Reflections on International Asset-Based Lending
Enforcement [of an obligation in the Sultanate of Brunei] is possible in theory but may well be impossible in practice. In Brunei it is also relevant to know who the individuals are who are involved in the [obligor company] whether they are well placed in government or members of the Brunei Royal Family. Recovery may be impossible against such companies. Excerpt from advisory letter of Brunei counsel
Although some U.S. asset-based lenders have been active in other countries for years, most prefer to confine themselves to purely domestic transactions loans in which the borrower, the collateral and the guarantors are all located in the United States and the loan proceeds are used in the United States.
In fact, when presented with a transaction that has international elements, U.S. asset-based lenders generally will try to "domesticate" it. Foreign receivables will be classified as ineligible unless fully backed by letters of credit, inventory located outside of the continental United States will be deemed ineligible, and other foreign assets that could be taken as collateral often will be ignored completely.
But today, as a result of the rapid globalization of U.S. business, U.S. asset-based lenders are being asked with increasing regularity to make loans in which international elements play a key role. It may be contemplated that foreign collateral will be part of the primary security or that a portion of the loan proceeds will be used as working capital by a foreign affiliate or for the acquisition of a foreign operation.
In many cases, the loans will be made in U.S. dollars to a U.S. borrower, which will in turn make funds available to its foreign affiliate by way of intercompany loans or capital contributions. However, in other cases lenders are being asked to make loans directly to the foreign affiliates and in currencies other than the U.S. dollar.
Interestingly, the borrowers in these transactions are often middle-market U.S. companies. International finance is no longer the sole province of giant multi-national corporations. With the evolution of the Single European Market and the emergence of Eastern Europe as a potential marketplace, there is every reason to believe that the need for international asset-based lending will escalate. As the needs of American business become more international, it seems both natural and inevitable that asset-based lending, which traditionally has been the mainstay of America business, will evolve to meet those needs.
This trend poses an interesting challenge for U.S. asset-based lenders. If they reject the challenge, they will be walking away from a substantial source of new revenues. Yet, if they accept the challenge, they will be confronted with a bewildering array of considerations not present in purely domestic transactions:
Foreign laws affecting: the creation, perfection, priority and enforcement of security interest; the form and functioning of business entities; interest rates; the validity and enforceability of guaranties; bankruptcy and insolvency; lender liability; environmental matters; labor and pension matters; and other issues of critical importance to U.S. asset-based lenders;
A broad range of U.S. and foreign tax considerations affecting both lender and borrower that can have a profound bearing upon the structure and economics of the transaction;
Issues relating to fluctuations in foreign currencies with substantial credit, loan availability and other implications;
Unfamiliar work habits and business practices;
Internal and external political risks that may be difficult, if not impossible, to assess;
Language differences that may pose serious communication problems (even if the foreign business people and attorneys speak English); and
Complex time zone and logistical problems.
Furthermore, asset-based lending in many other countries is neither as commonplace, nor as highly developed, as it is in the United States. This does not make the situation any easier.
The object of this paper is to provide U.S. asset-based lenders with an introduction to certain of the principal business and legal considerations affecting international asset-based loans, and to highlight some of the pitfalls. Ideally, it will also convey some of the flavor of these challenging and interesting transactions.
Analyzing the international elements of a transaction. How does one begin to analyze and evaluate the legal and structural aspects of an international asset-based transaction? Although there is no single correct way, the following approach has proven useful:
Break down the transaction into its essential business and legal requirements, as if it were a purely domestic transaction;
Determine whether, and if so how, each requirement is addressed by the laws and business customs of each relevant foreign country;
If the requirement is not addressed or inadvertently addressed, determine whether it is possible to address the requirement in some other way that is consistent with the laws of the foreign country;
If the requirement cannot be satisfied in another way, decide whether you are prepared to take the business risk;
Analyze the impact on the transaction of any lender liability, environmental, labor and other customary asset-based lending issues;
Concurrently with the above, analyze the impact of any tax or currency issues on the structure or economics of the transaction; and finally,
Work through the logistical aspects of the transaction.
Depending upon the complexity of the international elements, this can be a painstaking process. Unfortunately, there are no shortcuts. However, as is often the case when working through complex matters, it is helpful to keep certain simple, fundamental principles in mind. The following principles are especially helpful in international transactions:
Assume nothing. When doing an international deal, rid yourself of all preconceptions. It is a mistake to assume that our way of doing something is the only way that makes sense. Prepare to be amazed at the way many legal and business issues are addressed in other countries. Any assumption you make concerning how a particular issue will be resolved in a foreign country will probably be wrong.
Never accept "no" for an answer. The response from your foreign counsel that a particular objective cannot be achieved under his country's law may only mean that it has not been done before, or that your counsel does not fully understand your objective. Try to convince your counsel that the objective can be accomplished in a manner entirely consistent with the laws and customs of that country. Be creative and work with your foreign counsel.
Never accept "yes" for an answer, either. You may think you have reached an agreement with a foreign lawyer or business person, only to find that the two of you are speaking the same words but saying something quite different; you may be told that something is possible, only to be told later that it is impossible. Be precise in communicating. Make certain that the other person has fully thought through the issues and is certain of his or her answer. Asking follow-up questions and going through specific examples can assist in this process.
Be unsophisticated. Our natural desire to be regarded as sophisticated and knowledgeable an impulse that can be particularly strong in the atmosphere of international finance may prevent us from asking important questions. Do not worry that your questions may sound basic or irrelevant. Ask them anyway. Make certain that the other parties understand each question and that you understand each answer. Be especially wary of buzzwords; if you hear one you do not understand, ask what it means. The battlefields of deals are littered with the bones of those who pretended they knew all the answers.
Think backwards. Logistics play a huge role in international transactions. Always keep one eye on the timing and mechanics of each aspect of the deal. Working backwards from the final step in the transaction (which is usually the passing of funds), break the logistics down into their smallest steps, and then calculate how long each step will take. Focusing on logistics cannot be over-emphasized.
Foreign counsel
Having capable foreign counsel is a critical element in an international asset-based loan. It will not be difficult to find one who speaks English. However. just because someone speaks English does not mean that you speak the same language.
For example, your foreign counsel in a particular country may assure you that you can obtain a "good lien" on certain property in that country. However, your counsel's concept of what constitutes a good lien may be radically different from yours. Our concept of a "good lien" is really a composite of various other principles that we often take for granted under United States law, but which may not exist under the laws of a foreign country. For example, we routinely assume that a security interest in personal property will, with the insertion of the appropriate language in the security agreement, extend to after-acquired property and also secure future advances. However, these principles do not exist under the laws of every country. Unless you specifically ask about them, your foreign counsel may not realize that they are important to you.
There may also be perils associated with the lien, such as the possibility of secret liens, the existence of impediments to enforcement of the lien, or high recordation fees, which your foreign counsel regards as facts of life and therefore may not think to mention.
It is a mistake to assume that your foreign attorneys, no matter how competent, understand what you mean by a "good lien" (or, for that matter, any other term which you may use), or that they will alert you to all of the possible pitfalls.
Therefore, be as precise as possible in communicating the specific requirements of your transaction and ask questions designed to bring the hidden perils to light. Moreover, it is essential that this process occur as early as possible in the transaction in order to avoid unpleasant surprises (not to mention wasted time and expense) later on. Formulate, at an early stage, a series of questions for your foreign counsel concerning each of the requirements of the transaction. To minimize miscommunication, both the questions and the answers should be in writing.
Also ask foreign counsel to prepare, as soon as possible, a detailed closing checklist for those aspects of the transaction that they are handling. We have often found that, when we receive these checklists, we become aware of closing requirements and issues not previously mentioned to us by foreign counsel.
It is also prudent to request that written opinions from your foreign counsel, as well as from the borrower's foreign counsel, be delivered at closing. A draft of the opinion submitted to foreign counsel at any early stage in the transaction can save much time and energy. It helps to clarify the issues of concern to you and makes clear that you will want those issues addressed in the opinion. Unfortunately, in some countries legal opinions are less enforceable than in the United States. Yet even in these countries opinions are still useful for flushing out and clarifying the issues.
Be prepared for unusual local customs concerning attorneys' opinions. In some countries, opinions in loan transactions are routinely given by the lender's (as opposed to the borrower's) counsel. In other countries they are customarily not given at all. However, although you should be sensitive to local custom, you can usually obtain the opinions you need.
It is usually a good idea to have your U.S. counsel coordinate the efforts of your foreign counsel. This is especially important when the transaction involves numerous countries. Your U.S. counsel will probably be the most familiar with what you expect, and should help facilitate the analysis and communication process described above.
Asset-based lending concepts
When analyzing an international asset-based loan, you must determine how, if at all, each requirement of your transaction is addressed by applicable foreign law. This section examines various considerations that arise when you apply that procedure to certain fundamental asset-based lending concepts.
Liens
An obvious element of any asset-based loan is a good lien on the collateral that has the priority you require. Most countries have well-established procedures for lien creation and enforcement. Whether you can obtain a lien of satisfactory priority in a particular country requires, at a minimum, an understanding of the following factors:
The mechanics. Determine the proper mechanics for creating the lien on each type of collateral located in each foreign jurisdiction.
Note that there may be more than one method for obtaining a lien on a given type of property. If there is, determine the relative rights and obligations of the lender and the borrower under each method, as well as the relative advantages and disadvantages. In the United Kingdom, for example, a lien upon shares of capital stock may be created either by an "equitable mortgage" (where the share certificates are deposited with the lender or its nominee) or by a "legal mortgage" (where the statutory books of the company are changed to record the lender or its nominee as owner of the shares, and new share certificates are issued in name of the lender or its nominee). A legal mortgage generally is preferable from the lender's standpoint because beneficial ownership is transferred to the lender (subject to the borrower's equitable right of redemption) and enforcement is easier. In Germany, a lien on real property may be obtained either by a grundschuld or by a hypothek, the former being considered more beneficial for the lender because it is more flexible and easier to enforce.
After-acquired property and future advances. Determine whether the lien covers after-acquired property and secures future advances under a revolving facility, and if so, whether special language to that effect is required in the security document.
Priority. Ascertain whether your collateral is encumbered by other liens and whether your lien has the requisite priority. Is there a central registry, is the lien simply lodged on the borrower's official records, or must the lender rely solely on representations by the borrower? Is there a possibility of any "secret liens" on the collateral in favor of vendors, taxing authorities or others that will not show up on the record? Are there any environmental, labor, tax or other laws that can result in the imposition of a prior or junior lien in favor of a governmental authority or other lien claimant? In the case of a revolving facility, is the priority of your lien maintained even if the facility is temporarily paid down to zero?
Local custom and practice play a large role in this issue. For example, in the United States, when the collateral includes real estate, it is customary for the lender to obtain a title insurance policy insuring the enforceability and priority of the lien. However, in many other countries such protection is either typically not obtained or is unavailable. In some countries, real estate title examinations are conducted by attorneys (as was once common in the United States) instead of title companies. They are usually performed by the lender's attorneys, but sometimes, as in Canada, by the borrower's.
Filing fees. Determine what filing fees, taxes or other costs must be incurred in obtaining and preserving the lien. These can be substantial.
Third-party consents. Find out whether any consents by third parties are required in order to obtain the lien. For example, under the Uniform Commercial Code a borrower generally may grant a security interest in an account even if that is prohibited in the underlying contract that gave rise to the account. However, in some countries such a prohibition will be honored and, unless the consent is obtained, a lien on the account will be invalid.
Enforcement. Satisfy yourself that there is a practical method of enforcing the lien and realizing upon the collateral in the event of default. For example, if proceeds of accounts receivable are not being paid into a lockbox, can the lender obtain prompt possession or control of such proceeds if the borrower defaults? Is the equivalent of a landlord's waiver necessary to obtain possession of inventory or equipment located in a leased facility, and if so, is it possible to obtain one? What is the procedure for foreclosing the lien, and how long does it take? Satisfy yourself that there are no unacceptable legal restrictions on taking currency out of a jurisdiction, or restrictions legal or practical upon converting the currency to U.S. dollars.
Foreign business entities.
In the United States, we are accustomed to dealing with corporations, partnerships and trusts and the ways in which they function. Many countries have similar forms of business entities, but many also have evolved other types of business entities with no close United States equivalent. For example, in Germany one form of entity is known as an Aktiengesellschaft (designated by the letters AG in the company's name) and another is known as a Gesellschaft mit beschränkter Haftung (designated by letters GmbH in its name). The former is similar to a corporation as we know it; the latter combines elements of a corporation and a partnership. These are only two of various forms of German business entities. Therefore, make certain that you understand what forms of business entities you will be dealing with in your transaction and how they function (including, for example, the extent to which the owners of the entity may be insulated from personal liability, and the extent to which the entity can make dividends or other distributions to its owners).
The form of business entity can also affect your ability to collateralize a loan. For example, in a recent transaction, the lender expected to receive a pledge of the capital stock of a Brazilian company. The company was an entity known as a sociedade por quotas de responsabilidade limitada (a "limitada"). Unfortunately, we learned from our Brazilian counsel that it was not possible under Brazilian law to pledge the equity interest in a limitada. We also learned, however, that it was possible to obtain a pledge of the equity interest in another form of Brazilian entity, known as a sociedade anonima (similar to a conventional share corporation as we know it) and that the conversion of a limitada into a sociedade de anonima is a relatively painless process. Our client required that the conversion take place, and received the pledge it had requested.
Two new developments in this area have emerged from the European Community:
The European Council of Ministers has adopted a regulation for a new business organization known as a European Economic Interest Grouping ("EEIG"). The EEIG enables two or more companies or individuals from separate Member States engaged in industrial, commercial or professional activities to combine part of their economic activities, with a degree of flexibility, while preserving their legal and economic independence. The principal limitation of an EEIG is that its activities must consist solely of non-profit activities which are ancillary to the activities of its members (such as research and development and marketing).
The European Commission has submitted to the European Council of Ministers a draft regulation for a statute creating a European Company based upon the law of the European Community (or, on those points where the functioning of a European Company does not need uniform Community rules, on the law governing public companies in the Member State where the European Company has its registered office).
It is far too early to know how popular these new entities will become.
Documents
The documents evidencing international asset-based loans must, at a minimum, satisfy four separate criteria:
Enforceability. Each document must be enforceable with regard to signing requirements, consideration, remedies and in all other respects under applicable foreign law.
Clarity. Each document must accurately reflect the terms and conditions of the transaction.
Consistency. The affirmative and negative covenants, events of default and other terms of each document should be consistent with all other documents evidencing the transaction.
Ease of administration. All of the documents, taken as a whole, should facilitate ease of administration by the lender to the greatest possible extent.
In the case of documents pertaining to each foreign country, the job of satisfying the first criterion is primarily the responsibility of your foreign counsel, who should prepare the document and opine as to its enforceability. Satisfying the remaining three criteria is primarily the responsibility of your U.S. counsel.
In a sense, the ease of administration criterion poses the greatest challenge for your U.S. counsel. We employed a useful technique in a highly complex transaction, involving four lenders in different countries, four borrowers in different countries, loans made in four currencies and collateral in seven countries. We prepared a "master loan agreement" to which all of the lenders and borrowers were parties, as opposed to separate loan agreements for each borrower.
All provisions necessary to administer the loans, including provisions concerning advance rates, collateral eligibility standards, financial covenants and other affirmative and negative covenants, interest, amortization, fees, currency fluctuations, intercompany transactions and events of default, were contained in this single document. The master loan agreement was reviewed by counsel in each country to ensure that it conformed to the specific legal requirements for execution and enforceability under the laws of that country. As a result, the loans were substantially easier to administer than if the relevant provisions were scattered throughout numerous documents.
Insurance
Insuring collateral against casualty loss is a critical component of any U.S. asset-based transaction and is equally important where the collateral is located in a foreign jurisdiction. However, insurance coverage, and procedures for becoming the loss payee of such insurance, vary from country to country. Moreover, the insurance policies may have to be translated into English. Early in the transaction, make certain that you have ascertained that adequate insurance coverage is available, that you have identified the correct procedures for determining coverages and becoming loss-payee and that such procedures are being attended to in a timely fashion.
Control of proceeds of collateral
In the United States, a lender financing accounts receivable often insists upon the use of a lock-box or a blocked account. In other countries such procedures may be unknown. Alternatively, they may be available, but not generally used because of their potentially disruptive impact on the borrower's business. If control of collateral proceeds is an important element in your transaction, determine whether, and if so how, that can be accomplished in the applicable foreign jurisdictions.
This is one of many situations in which it has paid not to take "no" for an answer. We have been advised by counsel in several foreign countries that blocked accounts are not used. However, because blocked accounts are essentially a matter of contract, we were able to convince our foreign counsel that there was no reason they could not be obtained. Ultimately, we did receive them.
Guaranties
Subject to the limitations imposed by state fraudulent conveyance laws and Section 548 of the Federal Bankruptcy Code, U.S. corporations may generally guaranty the obligations of their affiliates. To deal with these laws, it is increasingly common to use guaranties that are limited in amount.
Many foreign countries impose analogous restrictions upon the ability of a company to give a guaranty. In the United Kingdom, for example, a company may not (with certain exceptions) give "financial assistance" in connection with the acquisition of its own shares. "Financial assistance" is defined broadly and includes financial assistance by way of gift, guaranty, security or indemnity by such company. The rule is relaxed when non-public companies give financial assistance, provided that the financial assistance may only be given if the company has net assets that are not thereby reduced, or, to the extent that they are reduced, if the financial assistance is provided out of distributable profits. In order to give financial assistance, the members of the company must pass a special resolution in a general meeting. Members must approve the financial assistance and the directors of the company must make a statutory declaration containing the particulars of the financial assistance to be given. The directors' declaration must state that the directors are of the opinion that the company will be able to pay its debts existing immediately following the giving of the assistance, and also that the company will be able to pay its debts as they fall due during the following year.
The statutory declaration must be accompanied by a report by the company's auditors stating that they have inquired into the state of affairs of the company and that they are not aware of anything which makes the declaration unreasonable under the circumstances. This procedure is known as "white-washing."
Although white-washing is cumbersome, it provides a degree of protection that is unavailable in the United States. If the giving of a guaranty or other form of financial assistance by a company has been white-washed, it is unlikely that the financial assistance will be set aside later. In the United States, however, such a transaction may be vulnerable to challenge even if it is adorned with solvency opinions, appraisals and other evidence of the lender's good faith.
In one transaction, it was important to obtain the guaranty of a German operating company even though the guaranty might be limited to the net assets of the company. We were advised initially by German counsel that such a guaranty would be "illegal" under German law. The German counsel was not familiar with the concept of a guaranty which was, by its terms, limited to the net assets of the company. However, he ultimately concluded that a guaranty with such a limitation would be lawful. This is another situation in which it paid not to take "no" for an answer.
Foreign bankruptcy laws
Before embarking upon an international asset-based deal, you should have at least a general idea about the bankruptcy laws of each relevant country. As a rule, most countries are far less lenient to debtors than the United States in that they do not have any equivalent of our Chapter 11. Rather, their bankruptcy laws reflect the philosophy that a company unable to pay its debts should be liquidated.
Like U.S. bankruptcy law, foreign bankruptcy laws generally provide a system of priorities for the distribution of a debtor's assets in satisfaction of claims. Such laws often have procedures, analogous to the preference and fraudulent conveyance provisions of the Federal Bankruptcy Code, for challenging the enforceability of certain transfers and payments made by a debtor prior to the bankruptcy proceeding.
There is generally little uniformity among foreign bankruptcy laws. There have been various attempts over the years to promote uniformity by treaties among nations, but so far only a few countries have become signatories.
Moreover, most nations have shown little willingness to recognize and enforce the bankruptcy laws of other countries when called upon to do so in connection with a foreign bankruptcy proceeding. The United States has at least made an attempt to respond to this situation. Section 304 of the Federal Bankruptcy Code provides that the trustee or other representative in a foreign bankruptcy proceeding may file an ancillary case in a U.S. Bankruptcy Court to reach assets of the foreign debtor located in the United States, without filing a full-blown bankruptcy proceeding. However, there is still much confusion as to the interpretation and application of Section 304.
As a result of this unwillingness, and the lack of uniformity among the bankruptcy laws of the various countries, extremely complex issues are raised in international asset-based transactions by the interplay among the various bankruptcy laws. For example, if a United States parent has foreign subsidiaries, and parent files a Chapter 11 proceeding in the United States, what effect will that have upon the subsidiaries (and, in particular, upon the ability of the holder of a lien on the assets of a foreign subsidiary to enforce that lien)? Can the parent seek to file a bankruptcy proceeding for its foreign subsidiaries in the United States? And if so, what is the jurisdictional scope of the automatic stay imposed by Section 362 of the Federal Bankruptcy Code upon a creditor seeking to enforce a lien on a foreign subsidiary's assets?
This area is not well-developed at this time, although it will probably evolve with greater rapidity in the future as a result of the growing globalization of U.S. and foreign business. Nevertheless, it is possible to make a number of generalizations:
If a U.S. parent files a bankruptcy proceeding in the United States for itself, but not for a particular direct foreign subsidiary, the business of the subsidiary, as well as the ability of creditors of the subsidiary to enforce liens on the subsidiary's assets, should as a legal matter remain unaffected by the bankruptcy proceeding. The assets of the foreign subsidiary are not assets of the parent's bankruptcy estate, and therefore should not be subject to the jurisdiction of the U.S. Bankruptcy Court.
The capital stock of the foreign subsidiary is another matter. It is an asset of the parent's bankruptcy estate, and accordingly the holder of a lien on such capital stock should, at least as a technical legal matter, be subject to the automatic stay imposed by Section 362 of the Federal Bankruptcy Code. However, if the lienholder is a foreign entity, and not subject to the jurisdiction of the U.S. Bankruptcy Court, it is very possible that the automatic stay would not be enforced by the courts of either the subsidiary's or the lienholder's country. On the other hand, if the lienholder were subject to the personal jurisdiction of the U.S. Bankruptcy Court, the lienholder probably would be bound by the automatic stay.
If the U.S. parent actually filed a bankruptcy proceeding for its foreign subsidiary in a U.S. Bankruptcy Court, the same considerations in the paragraph above would probably apply. That is, the holder of a lien on the subsidiary's assets would, as a technical matter under the Federal Bankruptcy Code, be bound by the automatic stay so as to prevent that creditor from enforcing its lien. Whether the automatic stay could be enforced would depend in part upon whether the creditor was subject to the personal jurisdiction of the U.S. Bankruptcy Court. If the creditor were a foreign entity not subject to such personal jurisdiction, and the U.S. trustee in bankruptcy for the subsidiary sought, in a foreign court, to enjoin a foreign creditor from enforcing its lien on assets in that country as a result of the automatic stay, it is quite possible that the foreign court would decline to do so. On the other hand, if the lienholder were subject to the personal jurisdiction of the U.S. Bankruptcy Court, the lienholder probably would risk contempt proceedings if it ignored the automatic stay.
If a bankruptcy proceeding is filed in the United States for a foreign subsidiary, but all of the assets of the foreign subsidiary are located in the foreign country and the creditors of the subsidiary are in large part foreign creditors, it may be possible to convince the U.S. Bankruptcy Court to dismiss the bankruptcy for the foreign subsidiary under Section 305 of the Federal Bankruptcy Code.
The issues raised in the above paragraphs become even more complex if the lienholders are a consortium of U.S. and foreign lenders, where some lenders may be subject to the personal jurisdiction of the U.S. Bankruptcy Court and others may not. In this situation, it may be relevant whether the agent for the consortium is a U.S. or a foreign entity. It may be useful here to appoint a foreign entity as collateral agent under the security documents in an attempt to insulate the liens on foreign assets from the jurisdiction of the U.S. Bankruptcy Court. On the other hand, that tactic might not work if the collateral agent also had a presence in the United States which subjected it to the personal jurisdiction of the U.S. Bankruptcy Court.
It will be fascinating to see how these issues are addressed (as they most assuredly will be) in the coming years. In the meantime, the interplay of domestic and foreign insolvency laws represents a gray area. The most that you can do is to be aware of the potential risks and attempt to structure your transactions in ways that maximize your ability to enforce your liens on the foreign assets.
Lender liability and environmental laws
The United States' courts generally are much more preoccupied with lender liability than foreign courts, which is not surprising in view of the predisposition of many foreign countries towards creditors as opposed to debtors. Nevertheless, it is important to inquire as to the general state of lender liability law in each country involved in your transaction.
The same is true of environmental laws. The United States has gone much further than many other countries in attempting to protect the environment. For example, we were advised last year by local counsel in Australia that environmental regulation in that country is not sufficiently advanced to warrant special concern with respect to environmental liabilities. We received similar advice from counsel in Mexico and Brazil.
There can be some rather unexpected environmental considerations in other countries. In Germany, a current environmental threat is the discovery of canisters of poisonous gas buried in the ground by the German military at the close of World War II.
The U.S. lead in environmental matters may diminish in the near future, as the world's environmental problems become more acute. For example, the environment is the subject of the various European Commission proposals, which appear to be motivated by a genuine concern for the environment and the quality of life.
Accounting issues
Generally Accepted Accounting Principles ("GAAP") used in the United States differ markedly from GAAP used in many other countries. Financial statements of a foreign subsidiary will typically be prepared in accordance with the foreign country's GAAP. Consequently, when negotiating the financial covenants applicable to foreign subsidiaries, the lender must either be aware of the differences in the accounting principles used in preparing the subsidiaries' statements or insist that the statements be modified to conform to United States GAAP. Further, if the financial covenants applicable to a foreign subsidiary are not expressed in the local currency of the subsidiary, it will be necessary to convert the statements to U.S. dollars.
If the borrower is a United States entity, FASB 52 will provide the mechanism for converting the borrower's foreign subsidiaries' financial results into United States GAAP and U.S. dollars for inclusion in the borrower's consolidated financial statements. A detailed discussion of the provisions of FASB 52 is beyond the scope of this paper, but in order to avoid unexpected results, lenders should become familiar with its provisions.
For example, under FASB 52, gains and losses due to currency fluctuations in asset and liability accounts of the foreign subsidiary are generally not included in current income. Rather, they are reported as a separate component of shareholders' equity. These types of concerns should be addressed when negotiating financial covenants with the borrower.
The foregoing concerns also apply to fees that may be owing to the lender based upon the success of the borrower. The loan agreement must clarify how these accounting issues are to be dealt with in calculating fees.
Foreign currencies
A full treatment of foreign currencies is beyond the scope of this paper. However, when thinking about doing international asset-based deals, you should, at a minimum, consider the following:
When your loans are both made and repayable in U.S. dollars, you have shifted the risk of currency fluctuations to your borrower. If you lend U.S. $1,000,000 to a United Kingdom company, and that company is obligated to repay U.S. $1,000,000, then, at least from a legal standpoint, it is of no concern whether the British pound sterling falls or rises in relation to the dollar; your borrower is still obligated to repay U.S. $1,000,000. However, it clearly matters from a business standpoint.
For one thing, currency fluctuations could have an adverse impact on your borrowers' ability to repay its loans. If the pound falls against the dollar, your borrower will have to spend more pounds to purchase U.S. $1,000,000, an additional cost that could have an adverse effect on its business. It is possible, however, to hedge against this risk. You may wish to insist that the borrower maintain such a hedge throughout the term of the loan facility.
Currency fluctuations can also have an impact on your borrower's loan availability. Say you are lending 80 percent of the face amount of receivables, denominated in pounds sterling. If the pound falls against the dollar, availability will shrink. For example, if the pound is worth U.S. $2.00, accounts receivable in the aggregate amount of £1,000,000 will be worth U.S. $2,000,000, which will support a loan of U.S. $1,600,000. However, if the dollar strengthens and the pound drops to U.S. $1.50, the accounts will be worth only U.S. $1,500,000, which will support a loan of only U.S. $1,200,000. As a result, if you have not yet loaned against the accounts, your borrower will be able to borrow less. If you already have loaned U.S. $1,600,000, your borrower will be required to pay you U.S. $400,000 in order to bring the loan back into formula.
In fact, this precisely what happened on the eve of funding of an international leveraged buyout in May 1989. The dollar had strengthened dramatically against the deutschemark during the preceding weeks, thereby eroding loan availability (calculated in dollars) under a German loan facility. This was serious, because the purchase price for the company was payable in dollars. As it happened, excess availability existed from other sources, and the loans closed. The buyer's error was not hedging against the impact of currency fluctuations upon the purchase price.
Simply insisting that loans (especially revolving loans) be made and repaid in U.S. dollars may not meet the needs of your borrower. Where foreign currency loans are required, the lender should try to maximize availability to the borrower of the required foreign currency, while minimizing the administrative burden in providing the foreign currency, and should also try to minimize the impact of fluctuations in applicable currency exchange rates. A lender who does not routinely make loans in the required foreign currency may have to break the loan facility down into smaller, jurisdictionally based facilities denominated in foreign currencies and bring in one or more additional lenders to make the foreign currency loans.
Tax issues
Tax issues may play a significant role in international asset-based transactions. Here are a few concepts to bear in mind.
Many countries impose a withholding tax upon various types of payments by a domestic taxpayer to a foreign taxpayer. The reference to "withholding" may be misleading; unlike U.S. withholding taxes on wages, which are really only deposits against an income tax that may be payable in the future, these types of withholding taxes are often separate taxes. For example, many countries, including the United States, levy a withholding tax on most types of interest payments made by a domestic company to a foreign company. The tax rate depends on the nationality of the foreign recipient, as tax treaties typically reduce or eliminate withholding taxes on interest payments. Payors domiciled in the European Community may also become subject to EC Directives affecting withholding taxes. These taxes constitute an additional cost for the borrower. Further, if the lender is to receive payments directly from a foreign borrower or if any foreign affiliate guaranties payments, the documents should provide that the payments by the foreign payor are to be "grossed up" for any applicable foreign taxes.
Withholding taxes may also apply to payments made between co-lenders to the extent that such payments are characterized by the taxing authority as interest or other amounts which would, if paid directly by the borrower to the co-lender, have been subject to the tax.
In many countries a payment by a domestic company to its parent in the form of a dividend will also be taxed. Thus, if you contemplate that your U.S. borrower will obtain the funds to repay your loan through dividends from its foreign subsidiary, factor into your cashflow projections the taxes triggered by such dividends. Similarly, loans among affiliated companies may in certain circumstances be treated as dividend payments to the common parent, thereby subjecting them to taxation (both when made and again when the "loan" is repaid). The granting by a subsidiary of a guaranty of its parent's (or affiliate's) obligations or the pledge by a subsidiary of its assets to secure payment of such obligations may also be treated as a dividend. The United States follows this rule and will treat the pledge by a parent of two-thirds or more of a foreign subsidiary's capital stock as a pledge of the subsidiary's assets and therefore as a dividend. In some jurisdictions, such as Germany, if a subsidiary (or an affiliate) guaranties the obligations of a parent, the guarantor may be deemed to have been paid a fee for having done so, and then be deemed to have transferred the same amount back to the parent as a dividend.
Bear in mind, too, that a lender's activities within a foreign country may become sufficient for that country to subject the lender's income to taxation. The activities of an agent will generally be attributed to the lender, unless the agent's activities are of a type generally performed by the agent for other parties. Depending upon the level of activity, the foreign country will generally try to tax the lender only on its income attributable to that country. But the acceptable level of activity within a country that will not subject a lender to taxation directly by that country should be checked in each case. Also, consider the activity that may arise if a default occurs and the lender or its agent finds it necessary to institute legal proceedings in a foreign country to take other actions in order to foreclose on the collateral in that country.
Finally, a lender should be careful to obtain advice as to peculiar tax rules in each relevant country (including the United States) in order to avoid unnecessary pitfalls. For example, Australia takes the position that if a loan is secured by assets located in Australia, then all of the interest paid on that loan, regardless of the domicile of the payor, is Australian source interest income subject to tax by Australia. However, an exception to this rule exists if the underlying loan is evidenced by a debenture. Australian counsel has interpreted the word "debenture" to include what we in the United States commonly refer to as a "note." Consequently, if the underlying loan is evidenced by one or more notes, then the special Australian sourcing rule does not apply.
Political factors
Perhaps the most extreme risks confronted by lenders engaged in international transactions arise from the uncertainties of a foreign political environment. A sudden shift can give rise to consequences ranging from restrictions on the convertibility of currencies to the expropriation of property. The consequences do not necessarily arise from the foreign government itself; they may also arise from the actions of the United States or other countries in the form of embargoes or other trade restrictions imposed in response to the foreign political situation.
In order to promote investments in certain countries, the United States has established an agency known as the Overseas Private Investment Corporation. This corporation insures companies investing in those countries (including lenders) against the risk associated with expropriation, contract frustration, currency inconvertibility and political violence. Some private companies also offer insurance against these risks.
A related risk is dealing with corrupt foreign governmental officials. Although foreign business people may advise you that making payments or gifts to governmental officials is a customary way of doing business in their country, such practices are illegal under the United States Foreign Corrupt Practices Act. Individuals and companies making such payments or gifts are subject to criminal sanctions, including imprisonment.
Obviously, these risks must be taken into account before venturing into a foreign country. Certain of these risks can be covered by insurance, but others cannot. Careful research into the political climate in the less stable countries is essential.
Banking law and foreign exchange restrictions
In addition to areas of U.S. and foreign law governing the transactions itself, a lender making international loans will also encounter an array of regulations regarding banking activities, foreign loans and currency matters under U.S. law as well as the law of the countries where the debtor resides or has operations. These laws must be thoroughly explored to ensure compliance in each jurisdiction.
Logistics
Closing any transaction is largely a matter of logistics. When the transaction has international elements, the logistics acquire a heightened complexity. Here are some things to keep in mind:
Time zones. Contending with different time zones can give new meaning to the concept of losing sleep over a deal. Plan on being up before the crack of dawn or past your bedtime in order to make that crucial telephone call. You do not always have to be the one who is inconvenienced; however, it takes a certain amount of practice and sensitivity to know how often you can wake someone else up in the middle of the night without jeopardizing the entire transaction.
With most countries, there is a window in which their business day overlaps with yours, but limiting communications to that window often wastes much productive time. With proper planning, the waste can be minimized. The fax machine can be useful: Send off a fax before you leave the office in the evening and, like shoes made by elves, the response will be waiting for you when you arrive the next morning.
Of course, no matter how carefully you plan, sometimes you have to turn your schedule on its head, especially as the closing approaches. In one transaction involving seven countries, the differing time zones necessitated a rolling closing that spanned almost 24 hours. But that it also part of the fun.
Moving papers. The movement of documents and other written materials from one place to another requires special attention in international transactions.
Facsimile machines are of critical importance. In fact, some recent international transactions could not possibly have been concluded under the same time constraints before the advent of the fax. Courier services are costly and often undependable, and can use up precious days.
Fax machines, too, have their limits. It still takes time -- even hours -- to transmit a lengthy document over international telephone lines. Some fax machines have a frustrating habit of disconnecting in the middle of a long document, which generally means that someone has to baby-sit the machine. Moreover, fax machines may not effectively transmit the shaded areas used by certain word-processing marking systems. But, even with the idiosyncrasies, fax machines have revolutionized international deals. Plan to rely on them heavily.
Here is one tip that we have found useful: When you have a long document, such as a loan agreement, that must be faxed repeatedly to various countries for review and comment, that process can place a heavy time drag on a transaction as you race towards closing. To avoid that situation, declare the document to be in final form at a certain point in time, even if more revisions are anticipated. Then make revisions in a short amendment. That way, you will only have to fax around the short amendment, not the lengthy document.
Moving people. Between the telephone and the fax machine, and with the assistance of foreign counsel, it is often possible to close the international aspects of asset-based transactions without sending business people or lawyers to the other countries involved. However, there may come a point in the transaction when that is precisely what you need to do, either for negotiations, or just to sit there to make certain that things go smoothly. Keep an open mind to doing so; it can make all the difference in the world.
Moving funds. Moving funds in preparation for a closing can be complex and time-consuming if foreign currencies are involved. In one recent transaction, funds were to come from four countries to a centralized location in the United States for transmittal to a seller in a leveraged buyout on the closing date. Moving the funds from the four countries to the central location took two days, but was accomplished prior to the closing (with the borrower bearing the cost of the funds for those two days) in order to avoid any logistical delays at closing.
Foreign holidays and work habits. Inquire about foreign business holidays. You may find that one falls on precisely the day you wish to close, or on a day that impedes your schedule.
Learn about foreign work habits. Although working around the clock has been commonplace in the United States for years, it is a habit that has only recently caught on in some countries, and is not practiced at all in many other countries.
Timing of ministerial acts. Actions which are essentially ministerial in the United States can be cumbersome in a foreign country. In the United States, recording a mortgage is a simple procedure, while in Germany the entire mortgage must be read aloud, word for word -- a procedure that can take hours as the German notary makes certain that the mortgagor fully understands the terms of the mortgage. In the United States, a merger can be timed with great precision to occur immediately before or after the funding of a loan. Someone stands in the Secretary of State's office and simply files pre-approved merger papers upon receiving a telephone call. In other countries a merger may require a court proceeding, which may be perfunctory but may also take months to complete. Know in advance about these timing considerations.
Signing and recording of documents. If a document is to be signed by a foreign company, its critical to know what corporate action (in the form of directors' resolutions and the like) must be taken before the document can be signed, how long that action requires, and what the signing requirements for the document are (i.e., by whom it must be signed, and whether that signature can be affixed by means of a power of attorney, and if so, the specific requirements for the power of attorney, such as who must sign the power of attorney, whether that signature must be notarized, and the proper form of notarization). Must the signatory be physically present in the foreign country to sign the document? Can it be pre-signed? Must the document be signed in front of a notary? Keep in mind that in many foreign countries, a notary plays a much different role than in the United States, where a notary merely affixes a notarial seal; instead, the notary is a professional who is paid substantial fees for presiding over the execution of documents. One must often travel great distances to appear before the proper notary. Some countries require that documents to be recorded in the country, but signed outside the country, must be countersigned by an official of the country in its embassy or consular office in the jurisdiction where the signing occurs. In some instances, a group of documents must be signed in a precise order to ensure enforceability.
Recording and filing fees. These costs can sometimes be quite high in foreign countries. In addition, various countries impose rather surprising charges on certain transactions that we in the United States view as ordinary.
Multi-bank credits and participations
If foreign currency loans are required, and it is not practical for the lender or its affiliates to make loans in foreign currencies, it will probably be necessary to bring in one or more foreign lenders (or U.S. lenders that have a foreign lending capacity). Unless the foreign loans are to be established and administered on a completely independent basis (not a desirable alternative if a truly integrated financing facility is to be achieved), some form of co-lending arrangements will be required. A key issue is whether the lenders wish to share the risks and benefits of the entire credit. If they do, such sharing can be accomplished through cross-indemnity and participation arrangements. With multiple currency loans, a lender can often make loans in the currency of its domicile and share the risks and benefits (through sharing and indemnity provisions) of the balance of the credit.
Thus, loan administration can be separated into local and global elements, with the lead lender being responsible for global administration, such as review of financial statements and monitoring of covenant compliance. Each local lender can administer the disbursement and collection of its loans and may serve as agent to protect and enforce rights to collateral within its jurisdiction. Similarly, each co-lender may sell participations in the global or local credit.
When structuring international syndicates, give special attention to issues relating to the resolution of disputes among the co-lenders, such as choice of law and forum. Often such issues do not receive sufficient attention in the optimistic atmosphere that frequently prevails among the co-lenders immediately before a closing.
The technical aspects and possible alternative forms of co-lending and participation arrangements are numerous and varied. Recognize that such arrangements may be an integral part of a successful international loan facility.
Conclusion
One of the remarkable qualities of the asset-based lending industry is its capacity to respond, with creativity and determination, to an ever-changing business environment. The globalization of American middle-market business that we are now witnessing is testing that capacity once again. I have no doubt that our industry will respond well to this challenge.
Incidentally, in case you were wondering, after receiving the advisory letter from Brunei counsel quoted at the beginning of this article, our client decided to exclude the Brunei collateral in calculating availability. Sometimes creativity and determination can only go so far.
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The Single European Market is the term given by the European Community to its goal of a single market for its twelve Member States (Belgium, Denmark, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain and the United Kingdom) by December 31, 1992. The purpose of the single market is to enable the European Community to compete more effectively against other major trading blocks. The goal is to be achieved by the removal of: physical barriers to the movement of goods and people (such as customs and immigration controls); technical barriers to the free flow of goods, professional and other services, capital and the like (such as technical standards, testing and certification procedures, licensing standards and taxes); and fiscal barriers (such as value-added taxes, income taxes and excise duties). The progress of these efforts has been impeded by the fact that legislation enacted by the European Community must also be enacted into law by the Member States in order to be effective, a process which, in the case of some European Community directives, may extend well beyond 1992 (if it occurs at all). Nevertheless, this process has already had, and will undoubtedly continue to have, a profound impact upon certain areas that affect international asset-based lending transactions, including company law, taxation and banking. Reference to various of the European Community initiatives will be made throughout this paper.
