What belongs in a local security document? The function of local security documents in cross-border finance

Introduction

Cross-border finance has become increasingly international, sophisticated and standardised. That development has brought obvious benefits. Multi-jurisdictional transactions can now be documented with a level of consistency that would have been difficult to imagine only a few decades ago. Standard form documentation, internationally recognised market practice and the widespread use of Agreed Security Principles have reduced transaction costs, streamlined negotiations and made complex financings more manageable.¹

Few practitioners would wish to reverse that development. The question is narrower and more practical: when a local security document forms part of a wider finance documentation package, how should one decide what belongs in that local document?

Although the discussion in this article draws on my experience as Swedish counsel in cross-border leveraged, corporate and restructuring financings, the issue is not uniquely Swedish. Swedish law is used here as the lens through which a broader documentation problem is examined. Any jurisdiction in which local security instruments coexist with foreign law facility agreements, intercreditor agreements and the Agreed Security Principles is likely to encounter similar questions.

The market’s preference against duplication is understandable. Why repeat provisions that have already been negotiated elsewhere? Why increase the risk of inconsistency? Why create several sources of truth when one will suffice?

Those are good questions. This article does not seek to challenge them, nor does it suggest that local security documents should become longer or more repetitive. Rather, it asks a different question: the fact that a provision appears elsewhere may explain why unnecessary duplication should be avoided, but does it also answer whether that provision performs an independent function within the local security document?

Put differently, the question is whether the local security document contains, or clearly incorporates, the conditions and mechanisms that may need to be relied upon for effective enforcement under the applicable local law.

In my experience, those are separate enquiries. The first concerns drafting efficiency. The second concerns the function of the local security document itself.

The distinction may appear subtle, but it is more important than it first appears.

The evolution of local security documentation

The role of local security documents has changed considerably over the past 20 years. Historically, local counsel were generally instructed to prepare security documentation by reference to local law requirements and local market practice. Although the commercial bargain had been agreed in the principal finance documents, local counsel retained considerable discretion in preparing those documents and determining how the local legal system should give effect to the transaction.

Today, particularly in larger international transactions, the process often follows a different path. The Facility Agreement is negotiated. The Intercreditor Agreement follows. Agreed Security Principles are settled. Lead counsel may then circulate standardised local security templates intended for use across several jurisdictions.

By the time local counsel are instructed, the practical instruction often resembles this: follow the agreed template as closely as possible, depart from it only where local law requires, and avoid including provisions already dealt with elsewhere in the Finance Documents.

From the perspective of transaction management, this is entirely rational. Consistency across jurisdictions is desirable; negotiations should not be repeated unnecessarily; amendments should, where possible, be centralised; and the documentation should remain coherent throughout the financing structure.

The question is not whether standardisation has been beneficial, but whether it has altered the function of local security documents in ways that merit closer consideration.

Why the market avoids duplicate drafting

The preference against duplicate drafting is well established. If substantially identical provisions appear throughout a documentation package, inconsistencies may emerge over time. One agreement may be amended while another is overlooked. Slightly different wording may invite unnecessary arguments concerning interpretation. Negotiations become longer and the documentation more difficult to maintain.

Maintaining a single “source of truth” for the commercial relationship between the finance parties is therefore a sensible objective. Financial covenants, leverage ratios, reporting obligations and many ordinary undertakings naturally belong in the principal finance documents. Repeating them throughout every local security document would seldom improve either legal certainty or transaction efficiency.

The issue is not whether duplication should be avoided. It generally should. The issue is whether avoiding duplication should always be decisive when determining the contents of a local security document.

Duplicate drafting, fragmented documentation and self-contained security documents

The legal profession has devoted considerable attention to the risks associated with duplicate drafting. Far less attention is given to the opposite phenomenon: in the pursuit of avoiding duplication, provisions directly relevant to local security may become fragmented across several agreements governed by different laws and typically subject to different courts or other dispute resolution mechanisms.

I use the expression fragmented documentation to describe that phenomenon. The issue is not that the relevant provisions cease to exist. They may be carefully negotiated and comprehensively drafted. The issue is that no single local security document may any longer identify, or even clearly direct the reader towards, the provisions most closely connected with the creation, preservation and enforcement of the local security itself.

There is also a more practical readability point. A local court, insolvency office-holder or enforcement authority may need to understand the conditions central to the local security without reconstructing them from several foreign law documents. Having those conditions collected in one local document, or at least clearly signposted from it, may therefore have value even where it involves a degree of duplication.

In this sense, a self-contained local security document need not mean an unnecessarily long or over-engineered document. It describes a document that can, so far as the local security interest is concerned, stand on its own or clearly direct the reader to the provisions on which it depends.

Whether that matters will depend on the transaction, the governing law and the role the local security document is expected to play. The point is simply that the question deserves attention alongside the more familiar discussion concerning duplicate drafting.

Commercial provisions and security-specific provisions

One reason the discussion becomes difficult is that it often treats all provisions alike. In practice, however, not every provision performs the same function. A useful starting point is to distinguish between commercial provisions and security-specific provisions.

Commercial provisions regulate the broader financing relationship between the parties. Financial covenants, utilisation mechanics, interest provisions, reporting obligations and many ordinary undertakings naturally fall into this category. There will often be compelling reasons for those provisions to remain exclusively within the principal finance documents.

Security-specific provisions perform a different function. Their primary purpose is not to regulate the financing relationship generally, but to identify, create, perfect, preserve or enforce the local security interest itself.²

Examples include provisions identifying the security assets, representations concerning ownership, title and the right to grant security, undertakings designed to preserve security, obligations relating to perfection, restrictions on dealings with pledged assets, information obligations relating to circumstances affecting the security assets, provisions dealing with substitutions, proceeds or distributions relating to the security assets and mechanics governing enforcement.

Representations concerning ownership, title and the security provider’s right to create security illustrate the point. Such representations are not merely commercial in nature. They help define the subject matter of the security interest created by the local document, and their significance may therefore extend beyond the commercial allocation of risk between the parties.³

None of this means that security-specific provisions should invariably be repeated. Nor does it mean that they must always appear in the local security document. The point is narrower: the existence of a provision elsewhere does not necessarily answer the separate question whether that provision also performs an independent function within the local security document.

That question deserves to be asked before the discussion ends with the observation that “it’s already in the Facility Agreement”.

What belongs in a local security document?

The distinction between commercial provisions and security-specific provisions provides a useful starting point, but it does not answer the central question.

How should one determine whether a particular provision belongs in the local security document?

One possible approach would be to begin not with the drafting process but with the function of the document itself.

A local security document is not simply another Finance Document. It is the legal instrument through which a proprietary security interest is created and, ultimately, relied upon and enforced under the applicable local law. If one begins with that function, a different discussion emerges.

Rather than asking only whether a provision already appears elsewhere, one might ask whether that provision performs an independent function within the local security document. The answer will not always be affirmative. Many provisions belong exclusively in the principal finance documents. Others require a more careful analysis.

Where a provision identifies security assets, confirms the security provider’s entitlement to grant security, preserves those assets, maintains perfection or regulates rights directly connected with the local security interest, one may legitimately ask whether it performs a function extending beyond the commercial relationship between the finance parties.

If it does, the fact that an equivalent provision appears elsewhere may not resolve the question. Repetition may be appropriate in some cases; express incorporation may be preferable in others; and omission may be perfectly acceptable in still others. The point is not to advocate a single drafting technique, but to ensure that the analysis begins with function rather than ends with duplication.

Illustrations from practice

Four simplified examples illustrate why the discussion is more nuanced than it may first appear. They are not intended to suggest that current market practice is incorrect.

Identifying the security assets

Assume that a Swedish share pledge agreement identifies the pledged shares but contains no representation that the pledgor is the legal owner of those shares or has the right to create security over them. Those representations instead appear exclusively in the English law Facility Agreement. From one perspective, duplication appears unnecessary. From another, the local document no longer contains the representations most closely connected with the subject matter of the proprietary security interest it creates.

Whether that matters will depend on the circumstances. The example nevertheless illustrates that the existence of a representation elsewhere does not necessarily determine whether it also performs an independent function within the local security document.

Preserving the security

Consider a different example. Restrictions on transferring pledged assets, obligations to preserve those assets or provisions relating to perfection have been removed from the local security document because similar undertakings already appear in the Facility Agreement. That approach may be entirely appropriate. Yet one might still ask whether obligations directed specifically towards preserving the local security interest differ, at least conceptually, from commercial undertakings designed to protect the lenders’ broader credit position.⁴

Enforcement before the local courts

Assume that enforcement of Swedish security depends on whether an undertaking contained only in an English law Facility Agreement has been breached. The Swedish security document is governed by Swedish law and subject to the Swedish courts, while the relevant undertaking sits in a different agreement governed by a different law and, potentially, subject to a different jurisdiction clause.

There is nothing unusual about that, and no suggestion that Swedish courts are incapable of applying foreign law where necessary. The example simply illustrates how the location of security-related provisions within the wider documentation package may influence the practical operation of the local security document once enforcement becomes necessary.

Agreed Security Principles

A further illustration concerns Agreed Security Principles. Assume they provide that local security documents should not contain provisions already included in the Facility Agreement and that local counsel should depart from the agreed template only where strictly necessary under local law. By the time local counsel are instructed, the documentation architecture has effectively been agreed.

The discussion no longer begins with the question: how should this security be documented under Swedish law? It begins with another: how can the agreed documentation structure be implemented under Swedish law with as few changes as possible?

That distinction may appear subtle, but it changes the drafting exercise: the starting point is no longer the local security document, but the internationally negotiated documentation framework.

Agreed Security Principles and the role of local counsel

Properly used, Agreed Security Principles perform an invaluable function. They encourage proportionality, reduce unnecessary cost, avoid over-engineered security packages and establish a common framework capable of being applied across multiple jurisdictions.

At the same time, they influence the role of local counsel. Historically, local counsel would often begin by asking how the relevant security should best be documented under local law. Increasingly, local counsel are asked to implement a documentation structure already negotiated elsewhere.

That evolution is neither surprising nor inherently problematic. Large international transactions require co-ordination. Lead counsel understandably seek consistency. Borrowers and sponsors value predictability. Lenders prefer documentation that can be managed centrally.

The practical consequence, however, is that local law may operate as a constraint upon implementation rather than as the starting point for the drafting exercise. Local counsel may be consulted only after the principal documentation architecture has been settled, and sometimes only to confirm that the agreed structure can be made to work locally. By that stage, the opportunity to influence the allocation of security-specific provisions across the wider documentation package may already be limited.

Swedish law provides one illustration. Questions concerning perfection, control over security assets, restrictions on dealings with pledged assets and the relationship between contractual obligations and proprietary rights may assume greater significance than practitioners from other jurisdictions initially expect. The same observation could be made in many other legal systems.

Local counsel therefore do not simply advise whether the agreed documentation structure is legally possible. They also advise how local security is expected to function within the relevant legal system once the transaction has closed. That advice is likely to be most useful when it is obtained early enough to inform the documentation structure, rather than only late in the process as a confirmation exercise.

From the closing room to the court room

Most finance documentation discussions focus on closing: the transaction must be documented accurately, negotiations completed efficiently and the package kept coherent, proportionate and manageable. Viewed from that perspective, avoiding unnecessary duplication is entirely rational.

The perspective changes once the financing ceases to perform as intended. The relevant question is no longer how efficiently the transaction was documented, but whether the local security can be understood, interpreted and enforced in the manner intended by the parties.

At that point, the local security document is no longer simply one document among many. It becomes the instrument upon which the secured party ultimately seeks to rely. That shift may justify asking whether the local document itself contains, or at least clearly identifies, the provisions most closely connected with the local security interest that a court, insolvency office-holder or enforcement authority may be asked to recognise and enforce. The issue is not merely where the relevant provision has been drafted, but whether the conditions for enforcement are sufficiently accessible, certain and enforceable within the legal framework governing the local security.⁵

This is particularly important where enforcement depends on steps, notices, determinations or conditions that are not purely commercial in character but operate as gateways to the exercise of local security rights. If those matters are found only in a foreign law Facility Agreement, or are connected to the local document only through a general reference to the Finance Documents, the secured party may still have a good answer. In some cases, however, a more self-contained local document or a clear incorporation mechanism may be needed for effective enforcement itself. It allows the person asked to give effect to the security to see, from the local security document itself, how the relevant conditions fit together and why the security is capable of being enforced. Even where not strictly required, it may reduce the scope for argument and affect how confidently the security can be relied upon. The drafting choice can therefore be relevant both to enforceability and to practical administration of the enforcement process.

Different governing laws, different courts

Cross-border financings frequently involve different governing laws for different parts of the transaction. The Facility Agreement and Intercreditor Agreement may be governed by English law, while Swedish security documents will generally be governed by Swedish law. Jurisdiction clauses often follow the same pattern. That structure is ordinary and appropriate.

Yet it may give rise to a practical question. Assume that the right to enforce Swedish security depends on whether an undertaking contained only in the English law Facility Agreement has been breached. If proceedings are brought before the Swedish courts in relation to the Swedish security, the court may first need to determine issues arising under an English law agreement before deciding whether the Swedish security may be enforced.⁶

That observation should not be overstated. Swedish courts are capable of applying foreign law where necessary, and there is nothing conceptually unusual about courts applying foreign law. The more interesting question is whether, if one were designing the documentation structure solely from the perspective of disputes concerning Swedish security, that would necessarily be the structure one would choose.⁷

The importance of express incorporation

In some transactions, the local security document expressly incorporates particular provisions contained in the Facility Agreement or otherwise makes clear that specified rights and obligations are governed by another identified Finance Document. Where that is done, the contractual architecture becomes transparent: anyone reading the local document understands that it forms part of a wider framework and knows where to locate the relevant provisions.

The position may be different where no such reference exists. In practice, one encounters situations where a provision has been omitted from the local security document because it is “already dealt with elsewhere”, yet the local document itself contains no meaningful indication that the omitted provision forms part of the legal framework governing the local security.

Whether that affects contractual interpretation will depend on the governing law and the particular circumstances. From a drafting perspective, however, deliberate incorporation and mere omission are not necessarily equivalent techniques. General or imprecise cross-references may fall somewhere between those two positions and may leave room for argument as to whether the relevant condition has become part of the local security arrangement at all.⁸

Parallel proceedings

The procedural picture may become more complicated where proceedings concerning different parts of the financing documentation are commenced simultaneously. Assume that proceedings concerning an alleged breach of the Facility Agreement are pending before the English courts or an arbitral tribunal, while enforcement proceedings concerning Swedish security are commenced before the Swedish courts.

To what extent should the Swedish court determine for itself whether the relevant undertaking has been breached? Should it await the outcome of the English proceedings? Could inconsistent findings arise? These questions will depend on applicable procedural rules and the particular circumstances. They illustrate a broader point: if terms critical to the effective enforcement of Swedish security are located only in an agreement governed by English law and subject to the jurisdiction of the English courts, the allocation of those terms across the documentation package may influence the procedural landscape once enforcement becomes necessary.

A local security document is more than an implementation document

Modern cross-border finance documentation is often described in terms of efficiency, consistency and standardisation. Those objectives are legitimate and have transformed international finance for the better. At the same time, there is a risk that local security documents are viewed primarily as implementation documents: instruments whose principal purpose is to implement a structure negotiated elsewhere.

There is considerable truth in that description. Local security documents form part of a wider financing structure and should not contradict the principal finance documents or renegotiate the commercial bargain. Yet they also perform another function: unlike the Facility Agreement, the local security document is the instrument through which the proprietary security interest itself is created and ultimately enforced under local law.

Recognising that distinction does not necessarily imply that more provisions should appear in the local security document. It does suggest, however, that the question should sometimes be approached from a different direction. Rather than asking only whether a provision has already been included elsewhere, one might first ask whether the local security document is expected to perform an independent legal or procedural function in relation to the security interest itself.

An alternative analytical framework

The discussion surrounding local security documentation could therefore be approached through three questions.

First, is the provision primarily commercial in nature, or is it primarily directed towards the identification, creation, perfection, preservation or enforcement of the local security interest?

Secondly, if the provision is security-specific, does it perform an independent function within the local security document? In that context, one should ask whether the provision may be critical to effective enforcement before a Swedish court. If so, the Swedish security should not be left, without analysis, to depend on provisions contained only in an English law agreement subject to the English courts where that dependency could impair the security’s intended function.

Finally, if it does, what is the most appropriate drafting technique: inclusion in full, express incorporation by reference, or leaving the provision exclusively within the principal finance documents?

This approach does not produce predetermined answers. Its value lies elsewhere. It encourages the discussion to begin with the function of the local security document rather than end with the observation that the relevant provision has already been drafted elsewhere.

Practical reflections

The observations in this article should not be understood as advocating a return to lengthy, self-contained security documents or rejecting modern finance documentation techniques. The efficiencies associated with standardised documentation are undeniable, and local counsel cannot realistically approach every cross-border transaction as though it were a purely domestic financing.

The purpose is more modest: to suggest that discussions surrounding local security documentation may benefit from one additional question. The observation that a provision is already contained in the Facility Agreement answers the duplication question. It does not necessarily answer whether the provision performs an independent legal or procedural function within the local security document itself.

The function should drive the drafting

If there is one proposition underlying this article, it is this: the content of a local security document should be determined primarily by the function that document is expected to perform under the applicable local law, not solely by the location of equivalent provisions elsewhere in the financing documentation.

That proposition should not be misunderstood. It does not imply that every security-related provision belongs in the local security document. Nor does it imply that incorporation by reference is inferior to repetition. In many situations, incorporation may be the preferable solution. The point is simply that, where a provision performs an independent function within the local security document, its inclusion, express incorporation or treatment in a more self-contained local document may deserve consideration irrespective of whether an equivalent provision appears elsewhere.

Looking beyond closing

Much of the documentation process inevitably focuses on closing: the transaction must be documented accurately, efficiently and consistently. From that perspective, avoiding unnecessary duplication is plainly sensible.

The perspective changes once the transaction encounters difficulty. The documentation may then be examined not by those who negotiated it, but by a judge, insolvency office-holder, enforcement authority or purchaser of distressed debt.

At that stage, the local security document becomes the instrument through which the local proprietary security interest is identified, interpreted and enforced. That change in perspective does not necessarily require different drafting, but it may justify asking different questions.

Concluding reflections

This is not an argument for more duplication or for a return to lengthy, self-contained security documents. The benefits of standardised cross-border finance documentation are real.

The point is narrower. The risks associated with duplicate drafting are well understood, but the opposite risk also deserves attention: security-related provisions may become fragmented across documents governed by different laws and, in some cases, subject to different jurisdiction clauses.⁹

That fragmentation may often be immaterial. In some cases, however, it may affect how the local security document is interpreted, relied upon and enforced once the transaction encounters difficulty.

The discussion should therefore not necessarily end with the observation that a particular provision appears elsewhere. It should ask: does the provision perform an independent function within the local security document?

If it does, the appropriate drafting solution should follow from that analysis rather than from a general assumption against duplication.

Key Takeaways

The discussion may be summarised in five observations.

• First, avoiding unnecessary duplicate drafting remains an important and legitimate drafting objective.
• Second, the opposite phenomenon – fragmentation of security-related provisions across multiple documents – may also deserve consideration.
• Third, not every provision performs the same function. A useful distinction may be drawn between commercial provisions and security-specific provisions.
• Fourth, the content of a local security document should be determined not only by where equivalent provisions already appear, but also by the function the local document is expected to perform under the applicable local law.
• Finally, discussions concerning local security documentation may benefit from moving beyond the question “Is this already in the Facility Agreement?” to a second question: “does this provision perform an independent function within the local security document itself, including by supporting effective future enforcement under the applicable local law?”.

If so, the drafting solution should follow from that analysis rather than from a general assumption that duplication should always be avoided. Sometimes the answer may be omission, sometimes express incorporation, and sometimes a more self-contained local security document that allows the reader to understand the central conditions for the local security from the document itself.¹⁰