Life is a series of trade offs. Nowhere is this more true than in the area of documentary terms generally, and loan agreements in particular.
I want to focus on transferability in this blog. The trade off used to be that as deal terms got looser (in favour of the sponsor/borrower) so did the restrictions on transferability (in favour of the lender). Quid pro quo.
Let’s look back to a time when leveraged loans generally contained multiple financial maintenance covenants and regular reporting requirements. Disregarding pre-funding limitations and settlement issues, the basic position was that the loans were liquid – subject to the borrower having a measure of control over the identity of its syndicate while all went well. Transfers to existing lenders and their associated parties (affiliates/related (common managed) funds did not require consent and, while those to other proposed lenders did, Borrowers accepted both that their consent could not be unreasonably withheld/delayed and that the consent requirement fell away if there was any continuing event of default.
During the more recent past, sponsors realised that this trade off might not work in their favour, as loan to own investors became more active by taking either blocking (minority) positions or controlling stakes in loans, with the potential to threaten the Sponsor’s equity investment following even a non material (non value destroying) default.
“White” (pre-approved) lender lists were introduced (with the implication, at least, that there probably wasn’t much point in asking for consent to transfer to anyone whose name wasn’t down) and the debate moved onto which entities were on the list, whether they could be added to or removed (and if so whose consent was required). Less commonly, deals included a “black “ (pre-disapproved) list (with, occasionally, the ability to in effect blacklist a potential lender after the deal signed). We have also seen increasingly complicated formulations (particularly in 2017) eroding the general principle that Borrowers should not unreasonably withhold consent and giving Sponsors unfettered discretion over transfers to “loan to own” (complicated definitions thereof applied), “hedge funds” (generally not defined), certain credit funds (“value” funds) plus industry competitors, sub contractors and suppliers.
Throughout all this, which some might see (I would) as playing round the edges, Lenders could at least take comfort from being able to sell to whomever they liked without consent if there was an event of default. There was liquidity (subject to finding a willing buyer) if things were getting ugly. I do not know if lenders took comfort or otherwise from the lower possibility of a default (technical or otherwise) in the current cov-lite loan era, emphasised by the ever increasing “flexibility” available to Borrowers in modern documentation. Perhaps they took comfort from wide white lists?
Whatever the reason, the general principle of free transferability during any event of default has gone without a noticeable fight.
In the final quarter of 2017 a cool 62.5% (yes that’s nearly two thirds) of deals in the Debt Explained RLT data base contained the provision that the requirement for borrower consent was only disapplied if there was a payment or insolvency event of default.
Gulp. How many TLB lenders want to be in a deal which is in insolvency proceedings? Do modern whitelists contain many (if any) potential buyers of the debt of an insolvent company (there goes the benefit of your white list- there will be no buyers!).
Payment default - there may (possibly, I would not put it more strongly than that) be some comfort from the wide white list (if you have one). But, given that all lenders are supposed to have the same information, a lender seeking to sell may seek hard to find a buyer taking a contrarian view.
And of course the most likely buyer, the value seeker (“vulture”- not in my view) may still be barred from buying without borrower consent; even if the borrower has to act reasonably at this stage of the game in considering the transfer request, this potentially introduces uncertainty and delay.
The general conclusion is that yet again lenders (knowingly or otherwise) have handed a great weapon to the sponsors - even as their investment falters the sponsors keep control and are better placed to regain value through a restructuring if they so wish.
I am sometimes asked for my view on recoveries when the next downturn comes (it may be closer than you think). I am very negative on recoveries for first lien cov lite as the defaults will likely only arise when the pot for recoveries is totally exhausted. And now lenders are locked in until that point. Good luck with that!
Or it may be that we are in a new paradigm where there will never be any material defaults. History suggests otherwise but I will keep my fingers crossed.
-- Stephen Mostyn-Williams, Chairman of Debt Explained
Stephen founded Debt Explained in 2009, following a 25 year career in leveraged finance. He has held senior positions at Cadwalader, Wickersham & Taft LLP; Shearman & Sterling LLP and Ashurst. Stephen co-founded the European High Yield Association and served as its chair for the first three years of its existence.