What is a loan participation?

A participation is a funding arrangement whereby a participant (buyer) provides to the loan originator and grantor (lender of record, existing lender) funding (a deposit) for the loan in exchange for a pro rata share of the payments of interest and principal received by the grantor from the borrower.  The grantor remains the lender of record in the facility agreement with the borrower, there is no change in the legal relationship between the grantor and the borrower, the buyer has no beneficial interest in the underlying credit agreement, and there is no contractual relationship (privity) between the borrower and participant.

Under the form of participation agreement recommended by the Loan Market Association (LMA), which is widely used for European transactions, the grantor of the participation undertakes to pay to the participant a percentage of amounts received from the borrower.  The participation is substantively treated like a participant’s financing of the grantor’s loan to the borrower, where the participant is an unsecured creditor of the grantor having no preferred status as a creditor of the grantor with respect to funds received from the borrower in the event the grantor becomes insolvent.

Under the form of agreement recommended by the Loan Syndications and Trading Association (LSTA) and generally used for US true participations, the participant acquires an undivided beneficial ownership interest in the underlying loan.  As a true participation, the participant is entitled to payments from the borrower even in the event of the insolvency of the grantor.  Should the participation instead be characterized as a financing, insolvency of the grantor would have the same consequences as an LMA English-law participation.