September 28, 2017 - This week, over 250 people logged in for an important webinar hosted by the LSTA focusing on “Out of Court Restructurings Through Credit Agreement Buckets”. LSTA GC Elliot Ganz moderated the panel which included James Millar of Drinker Biddle and Brendan Hayes of Millstein & Co. The panel was certainly timely. Holders of pre- existing debt in many of these situations like J. Crew, Norske Skog, Neiman Marcus and Cumulus, have objected to the use of the baskets arguing that the transactions go beyond what is permissible under the credit agreement. Indeed, earlier in the day Bloomberg ran a provocative “Gadfly” column citing J. Crew and suggesting that because of the ability of borrowers to facilitate restructurings detrimental to holders of bank loans through the use of credit agreement baskets, there was little difference between loans and bonds. Also, late last week the WSJ reported that some senior loans holders in J. Crew were upset over a restructuring that would leave them in a less favorable position than previously unsecured bond holders. With transactions like these front and center, the panel examined four situations, three of which were deal specific and all of which could happen more generally because of credit agreement terms that are already widely in use.
Before diving in, Mr. Hayes explained that a credit agreement or indenture “basket” is jargon for a maximum dollar amount for a specific exception to a covenant restriction. For example, a credit agreement may limit the borrower’s ability to incur debt but permit it to incur up to $X in certain enumerated situations. Borrowers push for loose and large baskets in order to build in up- front the maximum amount of flexibility.
Mr. Millar noted that in restructuring situations which are often brought before courts, the “words on the page” are critical, often much more so than what the parties’ expectations may have been in their original business deal, because the words in the credit agreement or indenture are what judges examine. For example, in Norske Skog, the issue boiled down to whether a “refinancing” could be a “permitted financing” under the indenture. While many market participants might view a refinancing as a subset of financing, the court found that the terms were not interchangeable and therefore the proposed transaction exceeded the bounds of the indenture’s basket. He noted that Black’s Law Dictionary defined the terms differently and the indenture itself used the words to mean different things. Similarly, in J.Crew, the issue is whether a proposed indirect transfer of valuable IP assets from the parent company to an unrestricted subsidiary was, as it was required to be under the credit agreement, “financed” with the “proceeds” received by the restricted subsidiary. The meaning of those terms rather than the possible expectations of the parties is what is likely to decide the question. Conversely, in Cumulus, Mr. Millar suggested that the court stretched to find a “negative inference” in order to prohibit an unusual restructuring that appears at first glance to have been permitted by the words of the credit agreement but likely was not what the parties expected when they agreed to the loan. (Mr. Millar’s memo on the Cumulus case is available here).
After examining the cases closely, the panelists concluded with a number of takeaways. First, the words in credit agreements are critical and it behooves lenders to thoroughly read and understand the terms of the baskets and other provisions. Second, as Moody’s noted last spring, aggressive restructurings taking advantage of flexible baskets are likely to continue because many existing credit agreements, particularly in retail, permit the types of deals, like J. Crew, that the market has been grappling with. And, perhaps most importantly, for so long as the loan market continues to be favorable for borrowers, we are likely to continue seeing new credit agreements that include large and flexible baskets.