October 26, 2023 - On October 25th, the LSTA joined NAWL and ACCFL to host a webinar on liability management transactions (LMTs), “Point / Counterpoint: Analyzing Liability Management Transactions from the Lender and Borrower Perspectives”. LSTA’s Tess Virmani moderated the panel of experts which included Nicole Fanjul of Latham & Watkins LLP, Michelle Kilkenney of Kirkland & Ellis LLP, and Surbhi Gupta of Houlihan Lokey. LMTs are – simply put – transactions by a company to restructure the liabilities on its balance sheet. They can take different forms, but several have become prominent in the loan market: the drop down financing (J Crew is perhaps the best known example of this type) and the uptiering transaction (Serta is now seen as the archetypal uptiering priming transaction) are two of them. A third type has emerged this year, the double dip. There are other LMTs, such as amend and extends and discounted debt buybacks, but the first three were the topic of the webinar.
Ms Virmani started the session by explaining some of the jargon used to describe these LMTs, such as “pulling a J Crew” which refers to a borrower transferring material assets to an unrestricted subsidiary. Another was “a Chewy Blocker” which refers to provisions of a credit agreement intended to prevent a subsidiary guarantor from being released from its guaranty obligations because it is no longer wholly owned by the borrower. Under a typical credit agreement, an unrestricted subsidiary is not required to become a guarantor and not subject to any of the representations and warranties, covenants, and events of default. They exist outside the credit agreement ecosystem. As such, the debt incurred by unrestricted subsidiaries (which is not limited by a credit agreement) and non-guarantor restricted subsidiaries (which is limited by a credit agreement) is structurally senior.
The panelists then set out the business case for LMTs and noted that increasingly companies are pursuing out of court LMTs to address their capital structure goals. The transactions are bespoke and require detailed legal and financial due diligence to address the company’s goals, while adhering to restrictions in the applicable credit agreement; such compliance is, of course, key. These transactions are becoming more common place in the market, and loan market participants will still work with a company even if they have done an LMT in the past. However, loan market participants must always bear in mind that how you behave will, of course, later impact you in the market. The business case for the borrower will depend on the stage of the market and the economy. Before COVID, maturity and discount were important for borrowers, while liquidity was more their focus during the pandemic.
Priming transactions have gained prominence as a tool for borrowers to raise additional secured debt capacity in distressed situations by creating a new class of debt that is senior to the borrower’s existing secured debt. Certain lenders, constituting a majority under the credit agreement, agree to provide a new loan that will rank senior in lien and/or payment priority to the existing loans (the “Super-Senior Loans”). Those lenders use the open market purchase provisions to uptier, sometimes at par, their existing loans into the facility evidencing the Super-Senior Loans. Prior to consummating the open market purchase, those lenders also amend the existing credit agreement to permit the incurrence and senior priority of the Super-Senior Loans, direct the agent to enter into an intercreditor agreement, and strip covenants leaving the non-consenting lenders with subordinated loans without covenant protections.
If the priming transaction does involve an exchange, the opportunity to exchange into new super-priority debt is an important enticement for creditors to consent to the transaction, as those who do not consent will be left with a subordinated claim. In some priming transactions, each creditor is given the opportunity to consent to and participate in the priming debt, but in many instances, the opportunity to participate is only provided to a subset of lenders with enough voting power to effect the necessary amendments. However, the panelists highlighted that, generally, transactions that do not give all creditors a chance to participate have been more vulnerable to court intervention. In small loan deals, the uptier is less common because there is not the opportunity to maximize the discount.
From the lender perspective, the LMTs do not have a great track record for avoiding bankruptcy. If the end game is to avoid bankruptcy, then there may be no merit to the transactions. A word of caution, lenders must examine the terms of their credit agreement and fully understand at the outset which transactions are permitted and which are prohibited under it.
Enivsion and Serta were then two case studies that were dissected before the double dip was explained. In the double dip structure, the company forms a subsidiary that then issues debt to a lender and that loan is guaranteed by the company. The subsidiary transfers debt proceeds to the company through an intercompany loan and the lender benefits from two claims against the company: a direct guaranty claim and an indirect intercompany claim Although this is not a novel concept, it is unknown how, in its current use, it will play out in bankruptcy.
Lenders have responded to the uptick in borrowers using LMTs, and although cooperation agreements are not new developments, the push to enter them has become more frequent. The cooperation agreement is a contract amongst lenders whereby a group of them agree not to support certain transactions unless a specific threshold of “coop” members also support the transaction. Finally, members were reminded to review the LSTA’s Market Advisory on LMT Drafting Fixes which includes helpful drafting tips and model language for lenders seeking to limit a borrower’s use of LMTs.