By Erlyne J. Nazaire, Senior Legal Editor, Practical Law Finance
Cross-border loan transactions present a great opportunity for United States (US) lenders. But these transactions are not without risk. This list, while not exhaustive, highlights issues that US lenders must consider when engaging in cross-border loan transactions. When extending a loan to a foreign corporate borrower, lenders should:
1. Engage Knowledgeable Local Counsel
Lenders should consult with local counsel early in the process to ensure the transaction is properly structured and enforceable under local law. Failure to engage local counsel in a timely manner may result in added costs and time spent restructuring the transaction. Local counsel can also provide invaluable insight on the political, legal and judicial culture in the jurisdiction, which may facilitate the transaction. For more information on selecting local counsel, see Retaining Foreign and Local Counsel Checklist.
2. Analyze Local Economic and Political Conditions
Political and economic conditions in the borrower's jurisdiction may adversely affect the borrower's ability to repay the loans and the lenders' rights under the loan documents. While it is impossible for lenders to prepare for every eventuality, thorough due diligence minimizes surprises and enables the lenders to be proactive in protecting their rights. This analysis should include an evaluation of:
- The government's views of foreign investments, including whether it has implemented procedures and programs to attract or promote foreign investment. Whether the government has expropriated or threatened to expropriate foreign property or assets. The jurisdiction's social structure and any divisions in the social fabric that may erupt in demonstrations against foreign investors.
Lenders should not confuse political or regime stability with an absence of risk or issues. Apparent stability may mask deep-rooted social and political divisions that could have an adverse effect on the lenders and their rights under the loan documents.
Lenders and their counsel should manage the due diligence process so that it is commensurate with the borrower's jurisdiction and the size, nature and structure of the loan transaction. For more information on these issues, see:
- Practice Note, Expropriation in International Investment Law.
- Practice Note, Political Risk Insurance: Is it Necessary?
- Practice Note, What Lenders Need to Know About Political Risk Insurance.
- Article, Political and Security Risks: Reflecting on 2013 and Looking Ahead to 2014.
3. Analyze the Legal Regime
Understanding the legal regime helps lenders manage their expectations when negotiating or enforcing their rights under the loan documents. It also helps the lenders make informed decisions about dispute resolution, governing law and other related matters. As part of this analysis, lenders should, among other things, evaluate whether:
- The local bar is familiar with foreign loan transactions. A foreign party can get a fair hearing in the local courts. The local courts will recognize and uphold foreign judgments.
For more information on these issues, see:
- Practice Notes, Why Arbitrate?
- Practice Note, Loan Agreement: Cross-border Provisions.
- Standard Clauses, Loan Agreement: Cross-border Provisions.
4. Understand the Legal Culture
US practices have been migrating into and affecting the legal cultures in many other jurisdictions. Jurisdictions that have historically used relatively short documents because the parties rely on the country's commercial or other relevant codes to fill in the blanks now often use US style agreements, where every issue (to the extent possible) is addressed in the documents, resulting in very long and complicated agreements.
Lenders and their counsel should be aware of and be sensitive to different local practices. This should not be dismissed as mere political correctness. Failure to be sensitive to local mores could upset the balance of negotiations or scuttle the transaction entirely. In addition, lenders should not assume that:
- Legal terms or jargon used in US transactions have the same meanings in the borrower's jurisdiction. Provisions that are customary or market in US transactions will be acceptable in the borrower's jurisdiction.
For more on these issues, see Practice Note, Cross-border Lending: Preliminary Considerations Checklist.
5. Know the Borrower
Lenders typically conduct legal due diligence on the borrower to identify the borrower's assets and liabilities and assess its ability to repay the loans. When making loans to a foreign borrower, this due diligence must go further and include a review of the laws and regulations that may apply to the loan transactions and the lenders' activities in the foreign jurisdiction.
US lenders are subject to various regulations that require them to verify the identity of their customers and ensure they are not extending financing to:
- Terrorists, criminals and other parties deemed hostile to the US. Persons listed on the Office of Foreign Assets Control's Specially Designated Nationals and Blocked Person's List. Persons engaged in money-laundering activities.
While these issues are also relevant to US borrowers, they are even more acute for foreign borrowers whose ownership structures and business operations may be less transparent. The borrower's jurisdiction may also have looser regulations (if any) regarding these matters.
Lenders that fail to comply with these provisions may be unable to enforce their rights under the loan documents. They may also be subject to fines and penalties, criminal liability and revocation of their bank charter.For more information on these regulations, see Practice Notes:
- OFAC, USA PATRIOT Act and other Anti-Terrorism Regulations Relevant for Lenders. US Anti-money Laundering and Trade Sanctions Rules for Financial Institutions. USA PATRIOT ACT and Know Your Customer Requirements for Lenders.
6. Implement Anti-Corruption and Anti-Bribery Procedures
Corruption poses a significant legal and economic risk for companies doing business in many foreign jurisdictions. Lenders typically include representations and covenants in the loan documents regarding the US Foreign Corrupt Practices Act of 1977 (FCPA) and other similar statutes to regulate the borrower's activities. They must also ensure that none of their representatives, employees, advisors or counsel engages in any activity that may be perceived as a kickback or a violation of the FCPA and other applicable laws.
- Be familiar with the annual Corruption Perceptions Index published by Transparency International to assess the scope of the corruption risk. Educate their representatives on their anti-corruption manuals and procedures. Implement procedures for learning about their agents' and representatives' practices when dealing with government officials to ensure they are in compliance with the FCPA.
For more information on the FCPA, see Practice Note, The Foreign Corrupt Practices Act: Overview and Foreign Corrupt Practices Act Compliance Checklist.
7. Evaluate the Transaction's Legal Risks
Legal risk, broadly defined, includes risks that can undermine or prevent the lenders from being repaid the full amount of their loans. An important part of any foreign loan transaction is ensuring that a court in the borrower's jurisdiction will give effect to the provisions of the loan documents and protect the lenders' interests. Lenders should consult with legal counsel to understand:
- The legal process in the jurisdiction, including whether any suits must be brought in a special court (for example, a commercial court) and how long it generally takes for a suit to be resolved. Whether, and the conditions under which, the local courts will enforce a foreign judgment, including whether they will re-examine any of the facts of the case and how long it takes to enforce a judgment.
For more information on these risks, see Practice Note, Loan Agreement: Cross-border Provisions and Standard Clauses, Loan Agreement: Cross-border Provisions.
8. Understand Any Security Interest and Guarantee Limitations
In a financing with a US borrower, the lenders often obtain a security interest in all of the borrower's assets, subject to limited exceptions. Creating and perfecting security interests in the US is relatively easy and inexpensive. However, in some jurisdictions:
- The category of assets in which the lenders can obtain a security interest may be limited. Perfecting the security interests in all of the borrower's assets may be expensive and time-consuming. The entities that can grant a security interest to the lenders to secure the borrower's obligations may be restricted.
Lenders should make sure they understand the mechanics for attaching and perfecting a security interest in the collateral in the borrower's jurisdiction. They should also understand any limits on their ability to take possession of and sell the collateral. For more information on these issues, see Practice Note, Security Interests: Cross-border Issues.
In addition, the obligations of US borrowers in syndicated loan transactions are often guaranteed by some or all of their subsidiaries. While downstream and cross-stream guarantees may be subject to increased scrutiny under US bankruptcy laws, they are generally enforceable. However, these guarantees are limited in many jurisdictions. Lenders should consult with local counsel on these issues. For more information on guarantee restrictions, see Practice Notes, Security Interests: Cross-border Issues and UK Financial Assistance.
9. Engage in Tax Planning
Interest payments to US lenders from a foreign borrower are subject to a withholding tax, and lenders are typically grossed-up the full amount of any taxes required to be withheld. These amounts can be significant and have a material impact on the transaction. Lenders should discuss with their tax and legal advisors the mechanisms that can be employed to make the transaction tax efficient, including any tax treaties and other bilateral agreements that may be available. For more information on these issues, see Practice Note, US Income Tax Treaties.
10. Identify Available Investment Treaties
The US is a party to many bilateral and multilateral investment treaties that establish the terms and conditions under which citizens of the signatory countries can invest in one another. These agreements are intended to promote investment and ensure the investments and assets of their nationals are protected. These treaties generally:
- Require the local government to treat US investors and their eligible investments as favorably as it treats its own investors and their investments or investors and investments from any other country. Set clear limits on the expropriation of investments and provide for payment of prompt, adequate and effective compensation when expropriation takes place. Provide for the transferability of investment-related funds in and out of the country immediately and using a market rate of exchange. Give investors from each party the right to submit an investment dispute with the government of the other party to international arbitration.
Lenders should discuss with counsel whether these treaties exist for the borrower's jurisdiction and how they can take advantage of them.
For more information on these treaties, see Practice Note, Securing Investment Protection for Foreign Direct Investment and Expropriation in International Investment Law.