Hardening Periods: Some practical considerations

Refinancing a loan

In circumstances where a loan is to be entirely refinanced, a new loan agreement is entered into by the lender and borrower and a new set of security documents will usually be drawn up. If this is the case, the new security documents will have their own hardening period, effectively re-starting the clock on the security’s validity.

Conversely, if a loan is amended or amended and restated, it is typical that the existing security package will be maintained. As such, the relevant hardening period will run from when that initial security was taken and, provided the appropriate period has passed, the security could very well be immune to challenge. However, whether this security is sufficient for a lender’s purposes will also depend upon whether the definition of ‘secured liabilities’ found in the relevant finance documents is drafted widely enough to incorporate all future debts owing to the lender, rather than only the original loan agreement. This is because security linked to the narrow interpretation of the drafting will only secure debt created under that specific loan agreement and, therefore, will not be relevant to any further loan amounts advanced.

These two situations demonstrate why careful consideration needs to be taken when deciding how to structure a refinance. A refinance or amendment may be undertaken for benign reasons, but often such decisions are taken by virtue of a borrower facing some kind of issue on repayment. If this is the case, lenders should seriously consider how likely it is that the security they are offered may be set aside at a later date and to structure a deal to avoid any later question from an insolvency practitioner. This is particularly relevant to situations where a lender wants to take additional security but, because of doubts regarding the borrower’s ability to repay, is reluctant to provide any additional funds, considering the discussion on the avoidance of floating charges in the previous article on hardening periods.

Drafting protection

One way in which lenders can be protected to an extent on a refinancing situation would be to include wording in the finance documents to the effect that if security was to be set aside, or money was to be clawed back by an insolvency practitioner following the selective repayment of a loan, then the lender would preserve its right to enforce its security from a third party obligor. This, clearly, will only work in situations where there is third party security, such as a guarantee or charge over shares (as any security granted by the borrower will be liable to be set aside by the insolvency practitioner). It would also be prudent to include similar wording in any deeds of release granted to third party obligors, with the effect that such release will be cancelled if any security/repayment from the borrower is successfully challenged by an insolvency practitioner during the relevant hardening period.

Secondary Trading

If you saw our recent article on secondary trading, you will be aware that lenders are permitted to trade loans once they have been entered into (subject to the terms of the loan in question). When trading loans, the typical method of transfer is novation which enables the incumbent lender to transfer both the benefit and the burden of the loan. In such circumstances a clean break will be achieved and the incoming lender will gain a right to repayment of the loan, together with any interest, and take the benefit of any security created under the loan. However, the new lender will also shoulder the potential liability associated with the insolvency practitioner’s power to set aside the security created if one of the transactions described in the first article on hardening periods is found to have occurred.

Novation will effectively cause the original finance documents to be cancelled and retaken.  As such, the hardening period associated with the security will start afresh. Incoming lenders in bilateral facilities, therefore, should be mindful that they will be liable for any security set aside and will have to contend with such security being open to challenge for a period of anywhere between six months to two years. In practice, however, this issue of the hardening period restarting may not present an insurmountable obstacle considering the market for traded debt is typically dominated by syndicated loans. Such loans will usually utilise a security agent who will enter into the relevant security documents on behalf of the various lenders. Given that the lenders are not party to these security agreements, novation of the loan will not have any effect upon them, meaning the security will continue untouched and the hardening periods will not start over.

Conclusion

Lenders will need to be wary of the potential for security to be set aside, and should be particularly careful when deciding how to structure any potential refinance to take into account how this may impact the hardening periods for security.

Please do not hesitate to contact our Banking and Finance team if you have any questions on the content of this article, or if you require any assistance when drafting documents to take into account hardening periods.