A broadly-syndicated U.S.-law credit agreement which closed recently includes language limiting the ability of lenders to grant pledges or sell participation interests in their loans. The language appears to be intended to prevent pledgees and participants from gaining direct rights under the credit agreement, but goes beyond provisions that are customary in the market by attempting to (i) prevent participants from gaining beneficial ownership of the participated loan and (ii) preventing participants and pledgees from obtaining direct ownership of the loan even in the event of the insolvency of the grantor or pledgor. Although this language may be ultimately unenforceable, by its terms it could prevent a collateralized loan obligation fund (CLO) from effectively pledging its loans to its trustee, and cause a lender that sells a participation interest using the forms promulgated by the Loan Syndications and Trading Association (LSTA), or any other form that effects a “true sale,” to be in non-compliance with the credit agreement. Collateral managers of CLOs, and market participants intending to sell or buy participation interests, should review pledge and participation provisions of recent credit agreements closely to confirm that they do not contain language that could be breached by, or could frustrate, ordinary market practices and expectations.

Pledges by CLOs -

A defining feature of a CLO is that it grants a security interest in its portfolio of loans and other assets to its trustee, for the benefit of the holders of its notes. Frequently, the collateral manager is contractually obligated to ensure that the trustee holds a perfected, first-priority security interest in the CLO’s portfolio. The ability to effectively pledge may also be a requirement under the CLO’s indenture in order for a loan to be eligible to be purchased by the CLO. To accommodate CLOs (as well as banks that pledge their loans to a Federal Reserve Bank), most credit agreements that are marketed to the U.S. loan market (and an increasing proportion of European credit agreements) include language explicitly permitting pledges without any consent or notice requirement.