May 1, 2019

By Angie Batterson and Adela Woliansky

Broadly, 956 was enacted as an anti-avoidance measure to ensure that earnings and profits of controlled foreign corporations (“CFCs”) would be subject to U.S. tax when repatriated by way of a dividend, a direct loan to a U.S. parent, or foreign credit support in the form of pledges, guarantees and collateral. As a result, credit agreements of U.S. borrowers with foreign subsidiaries restricted CFCs from becoming guarantors or granting liens over their assets, and limited stock pledges to less than 66 2/3% of the voting stock of such CFCs to secure the loan, because the 956 Deemed Dividends Rule could otherwise be triggered and give rise to U.S. tax liability.

While the Proposed Regulations are not yet final, they will become applicable for taxable years of a CFC beginning on or after the date they are finalized. Until then, taxpayers are permitted generally to rely on the Proposed Regulations prior to their becoming final for tax years after December 31, 2017.  The Proposed Regulations may not eliminate all adverse U.S. tax consequences from a pledge of or guarantee by a foreign subsidiary, so taxpayers should still consult with their tax advisors before deciding to rely on the Proposed Regulations.

Favorable Effects of Proposed Regulations

With the introduction of the Proposed Regulations, lenders can potentially expand the scope of their guarantee and collateral packages by including guarantees by, and 100% pledges over stock and assets of, CFCs or by incurring joint and several liability between U.S. parent and CFC subsidiaries. Lenders may also potentially reduce the risk of being structurally subordinated to creditors of foreign subsidiaries. Borrowers, in turn, may be able to achieve more favorable loan and credit terms, including greater covenant flexibility, lower interest rate margins, and better syndication prospects. Equally, the Proposed Regulations may expand borrowing capacity and limit the need for borrowers to obtain separate offshore financings for foreign subsidiaries.

Revisit Existing Loan Documents

Some existing credit agreements limit foreign credit support to less than 66 2/3% of the foreign subsidiary with no provision for obtaining a greater pledge, guarantee or collateral if material adverse tax consequences are no longer present. These limiting provisions should be revisited when amending existing credit agreements. Other existing credit agreements may contain “springing provisions” where, under certain collateral and guarantee requirements, borrowers may be required to add CFC guarantees and pledges, once there are no longer material adverse tax consequences or other material costs or impediments. Existing loan documents should therefore be reviewed to determine whether such springing provisions will require additional credit support to become available as a result of the Proposed Regulations.

New Loan Documents: Good News and Caution

While the Proposed Regulations are favorable to lenders lending to U.S. borrowers with foreign subsidiaries, documenting the deal presents various traps that a lender needs to avoid. Certain foreign local law requirements may impose varying and, in some cases, costly regulatory hurdles, such as licensing and regulatory approvals, legal formalities, and perfection requirements, as well as possible withholding tax implications and enforcement risks. Here, we highlight a sampling of the issues that lenders and borrowers should consider when negotiating the scope of foreign collateral and guarantee requirements in a post-956 Deemed Dividends Rule market. While there may be similarities between certain jurisdictions, the differences can also be significant and therefore the costs and benefits of obtaining foreign guarantees and security should be assessed on a jurisdiction-by-jurisdiction basis, with advice from competent foreign local counsel.

1. Licensing for Lenders in Foreign Jurisdictions

U.S. lenders may be required to hold licenses or authorizations prior to making loans or taking credit support in some foreign jurisdictions. In addition, local requirements may apply differently to bank and non-bank lenders, restricting cross-border loans in certain circumstances. For example, in certain EU countries, such as France and Italy, foreign banks must obtain licenses to carry out lending operations. In Italy, lending activities that are pursued without such authorization may result in sanctions and potential criminal liability. In Germany, the position is more nuanced. If a U.S. lender specifically targets the German market, a license is required; however, not so, if loans are granted at the borrower client’s own initiative. In Taiwan, in addition to obtaining the relevant regulatory authorizations, foreign lenders may also be required to establish a local branch in order to pursue lending operations on a repeat basis. In jurisdictions with no restrictions on making cross-border loans, U.S. lenders may, however, need to comply with other requirements such as hiring local employees, as is the case in the UAE. In China, a local borrower’s ability to access foreign loans may be subject to an approved foreign-debt quota, calculated under the supervision of the State Administration of Foreign Exchange. China also distinguishes between bank and non-bank lenders. Certain non-bank institutions, such as asset management funds, trust and investment companies, may only engage in lending activities with approval from the China Banking Regulatory Commission. Given the nuanced licensing requirements between jurisdictions, lenders should consult regulatory counsel in the relevant jurisdiction.

2. Ability of a U.S. Lender to take 

Foreign Collateral

In the U.S., lenders are accustomed to taking a blanket security over all current and future assets to secure outstanding and future indebtedness. However, in some countries, a lender’s security interest is restricted to specific, assets or classes of assets, and a lenders ability to take security over future assets may be subject to certain conditions or notification requirements. In Germany, for example, it is typical to have a separate security agreement for each asset class. The security agreement must describe the German collateral with specificity, although it is generally possible to grant security over future assets without ongoing amendments to the applicable security agreement to describe such assets.

Most foreign jurisdictions do not have a uniform scheme for taking security, such as the Uniform Commercial Code (“UCC”) or the Personal Property and Securities Act (“PPSA”) in Canada and Australia, where perfection and priority is achieved by filing. However, perfection and priority in other jurisdictions may be guided by numerous statutes and common law rules, with some security agreements requiring notarization to be effective. Under English law, no filing or registration is required to ensure the validity and enforceability of a lender’s security interests. Although registration is generally not a requirement for attachment of a security interest, a charge (i.e., security interest) will be void in the insolvency context unless it is registered within 21 days of creation with the Registrar of Companies. Priority, however, is governed by English common law rules, not by the order of registration. In Mexico, all security documents are subject to local notarization, with notary fees often based on the amount of the guaranteed obligations, adding procedural delays and significant transaction costs. In Australia, where a foreign entity takes security over local assets, approval of the Foreign Investment Review Board (“FIRB”) will be required where the value of the asset exceeds certain monetary thresholds.

3. Ability of a U.S. Lender to Obtain a Foreign Guarantee

The Proposed Regulations enable CFCs to guarantee the debt of a US parent, and, in taking such guarantees, US lenders should be cognizant of local corporate benefit and financial assistance rules in the context of acquisition financings. The corporate benefit test is applied widely across jurisdictions, although different standards apply to such evaluation. In England and Australia, the board of directors, and in Italy, the board under the supervision of the statutory auditor, may make this determination, acting in good faith and in the best interests of the guaranteeing entity. In France, to avoid the guaranty being voided, market practice has been to limit upstream or cross-stream guarantees to the proceeds of the guaranteed debt that is directly or indirectly loaned to that guarantor via an intercompany loan.

In acquisition financings, financial assistance may be prohibited in some circumstances. France and Germany have very strict financial assistance rules, with limited exceptions. In France, there is a blanket prohibition on public and limited liability companies (société anonyme, or société par actions simplifiée, respectively) providing guarantees or security to finance the acquisition of their own shares or the shares of other group members who are either direct or indirect shareholders. In Germany, financial assistance is prohibited in the case of German stock corporations (Aktiengesellschaft), and when provided by a limited liability company (GmbH), is subject to capital maintenance rules which prohibit the company from distributing to shareholders any assets required to maintain the nominal share capital of the company. The granting of upstream or cross-stream guarantees or security can be qualified under German law as an undue distribution of assets. Further, the German Supreme Court has yet to define the exact scope of the capital maintenance rules with sufficient legal certainty.

4. Recognition of U.S. Choice of Law Provisions and Enforcement of U.S. Judgments

Generally, as a matter of private international law, foreign courts will enforce a choice of law provision, provided that it does not contradict mandatory rules of the relevant jurisdiction or is incompatible with public policy. However, this golden rule, established by the Rome Convention, may have a more limited application in the context of secured transactions. In China, a real property mortgage or pledge over certain rights created in China, can only be governed by PRC law, as is the case in Mexico, where any action brought to enforce US law governed security over Mexican collateral will not be recognized. Furthermore, perfection of any US law security will not be enforceable against Mexican third parties. In France and Germany, security agreements must be submitted to French or German law and jurisdiction, if the assets are physically located there; a New York choice of law provision would therefore not be enforced. Accordingly, from an enforcement perspective, it may be necessary to obtain local foreign law-governed pledges, guarantees and other security in the relevant jurisdiction and local foreign counsel should be consulted on a case-by-case basis to determine the necessary documentation requirements, formalities and filings.

The judgment of a US court with respect to loan documents governed by N.Y. law may not necessarily be enforced in the local jurisdiction. In Australia, a judgment rendered by a U.S. court having jurisdiction recognized by an Australian court, for a readily calculable or fixed sum, would be recognized and enforced without a re-examination of the merits, subject to considerations of natural justice, public policy or fraud. In Belgium, prior to enforcing a foreign judgment, the courts will consider a multitude of factors, including whether the judgment violates public policy, is irreconcilable with a Belgian precedent or a prior foreign judgment that is amendable to recognition in Belgium, or if a claim in Belgium had been previously initiated between the same parties, and is still pending. In China, a judgment rendered by a U.S. court will neither be recognized nor enforced since there is no bilateral judicial assistance treaty in place, or precedents of reciprocity, whereas in England, a U.S. court judgment may be recognized according to common law principles, and enforced by methods generally available for enforcement of English judgments.

5. Agent or Trustee as the Secured Party

In U.S. syndicated or club deals, lenders are accustomed to the administrative or collateral agent holding security of the loan parties for the benefit of the secured lender group, and having the power to enforce such security on their behalf. This is also the case in other common law jurisdictions such as England, Australia and Canada. However, under some foreign laws, the security holder must also be the creditor. In Germany and Belgium, it is common to create a parallel debt structure for certain types of security, whereby the security agent is owed a “parallel” and equal debt to that owed to the secured parties. In Italy, parallel debt structures are not recognized and therefore the debt must be held directly by the creditor. The French Civil Code expressly allows security to be held by a security agent; however, this mechanism was only recently introduced and therefore practitioners and French banks have not as yet adopted a unified standard for its application.

6. Withholding Tax Implications of Interest and Fees Payable by Borrower to U.S. Lender

Many foreign jurisdictions impose withholding tax on interest and fees paid by a foreign subsidiary in the relevant jurisdiction to U.S. lenders. The amount of such withholding tax may be reduced or eliminated where tax treaties exist between the U.S. and the relevant jurisdiction. For example, in Canada, a treaty was signed in 2007 to eliminate withholding taxes on non-related party interest expense. Under the U.S.-Mexico tax treaty, such withholding taxes vary between 4.9%, 10% or 15%, depending on the nature of the lender, borrower and the loan. In England, the withholding tax rate is charged on annual interest, and may be as high as 20% where the loan is provided by a non-UK bank to a UK resident, although certain exemptions may apply subject to the application of the applicable double tax treaty. US banks making loans to Italian subsidiaries may also give rise to withholding taxes of 26% and 10%, subject to the application of the Italy/US double tax treaty, although where such loan is made by a U.S. branch authorized in an EU Member State no withholding tax would apply, again, subject to Italian direct lending laws and the loan term. However, in order to claim any applicable tax treaty benefits, U.S. lenders will typically need to submit certain filings to the local foreign tax authorities, or provide certificates of tax residency issued by the IRS to the borrower or other withholding agent.

7. Thin Capitalization Rule

Although not strictly an obstacle to granting upstream credit support, thin capitalization rules may limit the deductibility of tax on interest incurred on debt of a foreign borrower that is guaranteed by related parties. The rules are intended to discourage financing with debt as opposed to equity capital, if the increased debt leaves a company thinly capitalized.  Thin-capitalization rules are complex and should be carefully considered in the context of any cross-border funding, with expert local tax advice. In France, for example, to the extent that the debt of a French company is guaranteed by its subsidiaries, that debt is subject to thin capitalization limitations on interest deductibility, capped at the highest of 30% of taxable income, and €3 million. Where the debt-to-equity ratio of the borrower is lower than 1.5:1.00, these thresholds are lowered to 10% and €1 million, respectively. In the UK, borrowers are subject to a corporate interest restriction, broadly limiting deductible interest to 30% of EBITDA, calculated in accordance with the UK tax code. Any challenges to thin-capitalization brought by the UK revenue and customs department are based on transfer pricing rules. In Mexico, interest payments made by a Mexican resident company on a loan from a foreign related party are non-deductible if the debt-equity ratio exceeds 3:1.


8. Bankruptcy and Creditors’ Rights

The laws and proceedings of each foreign jurisdiction govern the types of enforcement actions and remedies that are available to lenders in an insolvency. Since insolvency laws are not standard across borders, lenders need to be mindful of and assess such particularities with input from expert local counsel ahead of taking guarantees and security in the relevant foreign jurisdiction. In France, for example, the order of priority of claims of creditors can vary depending on the insolvency procedure and the type of claim. Certain privileged creditors, including salaried employees and the tax administration, rank ahead of secured creditors, and it is generally rare to see secured creditors recover significant portions of their claims. Furthermore, there is no established French case law determining the validity of subordination and intercreditor agreements, which could be successfully challenged in an insolvency context.

9. Anti-Money Laundering

Compliance with U.S. anti-money laundering (“AML”) and other financial crimes-compliance laws, including sanctions and anti-corruption laws, will not necessarily be sufficient to demonstrate compliance elsewhere. Satisfying these additional compliance requirements may be costly and burdensome, involving registration with foreign government agencies, implementation of AML policies, and ongoing filing requirements of red-flag activity with foreign regulators. Typically, where US lenders have a physical presence in the foreign jurisdiction, such as a branch, they will be subject to local AML and sanctions compliance. In Mexico, where a US bank customarily grants loans to Mexican parties, Mexican AML requirements will need to be observed, including registration with the Vulnerable Activities Registry and filings of such activity with the Financial Intelligence Unit. Similarly in Italy, local AML law applies to non-EU banks authorized to operate in Italy without a branch.

10. Fair Lending and Anti-Discrimination Laws

Fair lending statutes and usury laws in a foreign jurisdiction may also apply to lenders entering into secured transactions with local borrowers and guarantors. In addition to criminal sanctions in Belgium, anti-usury laws prohibit increases in interest rates of more than 0.5% per annum on outstanding principal in an event of default. Belgian small-to-medium sized businesses (“SMEs”), with under 250 employees also benefit from greater contractual protections in credit agreements, including restrictions on break-fees and flexible voluntary prepayment provisions. In Italy, borrowers may be able to prepay outstanding loans in whole or in part without any prepayment costs or penalties. In the UK, while corporate lending is generally unregulated, on and after April 1, 2019, SMEs, including entities with a balance sheet total of less than £5 million, will be able to refer complaints regarding commercial lending to a financial ombudsman, with the power to make determinations, set compensation and publish enforceable decisions.

11. Privacy and Data Protection

Technology has facilitated the dissemination of information in international commerce. Consequently, privacy and data protection regulations have been reformed to tighten personal information protections. In the EU, the General Data Protection Regulation (“GDPR”) sets out detailed regulations governing collection and processing of personal data about individuals in the EU. These requirements are onerous, and non-compliance attracts significant fines; however, the circumstances under which the GDPR would apply in the US corporate loan market are rare, with the onus typically falling on European Economic Area (“EEA”) borrowers or lenders, including an EEA branch office or affiliate of a U.S. financial institution. Similarly, in Australia, the onus falls on corporate borrowers to ensure that any foreign entity with which they share personal information comply with the Australian Privacy Principles. In China, however, US lenders intending to transfer personal information collected in China will be subject to China’s cybersecurity laws, which impose prior consent rights and certain government security and clearance procedures. Otherwise, personal information collected in China can generally only be stored in the territory of China.


Ultimately, the impact of the Proposed Regulations on the secured lending market in the U.S. and abroad remains to be seen. Although the Proposed Regulations may eliminate the U.S. tax impediment to lenders seeking to take CFC guarantees and security to secure U.S. obligations, experienced local foreign lawyers in the relevant jurisdiction and international tax counsel will need to consulted to adequately determine both the benefits, risks and costs for each transaction.

Please feel free to contact Angie Batterson at 212.326.3663 or if you would like to discuss further any cross-border lending issues noted above.   TSL

The views and opinions set forth herein are the personal views or opinions of the authors; they do not necessarily reflect the views or opinions of the law firm with which the authors are associated.

About the Author

The authors, Angie Batterson and Adela Woliansky, would like to acknowledge the contributions of their Jones Day finance, tax and regulatory colleagues in the UK, Germany, Belgium, the Netherlands, France, Italy, Spain, Australia, Singapore, Hong Kong, China, Taiwan, Japan, Mexico and the UAE.  

Angie Batterson, a partner at Jones Day, has extensive experience in all areas of asset-based lending, with respect to both domestic and cross-border transactions.  She has advised clients in leveraged financing transactions across a broad array of industries, including health care, telecommunications, media, manufacturing, and energy, for 20 years.  She represents financial institutions, sponsors, issuers, and mezzanine providers in private debt financings, including in connection with senior secured credit facilities, first lien/second lien credit facilities, unitranche facilities, and mezzanine financings.  Angie also advises on intercreditor agreements and distressed debt financings, including debtor-in-possession (DIP) financings.

Adela Woliansky focuses on banking and finance transactions as an associate at Jones Day.  She represents lenders, agents, financial institutions, and corporations on a variety of financing transactions with a focus on acquisition finance.  Her transactional experience covers a wide range of industries including financial services, energy, media and communications, health care, and food and beverage.  Prior to joining Jones Day, Adela practiced at a leading international law firm in Australia where she worked with the banking and finance practice group.

Jones Day is a global law firm with more than 2,500 lawyers in 43 offices across five continents. The Firm’s lawyers lead ABL deals in many of its foreign, as well as US offices, including cross-border deals in Europe, Latin America, Australia and Asia.