Why do we need an agent to hold the security in the first place?
Taking security is a significant aspect of any secured financing transaction as it reduces the risk taken by the lenders, which allows borrowers to use cheaper financing for their business or transactions.
Therefore, taking the right security in the right manner is an essential legal aspect of financing transactions.
When financing is provided by a single lender the latter takes the security for financing and the situation is straightforward.
However, when larger amounts of financing are required, often the financing is provided by more than one lender so that the lenders can spread the risk of a default by the borrower among a larger group.
When the financing takes the form of a loan, this is often referred to as a “syndicated loan” (i.e., a loan provided by a large group of lenders, sometimes hundreds or even thousands in very large financings) or a “club deal financing” (when the lenders are just a few).
The financing is also provided by a large number of lenders (could be thousands) when it takes the form of a bond (also referred to as notes or debentures) issuance.
Where the financing is provided by more than one lender taking the security by all lenders is impracticable. Imagine what it would mean for the financing deal if tens or hundreds of lenders need to provide various documents (often with a lot of formalities such as notarised signatures, apostille, official translations, etc.) in order to be able to get them registered in the relevant security registers. That would require an enormous amount of time and effort, which would delay the financing and would add a significant cost to it.
The same issue would arise when the loan is finally repaid, and the security needs to be deregistered from the relevant security registers – again this would require collecting many documents with many formalities from all lenders.
If the loan is refinanced the same issues would arise too.
Also, all lenders need to be ranked at the same level in terms of security so that they can share the proceeds from enforcement of the security pro-rata among themselves. Each lender who is a secured party in the security documents and is registered as such in the relevant security registers would have an equal right to enforce the entire security if there is a default under the financing documents. Imagine what it would mean for financing if a lender holding a small percentage of the entire debt decides to enforce the security upon a default by the borrower (which could be a minor or technical default or a default that is capable of being remedied) while the majority of the lenders prefer to give the borrower the chance to remedy the default and continue to serve the debt in the normal way.
To avoid such a commercially undesirable situation, finance documents involving more than one lender as a rule provide that the security is held by a security agent for the benefit of all lenders and that the security agent will enforce the security only if a majority of the lenders (usually the lenders that hold 2/3 of the outstanding amounts of the financing) so instruct it and in the manner in which they instruct it. The rationale of this is that the finance documents protect the lenders who own the majority of the debt and the lenders that hold a minority of the debt must comply with the instructions of the lenders holding the majority of the debt.
In club deals (i.e., deals with just two or three lenders) the above considerations about the formalities of document collection might be less important, but the consideration about the lenders holding the majority of the debt being the ones who control the enforcement of the security equally applies.
A further benefit of appointing an agent to hold the security instead of the lenders is that, during the lifetime of a financing, a lender might decide (for various commercial reasons) to sell its participation in the financing (partly or entirely). If all original lenders are recorded in the various security registers as secured parties, the replacement of one lender with another (or adding another lender in case of a partial sale) would need to be registered in the relevant security registers. That would require collecting documents from the relevant lenders and applying to make the registration of the replacement or addition. In some cases (for example in the case of mortgages) such replacement would involve the payment of percentage-based fees to notaries and the state, which might add up costs to the replacement. If instead the security is held by the security agent, any change in the lenders’ composition would have no effect on the security and would need no actions with respect to the security registrations.
How could the agent hold the security?
Now that we have seen why it is important for an agent to hold the security instead of the lenders in case of a financing with more than one lender, let see how an agent could hold the security. In principle when various laws in Bulgaria refer to the taking of a security, they refer to “the creditor” being the secured party or imply that this is the case. This has led some lawyers in Bulgaria to the wrong conclusion that Bulgarian law does not permit anyone else but the lender (i.e., the person who has granted the financing) to hold the security. This conclusion is wrong. When the relevant provisions of the law refer to “the creditor” this simply means the “secured party”. Bulgarian law has a general unwritten principle that anything that is not prohibited by the law is permitted. In addition, Bulgarian law recognises the freedom of contract (i.e., that the parties to a contract can agree on anything as long as there is no prohibition in the law for that). Given these general principles of Bulgarian law, jumping to the conclusion that the law prohibits an agent from holding the security just because the relevant laws refer to “the creditor” when they regulate various types of security, does not seem justified.
In addition, there are specific laws in Bulgaria that expressly permit a person who is not the creditor of a debt to hold the security for the debt. For example, pursuant to the Public Offering of Securities Act an initial public offering (IPO) of corporate bonds in Bulgaria is permitted only if an agent of the bondholders is appointed, which, among other things, holds any security for the bonds for the benefit of the bondholders.
The Commerce Act allows the appointment of a bondholders’ agent with the rights under the Public Offering of Securities Act also in the case of a private placement of corporate bonds.
In addition, the Financial Collateral Agreements Act expressly permits taking financial collateral by an agent.
Given that Bulgarian law expressly permits or even requires the appointment of an agent to hold security in certain situations as described above, a conclusion that appointing an agent to hold the security is contrary to Bulgarian law in situations where it is not expressly mentioned by the law, does not seem justified.
To address concerns of the sort mentioned above (i.e., that only the creditor, meaning the person who actually gave the financing) can be a secured party, English lawyers have come up with the contractual concept of “parallel debt”.
What is a parallel debt?
The parallel debt is a clause in the finance documents pursuant to which the borrower promises to pay to the security agent the same amount of money that it owes to the lenders under the finance documents. The clauses also provide that a payment of an amount by the borrower to the lenders automatically discharges the same amount due by the borrower to the security agent under the parallel debt. In this case, the borrower never owes to the security agent on top of what it owes to the lenders. Of course, vice versa, if the borrower pays an amount to the security agent under the parallel debt this automatically reduces the debt of the borrower to the lenders with the same amount (although in normal circumstances this situation should not arise).
Under the parallel debt arrangement, the security agent has a claim for an amount of money due to itself. This allows the security agent to take security for a debt owed to it (rather than for a debt owed to the lenders) and avoids the concerns above by some lawyers that only “the creditor” can take the security.
Is a parallel debt legal and enforceable in Bulgaria?
Some lawyers in Bulgaria have expressed concerns that a parallel debt is not recognised by Bulgarian law and is therefore not valid and enforceable in Bulgaria. This conclusion is wrong.
First of all, the validity of any contract (or contractual clause) is determined by the law which governs it. This follows from the EU regulation on the law applicable to contracts – the so-called “Rome I Regulation”, which is mandatory in Bulgaria.
Rome I Regulation states that “The existence and validity of a contract, or of any term of a contract, shall be determined by the law which would govern it under this Regulation if the contract or term were valid”.
The main principle of the Rome I Regulation is that a contract shall be governed by the law chosen by the parties to the contract. This is called the “freedom of choice” rule.
The law chosen by the parties could be overridden only in exceptional circumstances – if provisions of the law chosen by the parties to govern the contract would breach provisions of the law of another jurisdiction, in which obligations arising from the contract are to be performed, which are crucial for safeguarding its public interests, such as its political, social, or economic organisation. These provisions are called by the Rome I Regulation “overriding mandatory provisions”. As seen, these are not just any provisions of the law of a country that are otherwise mandatory in it. These are provisions that are so crucial to the country where the contract is to be performed that a breach thereof is able to distort its political, social, or economic organisation. Further, an overriding mandatory provision would override the law chosen by the parties only insofar as such provision, taking into account its nature and purpose and the consequences of its application or non-application, would render the performance of the contract unlawful.
The use of a parallel debt or another way of allowing an agent to hold the security instead of the lenders in financing is a tool for reducing paperwork and bureaucracy in financings making the financing ultimately easier and cheaper and allowing a secondary market of loan participation. As such it does not affect the political, social, or economic organisation of Bulgaria. Quite the opposite – by ensuring easier-to-administer and cheaper financing for borrowers from Bulgaria, it actually helps the economy of Bulgaria.
Second, as mentioned above, even if the parallel debt is not expressly regulated by Bulgarian law, we do not see any prohibition in Bulgarian law for agreeing to use it as part of the freedom of contract principle.
BTW, English law (which usually governs cross-border financings involving Bulgarian borrowers or security providers) equally does not regulate expressly the concept of parallel debt. It is simply a contractual clause drafted under the freedom of contract rule. As far as we are aware, there is no doubt whatsoever that a parallel debt clause is valid and enforceable under English law.
In recent years we have seen parallel debt clauses governed by the laws of continental law jurisdictions (which are principally close to Bulgarian contractual law being also a continental law) such as Germany, Poland, and others.
Another argument raised by some lawyers in Bulgaria against the validity of a parallel debt is that under Bulgarian law a loan agreement is a real transaction (i.e., if the lender has not actually disbursed any money to the borrower there is no loan even if the loan agreement has been signed). Hence, they are saying that because the security agent does not actually disburse any money to the borrower under the parallel debt, the latter is invalid (does not exist). This conclusion is also wrong. It is based on an incorrect confusion of the loan obligation and the parallel debt obligation. The latter does not try to be a loan in the first place. The parallel debt obligation is an abstract obligation. Bulgarian law recognises in principle abstract obligations – for example promissory notes. A promissory note is similar to a parallel debt insofar as under a promissory note the issuer (the promissory) promises to pay an amount of money to another party (the beneficiary) without any explanation or reference to the reason for such payment. In practice, a promissory note is often issued in relation to a loan agreement and is linked to it, however, this is not said anywhere in the promissory note itself (as stating this in it would make the promissory note invalid).
The fact that Bulgarian law recognises an abstract promise by someone to pay an amount to another (i.e. a promise not linked to any reason) means that there is no reason to sustain a promise by the borrower to pay an amount to the security agent is invalid because the security agent has not given any money to the borrower.
Is the validity of the parallel debt in Bulgaria tested in the Bulgarian courts?
To our knowledge as of today, the validity and enforceability of a security governed by Bulgarian law and securing a parallel debt governed by English (or any other foreign law) has not yet been tested in the courts of Bulgaria. This is often raised as an argument by some local lawyers against the acceptability of such security.
This argument is also wrong. First of all, the lack of Bulgarian court judgments rendered on the question of the validity and enforceability of security governed by Bulgarian law and securing a parallel debt governed by English (or any other foreign law) does not mean that such security is not valid or enforceable. It simply means that no court in Bulgaria has ever been asked to consider this question. This in itself might even be seen as a positive signal meaning that no one has ever questioned the validity and enforceability of such security in Bulgaria.
As far as we are aware, courts in other continental law jurisdictions (e.g., France, Poland, etc.), have already confirmed the enforceability therein of parallel debt clauses governed by English or other foreign laws. The fact that the main principles of the contractual laws of these jurisdictions (as well as their political, social, and economic organisation) are in general similar to those in Bulgaria, is another positive sign that, should the Bulgarian courts be approached with this question, they should also confirm the enforceability in Bulgaria of a parallel debt clause.
Has the parallel debt been used in Bulgaria already?
Yes, in cross-border financings involving Bulgarian borrowers or security providers parallel debt is almost always used to create security held by a security agent.
Instead of a parallel debt, could the concept of joint creditorship be used?
Due to the concerns raised by some lawyers in Bulgaria over the validity or enforceability in Bulgaria of the parallel debt, some lawyers in Bulgaria have suggested using instead the concept of joint creditorship. In particular, they suggest including a clause in the loan agreement that the security agent will be a joint creditor of the debtor, together with the lenders, for the repayment of the loan. In this way, they are trying to put the security agent in the same role (i.e., of a creditor of the borrower) as the lenders thus allowing the security agent to hold the security in its own name.
In principle, this concept could also be used however, there is no principal difference between it and the parallel debt. In both cases, the security agent does not lend any money to the borrower but nevertheless becomes a creditor of the borrower.
Equally, to the parallel debt, Bulgarian law does not regulate the concept of joint creditorship. Therefore, the use of this concept does not seem to achieve any greater legal certainty compared to the use of parallel debt.
Key takeaways
The conclusions from the above are:
- using a security agent to take the security in its own name without registering the lenders as secured parties in the security registers is commercially beneficial to both the lenders and the borrowers hence lenders who use it would enjoy a competitive advantage over those who don’t use it
- taking security by a security agent is not contrary to or prohibited by Bulgarian law
- a parallel debt governed by English or another foreign law (and valid under such law) is enforceable in Bulgaria (even if this has not yet been confirmed by a Bulgarian court)
- a parallel debt governed by Bulgarian law should also be valid and enforceable in Bulgaria
By Damian Simenov, Partner, Boyanov & Co
