Foreign Exchange and Lending Agreements

Transcription
Foreign Exchange and Lending Agreements
Hello everyone, in this lecture an introduction to the Foreign Exchange Management Act, we would cover various
aspects of India's legal regime with respect to exchange control.
In particular, we will look at the evolution of India's Foreign Exchange Rules and Regulations. The policy changes that
resulted from the Foreign Exchange Regulation Act being replaced by the Foreign Exchange Management Act and the
principal differences between the two. We would then look at the key principles of regulation under the FEMA, the
concepts of current and capital account transactions, the different kinds of foreign exchange instruments, we'll
examine the difference between debt and equity, understand sectoral limits, look at the automatic and approval
routes for FDI. We would also then focus briefly on external commercial borrowings and their regulation.
Simplistically put, exchange control laws impose limitations on free convertibility of one currency to another.
Therefore, exchange control laws regulate how transactions, such as the exchange of goods or acquisition of assets
across borders would take place. Such laws create certain barriers against the free movement of goods and capital
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across borders, usually with the intent to protect the domestic market of players. Post-independence, India was a
closed economy with an absolute embargo on the free movement of goods and capitals across its borders.
Soon, after independence, the Foreign Exchange Regulation Act of 1947 or the FERA 1947 was enacted, and this
imposed severe restrictions on all forms of cross-border transactions. The FERA 1947 was subsequently replaced by
the Foreign Exchange Regulation Act of 1973 or the FERA 1973.
The purpose of FERA 1973 as evidence in its preamble was to regulate certain payments, dealings in foreign exchange
and securities, transactions indirectly affecting foreign exchange and the import and export of currency for the
conservation of the foreign exchange resources of the country and the proper utilisation thereof in the interest of the
economic development of the country.
The main purpose of the FERA was therefore the preservation of foreign exchange. 1990 onwards. India began a
gradual process of deregulation and liberalisation. A vital part of this process was a review of the FERA. As we have
seen, the FERA was intended to create barriers to growth and foreign investment, and was therefore the very anti-
thesis of liberalised reforms. In 1997, the Tarapore Committee on Full Capital Account Convertibility recommended
the replacement of FERA 1973 with a Foreign Exchange Management Act.
Subsequently, the Foreign Exchange Management Act of 1999 or the FEMA was enacted the FERA 1973 was repealed.
Contrary to the FERA, the preamble of the FEMA said that the purpose of the FEMA was to consolidate and amend the
law relating to foreign exchange with the objective of facilitating external trade and payments and for promoting the
orderly development and maintenance of the foreign exchange market in India.

Let us now look for a moment at the key differences between the FERA and the FEMA. The FERA led emphasis on the
regulation of currencies. Through FEMA, the approach, however, changed towards exchange control and shifted from
conservation and control to management of foreign exchange. To give an example, under section 31 of the FERA, no
non-resident could purchase immovable property in India without the special permission of the Reserve Bank of India.
If such permission was not provided, the transfer could not be affected.
While under the FEMA, restrictions still continue on the transfer of immovable property, powers have been provided
to the RBI to allow certain transactions where non-residents can purchase immovable property. In that sense, the
process of acquisition of immovable property in India has become much more simplistic.
The FERA had a very rigid approach towards Foreign Exchange Regulation. The approach of the FEMA is far more
flexible. Similarly, the FEMA removed the criminal consequences for a breach of exchange control laws and also
introduced provisions for compounding of offenses under the statute. Contravening the provisions of the FERA, on the
other hand, would have resulted in imprisonment. The punishment for violating the provisions of FEMA is a monetary
penalty, and it is only if the monetary penalty is not paid, does the penalty amount to an imprisonment.
Let’s take a look at the key principles of the FEMA. Over the years through regulations framed under the FEMA, there's
been a gradual and steady reduction in the degree of limitations, which are imposed on cross-border transactions.
However, despite this gradual liberalisation, certain cross-border transactions continued to be regulated under the

FEMA and the regulations framed their under. As we have discussed, the main objective for which the FEMA was
introduced in India was to facilitate external trade and payments.
In addition, the FEMA was also formulated to assist orderly development and maintenance of the Indian Forex market.
The FEMA introduced a definition for residents in India, which is similar to the definition which already existed under
the Income Tax Act. An Indian resident per the FEMA is one who stays in India for more than 182 days in the preceding
financial year.
In terms of its approach to foreign exchange transactions, the FEMA has classified transactions into two broad
categories: Capital account transactions and current account transactions. Every transaction involving a non-resident
and resident can be classified either as a capital account transaction or a current account transaction.
The fundamental rule is that, if it is a current account transaction, the transaction is permitted unless prohibited or
specifically regulated by the FEMA. However, for capital account transactions, the rule is that unless it is specifically
permitted, it is prohibited by the FEMA.
In terms of definition, a capital account transaction is defined as a transaction, which alters the assets or liabilities,
including contingent liabilities outside India of a person resident in India, all the assets or liabilities in India of a person
resident outside India. Also, included is a non-exclusive list of transactions referred to in sub-section (3) of Section 6
of the FEMA.
Current account transactions, on the other hand, is defined as a transaction other than a capital account transaction
and without prejudice to the generality of the foregoing, such transaction includes; one, payments due in connection
with foreign trade, other current businesses, services and short-term banking and credit facilities in the ordinary
course of business. Two, payments due as interest on loans and as net income from investments. Three, remittances
for living expenses of parents, spouse and children residing abroad; and four, expenses in connection with foreign
travel, education and medical care of parents, spouses and children.
Some examples of capital account transactions are purchase of shares of a company outside India, for which a general
permission has been given under the liberalised remittance scheme, obtaining foreign currency loans, again, a general
permission has been given under the external commercial borrowing regulations, which is subject to certain
conditions. Guarantees provided by an Indian resident to a loan taken by a non-resident. Similarly, some examples of
current account transactions include purchase of goods from a foreign party and payments made for such goods,
remittances for living expenses of parents, spouses and children residing abroad, expenses in connection to foreign
travel, education, etc.
Ultimately, the determination of whether a transaction is a current account one or a capital account one varies from
case-to-case and has to be examined on the basis of the facts.

We turn now to foreign investment into India. Foreign currency investments in India are either in the form of debt or
of equity. Generally speaking, any investment into equity shares or any convertible instrument, which compulsorily
converts into equity is considered as equity for the purpose of FEMA. Any optionally convertible or non-convertible
instruments are considered as debt. Therefore, a compulsorily convertible preference share what we call a CCPs is
considered as equity for the purpose of the FEMA, whereas an optionally convertible preference share or OCPS or a
redeemable preference share, an RPS are considered as debt.
Investments in an acquisition, whether complete or partial of Indian companies by non-resident entities and
individuals are governed by the terms of the Foreign Exchange Management, Non-Debt Instrument Rules of 2019.
These are colloquially called the NDI Rules. Permitted FDI includes both primary transactions, that is investments as
well as secondary transactions, that is purchase of shares or NDIs. Both transactions are subject to pricing guidelines.
For example, Facebook's investment into the Jio platform was a primary transaction, where Facebook infused funds
into Jio and were issued shares of Jio in return. On the other hand, when Walmart invested into Flipkart, it did both
the primary down that is it directly invested into the shares of Flipkart, but it also acquired the shares of several existing
shareholders of Flipkart through a secondary transaction.
The pricing guidelines specify that any transfer or issuance of NDIs by an Indian resident or a non-resident that is when
a non-resident is investing into an Indian company or a non-resident is buying NDIs from resident Indian holders should
not be below a threshold price. This threshold price is based on the valuation of the Indian entity in question. Similarly,
a transfer from a non-resident to a resident is subject to a ceiling price, which is based on the similar principle of
valuation.
The valuation has to be carried out by an accredited institution, keeping in mind, internationally accepted principles
of valuation. An interesting case in this respect was the dispute between NTT DoCoMo and Tata Sons before the Delhi
high court. This was in relation to a transaction through which DoCoMo had bought 26% stake in Tata Teleservices
Limited or TTSL in 2009 for $2.7 billion. DoCoMo and Tata had also entered into a shareholders' agreement, which
provided that if the Tata has failed to meet certain obligations in relation to TTSL, DoCoMo could request data to either
find a buyer for DoCoMo shares or buy the shares themselves at a minimum of 50% of the acquisition price.
On March 31st, 2014, TTSL failed to comply with the terms of the agreement, and DoCoMo had sent them a notice for
enforcement of their contractual obligations. Since the price per share was above the threshold value for purchase of
shares by a resident from a non-resident, Tata approach the Reserve Bank of India for an approval for the purchase,
which the RBI refused. Tata then communicated its failure to fulfill its obligations due to the RBI's objections to
DoCoMo. The matter then went into arbitration where DoCoMo succeeded and the arbitral panel unanimously held
that there existed an absolute obligation on Tata to perform the SHA.
It also held that since startup failed to fulfill its obligations, it resulted in a breach of contract and Tata was liable to
pay damages to DoCoMo of around $1 billion. For enforcing the award, DoCoMo move to the Delhi high court. Before
the Delhi high court, Tata argued that the award was invalid because the transaction was ultimately denied by the RBI.
The Delhi high court, however, held that the consent term between TTSL and DoCoMo valid, the court held that the
FEMA contains no absolute prohibition on contractual obligations. Therefore, the relevant clause of the agreement
was capable of being performed.
Further, it was held that the award is for damages for breach of contract and not for overseas purchase of shares. The
court held that no purchase of shares is taking place. So, the question of taking RBI's permission did not arise.
Therefore, the court ordered enforcement of the arbitral award. This is an important case to show that an Indian party
cannot use FEMA regulations to avoid a contractual obligation. Consideration for purchase or investment has to be
paid at the time of the transaction and cannot be in advance of the transaction or deferred beyond the transaction.
The only exception is that a maximum of 25% of the total consideration may be paid on a deferred basis for a maximum
period of 18 months. The sectors that I just talked about is of course an illustrative list. There are other sectors where
conditions apply, and therefore, FDI considerations have to be looked at from a sector-to-sector leads.

Over and above this, the government of India through Press Note 3 of 2020 dated April 17th, 2020 has amended its
foreign direct investment policy to curb what it calls opportunistic takeovers and acquisitions of Indian companies due
to the current COVID-19 pandemic. Accordingly, any investment being made from Bangladesh, China, Pakistan, Nepal,
Myanmar, Bhutan and Afghanistan, or where the beneficial owner of an investment into India is situated in, or is a
citizen of any of these countries requires prior approval of the government, regardless of the sector activities in which
the investment is being made.
This approval process is a complex and tedious one. All Chinese companies, all Hong Kong-based companies and funds
and all other international companies with Chinese shareholdings are impacted by Press Note 3. Example, Press Note
3 impacted the ability of Jack Ma's and group to participate in the rights and bonus issues by PayTM and Zomato, both
of which completed their IPOs recently and in both and was an existing investor.
Let's now look at the sectoral limits and approval and automatic routes for FDI. India now has a fairly liberalised FDI
regime where foreign investment is allowed in most sectors. There are only certain sectors where no FDI is permitted.
This includes atomic energy, gambling and betting operations, lottery businesses, real estate business, trading in
Transferable in Transferable Development Rights or TDRs, manufacturing of cigars, cheroots, cigarillos and cigarettes,
or of tobacco or tobacco substitutes.

In almost all other sectors, FDI is either permitted up to the sectoral limit indicated against each sector of activity or is
permitted up to 100% under the automatic route subject, in some cases, to applicable additional laws and regulations,
security requirements and conditionalities. In a few sectors, additional conditions are required to be complied with
such as minimum capitalisation requirements.
If an investment is under the automatic route, what it means is that the investments into the Indian company does
not require the prior approval of the Reserve Bank of India or of the central government through the concerned
Administrative Ministry of Department. For sectors in which limits apply, foreign investment is permitted under the
automatic route up to a certain percentage of investment and investment beyond certain percentage is either not
permitted or would require prior approval of the government as indicated in the FDI policy.

Some of the examples of sectors, which are partially under the automatic route and partially under the government
approval route or sectors where their conditionalities to FDI include one defense where 100% FDI has been permitted,
of which up to 74% is under the automatic route. For investment above 74%, approval of the government will be
required, which is likely to be given if the investment allows access to modern technology or for other reasons to be
recorded by the government at the time of giving the approval.
In the insurance sector, after recent changes, 74% FDI is permitted under the automatic route. In the Broadcasting
Content Services, 49% FDI is permitted, but with government approval and similarly in digital media 26% FDI is
permitted with government approval.
In the pharmaceutical sector, up to 74% FDI is permitted under the automatic route, and any investment above 74%
has to be with approval. Multi-brand retail allows 51% FDI with government approval; however, the investment is also
required to comply with additional conditions, which includes the FDI company should have a minimum capitalisation
of $100 million, 50% of the total FDI in the first tranche of US $100 million, would have to be invested in the backend
infrastructure within three years.
Retail sales outlets may be set up in those states, which have agreed or agree in future to allow FDI in multi-bland
retail trade. There must be a 30% mandatory local sourcing requirement from Indian micro, small medium industries,
which have a total investment in plant and machinery not exceeding US $2 million. Similarly, in single brand retail, FDI
is allowed up to 100% under the automatic route. However, such investments also required to comply with certain
conditions, such as the products have to be sold, should be of a single brand and the product should be sold under the
same brand internationally.
If the FDI is proposed to be beyond 51%, then sourcing of 30% of the value of the goods purchased should be done
from India, preferably from Indian micro, small and medium enterprises. Foreign investment in limited liability
partnerships or LLPs is permitted under the automatic route. For LLPs, which operate in sectors or activities where
100% FDI is allowed through the automatic route, and there are no foreign investments linked performance conditions.
Let's take a look for the moment at downstream investments. FDI into Indian companies or LLPs may be direct or
indirect. Indirect FDI is downstream investment made by an Indian company or LLP, which is foreign owned and
controlled, or what we call an FOCC. This FOCC in turn invests into another Indian company or LLP. For example,
Flipkart in which foreign investment is more than 50%, is considered as an FOCC. So, further investments and
acquisitions by Flipkart in India even if it's through a subsidiary of Flipkart, which is an Indian company is considered a
downstream investment.
Therefore, when Flipkart through an Indian subsidiary acquired 7.8% in Aditya Birla Fashion, which is another Indian
company, the deal still needed to confirm with FEMA pricing norms. As per the FDI policy, downstream investment is
also required to comply with the same norms as applicable to direct FDI in respect of relevant sectoral conditions,
entry routes, conditionalities and caps. This is with respect to the sector in which the downstream entity is operating.
In addition to investing under the FDI regime, foreign investors, which are registered with the Securities and Exchange
Board of India has foreign venture capital investors are allowed to invest in Indian companies in 11 specific sectors.

These sectors include biotechnology, nanotechnology, IT related to hardware and software development, seed
research and development, poultry, production of biofuels, hotel-cum convention centers with seating capacity of
more than 3000, research and development of new chemical entities in the pharmaceutical sector, the dairy industry,
etc.
It is important to note that pricing restrictions as are applicable to FDI, do not apply to a FVCI investments. The FEMA
also allows portfolio investments in India by SEBI registered foreign institutional investors and by certain qualified
foreign investors without being subjected to the FDI restrictions. These investments are governed by the SEBI Foreign
Portfolio Investor Regulations of 2019 or the FPI Regulations. FPIs include international central banks, sovereign wealth
funds, pension funds, university funds, international or multilateral organisations or agencies, corporate bodies, family
offices, individuals, etc.
An FPI may purchase equity instruments of an Indian company through a public offer or private placement, and such
investments are subject to the limits and margin requirements specified by the RBI or SEBI, but not other provisions
of the FEMA. An FPI may also purchase units of domestic mutual funds or Category III alternate investment funds as
well as offshore funds.

Let's take a moment to look at debt funding. Indian companies in regulated circumstances can obtain debt from foreign
investors. Basically, three routes are available.
FVCI lending. FVCI is a permitted to invest in debt instruments issued by Indian companies engaged in the specified
sectors we talked about before. These investments can be by way of optionally, compulsorily or non-convertible
debentures. Investment into NCDs by FVCIs can be made only in companies whether FVCI already has existing equity
or equity linked instruments and cannot exceed 33% of the total investment by FVCI. FVCIs are most favourable in the
infrastructure sector where investors use the FVCI for setting up capitalising the investee company with nominal
capital and investing the bulk of the investment as debt in the form of optionally or non-convertible debentures.
Rupee-denominated non-convertible ventures, foreign portfolio investment. FPIs can acquire rupee-denominated
non-convertible debentures issued by Indian corporates directly. These NCDs could be listed or unlisted. Unlisted NCDs
have certain end-use restrictions, such as real estate business and investment in capital markets. The NCD option can
be a preferred one since the route A, permit security creation in favour of a resident security trustee on behalf of the
investor. B, provides free transferability of the NCDs. C is efficient from a tax perspective and D, permits tracking
underlying stocks and investors can be passed on the equity upside as well. By building in adequate equity kickers for
investors, for example, as redemption premium or varying interest or coupon.
The third important route is the external commercial borrowings or ECBs is a route used extensively by foreign banks
and financial institutions. ECBs can be rupee denominated or foreign currency denominated. The possibility of foreign
currency denominated lending makes this option preferable to certain long-term looking lenders. However, the ECB
policy imposes certain conditions on the lending as well, and these are conditions, which every ECB loan must comply
with. This includes a minimum average maturity, the minimum period for which the loan has to be availed at the time
of borrowing and a ceiling on the all-in-cost, which is the maximum amounts that can be paid by the borrower to the
lender.
The all-in cost ceiling is the maximum amount of returns that can be paid to an ECB lender. This all-in cost includes all
charges, expenses, fees, including any guarantee fees. However, the all-in-cost ceiling does not include the withholding
paid by the borrower in India and does not include commitment fees in addition to default fees and penalty up to 2%
is also permitted within the overall all-in-cost ceiling. The all-in cost ceiling is currently 450 basis points spread over
the benchmark rate. All-in-cost ceiling is to be considered at the time of the investment lending being made and not
at the time when a fee is supposed to be paid.
The minimum average maturity period or MAMP is the minimum tenure requirements for loans availed under the ECB
route. MAMP is computed on a weighted average basis on a day-to-day basis assuming a 360-day year. The mechanism
for competition of the MAMP denotes that return of principal can be permitted even prior to the expiry of time
provided in the MAMP as long as the MAMP exceeds the requirement. For instance, if the MAMP for a loan is three
years, repayment of principal can be made from year one, as long as the weighted average tenure of the ECB loan
exceeds three years. Interest payouts prior to the three-year period are permitted without reference to the MAMP.
The requirement of a longer tenure and a lower return makes this route most suitable for foreign banking institutions
with LIBOR and other rates being lower than the all-in-cost ceiling, social impact funds and global funds engaged in
sectors like infrastructure, which have a long gestation period, including pension funds and sovereign funds.
Security creation is permitted freely under the ECB regulations and can be created in favour of the non-resident lender
directly or in favour of a resident security trustee. The security that can be created includes mortgage over immovable
property, charge over current assets, ledge of shares and personal corporate guarantee. In addition to these, credit
enhancement guarantees by non-residents are also permitted subject to such non-resident party, being an eligible
lender under the ECB guidelines. Enforcement of rights under an ECB agreement is also permitted, subject to certain
conditions under the ECB policy.

For instance, immovable property can be sold under enforcement only to a resident entity. Under the ECB regime, a
special window was created for issuance of rupee-denominated bonds or RDBs, sometimes also called Masala bonds
by Indian companies. This was a keen to a rupee-denominated ECB issued under the ECB policy, but certain relaxations
on compliances were provided for such bonds in an attempt by the government to externalise the rupee-denominated
lending. Benefits such as easier corporate law procedure and reduce withholding taxes made this option lucrative for
both lenders and borrowers. While the route has now been merged under the INR ECB route itself, the relaxations
continue.
Hello everyone, in this session, we would look at a loan agreement and the various components of that loan
agreement. In particular, we will look at what are the various provisions of a loan agreement and what implications of
each of those provisions are. So, what is a loan agreement?
A loan agreement is a binding contract between a borrower, that is the person who is taking money and the lender,
the person who is advancing money, that formalises the loan process and details the terms and schedule associated
with repayment. Depending on the purpose of the loan and the amount of money being borrowed, loan agreements
can range from relatively simple letters that provide basic details about how long a borrower has to repay the loan
and what interests will be charged to more elaborate documents going into hundreds of pages.

Standard format credit agreements for sophisticated international lenders and borrowers follow either the Loan
Market Association or LMA format or the Asia Pacific Loan Market Association or APLMA format.
Let's now go into the structure of a loan agreement. A loan or facility agreement will typically include the purpose
clause. What is the purpose of the facility?

That is what is the borrower allowed to do with the money received under the facility? For example, the proceeds can
be used for purchasing equipment or for construction expenses or for working capital, that is the regular expenses of
the company. Typically, the borrower would not be allowed to use the facility for anything other than the purpose for
which it is given.
Second, provisions relating to cost fees, expenses and other payment obligations. These include the operational terms
of the agreement, such as the amount being borrowed, the repayment schedule and the interest rate. The third section
is usually the section on representations and warranties, and the fourth section is the section of undertakings, also
known as covenants.
Undertakings are usually of three key types: Financial covenants, which require the borrower to maintain certain
financial ratios throughout the time of the loan. Positive covenants, which require the borrower to do certain things.
For example, the borrower must comply with applicable laws at all time or the borrower shall obtain all license and
approvals required for its business. And then, we have negative governance, which specify that the borrower shall not
do certain things without the approval of the lender. For example, the borrower cannot allow a change in control or
take additional loans.
The security and guarantee section covers what kind of security that is being provided for the loan. Is there a guarantee
from a third party? The next section is the events of default section. What constitutes default for the borrower? Is it a
failure to make an instalment payment on the due date? Is it a material breach of covenants under the agreement,
and more importantly, what happens if the borrower defaults on the loan? That is what are the rights of the lenders
when the borrower defaults, and finally, applicable to facilities with more than one lender, there are intercreditor
provisions, which are effectively provisions that govern the interaction between multiple lenders.
Let's start with interest and repayment clauses. This section covers the following; one, the rate of interest that is the
amount of interest that the borrower must pay on the borrowed amount. Now, interest rates can be of two types.
They can be fixed. That is a fixed number, like 7% or 10% per annum, or they can be linked to an index that is there is
an index lending rate plus a margin, which is the interest rate for that loan.
For international loans, the interest rate is linked to something called LIBOR, the London Interbank Offered Rate, which
serves as a globally accepted key benchmark interest rate that indicates borrowing costs between banks. Indian loans
on the other hand are usually linked to the MCLR or the marginal cost of fund-based lending rates. Although, there
are some banks, which continue to use their own individual prime lending rates or PLRs. The margin that would be put
on top of the index rate is determined based on a number of factors, including in particular, the risk associated with
the loan, the higher the perceived risk, the higher the margin.
Any lending at an interest rate considerably higher than the prime lending rate is called a subprime lending, which you
would recall cause the banking crisis in the United States in 2007. The interest payment clause would also provide for
the frequency at which the interest rate can be reset.

Also covered is the frequency of payment of interest, which is either monthly or quarterly. The number of instalments
and frequency of repayment of the principal amounts and principal amount repayments can be quarterly biannual or
annual. In some short-term loans, the entire principal amount is paid in one instalment, which is known as a bullet
repayment. Sometimes, the loan agreement will provide for additional interest, which is usually linked to
nonfulfillment of certain conditions.
For example, if the borrower fails to maintain the prescribed debt service ratio amount, or if the borrower fails to say,
create security over its assets in the timeframe permitted to it under the agreement, then additional interests may be
charged. The additional interest rate typically ranges between 1% to 2%. There is also in certain cases, a default interest
clause. This clause increases the interest rate payable on amounts, which are not paid when due. This default rate
should be an accurate reflection of the cost to the borrower of the amount not being paid with you.
Prepayments; in certain circumstances, a borrower is allowed to make a prepayment, that is, the borrower is allowed
to pay the loan early, prior to the scheduled repayment dates. Typically, prepayments attract what we call a
prepayment premium or break fee. This is designed to cover the bank's costs associated with early repayment. When
a bank provides a term loan, it makes an assumption with respect to the interest, it will receive over the period of the
loan. Therefore, if the loan is repaid early, the bank is likely to lose a part of its interest income even if it is able to
redeploy the funds on short notice.
The pre-payment freemium or break fee is intended to compensate the bank for this loss. For example, if the loan is
for a term of 20 years and the borrower wants to prepay it after 10 years, then the borrower would be a prepayment
penalty or 1% to 2% on the amount prepayment based on the contractual understanding between the borrower and
the lender. Prepayment without premium or break fee is permitted only in specific situations, for example, at the end
of interest periods.
Loan agreements also sometimes provide for mandatory prepayment clauses. That is situations where the borrower
is obliged to make a prepayment because of its contractual relationship with the lender. This is usually out of
extraordinary income, such as insurance or disposal proceeds. Sometimes loan agreements also provide for a cash
sweep where excess cash is used to repeat the lenders ahead of time. For example, a loan agreement one provide for
a cash sweep that says that any revenues are the borrower above a specified amount will be used to reduce the
outstanding loan in let's say a quarterly basis.

Representations and warranties. The representations and warranties are similar in all financing documents. They
concentrate on whether the borrower is legally capable of entering into the finance agreements, and the nature of
the borrower’s business. If the borrower’s asset is a steel plant, for example, then the lender would require
representations that the borrower has the necessary licenses to operate the steel plant, the borrower has possession
and legal rights to the land in which the plant is situated, the borrower has access to raw materials to produce steel,
etc.
Undertakings: Undertakings or covenants are divided into three parts; financial covenants, positive covenants, and
negative covenants. Financial undertakings or covenants govern the financial position and health of the borrower.
They set out certain parameters within which the borrower must operate and are intended to serve as a safety net to
the lender, by making it legally bounding for the borrower to maintain a certain limit or a ratio, or keep a certain level
of cashflow. The lender, therefore, ensures the safety and security of their lent-out money and protects itself from
risks associated with the loan agreement. Kinds of financial covenants include maintaining a certain debt to equity
ratio with typical ratio accepted across the industry is 70 30, that is, 70% debt and 30% equity.
Maintaining a certain Debt Service Coverage Ratio or DSCR, that is the ratio between the debt payment obligations
and the borrower’s available cash flow. For example, a DSCR of 1.25 means that if in the next quarter, the total amount
payable by the borrower to the lender is say 1 million, then, the border should be able to demonstrate cash flows of
1.25 million in that quarter to successfully meet the financial covenants.
Maintaining a minimum level of earnings before interest tax and depreciation, or EBITD maintaining a minimum level
of earnings before interest and tax, EBIT not exceeding a certain level of operating expenses, etc.
Breach of financial covenants can result in either an additional interest cost on the borrower or in certain cases allow
the lender to accelerate or recall the entire loan.

Positive covenants are covenants, which require the borrower to do certain things. This usually include a duty on the
boardwalk to supply financial information to the lender. For example, audited and management accounts, the lenders
want to ensure a certain conduct from the borrowers, such that the borrower remains best place to repay the loan
and does not expose itself to legal and business risks. Examples of positive covenants include compliance in law in
particular in relation to land and taxes, compliances with license and approvals, for example, the environmental
clearance for a project since the failure to comply with it may result in an interruption of the business of the borrower
and result in default of the loan.
Ensure that facilities and factories are in good working condition, provide yearly audited financial statements, ensure
accounting practices are in accordance with accepted accounting principles, comply with contractual obligations in
particular construction and operation in accordance with project documents, if applicable, take out and maintain
insurances, file and pay all taxes properly, diligently pursues its rights under the contracts, subsequently negative
covenants list, various activities that the borrower may not engage in without the lender's consent.
A key negative undertaking is one preventing dividend and other shareholder payments, which lenders will require to
ensure that there is no cash leakage from the borrower group. Similarly, the lenders would restrict the borrower from
additional loans. Let's take a scenario where the lenders have lent say 100 crores to the borrower. It has done so on
the basis of certain revenue projections of the borrower.
Now, if the borrower were to now go and borrow another 500 crores from the market, the lenders money is at
significant risk, and there is a higher possibility of the borrower defaulting on the loan. Therefore, the lenders would
restrict the borrower’s ability to obtain additional financing from the market. Other negative covenants typically cover
disposal of assets, issuance of new capital instruments, entering into a new line of business, etc.

Events of default. An event of default is a pre-specified condition or threshold that, if met, allows the lender or creditor
to demand immediate and full repayment of its debt. The following would constitute typical event of default in a credit
agreement clause.
Non-payment of any amount of the loan, including any interest amount, a breach of financial covenants, material
representation, inaccuracy or warranty breach, cross default, that is when the default under one loan agreement
triggers a default on another, a material adverse change or MAC, insolvency, events of default can be quite specific to
the asset being financed. For example, if the asset financed is a power plant, the termination of the power purchase
agreement from which the plant derives most of its revenues would be considered an event of default.
Similarly, if the asset is a road asset, then termination of the concession agreement under which the road was awarded
will be an event of default. Usually, event of default clauses provides for time periods or cure periods associated with
certain events of default. The lenders only have the right to demand repayment of the loan if an event of default has
occurred and is continuing if the event of default had occurred, but has been remedied or waived, then the lender
typically does not have the right to accelerate.

The typical rights of a lender in case of an event of default is as follows: Accelerate and call for an immediate repayment
of the outstanding loan amount. Enforce the security over the collateral provided by the borrower, convert their loans
into equity and take an equity position in the borrower, take over the management of the borrower, initiate insolvency
proceedings under the insolvency and Bankruptcy Code of 2016.
Security. Loans can be secured, that is with collateral or unsecured. The lenders will want to put in place as much
security for the financing as possible, security is both offensive and defensive, offensive to the extent that the lenders
can enforce the security to dispose of assets and repay debts where the project fails; defensive to the extent that
senior security can protect the lenders from actions by unsecured or junior creditors, that is, creditors that rank below
them in priority of being repaid and in bankruptcy.

Key available security, which is usually seen in credit agreements in India include a share pledge, that is a pledge over
the shares of the borrower, hypothecation of revenues and bank accounts. Under Indian law, hypothecation generally
means a charge, which can be a fixed or a floating charge on any tangible movable property existing of in future created
by the security provider in favour of the lender without the delivery of possession of tangible movable property to the
lender.
Charge over agreements and contractual rights, security over insurance policies, mortgage over immovable properties
of which there are two common forms in India, an English mortgage or a registered mortgage where the mortgage
property is transferred absolutely to the mortgagee with the condition that the mortgage property will be reconveyed
to the mortgage on discharge of the debt, or an equitable mortgage, which is created by depositing the title deeds
with the mortgage with an intention to create security for repayment of debt, the guarantee which can be either
personal or corporate.
Inter-creditor provisions. A syndicated loan agreement, that is, an agreement with multiple lenders, will contain
numerous provisions relating to coordination between the lenders. Inter-creditor arrangements relate to two key
issues where each class of creditor ranks as against the others in terms of debt claims against the data and the order
in which each class of creditor is entitled to the proceeds of any security and guarantees. Arrangements, which relate
to the first issue are about subordination and arrangements, which relate to the second issue are about priority.

An inter-creditor agreement will also cover issues such as voting rights of the different classes of creditors. Example,
when each class of creditor is entitled to vote on viva and what proportion of the vote they are entitled to. Similarly,
a certain majority of lenders need to agree before security can be enforced under a typical integrator arrangement.
In a syndicate scenario, it is also common to have a security trustee. A security trustee is the entity holding the various
security interests created on trust for the various lenders. This structure avoids granting security separately to all
creditors, which would be costly and impractical. Lenders also typically appoint a lender's agent or facility agent, who
coordinates the decision making between the lenders and acts as an interface with the borrower. With that, we
conclude the session on loan agreements.
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