June 23, 2022 - This week, the LSTA co-sponsored with the Creditor Rights Coalition an important symposium that took an in-depth dive into an issue that has vexed the leveraged loan market for several years and which has been the subject of much focus from the LSTA: the increasing use of aggressive liability management techniques by companies to advantage one group of creditors over another and the warfare that results among creditors for the spoils. The sold-out event, hosted by Lowenstein Sandler, brought together leading academics, lenders and other market participants, to address the problem from three perspectives: (i) What is Intra-creditor class warfare?; (ii) How did we get here?; and (iii) where do we go from here?
What is intra-creditor class warfare? The first panel framed the discussion with a historical journey through the past several decades of the leveraged loan mark that demonstrated its exponential growth in size and complexity over the years. Next was a technical review of the two predominant types of liability management strategies that are at issue, “drop-down” financings, like JCrew, and “uptiering” transactions, like Serta and TriMark. In drop down transactions assets (often the company’s intellectual property) are transferred outside of an existing collateral package often using unrestricted subsidiaries, and then offered to a sub-set of creditors to secure structurally senior financing. In uptiering transactions priming new-money and/or rolled-up debt is offered to a sub-set of creditors to enhance the priority of their claims to an existing collateral and guarantee package over other existing pari-passu creditors. The panel then engaged in a robust discussion of the litigation that has arisen from many of these transactions as well as the various strategies and dynamics that are in play with these schemes.
How did we get here? The panel began with a discussion of how a combination of the law, the state of loan documentation, and the makeup of market participants has created an environment that allows for intra-creditor class warfare. While loan documents have gotten longer and more complex, they are still “incomplete” and can never contemplate every contingency. At the same time, courts have shied away from enforcing an implied covenant of good faith and fair dealing, reasoning that complex loan agreements must be all-encompassing and do not lend themselves to judicial intervention. Finally, the nature of the market has changed over the years from a small, clubby, bank market to a larger, more impersonal institutional market. The remainder of the panel focused on how those dynamics have led to the current situation where market expectations are often not met and it has become more difficult to identify or enforce market norms.
Where do we go from here? The third panel began with a presentation of data that demonstrated that there has been a significant adoption by the market of loan documentation that restricts the use of uptiering transactions but no such trend with respect to drop-downs. The panel discussed the reasons and implications for those trends and engaged in a robust discussion of what it would take for a return to “norms” that would limit intra-creditor warfare. The panelists generally agreed that documentation alone was not the answer and that it would require that the costs of “going rouge” increase in order to make a dent.
The symposium was very successful in shining a light on a very critical issue in the loan market and we expect to follow up with additional such forums. Materials from the symposium are available here.