Vol 8 (2011) - Issue 3

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Lehman Strikes Again: European Loan Participations and Preference Risks

In the growing global market for commercial loans, market participants buy and sell syndicated loans using increasingly streamlined and standardised transfer structures. While loans are often sold directly by 'assignment,' it is also common practice to buy and sell loans by 'participation'. Under the participation structure, the seller (commonly referred to as the grantor of the participation) continues to be the lender to the borrower, but enters into a separate back-to-back arrangement with the buyer of the loan and 'grants' to the buyer (commonly referred to as the participant) a 'participation interest' in the loan, thereby transferring the economic risk of the loan to the buyer. As far as the borrower is concerned, nothing has changed, but where the seller and buyer are concerned, risk has been transferred. The specifics of the contractual relationship may vary from market to market but the methodology remains the same, along with the risk that all payments flow through the grantor.

Over time and as circumstances change, loans that were beneficially owned by way of participation can (in the jargon of the secondary bank loan market) be ‘elevated’ to direct assignments once the requisite administrative agent and/or borrower consent is obtained. This will often happen upon a sale of the loan by the participant to a third party, or where the underlying commercial reason for holding the loan by way of participation no longer prevails. Such 'elevations' customarily have been viewed as straightforward transactions -- when completed, the participant simply stands in the shoes of the grantor and becomes the lender of record of the loan on the books of the administrative agent.

Recent events in the Lehman bankruptcy proceedings, however, have raised questions about the effectiveness of elevations involving the standard form of participation agreement used in Europe and has resulted in monetary claims being brought by the Lehman estate against parties that elevated the pre-petition participations granted by Lehman, and, in some cases, may result in the painstaking unwinding of chains of sales and purchases of bank loans that were once owned by Lehman.



Background

Prior to their bankruptcy filings, Lehman Commercial Paper Inc. ('LCPI'), a subsidiary of Lehman Brothers Holdings Inc., and other Lehman subsidiaries originated commercial loans to borrowers and sold participation interests in such loans to third parties in the ordinary course of their business.

Certain parties requested elevations of their status from participants to lenders, and asked LCPI to assign or novate to them the underlying ownership interests in the loans, thereby removing LCPI from the chain of payments. At the time, LCPI agreed to these elevation requests and the elevations became effective either prior to LCPI’s bankruptcy filing or shortly thereafter. In fact, on 6 October 2008, the day after its bankruptcy filing, the United States Bankruptcy Court entered an order in the LCPI bankruptcy proceeding (the 'Elevation Order') that authorised LCPI, in consultation with the Official Committee of Unsecured Creditors in the Lehman bankruptcy cases, to elevate loan participations in accordance with the applicable credit agreements. The Elevation Order also provided, however, that ‘notwithstanding such elevation of participations … neither the Debtor nor the Committee nor any party in interest shall, by virtue of this Order, waive the right to subsequently argue that such participations … are not true participations and that any cash or securities distributed to holders of such participations … was property of the estate’.