Real estate finance—LMA updates documents to reflect market practice and publishes new financial covenant cure rider

What changes have been made to the Loan Market Association's (LMA) documentation for real estate finance (REF) and why?

Original news

Revised REF facility agreements and a financial covenant cure rider have both been produced by the LMA.

What are the key changes to the LMA REF facility agreements and why were they made?

The revised documentation was produced to reflect various market practice updates. The key changes which were made to both the facility agreement for use in multiproperty investment transactions and the facility agreement for use in development transactions are considered below.

Hedging provisions

Hedging arrangements are an important element in real estate finance transactions. They are used to minimise the risks associated with floating interest rates. Both the lender and the borrower's perspectives are aligned here—both parties wish to ensure that the borrower's rental income (which will be fixed) is sufficient to service interest repayments under the facility agreement.

The most common hedging strategies which are used in REF are the interest rate swap and the interest rate cap, both of which were reflected in the previous draft of the LMA REF documentation (cl 8.3 for the investment facility agreement and cl 8.4 for the development facility agreement). The effect of a swap arrangement is that the borrower swaps a floating rate of interest for a fixed rate. By contrast, the effect of a cap is that the borrower and hedging counterparty agree to an upper limit on LIBOR (the strike rate) for an upfront fee.

The revised documentation splits out the old provisions to make it clearer which terms should be incorporated into a draft facility agreement depending on the type of hedging which is to be put in place.

A new provision has been incorporated into the wording which applies to swaps—there is now an obligation to notify the agent if, in certain circumstances, the swap is terminated or there is a close out.

Two new provisions have been incorporated into the wording which applies to caps:

  • a maximum strike rate for the cap—this rate is agreed between the parties and documented in the facility agreement. This new provision will benefit lenders since it allows the borrower the freedom to enter into a cap within parameters acceptable to the lender
  • the premium for the cap must be paid by the borrower upfront—this then means that the borrower will have no ongoing payment obligations under the cap

Insurance provisions

Insurance is a key element of all REF transactions and the terminology can sometimes be confusing. Co-insurance can take the form of joint insurance (where all the insured parties have exactly the same insured interest) or composite insurance (where the parties to be insured have different insured interests). Composite insurance is the most appropriate type of insurance for lenders to take out in conjunction with the borrower's insurance. It creates more than one policy and this means that the lender has its own separate rights under the insurance. If the borrower’s insurance falls away due to an act or omission of the borrower, the lender’s policy should be unaffected.

The LMA drafting has been improved to clarify that the type of co-insurance to be taken out is composite insurance and that this is created in respect of the lender's own insurable interest. The terms of the loss payee clause have also been expanded upon and the non-vitiation language has been amended and is now easier to follow.

Events of default

The revised investment facility agreement includes the option to incorporate a new concept of 'Major Tenant' with a new event of default relating to such a tenant's insolvency. This option will be useful where the financing relies heavily on the rental income from one particular tenant.

The development facility agreement already included a concept of 'Principal Tenant' and cl 25.12 of the development facility agreement has been amended to reflect the new position in the investment facility—the event of default is no longer triggered by a failure to enter into the occupational lease but relates to insolvency issues.

Are there any additional changes to the development REF facility agreement?

The development REF facility agreement includes some additional minor amendments. For example, the definition of 'Availability Period' has been amended to add some optional wording relating to its expiry and the guidance notes on the definitions of 'Loan to Cost' and 'Loan to Value' have been expanded upon.

Additional drafting option for financial covenant cure rights

When are these provisions likely to be appropriate and what is their effect?

The new financial covenant cure rights rider is to be used with the LMA REF investment facility agreement where the lender and borrower have agreed that breaches of financial covenants can be cured by the borrower depositing cash into a bank account or prepaying the loan. There is a limit on how many times the cure rights can be exercised by the borrower over the life of the facility and how frequently they can be used in any interest period.

In respect of the cash deposit, the drafting provides for the creation of a new bank account called the 'Cure Account'. Cash can be withdrawn from the Cure Account if the borrower complies with the financial covenants for two interest periods after the deposit is made and there are no other continuing defaults or repeating representations which are or will be incorrect as a result of the withdrawal. If the financial covenants are not complied with on either of the next two interest payment dates, the majority lenders can direct the security agent to use the cash to prepay the loan.

Suzanna Corrigan, solicitor in the Lexis®PSL Banking & Finance Team.

First published on LexisPSL Banking & Finance. Click here for a free trial.

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