7/13/20 - Insights
Guidance for MSLP Lenders: How to Minimize Litigation Exposure
While the Main Street Lending Program (“MSLP”) was designed to ameliorate economic harm caused by the COVID-19 pandemic, it leaves lenders open to possible litigation exposure if borrowers fail to satisfy their obligations. How can lenders protect themselves and minimize the level of risk?
The Federal Reserve established the MSLP in April 2020 to concentrate economic support toward small and mid-sized businesses by creating three credit facilities to support lending throughout the United States. The program is administered through the Federal Reserve Bank of Boston, which created a special purpose vehicle (“SPV”) to purchase participations in loans originated by participating lenders. The SPV purchases approximately 95 percent of the loan, leaving the participating lender with some—albeit minimal—risk.
Due to the tripartite nature of a loan administered through the MSLP, a seemingly straightforward question arises for participating lenders: what obligations, if any, does a lender have for a borrower’s failure to satisfy its obligations under a loan administered through the program? That this question can even be asked in the first place is a novelty. The government’s other COVID-19-related economic stimulus programs have been marked by the absence of liability on the part of participating lenders. Indeed, unlike programs like the Paycheck Protection Program (“PPP”), lenders participating in MSLP may have potential litigation exposure to both participating lenders as well as the Federal Reserve. This article will, after briefly explaining the structure of the program, examine what such litigation may look like.
The MSLP is administered through three credit facilities: the New Loan Facility, the Priority Loan Facility, and the Expanded Loan Facility. Each facility offers loans with terms of five years, principal deferred for two years and interest deferred for one year, and an adjustable interest rate of LIBOR plus 300 basis points. Each facility offers a lender participation rate of 5%. In addition, each facility is available only to businesses with 15,000 or fewer employees and/or 2019 revenues of less than $5 billion.
The MSLP is administered generally as follows: first, a borrower who meets MSLP eligibility criteria (an “Eligible Borrower”) will apply for a loan with a participating lender (an “Eligible Lender”). The Eligible Lender, in turn, submits the Eligible Borrower’s loan participation program to the program’s SPV. The SPV will then purchase up to 95% of the submitted loan, with the Eligible Lender retaining the remaining 5%. Once the SPV’s purchase is completed, the Eligible Lender will then fund the loan.
As one would expect, lenders and borrowers participating in the MSLP are required to execute a series of agreements. The primary document, however, is the Participation Agreement under the Main Street Lending Program (“Participation Agreement”). Eligible Lenders and Borrowers must also execute certifications and covenants (“Certifications”). The Certifications detail straightforward representations made by the borrower to the lender, e.g., that the financial records submitted by the borrower in connection with the loan process fairly represent its financial condition. The MSLP has boilerplate forms for the Participation Agreement and the required certifications and covenants.
Unlike the jurisprudence developing in connection with the PPP, there are potential interactions with the provisions contained in the Participation Agreement and the Certifications that could create legal exposure for lenders.
As detailed above, an Eligible Borrower will apply for a MSLP loan from an Eligible Lender. Assuming all criteria are met, the loan will eventually be sold by the lender to an entity named MS Facilities LLC, the Federal Reserve’s SPV. This sale is effectuated through the MSLP Participation Agreement. That agreement is between the lender and the federal government, which begs the question: what are a lender’s obligations in the event that the borrower defaults on the MSLP loan?
Given the current economic climate, the risk of a borrower defaulting on an MSLP loan cannot be overstated. Critically, the Participation Agreement provides the standard of care applicable to lenders in such a scenario:
Seller will not be held to the standard of care of a fiduciary, but will exercise the same duty of care in the administration and enforcement of the Participation and the Transferred Rights it would exercise if it held the Transferred Rights solely for its own account, and except for losses that result from the Seller’s bad faith, gross negligence, willful misconduct or breach of any of the express terms and provisions of this Agreement, it shall not be liable for any error in judgment or for any action taken or omitted to be taken by it.
A number of questions and issues arise from this explicit standard of care. How does one judge whether a lender has appropriately observed the “duty of care in the administration and enforcement” of its rights under the MSLP loan? Does this duty extend to MSLP borrowers as well as the SPV? What exactly does “administration and enforcement” of an agreement that transfers 95% of a loan to the SPV mean?
While these—and likely many more—questions arise from the Participation Agreement, some guidance has been provided as to the extent and nature of this standard of care. The Federal Reserve’s “Frequently Asked Questions (June 26, 2020)” do provide some indication as to what this standard of care means, at least with regards to a borrower experiencing financial distress:
Once an Eligible Borrower misses a mandatory and due payment on the Program loan (beyond the applicable grace period), or the Eligible Borrower or Eligible Lender enters into bankruptcy or other insolvency proceedings, the Main Street SPV will have the option to elevate its participation to an assignment to be in privity with the Eligible Borrower. However, the Federal Reserve does not expect the Main Street SPV to use this right as a matter of course. Rather, the Federal Reserve would expect Eligible Lenders to follow market-standard workout processes and to exercise the standard of care set out in the Loan Participation Agreement (i.e., to exercise the same duty of care in approaching such proceedings as it would exercise if it retained a beneficial interest in the entire loan). In general, the Federal Reserve expects that the Main Street SPV generally would not expect to elevate and assign except in situations where (i) the economic interests of the Eligible Lender and the Main Street SPV are misaligned, or (ii) the loan amount is relatively large in comparison to other loans in the Main Street SPV’s portfolio of participations.
Elsewhere, the FAQ notes that except “to the extent set forth in any … standard of care or standard of inquiry … the Lender assumes no obligation or liability with respect to the accuracy and completeness of Eligible Borrower financial information.” Seen in this light, the Participation Agreement’s standard of care does seem to impose affirmative obligations on MSLP lenders. They are expected to act reasonably and observe ordinary course of business procedures, such as performing standard workout procedures for distressed borrowers and conducting ordinary course inquiries into the accuracy of financial information provided by borrower applicants.
This, of course, raises the question: what happens if a lender fails to observe this standard of care? For example, does a borrower have a right to sue a lender if the lender refuses to workout debt relief in the event that the borrower faces insolvency? Again, unlike the PPP context, the various forms for MSLP participation do seem to expressly contemplate that lenders can face liability. Moreover, these forms seem to leave open the possibility that lenders could be liable to both the MSLP SPV and aggrieved borrowers.
By no means should this assertion be taken to mean that litigation against lenders participating in the MSLP is necessarily warranted. To be sure, lenders who participate in the MSLP are motivated, at least in part, by the desire to address the economic turmoil caused by the COVID-19 pandemic. However, numerous news outlets have reported that many of the country’s largest banks have refused to participate in the MSLP. For example, a recent Financial Times article indicated that some bankers have avoided participating in the MSLP due to fears over the program’s complexities. Such a concern is in line with the potential litigation exposure a participating MSLP lender may face.
Guidance for Lenders
Faced with this potential litigation exposure, what can a lender do? One potential solution lies in another provision of the Participation Agreement. Paragraph 12.2 of the agreement states that lenders may rely on legal counsel, public accountants, and “other experts selected or accepted in good faith by” the lender. Paragraph 12.2 then goes on to state that lenders “shall not be liable for any action taken or omitted to be taken in good faith by [lender] in accordance with the advice of such” attorneys, accountants, etc.
This provision is notable for the mandatory bar (“shall not”) on liability. Thus, one way lenders participating in the MSLP can insulate themselves from potential litigation exposure is to enlist and rely upon the opinions of experts involved in the administration of an MSLP loan. This would likely entail engagement of such experts early in the loan process. Yet so long as participating lenders can show a good faith reliance on the opinions on such experts, they can avail themselves of a powerful contractual defense.
 See, e.g., PPP Agent Fees: A Guide for Accountants, Attorneys, and Consultants (available at: https://www.jdsupra.com/legalnews/ppp-agent-fees-a-guide-for-accountants-69728/) (detailing potential absence of private right of action for PPP Agents against PPP Lenders under Paycheck Protection Program).
 The SPV makes these purchases through up to $600 billion contributed by the Federal Reserve and $75 billion contributed by the Department of Treasury.
 Participation Agreement Under the Main Street Lending Program 12.1.
 MSLP Frequent Asked Questions (FAQs) at 48 (June 26, 2020) (available at https://www.bostonfed.org/supervision-and-regulation/supervision/special-facilities/main-street-lending-program/information-for-lenders/docs.aspx).
 Id. at 56.
 Participation Agreement Under the Main Street Lending Program 12.2.
 Id. (emphasis added).