New Swap Rules
New swap rules that took effect on April 1 threaten to make some guarantees and security packages in loan transactions unenforceable, according to Andrew Coronios and Monika Szymanski in the Chadbourne New York office.
The rules were issued by the US Commodity Futures Trading Commission under the Dodd-Frank Act. The CFTC took the position in a recent no-action letter that “swaps” include guarantees of swaps.
The problem is that every guarantor of swap obligations must be an “eligible contract participant” as defined by the CFTC in order for the guarantee to be enforceable. Lawyers are interpreting this also to affect security agreements and other collateral covering swap obligations. To qualify as an “eligible contract participant,” the entity must have more than $10 million in assets, a net worth of more than $1 million or backing for its obligations through a letter of credit, capital contribution agreement or similar arrangement from an entity with more than $10 million in assets.
Borrowers are often required to hedge interest rate or currency risk, and the loan documents are often written so that the guarantee and security documents cover not only the loan obligations but also the swap obligations. “Under the new rules, if a guarantor or grantor of security is not an eligible contract participant, then the entire guarantee or security document may be unenforceable, even where the direct counterparty to the swap itself is an eligible contract participant,” Coronios and Szymanski said. They said the problem usually comes up where a borrower is an eligible contract participant but its obligations are guaranteed or secured by affiliated companies that may not be.
They recommend taking a number of actions, including not accepting guarantees or security from ineligible entities and adding a “severability clause” that prevents the whole guarantee or security package from being invalidated if only part of it is unenforceable.