April 30, 2020 - As the month comes to a close, we look back at the five legal webcasts the LSTA hosted in April looking at different aspects of the COVID-related economic environment. We hope that you continue to find these offerings to be a useful resource. For program replays, please refer to our dedicated “COVID-19” microsite or, as always, “Past Events” on our website.
- Fund Finance in the Time of COVID-19: Joel Denny of Nomura, Meyer Dworkin of Davis Polk & Wardwell, and Michael Mascia of Cadwalader, Wickersham & Taft presented on the fundamentals of subscription facilities and NAV facilities and what the COVID-19 crisis has meant for the fund finance market. For the uninitiated, subscription facilities are revolvers primarily provided to new funds in which lenders will look to the uncalled capital commitments of the LPs to the borrower fund for collateral support. The facilities are often structured with a borrowing base that ascribe concentration limits and advance rates to LPs based on certain categorizations. Originally used for short term capital needs, these facilities have evolved over time and can now include L/C and multicurrency draws. Alternatively, NAV facilities, or asset backed facilities, are generally used by more mature funds where the fund has already invested the capital from LP investors. The facility is subject to a borrowing base tied to the NAV of the underlying portfolio investment. Turning to the current crisis, concern has been voiced that the industry’s record of no investor defaults during the Great Financial Crisis may not hold true given the sudden nature of the decline. So far, that has not been the case. What is being seen is preparation for what lies ahead. Some funds are calling capital earlier to clean down their subscription lines to ensure future availability, other fund borrowers are seeking to convert uncommitted facilities to committed ones. Funds are also looking to add “qualified borrowers” to their subscription facility. This feature allows a portfolio company to join the facility as an additional borrower. If a fund knows today that it needs to put additional equity into a portfolio company, it can instead have the portfolio company borrow under the subscription facility on an unsecured basis with no covenants without having to inject new capital (at least for a while). This can be a powerful tool in an environment like today where financing can be very costly or not available.
- Leverage Management: Company Buybacks and Sponsor Debt Purchases: Carolyn Alford and Bill Fuller of King & Spalding and Ted Basta of the LSTA presented on the dramatic drop in secondary market loan prices and the opportunity created for borrowers to de-lever at a discount through loan buybacks. The Great Financial Crisis resulted in new credit agreement technology, now widespread, that permits borrowers to buy back their term loans and sponsor affiliates of borrowers to purchase the term loan debt of their portfolio companies, subject to certain limitations. Debt buybacks incentivize borrowers to: 1) redeem more expensive debt first, 2) acquire debt from a smaller subset of lenders (i.e., the borrower gets to choose who they take out), and 3) purchase and cancel debt at the greatest discount to par available. For companies that have cash on hand (not from revolver draws), they can buy back their debt through Dutch auctions or open market purchases. When faced with a borrower’s desire to buy back its debt lenders should understand how repurchases might otherwise flow through the credit agreement and open up the potential for further flexibility. For example, many credit agreements increase incremental facilities by the amount spent to buy back debt. For deals currently being negotiated or amended, lenders should be sure this amount correlates to the actual dollars spent repurchasing such debt and not the par amount being retired. Sponsors with plenty of cash on hand will also be incentivized to purchase debt for several reasons. In many cases, the credit agreement will permit affiliate purchases, subject to a cap and certain other limitations around voting and information sharing. While limitations apply to sponsor affiliate purchases, lenders should be careful that those provisions are not circumvented. If incremental facilities are permitted, or the borrower is able to incur additional debt secured ratably with the existing loans, a sponsor could provide funding to the borrower through these vehicles and circumvent caps on overall affiliated lender debt. In other cases, a sponsor may be able to motivate a majority of lenders to waive or modify the limitations on “Affiliated Lenders” (in particular, the amount that such Affiliated Lenders may hold). It should be noted that bona fide debt fund affiliates are typically treated differently under the credit agreement and more akin to unaffiliated lenders.
- Semi-Annual Oil & Gas Industry Update: Buddy Clark, Ken Kattner, Jeff Nichols, and Kelli Norfleet of Haynes and Boone, LLP presented on current developments in the sector. Since 2010, US oil and gas producers have enjoyed incredible growth even passing Saudi Arabia and Russia as the world’s largest oil producers, but despite increased production, there was trouble in the sector before the coronavirus crisis hit. Prices were dropping, equity investors were leaving because of poor returns, and the volume of bank loans made to this industry had only marginally ticked up. Interestingly, the difference between this crisis and the 2015 crisis for the industry is that the fulcrum debt today is the reserve base loan, not the mezzanine (or high yield debt), as it was in 2015. However, as we saw in 2015, banks are seeking once again to include anti-cash hoarding provisions in their credit agreements. If they are an RBL lender, our experts noted that they should consider borrowing base redeterminations at this point, particularly before a draw under a revolving credit facility. Other lenders who are worried about their borrower becoming distressed should carefully review their collateral package and consider putting a depository account control agreement in place to keep a handle on the borrower’s cash-flow and to ensure there is no leakage of that cash, for that is part of the collateral that will give them leverage in a restructuring situation.
- Paycheck Protection Program under the CARES Act: What it Means for Senior Lenders: Alan W. Avery, Jane Summers, Alfred Xue, and Haim Zaltzman of Latham & Watkins presented on the implications for senior lenders raised by the CARES Act. The CARES Act includes a $349 billion package for the small business loan program (known as 7(a) loans under the SBA Act) through December 31, 2020. The maximum loan amount is 2.5 times the business’s average monthly payroll cost expenses plus the outstanding amount of an economic injury disaster loan capped at $10 million. There are a number of factors that make this program incredibly attractive to potential eligible borrowers, including the following: the entire amount of the loan can be forgiven, there is no requirement to show that the borrower was unable to obtain credit elsewhere, and interest rate cannot exceed 4%. A recipient can use a 7(a) loan to cover a number of costs including payroll costs, costs related to the continuation of group healthcare benefits during periods of paid, sick, medical, or family leave, employee salaries, and the payment of mortgages and rents. Despite the maximum size of the loan, which is $10 million, many lenders, borrowers and sponsors in the loan market will be affected, and companies that typically borrow in the loan market may themselves qualify. Of course, they still will have to meet all the other requirements of the PPP and not just eligibility, but with so many borrowers eligible for SBA loans, a broad swath of facilities provided by senior lenders will be affected. Initial reports are that senior lenders are accommodating PPP Loans generally as they are very attractive junior capital.
- The Impact of COVID-19 on MAE in M&A and Acquisition Financings: Julian Chung, Mark Hayek, Scott Luftglass and Matthew Soran of Fried Frank presented on recent MAE case law developments and the implications for M&A and acquisition financings. “Material Adverse Effect” (“MAE”) clauses are employed in acquisition agreements as tools whereby the risk of certain fundamental pre-closing adverse changes in the target business are allocated among the parties. In general, a MAE clause allocates the more company-specific risks to the seller and the more systemic risks and risks outside the control of either party to the buyer. Traditionally, there has been an extremely high bar in invoking an MAE from a court’s perspective and there is only one Delaware case that has held the buyer could terminate a merger agreement (Akorn v. Fresenius). The specific drafting of the MAE is extremely important, and many formulations will exclude “acts of God”, “epidemics” or “disease” unless the target company’s business is disproportionately affected. Since the last H1N1 outbreak, “pandemic” has been excluded from the MAE condition in more deals, although certainly not in all, and a new uptick in the exclusion of “pandemic” has been seen in public deals that have been announced since March 5th. It remains to be seen how courts will interpret this COVID-19 crisis in their MAE analysis. Turning to acquisition financing, it is a bedrock principle that there be no daylight between a buyer’s obligation to close on a transaction and the lenders’ commitment to fund, but, once the market opens up, the language of the MAE condition in the commitment letter may receive renewed focus from buyers, sellers and lenders. Leading into this crisis, lenders were often not a part of the negotiation of the MAE condition, but lenders may now be keen to have a voice in negotiating the contents of that condition. Where there had been a trend toward qualifying the MAE so that it must result in the failure of a condition precedent in the acquisition agreement or terminate the buyer’s obligations under an acquisition agreement, it is foreseeable that drafting may trend toward eliminating that qualification. Further developments in acquisition financing – and M&A transactions – are certainly expected, but it is difficult to predict those now without visibility into the duration of COVID-19’s economic impact.
The past two months have seen record webcast offerings, but education continues apace in May. We will be covering “Returning to Work: What You Need to Do!” on May 6th, “Arbitration for Resolution of Commercial Finance Disputes: Part Two” on May 13th and “Geopolitical Analysis and the Pandemic” on May 19th. For further information, please contact Bridget Marsh or Tess Virmani.