Banking & Finance 2019 Second Edition Comparisons

Last Updated October 08, 2019

Law and Practice


Davis Polk & Wardwell LLP represents private equity sponsors, borrowers, banks and other lenders across a broad spectrum of corporate finance transactions, including leveraged and investment-grade acquisition financings, middle market and direct lending financings, oil and gas financings and restructurings, and debtor-in-possession and exit financings, among others. The finance practice includes 18 partners in New York and London, each of whom has extensive experience in representing financial institutions and corporations in bespoke and ground-breaking financing transactions. With locations in New York, Europe, Asia and Latin America, the practice is well equipped to handle the most complex domestic and international transactions.

Following the global financial crisis and in connection with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, US federal regulators issued Leveraged Lending Guidance (the “Guidance”) in 2013 to address concerns about heightened leverage levels in the US loan market. This guidance mandated that regulated lenders consider a borrower’s ability to de-leverage as a fundamental component of lenders’ credit analysis in making a loan, and stated that leverage levels higher than six times total earnings before interest, depreciation and amortisation (“EBITDA”) “raises concerns” for borrowers in “most industries”. This statement led to increased reticence by regulated US financial institutions to make highly leveraged loans, thereby allowing unregulated, non-bank lenders and foreign institutions to increase their market share in the leveraged finance market.

While the leveraged loan market perceived considerable regulatory easing of the Guidance in 2017 and 2018, including as a result of a joint statement of federal regulators indicating that, while continuing to take the elements of the Guidance into consideration, they would not enforce the Guidance systematically as a rule, the leveraged loan market has not been free of critics. In 2019, prominent figures, including former Federal Reserve Chair Janet Yellen and Senator Elizabeth Warren, warned about the potential economic concerns and negative impact of excessive corporate debt. In response, the Loan Syndications and Trading Association argued that these concerns were misguided or exaggerated, citing strong credit performance, historically low default rates and improvements in systemic trends.

During this time, highly leveraged financings – with debt multiples commonly approaching or even exceeding seven times adjusted EBITDA – have accounted for a growing share of new leveraged loan issuance and have, in fact, surpassed pre-financial crisis highs. Further, the rapid growth of non-bank “direct” lenders has increased competition in the US loan market, permitting borrowers to request more aggressive terms, including even higher leverage multiples. While some of these aggressive terms are subject to push-back when market cycles or sentiment cools, most market observers continue to note a general erosion of covenant and other customary lender protections, including the prevalence of “covenant lite” term loans and overall higher permitted leverage levels.

Companies increasingly look to both the syndicated loan and high-yield bond markets to meet their financing needs, depending on market conditions and capital structure requirements. With the expectation of the Federal Reserve raising interest rates during 2018, issuers focused on the loan market, where high investor demand offered attractive high-yield-like terms along with customary loan prepayment flexibility. Conversely, as the Federal Reserve reversed course and, as of September 2019, lowered its target rates, demand has moderately shifted toward the fixed-rate bond market.

The high-yield bond market has continued to show significant overlap on structural terms with the leveraged loan market, as highlighted by the proliferation of covenant-lite loan structures, representing approximately 80% of all loan issuances in 2018 compared to 17% in 2007, and nearly a doubling of the number of secured bond issuances during the same period. Furthermore, certain economic terms in the loan market increasingly reflect those that are customary in high-yield bonds, including in some cases loans subject to “no call” or "hard call" periods requiring the payment of a make-whole or premium upon any voluntary prepayment. In particular, in LBO transactions, where buyers/borrowers seek to obtain financing in both the loan and high-yield bond markets, sponsors have increasingly pushed for substantially identical flexibility across their loans and bonds.

Certain differences do remain between loan and high-yield bond terms. Loans continue to provide lesser “call” protection – in terms of the scope, amount and duration of the premium – in connection with voluntary prepayments. Additionally, where leveraged loans and bonds are issued in a single capital structure, lenders typically continue to drive the guarantee and, where the bonds are secured, collateral structure, with the loan agent controlling enforcement proceedings and bondholders simply “piggy-backing” the scope of the loan collateral and guarantee package. Finally, loans, but not bonds, generally continue to restrict investments in non-guarantor subsidiaries and require interest rate spreads to reset upon higher yielding loan issuances (commonly referred to as “MFN protection”).

Despite these differences, the increasing similarity of terms continues to have a profound impact on the US syndicated leveraged loan market.

With private debt funds raising more than USD100 billion over the past four years, alternative credit providers have become an increasingly visible presence in the US loan market, with direct lending, or loans made without the use of a bank or other arranger acting as intermediary, continuing to grow dramatically. Assets under management across the direct lending industry have nearly tripled, from USD275 billion in 2009 to approximately USD770 billion as of June 2019, with much of the funding coming from insurance companies, endowments, pension funds, “Business Development Companies” and sovereign wealth funds. While these asset managers historically operated largely in the middle market, focusing on smaller corporate borrowers, direct lenders are increasingly viewed as “go-to” financing sources for top-tier transactions, including by providing “bought” tranches or one-stop financing solutions to large corporate borrowers and private equity sponsors. Competing directly with traditional bank arrangers, direct lenders have provided borrowers with greater flexibility when seeking commitments for complex financing structures. In particular, direct lenders are often willing to provide financing at higher leverage multiples, especially to borrowers lacking access to the traditional bank lending or high-yield debt markets, and offer greater speed of execution and certainty on terms, as their ability to hold the loans through maturity – and the corresponding absence of a need to syndicate the loans – obviates the need for a marketing process and potential for terms, including pricing, being “flexed” in the course of syndication efforts.

Banking and finance techniques continue to evolve in the face of the increased number of potential financing sources for loans, new strategies employed by debt activist funds and the proliferation of services offering covenant analysis services.

Increased Flexibility from Additional Financing Sources

As a result of intense competition amongst bank and non-bank lenders for financing transactions, there has been a marked increase in documentation flexibility in recent years, notably around incremental debt capacity, covenant-lite structures and utilisation of unrestricted subsidiaries. Private equity sponsors have been a key driver of this increased flexibility as repeat customers in both the syndicated leveraged and direct loan markets, by pushing for terms that are more aggressive in each subsequent loan transaction. Increasingly, borrowers push lenders to rely on an underwritten borrower-friendly documentation precedent to ensure the terms of the new financing are “no worse than” their most recent financing (and rely on “market flex” rights to scale back the most aggressive terms solely to the extent necessary to facilitate a successful syndication). Correspondingly, to ensure they remain competitive, bank lenders have become increasingly selective on terms requiring pushback, with heightened focus on foreclosing abuses witnessed in – and thus subject to the focus of – the syndicated market.

Debt Activism

The US loan market has recently experienced unique forms of debt activism, leading to heightened awareness by market participants of documentation terms that could lead to adverse and unintended consequences. Examples include lenders to a distressed borrower being more willing to resist “accretive” liability management transactions and treating loan defaults as a commercial opportunity. Most prominently, debt activist funds have started to engage in “net short activist” strategies, in which they amass large short positions against a borrower through credit default swaps and other derivatives (or other short positions) while simultaneously holding a smaller long position in the borrower’s loans or bonds, with the ultimate goal of asserting a default or otherwise taking an adverse position on their (smaller) long loan/bond position in order to benefit their (larger) short position. These debt activist strategies create anomalous economic incentives for holders of a borrower’s debt and, consequently, adverse outcomes for borrowers and, possibly, other creditors. Market participants harmed by these strategies have increasingly called for regulatory action to address this use of derivatives, and borrowers have sought to prevent “net short lenders” from voting their loans/bonds in a manner adverse to the borrower.

Covenant Analysis Publications

Services offering analysis of covenant packages of loan issuances have become increasingly visible in recent years, which has led to increased publicity for and focus on certain terms deemed to be of particular risk to lenders. While this publicity has allowed potential lenders to identify, organise and resist certain terms in loan documentation brought to the market, perhaps unsurprisingly, private equity sponsors and other borrowers have also taken advantage of the more rapid spread of information and increasingly sought to “cherry-pick” the most aggressive terms that have “cleared” the market in prior (even non-comparable) financings. Most recently, these services have instead begun producing “covenant ratings” designed to permit collateralised loan obligation funds and other lenders to efficiently assess the quality of loan documentation, leading to heightened concerns as to the fairness and accuracy of the analysis.

The US loan market has seen several recent legal, regulatory, tax and other developments that will shape the terms of loan financings in the near future, with the most prominent being the tax reform under the Tax and Jobs Act, the transition away from the London Interbank Offered Rate ("LIBOR") as the benchmark rate for loans, the enactment of the Beneficial Ownership Regulation, and newly released QFC Stay rules and Delaware LLC division rules.

Tax Reform

Recent tax reform in the US has begun to affect the structuring of credit support for loans. In late 2017, Congress passed the Tax and Jobs Act which, among other things, reduced the US federal corporate tax rate, introduced a territorial dividend exemption regime and limited interest deductibility. In May 2019, the US Treasury Department and the Internal Revenue Service issued final regulations, which effectively eliminate the “deemed dividend” rules under Internal Revenue Code Section 956, allowing US corporate borrowers (and partnership borrowers with US corporate owners) to obtain credit support from non-US entities without incurring US tax liability, in certain circumstances. Although it is now easier for certain US corporate and partnership borrowers to obtain foreign credit support, most qualifying US borrowers continue to retain customary Section 956 carve-outs of such foreign credit support and consequently domestic-only guarantee and collateral packages. Additionally, the new tax regime creates an incentive to borrow at foreign subsidiaries in higher tax jurisdictions, which increases pressure to eliminate customary restrictions on debt incurrence by non-loan parties. Finally, because of the greater discrepancy between US individual and corporate rates post-tax reform, loan agreement provisions allowing dividends by pass-through entities based on the highest personal tax rate now create a material discrepancy between the actual taxation of corporations and permitted tax distributions for pass-through entities.

LIBOR Successor Rate Provisions

LIBOR is currently relied upon as the benchmark rate for the vast majority of US loan issuances. Recent criticism of the intergrity of the process by which LIBOR has historically been determined – and the depth of the “observed transactions” on which it supposedly rests – has led to calls for its replacement, and the UK’s Financial Conduct Authority has announced that after 2021 it will no longer compel reference banks to submit LIBOR quotations. In response, regulators and loan market participants have begun preparing for a transition away from LIBOR to a replacement benchmark rate, with indications that the most likely successor in the US loan market will be the Secured Overnight Financing Rate, a rate based on a deep market of overnight secured financings monitored by the Federal Reserve. Arrangers and borrowers have increasingly included LIBOR successor provisions in their loan documents to accommodate an orderly transition away from LIBOR, although the precise terms of the replacement – and any corresponding adjustments to address its differences from LIBOR – have not yet been determined. These provisions generally focus on identifying the trigger event(s), the replacement rate and the mechanism for amending loan documentation to effectuate such replacement. On 25 April 2019, the Alternative Reference Rates Committee of the Federal Reserve released its recommended LIBOR fallback language for US dollar-denominated loans, which is slowly but surely working its way into US loan documentation.

QFC Stay Rules

In 2017, US banking regulators adopted the “QFC Stay Rules”, which are intended to ensure that, if the Federal Deposit Insurance Corporation (“FDIC”) becomes the receiver of a US globally systemically important bank (“GSIB”), the FDIC’s powers to transfer the qualified financial contracts (including swaps and derivative contracts – “QFCs”) of the failed institution to a bridge bank will be respected. This is accomplished by requiring QFCs of GSIBs and related entities to include language establishing that the banking regulators have the ability to stay termination of such QFCs and transfer such contracts in the same manner as they would under US bank insolvency law. GSIBs have begun complying with the QFC Stay Rules by including such provisions in loan agreements to the extent the related guarantee and collateral package applies to the borrower’s obligations under swaps or similar QFCs.

Beneficial Ownership Regulation

The Financial Crimes Enforcement Network issued a final rule in May 2016, which became effective in May 2018, requiring covered financial institutions to establish and maintain written procedures that are reasonably designed to identify the beneficial owner(s) of legal entity customers, and clarifying the enhanced customer due diligence requirements for financial institutions under the Bank Secrecy Act. As a result, in connection with offering new lending, treasury management, hedging, account or other services, covered financial institutions are required to verify information related to individuals who control the legal entity customer (including executive officers and senior managers), or directly or indirectly own 25% or more of the equity interests of such legal entity customer. These requirements are in addition to existing “know your customer” rules mandated by the USA PATRIOT Act, and are addressed in recent loan documentation by a requirement on covered borrowers to deliver a certificate as to its beneficial ownership at transaction closing (and certain other specified events) and provide lenders with updated information during the tenor of the financing.

Delaware LLC Divisions

In April 2018, the Delaware Limited Liability Company Act was amended to provide for, among other things, the division of a Delaware limited liability company into two or more separate limited liability companies. The amendments provide specific protections for lenders, including the application of joint and several liability of the divided companies to the extent the division constitutes a fraudulent transfer under applicable law. In addition, for limited liability companies formed prior to August 2018, restrictions included in loan agreements with respect to mergers, consolidations or the transfer of assets are deemed to apply to a division. Lenders have, nevertheless, also begun to incorporate specific clarifications in loan documentation to address such divisions, including prohibiting the transfer of assets to divisions and limiting the ability for limited liability companies that are loan parties to consummate divisions.

Financings in the US are typically provided by either traditional regulated banking institutions or non-traditional – often unregulated – alternative credit providers. The US operates under a “dual-banking system”, in which banks can apply for a state bank charter or a federal charter from the Office of the Comptroller of the Currency (“OCC”). Banks chartered by a state banking authority are primarily subject to the regulations of that state authority in addition to the Federal Reserve or the FDIC, while nationally chartered banks are subject to regulation by the OCC and are required to become members of the Federal Reserve System. Federal law also requires national and state banks to obtain deposit insurance from the FDIC.

Alternative credit providers, or direct lenders, may be subject to regulation under the Investment Company Act as an “investment company”, often operating under an exemption from many of the requirements, and are subject primarily to the regulations of the Securities and Exchange Commission.

Foreign banking organisations are subject to the International Banking Act of 1978 and the Foreign Bank Supervision Enhancement Act of 1991, and are regulated by the Federal Reserve, whose approval is necessary to establish a foreign banking institution in the US. Furthermore, foreign banking institutions must seek regulatory approval from the OCC or state banking supervisor to establish US branches and agencies. Upon receiving the appropriate licensing, foreign bank branches may provide a full range of banking services, including making loans.

In early 2019, the Federal Reserve proposed new regulatory requirements for US subsidiaries of foreign banks, providing relaxed capital and stress testing requirements while also imposing stricter liquidity requirements.

Under US law, there are generally no restrictions on or impediments to a US entity granting security interests to or providing a guarantee in favour of foreign lenders that differ from granting or providing them to a domestic lender.

The US does not currently impose any controls on foreign currency exchange that affect the US loan market, unless a party is in a country that is subject to sanctions enforced by the Office of Foreign Assets Control (“OFAC”) of the US Department of the Treasury. OFAC administers and enforces economic and trade sanctions based on US foreign policy and national security goals.

Most US loan agreements include a restrictive covenant limiting the borrower’s use of loan proceeds for specified enumerated purposes, which may be limited to specific transactions (eg, to finance an acquisition or to refinance existing debt) or generally for the borrower's working capital or other “general corporate purposes”. US loan documentation also prohibits borrowers from using loan proceeds in violation of relevant US and foreign anti-corruption and anti-money laundering regulations (principally the Foreign Corrupt Practices Act of 1977 and sanctions enforced by OFAC). In addition to these contractual restrictions, US law restricts the use of loan proceeds in violation of the margin lending rules under Regulations T, U and X, which limit loans used to acquire or maintain certain types of publicly traded securities and other instruments – acquiring the securities or investments “on margin” – if the loans are also secured by such securities or instruments; in effect, limiting the amount of collateral value the lender may assign to such securities or other instruments (currently, to 50%).

In US syndicated loan financings, an administrative agent is typically appointed to act on behalf of the lending syndicate to administer the loan, including managing borrowings, receiving and distributing payments, enforcing remedies and acting as an intermediary for communications between the borrower and lender syndicate. In secured transactions, a collateral agent will typically be appointed to administer collateral-related matters, and the grant of security and any guarantee is made to (or in favour of) such collateral agent for the benefit of the lending syndicate. While the lead arranger commonly acts as both administrative agent and collateral agent, in distressed situations where the exercise of agent duties and discretion may lead to disagreements among the lender syndicate or with the borrower, an independent, unrelated financial institution is often appointed by the syndicate to perform this function. Where financings involve debt securities or multiple lending groups sharing the same collateral, the security interests are sometimes granted to a collateral trustee or other “intercreditor” agent to act on behalf of all holders of the debt, subject to trust or other intercreditor arrangements setting out the relative rights of the various creditor groups. Trusts are used to supplement the agency relationship, either as simple collateral devices or, less often, as a way to comply with legal restrictions specific to the transaction.

In the US loan market, loan interests held by lenders are transferred between market participants through either an assignment or a participation. An assignment is a sale of all or part of a lender’s rights and obligations under the applicable loan agreement to another lender, following which the assignee replaces the assigning lender under the loan agreement with respect to the portion of loans assigned. As a lender under the loan agreement, the assignee benefits from all of the rights and remedies available to lenders thereunder.

US loan agreements typically provide for certain conditions to be satisfied in order for a lender to assign a loan. Typically, a minimum principal amount (and minimum increments above such amount) must be assigned as part of the transaction, and assignments generally require the consent of the borrower, the administrative agent and, in connection with assignments of unfunded commitments, certain other fronting lenders. Loan agreements usually provide for limitations on the borrower’s consent rights during the continuation of any event of default (or, increasingly, solely during the continuance of a payment or bankruptcy event of default). Furthermore, borrower consent is typically not required when assigning to an existing lender or affiliate of such lender, or if the borrower has not objected to a proposed assignment within a specified period of time (usually five to 15 business days).

A participation, in contrast, involves only a transfer of limited rights, principally the right to receive payments on the loan and very limited voting rights to protect such payment rights. The transferee of such rights is a “participant” in the loan, but does not become a lender under the loan documentation with contractual privity to the borrower. As such, even such limited voting rights are exercised by the lender who sold the participation, at the participant’s direction, not by the participant itself. Unlike assignments, participations almost never require notice to or consent from the borrower.

Finally, loan agreements typically permit a lender to pledge or assign a security interest in all or any portion of its rights in the loans to secure obligations of the lender, generally without the consent of the borrower, but do not allow the pledgee or assignee to realise on the interest to become a lender other than with the consent and other requirements described above.

Increasingly, loan agreements (particularly those involving private equity sponsors) restrict assignments and participations to “disqualified institutions” designated by the borrower or its controlling equity holder. The disqualified institutions generally include competitors of the borrower and certain financial institutions that the private equity sponsor or borrower deem undesirable, including as a result of such institution being likely to engage in activist strategies. These provisions are often heavily negotiated, with borrowers seeking to maintain flexibility to designate additional entities throughout the life of the financing and lenders seeking to minimise such flexibility in order to maintain the liquidity of the loan. In response to recent transactions in which “net short activist” strategies were employed by lenders, private equity sponsors increasingly seek to require potential lenders to represent that they do not have a net-short position as a condition of becoming a lender (and, thereafter, exercise voting rights).

Debt buy-backs by borrowers and their affiliates (including a private equity sponsor) are generally permitted in the US syndicated loan market, subject to customary requirements. In particular, borrowers and other loan parties are generally permitted to buy-back loans on the open market and pursuant to “Dutch” auction procedures under an offer made available to all lenders on a pro rata basis. Loan agreements will typically require that, in connection with any such buy-back, the purchased loans are cancelled and such buy-backs are not financed with loans under any corresponding revolving facility.

Alternatively, the private equity sponsor and its affiliates (other than the borrower and its subsidiaries) are typically permitted to make “open-market” purchases on a non-pro rata basis. Once held by an affiliate of the borrower, loans are generally subject to restrictions on voting, participating in lender calls and meetings, and receiving information provided solely to the lenders. Additionally, loans held by a private equity sponsor or its affiliates are subject to a cap, typically 25% of the applicable tranche of term loans. Bona fide debt fund affiliates of a private equity sponsor that invests in loans and other long-term indebtedness in the ordinary course of business are usually excluded from these restrictions, but are limited to constituting less than 50% of the loans voting in favour of amendments that require the consent of a majority of the lenders.

While the US does not have any specific rules or regulations mandating the terms of “certain funds” with respect to financing acquisitions of public or private companies, market dynamics have evolved such that financing commitments are generally subject to a limited and standardised set of conditions, colloquially referred to as “limited conditionality” or “SunGard” provisions. The narrowing of conditions precedent in a typical acquisition financing has been driven largely by the increased focus in M&A transactions on deal certainty, with the buyer/borrower seeking to align the conditions precedent to the financing with the conditions precedent to the acquisition to the greatest extent possible. The most important of these remaining conditions are as follows:

  • the accuracy of certain "specified representations" deemed critical to the enforceability and legality of the financing itself;
  • the accuracy of certain representations of the sellers or target made in the acquisition agreement the breach of which would permit the buyer to terminate the acquisition;
  • the absence of a material adverse change with respect to the target (matching verbatim the corresponding condition to the acquisition); and
  • conditions relating to the information and timing required by the arrangers to properly syndicate the loans in advance of acquisition closing.

Given these dynamics, it is customary for a buyer and arrangers to execute a commitment letter, which includes a detailed term sheet upon signing the acquisition agreement, thereby providing the buyer with committed financing subject to customary “limited conditionality”. If public, the company will typically announce the transaction along with details about the committed financing by filing information on a Form 8-K with the Securities and Exchange Commission. The buyer and the arrangers then negotiate definitive loan documentation for the financing prior to the closing of the acquisition, during which time the arrangers – with the assistance of the buyer and target – will seek to syndicate the loan commitment to the broader market.

Generally, there is a 30% US withholding tax on the gross amount of interest paid to a non-US lender. If a loan is issued at a discount in excess of a de minimis amount (“original issue discount” or “OID”), that discount is treated as interest income, subject to the 30% withholding tax, when paid. Certain fees may also be treated as original issue discount for this purpose.

However, there are several important exceptions to withholding on interest, as a result of which the expectation is usually that lenders to a US obligor should be able to avoid withholding on interest so that a gross up should not apply, without a change in law. Those exceptions include treaty exemptions, the portfolio interest exemption and an exemption from withholding if the interest is paid to a non-US lender that is engaged in a trade or business within the US (such as a non-US bank operating through a US branch).

The portfolio interest exemption applies to eliminate withholding on interest:

  • the non-US lender does not own (actually or constructively) 10% or more of the voting equity of the borrower;
  • the non-US lender is not a controlled foreign corporation related to the borrower for US tax purposes;
  • the non-US lender is not a bank extending credit pursuant to a loan agreement entered into in the ordinary course of its trade or business; and
  • the interest is not subject to certain contingencies (such as interest based on the income or profits of the borrower).

To qualify for an exemption to withholding, a non-US lender will generally be required to provide a US tax form to the borrower or agent – typically an IRS Form W-8BEN-E (for treaty benefits or the portfolio interest exemption) or an IRS Form W-8ECI (if the interest is effectively connected with the non-US lender’s US trade or business).

Principal payments and the proceeds from a sale or other disposition of a debt instrument are generally not subject to US withholding tax (except to the extent such payments are treated as a payment of interest or original issue discount). However, fee income that is not treated as original issue discount may be subject to 30% withholding unless a treaty applies or the recipient is engaged in a US trade or business – the portfolio interest exemption may not apply because the fee may not be treated as interest for US tax purposes.

Finally, in 2010, the United States enacted the Foreign Account Tax Compliance Act (“FATCA”), which imposes a 30% US withholding tax on non-US banks and financial institutions (including hedge funds) that fail to comply with certain due diligence, reporting and withholding requirements. FATCA withholding tax applies to payments of US-source interest and fees, without any exemptions for portfolio interest or treaty benefits. FATCA was scheduled to apply to payments of gross proceeds from a sale or other disposition of debt instruments of US obligors beginning on 1 January 2019, but on 13 December 2018, the Internal Revenue Service and US Department of the Treasury issued proposed regulations (the preamble to which specifies that taxpayers are permitted to rely on the proposed regulations pending finalisation) stating that no withholding will apply on payments of gross proceeds. Many countries have entered into agreements with the United States to implement FATCA, which may result in modified requirements that apply to financial institutions organised in such countries.

Under Section 956 of the Internal Revenue Code, if a foreign subsidiary of a US borrower that is a “controlled foreign corporation” (“CFC”) guarantees debt of a US-related party (or if certain other types of credit support are provided, such as a pledge of the CFC’s assets or a pledge of more than two-thirds of the CFC’s voting stock), the CFC’s US shareholders could be subject to immediate US tax on a deemed dividend from the CFC. Following regulatory changes published by the US Treasury and Internal Revenue Service in 2019, US corporate borrowers may now obtain credit support from CFCs without incurring additional tax liability, if certain conditions are met. However, despite the renewed ability for CFCs to provide credit support to US borrowers in certain circumstances, the majority of loan documents today continue to maintain customary Section 956 carve-outs, excluding CFCs from the guarantee requirements and limiting pledges of first-tier subsidiary CFC equity interests to less than two-thirds. In addition, the deemed dividend rules may still have an effect on US individuals.

Separately, non-US lenders should closely monitor their activities within the United States to determine whether such activities give rise to a US trade or business or a permanent establishment within the United States, in which case they could be subject to US taxation on a net-income basis. Whether a non-US lender is engaged in the conduct of a US trade or business or has a permanent establishment depends on all the facts and circumstances, including the activities that the non-US lender (and its agents) undertakes from within the United States.

National and state-chartered banking institutions are subject to usury laws, which are largely enforced at the state level. For these laws, “interest” may also include, among other things, overdraft and late fees. Nationally chartered banks cannot charge interest exceeding either the rate permitted by the state in which the bank is located or 1% above the discount rate on 90-day commercial paper in effect in the bank’s Federal Reserve district, whichever is greater. If the state where the bank is located does not prohibit usurious interest, the bank cannot charge interest exceeding 7%, or 1% above the discount rate on 90-day commercial paper in effect in the bank’s Federal Reserve district, whichever is greater. In general, state-chartered banks are permitted to use the same interest rate as national banks. If a state usury law prohibits state-chartered banks from applying the same interest rate as a nationally chartered bank, federal law will pre-empt such state law.

Under New York law, with certain exceptions, charging interest in excess of 16% constitutes civil usury, and charging interest in excess of 25% constitutes criminal usury. However, loans in excess of USD250,000 are exempt from the civil statute, but remain subject to the criminal statute. Loans in excess of USD2,500,000, which would include nearly all broadly syndicated loans in the US, are exempt from both the civil and criminal statutes.

Determining the Collateral Package

US law places few limitations on the assets of borrowers that are available to be pledged as collateral to lenders. The specific assets included in the collateral package with respect to a particular financing, however, are generally subject to negotiations between the borrower and the lenders, and (substantially) “all asset” pledges of real and personal property of borrowers are not uncommon, with negotiated exclusions generally addressing overly burdensome or expensive perfection requirements or consequences. Common examples of exclusions from US collateral packages are licences prohibited by law or contract (but the proceeds thereof may be included), assets that provide de minimis value, assets subject to certificates of title (including motor vehicles) and “intent-to-use” applications for the registration of a trade mark.

Creating an Enforceable Security Interest

The creation and perfection of a security interest in most categories of personal property are governed by the Uniform Commercial Code (the “UCC”), which has been adopted with some local differences in most states. In order to create an enforceable security interest with respect to personal property under Article 9 of the UCC:

  • the lender must provide value to the grantor of the security interest;
  • the grantor must have rights in the collateral or the power to transfer rights in the collateral to the lender; and
  • the grantor must either execute a security agreement providing a description of the collateral or, in the case of certain types of collateral, the lender must be in possession or control of the collateral.

To create and perfect a security interest in assets not governed by the UCC – real property, for example, which is subject to state-by-state rules for mortgages, and certain kinds of intellectual property – the parties will typically create a separate collateral document or mortgage pursuant to the applicable requirements of the law of the jurisdiction governing the property.

Perfection Requirements

Once an enforceable security interest has been created, lenders will need to perfect such security interest in order to “put the world on notice” and be able to enforce the security interest against other creditors and in bankruptcy proceedings. Article 9 of the UCC provides for four methods of perfecting security interests in personal property, including:

  • filing a financing statement (known as a UCC-1) in the appropriate jurisdiction, which includes the required description of the collateral;
  • possession, in the case of certain tangible assets;
  • establishing control, which may be effected by entry into control agreements in the case of deposit accounts, letter of credit rights, investment accounts and electronic chattel paper; and
  • automatic perfection, in the case of certain other personal property.

Timing and Cost Considerations

US loan documentation provides that minimum security interest creation and perfection requirements must be satisfied either at the closing of the financing or within a limited period following closing. Post-closing creation and perfection steps are generally limited to categories of collateral that require extended periods of time, including filing real property mortgages and negotiating account control agreements. Certain assets that cannot be perfected solely by the filing of a financing statement under Article 9 of the UCC and/or require separate documentation with respect to the creation of security interests therein, including real property or aircraft, will typically result in additional costs to be borne by the borrower. These can include the engagement of specialist counsel, including provision of legal opinions, or the payment of necessary filing or recording fees.

Article 9 of the UCC permits the granting of a floating lien in the form of an “all assets” pledge, which will include all personal property owned or later acquired by the grantor of the security interest, subject to any negotiated exclusions. As with other security interests in property governed by Article 9 of the UCC, floating liens are created when an enforceable security interest is perfected by the filing of a UCC-1 financing statement in the appropriate jurisdiction. While UCC-1 financing statements perfect on the floating lien by simply describing the collateral as “all assets”, lenders should take care to specifically describe the categories of collateral (including proceeds thereof) when creating the security interest in the security or pledge agreement in accordance with the requirements under Article 9 of the UCC. Importantly, the floating lien will only apply to personal property that is subject to the requirements of Article 9 of the UCC, as other assets – such as real property and federally registered copyrights – cannot be subject to a floating lien.

In the US, there are no general limitations or restrictions applicable to downstream, upstream or cross-stream guarantees other than the requirements applicable to guarantees generally. Because of the nature of cross- and upstream guarantees, lenders are always conscious of the risk of limitation or invalidation on grounds of fraudulent conveyance, which requires that the entity providing the upstream or cross-stream guarantee either receives adequate consideration for, or is solvent after giving effect to, the making of the guarantee. This is an inherently fact-based inquiry addressed by loan market participants by including “savings clauses” or other limitations on the amount of the guarantee obligation to ensure continued enforceability. Furthermore, lenders insist on drafting guaranty agreements to increase the chances of enforcement by, for example, requiring that the guarantees be “absolute and unconditional” (to avoid common law defenses), and not contingent upon commencing or exhausting remedies against the primary obligor. In certain regulated industries, such as a financing to acquire a registered broker-dealer, however, a guarantee by the broker-dealer or other regulated entity may be limited or precluded as a practical matter.

Additionally, certain considerations may apply in the context of upstream guarantees provided by a foreign subsidiary of a CFC US borrower. Prior to 2019, Section 956 of the Internal Revenue Code created adverse tax consequences for shareholders of a CFC when the CFC guaranteed or otherwise provided collateral to support debt of a US obligor. Following regulatory changes published by the US Treasury and Internal Revenue Service in 2019, however, Section 956 now permits US corporate borrowers to obtain credit support from CFCs without incurring additional tax liability, so long as certain conditions are met. However, despite the renewed ability for CFCs to provide credit support to US borrowers in certain circumstances, loan documentation continues to maintain customary Section 956 carve-outs in nearly all circumstances, excluding CFCs from the guarantee requirements and limiting pledges of first-tier subsidiary CFC equity interests to less than two-thirds of the voting stock. To the extent subsidiaries of a borrower are unable to provide guarantees or credit support, whether because of regulatory or tax issues or otherwise, lenders have traditionally relied solely upon the application of the restrictive covenants and events of default in the loan documentation to provide protection.

In the US, a target company is not generally prohibited from guaranteeing financing utilised to acquire its shares or granting a security interest in its assets, or from otherwise providing financial assistance for such acquisition financing. These guarantees and security interests, however, will be subject to review for fraudulent conveyance and may be subject to regulatory schemes that make providing a guarantee impracticable even if legal. Subject to such limitations, the provision of such guarantees and security interests is generally subject to negotiation between the borrower and the lenders providing financing to support the acquisition. Typically, lenders will require guarantees and security interests to be provided by the target company, along with delivery of the certificated securities of the target company, as a condition to the financing, with borrowers pushing to align the required target creation and perfection steps with the corresponding requirements of the target under the acquisition agreement.

The making of guarantees and the granting of security interests in assets by US entities are authorised by the entity’s board of directors, members or other governing body, in accordance with the business laws under its jurisdiction of formation. While these authorisations are typically obtained from a borrower’s subsidiaries through standardised corporate governance processes, some subsidiaries of the borrower – such as joint ventures and other non-wholly owned entities – may require additional consents from third parties. Once such consent is obtained, the provision of guarantees and the granting of security interests in collateral do not generally result in significant incremental costs. However, assets that require other consents, notices, filings or burdensome arrangements to perfect such security interests may impose a substantial burden on the borrower, which must be weighed against their value to the overall collateral package and the benefits derived to the lenders and so are often excluded from the collateral package.

Anti-assignment provisions in commercial contracts pose similarly difficult issues for lenders in secured financings. While certain statutory overrides of anti-assignment provisions in contracts are generally available under the UCC, if the restricted collateral is critical to the lender’s collateral package, lenders are likely to request consent from the third party as a condition to making the loan.

In the US, loan documentation typically authorises the administrative agent or collateral agent to acknowledge or confirm the release of the lenders' security interest at the sole cost of the borrower upon termination and payment in full of the obligations under the loan agreement. Additionally, agent(s) are generally pre-authorised to acknowledge or confirm the release of security interests in specific assets that are disposed of or guarantees of entities that are no longer subject to the guarantee requirements, in each case in transactions permitted under the loan documentation. Further action may be required by the agent(s) in order to evidence the termination of security interests that have been perfected, including the filing of UCC termination statements, terminating control agreements or executing other types of releases that may need to be recorded in the appropriate filing office.

Lenders are increasingly focused on unintended consequences of such provisions. For example, borrowers may rely upon exclusions from the guarantee requirements to release a guarantor that no longer constitutes a wholly-owned domestic subsidiary. Furthermore, borrowers have previously relied upon “trap-doors” in investment covenants to move valuable assets from guarantors to non-guarantor entities, automatically releasing security interests in the process.

Priority of Conflicting Security Interests

The priority of security interests of different creditors in the same assets of a borrower is generally determined by the UCC of the applicable jurisdiction and is subject to the following rules:

  • a perfected security interest has priority over a conflicting unperfected security interest;
  • conflicting perfected security interests rank in priority according to the time of filing or perfection; and
  • conflicting unperfected security interests rank in priority according to the time of when the security interest attached or became effective.

In addition, the UCC allows certain categories of collateral to be perfected by multiple methods, with priority determined based on the “preferred” method regardless of the rules set forth above. For example, with respect to investment property, securities accounts and certificated securities perfection via “control” or possession generally has priority over perfection by “filing” UCC-1 financing statements.


Lenders and borrowers may agree to structure a financing to provide for payment subordination or lien subordination, which can be accomplished contractually, structurally or both.

Where lenders agree to contractually subordinate the repayment of their loans or the priority of their liens, such subordination is typically accomplished through a subordination agreement or intercreditor agreement among the separate creditor groups. These written contractual arrangements define the relative rights of the senior creditors and junior creditors in the shared collateral and/or with respect to the priority of payments made by the borrower. Lien subordination arrangements will typically provide, among other things, that junior creditors are subject to a “standstill” period prior to exercising any enforcement rights or remedies with respect to the collateral, to allow for senior creditors to first and fully exercise such rights and remedies, and that payments received by junior creditors in violation of the agreement will be held in trust and turned over to senior creditors, limiting specified amendments to both senior- and junior-priority loan documents.

Structural subordination arises where obligations incurred or guaranteed solely by a company are effectively junior to obligations incurred by a subsidiary of the company, to the extent of that subsidiary’s assets. As the obligations incurred by the subsidiary are direct obligations of such entity, creditors of the subsidiary will be repaid by such subsidiary (or out of its assets) before creditors of the company, such subsidiary’s equityholder, in any insolvency scenario. Of course, the effect of this arrangement will depend on the relative asset value of the different obligors, but where the parent company is merely a “holding company” for the equity interests of its operating subsidiaries, creditors of an operating subsidiary will necessary be paid in priority to creditors of the holding company from such assets.

Section 510 of the Bankruptcy Code provides that subordination agreements are enforceable in a bankruptcy case to the extent such agreements are enforceable under applicable non-bankruptcy law.

In general, loan documentation provides for certain rights and remedies exercisable by the agent(s), acting on behalf of the lenders, following the occurrence and continuation of “events of default”. Typically, events of default include a change of control of the borrower, failure to make timely payments when due, misrepresentations, defaults under affirmative and negative covenants (either immediately or following a specified grace period), and the commencement of an insolvency or bankruptcy proceeding with respect to the borrower and certain subsidiaries. Upon an event of default, an agent may exercise the rights and remedies available to it under the loan documents, or may be directed to do so by a majority of the lenders. Alternatively, lenders may decide to continue working with the borrower to address the cause of the underlying event of default and either waive the event of default or enter into a forbearance agreement, thereby agreeing not to exercise its default remedies for a specified period of time, subject to compliance with specified conditions.

Article 9 of the UCC provides a secured party with several remedies following an event of default giving rise to enforcement rights, including the right to collect payments directly from the obligor under certain types of intangible assets collateral, including accounts receivable and deposit accounts, and the right to repossess collateral, either through judicial proceedings or non-judicially and further dispose of the collateral through either a public or private sale.

In order to exercise the remedies available to lenders under Article 9 of the UCC, lenders must comply with certain requirements intended to protect the borrower, primarily that the time, place and manner of any such remedy be commercially reasonable, including, in connection with a public sale, providing sufficient advance notification of the sale to the debtor and certain other creditors. Notably, an obligor filing for protection under the US Bankruptcy Code will result in an automatic stay of most remedies against collateral (with significant exceptions for securities contracts, derivatives and other specific categories of assets), such that the resolution of secured claims against corporate debtors will, as a practical matter, most typically occur through the bankruptcy claims process, rather than the direct exercise of contractual and common law foreclosure or other enforcement of remedies.

New York courts generally permit parties to select foreign law as the governing law of a loan agreement, but may decline to enforce a governing law clause if the law selected has no substantial relationship to the parties or the transaction, if there is no reasonable basis for the parties’ choice of law, or if the provision is contrary to a fundamental policy.

New York’s conflict of laws rules uphold foreign forum selection clauses, so long as the jurisdiction chosen has a reasonable relationship to the transaction – ie, a significant portion of the negotiating or performance of the underlying agreement is to occur or occurs in such jurisdiction.

Additionally, in cases involving a foreign state, the Foreign Sovereign Immunites Act permits a waiver of immunity either explicitly or by implication.

New York courts generally recognise and enforce a foreign judgment, subject to certain conditions, including due process and reciprocity. Despite the adoption of uniform laws among many states, a significant amount of diversity exists within the US in connection with both the procedure and substance relating to the recognition and enforcement of foreign judgments. Under federal common law, courts generally rely upon the principles of international comity set forth in Hilton v. Guyot with respect to the recognition and enforcement of foreign judgments.

The above answers only provide a general guideline to the relevant landscape, and does not contemplate all possible matters that are relevant to a particular financing (or even to financings generally), which are facts and circumstances specific.

As a company becomes distressed and at risk of insolvency, management may seek to reorganise the capital structure in an attempt to restore the business as a viable going concern. Prior to filing a petition for relief under Title 11 of the United States Code (the “Bankruptcy Code”), the company may attempt this reorganisation with its creditors non-judicially and in a consensual manner. This is typically referred to as an “out-of-court restructuring”.

Companies will typically prefer an out-of-court restructuring as a way to expeditiously address their capital structure problems in a cost-effective manner without the complications inherent in dealing with a bankruptcy court. Additionally, out-of-court restructurings tend to be completed more discreetly and out of view of employees, suppliers and other counterparties and stakeholders, as opposed to the scrutiny that may result from a public bankruptcy process.

Out-of-court restructurings can take many forms and are highly dependent on the structure of a company’s debts, the threshold lender consent requirements needed to effect changes to each piece of the structure under the applicable documents, and the willingness of creditors to agree to those changes. These reorganisations can include maturity extensions, debt-for-debt exchanges, debt-for-equity exchange offers or simply waivers of covenants.

Due to the need to obtain broad creditor support to implement material out-of-court restructurings, a company may find it difficult to obtain the agreement of all lender groups and thus may have to settle for only targeted changes to certain levels of its debt. Furthermore, material changes to the terms of any debt, including extending the maturity date or reducing the principal, will typically require the consent of all lenders holding the debt or all holders affected by the change. This issue is particularly acute where a company’s loans or bonds are broadly syndicated and therefore held by many entities with potentially divergent interests, creating a “holdout” problem.

However, a company’s debt documents occasionally provide flexibility to modify certain terms in an adverse manner and with less than 100% consent which, when combined with an exchange offer or similar refinancing transaction, can be used to coercively initiate transactions and push holdout lenders into a reorganised structure. This is most prominently seen in the high-yield bond market with the utilisation of exit consents in combination with exchange offers, in which the company invites bondholders to exchange existing bonds for new bonds issued with a lower principal amount (or other structural change) but a higher priority claim or otherwise enhanced other terms and, in return, the exchanging bondholders agree to amend the existing notes to adversely affect the terms applicable to non-participating holders by way of “covenant-stripping”. This creates an incentive for the bondholders to exchange their notes so as not to be left holding the existing bonds that are now devoid of meaningful covenant protections.

Even if a bankruptcy filing is unavoidable, a company may still decide to lay a foundation for its in-court restructuring by negotiating a restructuring support agreement prior to the filing, in which the company and creditors agree to the plan of reorganisation that will be presented to the bankruptcy court and which will take effect once the company enters Chapter 11 bankruptcy. This “prepackaged” or “prearranged” bankruptcy plan is intended to shorten and simplify the bankruptcy proceeding.

Whether a bankruptcy is voluntary or involuntary, the filing of a petition for relief under any chapter of the Bankruptcy Code will immediately result in an injunction referred to as an “automatic stay”, without needing further action by the bankruptcy court. The automatic stay prevents lenders from enforcing or perfecting their prepetition liens or guarantees, foreclosing on collateral, enforcing any prepetition judgments and terminating contracts following prepetition defaults, among other things. The automatic stay is intended to preserve the going-concern value of the business by addressing the collective action problem of creditors taking unilateral enforcement action to preserve their own investment to the detriment of other creditors (sometimes referred to as the “race to the courthouse”).

The bankruptcy court may grant creditors relief from the automatic stay, under certain circumstances. One basis for relief is “for cause”, which can include mismanagement, failure to preserve collateral or a lack of “adequate protection” of such lender’s interest in the collateral. “Adequate protection” refers to steps taken by the company to protect the secured creditor against diminution in the value of their collateral during the pendency of the bankruptcy proceeding. If a creditor is entitled to adequate protection and the company is unwilling or unable to provide it, then the bankruptcy court can grant the creditor relief from the automatic stay to seize its collateral. Furthermore, a creditor may seek relief where the company does not have “equity” in certain collateral (ie, the value of the collateral does not exceed the amount of loans secured by such collateral) and such collateral is not necessary to an effective reorganisation.

The Bankruptcy Code requires any liquidation or reorganisation plan to be “fair and equitable”; therefore, senior creditors must be paid in full or accept the plan prior to any payments made to junior creditors, and equity holders may only receive assets or payments after all creditors are paid in full. This hierarchy is commonly referred to as the “absolute priority rule”. The value of collateral securing creditor claims is distributed in accordance with the relative priority of the relevant lienholders, while unencumbered value is distributed to unsecured creditors in accordance with their statutory priority.

The Bankruptcy Code permits the court to subordinate all or a portion of a creditor’s allowed claim to all or a portion of another creditor’s allowed claim in order to remedy misconduct by the subordinated creditor.

Equitable subordination can only be granted if:

  • the claimant engaged in inequitable conduct;
  • the conduct injured other creditors or conferred an unfair advantage on the claimant; and
  • it is not contrary to the principles of the Bankruptcy Code.

While “inequitable conduct” is not defined in the Bankruptcy Code, it is typically considered to include fraud, breach of fiduciary duties and illegality. Additionally, insiders and fiduciaries are usually held to a higher standard in determining inequitable conduct. Equitable subordination is rarely granted by the court, and is considered to be an extraordinary remedy.

Lenders face several risks when a borrower, security provider or guarantor becomes insolvent, including the use and dissipation of its cash collateral, fraudulent conveyance risk, preference risk and subordination to debtor-in-possession financing.

Use of Cash Collateral

During a Chapter 11 bankruptcy proceeding, the court may permit a company or bankruptcy trustee to use cash collateral in order to continue operating the business, over a secured lender’s objection, only if “adequate protection” is provided to protect against the value of the lender’s security interest declining. Adequate protection may be accomplished in a variety of ways, including in the form of replacement liens or cash payments. In practice, debtors typically negotiate the terms of a consensual stipulation with creditors holding liens on their cash, allowing for continued use of the cash, and rarely seek permission to use cash collateral over the objection of the lienholder(s).

Fraudulent Conveyance

The Bankruptcy Code grants the company or bankruptcy trustee the power to “avoid” certain prior transfers that constituted fraudulent conveyances in order to recover assets for the estate. A fraudulent conveyance occurs where the company received less than reasonably equivalent value in exchange for a transfer or obligation and, either before or after the transfer the company was insolvent, had unreasonably small capital or believed it would incur debts beyond its ability to repay. This concern is generally heightened in leveraged buyout transactions, where courts may deem the “transfer” to a lender of its collateral or the incurrence of the debtor’s obligation to repay the debt incurred to fund the transaction voided as a fraudulent conveyance.

Preference Risk

Generally, the company or bankruptcy trustee may recover certain “preference” payments made to lenders within the 90 days immediately prior to the company filing for bankruptcy (or one year for insiders). Lenders may be able to avoid this preference risk where such payments are intended to be in exchange for new value provided to the company or are in the ordinary course of business. Lenders will seek to address preference risk in loan agreements by requiring that additional junior debt incurred by the company does not mature earlier than 91 days following the maturity of such lender’s loans.

DIP Financing

A company will occasionally require financing shortly after filing for bankruptcy under Chapter 11 to fund its operations during the bankruptcy. In these cases, the company or bankruptcy trustee can seek the bankruptcy court's approval to incur debt, which may include “priming” liens that can be senior to the liens securing debt outstanding prior to the bankruptcy. Such financing is referred to as debtor-in-possession or DIP financing, and may be approved over the objection of the existing lenders if, after notice and hearing, the company is otherwise unable to obtain financing and the existing lenders’ liens are adequately protected – ie, they are compensated by any harm suffered by virtue of the priming.

There is a long history in the United States of natural resources and infrastructure projects being developed and financed through classical and innovative project finance techniques. Fundamental to a successful project financing is the allocation of risks through a robust contractual framework – for both the commercial arrangements (such as for construction, raw material supply and product offtake) and the financial arrangements (including enforcement of the security package). Both domestic and foreign participants can have confidence that, in the United States, arrangements clearly written down in contracts will be upheld by the courts in a consistent manner without undue delay, especially where the parties elect New York law as the governing law for their contractual arrangements. This is due to its popularity resulting in a large amount of case law precedent producing more certainly regarding the outcome of a dispute.

Trends that point to a continuing lively amount of activity utilising project finance techniques include the surplus of natural gas that has developed rapidly over recent years through the shale gas revolution – leading to the aggressive construction of liquefied natural gas (“LNG”) plants for product export. Another equally relevant trend is the pressure from climate change concerns to produce cleaner energy, less dependent on coal. More activity in the renewable energy (solar and wind) sector and in both new and conversion projects to construct natural gas fired power plants is expected. The natural gas revolution is also driving a need for a more extensive gas pipeline network across the country.

8.2 Overview of Public-private Partnership Transactions below mentions the President’s Initiative for Rebuilding Infrastructure, highlighting an obvious need at all governmental levels for dealing with antiquated and deteriorating ports, airports, roads, local and long distance rail networks and bridges. There are several current projects in progress in these sectors, and significant additional activity is expected, involving private and public co-operation where possible.

The public-private partnership (“PPP”) is often cited by politicians and business interests alike as a model for a way forward for increased infrastructure improvement and other projects in the United States. Despite the appeal of the idea, practice has not coalesced around a single paradigm for allocating risk, reward and responsibility among the private and public participants. Some states have undertaken large projects, but the practice is largely state-by-state and specific to the particular project, with no significant guidance through a centralised, federal agency. As a result, transaction costs and challenges can be higher than anticipated, and the promise of PPP as a way to effect important improvements to roads, bridges, public transportation systems and airports (among other public projects) has perhaps been under-realised. Large programmes are often discussed at the federal level – most recently the President’s Initiative for Rebuilding Infrastructure in America proposed in 2018 by the Trump Administration, with the goal of stimulating USD1.5 trillion in infrastructure – but so far without the level of specificity that suggests a single structure. However, given the bipartisan attractiveness of the idea of a federal policy supporting infrastructure projects and an umbrella initiative to do so, this could change quickly.

The need for regulatory and governmental approval for a project, including the related financing, will depend on the nature of the project itself, and is not specific to the nature of the financing involved. For example, an energy project may require approval or at least be subject to the jurisdiction of the Federal Energy Regulatory Commission. Sponsors and financing parties must also look to the applicable state and local law requirements.

As a general matter, US projects in the oil and gas, power and mining sectors seeking financing from banks and other financing sources will need to be able to demonstrate ongoing compliance with federal, state and municipal zoning, building and construction codes, occupational health and safety regulations and environmental requirements.

The generation, transmission and distribution of electric power in the United States is subject to extensive regulation at both the federal and state level.

The US wholesale electricity market consists of multiple distinct regional markets that are subject to federal regulation, as implemented by the Federal Energy Regulatory Commission (“FERC”), and regional regulation, as defined by rules designed and implemented by Regional Transmission Organizations (non-profit corporations that operate the regional transmission grid and maintain organised markets for electricity). These rules, for the most part, govern such items as the determination of the market mechanism for setting the system marginal price for energy and the establishment of guidelines and incentives for the addition of new capacity.

Retail electricity markets are regulated at the state level. In exchange for the right to sell or distribute electricity directly to end-users in a service territory, utility businesses are subject to government regulation at the state level by public utility commissions, which sets the framework for the prices (“tariffs”) that utilities are allowed to charge customers for electricity to earn a regulated return on assets, and establishes service standards that they are required to meet, the issuance of long-term securities by the utility, and certain other matters.

The siting, design, construction and operation of natural gas and appurtenant facilities, the export of LNG and the transportation of natural gas are subject to extensive regulation under federal, state and local statutes, rules, regulations and laws. Approval from FERC, acting under the authority of the Natural Gas Act of 1938 and other statutes, must be obtained in order to construct, own, operate and maintain the LNG facilities, terminals and interstate pipelines. Retail delivery of natural gas is subject to local regulation.

Foreign sponsors of projects in the United States also need to be aware of the jurisdiction of CFIUS (the Committee on Foreign Investment in the US), which is authorised to review certain transactions involving foreign investment in the US in order to determine their effect on national security. The Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”) is aimed at strengthening and modernising CFIUS, and became law on 13 August 2019. It expands the scope of covered transactions to include:

  • the purchase, lease or concession by or to a foreign person of real estate located in proximity to sensitive government facilities;
  • “other investments” in certain US businesses that afford a foreign person access to material non-public technical information in the possession of the US business;
  • any change in a foreign investor’s rights resulting in foreign control of a US business or “other investment” in certain US businesses; and
  • any other transaction designed to circumvent CFIUS jurisdiction.

Please see Chambers Global Practice Guide: Project Finance 2019 for a discussion of the issues relevant to structuring a project finance transaction.

As above, given the complexity of this topic, an interested reader is advised to consult Chambers Global Practice Guide: Project Finance 2019.

Issues affecting the acquisition and export of natural resources are of growing importance as the US is expected to become a net exporter of energy by 2020, with the production of crude oil, natural gas and natural gas plant liquids outstripping the growth in US energy consumption. Exports of natural resources generally may be subject to general or specific economic sanction regimes. In addition, approvals from the Department of Energy are required for the export of domestically produced LNG.

Projects in the United States are subject to the US Clean Air Act, the US Clean Water Act and various other federal, state and local laws and regulations enforced by the US Environmental Protection Agency and comparable state and local governmental bodies relating to the following, among other matters:

  • the protection of the environment and natural resources;
  • the generation, storage, handling, use, treatment, disposal and transportation of hazardous materials;
  • the emission and discharge of hazardous materials into the ground, air or water, including greenhouse gases;
  • the use of water;
  • habitat protection, wetlands preservation and coastal zone management;
  • remediation of contamination;
  • waste disposal;
  • endangered species, historic property, antiquities and cultural preservation; and
  • noise regulation.

It should be noted that, although not a legal requirement, it is an internal requirement of most banks that projects being financed by them comply with the Equator Principles.

Projects will also be subject to a number of federal and state laws and regulations, including the federal Occupational Safety and Health Act, and comparable state statutes, whose purpose is to protect the health and safety of workers. Projects will be required to develop an internal safety, health and security programme designed to monitor and enforce compliance with worker safety requirements, and to routinely review and consider improvements to such programmes.

The nature and extent of the regulation will depend on the location and industry sector.

There are no US laws specifically addressing Islamic finance; financial institutions offering Islamic finance products are subject to the same laws and regulations as those offering more conventional instruments. Financial institutions offering Shari'a-compliant products typically have a Shari'a supervisory board, whose purpose is to review and approve practices and activities to ensure compliance with Islamic principles. The standardisation of Islamic finance regulations and laws is of increasing interest across global markets, in part because Shari'a law is open to interpretation and Islamic scholars are not in complete agreement with respect to its application to loans and other financings.

Some states, including New York and Illinois, have adopted legislation aimed to encourage Islamic finance transactions.

The regulatory and tax framework applicable to Shari’a-compliant products is the same as that applicable to more conventional instruments.

The OCC has issued formal guidance regarding Islamic-related financing products, specifically concerning Shari'a-compliant mortgage products. In 1997, the OCC issued guidance regarding “leases”, and recognised “cost-plus” financings under Shari'a law in 1999.

The manner in which the claims of sukuk holders would be treated in US insolvency or restructuring proceedings remains largely untested.

There have not been any recent notable cases in the US regarding Islamic finance.

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Davis Polk & Wardwell LLP represents private equity sponsors, borrowers, banks and other lenders across a broad spectrum of corporate finance transactions, including leveraged and investment-grade acquisition financings, middle market and direct lending financings, oil and gas financings and restructurings, and debtor-in-possession and exit financings, among others. The finance practice includes 18 partners in New York and London, each of whom has extensive experience in representing financial institutions and corporations in bespoke and ground-breaking financing transactions. With locations in New York, Europe, Asia and Latin America, the practice is well equipped to handle the most complex domestic and international transactions.