After highlighting some deal mechanics that may appear straightforward in the term sheet stage but can present significant pitfalls during the execution of distressed transaction documents (see Part 2), we now return to our blog post series (see Part 1 for an introduction to the blog post series) to discuss lender and agent internal compliance policies that can cause unanticipated delays.
KYC and Broader AML Issues
A nearly completed restructuring may get held up on account of a failure to start working with an agent on know-your-customer (KYC) processes sufficiently prior to a closing target date. For example, it may be essential to a deal for a company to open a new deposit account (whether or not at an existing cash management institution of the company), which will without exception require the depository bank to run KYC checks. In non-distressed financings, deposit account control agreements are frequently permitted to be put in place post-closing; however, distressed transactions may hinge on perfected security interests in cash accounts, and 90-day preference periods (where freshly perfected security interests may be voided by the bankruptcy court) make post-closing account openings and control agreements unattractive.
There are also instances where non-existing rescue lenders are brought in at the last minute to address extreme liquidity problems, which makes it difficult to fulfill KYC requirements in a timely fashion. This scenario can be problematic if there is truly a need for emergency funding. We especially see this scenario when a company insider might try to provide emergency financing via another tranche in an agented credit facility agreement. No matter how much pressure you put on the depository bank, it may be impossible to get KYC completed on time.
Transactions may also hit operational hurdles on account of stakeholders not vetting transaction structures with an administrative agent (especially when such agent is not driving the negotiation process). A transaction structure could trip anti-money laundering laws (AML) or banks’ internal AML policies and the fail-safes entrenched in their compliance functions, particularly with respect to cashless transactions. For instance, OID not processed through an arranger at origination may require non-ordinary course approvals to trigger a manual AML review, since there are no wires triggering an automatic review.
ESG Policies
While ESG (Environmental, Social and Governance) issues tend to make themselves known in the early stages of negotiations, stakeholders still should consider that some institutions have ESG policies that will make certain deal structures impossible, including structures with maturity extensions or new money components. Parties should be on high alert especially when attempting to restructure a company in an industry with clear ESG implications. While some institutions allow ESG policies to be overridden by top management, some policies will be entirely inflexible.
Flood Diligence
For distressed credits secured by real property, execution of transaction documents can also be delayed by lending institutions’ internal policies for compliance with the National Flood Insurance Reform Act of 1994. If any real property is added to the collateral package as an incentive for lender participation or there is existing real estate collateral plus a significant modification to a credit facility (such as a maturity extension or tranche addition), certain institutional lenders will need to diligence real property collateral to determine whether it can be party to such facility when secured by such real estate collateral. The time required to conduct such diligence depends on each institution’s internal policies (including whether new flood searches need to be ordered) and may take weeks.
We note that flood diligence often requires the borrower to provide detailed information to lenders concerning the real property, which can take time for the borrower to compile if not already organized or readily available or not subject to standard address conventions (i.e., mining rights that rely on property descriptions rather than P.O. addresses). While it might not seem like a gating term for a transaction in the term sheet stage, we recommend identifying a value threshold for requiring real property to become collateral early on, so this process may get started.
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See Part 4 where we address general strategies for minimizing execution risk and letting those substantive restructuring terms really shine.
