few reasons why participation agreements merit individual representation for each participating lender.
Ensure Each Lender’s Best Interests are Represented
In any deal, a lead lender is represented by counsel acting in good faith, but the lead lender’s needs come first. Alternatively, the attorney for a loan participant will ensure that the participant’s needs are represented well and that the terms of the participation agreement are in the best interests of that participant.
Counsel for individual lenders will review more than just the key provisions of the agreements to understand the participant’s rights and remedies and negotiate for them upfront. The attorney will also review the underlying loan documents and the legal duties and obligations of each party under the participation agreement, as well as the timing, participation percentage, and how their client’s interests compare to those of the other parties under the participation agreement.
While there are times when a group of loan participants choose to be represented by a single counsel, it is not always in the best interest of each lender. There are a number of details that can be overlooked if a participant does not work with experienced legal representation.
Understand How the Participation Loan Agreement Impacts Each Party
A loan participation agreement spells out the rights, duties, and obligations of all parties, including the lead lender and each participant. While these agreements often originate because of professional relationships between lenders, they are not a handshake transaction. A formal, legal document outlining all the terms and conditions of the participation agreement is imperative to protect all parties, and each party should understand how that agreement impacts them.
When reviewing the loan participation agreement, counsel will look for answers to these questions as they apply to each specific lender:
- Is it a Master Participation Agreement that covers all future participations or an agreement that contemplates just a one-time purchase? Often, a master agreement can be complicated, and a participation agreement for each loan could be cleaner.
- Does the underwriting and creditworthiness of the loan parties fit within the policies and procedures of the participating institution? It may be common practice for a loan participant to rely on the credit report that the lead lender sends over, as it saves time and money, but it’s still important to ensure it is congruent with the loan participant’s internal lending policies and that it fits within the portfolio parameters.
- What does the loan agreement spell out? What about the Promissory Note? Loan Maturity? Terms and conditions? Fees? More?
Secure All Necessary Documentation
In general, the lead lender conducts a thorough due diligence process and sends relevant information to loan participants. But loan participants may want to do a little more investigation on their own. As part of the due diligence process, each lender should ensure they receive their own copies of the following:
- Loan approval memorandum. This offers an overview of the borrower, the purpose of the loan, and the risks.
- Opinion of Borrower’s Counsel. The lead lender should receive the opinion, but it is important for all loan participants to also have their own copy in case there is a dispute.
- Insurance certificates of the borrower. If there is a loss, a loan participant must ensure that collateral is covered.
- A survey exception in the title policy, if applicable.
- A loan document elections package of all existing loan documents for buying into an existing loan arrangement.
Gain From Experience Throughout the Process
Perhaps the best reason to work with an experienced attorney before purchasing an interest in a participated loan is to leverage their first-hand knowledge of what to look for and what to avoid in the participation agreement.
There are any number of ways that a loan participant can miss an opportunity. For example, a lawyer will be able to discern if the participant has the right to share in any origination fees, commitment fees, closing fees, prepayment fees, exit fees, or other fees as part of the loan where the lead lender is profiting. Again, it is worth noting that the participation agreement is drawn up for the benefit of the lead lender, and all business negotiations must happen between the business parties (namely, the lead lender and the participant) before signing any documents.
Counsel representing individual participants will also pay close attention to a buy-out or similar clause. Some lead lenders may include a clause to buy out loan participants or sell the underlying loan to another institution within a set number of days of written notice to the participant. Conversely, if a loan is extended or modified, legal representation can help negotiate a participant’s rights to then exit the participation up front rather than be stuck in a loan that the participant expected to mature prior to extension or modification.
The bottom line on loan participations is that as the practice of sharing loan obligations becomes more prevalent, it is important for lenders, whether they are the lead lender or a loan participant, to ensure their rights and best interests are protected.
Sassoon Cymrot Law, LLC has the knowledge and experience to ensure that a loan participation agreement is in your institution’s best interests. Contact us to find out how we can help.