Best practices for complex multi-jurisdictional collateral

Author: | Published: 21 Mar 2016
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When creating complex multi-jurisdictional collateral arrangements, managing teams and reconciling legal regimes is half the challenge

As credit markets tighten and volatility remains a feature of cross-border credit markets, lenders are requiring borrowers to pledge more collateral. At the same time, corporations are expanding their international reach – both in terms of geographic coverage and asset diversity. These realities have made the collateral agent's role more complex and places a premium on the negotiation and execution of complex multi-jurisdictional security packages. There are, in essence, four aspects of best practice to keep in mind.

1 Negotiate standalone security documents

To the extent possible, which will depend on the relative negotiating strength of the collateral agent, security documents should be drafted so they each function as a standalone document. It may appear to be duplicative for each of them to include provisions from the umbrella agreement that might be more efficiently handled by cross-referencing (for example, indemnity rights, costs and fees, consequential losses, collateral agent's retirement and waiver of immunity). But it is imperative that the applicable provisions are enforceable and function to protect the collateral agent as expected under local laws.

By simply-cross referring to the umbrella agreement, the collateral agent risks involvement in an enforcement scenario where courts in the jurisdiction where the collateral is located fail to interpret the foreign law-governed umbrella agreement's provisions as expected. For example, not all jurisdictions recognise the concept of mortgagee in possession. Therefore, to provide the collateral agent with appropriate comfort in respect of any necessary administration of the security package, the collateral agent (through its international counsel working in conjunction with local counsel) should avoid cross-referencing the umbrella agreement. Instead, each security document should directly set forth these provisions. This has the added benefit of forcing local counsel to take a view on each provision, reducing the potential for these provisions to be declared void or to negatively impact the collateral agent under local laws.

2 Understand limitations driven by local law

Multi-jurisdictional security packages often cover a wide range of very diverse jurisdictions. This requires collateral agents to engage a broad group of local counsel, including some that may lack experience drafting and negotiating transaction documents required to function seamlessly under a complex umbrella agreement. They need to be managed and coordinated by experienced international counsel, so that the local security requirements and practice dovetail with the umbrella agreement and meet the collateral agent's institutional expectations as well as the transaction timeline.

Time management is key to successfully orchestrating these deliverables in such a transaction. The collateral agent and its counsel must build in sufficient lead time to negotiate opinions with local counsel. Each opinion must cover not only corporate opinions related to the borrowing entities incorporated in such jurisdiction, but also the security pledged and foreign law-governed security documents to which a locally-incorporated obligor is contracting. For example, if a Barbadian entity pledges New York shares under a New York law-governed share charge, this will require two opinions. First, the New York opinion must cover the enforceability of the share charge. Second, the Barbadian opinion must cover the incorporation, good standing, due authorisation and execution, filing requirements in Barbados (if any), and also the enforceability of the share charge. In short, the collateral agent must be comfortable that the share charge, while governed by New York law would be enforceable in Barbados against the Barbadian entity.

"As the security package becomes more complex, the number of opinions quickly multiplies"

As the security package becomes more complex, the number of opinions quickly multiplies. Some firms may prefer giving so-called clean registration opinions, which may only be delivered a few days after signing and once all registration and filing requirements have been completed. Post-closing registration and filings often require originals to be presented to the relevant authorities along with additional paperwork such as the register of charges. It would also be prudent for the collateral agent to request local counsel to run preliminary searches, subject to cost considerations, to ensure there are no last minute surprises such as previously registered charges over the collateral or a winding-up order against the obligor.

Additionally, the collateral agent and its counsel must recognise that as the jurisdictions increase, the complexities (and logistics) surrounding execution of the security documents also increase. For example, one jurisdiction may require execution be completed and witnessed in a specific jurisdiction while others may be silent on the location where execution occurs. Alternatively, some may require documents be signed and kept outside of the jurisdiction due to stamp duty implications. Or, one jurisdiction may have timing requirements around execution driven by filing rules, requiring close attention to the timing of the execution of certain security documents. Physical signing meetings pose logistical challenges that must also be kept in mind. For example, the officer signing on behalf of the contracting entity may not under local law have authority to sign on behalf of the contracting entity, which could require a new power of attorney to be granted and for it to be notarised, consularised and sent to the place of signing in advance. While paying attention to execution requirements is a typical task for any transaction, when it involves a complex multi-jurisdictional security package this task takes on paramount importance.

All ancillary documents, such as title deeds, must be delivered in original to the collateral agent at closing or immediately thereafter. This requires significant coordination and timely collection of originals from obligors by each local counsel. Where possible, local counsel should be requested to provide a summary of registration and filing requirements and a checklist of ancillary documents to be provided to the collateral agent at closing.

The collateral agent and its counsel will benefit from taking the time to map the entire process – from negotiation of the security documents, to opinions and execution – on a Gantt chart or similar project management schedule. As the myriad of jurisdictions, each with its own requirements, constantly increases, it can be a colossal task to manage the process without such chart or schedule. Mapping the time constraints will aid the collateral agent and its counsel in meeting all deadlines.

3 Negotiate form security documents

One way to ensure consistency across the security package is for international counsel and the collateral agent's counsel to negotiate a form document for each security class to be included in the package. Then, local counsel negotiate variations thereof taking into account local law requirements. As collateral agents often require their counsel to review security documents against provision grids (in addition to the overall legal reviews), this underlying consistency will increase efficiency as the collateral agent's counsel will not need to spend unnecessary time ensuring key provisions are included in each local security document.

4 Expect the unexpected

The larger the security package, the more important it is for the collateral agent to expect the unexpected. As the package grows, so does the unknown. One thing the collateral agent should look out for is the fact that not all jurisdictions allow for future secured creditors to benefit under a pari passu collateral sharing arrangement. In this scenario, the collateral agent's preference should be to create subsequent ranking charges each time future indebtedness is required to benefit from the shared collateral, instead of releasing and retaking existing security which, in most jurisdictions, will cause the hardening period to restart. In addition, release and retaking of collateral requires an evaluation of the provisions of release under documents governing the secured debt and security documents – a process which, in itself, can be complex, costly and time consuming.

Other unexpected variations or surprises include new security being added late in the negotiation process, belonging to an asset class not previously contemplated or being located in a new jurisdiction. Collateral agents typically require internal approvals before taking security over certain asset classes such as land mortgages, or they may require approvals for taking security in particular jurisdictions. For example, most collateral agents will be unable to take security directly in China, Indonesia, India, or Vietnam. Some jurisdictions require the contracting entity be locally incorporated or the collateral agent may require one of its local affiliates act as the contracting entity, in which case there will be additional internal processes to be completed and know-your-client checks to be performed. Moreover, the entrance of the newly added security may be as late as the day before the transaction's scheduled signing or even weeks after. The collateral agent's counsel must remain agile throughout the negotiation and execution process and keep open dialogues with the borrower's counsel and local counsel, which will hopefully lead to the collateral agent's counsel being informed about any new security as soon as possible. When an unexpected local law issue is uncovered, the collateral agent must act quickly in conferring with local counsel.

By Mayer Brown JSM partner Thomas Kollar and counsel Nishrin Hussain in Hong Kong, and Mayer Brown associate Stephanie L Mills in Chicago. The authors thank Mayer Brown partner Jason T Elder for his contribution to this article