Davis Polk & Wardwell Newsflash

Lehman Commercial Paper Inc. Bankruptcy Provides Insight into the Potential Impact on Borrowers of Defaults by Lenders

October 8, 2008

On October 5, 2008, Lehman Commercial Paper Inc. (“LCPI”) filed a motion for protection under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”).  LCPI is a subsidiary of Lehman Brothers Holdings Inc. (“Lehman Holdings”), which previously filed for bankruptcy in September 2008.   LCPI acts as a lender, administrative agent or syndication agent in hundreds of commercial loans.

The first-day motion filed by LCPI and related orders granted by the Bankruptcy Court provide some useful insights into the potential impact on corporate borrowers of a bankruptcy filing by a lender or the administrative agent under their credit facilities if such lender or agent is subject to Chapter 11.  Note that if the troubled lender or agent is a regulated bank, it will be subject to an FDIC receivership instead of Chapter 11.

Bankruptcy Court Authorizes Continued Use of LCPI Agency Bank Account, Termination of Agency Relationships and Elevation of Loan Participations

According to the motion filed by LCPI with the Bankruptcy Court, it currently acts as administrative agent with respect to several hundred commercial loan facilities.  To permit LCPI to continue to operate as agent during the bankruptcy proceedings while it winds down operations, the Bankruptcy Court has authorized LCPI to continue to use its agency bank account at Citibank to intermediate advances received from lenders to fund new loans and payments of principal, interest and other amounts from borrowers to be distributed to lenders.  LCPI argued in its motion that this was necessary to assure both borrowers and lenders that, in the course of performing its role as administrative agent, funds in its agency bank account will not (except to the extent owed to LCPI itself) be included in LCPI’s bankruptcy estate and, accordingly, will not be subject to the claims of LCPI’s creditors.

LCPI also sought, and received, permission from the Bankruptcy Court to terminate and transfer its administrative agency role in accordance with its business judgment.  LCPI has been authorized (but not directed) to transfer, assign or resign from all administrative agency positions in accordance with the provisions of the applicable credit agreements.  LCPI stated in its motion that it would seek to transfer or resign its agency positions as expeditiously as possible in order to limit further liability arising from its role as agent and its possible inability to perform that role in the future.

Finally, with respect to participation interests or sub-participation interests previously sold by LCPI to third parties in more than 500 loans, the Bankruptcy Court authorized LCPI, in consultation with the Official Committee of Unsecured Creditors, to elevate the rights of such participants to direct lenders (and sub-participants to participants), to the extent permitted by the provisions of the applicable credit agreements and other applicable agreements.  These elevations would remove LCPI from an intermediary position between borrowers and loan participants or sub-participants and release LCPI from relevant funding obligations in the future.

Impact of LCPI’s Bankruptcy Filing on Credit Facilities

These Bankruptcy Court orders should permit LCPI to carry out its obligations as administrative agent under a particular credit facility for so long as it retains that agency role.  However, it seems likely that LCPI will be looking to resign and transfer its responsibilities to a successor agent as soon as practicable, to the extent permitted by the applicable credit agreement.

According to LCPI, as a lender under various credit facilities, it holds fully funded loans as well as unfunded commitments to extend loans in the future.  LCPI stated in its motion to the Bankruptcy Court that since the commencement of Lehman Holdings’ Chapter 11 case, LCPI has not made any advances on its own account to satisfy ongoing funding commitments and that it has billions of dollars of unfunded loan commitments.

Under the terms of many (though not all) credit facilities, a defaulting lender’s failure to perform its funding obligations would permit the borrower to seek to replace that lender with a new or existing lender willing to assume the defaulting lender’s commitment.  But this right is of course useful only if the borrower can identify a lender willing to undertake that commitment.  If no substitute lender can be found to undertake the commitment on those terms, the facility will as a practical matter be diminished by the amount of the defaulting lender’s unfunded commitment.

In addition, if the credit facility contains a swing line sub-facility, the swing line lender may seek to refinance any outstanding swing line loans with revolving loans that are to be provided by the syndicate members in accordance with their commitments (or to cause such syndicate members to fund their applicable risk participations in such swing line loans), which will result in the borrower having to pay back the defaulting lender’s portion of such swing line loans prior to the stated maturity of such loans.

In LCPI’s case, these problems may be mitigated in circumstances where LCPI successfully elevates an interest in which it has sold a participation into a full assignment – i.e., the participant will become a full “lender” under the relevant facility and LCPI will be eliminated as a party.

If LCPI is a defaulting lender under a letter of credit facility or sub-facility, the borrower may be faced with the additional challenge of not being able to obtain new letters of credit or extend outstanding letters of credit.  Under the terms of many credit facilities, the existence of a defaulting syndicate member suspends a letter of credit issuer’s obligation to issue a letter of credit or extend an existing letter of credit unless arrangements satisfactory to the issuer have been made to protect it against the risk of default by the defaulting lender.  In a facility that works this way, the borrower will be required either to replace LCPI (which, as noted above, may be difficult to accomplish in today’s market) or make other suitable arrangements, which might include posting cash collateral to protect the issuer’s exposure.  The borrower would, of course, need to review carefully the negative pledge and other relevant terms of its credit agreement and other facilities to determine whether it may do so, as many credit facilities limit such cash collateralization.

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