US Private Placements for European Issuers

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1 financing BRIEFING april 2013 Recent turmoil in European debt markets has prompted many European companies to consider alternative sources of debt financing. One source of funding which is proving increasingly attractive to European corporate treasurers is the US private placement ( USPP ) market, where US insurance companies, pension funds and other investors have for several decades made debt financing available to US and non-us companies. Lending to European borrowers in the USPP market has increased dramatically in recent years and now represents a sizeable proportion of the overall market. In 2012 the USPP market exceeded $50 billion, with UK borrowers alone accounting for 20% of total USPP borrowings and European borrowers making up a further approximately 15%. This Briefing contains an overview of the nature of the USPP debt product and the documentation used in the USPP market. It goes on to highlight some of the differences between the USPP product and more traditional loan and eurobond financing which may assist European corporate treasurers who wish to gain a better understanding of what a USPP issue may involve. MARKET OVERVIEW Lending in the USPP market takes the form of registered notes offered to a small club of investors or syndicate arranged by an investment bank referred to as an offering agent (the Arranger ), or, in some cases, placed with a single investor in a bilateral deal. Where there is an Arranger, this role is normally performed by one of the borrower s relationship banks but, unlike in a syndicated loan transaction, the Arranger is not normally one of the USPP investors. The notes are normally issued with a fixed coupon and denominated in US dollars although there may also be series denominated in Sterling and Euros or Canadian Dollars, with maturities from 3 years to as long as 30 years. The market allows for significant flexibility in issue size, with issuances ranging from as little as $15 million to as much as $1.5 billion for very strong borrowers. In addition to standalone issuances, some USPP investors also offer to provide an uncommitted programme enabling multiple issuances. The notes are not publicly offered or listed and are not registered with the SEC. Borrowers do not require a public rating for the debt. USPP notes are, however, given a private rating by the Securities Valuation Office of the National Association of Insurance Commissioners (the NAIC ). This NAIC rating is a prerequisite for USPP investors that are US insurance companies as the NAIC requires the financial assets of these investors to be rated by it for regulatory purposes. The predominance of US insurers as investors in the USPP market has resulted in the NAIC rating having a significant bearing on investor appetite for and pricing of the notes, even amongst non-insurer USPP investors. Traditionally, and particularly if the USPP is intended to be offered to a syndicate of investors, the borrower has been required to prepare a private offering memorandum, although listed borrowers for whom significant

2 existing public disclosure is available may be able to agree a waiver to this requirement. If required, the private offering memorandum is typically more akin to an information memorandum prepared in connection with the syndication of a loan facility than it is to a US-style offering circular for a high yield bond issue. Even where no offering memorandum is required, borrowers should expect that USPP investors will require the cooperation of the borrower in answering due diligence inquiries which are typically more extensive than would be required for a Eurobond or syndicated loan (although less extensive than the due diligence required for a high yield bond). DOCUMENTATION The primary transaction document is a note purchase agreement ( NPA ), under which the initial investors agree to subscribe for the notes. Under the NPA, the borrower makes representations, warranties and undertakings in favour of the investors which remain in effect throughout the life of the notes. Standard forms of the NPA are maintained by the American College of Investment Counsel. For non-us borrowers, this standard form is called Model Form X and has two variants: Form No.1 (for borrowers whose credit is equivalent to a rating of A or better) and Form No.2 (for borrowers whose credit is equivalent to a rating of BBB or better). The borrower representations, warranties and undertakings in Model Form X are significantly more extensive than would normally be found in a Eurobond a more appropriate comparison would be a bank facility based on a model form for investment grade borrowers published by the Loan Market Association ( LMA ). Model Form X is universally used as the basis for transactions in this market, but as the level of covenants required of the borrower in Model Form X is not dissimilar to the level of covenants usually seen in LMA based facility agreements, it is normally desirable for the borrower to seek to make changes to Model Form X in order to achieve consistency across its two sets of financing. Examples of some of these areas are highlighted below. The structure of the NPA is such that, even if a particular series of notes is subscribed by a group of investors, the borrower does not interface with an agent acting on behalf of that series. Instead the borrower enters into a NPA with each USPP investor for that series of the notes on a bilateral basis, subject to a requirement that many of the consents that might be required to waive or amend the terms of the NPA will be determined by a specified majority of the USPP investors of that series. Similar to a syndicated loan, there are certain waivers and amendments which require all USPP investors to consent, including any change to the maturity date, interest rate or prepayment premium applicable to any notes. Typically, a breach of the non payment event of default would also entitle any single USPP investor of a series to accelerate the repayment of its own notes. WAIVERS, CONSENTS AND AMENDMENTS As there is no agent appointed to act for the USPP investors, the borrower may wish to maintain ongoing relationships with individual USPP investors (even if this may be time consuming) as, if the USPP investors are familiar with the borrower s business and financial position, then this may assist the borrower should it need to seek the USPP investor s consent for a covenant waiver or amendment under the NPA. In addition, it is worth noting that in the event that the required USPP investors consent is not forthcoming, even if the borrower might otherwise be prepared to prepay the notes, this is often unattractive as a consequence of the prepayment premium which applies on optional prepayment (see Early Redemption below). 02

3 NOTE PURCHASE AGREEMENT AREAS FOR CONSIDERATION General In light of the issues concerning waivers, consents and amendments mentioned above and the long maturity of some USPP debt, and as with any other borrowing, borrowers are advised to ensure that the terms of the NPA permit sufficient flexibility for their ongoing business during the life of the debt. As previously noted, for borrowers who already have a European bank facility in place, it is likely that there will be significant overlap between the representations, warranties and undertakings found in their bank facility agreement and the provisions of Model Form X. However, a detailed comparison is likely to reveal many subtle differences. In order to minimise the additional compliance burden resulting from an issuance of USPP notes, it is therefore not unusual for European borrowers to seek amendments to the terms of the NPA to conform the substance of Model Form X to the terms of their bank facility agreement. As a principle, it is generally acceptable to USPP investors that the representation and covenant package in a borrower s NPA should be substantially the same as the representation and covenant package in the borrower s bank facility agreement. Indeed, USPP investors may be prepared to accept that certain covenants are simply aligned to those in the senior bank facility agreement, whatever those terms may be in the future (e.g. the guarantor coverage test or cross default threshold). On the other hand, it is common market practice for the NPA to include certain provisions with no direct equivalent in the LMA model form facility agreement for investment grade borrowers. Some of these provisions are found in Model Form X and others are additional provisions reflecting established requirements of investors in this market. Examples of these provisions include a covenant restricting subsidiary borrowings and a covenant restricting the borrower and its subsidiaries from entering into transactions with affiliates except in the ordinary course of business and on arm s length terms (excluding subsidiaries but including shareholders owning 10% or more of the company, entities in which the borrower has a minority interest, joint ventures and some joint venture partners). Prospective borrowers should carefully consider the impact of the restrictions imposed by these provisions in light of their ongoing business and, where necessary, seek carve-outs from these covenants. Governing Law Model Form X is governed by New York law. This means that, where a borrower has a European bank facility in place which is governed by (for example) English law, even where the drafting of the NPA has been conformed to the drafting of a borrower s bank facility, the legal interpretation of that drafting may differ. As a consequence, a number of European borrowers entering the USPP market have required the governing law of their NPA to be amended to English law to further streamline compliance across their debt obligations. Most Favoured Lender Although it is not included in Model Form X, it is common for USPP investors to require most favoured lender protection, particularly for borrowers using a senior bank facility to meet their primary financing needs. Under this provision, lender enhancements to the terms of the borrower s other financings must be replicated in the USPP notes. The inclusion of a most favoured lender clause may, in principle, be acceptable to many borrowers and is consistent with the general principle of placing a borrower s USPP investors on the same footing as its banking creditors. However, a borrower should take care to ensure that the scope of the provision is clearly delineated. Whether an amendment to another financing arrangement is an enhancement for the relevant lenders can be difficult to determine in practice, as it may involve some changes which benefit lenders and other balancing changes which benefit the borrower, or its effect may be dependent on the applicable fact-pattern. It is therefore advisable (and often achievable) to restrict the scope of most favoured lender provisions to amendments to a narrow sub-set of specific clauses in an existing debt arrangement, for example, the financial covenants originally 03

4 agreed in the NPA. In addition, it may also be possible to negotiate the most favoured lender provision such that if, for example, a financial covenant is made more beneficial to a creditor under the bank facility agreement but is then subsequently relaxed, this subsequent relaxation is mirrored under the NPA. Early Redemption Model Form X permits voluntary early redemption of the notes, but this is subject to call protection by way of a make-whole payment for the life of the notes, calculated by reference to a reference gilt (or other applicable government bond) plus a margin. Provisions requiring the redemption of the notes on a change of control are not included in Model Form X, but are commonly required by USPP investors. It is common, but not universal, for UK and other European borrowers to require that no make-whole amount is payable on a change of control. If, however, a make-whole does apply, the borrower s directors should consider carefully whether the benefits to the borrower of the transaction justify the poison pill which may result from this provision. In addition, it is worth noting that, notwithstanding that voluntary early prepayment could be costly to the borrower, if the borrower s senior bank debt has mandatory prepayment provisions (e.g. on disposals), the USPP investors may well require an equivalent prepayment right to be offered to them. Clearly, the borrower will only be able to offer such a right to its USPP investors if both its lending banks and its USPP investors accept pro-rata prepayment. Tax Gross-Up The withholding tax provisions of Model Form X are generic as to the jurisdiction of the borrower and do not adequately deal with withholding tax issues which arise between USPP investors and UK borrowers. Accordingly, it is advisable for the borrower to agree a position which is mutually acceptable between it and the USPP investors. Furthermore, where a requirement to gross-up payments to an investor arises, Model Form X provides that a borrower s right to redeem the notes held by that investor is subject to the payment of a make-whole amount for the life of the notes (typically a percentage of the make-whole payable in relation to voluntary redemptions described above). A borrower entering into a USPP transaction should seek specific advice on these provisions. Guarantees As with bank lenders, USPP investors may require that notes issued by a borrower which is a holding company should be guaranteed by its operating subsidiaries. Where a borrower has a senior bank facility in place, USPP investors commonly require that the USPP notes should benefit from the same guarantors as the bank facility, typically with a future-proofing provision that ensures that the guarantor coverage under the senior bank facility and the notes remain aligned, so that if any guarantors subsequently accede to or resign from the bank facility agreement they also accede or resign as guarantors of the notes. Unlike in the LMA bank facility agreements, the guarantee is typically not documented in the main body of the NPA, but in a separate guarantee agreement based on a standard form. This contains representations and covenants given by the guarantor(s). As with Model Form X, borrowers should consider these provisions carefully for compliance implications. Confidentiality and Transfer USPP investors are not subject to the same duties of confidentiality as banking institutions, and Model Form X therefore contains specific investor confidentiality provisions. However, these provisions contain a number of quite wide permissions for disclosure of confidential information. It is therefore not unusual for borrowers to negotiate more restrictive disclosure provisions, including, for example, prohibiting disclosure of confidential information to competitors. Similarly, the borrower may seek additional restrictions on transfer by lenders, including to prevent any purchase of the notes by its competitors. 04

5 CONCLUSION The USPP market represents an alternative source of funding for many UK and European companies, particularly for those with a longer term funding need. However, any borrower seeking to enter this market should be mindful that the buy-to-hold nature of the USPP investors may lessen its flexibility should it subsequently wish to make early repayment. It is advisable, where possible, to seek to align the terms of its NPA with the terms of its existing senior bank facility agreement to prevent an additional compliance burden arising from inconsistencies in its two different covenant and information packages. We have advised a significant number of European corporate clients on USPP issues. For further information on the matters highlighted in this briefing, please contact one of the following or your usual adviser at Slaughter and May: Ed Fife: Miranda Leung: Stephen Powell: Slaughter and May One Bunhill Row London EC1Y 8YY United Kingdom T +44 (0) Slaughter and May 2013 This material is for general information only and is not intended to provide legal advice. For further information, please speak to your usual Slaughter and May contact. ksm38.indd413

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