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When modifying a secured loan facility, consider these issues—14

2018-11-30 08:49:41

By Paul Kibuuka @isidoralaw

It is not unusual for terms of a secured loan facility agreement to change, but what happens to the original security taken by a lending bank? Does that security continue to be in full force and effect in all respects after modifying the terms of the facility agreement? Taking new security costs time and money; in addition, new security documentation will require perfection (see, Kibuuka, Paul. “Documenting, perfecting banks’ security interests—Part 3.” The Citizen. 1 September, 2018) and even fresh legal advice typically at the borrower’s expense.

In light of this and of the political or cultural pressure to keep borrowing costs low, a lending bank needs to carefully consider if taking new security will fortify its position as the extant security. If it does not exercise caution, it may come to shockingly find that it is unsecured.

Therefore, in this fourteenth part of our ongoing 30-part series, we elucidate some of the top issues for lending banks to consider when modifying secured loan facilities. An understanding of these issues will foster an appreciation of the risks they face and the possibility that the extant security may not continue to be effective. 

But first, it should be noted that at the time of creating security interests, such as, where applicable, the mortgage, the charge or the pledge, the borrower and the lending bank define the gamut of the liabilities secured under a security agreement. Needless to say, a borrower’s obligations under a subsequently modified loan facility agreement may still square with that gamut. 

However, where the gamut of the liabilities secured by the extant security is thin, so much so that it excludes coverage for the said obligations, the need for new security becomes apparent. In that respect, therefore, a borrower and a lending bank may execute a deed of confirmation in which the borrower confirms to the lending bank that, despite modifications to the loan facility agreement, the extant security to the lending bank continues in full force and effect.

It follows from the above that a lending bank will need new security if the modified obligations of the borrower are outside the purview of the meaning of secured liabilities as provided for in the original documentation. In order to make that determination, it’s important to consider the following top issues.  

First, is all the money owed to the lending bank by the borrower secured by the security granted by the borrower; stated differently, does the lending bank have an “all-monies” security? If yes, there are hardly any challenges. Where restrictions cannot be implied into the gamut of the secured liabilities, an all-monies security can secure the modified liabilities without more. Yet, normally security is granted to secure liabilities under a specific loan facility agreement (i.e. transaction specific security), necessitating close scrutiny of the agreement.

Second, does the language of the loan facility agreement clearly envisage modifications to the agreement? If not, a lending bank has little assurance that the obligations under a modified loan facility agreement would continue to be secured by the extant security; if yes, the issue would be about how to deduce that language.

Third, and taking cue from the ninth part of this series (Kibuuka, Paul.  “Critical issues in third party security for bank loans—Part 9.” The Citizen. 13 October, 2018), is the new security is direct (first) party or third party security. As we learnt in that part of the series, a third party security (like a guarantee) secures a surety’s obligation to a lending bank and not the direct obligation.

So, if a lending bank varies materially the loan facility agreement, this may inadvertently release the guarantor/third party security, consistent with Chitty, J’s observation in Bolton v. Salmon [1891] 2 ch. 48, Ch D), which is substantially in accord with Section 85 (Discharge of surety by variance in terms of contract) of the Tanzanian Law of Contract Act, Cap 345.

Ambiguity about modifications, amendments and variations leads to imprecision and is insufficient to ensure that the original security or the new security remains in full force and effect in all respects. If the security is a direct security, the foregoing narrow interpretation to modifications of a secured loan facility agreement will not be needed.

All the same, careful drafting is required to ensure that the modifications don’t result into an entirely new agreement which may necessitate taking new security.

Paul Kibuuka is the managing partner of Isidora & Company Advocates, a corporate, commercial and financial law firm. This article was published in The Citizen on Saturday, 17 November 2018

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