Participation Agreement

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Participation Agreement

A Participation Agreement is an agreement to share risks and liabilities with regard to an investment or a transaction. It is most commonly used in banking contracts and is called a loan participation agreement. This comes into play when multiple lenders give loans to a single borrower. The lead bank recruits’ other banks to participate in the transaction and share the risks and profits. “Participations” in the loan are sold by the lead bank to other banks. In such a transaction, there is collaboration among lenders to share a loan that is too big for any one of them individually. Such loans are called syndicated loans and can sometimes include more than a hundred banks spread out all over the world.  

When Do You Need a Participation Agreement

A participation agreement is needed when a lead bank sells “participation” in a loan to other banks or financial institutions. A contract called a loan participation agreement is entered into between these banks. 

This purpose of the participation agreement is to share the risks attached to a large loan between multiple lenders.  Loan participations can either be made on a pari-passu basis with equal risk sharing for all loan participants, or on a senior / subordinated basis, where the senior lender is paid first and the subordinate loan participation paid only if there are sufficient funds left over to make the payments. 

The participation agreement governs the relationship between the selling lender and participant only but does not affect the credit agreement

Inclusions in a Participation Agreement

The participation agreement must clearly state the names of the parties between whom the agreement is entered into. This will include the bank which is selling the participation interest (usually just called the Bank) and the bank or financial institution to whom the participation interest is sold (usually called the Participant). The terms and conditions under which the participation is sold to the participant must also be mentioned. 

The date on which the agreement is entered into must also be mentioned along with the territory in which the agreement is enforceable. Apart from this, the agreement must clearly mention under which law it will be governed and how the agreement shall be terminated. The manner in which the agreement is to be modified should also be described.

How to Draft a Participation Agreement

The following are the steps to be followed while drafting a participation agreement: 

  • Decide on how much participation interest is to be given to a particular bank.
  • If there are multiple participants, decide the priority of each of their participation interests.
  • Decide how the purchase price of the participation interest is to be paid.
  • Clearly outline the responsibilities of the parties.
  • Lay down what events amount to events of default on part of each of the parties.

Benefits of a Participation Agreement

  • Selling loan participations allows the lead bank to originate an exceptionally large loan that would otherwise be too large for it to handle by itself. By engaging other banks as participants, the lead bank can remain within its own legal lending limits and still come up with sufficient cash for funding.
  • Banks that buy loan participations share in the profits of the lead bank. If a lending institution isn’t doing much business on its own, it can team up with a profitable “lead bank” to generate more lending income.
  • Buying participation loans is a way for banks to diversify their assets. By investing a variety of loans in different locales, they reduce their risk and exposure to potential losses if a calamity were to strike their particular community.
  • Selling loan participations allows a bank to reduce its credit risk to a customer or specific community that entails greater than average risk.

Key Clauses in a Participation Agreement

The following are the key terms of a participation agreement:

  • Purchase of participation interest
  • Custody of loan documents
  • Priority of participation interests
  • Payment of purchase price
  • Servicing of the loan
  • Set-offs and deposits
  • Foreclosure and possession of collateral
  • Representations, warranties and covenants of the bank
  • Representations, warranties and covenants of the participant
  • Bank’s obligations to participant
  • Loan advances
  • Extension of credit
  • Set-offs by participants
  • Future participations
  • Repurchase rights
  • No interests in other financing
  • No third-party beneficiary
  • Events of default
  • Limitation of liability
  • Indemnification and damages
  • Modification of the agreement
  • Termination of the agreement
  • Governing law and jurisdiction
  • Dispute resolution and arbitration
  • Notices

What Happens When You Violate a Participation Agreement

When an event of default occurs under a participation agreement, the other party will have the right to terminate the agreement. The events of default will be clearly listed out in the agreement and whenever one party does an act that amounts to an event of default, it will give the other party the right to terminate the agreement and to take any other action at law or in equity which it may deem necessary or desirable under the agreement in order to enforce the performance and observance of any obligation, agreement or covenant under the agreement with respect to which such an event has occurred.

The agreement can also mention that all disputes arising out of the agreement will be subject to the exclusive jurisdiction of a specified court.

Sample of a Participation Agreement

If you require a template of a participation agreement, you can download a sample here

Download Participation Agreement Template

Participation Agreement

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