Sacred Rights Credit Agreements
Actual defaults do not refer to restrictive covenant violations (EoDs), but to the declaration of bankruptcy, loss of interest or capital, or non-performing exchange of one instrument for another. LPs can expect actual defaults to increase in a credit cycle. In fact, the rise in defaults determines the credit cycle! SQs should therefore request an updated list of actual failures when tracking their portfolios, and SQs should be aware of the nuances of each type of failure. In addition to the fact that there are no significant financial covenants, the documentation on leveraged loans often includes loosely structured operating restrictive covenants that allow non-performing borrowers to raise additional capital to avoid a full restructuring or insolvency. The first wave of controversial financing transactions began in 2016, when non-performing borrowers began using permissive investment and asset sale baskets – sometimes referred to as “traps” – to remove collateral from the reach of existing secured creditors. Transactions (notably with J. Crew) illustrate this tactic, in which borrowers use investments and other baskets to transfer encumbered assets to subsidiaries “without restriction”, thereby removing assets from the secured lenders` existing collateral package. The newly released assets are then used to secure new financing. Finally, while litigants may feel compelled to file a complaint for breach of good faith and fair trade, TriMark points out that these claims must be independent of a claim of infringement (i.e. “cannot be used to impose obligations or restrictions beyond what is stated in the contract”) and cannot claim exactly the same damages. From an editorial point of view, it can easily be assumed that certain actions not expressly mentioned in the credit agreement, if taken, would constitute a breach of the obligation of good faith and fair trade. TriMark`s opinion suggests that rapporteurs should reconsider this hypothesis. Similarly, unauthorized interference in the contract does not appear to be a viable way to involve the borrower`s equity promoters in the dispute, as courts will be inclined to consider from the outset whether these developers had an economic justification for their actions – and can quickly reject them if those justifications are even credible from a distance.
In response to lean structures, LPs should consider asking senior debt funds for a migration analysis or report: an analysis of trends in key credit indicators such as debt and hedging ratios, which are typically anchored in covenants. Senior debt funds should be able to provide debt and hedging ratios at the time of closing a loan and at each subsequent closing date of the borrower (provided that covenant-lite structures have not eliminated financial reporting requirements). SQs can request this information on a regular basis so that they can track the migration of these key credit indicators. In the absence of an EoD to report, SQs may find this analysis useful in formulating an opinion on the health of each borrower. This information should not be too cumbersome, as it is often used by portfolio leverage providers. Migration is probably the best leading indicator of deteriorating credit quality and may indicate EoDs that should have occurred if restrictive covenants had existed. One of the many advantages that the primary lender enjoys is that if the borrower chooses to do so, they appoint the lead lender (or its affiliate) for agency and arranger roles as part of the credit documentation. When the lead lender assumes the role of administrative agent, collateral agent and/or senior arranger, in addition to the usual related tasks – communications and payment management, lien development, execution of ancillary documents, etc. – it will also take discretion in making certain decisions. The scope of this discretion can vary significantly from transaction to transaction in the mid-market segment, with agents in some cases having the ability to make many unilateral decisions that would otherwise require the approval or direction of the required lenders.
In Serta, dissenting lenders held approximately 30 per cent of the outstanding amount of Serta`s $2 billion loan, with accepting lenders holding more than 50.1 per cent of the initial lien loan; As such, the willing lenders were “necessary lenders” under the credit agreement. The lender`s divergent complaint alleged that all affected lenders – not just “required lenders” – had to approve any amendment that “modifies or modifies the provisions of Article 2.18(b) or (c) of the [credit] agreement in a manner that, in its terms, would alter the prorated allocation of payments required for that.” The lender`s main argument differs is that by granting a super priority position in the cascade, the transaction violated the limitation of the agreement to change the pro-rata allocation provision without violating the consent of each relevant lender. In the end, the judge, who in her view rejected an application for an interim injunction, concluded that the loan agreement appears to allow for a non-proportional exchange of debt for debt in an open market transaction. Article 9.05(g) states: “Any Lender may at any time assign all or part of its rights and obligations under this Agreement with respect to its term loans to an affiliated lender. Disproportionately. through purchases on the open market. without the consent of the administrative officer. The court also noted that “the proposal does not require the release or guarantee of guarantees subject to [Serta`s] existing first-lien term loans.” Given that the court found that the amendments “do not affect the so-called `sacred rights` of the claimants under the credit agreement, the consent of the claimants does not appear to be required.” In the spring and summer of 2020, a group of LBO lenders that held the majority of the debt worked with TriMark and its equity investors to conduct a restructuring transaction that the court said included three main components. Initially, TriMark entered into a “super senior credit agreement” in which the company issued a new “super senior first-out debt” to participating lenders.
TriMark has not offered to issue this new debt to the remaining LBO lenders. Second, TriMark issued a new “second-tier super senior debt” to participating lenders in a dollar-for-dollar exchange for the debt they originally held in the LBO loan. Finally, participating lenders removed restrictive covenants from the original loan agreement that: (1) allowed TriMark to incur new senior debts to the LBO loan; (2) subordinated the guarantee position of the LBO loan of super senior debt instruments; and (3) created new barriers designed to prevent the remaining LBO lenders from successfully suing the borrower and participating lenders (i.e., expanding the scope of the “no-action clause”).  Before actual defaults occur, senior debt funds may be tempted to modify their loan agreements to account for a borrower`s presumed temporary financial difficulties. CA defines changes as those made to widely recognized “sacred rights” and the conversion of interest to PIK at the lender`s discretion. The plaintiffs – the remaining LBO lenders – filed a lawsuit in New York against TriMark, its equity sponsors and the participating lenders, asserting several claims: (1) a declaratory judgment that the original loan agreement, as amended by the participating lenders, is void and unenforceable; (2) TriMark and the participating creditors breached the original credit agreement; (3) that the defendant`s actions violated the implied duty of good faith and fair trade; (4) that the transaction constituted a fraudulent transfer; and (5) that the promoters in TriMark`s capital unlawfully interfered with the original credit agreement by assisting in the planning of the underlying restructuring transaction. The defendants filed a motion to dismiss all charges. 4 Although there is no uniform definition of “required lenders”, credit agreements generally define the term as lenders holding more than 50% of the principal amount of the loan. Also, as mentioned above, significant changes to documents may occur instead of an actual failure. In many ways, significant changes can serve as mutual agreements between a borrower and a senior debt fund that an actual default has occurred (or would have occurred).
SQs can therefore inquire about material changes. However, not all hardware changes are bad, so SQs should make sure to determine the reasons for each change. The person responsible for the transaction has more control over the loans than other lenders in a variety of ways, some of which are difficult to measure, including influencing terms, selecting previous documents, and selecting lawyers. However, we will focus on the most tangible aspects of the lead lender`s role (which are also most relevant during a job): the discretion given to the lead lender (or an affiliate) in connection with credit documentation in their role as agent or arranger, and the relative voting rights of lenders in the club to approve changes to loan documents. On the other hand, the Court dismissed the defendant`s application to dismiss the defendant`s other declaratory judgment and the plaintiffs` claims for failure to fulfil obligations. The tribunal was satisfied that the other theory of the plaintiffs` assessment had overcome the request to dismiss the obstacle. It concluded that the applicants had presented a plausible interpretation of the credit agreement, that the lenders at issue had indirectly implied the sacred rights of the non-participating lenders […].