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Select clauses in syndicate finance arrangements

Financial covenants

Financial covenants are not inserted in investment agreements – which merely include points on which investors’ vote is required to undertake specific business activities. Financial covenants are inserted in a loan transaction to ensure that the borrower meets financial standards. The purpose is to protect the interest of the lender – a business will have the ability to repay only if it maintains a certain amount of equity, profits or cash flow which correlates to its expenses or loans. Disproportionate expenses or loans will adversely impact its ability to run sustainably or meet its obligations. Financial covenants are typically accounting ratios (the exact definition of a specific ratio could be customized depending on the nature of the transaction) and enable lenders to specify metrics. This is done with the objective to provide them comfort about the ability of the borrower to service the loan at all points in time.

These covenants are typically in the form of financial or accounting ratios - borrowers are required to ensure that their business is within these limits at all points in time for the duration of the loan. Failure to maintain the ratios can lead to an ‘event of default’, which essentially causes a default under the agreement and invokes the lender’s right to claim the entire loan (with interest) back. This right of the lender is known as ‘acceleration’. There may be periodic reporting mechanisms from the borrower to the lender (so that the lender is kept informed of the status of compliance with these covenants).

The financial covenants largely vary from one agreement to another based on the circumstances, financial conditions of the borrower and nature of the transaction involved. Typical financial covenants are discussed below:

i) Debt to equity ratio – It requires the borrowing entity to ensure that its debt should not exceed a certain multiple of its equity represented by its share capital (and accumulated profits and reserves). This financial covenant is generally inserted to prevent over-borrowing in comparison to the equity. In the financial crisis, several investment banks were ‘highly leveraged’, that is, their debt went almost as much as 60 times that of their equity, which made them especially vulnerable to any crisis.

ii) Minimum net worth – This covenant would require the borrower to ensure that the value of all its tangible assets excluding all the outstanding liabilities should not be less than a specified limit. This ensures that all the revenue-generating assets are not liquidated.

iii) Current ratio – This covenant would typically require the borrower to maintain a certain ratio between its current assets and current liabilities. The provision ensures that the borrower has sufficient liquid assets to make the payments to the lender.

iv) Minimum working capital – The provision requires the borrower to maintain a minimum level of liquid assets which should be more than the current liabilities (this is done to ensure that the borrower has the ability meet short-term payment obligations, typically for the next 12 months). This provision also ensures that the borrower has sufficient liquid assets to make interest payments to the lender.

v) Debt service ratio:  The provision measures the ratio of its annual profits (prior to payment of tax), interest and loan repayments. It is specified to ensure that the borrower’s profits exceed its obligation on loan repayments is maintained in a particular ratio.

Essential pointers about financial covenants

The borrower when fixing and determining the ratios for the financial covenants it should take into account the following issues:

i) The impact of the different covenants on operational flexibility must be studied by the borrower. Different financial covenants applied together may severely restrict the freedom of the borrower to operate and take business decisions.

ii) It is important to pay attention to the definition of different ratios under the agreement. Some of terms can be misleading if not carefully analyzed. The definitions of a particular ratio in a specific loan agreement may be different or much more nuanced as compared to its ordinary accounting treatment or popular meaning.

iii) While determining the fixed ratios, one should take into account the market performance of similar projects to understand whether the conditions stipulated by the lender are realistic or arbitrary. Some headroom may be kept so that the borrower is able to meet contingencies without triggering acceleration rights of the lenders.

Negative covenants

At the same time, lenders also insert various negative covenants – these are very similar to the issues on which financial investors have affirmative voting rights as per investment documentation (see the discussion on shareholder agreements to refer to the matters on which negative covenants are taken). Any action by the company on these matters will require the permission of the lenders, otherwise an event of default will be triggered under the agreement.
Breach of a negative covenant or financial covenant can amount to an event of default under the loan, which can trigger repayment obligations. Often repayment obligations are not automatically triggered, but activate only once the borrower fails to rectify a default situation after being notified about it by a lender.

Lender’s rights to appoint directors

Unlike investment agreements, it is not so common for lenders to appoint a director to the board of the company – until there is an event of default. Further, even when the director is appointed, his role is more in the nature of an observer (who can watch and keep the lenders informed of the company’s internal meetings and decisions) rather than an active participant who can sway the direction or outcome of the meetings.

However, lenders may appoint a nominee to the board right from the earliest stages of the transaction, where hybrid instruments (convertible debentures or preference shares) or equity are also involved in the transaction.

Articles need to contain a provision to enable the lenders to appoint nominee directors.– most standard form templates of articles by default already include a provision empowering lenders to appoint a director to the company protect their interests.

Mandatory prepayment clause

Prepayment of the loan is typically a choice left to the borrower – however, lenders tend to discourage prepayment as it impacts their predicted cash flows (they lose out on the interest payments since the principal due reduces). Therefore, prepayment may accompany additional fees or be prohibited during certain time periods. However, under certain circumstances the borrower must compulsorily prepay the loan. Compulsory prepayment sounds like an acceleration clause, so how are the two different? Acceleration is triggered when there is a default. Acceleration under one loan agreement also triggers a ‘cross-default’ provision, that is, it amounts to a default under any other loan agreements of the borrower. Prepayment, on the other hand, does not trigger this provision.

Mandatory prepayment takes place when any action taken by the borrower or the external circumstances change in a way that the purpose of the loan transaction as originally envisaged completely changes, so the lender may not want to continue with the arrangement. Since it is not the borrower’s fault, it is not called an event of default.

Situations which trigger compulsorily prepayment could be:
  • dsposal of assets – especially when a holding company that has taken the loan has multiple subsidiaries (and it sells of a subsidiary or its assets), or if an operating company sells off its key assets, say, a key products vertical  
  • Change in law which can render the transaction illegal or unviable
  • Ratings downgrade in the creditworthiness of the borrower or the country of the borrower.
Note: Mandatory prepayment is not considered a cross-default.

Negative pledge clause

A lender has typically made the loan after undertaking an assessment of the borrower’s ability to repay. Even if the loan is unsecured, the lender may have taken into account the total assets of the borrower. In case of default the lender has the right to proceed against the borrower – if the borrower cannot repay, the lender has certain rights to initiate liquidation proceedings and recover dues.

However, what can an unsecured lender do if the borrower subsequently creates a security in favour of other lenders, or sells its assets away, after taking the loan? This may not be in the lender’s interest – therefore, the lender typically places restrictions on the borrower’s powers to create security over its assets (any security which gives preference to other lenders) or to transfer or sell the assets.

At the same time, the borrower may not want the lender to interfere in ordinary dealings with the assets, especially when the borrower is involved in trading of those assets. Similarly, small sales may also not appreciably impact the borrower’s ability to repay. For these reasons, the borrower and lender may agree to exclude certain transactions from the applicability of this clause.

The clause is worded in the following terms typically:



  1. No Obligor shall (and the [Guarantor/Borrower] shall ensure that no other member of the Group will) create or permit to subsist any Security over any of its assets.
  2. No Obligor shall (and the [Guarantor/Borrower] shall ensure that no other member of the Group will):
    1. sell, transfer or otherwise dispose of any of its assets on terms whereby they are or may be leased to or re-acquired by an Obligor [or any other member of the Group];
    2. sell, transfer or otherwise dispose of any of its receivables on recourse terms;
    3. enter into or permit to subsist any title retention arrangement;
    4. enter into or permit to subsist any arrangement under which money or the benefit of a bank or other account may be applied, set-off or made subject to a combination of accounts; or
    5. enter into or permit to subsist any other preferential arrangement having a similar effect, in circumstances where the arrangement or transaction is entered into primarily as a method of raising Financial Indebtedness or of financing the acquisition of an asset.” 
  1. Paragraphs (a) and (b) above do not apply to:
    1. any Security listed in [Schedule 8 (Existing Security)] except to the extent the principal amount secured by that Security exceeds the amount stated in that Schedule;
    2. any netting or set-off arrangement entered into by any member of the Group in the ordinary course of its banking arrangements for the purpose of netting debit and credit balances;
    3. any lien arising by operation of law and in the ordinary course of trading provided that the debt which is secured thereby is paid when due or contested in good faith by appropriate proceedings and properly provisioned;
    4. any Security over or affecting any asset acquired by a member of the Group after the date of this Agreement if:
      1. the Security was not created in contemplation of the acquisition of that asset by a member of the Group;
      2. the principal amount secured has not been increased in contemplation of, or since the acquisition of that asset by a member of the Group; and
      3. the Security is removed or discharged within [       ] months of the date of acquisition of such asset;
    5. any Security over or affecting any asset of any person which becomes a member of the Group after the date of this Agreement, where the Security is created prior to the date on which that person becomes a member of the Group, if:
      1. the Security was not created in contemplation of the acquisition of that person;
      2. the principal amount secured has not increased in contemplation of or since the acquisition of that person; and
      3. the Security is removed or discharged within [        ] months of that person becoming a member of the Group;
    6. any Security created pursuant to any Finance Document;
    7. [                                                                 ]; or
    8. any Security securing indebtedness the principal amount of which (when aggregated with the principal amount of any other indebtedness which has the benefit of Security given by any member of the Group other than any permitted under paragraphs (i) to (vii) above) does not exceed [                  ]  (or its equivalent in another currency or currencies).
Material adverse effect clause


“"Material Adverse Effect" means a material adverse effect on (a) the business, operations, property, condition (financial or otherwise) or prospects of the Group taken as a whole; (b) the ability of any of the Obligors to perform its obligations under the Finance Documents; or (c) the validity or enforceability of this Agreement or the rights or remedies of any Finance Party under the Finance Documents.”


The clause discharges the lender(s) from disbursing any further loan if there are significant changes to the business operations, property, financial or other conditions of the borrower or the Group as a whole. This clause is hotly negotiated by borrowers to ensure that it is not ambiguous and is not used as a safety net by the lender to resile from its lending obligations.

The borrower can negotiate and carve out certain exceptions, such as this, “Material adverse change does not include change in 'general economic conditions', unless such changes adversely harmed the Borrower in a ‘materially disproportionate manner'.” The foregoing clause is a broad exception, which allows the Borrower to receive the funds, even if there is crisis in the general economic condition of the market which has also affected the borrower in a manner similar to the peers in the industry. However, the lender can invoke the provision if the borrower has suffered more than its peers in the industry. The clause can also identify the party or the person in whose opinion there is a material adverse change. The clause can be suitably modified to read like this, “‘which, in the opinion of the Lender, will have a material adverse effect”.
Change of control provision



“If [[       ] ceases to control the Borrower]/[any person or group of persons acting in concert gains control of the Borrower]:
  1. the Borrower shall promptly notify the Agent upon becoming aware of that event; and
  2. if the Majority Lenders so require, the Agent shall, by not less than [       ] days notice to the Borrower, cancel the Facility and declare all outstanding Loans, together with accrued interest, and all other amounts accrued under the Finance Documents immediately due and payable, whereupon the Facility will be cancelled and all such outstanding amounts will become immediately due and payable.
    1. For the purpose of paragraph (a) above "control" means [          ].
    2. [For the purpose of paragraph (a) above "acting in concert" means [        ].]”


This clause allows the lenders to cancel the loan facilities and require the borrower to make prepayment of the principal along with interest of the amount already disbursed under the loan agreement, if there is a change in the control of the company after the execution of the agreement. As the actual control lies with the shareholders of the company, over which the borrower does not have any control, it is quite essential to negotiate certain terms and conditions. It can specify that the provisions of the clause will be effective only if a certain person, a group of person or an entity ceases to have control over the country. The word “control” needs to be defined properly to clear any ambiguity in understanding the nature of control a person may have. For example, a managing director of a company may have certain powers granted under the Articles of Association of a company, but he might not be a shareholder and have any voting rights during merger of the company. The borrowers might also negotiate on the point that the provision regarding cancellation and repayment of the loan will be effective only on the lenders who have expressed their wish to exit the loan arrangement upon the triggering of the event mentioned in the provision. Another, point of negotiation is the notice period; borrowers should try to negotiate for a longer notice period which will allow them to enough time to arrange for new lenders. The borrowers may also seek other carve-outs and exceptions to the provisions, for example, change in control provision will be applicable only if there is a downgrading of the credit rating of the borrowers, or allow inter-group restructuring and transfers if there is no change in the ultimate control of the company.

Event of Default or ‘EOD’ clauses

Under a syndicated loan, generally an event of default is triggered under the following situations:
  1. Non-payment of amount due to be paid to any of the lenders
  2. Breach of financial covenants (explained above)
  3. Breach of representations and warranties clauses
  4. Liquidation and insolvency proceedings
  5.  Misrepresentation
  6. Actual insolvency
  7. Material adverse change
  8. Change of control
  9. Cessation of business
  10. Cross default
An event of any of the above listed default would give the lenders the following rights:
  • right to accelerate (immediate repayment of the outstanding loan)
  • right to terminate the agreement and further disbursement of loan
  • Further loans may be suspended under the condition precedent clause
  • It may qualify as cross-default under any other loan agreement
Right to accelerate

Once an event of default has triggered, it will give the lenders a “right to accelerate” the loan, which will allow the lenders to cancel all the further loans to be given under the agreement and demand for immediate repayment of the outstanding loan already disbursed by the lenders. A typical, right to accelerate clause looks like this:



On and at any time after the occurrence of an Event of Default which is continuing the Agent may, and shall if so directed by the Majority Lenders, by notice to the Borrower:
  1. cancel the Total Commitments whereupon they shall immediately be cancelled;
  2. declare that all or part of the Loans, together with accrued interest, and all other amounts accrued or outstanding under the Finance Documents be immediately due and payable, whereupon they shall become immediately due and payable; and/or
  3. declare that all or part of the Loans be payable on demand, whereupon they shall immediately become payable on demand by the Agent on the instructions of the Majority Lenders.


In the event of a restructuring (if the borrower is defaulting, lenders typically try to ‘restructure’ the loan instead of taking the borrower to bankruptcy), a right to accelerate gives the lenders some negotiating leverage – they can use the right to stop disbursing further amounts under the agreement as a bargaining chip to get a better restructuring deal.

Lenders want the clause to be drafted in such a manner that the clause would trigger in all possible event of default or “EOD” situations, without any additional conditions or qualifications like “material event” or “substantial event”.

Cross default

Assume that a borrower has taken multiple loans – it defaults on one of them (provided by Lender A), is sued by Lender A, who is able to get his money back by enforcing his dues against the assets of the borrower. What happens to Lender B, to whom the payment falls due after a month? What if Lender B gets nothing? Assuming both Lenders A and B are unsecured lenders, Lender B does not want his rights to be inferior to those of Lender A merely because the repayment time to Lender B falls on a later date. The “cross default” provision is generally inserted in a syndicated loan agreement to ensure that a default under any other loan agreement simultaneously triggers the default provisions under the present agreement as well, so that all lenders are able to claim their dues against the borrower.

(Since this is a standard term, in a real situation, default under multiple agreements will simultaneously get triggered, which can force the borrower into bankruptcy. In a real life situation, borrowers approach lenders to start discussions around restructuring debt in the event of an imminent default, to avoid such bankruptcy. A typical “cross default” event is defined as follows:


Cross default

  1. Any Financial Indebtedness of any member of the Group is not paid when due nor within any originally applicable grace period.
  2. Any Financial Indebtedness of any member of the Group is declared to be or otherwise becomes due and payable prior to its specified maturity as a result of an event of default (however described).
  3. Any commitment for any Financial Indebtedness of any member of the Group is cancelled or suspended by a creditor of any member of the Group as a result of an event of default (however described).
  4. Any creditor of any member of the Group becomes entitled to declare any Financial Indebtedness of any member of the Group due and payable prior to its specified maturity as a result of an event of default (however described).


Stamp duty related to loan and security documents

Please check the annexure for the applicable stamp duty on Loan Agreement, Deed of Hypothecation, Deed of Pledge, and Mortgage Deed in different states.

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