Asset-Level Eligibility Series: Governmental Authorities

This Legal Update explores why, in order for an underlying loan to be included in a warehouse facility's borrowing base, the underlying loan's obligor cannot be a governmental authority.

Example of Eligibility Criteria:

• The Obligor of such loan is not a Governmental Authority.

What is a "Governmental Authority"?

Although somewhat negotiable, a "Governmental Authority" is typically a bona fide governmental authority—including any nation or government; any state, province, territory, or other political subdivision thereof; any central bank; or any other entity exercising executive, legislative, judicial, regulatory, or administrative functions.

Why does it Matter if the Obligor is a "Governmental Authority"?

Although there are numerous considerations, two primary concerns associated with lending against an asset for which the obligor is a Governmental Authority are (i) the capacity and authority of such entity to validly enter into the underlying loan, and (ii) the enforceability of remedies with respect to the underlying loan following (a) any event of default by the borrower under the warehouse facility, such as the transferability of the underlying loan from the warehouse facility's borrower to a third party (e.g., the warehouse lender or its transferee), or (b) any event of default by the Governmental Authority under the underlying loan, such as direct enforceability against such entity.

The capacity and authority of an obligor that is a Governmental Authority is typically derived from one or more authorizing statutes or regulations. For example, if the obligor is a local US municipality, its authority may originate from a state constitution and be implemented through a combination of state statutes, county ordinances, city codes, and local municipal regulations. Additionally, such entities may be governed by one or more boards, each of which may adopt policies or mandates with which the obligor must comply. Each level of statutory or regulatory authority may impose restrictions or limitations on the obligor's ability to incur indebtedness, pledge collateral, or otherwise enter into financing arrangements. The extent of due diligence required to determine whether an underlying financing to any such obligor is within such obligor's legal capacity and authority can be costly and substantial, and such burdensome requirements—together with the associated risks—often lead warehouse lenders to exclude these types of obligors from the collateral pool in their entirety.

Further complicating the eligibility analysis, many of the applicable statutes, regulations, or policies may include provisions that impact the requirement or capacity of Governmental Authorities to perform. Such provisions may impact such entities' ability to contract and/or any remedies available to a counterparty facing any such entity. These types of limitations can be difficult for a warehouse lender to assess and comply with, particularly due to the fact that the lender would only hold and/or deal in the underlying loan following enforcement against the warehouse borrower and would usually rely on its ability to transfer the loan and/or collect from the borrower in order to make itself whole. In addition, depending on the underlying obligor, it is possible that additional statutory or regulatory transfer restrictions may apply, such as those applicable under the Federal Assignment of Claims Act or other similar statutes or regulations, that set forth parameters around a counterparty's ability to assign an obligation of a Governmental Authority. In an extreme scenario, it is also possible that the governing provisions can render any obligations entered into in contravention thereof void or voidable. It also would be common for laws and regulations governing any such entity to limit the jurisdictions in which claims may be brought in respect of its obligations under a loan facility. Such parameters may include requirements that claims be filed in specified courts or forums, which may not be practical for the warehouse lender. Moreover, Governmental Authorities may benefit from sovereign immunity or similar doctrines, which may limit the ability of a secured party to sue any such obligor for payment or enforce a judgment. These transfer restrictions and/or legal defenses may significantly impair a warehouse lender's ability to enforce rights or remedies in connection with the loan collateral.

Conclusion

Due to the complexity, increased diligence requirements, and transferability and enforcement risks associated with lending to a Governmental Authority, it is often more prudent and cost-effective for a warehouse lender to exclude such assets from the eligible collateral pool. By limiting exposure to these types of obligors, a warehouse lender can reduce legal uncertainty and ensure greater predictability with respect to the performance, transferability, and enforceability of the collateral pool.

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This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.