Short & Sweet – Direct Agreements between Lenders and Borrowers' Counterparties
So called ‘direct agreements’ in the context of debt financing, has the main purpose of establishing a direct contractual relationship between a lender and the borrower’s counterparties for the purpose of enabling the lender to gain control over the borrower’s contracts.
Direct agreements are most common for project financings and other facilities where the value of the assets being financed at large depend on the borrower’s contracts. Examples are e.g. direct agreements for all major contractors and counterparties for a project financed wind farm or for the bareboat charterer of an asset/term loan financed vessel.
A typical direct agreement has key elements such as:
- The contractual counterparty acknowledges any security interest the lender has in the contract (often assignment of monetary claims) and undertakes to inform the lender of contract defaults and occurrence of certain other events
- The lender is given an option to remedy a borrower’s default under the contract within a certain time period and on certain conditions, in effect prohibiting the contractual counterparty from terminating the contract without giving the lender the chance to remedy
- The lender is upon the borrower’s default under its loan agreement given options to (through a nominee) step-into the contract for a short-term period or replace the borrower (for a definitive long term period) by entering into parallel identical contracts with the contractual counterparty
Direct agreements are important for Norwegian transactions as Norwegian law generally does not allow security over contracts and since bankruptcy trustees have a statutory right to accede to the bankrupt companies’ contracts (dekningsloven 7-3).
Attempts to bypass this legislation by establishing accession or transfer rights for the lender is quite likely to be set-aside as an invalid attempt on creating a contract assignment, and if found invalid the agreement is not binding for neither the parties nor third parties affected by the assignment (such as bankruptcy trustees). Due to this, it is important that Norwegian direct agreements are carefully worded and clearly establish a parallel regime, i.e. a right for the lender to enter into new contracts rather than replacing the borrower in existing contracts.
Direct agreements establishing a lender’s parallel contractual regime does not legally prohibit a bankruptcy estate from acceding to the bankrupt borrower’s contracts. However, if the direct agreements are accompanied by valid security over the borrower’s material assets, it is not practical and with little value for the bankruptcy estate to make use of its accession right.
In an enforcement scenario, enforcing direct agreements and security over the borrower’s assets is often the alternative approach to enforcing pledge over the borrower’s shares. By enforcing direct agreements and asset security, the assets can be sold on detached from the borrower, as oppose to sale of the borrower’s shares where the claims and other legal relations of the borrower remain.
We work on a day-to-day basis with transactions involving direct agreements and are happy to answer any further questions you may have.