What is the role of a collateral agent or security agent?
Article 3 minute read

What is the role of a collateral agent or security agent?

07 February 2019

When would a company need to use a collateral agent (also known as security agent or security trustee)? When lenders take collateral as security for their loans, a collateral/ security agent is often appointed to enforce rights against the collateral in the event of the borrower’s default under the loan or bond documents.

They can also hold the collateral during the term of the loan. There are several reasons the appointment of a collateral agent may be desirable. There may be a syndicate of lenders for the loans, so it may make sense to centralize the collateral-related duties by delegating them to one agent which will act at the direction of the requisite number of lenders (as specified in the transaction documents). It is also possible that collateral may be located in a jurisdiction where the lenders or trustee does not have a presence. Creditor’s rights in pledged security/collateral are typically determined by local laws, so it may be prudent to hire a local agent familiar with the local jurisdiction. It is also possible that the lender is not suited to hold collateral and so an agent with appropriate capabilities needs to be retained.

The role of a collateral/ security agent/ security trustee

Prior to the default, the agent’s role in a secured financing is usually a simple one. It involves accepting the pledge of the applicable collateral and enforcing rights against that collateral when directed to do so.

The collateral agent may be required to hold certain types of collateral. The collateral could be a type in which a lien can only be effective if the collateral is in the physical possession of someone other than the borrower. This collateral often consists of documents such as stock certificates, contracts or deeds. The transaction documents may require the collateral agent to take special actions in respect of the collateral, such as safe keeping in secure fire-proof facilities and indicating in its records that the collateral is held for the benefit of the lenders.

In some jurisdictions, for the lien to be effective, the collateral agent may need to be named as the secured party.  The agent may be required to sign documents governed by local law which create a lien and provide the agent with the ability to exercise rights in the collateral (such as a foreclosure). In this situation, the agent will need to retain local counsel – at the expense of the transaction sponsor or the borrower – to review these documents and ensure the collateral agent is not subjected to any unexpected liabilities.

If a default occurs under the financing, the collateral agent may be called upon to enforce the rights in the collateral. The agent will do so only at the direction of the specified lenders or bondholders, and should be indemnified for the costs of enforcement, including counsel fees. Any proceeds (generally net of the agent’s expense) will be remitted to the lenders in respect of their loan.

There should be minimal risk for an entity serving as a collateral agent if the documentation is drafted correctly. The documentation should clearly provide that the agent’s duties are ministerial in nature, so that the agent exercises no discretion and acts only at the direction of the lenders. The documentation should also provide an indemnity of the agent for its actions (typically subject to the agent’s gross negligence or wilful misconduct, and should be clear that all costs of enforcement are covered by the lenders).

It is possible that in some jurisdictions liens may be difficult to enforce and enforcement efforts may result in protracted litigation. Additionally, the agent may not desire to foreclose upon certain some types of collateral for reputational reasons. Each appointment must be examined on a case-by-case basis.

TMF Group

TMF Group can provide collateral/security agent services as well as a comprehensive range of capital markets services across our global footprint. As an independent service provider, our local experts can take care of paperwork as well as work through local technicalities to streamline the legal work required by the client to reduce legal expenses. Find out how we can help your business. Talk to us

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Written by

Edward O'Connell

General Counsel - Senior VP, Corporate Governance

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