Growing Interest in Utilising Equity Commitment Letters in the Context of Sponsor Margin Loans

Reasons for ECLs

• In the context of MLAs facing single-purpose borrowers, the ECL acts as a safeguard to ensure that if there were a shortfall in funding, especially in case of a margin call, a capital injection by the ECL Provider will be made to ensure the ECL Receiver’s underlying loan obligations are satisfied.
• With a large fund standing behind the ECL, lenders typically feel more comfortable to relax the otherwise very tight timelines within which any cash has to be posted upon margin call, or to relax the triggers that result in mandatory prepayments.
• The use of ECLs may also be driven by tax reasons whereby the ECL Provider may prefer not to be facing a lender directly, in order to avoid negative tax consequences for itself and/or any of its investors.
• To the extent the underlying fund is subject to any borrowing or analogous limits, ECLs may be a helpful tool to ensure that no breach of those limits will occur, while being able to provide credit support to the ECL Receiver.

Obligations of the ECL Provider

The ECL Provider is obligated to inject the capital as stated in the ECL. Where multiple funds provide the ECL, their obligation is typically joint and several and any of the funds can fully fund the obligations under the ECL as selected by the sponsor. The ECL does not create any direct, contractual obligations on the LPs invested in the main fund.

Key Provisions of the ECL

Amount of Capital

The ECL specifies the maximum amount of capital (i.e. the commitment) that the investors commit to providing.

• In an MLA transaction, the ECL commitment generally matches the underlying loan obligations.
• In a subscription finance transaction, the commitment tends to equate to the ECL Provider’s unfunded capital commitments.

The payment is typically due to the borrower (not to the lender(s)), but can be structured in the ECL as being made directly to a secured collateral account, on behalf of the borrower, to satisfy the obligations under the MLA. Where the borrower is set up as a bankruptcy remote single-purpose vehicle, there is limited risk that other creditors would be able to establish a claim in an attempt to benefit from the funds provided by the sponsor pursuant to the ECL.

Conditions for Capital Injection

The ECL sets out specific conditions under which the capital must be injected. This could include:

• A margin call on the MLA due to a fall in the collateral value; or
• A need for additional funds to maintain the required LTV.

Timelines

The ECL outlines the timeframe within which the ECL Provider must provide the capital after the specified condition occurs. This varies in the market between a few days (e.g. the second business bay) and several weeks (e.g. 12 business days).

ECLs are either provided upfront (at the signing of the MLA), ‘in exchange’ for more relaxed terms around triggers; or a form of ECL is appended to the MLA and is to be delivered upon a specific trigger as a way for the ECL Provider to delay any enforcement procedures, thereby getting additional time to obtain the funds to provide additional capital to the ECL Receiver. In these situations, the ECL Provider typically confirms that it has called for capital at the same time as providing an executed ECL to the ECL Receiver and this allows the ECL Receiver to benefit from extended cure period under the MLA terms.

Third-Party Rights

Unlike guaranty agreements, lenders and administrative agents under a syndicated MLA are not parties to the ECL but can nevertheless enforce the terms of the ECL through the administrative agent (or directly by the lender in the context of non-syndicated MLAs), relying on third-party rights provisions set out in the ECL.

A third-party clause in the ECL ensures that no other unsecured creditor of the ECL Receiver should be in a position to enforce the rights under the ECL.

Representations and Warranties

Thorough due diligence should drive a tailored set of representations and warranties set out in the ECL or directly in the MLA. In particular:

• The ECL Provider needs to be permitted under its organizational documents to call capital from its investors in an aggregate amount at least equal to the aggregate commitments under the ECL from the uncalled capital of the ECL Provider.
• Representations and warranties should prospectively bind the ECL Provider to maintain sufficient headroom in the uncalled capital (taking into account any other guarantees or ECLs granted at any point in the future) that will at all times allow the fund to satisfy its obligations under the ECL.

It is common to obtain representations and occasionally even warranties from the ECL Provider (under the terms of the ECL) to maintain certain minimum NAV and liquidity, in each case, for the duration of the MLA financing. Additional reporting requirements are often imposed on the ECL Receiver to ensure that the lender can monitor the ECL Provider’s compliance with any such representations and warranties.

Conclusions

ECLs offer several attractive features that can significantly enhance the ability of sponsors to raise capital from lenders. They provide a robust mechanism for ensuring that loan obligations are met, thereby offering comfort to lenders and flexibility to borrowers. However, it is crucial to carefully negotiate the terms of ECLs to address potential risks, particularly those related to enforcement.

Lenders should seek expert legal advice to ensure that all aspects of the ECL are thoroughly vetted, their interests are adequately protected and thorough due diligence is done in order to tailor the representations and warranties set out in the ECL.

As the use of ECLs continues to grow, understanding their role in MLA transactions, as well as their implications, will be vital for all parties involved. By doing so, lenders and borrowers can leverage ECLs to enhance their financial strategies and achieve their objectives.