Sunday, February 16, 2014

2013 FATCA Riders for LMA loan facilities – Grandfathering, risk allocation, and technical aspects


What is FATCA and how should you deal with it in loan agreements?


FATCA

FATCA means “Foreign Account Tax Compliance Act”. The legislation intends to provide U.S. tax authorities with better insights into U.S. citizens’ cash flows from and to the U.S. It leaves foreign (from a U.S. perspective) financial institutions with two options: They can meet reporting requirements on the cash flows or pay a 30 % withholding tax.


LMA

The loan market association (LMA) has been founded in 1992. Its mission is to “improve liquidity, efficiency and transparency in the primary and secondary syndicated loan markets in Europe, the Middle East and Africa”. It is most well known for its standard loan documentation that it recommends to its members.





Therefore, it makes perfectly sense that this association thinks about how to deal with FATCA legislation in loan agreements. As a result of its considerations, the LMA has published, in July 2013, 23 pages of clauses (“FATCA riders”) which amend the association’s standard loan documentation to make it compliant with the new U.S. tax legislation.

As of today, the LMA has identified three main issues – grandfathering, FATCA risk allocation, and technical FATCA aspects.


Grandfathering

Grandfathering simply means that FATCA legislation will not apply to cash flows under loan agreements signed prior to a specific date. If you look at it from the other angle, existing loan agreements will continue being governed by old tax legislation.

I don’t know what this has to do with your grandfather. Perhaps you can think of it as the legislator being respectful about the experience and wisdom of your grandfather, thus preventing him from losing any pre-acquired rights through new rules.

Grandfathering is not something that you have to regulate in your contract. It is something that the legislator himself fixes. Thus, LMA’s role is limited here to bolstering up grandfathering legislation. The association proposes that banks introduce additional stipulations in loan agreements, such as

  • ensuring that no obligor is a U.S. entity;
  • providing for prepayment of the loan if FATCA applies, unexpectedly;
  • forcing a borrower or guarantor to resign if FATCA applies to him.


FATCA risk allocation

In a loan agreement, you have two parties – lender and borrower. Consequently, you can allocate FATCA risk either to the borrower or to the lender.

As you might expect, FATCA risk is usually shifted to the obligor by providing for a gross-up: This simply means that the borrower will reimburse any amount paid by the bank or the agent under FATCA to U.S. tax authorities. In addition, the Loan Market Association suggests that the obligor should represent, in the loan agreement that it is not subject to FATCA withholdings. If this representation turns out wrong, this will constitute an event of default under the loan agreement.

FATCA risk can be shifted to the lender. In legal terms, this means that each party of the loan is entitled to make FACTA related payments while, at the same, not being obliged to increase any payment under the loan agreement.


Technical FATCA aspects

The LMA proposes some additional, more technical, FATCA stipulations for loan agreements:

  • To change the FATCA status of a party, its consent shall be required.
  • All lenders will have to consent to any accession or resignation of a borrower or guarantor if this changes FATCA relevant circumstances.
  • Each party will be allowed to make FATCA payments, if required.
  • Every lender or agent should be entitled to withhold FATCA portions of payments.
  • The agent shall be able to request FATCA relevant information from obligors and other lenders.
  • Upon request, any party should confirm that it is subject to or exempt from FATCA regulation.
  • The agent will need to resign if it is subject to any FATCA withholding.
  • FATCA related issues should be subject to special majority decision-making rules.
  • Payment mechanisms such as distribution and waterfall shall give special consideration to FATCA related payments.


To conclude, let me turn back to my question above (What is FATCA and how should you deal with it in loan agreements?): FATCA is a U.S. legislation which requires foreign financial institutions to provide information about foreign lenders to U.S. tax authorities or to pay a 30 % withholding tax. You should deal with this in your credit agreement by making sure that FATCA doesn’t apply, shifting the risk on the borrower, and regulating technical aspects such as decision-making on FATCA and payment mechanics.


Resources:

  • LMA FATCA Guidance dated 9 February 2012
  • LMA FATCA Riders dated 16 July 2013
  • U.S. Internal Revenue Code, Chapter 4 – Taxes to enforce reporting on certain foreign accounts