Is a Participation Agreement a Security

The Loan Syndications and Trading Association, Inc. (”LSTA”) has published several participation agreements in standard form, but unlike derivative agreements used for multiple transactions on different products and governed by a framework agreement between a trader and a counterparty, LSTA participation agreements are structured as ”stand-alone” documents and do not contain cross-default or clearing clauses. As a general rule, the grantor does not have the right to offset an unpaid draw against the participant`s right to receive payments for other entries that the participant may hold under the grantor`s banner. Thus, in the context of an effective participation in the sale, the grantor sells an economic interest in the loan to the participant and, under the annex to the guarantee, the grantor withdraws a security right in the equity and the guarantee. The grantor would offset the proceeds from the sale of the loans and bonds, as well as the cash from the liquidation of the security account, against the amount owed by the participant to the grantor as a result of the participant`s failure to finance. To the extent that the total amount realized for all guarantees exceeds the amount due to the grantor, the excess would be paid to the participant. If the grantor is not supplemented by the use of the ancillary product, it would have a continuing claim against the participant for damages without compensation. Such a claim could include interest and costs and expenses (including attorneys` fees) incurred by the grantor in the auction of the terminated interest and the liquidation of the collateral account. The relationship between the lead lender and the participants is defined in an equity agreement or certificate reflecting the investment made by each participant, the interest rate and any other conditions related to the participation. The agreement should explicitly specify the obligations of the lead creditor, including: The grantor may have a claim for compensation against the participant for damages resulting from the participant`s breach of the participant`s financing obligation under the participation agreement, but the value of that unsecured contractual claim against an insolvent counterparty may be limited. A Loan Participation Rating (LPA) is a fixed-income security that allows investors to purchase portions of a loan or set of outstanding loans. LpN holders participate proportionately in the collection of interest and principal payments and are also exposed to a proportionate default risk.

Since a genuine participation in the transfer is structured as the sale of an economic interest in the underlying loans and obligations to the participant, the grantor does not have the right to unilaterally terminate the participation, even if the participant defaults on its financing obligations. Currently, the prevailing view in the courts is that there is no implicit fiduciary duty in agreements between sophisticated financial institutions. Lead lenders create equity agreements in the form of a buy/sell agreement that states that the lead lender transfers economic rights to the associated loan to the participants without creating an agency relationship. The lead lender will wish to include full exculpatory language in the participation agreement, which expressly states that it will not enter into any fiduciary duty to the participant(s). Agreements also generally require participants to acknowledge that they have conducted their own due diligence and reviewed all relevant credit documents. Since courts generally comply with the lender`s relief terms and limitations of liability, participants should be aware of the specific obligations that the lead lender owes them and conduct their own credit analysis independent of the debtor. Banks, credit unions or other financial institutions often enter into loan participation agreements with local businesses and may offer loan participation notes as a type of short-term investment or bridge financing. Participating lenders enjoy several advantages, including the ability to diversify their portfolios without having to shoulder the burden of underwriting and servicing loans.

However, despite these obvious benefits, there are somewhat discrete risks associated with buying and selling shares. These risks can cause significant problems if lenders do not identify and mitigate them immediately. This is a significant benefit of a properly drafted equity agreement – if an equity is treated as a genuine sale, it allows the grantor to remove the equity loan from its balance sheet. This agreement also benefits the participant by protecting its participation in the loan in the event of the grantor`s insolvency. .