Why pay off your debt when it's cheaper to owe it to yourself?

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  • Purchase of debt by borrower

    Tim Polglase is, of course, right in saying that one must examine what the loan agreement says - particularly in an era of ‘ covenant lite’ loans.

    However, a well drawn document will normally define ‘transferee’‚ as meaning a bank or other financial institution‚ to which a transfer is sought to be made. The borrower and its associates may fail to qualify as a financial institution and therefore be ineligible to take a novation under a Transfer Certificate.

    However, ‘Bank’‚ is often defined to include not only a Transferee but any successor in title or assign. The original bank would not be relieved of its obligations under the loan agreement but would have assigned the benefit in the absence of a specific bar on such an assignment. The effect of such a bar is reviewed in paragraphs 16.41 and 16.42 of Lingard’s Bank Security Documents (4th edition).

    But what about the commercial realities? By buying in a participation or part of a participation, the borrower is effectively buying in part of the loan contrary to restrictions on prepayment. As this causes a reduction of the sum owing by the borrower under the loan agreement, the original bank could find itself liable to share its receipts with other syndicate members under a redistribution of payments clause.

    It would, of course, be possible for the borrower to arrange for a participation to be bought by a friendly financial institution, but this would entail remaining liable on the original loan as well as financing the purchase.

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