February 28, 2024 - This article was first published in the 2024 winter edition of Loans Magazine, which can be accessed here. There are two legal projects on which the LSTA’s Primary Market Committee and the Commercial Finance Committee of the American Bar Association (“ComFin Committee) have collaborated on for more than a year: the drafting of the Emerging Business Credit Agreement and the refreshing of the ABA’s First Lien/ Second Lien Intercreditor Agreement. The new form of Emerging Business Credit Agreement was recently published in final form by both the LSTA (it is the first bilateral credit agreement to be added to the LSTA’s suite of documents) and the ABA (as a new business law section tool). The second project involves the updating of the ABA’s Model Form of Intercreditor Agreement which will also be available to LSTA Members as the Form of First Lien/ Second Lien Intercreditor Agreement. The revisions to the Model Form are at an advanced stage, and we hope to publish it by the end of 2024. I discuss both of these projects below and would invite all our LSTA members and ComFin Committee members to submit comments and questions on them to me.
EMERGING BUSINESS CREDIT AGREEMENT
The new Form of Emerging Business Credit Agreement includes three supplements, a Security Supplement, a Financial Covenants Supplement and an Agency Supplement. The Committees worked under the expert guidance of LSTA external counsel, Thomas Mellor and Sean Zoltek of Morgan, Lewis & Bockius LLP, who drafted the EBCA form and helped lead us through the thoughtful committees’ comments. They have led us in the production of an excellent form with numerous guideposts and in-depth drafting notes, some of which are highlighted below.
The EBCA is intended to be used for a borrower that is an “emerging business”. For the purposes of this form, the term “emerging business” captures a borrower that is no longer a new venture but is not yet an established middle market company. The current form is designed to bridge the gap between the “off the shelf” form for new venture companies and the more highly negotiated and tailored agreements of the larger more established middle market companies. Borrowers using these forms will likely be generating regular and consistent revenue but will often not have consistently positive EBITDA. They will likely desire more flexibility when it comes to running their businesses and making decisions about, for example, investments and distributions. Our goal with this form was to take into account the interests of the borrowers their growing businesses, on the one hand, and, on the other hand, those of the lenders who are willing to put their money at risk, in order to create a more balanced form that the parties can then use as they start their negotiations. We anticipate that our form could be useful for loans between $25 million to $100 million. The form assumes the borrower is formed in the US and has U.S.-based operations with limited, if any, foreign operations or assets located outside the US. If significant activity takes place or material assets are located outside the U.S., then parties will need to adapt the form and include foreign borrower and/or foreign assets language as well as considering local law requirements, in particular, if there are foreign guarantors—and of course, the taxes clause. As with all LSTA forms, the agreement is governed by New York law; however, because of comments from the ComFin Committee, in the penultimate turn of the document, we included provisions specific to credit agreements that are governed by the laws of California, Illinois or Texas. For example, drafting notes in Annex I to the EBCA highlight language that should be included if the agreement is governed by the laws of California or if the entity has assets, in particular real estate assets, located there, and language has been provided whereby each loan party waives all rights and defenses that they may have if their obligations are secured by such real property.
As noted above, we have also drafted a Security Supplement, a Financial Covenants Supplement, and an Agency Supplement for the EBCA. The terms of a security agreement have been incorporated in the credit agreement itself; this reflects common practice in the venture debt space where the loan is to be secured. This form assumes that subsidiaries of the borrower will become guarantors of the facility irrespective of whether or not the facility is secured. Additionally, because the borrower’s own collateral and structure is typically more straightforward than companies further along in their life cycle, the incorporation of security terms in the credit agreement itself can be more easily achieved. The separate Security Supplement serves this purpose, but, of course, if the parties prefer to use a separate security agreement the form can easily be adapted for that purpose. Parties should note that the Security Supplement is not exhaustive of all applicable security interest provisions that parties may need for their deal; only the typical ones have been flagged for the draftperson’s consideration.
Loans extended to emerging businesses often will not include financial or performance covenants. As noted in the covering memo of the Financial Covenants Supplement, because the borrower’s future growth trajectory is uncertain, it may be practically difficult to draft meaningful metrics at closing that can accurately predict the company’s growth prospects and its ability to comply with financial or maintenance covenants while the loan is outstanding. As such, the parties may agree to include more deal-specific reporting mechanisms for such performance metrics rather than more traditional leverage and fixed charge maintenance covenants. If financial and performance covenants are included, they will be heavily negotiated and well-tailored to the borrower, its business, and the relevant industry. Because EBCA loans typically have only one lender, we were able further to streamline the EBCA form by not including the LSTA agency provisions. However, if the deal is being done on a club basis, agency provisions can be included, particularly if the deal is secured or includes more than a small number of non-affiliated lenders. A sample Agency Supplement has been included if the deal requires an agent.
As with all forms of agreements, we have attempted to flag issues and provide a starting point for parties to consider and adapt to the borrower’s business. This is particularly true for the representations and covenants. The parties must of course consider the nature of the representations and covenants that are suitable for the borrower and its business.
FIRST LIEN/ SECOND LIEN INTERCREDITOR AGREEMENT
During the Great Financial Crisis, the ABA’s ComFin Committee tackled the enormous task of producing a Model Form of Intercreditor Agreement (the “Model Form”) and published it in 2010. Until then, there really had been no standard form in the market because those agreements varied so widely depending on the applicable deal terms. The ABA’s Model Form reflected as far as possible market practice at that time and also tried to protect the interests of both first and second lien lenders. The goal of the Committees this time is to refresh the Model Form and include the knowledge and insights of those that have worked with it and other intercreditor agreements in their deals over the past dozen or more years.
Intercreditor agreements are incredibly complex instruments that govern the relationship between two groups of secured parties—in our form, first lien lenders and second lien lenders. If the borrower defaults or files for bankruptcy, the agreement sets out the rights of the parties to the collateral of the borrower. The Model Form addresses the relative priorities in that shared collateral, enforcement of that collateral, issues that may arise in a bankruptcy proceeding, the releases of collateral, as well as other ancillary matters.
By way of background and as general refresher for those who may not work with these agreements on a regular basis, the secured party’s rights with respect to the collateral (other than real property) are governed by Article 9 of the Uniform Commercial Code which is uniform across all the states. The default rule, which governs with respect to the collateral where there is more than one party, is the first to file or perfect rule. In other words, the first secured party to file a financing statement will have priority over later filing secured parties. But that general rule has exceptions, and the UCC also recognises that parties may alter that rule by contract. Thus, an intercreditor agreement can specifically override what would otherwise be established by Article 9 and reset the priorities according to the contract. All the principles of contract law will apply, however, and as such any party that is not party to the intercreditor agreement will not be impacted by the terms of that contract. Thus, there may be a tax lien, a judgment lien, or even a secured party that is not a party to the intercreditor agreement, and their priority will be established by Article 9.
As is typical of these agreements, the Model Form effectuates lien subordination. Lien subordination alters secured parties’ priorities and collection with respect to the shared collateral. As noted in the Model Form, the heart of the intercreditor agreement is the lien subordination provision pursuant to which the second lien lenders agree that their lien on the common assets will be junior and second in priority to the lien of the first lien lenders, including typically both liens on personal property and liens on real estate. The first lien lenders and the second lien lenders are likely to have different points of view as to how broadly the lien subordination provision should be worded. The first lien lenders are likely to insist that their lien on the common assets should remain superior (at least up to the amount of the first lien cap) even if the first lien lenders fail to perfect their lien properly or allow their lien to lapse or their lien is avoided in bankruptcy or otherwise. Second lien lenders may instead take the position that only collateral in which both first and second lien lenders have a valid and perfected security interest not subject to avoidance as a preferential transfer or otherwise by the debtor or a trustee in bankruptcy should be subject to the lien priority provisions, although the Model Form notes that position is quite rare in current market practice for syndicated facilities. In practice, the view of the first lien lenders has typically prevailed on this issue although there is increasing recognition of the unintended “payment subordination” by the second lien lenders that may result if the first lien lapses or is avoided in bankruptcy, and the second lien lenders are forced by their agreement to an “absolute” priority provision to be subordinate to the now unsecured first lien lenders.
As further noted in the drafting notes of the Model Form, the second lien claimholders generally retain the right to exercise rights and remedies as unsecured creditors, i.e., the ability to collect and enforce upon the debt obligations. This is consistent with the general view that intercreditor agreements should effectuate lien subordination (but not debt subordination). The drafting note cautions that first lien lenders should take care that this section does not override other important parts of the Model Form. Certain important protections in the Model Form, such as the waiver by the second lien claimholders of the right to contest the first lien claimholders’ liens and the agreements relating to insolvency proceedings, concern matters that could be brought by unsecured creditors. If the second lien claimholders retain all rights as unsecured creditors notwithstanding any other provision of the Model Form to the contrary, those negotiated protections for the first lien may be vitiated.
As noted in the 2023 Summer Series webinar (see below), the intercreditor agreement has adapted to developments in the US loan market in recent years. In the past, if you had a single series first lien and second lien, it would be between one first lien collateral agent representing its own secured parties and a second collateral agent. Now, however, with the ability of a borrower to incur incremental debt that can be secured through a separate facility the intercreditor documentation has had to follow suit to allow for more than one credit facility at any given priority level. As such, like most intercreditor arrangements in the US today, the Model Form has been updated to provide for a multi series style intercreditor agreement. Unlike a “single series” which is a bilateral agreement between two series of secured parties, the “multi series” contemplates any number of series of secured debt. The form includes, as an exhibit, a form of joinder agreement which includes the mechanics to add additional series of secured debt. The Model Form does not cover whether the additional debt is permitted. That will be governed by the debt documents themselves; however, the form does include a debt cap (the Form includes helpful footnotes that discuss the debt cap and how it works; I encourage you to review them because they are too detailed to include here).
The matters that the Model Form covers are varied. First, as you would expect, it covers priority with respect to the collateral. As noted above, priorities established by the intercreditor agreement intentionally override the priorities that would apply under applicable law. Most commonly, such contractual priorities apply notwithstanding the date, time, method, manner or order of grant, attachment or perfection; any provision of the UCC or any other applicable law; any defect or deficiencies, or failure to perfect or lapse in perfection; or any avoidance as a fraudulent conveyance or otherwise. It also addresses the waterfall and, therefore, provides for pro rata payment in full of each senior class before any value is applied to any junior class (subject to any debt caps). It also addresses the control of remedies and provides for the control of remedies to senior class, either permanently or for a limited period referred to as the “standstill period”. This is commonly 180 days but may range from 90 – 270 days. It should be noted that the expiration of the standstill does not override the waterfall. Even during the standstill period, second lien claimholders may take certain actions to preserve their position as provided in the Model Form. For example, second lien claimholders are granted the rights to file a proof of claim, to vote on a plan of reorganization, and to make other filings, arguments, and motions with respect to the second lien obligations and the collateral in any insolvency proceeding involving the borrower. Importantly, as provided in the Model Form, gaining control of enforcement does not mean gaining waterfall priority. An enforcing junior lien still hands over all proceeds to pay off the senior class. Matters covered in the bankruptcy section of the Model From which are typical of intercreditor agreements are the ability to provide for DIP Financing, adequate protection, ability to get post-petition interest, ability to control asset sales, voting, and release of collateral. Other ancillary matters that are covered include an agreement not to challenge liens, the purchase right (ie, junior class has the option to purchase senior obligations at par following negotiated trigger events such as payment default, enforcement on collateral, and bankruptcy), and the proceeds of insurance.
We are delighted that Brian Rock of Latham & Watkins is our external counsel on this project. Mr. Rock has indepth knowledge of these very complex agreements and shared his insights with us in an excellent webinar during the 2023 LSTA Summer Series on Intercreditor Agreements, and I encourage you to view it if you are new to these documents or seeking a refresher (click here for the slides and here for the replay). There is also a very helpful article, Intercreditor Agreements Between First and Second Lien Lenders: Overview, by Practical Law on the LSTA University webpage on this topic. All LSTA members are invited to join the LSTA’s Primary Market Committee and, as Chair of the ABA’s ComFin Committee, I welcome all ABA business law section members to this Committee. There are so many fascinating and active subcommittees, please do review and join one or more of them. We look forward to working with LSTA Members and ABA Business Law ComFin Committee Members under the expert guidance of Brian Rock as we complete the updating of the Model Form.
