Doing Business in Oman: Market Disruption Clauses in Loan Agreements

We understand that the market disruption clause has recently been invoked by more than one Omani bank in relation to loans to at least one Omani company following the turmoil in the banking sector at the end of last year. Previously this clause had seldom been relied upon by lenders and therefore had not been highly negotiated by borrowers. Lenders have been reluctant to rely on this clause for reputational and competitive reasons - they are nervous about revealing they have to pay more in the interbank market than the LIBOR (London Interbank Offer Rate) and their actual funding costs.

The market disruption clause in the Loan Market Association (“LMA”) style loan agreement can be triggered if the cost of obtaining matching funds in the market to fund a loan for lenders with the required percentage of participation (typically varies between 25% and 50%) is in excess of LIBOR. If this clause is triggered, then the interest rate on each lender’s share of the loan for that interest period will be calculated using the actual cost to that lender of funding its share of the loan from whatever source it may reasonably select. This clause will need to be re-triggered for each interest period.

When this clause is triggered, the borrower may request that the agent enter into negotiations for up to 30 days with a view to agreeing a substitute basis for determining the interest rate. In reality, this may not assist the borrower, as any substitute basis for determining the interest rate will require all lenders’ consent.

Issues of concern for the borrower where this clause has been triggered include:

• An increase in the borrower’s funding costs - the actual cost of funds will be payable to all of the lenders;
• The potential breach of certain financial covenants – such as the interest cover ratio – in the loan agreement; and
• If there is any interest rate hedging, this hedging is no longer likely to match the interest rate payable - there are typically no market disruption provisions relating to LIBOR in such hedging arrangements.

Actions that a borrower could subsequently take include:

• Requesting that the additional interest costs should be ignored in calculating the financial covenants;
• Prepaying the lenders with the highest funding rates - this is likely to require all lenders’ consent and may encourage lenders to quote higher funding rates;
• Selecting shorter interest periods – there tends to be greater liquidity available in the market for shorter interest periods and it would also shorten the period during which this clause would apply; and
• Agreeing a higher interest rate payable under the loan agreement - this is only likely to require consent of a majority of the lenders but all lenders’ consent would be required to effectively bind the lenders from subsequently triggering this clause.

The wording of the market disruption clause in a loan agreement will need to be reviewed carefully as it is likely to differ from the LMA style loan agreement.