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Moving the Goalposts

Posted on Jan 09, 2013 by  | 0 Comments

A key consideration for companies when they are deciding whether to borrow money from lenders is the cost of the finance, i.e. the rate of interest charged on the loan and the lender's margin (or profit).

Many companies were able to secure relatively low rates and margins due to increased competition in the market before the credit crunch happened. However, following the credit crunch, many lenders have requested corporate borrowers accept an increase in their rates and margins much to their chagrin.

 NASTY SHOCK

Corporate borrowers are obviously aghast at any increase in rates and margins in the current economic climate and we are aware of some borrowers on fixed rate loans who believed that they were taking out a loan with fixed rates (both interest and margin) for the duration of the loan. It came as a nasty shock to those borrowers when the lenders requested increases in the fixed rate of interest (and margin).

LEGAL POSITION

Can the lender review the loan’s fixed interest rate (and margin) and propose an increase? The answer is yes. There is nothing unlawful in a lender reviewing a corporate borrower’s loans and proposing an increase in the interest rate to take account of an increase in commercial risk. Of course, as a matter of contract, the interest rate is fixed so the borrower may reject the increased rate proposal and insist on the agreed rates set out in their loan agreement.

GAME OF POKER

However the lender will usually review the loan and propose an increase in the interest rate when they have discovered that the borrower is in breach of a loan covenant which will invariably entitle the lender to demand early repayment of the loan due to an “event of default”.

This puts the lender in a strong bargaining position and gives it scope to force upon the borrower a renegotiation of the interest rate (and margin). A game of poker may then ensue, with the bank threatening to play it’s ace card, immediate repayment of the loan while the borrower’s best card if it is unable to cure the breach (or the lender has waived the breach) may be to call the lender’s bluff to use the ultimate sanction (as the lender will generally be reluctant to do so).

A SALUTORY LESSON

The issue of interest rate margins arose in the recent English swap case of Green & Rowley v RBS. The Claimants argued that they were told their interest rate swap fixed not only the base rate but also the margin. The swap did fix the base rate but not the margin.

After hearing the evidence, Judge Waksman QC preferred the lender’s version of events which was that they had told the borrowers that the swap affected only the base interest rate. The moral of this story is that if the lender states that the interest rate and margin is fixed for all time then it should be documented to assist evidentially in any future dispute.

Corporate borrowers need to be aware that should they breach any of their covenants and an event of default arises then they are often at the mercy of the lender who may then force the borrower to accept increases in the fixed loan rate and margin or pull the plug. 

CONCLUSION

Prevention is better than cure. Borrowers should closely monitor their loan covenants to ensure compliance so that a breach can be avoided and any problems are identified before a breach arises so the loan can be renegotiated from a better bargaining position.

It is clearly in the interests of borrowers to monitor compliance of their loan covenants to avoid a costly and often lengthy renegotiation process with the lender which may ultimately result in the goalposts being moved.

Has your lender proposed increasing your loan's interest rate or their margin? Are you in breach of a loan covenant? Do you need assistance in negotiations with your lender?

If so, MBM Commercial LLP may be able to assist you. For more information, please contact Neil Morrison, a Senior Solicitor in the Financial & Banking Disputes team, on 0131 226 8200 or neil.morrison@mbmcommercial.co.uk

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