How A BA Works 

A BA consists of a draft containing a promise to pay a sum certain at a specified date drawn by a borrower and stamped or accepted by a bank. By accepting the draft, the bank assumes the primary obligation to pay the principal face amount of the BA at maturity.

The BA is rendered negotiable through an effective endorsement by the borrower, enabling the BA to be sold at a discount by the borrower (a) to a lender under a credit facility being provided to the borrower or (b) if the borrower has sufficient distribution capability (and usually only investment grade issuers have such capability), directly to a purchaser in the secondary market. In either case, the lender or purchaser may further negotiate the BA or hold it until maturity. If the purchaser holds the BA to maturity, it is entitled to present the BA to the accepting bank for payment of the principal face amount of the BA. In this manner, the borrower may use the superior credit rating of the accepting bank to lower the borrower’s cost of borrowing.

BAs usually have a term of 30 to 180 days. For trading convenience, BAs are also drawn in convenient amounts, usually in integral multiples of hundreds of thousands of dollars. BAs are usually denominated in Canadian dollars but also may be denominated in US dollars.

Pricing

The cost to the borrower is a function of the discount applied to the BA and an accepting fee charged by the bank. At the time of acceptance, the bank charges an acceptance fee based upon the face amount and the term of the BA. The fee charged in respect of any particular instrument will reflect the bank’s assessment of the drawer’s credit-worthiness. The discount reflects the purchaser’s assessment of the risk of the transaction (as measured in relation to the bank’s credit-worthiness) and the amount charged by the purchaser for the use of its funds until the date of maturity. BA funding is usually 50-75 basis points cheaper than floating prime rate funding.

Common BA Terms

In practice, banks assume an active role in the trading of BAs. It is common for loan agreements to provide that the bank, after accepting a BA, may sell the BA.

At the date of maturity, the holder of the BA calls upon the accepting bank to honour its obligation, the accepting bank pays the holder and then looks to the borrower for reimbursement. Typically, the loan agreement provides the borrower with the option of either “rolling the BAs” (i.e. issuing new BAs and reimbursing the accepting bank for the matured BAs with the proceeds of such new issuance) or using some other method of availment under the facility to reimburse the bank, such as borrowing through a Canadian prime rate advance.

 This post was authored by Richard Borins and Joyce Bernasek.

The Loan Parties’ US counsel requested that the Canadian security agreement be conformed to the US security agreement on point. We advised our client to not accept this request on the basis that the Personal Property Security Act (Ontario) ("PPSA") does not apply to a claim in or under, or the proceeds of, the Loan Parties’ property insurance (which is unlike some other Canadian jurisdictions where the PPSAs are stated to apply to insurance proceeds) and, accordingly, the Canadian security agreement should contain an assignment by way of security. Canadian counsel for the Loan Parties agreed with us and, accordingly, the Canadian security agreement was not conformed to the US security agreement on point.

The covenant in the 2012 credit agreement on naming the collateral agent as loss payee under the Loan Parties’ property insurance also was amended, from the unconditional covenant contained in the original credit agreement, to require the Loan Parties to use commercially reasonable efforts to so name the collateral agent. This accommodation of the Loan Parties was made on account of their expressed administrative burden in amending approximately 100 insurance policies (the collateral agent not being the same person under the refinancing as in the original financing). We advised our client that in order to be perfected on property insurance, the insurers should at least be notified of our client’s interest in the Loan Parties’ insurance and requested to acknowledge that interest. The collateral agent made the business decision that it would accommodate the Loan Parties on point and only require their commercially reasonably efforts to name the collateral agent as loss payee.

It is customary in secured transactions that the loan parties represent and warrant and covenant to ensure that the liens granted to the lender parties are perfected first priority liens on the collateral, subject to permitted liens. In the secured refinancing referred to above, such representation and covenant should provide for an exception for insurance claims and proceeds until the applicable action is taken to perfect the assignment of such claims and proceeds.

Section 347 of the Criminal Code (Canada)

Section 347 of the Criminal Code makes it an offence to enter into an agreement for, or to receive, interest at a rate exceeding 60 percent per year. Section 347 applies to a very broad range of commercial transactions involving the advancement of credit, including secured and unsecured loans and commercial financing agreements. Section 347 has been employed where a borrower asserts the common-law doctrine of illegality to avoid or recover an interest payment.

Does Section 347 Apply? – An Advance of Credit

In determining whether section 347 applies, a preliminary issue arises: characterization of the agreement. The agreement must involve the advance of credit. To characterize an agreement, courts look to the intention of the parties as evidenced by their agreement; in other words, it is an exercise in contractual interpretation. Where an agreement has features of both debt and equity, courts look to the substance of the agreement; courts focus on the main thrust of the agreement and not on aspects which are only incidental or secondary in nature. The more contingent the equity aspects of the agreement, the more likely an agreement will be characterized as an advance of credit.

"Interest" Under Section 347

Assuming an agreement is characterized as an advance of credit, the prohibition contained in section 347 becomes an issue. Though it is unlikely that a sophisticated lender would enter an agreement which, on its face, provided for interest at greater than 60 percent, the definition of “interest” in the Criminal Code and its application may present issues when the total return to the lender includes warrants or other equity sweeteners.

Section 347 uses an extremely broad definition of interest. Interest is defined as the aggregate of all charges and expenses, in any form, that are paid or payable for the advancing of credit. This definition is extremely comprehensive, encompassing many types of fixed payments which would not be considered interest proper at common law or under general accounting principles. In determining what constitutes interest for the purposes of section 347, courts look to the substance, and not merely the form, of the transaction to determine whether the return the lender has received constitutes a cost incurred by the borrower to receive credit from the lender and is therefore, “interest”. For example, royalty payments on items manufactured by a borrower have been included in the calculation of interest for the purposes of section 347. Thus, warrants or other equity sweeteners may similarly be captured by the definition of “interest”.

The next issue is the time period for calculating the interest rate. In determining the amount of interest received by a lender, courts calculate interest over the period in which credit is actually available. Accordingly, if warrants or other equity sweeteners are captured by the definition of “interest”, they may be valued at the time of exercise rather than at the time when the agreement is entered into.

Remedies

Finally, if courts find that an agreement has breached section 347 they are free to employ judicial discretion to provide flexible remedies that are tailored to the contractual context before them. Where the arrangement contravenes section 347 and is otherwise unobjectionable, (e.g. it is not a loan-sharking arrangement), courts will typically employ the remedy of notional severance. Notional severance involves courts reading down the interest rate provisions of the agreement to avoid the illegality and thus partially enforce the agreement. Factors that have been cited as supporting the remedy of notional severance include: 

1. whether the agreement inadvertently contravenes section 347;
2. whether the parties are experienced in commercial matters and negotiated at arm’s length;
3. whether the parties were of relatively equal bargaining power; and
4. whether the parties had the benefit of legal advice in the course of negotiations leading to the agreement.

This entry was authored by Richard Borins, Benjamin Leith and Michael P. Doris.

In U.S. law governed loan agreements, the provision limiting interest is usually framed that if interest at the stated rates would result in unlawful rates, then the interest rates shall be reduced to the maximum lawful rates. Canadian courts have refused to enforce such a provision on the basis that they would be required to rewrite the contract by determining which, and in what sequence, element(s) of “interest” should be reduced in order to attain an effective annual interest rate that does not exceed the lawful rate. The result of the Canadian courts’ refusal to enforce such provisions has been, in some cases, that lenders have been denied all “interest”.

Accordingly, to be enforceable, provisions limiting interest should specify the order in which the elements of “interest” shall be reduced so that the effective annual rate of interest provided for in the loan agreement will not be in contravention of the Criminal Code (Canada) (for example, the interest rate on the loan shall be reduced first, then fees shall be reduced etc. until the lawful effective annual rate of interest is attained).

Agent for Non-Signatories

The parties on whose behalf the agent is to act (collectively, the “creditors”) must formally appoint the agent as their agent. On occasion, not all secured creditors will actually sign the credit agreement (collectively, “non-signing creditors” (as distinguished from “signing creditors”)), such as cash management or hedging providers. Before any non-signing creditor is entitled to the benefits of the collateral security, such non-signing creditor should be required to deliver a simple agreement pursuant to which the agent is appointed as its agent and it agrees to the exculpatory and indemnity provisions of the credit agreement in favour of the agent. Alternatively, signing creditors might, on behalf of (and explicitly acting as agent for) any of their affiliates which are non-signing creditors, formally appoint the agent as agent for such affiliates as well as for themselves under the credit agreement.

Scope of Duties

Credit agreements typically include specific provisions to the effect that the agent has no independent duties except as may be specifically provided for in the loan documentation. The agent and the creditors should consider how to best describe the duties (and powers) of the agent in the credit agreement so that the agent can react appropriately to creditor direction. The agent will typically be authorized to take direction from a majority (or whatever the appropriate level of voting might be) of the signing creditors as to matters not expressly provided for in the loan documentation (including, for example, credit bidding). Prohibiting any creditor from taking any action to protect or enforce its rights arising out of the loan documentation without first obtaining the prior consent of the agent and a majority (or whatever the appropriate level of voting might be) of the signing creditors may offer an additional level of protection to the agent in the event of disagreement between creditors.

Reimbursement and Indemnification of Agent

It is conventional for the agent to be fully protected by the signing creditors against liability to the creditors, the borrower(s) and any guarantor(s) (collectively, the “loan parties”), and/or any third parties (except, in all cases, to the extent of gross negligence or wilful misconduct on the part of the agent). This indemnity will usually also cover all losses suffered and expenses incurred by the agent, including the non-payment of any fees owed to the agent. It is also conventional to provide for reimbursement and indemnification by the loan parties of the costs and expenses of the agent and of the creditors.

Related issues to consider from the agent’s perspective include:

• specifying that the agent’s indemnities apply notwithstanding the comparative, contributory, or sole negligence of the agent;
• specifying that the agent’s indemnity from the creditors applies to claims by creditors against the agent;
• authorizing the agent to refrain from acting on the direction of the creditors if in the opinion of the agent its indemnities are insufficient or the ability of the agent to potentially make a claim thereunder has been impaired; and
• ensuring that the obligations secured by any liens granted in favour of the agent (the “secured obligations”) include loan party obligations in respect of reimbursement and indemnification, and that such liens are granted to the agent in its own capacity as well as for the benefit of the creditors.

The agent will, however, usually have to accept any risk associated with collecting from the creditors their respective shares of any amounts owing to the agent pursuant to its indemnity from the creditors.

Contingent Obligations

The agent should also ensure that the secured obligations include contingent obligations. This way, unless a reserve (or letter of credit or similar protection) is provided for its benefit, the agent could potentially refuse to discharge its liens upon termination of the credit agreement if there remains a reasonable possibility that it may need to claim against the loan parties for reimbursement and/or indemnification. This may be particularly useful to the agent in a bankruptcy or insolvency scenario if the creditors propose to settle their claims against the loan parties notwithstanding the agent’s potential exposure to continuing contingent liability. It is similarly desirable, albeit uncommon, for the agent to be specifically authorized to withhold reserves from distribution proceeds after default in respect of future amounts anticipated to become payable to the agent pursuant to reimbursement and indemnification provisions of the loan documentation.

Provisions Surviving Termination

More generally, the agent should ensure that all reimbursement and indemnification obligations in its favour survive not only termination of the credit agreement but also the resignation or dismissal of the agent (accordingly extending to any post-transaction activities of a former agent in connection with an agency succession) or departure of a creditor from the syndicate.

The agent should also consider bargaining at the outset that any creditor sponsored entity emerging in a bankruptcy or insolvency scenario from a bid by the creditors shall assume (ideally on a secured basis) the reimbursement and indemnification obligations of the loan parties.