Current Issues in Syndicated Lending: Defaulting Lenders and the Failure to Fund

Most current syndicated credit agreements include a concept of a defaulting lender to address situations where a lender fails to fund its pro rata share of an advance, reimbursement, or participation under a syndicated credit agreement (any such lender, a “Defaulting Lender”). For example, the Model Credit Agreement Provisions (Effective May 2005, the “Model Provisions”) for syndicated credit agreements published by the Loan Syndications and Trading Association expressly give a borrower the right to require any Defaulting Lender “to assign and delegate, without recourse (in accordance with and subject to the [applicable assignment terms and conditions], all of its interests, rights and obligations under this Agreement and the related Loan Documents ' to an assignee” at par. (See, Model Provisions, Yield Protection, Section 3(b) Mitigation of Obligations; Replacement of Lenders) Notably, the Model Provisions do not include a formal definition of “Defaulting Lender,” and except as described above, the Model Provisions do not address Defaulting Lender issues. Unlike the Model Provisions, most syndicated credit agreements do include a formal definition of “Defaulting Lender,” and this definition frequently includes any Lender that is deemed insolvent or is in receivership within the definition. As evidenced by the Model Provisions, defaulting lender terms were typically drafted with the expectation that a Defaulting Lender would be a rare and isolated occurrence, and could be readily replaced by an assignment at par.

The differences between the obligations of a Defaulting Lender with an outstanding revolving credit commitment (or other unfunded commitment such as a delayed draw term loan commitment) and a Defaulting Lender holding a fully funded term loan have revealed other weaknesses with typical Defaulting Lender provisions. As discussed more fully below, a Defaulting Lender with an unfunded commitment presents credit risks to the borrower, the administrative agent, and the other lenders. A Defaulting Lender holding a fully funded term loan, however, presents no credit risk to the borrower. With respect to the administrative agent and lenders, the only credit risk presented by a Defaulting Lender that has fully funded its term loan obligations relates to indemnification obligations (which typically only arise in the event that the borrower has breached its indemnification obligations) and obligations to share amounts recovered by such Defaulting Lender on account of the exercise of set-off rights or otherwise in excess of its pro rata share of such recoveries.