Feature

posted 21 Dec 2009 in Volume 13 Issue 3

Review of the year

The final countdown (for 2009)

Nick Grandage counts down the top ten most frequently asked questions during 2009.

During 2008, the top-ten questions we were most frequently asked focused on Libor, the cost of funds and, not surprisingly, questions about borrower insolvency, security and enforcement – especially in the last quarter.

For 2009, the top-ten is more eclectic. Questions about Russia, Kazakhstan and Ukraine have featured for different reasons, but perhaps the most interesting one to come up was – what is trade finance? Not in an existential sense, but a practical one related to the major banking default in Kazakhstan and the argument over where the line between trade finance and other forms of financing ought to be drawn.

That, however, comes in at number six. In the spirit of the very best DJs, I’d like to count down Denton Wilde Sapte’s top-ten legal issues of 2009, starting at number ten…

10. Henry VIII and the Banking Act 2009
A lot has been written about governments’ increasing use of all-encompassing ‘enabling powers’ and statutory instruments to enable them to make orders that are every bit as far-reaching as standard legislation – but without the hassle of actually asking Parliament every time (and all the public debate that may entail).

Section 75 of The Banking Act 2009 not only grants the Treasury such rights, but also enables it to apply those powers retrospectively – what was an entirely lawful activity on Monday could be deemed unlawful and subject to legal action on Wednesday.

Applying law retrospectively is never a good idea: ‘ignorance of the law is no defence’ is a long-held legal principle in criminal law, but if the Treasury has the power to make and apply law retrospectively, who can know what the law actually is unless they enjoy the gift of prophecy?

9. Changes to the LMA standard documents
Most syndicated facility agreements are now based on the Loan Market Association (LMA) standard format document. A number of new terms were introduced this year:

The exceptions to the negative pledge have been widened to include set off and close-out netting arrangements in hedging transactions where they are entered into for:

i. Hedging any risk to which the company is exposed in its ordinary course of trading;

ii. The company’s interest rate or currency management operations in the ordinary course of business and for non-speculative purposes;

A ‘yank the bank’ clause whereby the borrower can repay (or replace) a lender to which it would have to make extra payments. Good credit borrowers have sought to extend this to include a right to repay or remove banks that do not consent to decisions;
Lenders may grant security over their rights to central banks as part of special liquidity programmes and as part of securitisations;
An express confidentiality undertaking on the lenders. For bank lenders this does little more than restate the position at law; and,
Provisions dealing with defaulting lenders and impaired agents.

Defaulting lenders are lenders that have failed to fund (or stated that they will not) or are insolvent. There are a number of effects, from cancellation of commitments to disenfranchisement and potential replacement. Similarly, impaired agents can be removed or bypassed, both for payments and information. These concepts have not yet worked their way into trade finance facilities.

8. Changes to Ukrainian finance laws
Ukraine has been a headache since the eruption of the financial crisis. The new Ukrainian finance laws are an attempt by the government there to tackle some of the challenges the country is facing.

Its key clauses include:

a. Foreign currency control regulations. The maximum term for the return by a Ukrainian exporter of foreign currency proceeds under export contracts after the export of goods has been reduced from 180 days to 90. Failure to comply will result in a fine of 0.3% for each day of delay. It is likely that it will be applied to contracts in effect when the new law came into force, according to Ukrainian law firms;

b. Debt acceleration prohibition. This new law will prevent the acceleration of payments by a Ukrainian obligor under foreign currency loan agreements with ‘non-resident lenders’. It also requires the National Bank of Ukraine to suspend registration of any supplemental agreements that have the effect of accelerating payment under existing loan agreements and forbids prepayments being made under existing loan agreements.

This not only forbids prepayments being made by a Ukrainian borrower, but also prevents the repayment of a facility by a Ukrainian borrower following an acceleration of the facility agreement (most likely after a default). The new law would not prevent lenders from exercising their acceleration rights under the facility, but may prevent the accelerated payment being made by the Ukrainian borrower.

7. Changes to Kazakh banking laws
Kazakhstan adopted new banking laws in the summer. They were the first of their kind adopted in the region and were implemented in response to the financial crisis.

However, there is no guidance from courts or the bank regulator. The law is also not clear on certain points and lacks detail, so current restructurings have had to fill-in the gaps to a certain extent. The regime is similar to a scheme of arrangement in the UK and is intended to follow the UNCITRAL model law.

Once two-thirds of the creditors approve the plan, it becomes binding on all creditors. This is intended to ease the process as it is no longer necessary to get the consent of each individual creditor.

The two-thirds is of all the claims, with no distinction between different creditor classes. The process is meant to be supervised by the court.

6. Changes to Russian security laws
In December 2008, Russia adopted amendments to the Russian civil code, which included laws relating to security. One of the key changes was the newly introduced out-of-court enforcement procedure for mortgages (pledges of immovables) and pledges (pledges of movables).

Before the changes, lenders could only enforce mortgages by obtaining a decision of a Russian court. Lenders could agree out-of-court enforcement with the pledgor for pledges of movables, but for both mortgages and pledges the secured asset could only be sold by public auction under the Russian civil code.

The amendments allow the possibility of enforcement by other methods, such as transfer of ownership, direct sale or public auction arranged by the lender, all without getting a court order. It is necessary to agree with the pledgor that enforcement may be made this way and documents made before the new law will need to be amended if the lender wishes to take advantage of its terms.

Enforcement is still not straightforward – notice to the debtor is required, the debtor has a right to petition the court in the event of a dispute about the procedure and it is unclear whether the parties can set out more than one out-of-court procedure giving the lender a right to choose one when the time for enforcement comes¹.

5. The meaning of ‘trade finance’
What is the meaning of trade finance? This has been debated vigorously this year because in a restructuring, genuine trade finance debt is normally given priority. It is important to note, however, that no legal system gives priority to trade finance debt as a matter of law on the liquidation of a borrower.

On a liquidation, debt ranks equally irrespective of whether it is trade finance or anything else. However, what is ‘trade finance’ may be important in the context of restructuring, in particular a bank restructuring, where continuing operations may require trade finance debt to continue. The best example is letters of credit (LCs) issued by a bank. There is no definition at law, but here is the definition adopted in a recent restructuring:

All documentary letters of credit issued by the Bank;
Any discounting of documentary LCs issued by the Bank and promissory notes issued as part of deferred payment documentary LCs of the Bank;
The refinancing of the Bank’s liability under a documentary LC issued by it on the basis that such refinancing was specifically related to such documentary LC and there was an underlying trade transaction; and,
The provision of finance to the Bank in respect of the financing of a specific import or export where such financing was specifically tied to that underlying trade transction.

This definition would, therefore, exclude financing for working-capital purposes, including ‘trade-related debt’, where there was no specific underlying import or export trade transaction; standby LCs and letters of guarantee; and, any debt where the underlying trade transaction does not involve the import or export of goods to or from the country of the bank.

There is no right or wrong answer to this question and the answer will depend upon the attitude of creditors and the importance of trade finance to the viability of that bank.

4. Independent nature of trade finance instruments
Enka Insaat Ve Sanayi A.S. v. Banca Popolare Dell’Alto Adige SPA

This case reminded us of the law about when a bank can refuse to pay under an instrument, such as a LC or demand guarantee, and reaffirmed that the test is a very difficult one to meet. It concerned performance bonds issued by banks to support the obligations of construction contractors. The wording was normal and echoed wording commonly seen in standby LCs and demand guarantees.

The bank, however, refused to pay on the basis that they were made fraudulently (as the demands complied with the terms of the performance bonds this is the only basis they could refuse to pay). It was clear that Enka had not sought to quantify its losses for the breaches of contract that resulted in the claims, nor considered this when making the claims. It had simply claimed in accordance with the terms of the bonds.

The banks argued because Enka was making claims based on breaches of contract without considering its losses, this amounted to a fraudulent claim.

The court treated the performance bond like a LC. It is well-established law that a bank can only refuse payment under a letter of credit (assuming conforming documents are presented) if there is clear and compelling evidence of fraud. Here the court held that it made no difference whether Enka had considered what losses it might have made. The terms of the guarantee were met and it declined to look beyond this.

3. Changes to URDG and Incoterms
URDG [Uniform Rules For Demand Guarantees] 458 was published in 1992. It was a compromise and so, unfortunately, pleased no one.

It is rarely used in the UK (perhaps for about 2% of demand guarantees issued out of UK branches), but it is more popular in some countries, such as Sweden. The reason for its general unpopularity is Article 20. Here, even if the guarantee wording requires only a simple demand to make a claim, the beneficiary must present a statement of breach as well. The revision will come into force on 1 July 2010.

Making a guarantee subject to a set of rules is a legal shortcut:

anything the rules deal with, you do not need to set out in your guarantee. The new rules have more to offer because they are much more comprehensive. There are 35 articles as opposed to 28 under 458 and the articles in the new revision are more extensive, so it is four to five times longer than 458, as well as having 11 articles dealing with points not covered by 458.

The new revision of URDG did not receive universal approval among members of ICC UK’s Banking Commission, but even those not entirely happy with it agreed that it is much better than 458.

Because it now deals clearly with several issues of concern to banks and offers more certainty and protection to all parties involved in a guarantee transaction, there are some strong arguments for using it.

Incoterms 2010 will replace Incoterms 2000 in Autumn 2010. These are a set of ICC three letter codes, each of which is short-hand for a set of delivery terms that specify details, such as what modes of transport will be used for delivery, which party is responsible for arranging the transport, which party is responsible for insuring the goods and so on.

2. The zombie-like qualities of the Slavenburg register…
The Slavenburg register – named after a court case in 1980 – has long been an embarrassing quirk of English law. Companies incorporated in the UK must register most charges they create at Companies House within 21 days of their creation. Yet what should happen with a company not registered in the UK: must it register charges?

The Companies Act 2006 states that a company must register charges over property in England and Wales if it has an established place of business in the country. Unfortunately, the register is not conclusive, so if your Mongolian metals producer has set up a branch in the UK and not told anyone, then technically you had to register the charge within 21 days.

And registration of the charge could not be made if Companies House had no record of the borrower. Following the decision in the Slavenburg case, when you tried to register you got a polite letter back from Companies House telling you that, if by any chance such a place of business exists, they would treat your charge as having been registered in time.

This lunacy should have ended on 1 October 2009, when the Overseas Companies (Execution of Documents and Registration of Charges) Regulations 2009 introduced a single regime for registration and filing for overseas companies that set up a place of business, including a branch, in the UK.

The regulations set out when a charge or mortgage will be registrable: briefly, assignments under English law contracts and charges of bank accounts in the UK are likely to be registrable, while pledges are not.

It is a serious issue. Failure to register a registrable charge or mortgage will make it void against a liquidator of the company, an administrator of the company and any creditor of the company.

However, the issue refuses to die because section 1048 of the Companies Act 2006 also enables an overseas company to register in the UK with an alternate company name. That name is treated as the company’s name “for all purposes” – so if the borrower has registered with a different name then the search of the legal name will not reveal it.

Back to square one. Our recommendation is that:

The borrower is required in the facility document to state whether it has a UK place of business;
The register is searched with the legal name (you can search for a single word which will pick up all registrations with that name); and,
No attempt to register is made if the search reveals no place of business.

1. Mercury and the execution of documents
R (on the application of Mercury Tax Group and another) v. HMRC

Mercury ran a tax avoidance scheme for several clients, but the Revenue suspected that it had dishonestly carried out the scheme. Clients had signed key documents, intended to take effect as deeds, in draft. Mercury had then transferred the signature pages to the final versions of the documents, which contained different details (and subject matter).

Mercury argued that this was standard practice and did not prevent the deeds being effective.

The court decided that the transfer of signature pages from an incomplete version of the deed in question to a later, complete and amended version, was ineffective. The judge commented that a document to be signed “exists as a discrete physical entity … at the moment of signing” and that “signing an actual existing authoritative version of the contractual document gives some … protection against fraud or mistake”.

This raised questions about how effect could be given to deals in ‘virtual closings’ and led to the formation of a working party of sub-committees of the Law Society and the City of London Law Society.

The working party prepared guidance, approved by Mark Hapgood QC, on how to execute documents at a virtual closing. It remains best practice to produce counterpart original documents at closing, particularly where documents are to be registered, and where documents are deeds, as most English law security documents are. PDF signature pages may be circulated as evidence of the signature on the original documents.

If closing is to take place virtually, the following represents best practice. The signatory:

Receives an e-mail with the Word or PDF attachment of the final form of the document to be signed;
Prints out the signature page;
Signs the signature page with a ‘wet ink’ signature;
Scans the signature page into the computer to produce a PDF file;
Sends an e-mail to the lawyers coordinating completion attaching:

The Word/PDF attachment of the final version of the document;
The PDF of the signed signature page;

The PDF/Word counterparts of all the parties to the document will together form a signed ‘electronic’ original.

Nick Grandage is a partner at Denton Wilde Sapte, specialising in trade and export finance in the emerging markets. He can be contacted by e-mailing nick.grandage@dentonwildesapte.com

This article is based on a seminar presentation by Grandage. For more information about Denton Wilde Sapte’s trade finance seminar programme for 2010, please e-mail deborah.shell@dentonwildesapte.com

1. For a comprehensive briefing note about Russia’s new security laws, please e-mail Deborah Shell at the address above.