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LMA Real Estate Finance Documentation Update

01 August 2012

Allen & Overy advises the Loan Markets Association (LMA) on the new Single Currency Term Facility Agreement for use in real estate finance multi-property investment transactions.

By Mark O'Neill,  Partner,  Allen & Overy

On 23 April, 2012, at the LMA’s early evening seminar held at Allen & Overy’s London office, the LMA launched the
latest addition to its primary documents: a Facility Agreement for real estate investment transactions in England, Wales and Scotland. This article provides an overview of the new Agreement and some of the key issues raised and discussed during the development process.

The working party

During the early part of 2011, a number of the participants in the London real estate finance market came to the conclusion that there would be a benefit in having access to a facility agreement that reflected current ‘market practice’.
The Agreement is the result of the hard work and commitment of representatives of some nine banks and eight law firms active in the UK real estate finance market and the LMA. The banks were Barclays, Deutsche Pfandbriefbank, Deutsche Postbank, Eurohypo, HSBC, Lloyds, RBS, Santander and Societe Generale. In addition to Allen & Overy, the law firms were Addleshaws, Burness, BLP, Cameron McKenna, Clifford Chance, DLA Piper and Simmons & Simmons. The Commercial Real Estate Finance Council (CREFC) was also represented.

The assumptions

The Agreement assumes the following:
  • a single currency term loan facility;
  • corporate borrowers and guarantors incorporated in England and Wales;
  • properties located in England, Wales or Scotland;
  • the transaction structure is as illustrated in the diagram below;
  • the loan is provided on a floating rate basis with interest rate hedging provided separately (guidance is give in relation to fixed rate loans);
  • the Hedge Counterparties are parties to the Agreement to regulate the relationship between the Finance Parties and to allow the Hedge Counterparties to benefit from the security;
  • the facility is used for investment in a portfolio of properties rather than for development and assumes a portfolio of properties rather than a single property;
  • the financial covenants consist of historic and projected interest cover covenants and a loan to value covenant;
  • security is granted over the assets of the holding company and each property-owning borrower, and over the shares in the holding company; and
  • any debt provided by the sponsor is subordinated, and security is granted over that subordinated debt.

Unlike in most other areas of commercial finance, in real estate finance, although the use of companies is common, we also see the regular use of partnerships, limited partnerships, limited liability partnerships and unit trusts, as well as combinations of these vehicles. The Agreement assumes that the vehicles will be companies – this is still the most common structure and allowed closest alignment of the Agreement to existing LMA templates.

The changes that would need to be made for other vehicles, whilst time consuming, are not particularly controversial – and could possibly be the subject of a future project. The roles of the Agent and the Security Agent have been separated to cater for the possibility that these roles are filled by different parties. This will not be a requirement for all transactions.
The provisions dealing with the appointment of each agent are taken from the LMA investment grade facilities agreements (for the Agent) and the leveraged finance intercreditor agreement (for the Security Agent)
  • in future there may be scope to combine these provisions.
The financial covenants included in the Agreement reflect those that appear most commonly in real estate investment financings. As with other aspects of the Agreement though, these will need to be considered on a case by case basis, as covenants frequently require crafting to meet the particular requirements of a transaction and other covenants, such as debt service, debt yield and weighted average lease term, are not uncommon.
Bank account mechanics tend to vary from transaction to transaction. The Agreement provides a framework for one structure, but it is expected that it can be readily adapted for specific transactions. It will be necessary for the user of the document to draft security documentation separately.
 

Relationship with other LMA primary documents

A number of provisions will appear in a credit agreement, whatever the market, and are often referred to as ‘boilerplate’. Significant provisions in this category, which are often the subject of considerable negotiation, include interpretation, tax gross up and indemnities, increased costs, other indemnities, mitigation, costs and expenses, guarantee and indemnity and role of the Agent and Arranger.
The agreed approach for the Agreement was that the boilerplate would, where appropriate, follow the form in the existing LMA primary documents. There were some issues to be overcome in using this approach, for example:

the investment grade facilities agreement is an unsecured document, and the leveraged finance facilities agreement contain security agent provisions;
  • some provisions considered boilerplate in the investment grade or leveraged market are not viewed in the same way in the real estate finance market; and
  • the boilerplate includes provisions that users may consider more detailed than would be typical for a real estate finance transaction.

What is market practice?

The Agreement aims to reflect what is accepted as the market practice today, and this led to some interesting debate between working party members. These issues tended to arise in two areas:
  • first, approaches to documentation develop over time. In some cases, some members felt that certain approaches had become market, whilst other members disagreed;
  • secondly, various lenders (and, indeed, borrowers and sponsors) have their own policy points, which of course they would like to see  reflected in documentation.
In both cases, provisions were included as standard only if there was general agreement that they reflected market practice. In some cases, where a consensus could not be reached, that is addressed by leaving the drafting open and, in others, by way of footnotes.
 
Trends appearing in the market, including changes to the rights of hedge counterparties and the use of LMA drafting options such as restrictions on debt purchase transactions, alternative financial covenants and covenant cure mechanics, were debated in this context, but the general consensus was that they were something to be dealt with on a case by case basis.
 
Even where the inclusion of a provision may be considered market practice, details may vary considerably from transaction to transaction. Although the Agreement provides a framework, we expect that its provisions will need to be tailored.

Benefits

The Agreement represents a first step towards bringing a greater degree of standardisation to the documentation used in this market. There are a number of reasons why this is beneficial, and three that are particularly important are
  • Efficiency – from a conceptual perspective, the more standardised the documentation, the more time that can be spent on those aspects of the transaction that are important to the participants.
  • Supervision – whilst most lenders will have existing house views on documentation, their ability to control this is somewhat limited insofar as they are involved in syndicated loan transactions – particularly if the lender concerned is not an arranger. So a document more generally accepted in the market place should help.
  • Loan book management – we have seen recently a good deal of focus by lenders on managing their loan books. Frequently this has involved selling off loan books or using loan books as collateral, either for central bank or private sector funding initiatives, and these processes are made more efficient, and potentially enhance the portfolio, where there is a greater degree of consistency in the product.
The Agreement is intended as a starting point for negotiation. Individual parties are free to depart from its terms and will be expected to do so given the wide variety of transactions that may be documented using the Agreement as a base. Although it is anticipated that lenders and borrowers with existing documentation may choose to continue to use that documentation, there is a perception that lenders are looking to bring documentation to a standard more reflective of the current market. It is hoped that over time, market participants will see the benefits of a more homogeneous approach.

This article first appeared in the LMA's July 2012 Newsletter.