Date: Sat, 1 Nov 2008
From: "Paul Backer" <pauljbacker@gmail.com>
Subject: survive the crisis, part 3
Survive the Emerging Market Crisis (Russia and CIS)! Part 3, Finance and Legal.
DISCLAIMER: This article is uncompensated. It is NOT legal advice. Everything herein is personal opinion. It does not represent anyone else’s opinion. It does not address any current or past client or employer matter.
I do find Soho Rooms face control inexplicable, but I am not making a particular effort here to make fun of Dan Rapoport, widely rumored to be a fellow ZBT brother. At the same time, what’s the deal with the inedible orchids on every plate? I digress.
“C-de Krupskaya, if it becomes necessary, we will find C-de Lenin a new widow.” Attributed to I.V. Stalin (Dzhugashvili)
“How many tank divisions does the Pope have?” Attributed to I.V. Stalin (Dzhugashvili)
Every business borrows funds, lends funds or operates on its own funds. Your ability to control your financial situation in a crisis comes down to 1. availability of viable options and 2. coercive capacity. If you are a borrower, the crisis presents significant new challenges. The cost of existing finance lines may increase dramatically. Efforts may be made to materially alter other terms of existing finance lines. Existing finance lines may be curtailed or cancelled altogether, correspondent relationships terminated. New finance lines become unobtainable or prohibitively expensive. Perhaps, the largest change is the attitude of lenders toward borrowers.
Now, the big game in town is government support not loyalty of borrowers. It’s not personal, it’s business. It may even be good for your business.
Ukrainian, Russian and Kazakh news sources report a spate of lender efforts to either materially alter the conditions and/or the cost of existing lines of financing. These have taken the form of “forcefully recommending” that multi-year term mortgage borrowers repay their mortgages within several weeks. Other lenders engaged in versions of margin calls against their borrowers’ collateral. Several banks notified their borrowers that in light of the “new financial realities” they will be charged new rates, not the ones contractually agreed at the time of the loan. Some banks notified borrowers that their committed but unrealized (not drawn down) lines of financing (revolving loans, etc.) are terminated, etc.
This makes a borrower’s life much more exciting. But, that’s what a crisis is for, isn’t it? The bad news for borrowers is that if you hold an unrealized line of financing and your lender indicated intent to withdraw it, you are likely out of luck and lack effective recourse. Of course, you can sue if the termination (as it probably does) violates your lending agreement and/or applicable law. However, in terms of cost and benefit, litigation to restore a withdrawn line of credit is likely to be (as the Russians say) a game not worth the candle.
Even in the best case scenario where your bank (somewhat miraculously) fails to find colorable prudential grounds for termination or a borrower’s technical violation (late notices, failure to send notices in the correct form, technical errors in submitted documents, etc.) or to successfully argue that a force majeur condition exists, as the local currency has plummeted, the local lending rates rocketed, etc., you are still not likely to benefit.
Banks have specialized resident legal staff, who are pretty good. As a legal professional and law instructor, I trained a number of them myself. It is likely to be a very long wait before you get a bank into court. If you win, they will appeal. The process will take years. You may recover a small fraction of your actual legal costs. Liquidated damages are extremely unlikely. A court is also unlikely to compel specific performance. In a time of failing banks and state intervention, if a lender states that they don’t want to lend to you, because you are not a safe borrower, the court will likely accept the argument. Banks are given (particularly during a crisis) significant deference as to whom they lend.
Finally, you are likely to find yourself on the wrong side of public policy. Many of the banks in question are recipients of public largesse. Imagine that you are in Kazakhstan and your issue is with one of the four dominant banks reputedly set to receive $5 billion in support from the Kazakh government. If the local federal government used budgetary funds to shore up a lender, the likelihood of a responsible local court forcing them to lend to you is vanishingly small.
What can one do in a crisis if he has an unrealized finance line at an interest rate far below market? Kind of sounds like money found on the street. Maybe one should pick it up? Draw down the credit limit. And… umm… incidentally, to avoid real “D’uh” moments, probably not keep the cash in the lender bank. Seriously, it sounds crazy, but people do stuff like that. Currently, banks in Russia pay up to 16.5% per annum in RFR, so if one has a credit line at a much lower rate…
The limited enforceability of revolving credit and financing agreements generally is something of good news for businesses which provide financing. It gives them the opportunity to review their existing lending commitments, and rationalize the ones that are no longer economically viable. In American English this is called the doctrine of fruitful contractual breach. Don’t do self destructive deals, honor the penalty and liquidated damage provisions (typically none for a lender in a revolving credit agreement), but don’t engage in self-mutilatory transactions.
As a former expert in Sharia finance law, I am far happier discussing the difference between riba and lariba (figs are involved) than hear a civil code colleague drone on about the sanctity of contract. No such thing in a crisis. A contract is not a mutual suicide pact. If a deal doesn’t make sense, honor your obligations to your stakeholders. The actual legal costs in the somewhat unlikely event of litigation are under $20,000 per annum, and the process can be expected to last 2-3 years. Cooler heads will prevail. What about regulators? Won’t they compel you to lend? Not if the loan raises fiduciary, stability and viability concerns. Not in a crisis.
Is the world watching? Well, yes, but probably not you or your transaction. Mostly, I think the world watches Dexter, CSI (original, not the hackneyed overacting twitching of Senise(sic) and Caruso) and the Simpsons. Even if the world wanted to watch your transaction, that is tough to do in emerging market states. Broadly, legal proceedings and documents in many former Soviet states are not open to the public. One can’t really show up in a Russian courtroom and “sit in” on someone else’s commercial litigation or formally get copies of litigation documents from the court. The guard won’t allow you in the room and/or the building. If you feel that is illegal, you are welcome to sue and then use your “back in time” machine to attend.
Contrast this with the U.S. and other nations where one of the common ways to defeat confidentiality and non-disclosure provisions is to include company confidential documents in a litigation, so they become public record. Some cynics argue that airing protected information is the sole purpose of some litigation. We are not cynics. Support for commercial secrecy, especially in legal proceedings and secured lending is wrongheaded, facilitates fraud and malfeasance. This is how it is in many emerging market nations. I am a very big fan of UCC1s, they aren’t.
Keep in mind that peacetime rules don’t really apply in a crisis. Up to July of 2008, it would have likely been a significant and newsworthy item if a sizeable local lender failed to honor a commitment to lend. That is not the case now, when banks seem to either be rescued or lose their license every couple of weeks. The public relations cost of not honoring a lending commitment at this time is largely zero. Most everyone who is paying attention has already fled to “quality”.
Russia’s Sberbank reports double digit asset growth. The rest are either not “smart money”, suffer learned helplessness, persistent vegetative state or have an articulable reason for remaining with a private, and therefore definitionally more vulnerable (at this time) bank. Not one of these customers genuinely cares if someone else’s credit line was rescinded. If a bank is prepared to terminate your credit line, it is a definitional indication that they are not terribly concerned about your reaction.
Back to borrowers. What is the good news? If you “realized” your finance line, if you got the cash money greenbacks, your position is very different. Your lender has to be much nicer to you. Can your bank unilaterally accelerate your mortgage or other long term loan, because your collateral no longer covers it? No. An appraisal must be made by a qualified professional, and is subject to court proceedings to appeal.
Sidebar. I keep repeating that in a crisis, a good transactional lawyer earns a multiple of his costs for his clients. Readers ask for examples. This is an example. Think of the phrase, 1. qualified professional, 2. make an appraisal. A request to do so must be formally made by a lender in accordance with the notification procedure provided for contractually or by statute. It is responded to in an appropriate manner or not. Legitimate grounds for this demand (contract or statute) must be identified. This person’s presence on the premises must be somehow agreed. The methodology must be agreed. He must gain access to the premises and issue a formal finding. This finding can be appealed, etc., etc.
Ultimately, best practices as partially described in the Survival Guide are important, ideas in this Survive the Crisis! series may have some value, but surviving a crisis is just as much about controlling the narrative and the timeline as anything else. If you are the one borrower who is most effectively resistant to extralegal impacts, they will go pick on someone else and you materially increase your chances to survive. Effective counsel dramatically reduces your counter-parties’ ability to successfully coerce you and help you maintain control of the timeline.
Can your lender unilaterally change your interest rate absent a specific contractual provision? No. The legal presumption is that any interest rate written into a loan agreement, absent specific contractual provision to the contrary is FIXED. What happens if your bank lent you funds at 10% a year and the market is now at 25%? Sad to be them. Perhaps they go out of business and you repay your loan to their legal successors. As long as the amount of your payments doesn’t change, what’s the difference? Hopefully, someone at the lender loses their job for incompetent drafting and better transactional lawyers get hired.
This is a good time to touch briefly on what makes a good transactional attorney v. one able to only prosper when the fields are littered with milk and honey. A good transactional lawyer is pedantic and often, a high level functioning paranoid. He is the guy who put indexation into contracts with RFR when it was touted as the new French Franc in 1998, 6 to a dollar!, 6 to a dollar! When major lenders such as EBRD rather famously failed to do so.
He is valuable to any entrepreneur, because he is not playing at being James Bond (very mysterious), J.P. Morgan (an oligarch) or Dan Rapoport (very glamorous, and now a GQ editor). He just keeps the ball moving forward. Probably, the guy isn’t cut out to be any of the above, but it’s OK. Anyone who has ever played rugby knows the beauty of keeping the ball moving forward in the dirt and the rain. There really is a thrill to taking a global crisis, breaking it down into component parts as it affects a particular client, taking control of the narrative and the timeline and keeping the ball moving.
NOTE: Are we in a force majeur situation? No lender to date has formally made this argument, as it puts them on the wrong side of the powers that be. Force majeur is a flood, an earthquake, civil war, revolution, war, government action, etc. Ask your lender to pick one and say that for attribution in a courtroom when the government put its prestige at stake as to its ability to effectively mitigate the crisis.
As always, any questions, comments, etc. to pauljbacker@gmail.com.