• New Dodd-Frank Rules Impact Loan Guaranty Agreements
  • May 23, 2013
  • Law Firm: Dressman Benzinger LaVelle psc - Crestview Hills Office
  • Effective this Spring, new rules under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) will significantly impact guaranty agreements in loans that involve "swap" agreements.  The new rules interpret a swap agreement under Dodd-Frank to include any guarantee of a swap agreement.  As a result, guaranty agreements will be subject to the rules and penalties set forth in Dodd-Frank and its regulations.

    Under Dodd-Frank, parties entering into a swap agreement must be "eligible contract participants" (ECPs), which are typically entities holding more than $10 million in assets.  Thus pursuant to the new rules, guarantors of swap obligations must now be ECPs.  While many borrowers hold more than $10 million in assets and qualify as ECPs, guarantors are often small subsidiaries or individuals who do not meet this threshold.  Lenders and borrowers often rely on the guarantees of subsidiaries and owners to meet underwriting requirements, and these new rules may cause roadblocks in the approval process.

    For Dodd-Frank to apply, the guaranty agreement must guarantee the obligations of the swap agreement.  However, most guaranty agreements define the guaranteed "obligations" broadly to include swap obligations.  In these situations, unless the guarantor is an ECP, the subject guaranty is either (a) unenforceable to the extent that it guarantees swap obligations, or (b) unenforceable in its entirety.  It is not yet clear which position courts will adopt, but Lenders should modify loan documents to plan for the worst.

    Lenders have two realistic options:  (1) include language in the guaranty agreement specifically excluding all swap obligations from the guarantee, i.e. a carve-out provision, or (2) utilize a "keepwell" agreement. In a keepwell agreement, ECP parties to the swap agreement provide assets to non-ECP parties at the time the swap is initialized, allowing the non-ECP party to cover the shortfall from the $10 million.  The non-ECP party may then lawfully enter into the swap transaction.  Lenders should adopt one of these solutions (or an alternative) in future transactions, as well as existing transactions where the swap has yet to initialize.

    Unfortunately, rule makers left several questions unanswered.  In addition to the issues discussed above, it is not clear whether the new rules affect other documents that secure swap obligations, such a security agreements, assignments or mortgages.  At this point, until a rule or interpretation states otherwise, it is reasonable to continue to secure swap obligations with these documents.  However, lenders, borrowers, and other loan parties should monitor developments in this area.