Refinancing can be a good option for parties looking to secure better terms and conditions from existing loan agreements. For example, in order to obtain a better leverage ratio and partial principal repayment, a borrower of power plant project financing might consider refinancing for the purpose of lowering the interest rate and DSCR required after some time after the start of the operation since the risk profile of the exploitation phase is different from that of the development phase.
For the refinancing of syndicated loans, which involves changing some of the members of the syndicate, some may be familiar with the amendment and restatement (“A&R”) method used in other jurisdictions where the parties and the terms and conditions of the existing loan agreement are amended globally and only the increased portion of the loan (if any) is newly extended without repayment of the existing loan. Despite some economic advantages of the A&R approach, it has not been widely adopted in the Japanese banking industry. Instead, it is more common to see a traditional physical refinancing approach with existing loans paid off in full along with the extension of new loans and the replacement of original financing documents with new financing documents. This article summarizes practical features and things to consider when adopting the A&R approach to refinancing in Japan.
II. Why the A&R approach is preferable
There are a number of reasons why the A&R approach is more preferable than traditional physical refinancing. Here are four of the most common:
(i) Mortgage Registration Tax Savings
If a mortgage was given to lenders as part of existing loans, the same is often required by refinancing lenders. Since the registration fee for transferring an existing mortgage is lower than registering the establishment of a new mortgage1, the A&R approach can be more cost effective.
(ii) Avoid the cost of financing breaks
A borrower is generally required to pay break finance charges to lenders when repayment of loans is made on a date other than an interest payment date for existing loans. This means that the borrower will only be able to refinance on a date that coincides with the interest payment dates – usually three or six months. Under the A&R approach, to the extent that the loan amount after the A&R refinance is greater than the existing loan amount, no physical repayment of the loans would take place and, therefore, no cost of breakout financing. would be due. This gives the borrower additional timing flexibility when refinancing.
(iii) Maintaining capitalized costs
From an accounting perspective, some borrowers may have capitalized the initial financing costs based on their past transactions. Unlike traditional physical refinancing, capitalized costs can be maintained under the A&R approach since the existing loan facility will continue to exist despite a change in lender group or certain changes to financing documents.2
(iv) Effective Negotiations
Unlike traditional physical refinancing where the scope for changing existing terms and conditions is unlimited and the scope of negotiations could be extended, under the A&R approach parties would naturally prefer to maintain existing terms and conditions to the extent that they are irrelevant to the objectives of the refinancing. From a legal point of view, any modification that could lead to a change in the identity of the loans must be avoided in order to maintain the existing securities. Therefore, adopting the A&R approach could greatly improve the efficiency of negotiations by focusing only on the objective of refinancing itself, and save time and money for all parties.
III. Why the A&R approach is not common in the Japanese market
Despite the advantages mentioned above, the A&R approach is generally not adopted in the Japanese market for the following reasons:
(i) Individual loan transfer required
Under the A&R approach, to the extent that the contemplated refinancing involves a change in syndicate membership, loans will be transferred from existing lenders, whose participation will decrease, to other lenders, whose participation will increase upon refinancing.
Under the Japanese Civil Code (Law No. 89 of 1896, as amended), a sale and purchase (baibai) must be entered into between an individual seller and an individual buyer with respect to the exact portion to be sold and bought. Thus, the parties have an additional burden to specify each seller and its corresponding buyer and the loan amount to be transferred between each seller and buyer in the A&R agreement. The method of payment of the sale and purchase price must also be taken into account because the payment of the buyer must in principle be made to the corresponding seller.
(ii) Security created for individual lenders
In some jurisdictions, because security is given to a single entity such as the security trustee instead of each individual lender, the transfer of loans from an individual lender would not require a transfer of security depending on how the security is structured. However, under Japanese law, it is common practice in the market for individual security to be provided for each individual lender. 3 Accordingly:
(a) A prudent and practical interpretation of the perfection method of creating a pledge of contractual rights (which is generally given to project finance lenders of the borrower’s contractual rights under the project documents) would be that it is necessary to obtain a letter of consent again from the counterparty to the applicable contract to perfect the pledge after the A&R refinancing. Therefore, under such an interpretation, the A&R approach would not necessarily simplify the refinancing process.
(b) Any increased portion or other new loan (if any) must be secured by a newly created individual security that is separate from security created in favor of existing lenders. Since the order of priority of security is determined by the time of third-party effectiveness, if the parties intend to ensure that the order of priority between existing and new security is the same, it would be necessary to alter the priority of the already enforceable security interests. In this respect, although there is a legal provision for such a change in the order of priority of mortgages (teitou-ken) 4 , other types of securities, including pledges (shichi-ken), do not have no similar legal mechanism and there is no established understanding of how to effect such a change.
As the A&R approach has not been widely used in the Japanese market, some lenders may need more time to assess the transaction. Since the A&R agreement will involve all existing and new lenders6, borrowers and refinance arrangers also have the task of obtaining the understanding of all related parties.
IV. How to Get A&R Refinance
The A&R approach remains a practical and preferable option in certain circumstances. Entities interested in adopting the A&R approach would be well advised to keep the following points in mind.
(i) Individual Loan Transfer Agreement
An A&R agreement will list the details of individual loan transfers, including each seller, buyer, and the amount to be transferred between each seller and buyer. Settlement of the sale and purchase price will be made collectively through a paying agent designated by each purchaser. 7
The risks regarding the repayment of the loan itself must be borne by the borrower in the same way as in traditional physical refinancing, including conditions precedent to the A&R agreement, representations and warranties, events of default and similar standard provisions. 8
(ii) Reinstatement of securities other than those relating to registration tax
Given the legal and practical factors described in Section III (ii) above, instead of taking a one-size-fits-all approach to different types of security interests, parties may take different approaches to how mortgages and other security interests are managed. This means that, on the one hand, in relation to a mortgage, the parties can have the registered mortgage transferred from one lender to another and, if a new mortgage is established, create and register this new mortgage and implement the change of order of priority within the framework of the aforementioned statutory mechanism of the Civil Code. On the other hand, since there is no similar mechanism for the other security interests, the parties may choose to first cancel the existing security interests and then reinstate new security interests in favor of each of the current and new lenders after the refinance A&R and follow perfection procedures again. 9
V. Additional Considerations
Several other points should be considered and documented when implementing A&R refinancing. For example, since the A&R structure requires the participation of all existing and new lenders, more thought may need to be given to the options available if one or more of the exiting lenders rejects the A&R refinance proposal. The management of the existing interest rate swap is also another area that requires careful consideration. Entities considering adopting an A&R approach to refinancing are recommended to consider all practical benefits and risks of the Japanese legal system and market practices in the Japanese banking industry.