The scope of restrictions that will cause a loan default or the borrower or guarantor to have partial or full recourse liability for a loan—otherwise known as non-recourse carve-outs—has evolved and expanded, according to JR Kasman founder Jennifer Kasman.
Since these transactions can have such high stakes, Jennifer gave us five tips for negotiating entity transfer restrictions in your loan documents.
Scope of Restriction
Make sure you have clarity concerning the extent to which an entity transfer restriction applies to both direct and indirect interests. Sponsors should consider whether the restriction unfairly exposes the borrower or themselves to liability if an indirect interest holder or non-controlling member breaches the restriction. It’s also helpful to give managers the ability to transfer their membership interests (versus their management duties).
Prior Notice Requirement
It’s become en vogue for lenders to require advance notice of all transfers, including transfers that are expressly permitted without their consent. For some transfers, prior notice may not be practical or can be easily overlooked by an entity. Consider requesting that the prior notice requirement be eliminated or an annual reporting requirement certifying ownership can be used in lieu of prior notice.
Permitted Transfers and Ongoing Representations and Warranties
Loan documents typically allow certain enumerated transfers to be permitted without the lender’s prior consent with a permitted transfer provision. If the loan documents contain any ongoing or reaffirmed representations of how entity ownership is held or constituted, make sure that the representation is qualified to apply to any permitted transfer provision.
Transfers “To” and “From”
In many cases, borrowers and guarantors are concerned about the parties that an interest may be transferred to. However, it’s also important to consider the possibility of a party wishing to unwind a transfer during the loan term. If a permitted transfer provision allows transfers to a family member, trust or entity, you should confirm that the same provision will allow a transfer of interest back to the grantor or another member.
It’s critical to make sure that the loan documents’ other provisions outside of the transfer restrictions appropriately cross-reference any rights granted to the borrower or guarantor in a permitted transfer provision. For example, it’s not uncommon for loan documents to contain a separate covenant that restricts changes to an entity’s organizational documents. Any covenant like this should be qualified, so that any changes can be made as a result of the transfer.