Norway: The lender versus the borrower

Author: | Published: 1 Oct 2009
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International syndicated banking is a highly developed trade in Norway. For ship financing Norway is an international centre. Norwegian banks initiate and administer loan facilities issued by international bank syndicates on a large scale. This capacity is normally referred to as an agent bank. The handling of legal disputes which may arise out of or in connection with the loan agreements governing such facilities are among the various responsibilities of an agent bank. Norwegian agent banks will normally use Norwegian civil courts as the venue of jurisdiction and Norwegian law as governing law in the facility agreements.

Therefore, a number of legal issues that became apparent under the recent credit crunch, and which, pursuant to the loan agreement shall be solved on the basis of Norwegian law, are not without international interest.

Two particular issues arose out of the credit crunch. Both are based on the Norwegian Agreement Act § 36. This is a clause also known as the contractual general clause on adoption of contracts. It gives a party to an agreement a general right to demand the unilateral revision of an agreement, to be imposed by the courts, if there are grounds present that make the current agreement unreasonable. Needless to say, such a clause will come to the forefront during times of unexpected turmoil. Due to the financial crisis, and the very real fear of a collapse in the global financial system that prevailed at times, the Agreement Act § 36 suddenly became of acute interest, in a field where this was not to be expected.

Firstly for periods, the two issues are, related to the fact that, the interest rates which the borrower had to pay pursuant to loan agreements fluctuated wildly. That the loan agreements under such circumstances may be adapted subject to Agreement Act § 36 is readily apparent, and in most cases the only practical claim a borrower might set forth.

Secondly, the fear of a collapse also led to the lenders in the syndicates depositing their available funds long-term, to preserve them for future obligations to contribute funds to facilities. This is a problem, since the facility agreements are normally based on the presumption that lenders make short-term deposits to match the borrower's drawdown of the facilities. In these cases an adaptation of the loan agreements on the basis of the Agreement Act § 36 is an apparent claim a lender may set forth.

As to the parties' regulation of their relation, they commonly use one of the English Loan Market Association's (LMA) Primary Documents, which are used as the basis for drafting the Norwegian agent banks' standard terms. Each agreement must, as always in the sphere of party autonomy, be interpreted on its own merits. However, the banks and borrowers have tended to rather uncritically rely on the form as it is, especially as to its technical provisions, including interest rate regulation. Therefore, and due to the fact that it would be of minor general interest to consider specific modifications by random parties, the LMA Single Currency Term and Revolving Facilities Agreement – Primary Documents (the Agreement), will be used as the legal starting point for the issues we will discuss herein. Nonetheless we must emphasise that it is the concrete facts in each actual case that will be decisive. We are in this format limited to highlighting and discussing relevant legal aspects and providing tentative conclusions in the light of typical circumstances.

The Agreement Act § 36 is a mandatory rule, and therefore applicable no matter how unsuitable it may be considered in an international legal relation. As long as it is deemed unreasonable to uphold an agreement's original content it may be revised pursuant to the Agreement Act § 36 . This does not mean that a possible international aspect of an agreement is without relevance. This must also be taken into consideration in the assessment of whether the Agreement Act § 36 shall be applied in any given case.

If applicable, the Agreement Act § 36 gives the court a discretional scope to adapt the legal agreement. The clause states that an agreement may entirely or partially be set aside or adapted. The adaptation must be done subject to the main criterion unreasonable, which means that the mandate is to restore reasonability.

The Agreement does not provide a basis for the borrower to enjoy any relief from his obligations in case interest rates soar to unexpected levels. Therefore, the borrower must be understood to have assumed the risk of all moves in interest rates and must perform accordingly pacta sunt servanda, which is the starting point and general rule of all law.

The question that arose under the credit crunch was if it would be unreasonable that the lenders affirm the Agreement, or had the circumstances become so extreme that this would be unreasonable, thereby giving the borrowers a legal right to revise the obligations.

The wording of the Agreement Act § 36 instructs that a high threshold for applying the provision prevails. In the preparatory works the legislator states that positively unreasonable matters must be present, and that it is of course not sufficient that there more reasonable solutions exist. Principally the Agreement Act § 36 was passed to give a general provision to protect consumers, especially when entering into agreements based on non-negotiated standard terms. This suggests a restrictive application of the provision to commercial agreements between professional parties. In the plenary decision published in Rt 1990 on page 284 (the Norwegian periodical for issuing the Supreme Court's decisions) the Supreme Court also stresses that it is supposed to be used with caution.

The criterion unreasonable is vague and discretional and so it directs towards a concrete, holistic evaluation of the circumstances. The provision defines the point in time for the assessment to be when the agreement is affirmed, at which time events subsequent to entering into the agreement are relevant.

It is assumed that the Agreement Act § 36 has consumed the former, unwritten doctrine on subsequently failed contractual assumption. In the preparatory works the lawmaker guides that "the assessments with regards to the relevance of subsequently occurring circumstances at the whole would be the same as pursuant to the doctrine on subsequently failed contractual assumption." Furthermore it stated that "the doctrine and case law under this gives guiding and is directional to the courts practice of the mitigation rule insofar as the significance of subsequent occurring circumstances." The lawmaker also emphasises that adaptation or mitigation only is possible in the more extraordinary of cases.

The unwritten doctrine has common features with the principles of force majeure, but is not identical to this. One criterion is that the assumption must have been motivating to the party wanting to mitigate his obligation, meaning that its promise to perform had not been given if the promisor had known of the subsequent occurring events. If so, the assumption is said to have significance. The promisor's assumption must, furthermore, have been apparent to the other party. And finally, it must be reasonable that the other party, post-signing, assumes the risk for the failed assumption. For this to be reasonable, a minimum requirement is that the promisor could not foresee or should not have foreseen the subsequent circumstance, and even if all these criterions are fulfilled it must also constitute an adequate allocation of the burdens from the subsequent circumstances that the other party must carry these by mitigation.

Normally, it may safely be assumed that the borrower has agreed to the agreement knowing that the interest rate could fluctuate higher and maybe much higher. This is a risk assumed by the borrower. Hence, the assumption in most cases would not fulfil the criteria of being motivating. The borrower's failure to fulfil this criterion under the doctrine makes a compelling argument against the agreement being unreasonable to affirm. Having regard to the legislators comments provided above and the general rule (pacta sunt servanda), little room should then be left for the application of the Agreement Act § 36.

However, a distinction between the Agreement Act § 36 and the older doctrine is that the doctrine operates with firm criteria whereas the Agreement Act § 36 provides for a concrete holistic evaluation of the reasonability. It is hence necessary to examine the circumstances closer.

The Agreement Act § 36 decides that the parties' resources shall be emphasised in the evaluation. Parties to a commercial loan agreement must be assumed to be resourceful and capable of protecting their interests. In the case issued in Rt 2003 page 1132, the Supreme Court also holds out that there must be extremely good reasons to find unreasonableness and set aside agreed criteria in commercial contracts between professional parties. One further factor in the evaluation of the reasonability is, naturally, the contents of the Agreement. If the loan costs for the borrower become extremely, or even unmanageably, high this weighs in direction of applying the Agreement Act § 36. In a case published in Rt 1999 s 922 the minority of the Supreme Court based its decision not to apply the Agreement Act § 36 on the situation being unlikely, but foreseeable. All-in-all it cannot be excluded that the Agreement Act § 36 is applicable in more extreme cases.

Consideration shall also be given to the circumstances at the time of the formation of the agreement. Such circumstances present during the formation of agreement may be similar to for instance the situations described in the Agreement Act §§ 28 to 33 – such as duress and coercion. Normally, this gives little guidance when using the Agreement.

The Agreement Act § 36 also allows for many other circumstances to be considered. In light of this any breach of any obligation to renegotiate a contract, if such an obligation can be established, is relevant. This means that the Agreement Act § 36 could provide a remedy to such a breach.

The threshold for being excused for non-performance of payment obligations is higher than for other commitments, for the case issued in Rt 2000 page 610.

As the almost invariable rule, the borrower cannot have his obligations under the agreement adapted or terminated due to soaring interest rates. Other relevant and particular circumstances must be present.

The Agreement contains a market disruption clause. One situation the Agreement fails to recognise is that one or more lenders cannot obtain funds in the interbank market at all, a key topic of the credit crunch. The lenders would nevertheless be obliged under the Agreement to provide the facility. This would constitute a very serious problem, since the lenders would be exposed to the knock on effect of the borrower's lack of funds, which could be huge losses. However close this never became a reality during the credit crunch.

Another situation to which the market disruption clause does not provide a solution is more practical. Driven by concerns raised by rating agencies, lenders participating in revolving loan facilities structured as rollover loans felt compelled to fund their participation on an unmatched basis. A revolving loan made to refinance another revolving loan which matures on the same date as the drawing of a consecutive revolving loan is known as a rollover loan. Funding on an unmatched basis means that the lenders deposit more money than they are obliged to provide to the facility on the rollover date, in order to preserve liquidity in case they cannot obtain new funding on the next rollover date.

The problem with this arrangement is that the lenders under the Agreement are only entitled to interest fixed for the interest period selected by the borrower. If the interest rate at the quotation day for the next rollover interest period is for instance lower than the interest rate on the lenders' deposits, the lenders would be operating with reduced margins, and possibly large negative margins. In periods with fast and large interest rate fluctuations lenders may be exposed to heavy losses. Similar to this situation is that the lenders, to consolidate their participation in a term loan or a normal revolving facility, make deposit before the quotation day of the loan.

Unlike the situation for the borrower, the Agreement cannot in most cases be interpreted to mean that the lenders have undertaken this risk. On the contrary, the parties have adopted measures to limit lenders risk for subsequent events, by using a market disruption clause. The effect of which is to entitle the lenders to cover their real costs of funding plus revenue in different subsequent events. The market disruption clause in the agreement, however, fails to regulate the issues set out above.

One possible legal basis for the Norwegian agent banks to resolve this situation is by demanding an interpretation or supplementation of the Agreement under the present facts. An alternative is applying the Agreement Act § 36, and revising the agreement in order to avoid unreasonable results. The connection between these two approaches is strong, and the matters and arguments to be considered would, to a large degree, be the same. This is apparent from the Supreme Court in the case published in Rt 2000 s 806 which states that the "starting point is that the agreement's provision on price is clear, and that there must be strong arguments to set it aside – either this is denoted as a result of general principles of interpretation or as a result of adaptation (by use of the Agreement Act § 36) of a contract."

We consider adaptation the honest approach, as it rules out the parties becoming exposed to a de facto, but not openly discussed, reasonableness test by the courts, under the guise of interpreting the agreement.

The question then becomes whether or not the Agreement Act § 36 is applicable in the situation outlined above. The case Breivik v Oslobanken AS published in Rt 2000 s 610 has already been mentioned above. In the liquidation of a bank it was alleged that the bank was not obliged to perform its pension commitments, inter alia owing to it suffering general problems with settling its debts. The Supreme Court's retort to this was that the bank's "payment problems (its insolvency) cannot amount to it being unreasonable to affirm the pension rights. It still must be a clear general rule in Norwegian law (which must prevail with few exceptions) that an obligor, and indeed a bank, cannot consider itself unbound to a monetary obligation owing to its own payment problems." Even more this must be the case if a lender was not suffering such payment problems, but only was dissatisfied with narrowing or negative margins.

In an arbitration award, the so called Mascot case, two shipping companies entered into an agreement priced in dollars. The agreement contained a clause which was supposed to hedge Mascot's exposure to fluctuations in the dollar's exchange rate. If the clause was given effect in accordance with its wording, a long term move in the dollar led to unforeseen consequences for Mascot. The arbitration court declared that the clause was not adequately formulated with regards to its intended purpose, and based on this and other arguments, it found that the agreement was unreasonable to affirm and that Agreement Act § 36 was applicable. Confer also cases printed in Rt 1991 page 220 and Rt 1935 page 122. The fact that the parties have tried, even unsuccessfully, to regulate their relation so that the lenders are entitled to real costs, seems to be a viable argument for the application of the Agreement Act § 36 if a situation occurs where lenders begin to take losses.

It is of course the parties themselves that must suffer the consequences of a financial crisis and a credit crunch. However, a well functioning credit market is of high public interest. The lenders using the Agreement will almost exclusively be large financial institutions, which if troubled can cause widespread disruptions to society in general. They are indeed subject to strict public regulations directed at securing sufficient capital. An interesting question in this context is whether it is acceptable or not to take the interests of society at large into consideration when applying the discretional Agreement Act § 36? This would lower the threshold of applications for larger banks. In our view the Agreement Act § 36 is a provision aimed at the relation between private parties, and that as the general rule considering the interest of society may not be done. In extreme cases, where the banking industry may be at risk of collapse, this may, nevertheless, form a valid argument.

It is not possible to form any general conclusion, but in our view, a borrower is more at risk than a lender to have an agreement revised subject to the Agreement Act § 36 due to extreme fluctuations in interest rates.

There is no doubt that interest rate regulation in the Agreement, which Norwegian agent banks and other financial institutions use in a large number of their facility loan agreements, functions satisfactory under all but the most extreme circumstances. In light of our findings, a few remarks are nevertheless in order. With regards to the borrowers, it is clear that they have a strong interest in ensuring that their position in cases of rate fluctuations is strengthened. The lenders on their side should provide for a more adequate regulation of the problems faced when unmatched funding takes place and when funds cease to be available in the interbank market in general.

About the author

Fred Litsheim is an associate with Kvale & Co, assigned to the banking and finance and M&A/corporate departments. His practice spans over several areas of law, with a core focus on financial law. He obtained his Master of Laws from the Faculty of Law, University of Bergen. He has written a graduate thesis on the financial crisis’ impact on prevailing standard loan facility agreements for banking consortiums.
Contact information

Fred Litsheim
Kvale & Co

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