JANUARY 2008 Issue No. 73

Welcome to the January 2008 edition of
Business Leasing and Finance News

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FOUNDER'S NOTE
By David G. Mayer

Optimism

Welcome to our 73rd consecutive month of publishing BLFN, which began its existence as Business Leasing News (BLN) in January 2002. BLFN owes a special thank you to each of you around the world for reading BLFN in 2007 and to the Patton Boggs LLP team that has made this newsletter possible. In this, our 7th year, we will expand the scope of our subjects on finance and leasing transactions and related topics to reflect the ever increasing globalization of business. We will also share with you articles or alerts written by other Patton Boggs lawyers when relevant to BLFN’s mission statement. We will strive to provide you with even more concise, useful and interesting editions of BLFN.

I look forward to 2008 with some optimism and concern. Optimism may not be your cup of tea, but apparently we are built for optimism, according to an article titled “Except in One Career, Our Brains Seem Built for Optimism,” The Wall Street Journal, S.W. Ed., Page B:1, Col. 1 (Nov. 9, 2007). One study with a finance focus concluded that “Optimists…worked longer hours every week, expected to retire later in life, were less likely to smoke and, when they divorced, were more likely to remarry. They also saved more, had more of their wealth in liquid assets, invested more in individual stock and paid credit-card bills more promptly.”

In 2008, we face a possible recession, continued high oil prices and a cascading subprime mortgage crisis. The credit markets have not, in all likelihood, seen the worst or end of the fallout. World affairs could not be more complex geopolitically with the likes of Iranian nuclear threats.

Yet, we still can have reason to have tempered optimism stemming from what we individually and collectively can accomplish in the New Year. Can we challenge ourselves to outperform 2007? Can we work smarter, not just harder? Can we make 2008 a year of accomplishment over that of 2007?

Sometimes I feel like an optimist, but it’s curious that the one career that did not seem built for optimism was, you guessed it, lawyers. As the article said, for lawyers “pessimism is considered prudence.” That may well be true, but optimism sure helps make deals happen.

I hope your 2008 will be imbued with optimism and prosperity. Happy New Year and all the best in 2008!

1. CFIUS Reform Will Test Foreign Investment in U.S. Infrastructure Projects

Government review is now mandatory for any transaction that will result in a foreign entity gaining control of critical infrastructure or technology. If you are or have a foreign partner in a transaction involving the acquisition of critical infrastructure or technology, there are important legal and political challenges to your project that you must consider.

The attempted acquisition by Dubai Ports World (DPW) of six major facilities in 2006 was a political debacle. While the deal was approved by the Committee on Foreign Investment in the United States (CFIUS), it unraveled because of political concerns that the security risks of foreign control of critical infrastructure had not been given enough weight by CFIUS. DPW was not the only deal to focus the Congressional spotlight on foreign control issues. Others – including the unsuccessful 2005 bid by the Chinese national oil company CNOOC to buy the U.S. oil company Unocal and the acquisition of Sequoia Voting Systems of Oakland, California, by Smartmatic, a Dutch company contracted by President Hugo Chávez’s government to replace Venezuela’s elections machinery – snowballed demand for CFIUS reform.

* Term to Know: CFIUS, or more formally the Committee on Foreign Investment in the United States, is a federal interagency committee consisting of the Treasury, Commerce, Defense, Justice and Homeland Security Departments, along with the United States Trade Representative and other agencies invited to participate on a case-by case basis. Treasury chairs the committee and the Director of National Security is a non-voting member.

Not surprisingly, Congress has now overhauled CFIUS by enacting the Foreign Investment and National Security Act of 2007 (FINSA). FINSA became effective on October 24, 2007 and now provides for CFIUS review of foreign control of “critical infrastructure,” potentially bringing far more transactions into question. FINSA significantly raises the stakes for all foreign investors seeking to acquire U.S. infrastructure. Investigations can only be waived by a joint certification by the Secretary of the Treasury and the head of the agency that is principally concerned that the transaction will not adversely affect national security. CFIUS is still required to investigate any transaction in which the acquiring entity is controlled by a foreign government. There is now mandatory reporting by CFIUS to Congress on its findings at the end of its 30-day review and again at the end of any investigation. Where CFIUS approval provided finality in the past, FINSA allows CFIUS to reopen review where it is claimed that there has been a breach of any agreement to mitigate national security concerns. If such a breach is found to have occurred, CFIUS can recommend that the President order an acquisition unwound even years after the deal was closed.

* Term to Know: “Critical infrastructure” is defined in FINSA as “systems and assets, whether physical or virtual, so vital to the United States that the incapacity or destruction of such systems or assets would have a debilitating impact on national security.” 50 U.S.C. App. § 2170(a)(6), as amended by FINSA § 2.

Furthermore, the Act extends the meaning of “national security” to include “homeland security, including its application to critical infrastructure.” 50 U.S.C. App. § 2170(a)(5), as amended by FINSA § 2. While this appears to be a sweeping definition of critical infrastructure, there is some suggestion that it will be narrowed by regulations to be issued early this year. For now, however, it is safest to give it the widest possible meaning.

* Term to Know: “Critical technology” means “critical technology, critical components, or critical technology items essential to national defense.” 50 U.S.C. App. § 2170(a)(7), as amended by FINSA § 2.

CFIUS has until April 2008 to issue regulations. Until then potential foreign buyers of U.S. infrastructure will have little official guidance beyond the statutory text.

*Technical Point: Given FINSA inclusion of “homeland security” within “national security,” it is worth noting that the Homeland Security Act of 2002 extended the definition of “critical infrastructure” beyond the national security context to “national economic security, national public health or safety, or any combination of those matters.”

Administration officials have suggested that CFIUS will limit its review to the effect of critical infrastructure on what has traditionally been considered to be national security. It remains far from certain whether that intention will survive the first political storm.

*Insight Point: The practical application of these definitions to a particular asset unfortunately remains as much art as science. The Department of Homeland Security (DHS) is responsible for developing strategies for protecting critical infrastructure. It has identified various sectors that encompass high-risk elements of critical infrastructure, including energy (electrical, nuclear, gas and oil, and dams), transportation (air, highways, rail, ports, and waterways), water systems, the chemical and defense industries, food and agriculture, health systems and emergency services, telecommunications, information technology, and banking and finance. Obviously not all assets in these sectors will be critical, but this list provides some idea about how far FINSA has expanded the reach of CFIUS beyond its traditional defense and intelligence concerns.

Under FINSA, the potential acquisition of a major power plant or energy transmission system, railway or port facility, chemical plant, or water treatment system by a non-U.S. entity must now be analyzed to determine whether CFIUS review should be sought. The decision of a party to notify CFIUS of a pending transaction remains voluntary, but CFIUS, as before, can initiate review itself. CFIUS still has just 30 days to review and clear a transaction, or to decide to investigate its national security consequences. The risk of not notifying CFIUS well before closing is that the transaction may have to be unwound or its terms substantially altered if it is subsequently determined to pose a risk to national or homeland security. That also means that agencies like the U.S. Departments of Transportation or Energy, which traditionally did not have a voice in this process, may become critical players along with CFIUS members like Commerce and State.

*Tip: It may be advantageous to go through the CFIUS process just to get a ruling from CFIUS that FINSA does not apply to the deal because that in itself can provide a measure of finality. Even if you choose not to file formally with CFIUS, it may be advantageous to be able to point to informal discussions with CFIUS staff on whether the deal might have national security implications.

Going before CFIUS is not itself without risks. Until regulations are issued and some experience is gained under FINSA, there will be uncertainty as to how CFIUS will interpret its new authorities. The CFIUS process necessarily entails some risk of delay. Despite the statutory deadlines, obtaining CFIUS approval can take several months. The terms of a deal may need to be adjusted, sometimes significantly, to mitigate any concerns that CFIUS might raise. The new requirement for CFIUS to report to Congress at each stage of its consideration increases the risk that political concerns may influence the outcome far more than in the days before Dubai Ports World.

*Insight Point: Anecdotal evidence indicates that CFIUS has increasingly imposed conditions on its approval and informally blocked more transactions than in the past. These trends are likely to increase for some time under FINSA, so these potential risks must be taken into account and managed carefully when considering any transaction that will result in foreign control of infrastructure.

Congress will focus like a laser on all deals that come through the CFIUS process for the foreseeable future. The inclusion of “critical infrastructure” and “critical technology” now means that more companies than ever need to worry about the concerns raised by Members of Congress in the informal process and review. As Dubai Ports World demonstrated, managing these risks goes well beyond satisfying the concerns of the CFIUS member agencies. The CFIUS agencies approved the DPW transaction, but Congressional outrage forced DPW to unwind its acquisition of the U.S. port facilities. The politics of the deal will be as important, if not more so, than the substance in completing these reviews.

*Tip: While the mandatory reporting to Congress comes after CFIUS has made its recommendation, it is crucial that companies consider strategic outreach to key committees in Congress even before filing with CFIUS. Companies will not be part of or included in CFIUS’s Congressional briefings, and will not be able to control the message or the discussion at that point.

As the new legislation expands the number of agencies that may be brought in to the CFIUS review, and widens the types of “critical infrastructure” acquisitions on CFIUS’s plate, it also expands the number of oversight committees that will need to be briefed. This process now includes committees like the House and Senate Homeland Security Committees and the House and Senate Transportation Oversight Committees, and depending upon the type of infrastructure asset, other committees such as Energy and Commerce—all run under the hands of strong chairmen who have very specific ideas about these types of deals.

*Action Item: If your deal involves a foreign partner in an acquisition, the effects of FINSA must be carefully weighed early in any planning. You must determine if the company or assets being acquired could be considered critical infrastructure or critical technology. If so, the role of the foreign partner must be evaluated to determine whether it would have significant influence over use or disposition of the asset or technology by a non-U.S. entity. A decision must be made on whether to voluntarily initiate CFIUS review.

Early outreach to Congress and informal briefings may be critical to a CFIUS review. Remember, as DPW found out, the Court of Public Opinion, as determined by the Congress, may define your deal, if you do not act as needed to manage the expansive CFIUS process.

Thanks to Steve McHale of the Homeland Security, Defense, and Technology Transfer at Patton Boggs LLP for contributing this article.

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2. New Protocol in Canada to Eliminate Cross-Border Withholding Tax

U.S.–Canadian cross-border loans are about to receive a boost from a new protocol to an existing tax convention involving the two countries.

*Term to Know: A protocol in the realm of international diplomacy represents supplements or amendments to a treaty, which is an agreement that involves two or more signing countries or diplomatic organizations. 

The U.S. and Canada originally signed the Canada-U.S. Income Tax Convention in 1980 (Convention). The current protocol, which is the fifth one to the Convention, includes new provisions that, over a period of time, will eliminate withholding taxes between the U.S. and Canada in addition to numerous other tax policies affecting individuals and businesses.

The Fifth Protocol

The Protocol signed on September 21, 2007 proposes to change and update many of the provisions of the existing Convention.

Cassels Brock & Blackwell LLP noted in recent publications that the Protocol will have a significant impact on many types of cross–border transactions.

*Tip: Each transaction will have to be assessed on case–by–case basis. Leases are excluded to the extent the rent payments do not constitute interest.

The Protocol must be ratified by the U.S. and Canada with each giving notice to the other. The Protocol will take effect two months after the latter of (i) the latter notification of one country to the other or (ii) January 1, 2008.

*Tip: Watch for transition issues in applying the exemption, after it enters into force. See New Effective Date for Proposed Exemption from Withholding Tax under the Income Tax Act (Canada), By Ken Snider, Cassels Brock & Blackwell (Nov. 23, 2007).

Below are brief explanations of several key elements of the Protocol.

Elimination of “Withholding Tax” on Interest

According to the Department of Finance – Canada:

• Who It Affects: Any resident of Canada or the United States who pays interest to a person in the other country. This group may implicitly include interest on financing leases.
  
  
• Current Rule: If interest is paid across the Canada-U.S. border, the tax treaty generally allows the payer’s home country (the “source country”) to tax that interest. The tax, at up to a 10 percent tax rate, is collected by requiring the taxpayer to withhold and remit a portion of the interest payment – hence the term “withholding tax.”
  
  
• New Rule: The source country, during a phase-in period, will not be required to tax cross-border interest between unrelated persons starting in the second month after the Protocol enters into force.
  
  
• Example: A resident of Canada who borrows money from a U.S. lender will no longer have to withhold and remit Canadian tax on the interest payments.
  
  
• Significance: Reduces borrowing costs; makes cross-border investment more efficient; removes an impediment to cross-border transactions.
  
  
• Application: Applies to interest paid between unrelated (arm’s length) persons – e.g., a bank and its customer – as of the second month after the Protocol enters into force. For interest paid between related persons – e.g. a subsidiary company and its parent company – full exemption applies as of the third year after entry into force. For the first and second years after entry into force, the source country tax rate limit is reduced from 10 percent to 7 percent and 4 percent, respectively.

*Technical Point: Certain interest may continue to be taxed up to a 15 percent rate if the beneficial owner of the interest is a U.S. resident under the Treaty. These taxable items arise from (i) receipts, sales, income, profits or other cash flow of a borrower or a related person, (ii) any dividend, partnership distribution or similar payment made by a borrower or related person or (iii) any change in the value of any property of a borrower or related person, (iv) contingent interest that is not portfolio interest under U.S. law, or (v) interest to the extent the amount thereof exceeds what would have been charged in an arm’s length relationship (that is, higher interest due to a special relationship between payer and the beneficial owner of the interest). See International finance transactions – Update on proposed elimination of Canadian withholding tax, Oglivy Renault LLP (Nov. 13, 2007).

From the day the Protocol takes effect, the lending business in the U.S. and Canada should show a significant increase in volume, a welcome change in the U.S., as the restraint posed by the withholding tax in Canada will begin a phase out on certain transactions and create new cross-border lending opportunities for both countries.

Thanks to of Cassels Brock & Blackwell for reviewing this article.

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3. BLFN’s Case & Comment: Banks Stand Together in Syndications under Beal v. Sommer

Syndicated loan arrangements occur every day. Lenders act in concert through an agent bank to advance loan proceeds to their borrower. When credit trouble happens, banks look for solutions, but can they do so alone – outside the syndicate? The case of Beal Savings Bank v. Sommer, 8 N.Y.3d 318, 834 N.Y.C.2d 44 (2007) addresses this broad issue.

FACTS OF CASE: On February 26, 1998, a lending syndicate, originally of 13 lenders (Lenders) invested in the construction of Aladdin Gaming, LLC (Borrower) to develop the Aladdin Resort and Casino in Las Vegas, Nevada. The Lenders advanced $410 million through the Bank of Nova Scotia (succeeded by BNY Asset Solutions, LLC), the Administrative Agent. A Credit Agreement specified the primary terms of the loan. Ancillary documents included a “Keep-Well Agreement.” Beal Savings Bank alleged that Sommer breached the terms of the Keep-Well Agreement causing a default under the Credit Agreement. A year later following a bankruptcy of the Borrower, 36 Lenders (all but BFC, Beal’s assignor) agreed that the terms of the settlement were of greater benefit to the consortium than an attempt to recover against the supporting sponsors under the Keep-Well Agreement. Beal argued in subsequent litigation that the Keep-Well Agreement authorized Beal to act on alone outside of the group of banks to enforce the sponsor’s obligations under the Keep-Well Agreement.

ISSUE: Can one lender in a syndicated loan arrangement sue the borrower on its note contrary to the decision of the other lenders to forbear from taking such action?

OUTCOME: No. When lenders intend to act collectively in the event of default and for other decisions under a syndicated loan, an individual lender is precluded from “disrupting the scheme of the agreements at issue.” The New York Appellate Division and the New Court of Appeals concluded that the Keep-Well must be administered in accordance with the terms of the Credit Agreement, which sets forth the procedures in the event of default. Those procedures provide for collective action of the Lenders and do not allow individual lenders to sue on its note.

LAW OF CASE: According to the New York Court of Appeals, New York law requires that construction of an unambiguous contract be determined as a matter of law. The intention of the parties may be gathered from the four corners of the instrument and should be enforced according to its terms.  Agreements should be construed so as to give full meaning and effect to the material provisions. A reading of the contract should not render any portion meaningless that is not material to the meaning of the whole contract. Further, a contract should be “read as a whole, and every part will be interpreted with reference to the whole; and if possible it will be so interpreted as to give effect to its general purpose.” Taken as a whole, the New York Court of Appeals concluded that the provisions of the Credit Agreement in Sommer required collective action by the Lenders; and Beal could not act alone.

*Comment: The New York Court of Appeals reviewed many provisions of the Credit Agreement to ascertain the intent of the parties. A close reading of the decision suggests that drafters should focus on making the language clear, even more clear than in the Sommer case, that individual lenders cannot act alone, that notes only evidence debt and do not give independent rights of action by lenders, and that an orderly decision process by all the lenders, voting as a group and acting exclusively through an agent bank, will control any dissenting lender’s actions and set the course of the lender group. Beal Bank tested this premise and the Court reached the correct decision, providing certainty and clarity to syndicated loan financings. No bank may act alone in a syndicate unless the language unambiguously allows such action, which seldom if ever occurs.

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4. BLFN’s Finance 101: What Is a “Keep-Well Agreement”?

Beal v. Sommer, the case discussed in Case & Comment, defined a Keep-Well Agreement as follows (in footnote 1):

A Keep-Well Agreement is a contract by a parent company promising inancial assistance and management support for its subsidiary. This agreement confirms the parent company's obligation to maintain the subsidiary's favorable finances. See Securities and Exchange Commission, Disclosure in Management's Discussion and Analysis about Off-Balance Sheet Arrangements and Aggregate Contractual Obligations, RIN 3235-AI70, n 77 [Jan. 28, 2003].

A Keep-Well Agreement is not a guaranty. A “guaranty” is an agreement by one party in favor of another party to accept responsibility for, or pay the debt or obligation of, another person or entity that is the primarily liable party. For example, a sister or parent company could guaranty the obligations of a subsidiary to repay a loan or to pay rent for equipment under a lease or loan agreement. See BLFN’s Finance 101: What Is a “Guaranty”? By David G. Mayer, Business Leasing and Finance News (Dec. 2007).

The fundamental difference between a guaranty and a Keep-Well is the guaranty offers direct assurance to a party that it will perform and/or pay obligations to the creditor for and in place of the debtor should the debtor fail to perform its obligations or pay its debts. In contrast a Keep-Well provides indirect benefit to creditors to strengthen an affiliate so the affiliate can perform its obligations, increase its creditworthiness or remain solvent. PwC explained a Keep-Well as follows: 

            (1) ACo holds 100% shares of XCo

            (2) ACo maintains Xco’s net assets valued at US$10,000 or more

            (3) ACo promises to provide sufficient funds to XCo if XCo’s current assets are not sufficient to repay its debts.

In other words, a Keep-Well Agreement is a contract between a parent company and a subsidiary (not a creditor) which provides creditors assurance that the parent company will furnish necessary financing or other credit support to keep a subsidiary in a certain financial condition for a pre-determined period of time (that is, keep a subsidiary financially well).

*Tip:You can remember the difference between a guaranty and a Keep-Well Agreement because a guaranty is signed directly in favor of creditors, but a Keep-Well is signed with a subsidiary and not a creditor. They have different functions, but both improve creditworthiness for lenders or lessors.

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About Patton Boggs LLP; Upcoming Speech; Other Publications

About Patton Boggs LLP

Patton Boggs LLP is a law firm of more than 600 attorneys and other professionals located throughout the United States and internationally in Doha, Qatar.

Patton Boggs has major practice areas in Business, Intellectual Property, Public Policy, and Litigation. These areas are composed of many practice groups designed specifically to meet client needs and the trends in developing legal markets. David G. Mayer often focuses on aviation, power, transportation, infrastructure, and technology matters.

The firm provides a broad array of skills in domestic and international business transactions, including equipment finance and leasing, corporate finance, secured transactions, syndications, mezzanine finance, federal leasing, project finance, real estate, health care, pharmaceuticals, technology transactions, and public policy work.

Upcoming Speech

How Cape Town Affects Partial Interests in Aircraft , Strategic Research Institute, to be presented on February 5, 2008 by Amanda Applegate, NetJets Sales, Inc., Bruce Marshall, Bombardier Flexjet and David G. Mayer, Patton Boggs LLP, at 15th Annual Registry Summit, Hyatt Regency Pier 66, Fort Lauderdale, FL.

Sample Publications

The following is a partial list of articles by David G. Mayer:

• Equipment Leasing and CERCLA Liability, by Russell V. Randle and David G. Mayer, LNJ Leasing Newsletter (Dec. 2007).
  
  
• Navigating the New Reality of Equipment Leasing and CERCLA Liability, by Russell V. Randle and David G. Mayer, LNJ Leasing Newsletter (Nov. 2007).
  
  
• Managed Service Providers Use Innovative Capital Structures to Fund CAPEX, Financier Worldwide, by David G. Mayer (May 2007).
  
  
• The USA PATRIOT Act Renewed: Reassessing Money Laundering Risk in Finance Transactions, by Stephen J. McHale and David G. Mayer, LNJ Leasing Newsletter (Two Parts: Nov. & Dec. 2006).
  
  
• Unique Pad Gas Lease Supports Project Financing and Development of Gas Storage Facility in U.S., by David G. Mayer (with Fortis Capital Corp.), Asset-Based Lending Review, Financier Worldwide (Nov. 2006).

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Thanks to BLFN’s Team

I would like to thank BLFN’s team at Patton Boggs LLP. The team includes Bryon Wilems, an associate in the firm’s business transactions group; the Patton Boggs staff, Paul Dumansky; our Marketing Manager, Mark Holub; our Project Manager, Melissa Green; and our designer, Winston Jackson. Thanks also to Douglas C. Boggs, a Business Group/Securities partner and web site reviewer for BLFN, and our Marketing Chief, Mary Kimber, for assisting BLFN through our firm’s editing, design, and posting process.

All the best,

David

David G. Mayer
Founder: Business Leasing and Finance News
(formerly Business Leasing News)
Partner: Patton Boggs LLP
2001 Ross Avenue
Suite 3000
Dallas, Texas 75201
(214) 758-1545 (phone)
(214) 758-1550 (fax)

E-Mail: dmayer@pattonboggs.com

© David G. Mayer 2008

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