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Financial Institutions: Banking & Finance Transactions

Financial Institutions: what to have in mind before entering into a Banking and Finance transaction?

Introduction:

The proper structuring of a finance transaction ensures the due performance of the terms of the same, especially in situations of default and more specifically in the event of insolvency of the borrower. It is of importance that the lender is able to enforce its claim if something goes wrong, in situations where the borrower is unable to pay its debts, or in case of any winding up or the commencement of liquidation procedures and so on. This article will attempt to provide guidance to financial and banking institutions on what to consider when entering into such transactions, especially in relation to banking and finance transactions involving a Cyprus law element.

Proper security in place:

As a first step financial institutions should ensure that proper security is in place. What constitutes proper security will not only depend on proper drafting of the security documentation, but will also be dependent on the due registration and perfection thereof.

Pursuant to the provisions of section 90 of the Cyprus Companies Law, Cap. 113 (“Companies Law”) if a charge constitutes a registrable charge, failure to register the same with the Cyprus Registrar of Companies will result in the charge being invalid against the liquidator of the company. The obligations secured under a charge which has not been duly registered will not be recognized by the liquidator as secured obligations and the chargor will essentially be ranked at least pari passu, together with all the other unsecured creditors. Therefore the obligations under an unperfected charge will constitute unsecured obligations in the eyes of the liquidator and will rank together with the unsecured creditors. Assets which are subject to a registrable charge that has not been registered, should be available to the general pool of creditors, as if no such charge existed.

Similarly, other laws may be relevant in relation to the perfection of other types of security. For instance, pledges over shares in Cyprus companies should be perfected pursuant to the procedure prescribed by the Cyprus Contracts Law. A pledge over Cyprus shares if not perfected in accordance to the provisions of the Cyprus Contracts Law will not be valid and enforceable.

Solvency of the borrower:

Banks and lenders in general should ensure that at the time of entry into the transaction the borrower is solvent. Obtaining a legal opinion and receiving copies of up to date financial statements or management accounts may provide some level of comfort to the lender in relation to the likelihood of insolvency.

This is of essence in the light of section 301 of the Companies Law which provides that in the event of any liquidation of a company any conveyance, charge, mortgage, delivery of goods, payment, execution or other act relating to property that took place within a period of six months of the commencement of the winding up of the company may be considered as a fraudulent preference of its creditors and be set aside. A preference is considered to be fraudulent if it is intended to put a creditor in a better position in the event of liquidation of the company than the creditor would have been without such action. Any creditors who benefited from a fraudulent preference are obliged to repay any benefit they obtained therefrom and the same are considered to be sureties of the company for an amount equal to the value of such benefit.

Security created within the said six months period will have to pass the test of whether it can be considered as constituting a fraudulent preference. This, in the normal course of events, will not be a problem unless, by creating the security, the result is that an existing creditor is put in a better position than such creditor would have been but for the granting of the security. In the absence of any intention to defraud the other creditors by favouring one creditor, security will be enforceable.

Furthermore the Companies Law also provides that a floating charge created within 12 months from the commencement of the winding up is void unless it is proven that the company was solvent immediately after the creation of the charge.

Financial collateral arrangements:

Financial institutions should also keep in mind that financial collateral arrangements provide additional comfort to lenders since on a recent amendment of the Cyprus Financial Collateral Arrangements Law 43(1)/2004 (the “FCA Law”) it was clarified that the power to reasonably execute, undertake any liquidation and valuation of any financial collateral is not affected by the provisions of the Companies Law on examinership. It has been specified that the provisions of the FCA Law will be in effect irrespective of the provisions of Part IVA of the Companies Law (which is the part covering examinership). Furthermore, section 9 of the FCA Law now provides that a close out netting provision takes effect in accordance with its terms irrespective of, inter alia, the provisions of Part IVA of the Companies Law.

Moreover it has also been explicitly stated that irrespective of the provisions of Part IVA of the Companies Law, the provisions of the FCA Law as regards enforcement of financial collateral arrangements are to be applied without prejudice to any requirements under the applicable law to the effect that the realisation or valuation of financial collateral and the calculation of the relevant financial obligations must be conducted in a commercially reasonable manner.

In a nutshell, the examinership process (which came into force in mid-2015) intents to rescue a viable company with liquidity problems through reorganisation in an attempt to avert the liquidation thereof. With the submission of an application for the appointment of an examiner the company goes under court protection for a period of four (4) months from the date of the filing of the petition, during which period, enforcement cannot occur. Hence the importance of having a financial collateral arrangement in place becomes evident, since such arrangement would be enforceable in the event of examinership, while another type of security would not be (at least not without the consent of the examiner and/or the sanction of the court).

In any case the FCA Law has the effect of dis-applying certain insolvency provisions set out in the Companies Law, by providing that a financial collateral arrangement as well as the provision of financial collateral under such arrangement may not be declared invalid or void or be reversed on the sole basis that the financial collateral arrangement has come into existence, or the financial collateral has been provided on the day of the commencement of the winding up proceedings or reorganization measures, or within a prescribed period prior to such events. Moreover it is not necessary to register a financial collateral arrangement with the Cyprus Registrar of Companies in order for it to be valid against the liquidator of the company. An analysis of what constitutes a financial collateral arrangement is outside the scope of this article.

Therefore in the light of the above, it is suggested that financial collateral arrangements where applicable, enhance the position of financial institutions in a corporate finance transaction.

Proper drafting:

Proper drafting of transaction documents can provide protection to financial institutions especially in relation to their ability to enforce. It is of importance that the ‘event of default’ is properly defined, as to allow timely enforcement. For example, the commencement of an insolvency procedure should be included in an agreement as an event of default for the purposes of triggering the termination and enforcement procedures set out thereunder. The due drafting of provisions in relation to the enforcement of charges and pledges is also important since in certain instances the possibility to enforce a pledge out of court will save the pledgee both time and resources.

Conclusion:

No banking and finance transaction is the same. However, as examined above, there is a minimum of considerations that financial institutions should have in mind when negotiating the provision of loans and the entry into other financial arrangements. It goes without saying that securing proper legal advice would definitely enhance the position of such institutions in a wide range of transactions.