USA Trends and Developments Contributed by: Meyer C. Dworkin, James A. Florack, Vanessa L. Jackson and Kenneth J. Steinberg, Davis Polk & Wardwell LLP
Continuing Evolution of Liability Management Transactions Loan market participants have, over the past 12 months, continued to execute increasingly complex liability management exercises to address borrower needs for liquidity and operating runway. At the same time, loan documentation terms have continued to trend increasingly borrower-friendly on account of strong buy-side demand. An ongoing theme of the leveraged loan market has been lenders’ continuing efforts to appropriately balance the following compet- ing considerations: on the one hand, offering market- competitive flexibility to borrowers on key economic and operational loan terms; and, on the other, main- taining discipline on fundamental documentation protections against aggressive liability management exercises. Lenders have managed these opposing considerations through both direct documentation protections – covenant restrictions targeting these exercises – as well as, more recently, arrangements with other lenders outside the four corners of the loan documentation, with the rise of so-called co-opera- tion, or “co-op”, agreements the most prominent example of this over the past year. Liability management transactions were historically based on two fundamental structures: uptiering trans- actions and drop-down financings. Borrowers and opportunistic lenders have, over the past few years, innovated both new forms of liability management transactions (eg, “double-dip” and “pari plus” facili- ties) as well as further refined existing structures in manners not contemplated (and, thus, not restricted) when the original loan documentation was initially executed. This article traces the continuing evolution of liability management transactions as well as the broader set of loan documentation provisions and other protections implicated by their most recent and novel structures. Uptiering transactions Uptiering transactions result from borrowers providing (new) lenders with claims against an existing collat- eral package that is contractually senior to the claims of existing creditors. This seniority is typically docu- mented through the lien priority of the (new) lenders on the collateral provided to the existing creditors, but, in certain cases, is addressed via payment priority in
the collateral proceeds waterfall. Participation in an uptiering transaction is usually offered by the borrower to all or a subset of existing lenders as an incentive to provide the new financing. These lenders, in turn, often exchange all or a portion of their existing (now junior) loans for the contractually senior debt. Such “debt- for-debt” exchanges of the existing loans are usually made at a discount to par (typically at or above the existing market price of the loans exchanged) and are characteristically accompanied by an “exit consent” from the participating lenders to effectuate not just the essential lien subordination of the pre-existing facility but also necessary (or otherwise desirable) amend- ments to the existing facility. This ability of borrowers to capture the “offer discount” of loans trading below par is a key reason – along with the need to approve lien subordination and other essential uptiering fea- tures – why uptiering transactions are most naturally consummated with existing creditors, since financing sources that are not existing creditors are not able to provide the borrower with the discount that is effected through the exchange or agree to the “exit consent” immediately prior to the exchange. The primary benefits of these transactions for bor- rowers are the additional liquidity resulting from the new financing, the reduced overall debt burden arising from the deleveraging exchange (including the “dis- count capture”) and additional financial and negative covenant flexibility and extended maturities often pro- vided for in the exit consent. As a practical matter, these exchanges have generally relied on the “open-market purchase” right included in many credit facilities. The US Court of Appeals for the Fifth Circuit, however, recently held that such open market purchases were required to be made on a rec- ognised exchange, available to all lenders, which calls into question the efficacy of such exchanges and roll- ups. Loan market participants have responded in a variety of ways, including arrangements that ensure that all lenders are offered the right to participate in the purchase/exchange, often with some special incen- tives provided to a particular group of lenders. Drop-down financings Borrowers in drop-down financings, in contrast, iden- tify assets that are readily separable from their busi-
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