THE ROLE OF THE LAWYER IN EXTERNAL DEBT MANAGEMENT
by Mr. Lee C. Buchheit
(Article Reference: Document No.5, October 1995)

Any lawyer who has practiced hi the field of international financial law can recount stories of term sheets for major financings that arrived on his or her desk with a note reading, "Counselor, enclosed is the term sheet for the XXX Project that the [Minister of Finance] [Chief Executive Officer] signed yesterday. Kindly prepare the appropriate documents." These notes usually call forth a deep, world-weary sigh from the chest of the lawyer. A common variation of this note, however, can produce an audible gnashing of lawyerly teeth: "Counselor, enclosed is a fully executed copy of the credit agreement for the XXX Project signed by the [Minister] [Chief Executive Officer] yesterday. Kindly transmit soonest your legal opinion that the agreement is a legal, valid, binding and enforceable instrument of the [Republic] [Company]."

The first of these messages serves to remind the lawyer that he was not invited to participate in the negotiation of the terms of the financing for Project XXX; the second reveals that the client even found it possible to dispense with legal advice when negotiating the actual credit agreement. In the case of a borrower, this usually means that the client's review of the draft credit document - if indeed that review ever extended beyond the interest rate formula and the repayment schedule - was guided solely by the light of natural reason.

I. The Fallacies
Why are lawyers so often relegated to an ancillary role in the negotiation of important external financing arrangements? After all, the medical profession has had at least some success in persuading people to consult their physicians before they become ill, on the theory that it is far easier and cheaper to prevent disease than it is to cure it. Why then has the legal profession not made similar progress in convincing its clients of the virtues of preventive legal advice? The reluctance of some clients to consult their lawyer before making important financial commitments can result from a misunderstanding about the appropriate role of legal counsel in external borrowing transactions. Here are some of those misunderstandings:

Fallacy One: These are business issues
Some clients believe that the sole purpose of a term sheet is to record the understandings of business people about business issues. Why ever, they ask themselves, would one invite the views of a lawyer about obviously commercial matters? The fundamental error motivating this question is a belief that the universe of potential issues in a financing transaction divides neatly between business points and legal points. It doesn't.

A great many of the so-called "legal issues" in a financing transaction are matters of such significance that a lender or a borrower would be well-advised to reconsider its position on the pricing of the credit depending on how those legal issues are resolved. For example, should the interest rate be 7% p.a. with a full tax gross-up, or 8% p.a. without such a gross-up? The lender might accept a facility fee of 0.50% if it receives a satisfactory indemnity from the borrower for potential claims of third parties, but demand a fee of 1 % in the absence of such an indemnity. A borrower might happily pay an extra 50 basis points on the interest rate for a loan if it could thereby avoid the inclusion of tight financial covenants or a paralyzing negative pledge clause in the credit agreement.

Many of the legal provisions in a standard financial contract can have pricing consequences for one side or the other. Lenders have always understood this. The lender's draft of the term sheet or mandate letter will therefore typically be crystal clear as to the interest rate, fees and expense reimbursement, while dismissing all other matters with the phrase "representations, covenants, events of default and jurisdictional provisions standard for this type of financing." Such a term sheet deliberately locks-in the financial terms, while allowing the lender full scope to negotiate the other provisions of the credit agreement in accordance with the lender's own understanding of standard market practice.

The very best time - often the only time - for the borrower to negotiate significant legal issues is before a mandate has been awarded. Only at this stage can the borrower advocate a particular approach to important legal issues and force the lender to consider whether that approach really will have pricing consequences for the deal. Until they are clutching a signed mandate, many lenders will be reluctant to increase their price quote for fear of losing the business to a competitor institution. A well-advised borrower may thus be able to win, at the pre-mandate stage, some important documentation points which would have been rejected by the lender out of hand had they been raised after the mandate was signed. Even if the lender does seek a change in the pricing of the credit in light of the borrower's proposals regarding significant legal issues, the borrower can at least then make an informed decision about the relative significance of those issues to it in light of the additional cost they will entail. Naturally, there are some contractual provisions (such as the governing law clause) about which many lenders feel so strongly that they would not be prepared to continue with the transaction in the absence of a customary treatment of the matter in the credit agreement. But most issues do not rise to that level. Unless the borrower seeks legal advice before the mandate or term sheet is signed, however, it may forfeit its moment of greatest negotiating leverage[1].

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Lee C. Buchheit is a partner hi the New York office of Cleary, Gottlieb, Steen and Hamilton, an international law firm. Mr. Buchheit practices in the international corporate and financial areas, including Eurodollar financial transactions and sovereign debt restructurings. He has previously served in the Hong Kong, London, and Washington, D.C. offices of the firm. Mr. Buchheit is the author of How to Negotiate Eurocurrency Loan Agreements (Euromoney Publications, 1995) and Secession: The Legitimacy of Self-Determination (Yale University Press, 1978). He has contributed chapters to several other books and publishes frequently in professional journals. Mr. Buchheit serves as an adjunct professor at Columbia University's School for International and Public Affairs. He is a member of the Bar in New York, Washington, DC and Pennsylvania.

[1] This is not to say that issues cannot be raised with a lender after the mandate or term sheet is signed. One must recognize, however, that the burden of persuasion rests heavily upon a party seeking to renegotiate an issue that has already been addressed in the mandate letter or term sheet.

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