Asset-Level Eligibility Series: “Eligible to be Sold” & Transferability Restrictions

This Legal Update explores why, in order for an underlying loan to be included in a warehouse facility’s borrowing base, the underlying loan must be eligible to be sold and transferred to the facility’s SPV borrower, the grant of a security interest in the underlying loan in favor of the facility’s agent must be permitted, and any transfer to the facility’s agent (or a third-party buyer) resulting from a foreclosure must be permitted.

Examples of Eligibility Criteria – “Eligible to be Sold” & Transferability Restrictions:

• Such Collateral Obligation is capable of being transferred to and owned by the Borrower (whether directly or by means of a security entitlement) and of being pledged, assigned or novated by the owner thereof or of an interest therein, subject to customary qualifications for instruments similar to such Collateral Obligation (i) to the Facility Agent; (ii) to any assignee of the Facility Agent permitted or contemplated under this Agreement; (iii) to any Person at any foreclosure or strict foreclosure sale or other disposition initiated by a secured creditor in furtherance of its security interest; and (iv) to commercial banks, financial institutions, offshore and other funds (in each case, including transfer permitted by operation of the UCC).
• Such Loan is eligible under its Underlying Instruments (giving effect to the provisions of UCC §§9‑406 and 9‑408) to be sold to the Borrower and to have a security interest therein granted to the Administrative Agent, as agent for the Secured Parties.

What are Lender Assignments and How Might Restrictions on Sale/Assignability Arise?

A lender assignment involves an assignor lender selling and assigning some or all of its interests in a credit facility, including its related rights and obligations, to an assignee lender, which purchases and assumes those rights and obligations and becomes a party to the facility. The assignor is released from its obligations and exits the facility, unless the assignment pertains to only a portion of the assignor’s interest.

I.    Contractual Restrictions Under Loan Documentation

Standard credit facility documentation includes assignment and participation provisions. They govern a lender’s ability to assign or sell its interest in its loans or commitments and set certain conditions with respect thereto. A key tension underlying negotiation of these provisions is balancing a lender’s wish to maximize the pool of potential assignees against a borrower’s desire to control who may gain access to its non-public information and the identity of its lending partners.

Typical assignment limitations in a loan agreement pertain to the assignee’s identity (e.g., whether (1) it is an “Eligible Assignee” or “Approved Fund,” and (2) it falls into any category of prohibited assignees, such as natural persons, affiliates of the borrower, or a defaulting lender), whose consent is required (e.g., the administrative agent’s and, under certain circumstances, the borrower’s), minimum amounts for the assignment, and delivery of specified assignment documentation. A borrower may also negotiate restrictions on assignments to “Disqualified Institutions” or “Competitors.” It is possible a warehouse lender may fall into one of those categories (although competitor restrictions can be highly negotiated and vary on a deal-by-deal basis).

II.  Uniform Commercial Code (UCC) Treatment of Anti-Assignment Provisions

Article 9 of the UCC governs secured transactions, including warehouse facilities. It provides a framework for how creditors can take a security interest in a debtor’s personal property, perfect that interest and, if the debtor defaults, ultimately enforce that interest. It also applies to a sale of certain types of payment rights, including “payment intangibles” (such as a right to receive payments on a loan asset) and promissory notes.¹

Article 9 promotes a strong public policy favoring free assignability of contractual rights. To facilitate assignments of certain types of property (including payment intangibles and promissory notes) in connection with secured transactions, UCC §§9-406 and 9-408 provide rules that, under specified circumstances, override anti-assignment clauses under certain laws or a contract. Determining whether §9-406 or §9-408 applies requires first identifying the type of collateral, transaction (i.e., whether the assignment takes the form of a grant of a security interest or an outright sale), and transfer restriction (i.e., statutory or contractual).

Of focus here is §9-406(d). It applies to a security interest in, but not a sale of,² payment intangibles and promissory notes and covers contractual assignment restrictions (but not restrictions imposed by law). Under §9-406(d), notwithstanding assignment restrictions in a contract between an account debtor and a payee (e.g., in the context of a warehouse facility, a loan agreement between a borrower on an underlying loan asset and the facility’s borrower, respectively), a payee on a payment intangible (such as loan receivables) may freely assign the obligations. The effect of §9-406(d) is to invalidate the contract’s anti-assignment provisions and render any default that arises under the contract from a breach of its anti-assignment provisions ineffective.

What Sales or Transfers May Warehouse Facilities Involve?

There are two types of assignments and transfers that may arise in the context of a warehouse facility:

• Transfer to SPV Borrower: Typically, in connection with establishing a warehouse facility, a private credit fund will sell and transfer a portion of its loan portfolio to a newly created special purpose vehicle (SPV), which is the borrower under the facility. Assignability provisions in a loan agreement often permit assignments to a lender’s affiliates without requiring consent from the administrative agent or borrower, thereby streamlining the process of validly transferring the private credit fund’s loan assets to its affiliate, the SPV borrower.
• Foreclosure Transfer:The SPV borrower grants a security interest in its loan portfolio to the warehouse facility’s administrative agent as collateral. If the warehouse facility experiences an event of default and the secured parties exercise remedies, this pledge positions the administrative agent (or a buyer at a foreclosure sale) to become an assignee and take over the pledged loan assets from the SPV borrower.

It is important that the loan documentation for an underlying loan permit both types of transfers, including the related grant of a security interest to the warehouse facility’s administrative agent. Both the warehouse borrower (which is itself a lender on the underlying loan assets) and warehouse lender must be aware of any assignability restrictions that govern the underlying loan portfolio, in order to ensure they comply with the relevant requirements (the exact makeup of which can differ on a loan-by-loan basis). The same assignability requirements will govern both types of transfers.

Why Do Warehouse Lenders Care if the Borrowing Base Includes Loans That Are Not “Eligible to be Sold” or Transferrable?

Compliance with a loan’s sale and transferability restrictions is important for both types of warehouse facility transfers mentioned above (and, often, for the same reasons). UCC §9-406(d)’s treatment of contractual anti-assignment provisions would apply to an assignment of the payment stream owed to a private credit fund on its loan portfolio, but it would not apply to the fund’s full interest in the underlying loans. Thus, while a warehouse borrower’s and lender’s right to receive loan receivables from the SPV borrower’s loan portfolio should be protected by UCC §9-406(d) (even if an underlying loan’s contractual assignment restrictions are not complied with), an assignment of other rights pertaining to the loan portfolio would not be protected by this section of the UCC. Accordingly, in order to receive the full benefit of an intended assignment, it is important to be aware of potential repercussions of an invalid assignment.

A valid assignment is crucial to provide clear legal standing for the assignee, so that it can enforce the loan asset’s terms and receive payments without delay or challenges to its ownership of the loan asset. It should also provide clarity to the underlying borrower and administrative agent about to whom payments on the loan asset should be made. These results are crucial for an SPV borrower to receive the loan proceeds that will service the warehouse facility on a timely basis. Similarly, it is important for a warehouse lender, if it forecloses on the collateral, to constitute a valid assignee on a loan asset, so that it can efficiently and effectively establish its right to receive cash flows from the underlying loan and be repaid and otherwise exercise rights on the loan asset.

In addition, a loan agreement may stipulate potentially severe, concrete consequences to an invalid assignment that both a warehouse borrower and lender want to avoid. Common remedies under a loan agreement (including in the LSTA’s model credit agreement provisions) for a breach of its assignment provisions are to allow the borrower to remove the assignee by terminating its commitments and repaying outstanding obligations owed to it or by forcing the assignee to assign to an entity that satisfies the eligibility requirements for assignments (i.e., a “yank-a-bank” provision). Moreover, invalid assignees may be prohibited from receiving information provided by the borrower to its lenders and may be barred from attending lender meetings and exercising voting rights. It is also possible that the parties may negotiate other repercussions for an invalid assignment (e.g., that it is void ab initio).

Thus, if a loan asset is invalidly assigned to an SPV borrower and/or a warehouse lender (or foreclosure buyer), these consequences could meaningfully cut against the value of the underlying loan as collateral for the warehouse facility. Also, it is worth noting that a warehouse facility is usually non-recourse to the private credit fund. So, if the SPV borrower’s loan portfolio fails to repay the warehouse lenders in full in an enforcement scenario (whether due to challenges or delays over an assignment’s validity or for other reasons), the warehouse lenders cannot pursue the fund to make up the deficiency.

Conclusion

Significant consequences for both assignor and assignee may result from a violation of a loan agreement’s assignability provisions, including reputational damage, potential liability/claims, and challenges to the validity of the assignment and assignee’s legal ownership of the loan asset. In turn, there may be delays or other problems for the assignee’s receipt of payments from the loan asset and exercise of its other rights (such as access to the borrower’s confidential information, voting rights, etc.). A loan agreement may also provide a borrower with the right to yank an invalid assignee from the facility or otherwise repay its outstanding obligations early.

The same assignability restrictions apply to both types of transfers involved in a warehouse facility (i.e., a transfer of a loan asset from a private credit fund to an SPV borrower and, in a foreclosure scenario, a transfer to the facility’s administrative agent or a foreclosure buyer). To protect the value of the loan asset, ensure orderly payments on the loan asset, and ease enforcement mechanics, a typical borrowing base eligibility criterion for a warehouse facility is a requirement for the underlying loan’s documentation to permit the sale or transfer of the loan asset to the SPV borrower, the pledge thereof to the facility’s administrative agent, and a foreclosure on the loan asset by the administrative agent (or a foreclosure buyer).

¹ This Legal Update’s coverage of the UCC is limited to its treatment of payment intangibles and promissory notes.

² UCC §9-406(e).