Loan Portfolio Sales - Legal Due Diligence Process for Buyers

The ByrneWallace Banking and Finance team has extensive experience in managing and advising on large portfolio disposals and acquisitions. This article sets out key points for purchasers/bidders to consider in relation to the legal due diligence process. 

The legal due diligence process is an integral part of the loan portfolio acquisition process. It assists the prospective buyer (the “Bidder”) with its assessment of (i) the value of the portfolio and (ii) the optimal method for transferring the economic value of the portfolio to the Bidder. 

Confidentiality Agreement

Prior to starting the legal due diligence, a Bidder will typically be required by the seller to enter into a confidentiality agreement. This is typically a standard document with limited leeway for negotiation. However, some of the key issues that the Bidder should consider include: the duration of the confidentiality undertaking, the restrictions on the permitted use of the information made available by the seller, whether the confidential information can be shared with its legal and financial advisers, the scope of the confidential information and whether there are any indemnities required.

Process Letter

Typically, the seller or its agents will issue a “process letter” to a prospective Bidder detailing the envisaged road map to a sale of the portfolio. This will stipulate the timelines and phases for the bid process, the operation of a virtual data room and the transfer mechanics. It should stipulate the content and form of any offer to be made by the Bidder. It will often provide the form of loan sale agreement. 

Approach to Legal Due Diligence  

A Bidder will then need to consider the level of legal due diligence that is required and feasible to achieve its objectives within usually tight timescales. The approach chosen by a Bidder is usually based on a cost benefit analysis considering certain factors such as the volume of the loans to be acquired, whether the entire (or part only) portfolio must be acquired, the extent of information made available by the seller on its data site, whether a legal due diligence report has been prepared by the seller and made available (on a non-reliance basis) and the nature of loans. For example, a legal due diligence of consumer loans could involve reviewing template terms and conditions together with a limited sample of loans and security, whereas for corporate loans (where the documents are more highly negotiated), the legal due diligence could involve conducting a detailed review of a sample of the top 50 loans (based on facility amounts) and related security and perhaps, a small sample of the lower value loans. 

ByrneWallace can advise on appropriate review templates depending on the Bidder’s requirements and the ultimate strategy and aim of the Bidder (for example, a loan-to-own purchaser will have different concerns than a purchaser that intends to be involved in more traditional lending).  

Where a limited legal due diligence of sample loans is conducted, we would recommend that satisfactory representations and warranties are included in the loan sale agreement to cover all of the loans and security. In addition, financial and commercial information in respect of all the borrowers in the entire portfolio should be obtained from the seller (assuming that the entire portfolio is being acquired) regardless of whether the legal due diligence covers sample loans only.

Covid-19, Brexit, Default by the Borrower and Enforcement Considerations  

The uncertainty generated by Covid-19 pandemic and Brexit will, of course, present challenges in relation to the valuation of a portfolio and the expected financial performance of the borrowers. In the current climate, therefore, Bidders (and their lawyers) undertaking a legal due diligence should conduct the reviews in the likelihood that a default under the loan agreement has or will occur and that enforcement of security and guarantees may be necessary. 

The seller should make a full disclosure of any defaults, waivers, amendments and extensions requested by the borrower (whether accepted or not by the lenders) and confirm whether there have been any changes to, or waivers in respect of, the financial covenants as a result of the Covid-19 pandemic or otherwise. Disclosure should also be made by the seller if it has started insolvency proceedings against a borrower in the portfolio.   

Furthermore, if the loan is a syndicated loan, the Bidder should be clear about its voting rights within the lender group, in particular in relation to amendments, waivers and enforcement. In addition, the Bidder will need to evaluate whether it would be acquiring obligations in relation to undrawn facilities (for example, for working capital requirements during the Covid-19 pandemic or in the unlikely event that the documentation does not contain a drawstop).  

Transfers/Assignments

Lawyers for the Bidder will also need to ascertain from the outset whether there are restrictions on the transfer of the loans and security, for example, a borrower may have consent or notification rights, or there may be white lists (i.e. approved lenders to which a lender can transfer its interests without borrower consent) and black lists (i.e. select institutions to which a loan cannot be transferred).  

Security Package – Risk Analysis

It is crucial for the loans to be secured by a robust and enforceable security package. Typically, as part of any due diligence, lawyers for the Bidder will identify material risks where, for example, a seller’s security may not be valid or perfected, or a lender or security holder may need to remediate the security position. If the security package includes security over real estate assets, title reviews may also be required to be undertaken (depending on the Bidder’s ultimate strategy). 

Foreign Assets

Where the secured assets are located in a foreign jurisdiction (different from the jurisdiction of incorporation of the borrower or security provider or the governing law of the loan agreement), this could present issues in respect of the transfer and enforcement of security. In addition, an understanding of the risks of insolvency processes in different relevant jurisdictions may be necessary since insolvency processes are not uniform. 

Subordinated Creditors / Inter Creditor relations

Where a Bidder is acquiring senior debt, it is also important that the lawyers for the Bidder conduct a thorough analysis of any intercreditor arrangements in place with subordinated creditors. The Bidders should request information on the existing working relationship with those subordinated creditors.  For example, subordinated creditors may have consent rights, or standstills may apply to the senior lenders, prior to the enforcement by the senior lenders of the security. The subordinated creditors may also have the right to buy out the senior debt.   

In short, there could be multiple issues which could render security defective or unenforceable or delay enforcement of the security and which the Bidder should take into consideration as part of its overall valuation of the portfolio.  

Loan Sale Agreement and Transfer Documentation  

This article does not propose to cover the negotiation of the loan sale agreement and the transfer mechanisms but the lawyers for the Bidder will, of course, typically guide the Bidder through these other aspects of the loan sale acquisition process also.   

0

For further information, please contact Mark Kavanagh or Triona Ryan from the ByrneWallace Banking and Finance team, or your usual ByrneWallace contact.