LSTA Releases New Trade Documents, Including Distressed Buy-In/Sell-Out (BISO) Provisions

September 11, 2011

The Loan Syndications and Trading Association (the “LSTA”) released revised trading documents for the settlement of secondary market trading of distressed and par and near par loans with a trade date on or occurring after September 9, 2011. The most significant revision to the trade documents is the inclusion of Buy-in/Sell-Out (“BISO”) provisions in the Standard Terms and Conditions for Distressed Trade Confirmations. Modeled after the BISO provisions that are currently available for par/near par trades, the BISO provisions for distressed debt trades address problems of settlement delays caused by a non-performing counterparty by providing mechanisms to compel trade settlement.

Summary of Distressed BISO Provisions

The new distressed BISO mechanism enables a performing party in a distressed trade to compel performance of a non-performing counterparty or ultimately terminate the trade and effect a cover transaction. It is important to note that BISO is available only for trades settling by assignment, so a party cannot avail itself of these provisions when settling by participation, by netting arrangements, or on proceeds.

In order to avail itself of the BISO provision, a party must be a performing party, meaning it must have completed its delivery obligations towards settlement of the trade. Accordingly, the buyer must have executed the trade confirmation and certified that it is ready, willing, and able to execute and deliver its signatures to settlement documents, subject to review of the documents and upstreams. Similarly, a seller must have also delivered closed upstreams to the buyer for review and the drafting party must also have delivered draft documents and the non-drafting party must have timely provided comments or signatures to the documents.

As a general rule, if a counterparty fails to perform, the performing party may avail itself of BISO by sending a notice (the “BISO Notice”) to the non-performing party if a trade has not settled within 50 business days after the trade date (the “Trigger Date”). The Trigger Date, however, may be extended under certain circumstances.

A non-performing party has a 20 business day cure period from receipt of a BISO Notice to move the trade toward settlement, unless it is a seller able to invoke the Upstream Shield (as further discussed below). If such non-performing party is the drafting party, it must deliver draft documents in “reasonably acceptable form” conforming to market standards. If such non-performing party is not the drafting party, it must deliver to the drafting party its signatures to the settlement documents with authorization to submit the assignment agreement to the administrative agent along with any comments it may have to the draft documents.

A seller must deliver closed upstreams to a performing buyer in a timely fashion. An exception to this rule is the “Upstream Shield”, which permits an innocent seller caught in the middle of a chain of open trades to shield itself from a BISO Notice by delivering: (i) a copy of the upstream trade confirmation with the purchase price and rate redacted; (ii) draft transfer documents; (iii) copies of any predecessor transfer documentation in its possession; and (iv) a written certification, which among other things, states that the seller is a performing party under the upstream trade confirmation. In order for the Upstream Shield to be effective, however, the open upstreams must have a trade date not later than 5 business days after the trade date relating to the trade for which the non-performing seller has received a BISO Notice. Additionally, if the seller’s upstream counterparty is non-performing, the seller must also make commercially reasonable efforts to utilize the BISO mechanism against its upstream. It is important to note that a seller may not change its upstream allocations to a downstream after it has invoked the Upstream Shield.

If the non-performing party fails to cure or invoke the Upstream Shield, the performing party is permitted to effect a cover transaction with a third party during the next 10 business days following the cure period, with any economic shortfall subject to reimbursement from the non-performing party, thereby availing the performing party of the same economic benefit it would have received had it settled the trade with its original counterparty. Effecting a cover transaction is meant to make the performing party whole, and it is not meant to economically advantage or disadvantage either party. If the performing party does not effect a cover transaction within 10 business days after the expiration of the cure period, it cannot utilize the BISO provision again without the agreement of the non-performing party.

Although the BISO provisions do not apply when there is an impossibility of consummating the settlement of a trade, such as during a period when the administrative agent is not processing the settlement of assignments (i.e., a credit freeze) or because of an order of a bankruptcy court, there is no tolling period for the Trigger Date following such a delay and the Trigger Date will not change due to an impossibility of settlement. For example, if a credit freeze were lifted a day before the Trigger Date, the Trigger Date will not have moved as a result of the credit freeze, so a party may initiate the BISO process.

Considerations for Market Participants in light of Distressed BISO

Participants in distressed debt trades should be aware of several potential challenges when invoking the BISO provisions. BISO delivery requirements may present some problems for the non-performing party, particularly when a credit is newly distressed. Under the new BISO rules, a non-performing drafting party must deliver drafts of relevant trade documents in “reasonably acceptable form,” which may include blanks for items, such as administrative details. However, when a credit is newly distressed, there may be a disagreement in the marketplace about whether to include additional language unique to the specific credit being traded. This raises the question of what constitutes a “reasonably acceptable form” and, as a result, whether BISO is an appropriate remedy for expediting the settlement of the trade. Similarly, if a non-performing non-drafting party has outstanding substantive comments to a purchase and sale agreement or upstream that is still being negotiated, it may be hesitant to authorize the submission of its signatures to the assignment for settlement.

Sellers should closely monitor their upstream allocations to avoid losing its Upstream Shield protection. Any seller who wishes to preserve any possible Upstream Shield must maintain sufficient inventory of upstream trades with trade dates no more than 5 business days after that of the downstream trade . Absent this precautionary measure, the seller may be without an effective Upstream Shield regardless of its upstream counterparty’s non-performance.

Parties should note that the Trigger Date will not be extended as a result of a credit freeze. Thus, in light of BISO, it may be prudent for parties to continue to negotiate and finalize documents during a credit freeze or bankruptcy proceeding which makes immediate settlement impossible in order to be prepared to close quickly when settlements resume.

Finally, parties should carefully weigh the benefits and consequences before invoking BISO with respect to any specific trade. There is no time limit for when a party may use BISO against its counterparty. In most instances, however, a party may only use BISO once. A performing party may, therefore, wish to take advantage of the unlimited time frame for issuing a BISO Notice and ensure that it can secure a potential cover transaction as protection should the non-performing counterparty be unable to cure within the allotted cure period.

Effective communication between parties and their counsel will be paramount under the new distressed BISO regime. Counsel should be timely informed of trades and receive all applicable documentation required to draft transfer documents or review upstreams. Since the Trigger Date is measured from the date of execution of the trade confirmation, counsel must be in a position to review documents as soon as possible in order to comply with the performance timelines imposed by BISO. As such, parties should consider streamlining their processes for forwarding trade information and documentation to their counsel and ensuring timely completion of drafting and review, and counsel similarly must be responsive and proactive in obtaining any missing documentation.