COLLATERAL ASSIGNMENT OF HEDGE JOSHUA STEIN LATHAM

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JST MODEL HEDGE PLEDGE COLLATERAL ASSIGNMENT Joshua Stein edits AFTER Larry SAfran

COLLATERAL ASSIGNMENT OF HEDGE

Joshua Stein

Latham & Watkins LLP

[email protected]

www.real-estate-law.com

This model Collateral Assignment of Hedge (“hedge pledge”) defines the relationship among the borrower, the lender, and the issuer of a rate cap (or, less commonly in real estate, an interest rate swap or other hedging transaction). This model includes many provisions often seen in any “industry standard” hedge pledge. The author has tried to translate those provisions into “Plain English.” Some provisions in this model address issues not always considered in a typical hedge pledge, but in most cases suggested by the thorough discussion in Mark A. Guinn & William L. Harvey, “Taking OTC Derivative Contracts as Collateral,” 57 THE BUSINESS LAWYER 1127 (May 2002). Anyone interested in learning more about how a secured lender views rate caps, swaps, and their siblings and cousins should read this article. The author acknowledges with thanks the exceptionally helpful comments from Michael E. Buckley of Jones Vargas, Las Vegas, NV, and the author’s partners Carlos Alvarez and Lawrence Safran. Any errors are the author’s alone. Copyright (C) 2005 Joshua Stein.

This COLLATERAL ASSIGNMENT OF HEDGE (this “Assignment”) dated as of _____________, 200__ (the “Effective Date”), is made by __________________, a _____________, with an office at _________________ (“Borrower”), in favor of ___________________, a _____________, with an office at ______________________ (with its successors and assigns, “Administrative Agent”). Capitalized terms used but not defined in this Assignment shall have the same meanings as in the Loan Agreement dated as of the Effective Date (as amended from time to time, the “Loan Agreement”), between Borrower, as borrower, and Administrative Agent, as Administrative Agent for the benefit of the Lenders,1 and if not defined in the Loan Agreement shall have the definitions in the Hedge (as defined below).

  1. Collateral Assignment. To further secure the Obligations,2 Borrower assigns and transfers to Administrative Agent, and grants to Administrative Agent, in each case for the benefit of the Lenders, a security interest3 in all of Borrower’s right, title and interest, whether now owned or later acquired, now existing or later arising, in, to, and under the following (collectively, as amended from time to time in compliance with this Assignment, the “Hedge”):

    1. Hedge Transaction(s). The interest rate cap, collar, floor, swap, swaption, forward foreign exchange transaction, currency swap, cross-currency rate swap, currency option, forward rate transaction, basis swap, interest rate option, other interest rate protection product(s) or agreement(s), option(s) to enter into any of the foregoing, or combination(s) of any of the foregoing, as described or attached in Exhibit A, entered into with the issuer(s) identified in Exhibit A (the “Issuer”),4 to seek to hedge Borrower’s exposure to fluctuations in interest rates or currency valuations;5

    2. Confirmations. Only the confirmations and schedules issued by Issuer for the Transaction(s)6 identified in Exhibit A (the “Confirmations”);

    3. Security. Any and all collateral supporting Issuer’s obligations under any of the preceding Hedge Documents;

    4. Rights and Remedies. All rights and remedies under any of the preceding Hedge documents, including any right to declare an Early Termination Date;

    5. Hedge Payments. All payments that any of the preceding Hedge documents require or permit Issuer to make, when and as such documents contemplate, whether upon termination or default (including default, cross-default, or early termination, a “Termination Hedge Payment”), or otherwise, but in all cases subject to and in accordance with the terms of such documents (the “Hedge Payments”); and

    6. Proceeds. All proceeds of any of the foregoing, as defined in the Uniform Commercial Code (the “UCC”), and all rights of Borrower to receive or otherwise relating to any of the foregoing.

  2. Continuing Liability under Hedge. This Assignment does not limit Borrower’s obligations or liability, or impose any obligation or liability on Administrative Agent, under the Hedge. Administrative Agent shall have no duty to enforce the Hedge or collect any Hedge Payment. Except where this Assignment expressly limits or modifies any terms of the Hedge, this Assignment is subject to all such terms.7

  3. Impairment. Without Administrative Agent’s prior written consent, which Administrative Agent may withhold for any reason or no reason:

    1. Transfer. Borrower shall not assign, convey, encumber, grant a security interest or option relating to, hypothecate, mortgage, pledge, sell, or otherwise dispose of (directly or indirectly, voluntarily or involuntarily, by operation of law or otherwise, and whether or not for consideration) (“Transfer”) any Hedge. Issuer shall not acknowledge, honor, or recognize any such Transfer. To the extent the Hedge requires Borrower’s consent to any Transfer by Issuer8, such Transfer shall also require Administrative Agent’s consent.

    2. Amendment. Neither Borrower nor Issuer shall amend, cancel, modify, or terminate (or give any Termination Notice under) the Hedge, or waive any of its terms.

    3. Additional Transactions. Borrower shall not enter into, and Issuer shall not issue or confirm, any transactions under the Hedge, except the Confirmation(s).

  4. Status and Consent. Issuer represents and warrants to Administrative Agent that: (a) Issuer has duly authorized, executed, and delivered, and been fully paid for, the Hedge; (b) the Hedge is in full force and effect as against Issuer; (c) Issuer and Borrower have entered into no agreements about the Hedge except as the Hedge states; (d) to Issuer’s knowledge, no party is in default under the Hedge; and (e) Issuer has received notice of (and consents to) this Assignment and has received no notice of any other presently effective Transfer of the Hedge.9

  5. Administrative Agent’s Security.

    1. Waiver of Netting. Issuer waives any right to net or setoff against any Hedge Payment(s), except on account of Confirmation(s) in Exhibit A (the “Netting Waiver”).10

    2. Loan Event of Default. If an Event of Default exists under the Loan Agreement11 (or if Borrower fails to perform any obligation to Administrative Agent under this Assignment and does not cure such failure within five business days) (an “Event of Default”), or if any Termination Event occurs for Issuer, then Administrative Agent may (but need not) notify Issuer in writing that an Automatic Early Termination (hence an Early Termination Date) shall have occurred under the Hedge (a “Termination Notice”). Any Termination Notice shall be fully effective without Borrower’s consent, confirmation, or signature.

    3. Loan Repayment. If Borrower repays the Loan, then an Early Termination Date shall automatically occur under the Hedge. Notwithstanding anything to the contrary in any Loan Document, Administrative Agent need not release any Security Document unless and until Borrower has performed all its obligations (if any) arising under the Hedge on account of such Early Termination Date.12

    4. Termination Value.13 Any termination value of the Hedge shall be determined using the “Market Quotation” method (not the “Loss” method).14 The net termination obligation shall be determined using the “Second Method.”15

    5. Intended Beneficiary. Administrative Agent is an intended beneficiary of the Hedge. Whenever any Event of Default exists, Administrative Agent may exercise any right, and give any notice, under the Hedge, with no need for Borrower’s consent, confirmation, or signature. Issuer shall perform accordingly under the Hedge.

  6. Hedge Payments. Whether or not any Event of Default exists, Borrower directs Issuer (and by countersigning Issuer agrees) to pay all Hedge Payments only as Administrative Agent directs in writing. Subject to further direction from Administrative Agent, Issuer shall pay all Hedge Payments to the following account: ___________.16

  7. Hedge Payments.

  8. Exercise of Remedies. Issuer consents to any Transfer of the Hedge resulting from (or in lieu of) Administrative Agent’s exercise of any Administrative Agent’s Remedies17 and any direct or indirect Transfer by any resulting transferee or its direct or indirect successors or assigns (all such Transfers, collectively, “Administrative Agent Transfers”).

  9. Issuer Protection. Issuer may conclusively rely, without investigation, on any notice or demand from Administrative Agent about the Hedge or any Hedge Payment, Event of Default, or related matter (an “Administrative Agent Direction”). Borrower irrevocably instructs Issuer to disregard and ignore any instruction from Borrower inconsistent with any Administrative Agent Direction. Borrower shall hold harmless and indemnify Issuer from and against any and all claims, damages, expenses, judgments, liabilities, losses, and penalties (including reasonable attorneys’ fees and disbursements) that Issuer incurs because Borrower or any other Person asserts any claim against Issuer that arises from or relates to any act or omission of Issuer in reliance on any Administrative Agent Direction (unless caused by Issuer’s gross negligence or willful misconduct). To the extent that Issuer pays any Hedge Payment to Administrative Agent, it shall satisfy Issuer’s corresponding obligations to Borrower under the Hedge.

  10. Administrative Agent Protection. Any person that acquires the Hedge through an Administrative Agent Transfer shall have no obligation and no liability under the Hedge, including any obligation to make any payment the Hedge requires of Borrower. Issuer shall at all times look solely to Borrower under the Hedge. Nothing in this paragraph limits Issuer’s: (a) obligations as Issuer; or (b) right to offset or net any payment, or exercise any other rights and remedies (including termination rights), as the Hedge allows, subject however to the Netting Waiver.

  11. Termination. This Assignment and Administrative Agent’s rights under this Assignment shall terminate and Administrative Agent shall confirm such termination in writing (an “Assignment Termination Date”) if and when either: (i) the Hedge terminates or expires and Issuer has paid all Termination Hedge Payments as this Assignment requires; or (ii) a Termination Date has occurred under the Loan Agreement. If any Assignment Termination Date occurs, Administrative Agent shall, at Borrower’s expense, confirm in writing that this Assignment has terminated. Administrative Agent shall then have no rights, remedies, or claims under this Assignment, and Issuer shall pay all Hedge Payments and recognize all Transfers as Borrower directs, subject to the terms of the Hedge, without regard to this Assignment.

  12. Borrower-Administrative Agent Agreements. As between Borrower and Administrative Agent only, without affecting Issuer, Borrower and Administrative Agent agree:18

    1. Assurances. Borrower represents and warrants: (a) the Hedge and this Assignment are enforceable against Borrower and (unless Administrative Agent or its Affiliate) Issuer; (b) the copies of the Hedge attached to this Assignment (or otherwise provided to Administrative Agent) are true, correct, and complete; and (c) Borrower owns the Hedge free and clear of any claims of others, and has not Transferred its interest in the Hedge to anyone except Administrative Agent.

    2. Replacement of Hedge. If either (a) Issuer’s long-term unsecured debt rating as maintained by ____________ falls below __________ or (b) Issuer’s short-term unsecured debt rating as maintained by _____________ falls below ________, then Administrative Agent may require Borrower to replace the Hedge at Borrower’s expense with a new Hedge on the same terms as the Hedge, issued by a new Issuer (reasonably satisfactory to Administrative Agent) whose ratings equal or exceed those referred to in this sentence. For any such new Hedge, the issuer, Borrower, and Administrative Agent shall enter into an Assignment in substantially the same form as this one. After Borrower has performed its obligations under this paragraph, the parties shall cooperate to release the Assignment of the replaced Hedge. Borrower shall pay Administrative Agent’s reasonable out of pocket costs, including reasonable attorneys’ fees, in reviewing and approving the documents this paragraph requires.

    3. Collateral; Remedies. The Hedge shall constitute Collateral. If any Event of Default exists, Administrative Agent may exercise all Administrative Agent’s Remedies, which are cumulative. Administrative Agent may exercise them partially or sequentially and in any order. If Administrative Agent liquidates or terminates the Hedge upon on Event of Default, Administrative Agent shall have no liability to Borrower for any resulting loss.

    4. Borrower Obligations. Borrower shall, for the Hedge: (a) perform all its obligations, if any; (b) exercise with reasonable diligence all its rights and remedies; (c) not cause or permit Issuer to assert a claim, defense, or counterclaim against its obligations; (d) promptly give Administrative Agent a copy of any notice Borrower sends or receives; (e) not release any obligation of Issuer; and (f) hold in trust (as a fiduciary for Administrative Agent) and within two business days remit to Administrative Agent any Hedge Payment that Borrower receives. This Assignment does not limit any Obligations.

    5. Application of Hedge Payments. If Administrative Agent receives any Hedge Payment, Administrative Agent shall apply it against the Obligations, in such order as Administrative Agent determines subject to the Loan Agreement. Borrower shall remain responsible for the full and timely payment of all other Obligations.

    6. Nonrecourse. The Nonrecourse Clause: (a) is incorporated by reference as if set forth in full; and (b) shall apply to Borrower’s obligations under this Assignment.19

    7. UCC Financing Statement; Further Assurances. Borrower consents to Administrative Agent’s filing a UCC financing statement (and making any other filings) necessary or appropriate, in Administrative Agent’s judgment, to perfect Administrative Agent’s security interest in the Hedge. Borrower shall execute such certificates, deliveries, and documents as Administrative Agent reasonably requests from time to time to further effectuate the parties’ intentions. Borrower represents and warrants that its full legal name is as typed on the signature page(s) of this Assignment.20

  13. Waiver of Jury Trial. ALL PARTIES WAIVE ANY RIGHT TO HAVE A JURY PARTICIPATE IN ANY WAY IN RESOLVING ANY DISPUTE, WHETHER SOUNDING IN CONTRACT, TORT, OR OTHERWISE, ARISING OUT OF, CONNECTED WITH, RELATED TO, OR INCIDENTAL TO THIS ASSIGNMENT, OR THE INTERPRETATION OR DETERMINATION THEREOF, OR THE ENFORCEMENT OF ANY ADMINISTRATIVE AGENT’S REMEDIES, OR THE RELATIONSHIP OF THE PARTIES REGARDING THE LOAN, THE HEDGE, AND ALL RELATED MATTERS (A “DISPUTE”). ANY DISPUTE SHALL BE RESOLVED IN A BENCH TRIAL WITHOUT A JURY.21

  14. Miscellaneous. The law that governs the Loan Agreement shall govern this Assignment and any Dispute. If Administrative Agent assigns the Loan, then Issuer shall upon request confirm to the assignee that such assignee has succeeded to Administrative Agent’s rights and obligations under this Assignment and such other matters as the assignee shall reasonably request. This Assignment may be executed in any number of counterparts. Each shall be an original. All constitute one instrument.

[Signature Page Follows.]


IN WITNESS WHEREOF, Borrower has executed this Assignment as of the Effective Date.

BORROWER:


NAME OF ENTITY


[SIGNATURE BLOCK]



Attached:


Issuer Confirmation

Exhibit A – Description or Copy of Hedge


ISSUER CONFIRMATION


Issuer accepts, agrees to, and acknowledges the foregoing Assignment and all its terms. In the event of any inconsistency between the Assignment and the Hedge, the Assignment shall govern and modify the Hedge.


ISSUER


[SIGNATURE BLOCK]


Date: ______________________, 200__


EXHIBIT A

DESCRIPTION OF HEDGE AND ISSUER



Issuer

____________________

Hedge (Master Agreement)

____________ Agreement (________ Reference No. _____), dated as of __________, as supplemented by [the Schedule(s) thereto dated as of the same date and] as amended from time to time (in compliance with the foregoing Assignment) between Issuer and Borrower

Amendment(s)

Transaction Amendment (__________ Reference No. _________) dated as of ____________

Confirmation(s) as of Effective Date

Confirmation(s) issued under Issuer’s Reference No. _____ dated as of __________


1 If the Loan Agreement describes the lenders as, for example, the “Secured Parties,” conform all references.

2 The Loan Agreement should define “Obligations” broadly enough to pick up all obligations under this Assignment, all other loan and security documents, and of course the Loan Agreement itself.

3Administrative Agent must perfect this security interest. Because the Hedge is a general intangible, Administrative Agent will need to file a UCC financing statement, in the jurisdiction where Borrower is located under UCC § 9-307 (usually the jurisdiction of organization), identifying the Hedge as collateral. This is true even if Issuer is Administrative Agent or Administrative Agent’s affiliate. If the Hedge were a bank deposit in the same institution, entirely different perfection rules would govern. Use of those rules for a Hedge could produce disaster.

4 Issuer will typically be the lender’s “swap desk.” That institution’s involvement in the transaction will usually assure it an “inside track” for the swap assignment. Borrower may still hold a reverse auction just to keep everyone honest. The “bidding package” should include a copy of the Collateral Assignment of Hedge that will be required. For purposes of closing documentation and perfection of security interests, the lender should treat the swap issuer as an independent third party.

5 International Swaps and Derivatives Association, Inc. (“ISDA”), formerly the International Swap Dealers Association, has promulgated a standard document format for Hedges, vastly simplifying transactions that once required extensive negotiations. Most Issuers still use the 1992 ISDA documents, although ISDA issued new ones in 2002. ISDA documentation for any Hedge will typically consist of three pieces: (1) a Master Agreement; (2) a Schedule to the Master Agreement, giving details about the parties and other matters, and modifying some terms of the Master Agreement; and (3) a Confirmation to memorialize the terms of a specific hedging transaction. Item “1” is an ISDA printed form and quite standard. Item “2” reflects the tastes of each Issuer, often overriding specific provisions of the ISDA printed form. Item “3” should precisely match the terms of the loan being hedged. A lender accepting a hedge pledge should review all three components (emphasizing the last). Although this model hedge pledge seeks to cure the most common problems in Hedge documents, other issues could arise as well. The time to fix them is before the closing (or else not close). For a discussion of how Hedges work and what a lender should watch for, see the Guinn and Harvey article cited in the introductory paragraph. Issuers sometimes use non-ISDA Hedge documents, requiring greater scrutiny by all parties, particularly as to definitions.

6 A single Master Agreement can relate to more than one Transaction (as defined in the Master Agreement). A Hedge involving a real estate single-purpose entity should, however, typically relate to only one Transaction. The Master Agreement should cover no other Transactions involving that entity or anyone else.

7 The preceding sentence favors Issuer rather than Administrative Agent, but Issuers often request it.

8 Standard ISDA documents (both the 1992 and 2002 editions) prohibit assignment. Even if an Issuer does not enter into an ISDA Master Agreement, the Hedge documentation may incorporate the ISDA Master Agreement by reference (along with its assignment prohibition). Any Hedge will, however, nearly always constitute a “payment intangible” under the UCC. Therefore, UCC § 9-406 will override Borrower’s agreement with Issuer not to grant a security interest in the Hedge and will validate the security interest this Assignment creates. UCC § 9-406 will not, however, override the Transfer prohibition in this Assignment.

9 As the preceding footnote explains, Administrative Agent normally does not need Issuer’s consent to obtain a good security interest, even if the Hedge documents require it. Nevertheless, Administrative Agent typically should, and do, obtain Issuer’s assurances and covenants as set forth in this Assignment.

10 Issuer’s waiver of set-off and netting can be critical to giving Administrative Agent the benefit of its bargain. Absent this waiver, Issuer could “net” (or offset) any payments it might owe under other (unrelated) Transactions under the same Master Agreement. Moreover, given the widespread use of separate “netting agreements” in the world of swaps, Issuer could probably even net its obligations under the Hedge against Issuer’s obligations under unrelated hedge documents with the same Borrower or perhaps such Borrower’s affiliates. Any such “netting” could dilute or eliminate the protection against interest rate volatility that Administrative Agent wanted to achieve. Guinn and Harvey (cited in the introductory paragraph) discuss these concerns at greater length.

11 The Loan Agreement should say, once, that if an Event of Default has been cured and is no longer continuing, then it no longer exists. This avoids any need to repeat the same concept again and again with every reference to “Event of Default.”

12 This paragraph applies only if: (a) the Hedge consists of a swap or other product that imposes obligations on Borrower; (b) the Security Documents secure those obligations; and (c) the Hedge documents do not already cover this matter.

13 For reasons explained in the next two footnotes, delete this paragraph if Issuer uses the 2002 ISDA Master Agreement.

14 When a Hedge terminates prematurely, the “loser” in the transaction must pay the “winner” an amount to compensate the “winner” for the loss of future interest rate protection. The “Market Quotation” method (seen only in the 1992 ISDA Master Agreement) measures that compensation based on an average of marketplace quotations of how much the winner would need to pay to buy equivalent protection for the remaining term of the Hedge. The “Loss” method allows the winner to calculate its total losses based on a number of elements, some of which can be rather hard to pin down (and hence rather easy to overstate). The “Market Quotation” method is both easier to apply and more objective. The 2002 ISDA Master Agreement eliminates both methods, replacing them with a “Close-Out Amount,” much like the 1992 “Market Quotation” method.

15 The “First Method” prohibits a defaulting party (or an “affected party,” such as a party whose merger triggered an unexpected termination) from ever receiving a termination payment. The “Second Method” allows either party to receive a termination payment, if such party was the “winner” at the time the Hedge terminated. The 2002 Master Agreement eliminates this distinction, using the “Second Method” calculation in all cases.

16 Though not essential, the last sentence can eliminate a separate direction letter, assuming the parties are ready to identify the account to receive Hedge Payments. This paragraph assumes Issuer will pay Hedge Payments directly to Administrative Agent, eliminating some potential risks and delays. Administrative Agent will particularly prefer direct payment if the loan requires a “hard lockbox” for rents, as the two are functionally equivalent. Borrower will usually prefer the following language instead of this paragraph: “If either (a) Administrative Agent notifies Issuer that any Event of Default exists; or (b) the Hedge terminates or is in default for any reason, then unless and until Administrative Agent consents otherwise in writing, Issuer shall pay all Hedge Payments only as Administrative Agent directs in writing.”

17 Define this term in the Loan Agreement to mean all rights and remedies of Administrative Agent, whether under the Loan Documents, at law (including the UCC), or in equity.

18 The parties may want to move these provisions into the Loan Agreement or other basic “deal document.”

19 The Nonrecourse Clause should perhaps include a carveout for Borrower’s failure to apply correctly any Hedge Payments that Borrower might receive, functionally equivalent to a misapplication of rental income.

20 Administrative Agent’s financing statement must list Borrower’s full and exact legal name. This sentence provides a cross-check. Administrative Agent should, of course, confirm the name independently and not rely solely on Borrower’s assurances.

21 This may represent the single most important paragraph in every legal document. It refers not only to this Assignment and Administrative Agent’s security, but also the parties’ entire relationship regarding the loan, the security, and anything related. Recent California cases limit the enforceability of jury trial waivers. Those cases may alone justify choosing New York law if the parties have not already done so for other reasons.

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CHAPTER 07 ‑ COLLATERALIZATION OF DEPOSITS SECTION 0100 ‑
collateral
COLLATERAL ASSIGNMENT OF HEDGE JOSHUA STEIN LATHAM


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