Credit agreement terms: lessons learned when things go bad, and things to pay attention to when things are good

Transcription

1 Credit agreement terms: lessons learned when things go bad, and things to pay attention to when things are good Presentation to American Bar Association August 6, 2011 Adam Maerov Stephanie Robinson

2 Presentation Overview Discussion items: 1. Credit bidding 2. MAC clauses 3. Financial covenant default language 4. Cash hoarding restrictions 5. Equity cures 2

3 Presentation Overview Discussion items: 6. Defaulting lenders 7. Approved lender clauses 8. Accordion or incremental features 9. The Indalex decision McMillan who we are Questions? 3

4 1. Credit bidding Right of a secured creditor to offset, or bid, its secured claim against the purchase price in a sale of its collateral The CCAA and BIA do not expressly provide secured creditors the right to credit bid their debt Helpful to have debtor agree to remedy in credit and security documents amendments to the BIA and CCAA make this more important Also helpful in syndicated loans to specify that Majority Lenders can authorize credit 4

5 2. MAC clauses Use in commitment letters, credit agreements Typical representation that borrower repeats as a condition precedent to drawdown Having no MAC as condition precedent to borrowing allows the lender to cut off funding for future loans if a MAC occurs, but does not give the lender broad rights and remedies it would have after an event of default As an event of default 5

6 2. MAC clauses When negotiating a MAC: where possible, define "material adverse change" in objective terms (by reference to threshold) level of lender discretion/duty to act in good faith? helpful for the lender to have forward looking language such as "prospects borrower may want to push back where no MAC is a condition of draws developments vs. events 6

7 3. Financial covenant default language - When is the borrower in default? - Financial covenants are calculated on quarterly financial statements - difficult to determine if default has occurred before financial statements are received - Even after the end of a quarter, depending on drafting of credit agreement, can be difficult to call a default even if it looks like the borrower may not meet its financial covenant tests - Does lender have an obligation to fund borrower in the face of an impending financial covenant default? 7

8 3. Financial covenant default language The Chase Manhattan Bank v. Motorola, Inc. lessons learned: If borrower s performance is substantially short of targets, significant due diligence should be done - and documented - to confirm borrower s ability to comply with financial covenants at future test date Lapse of time borrower should consider whether it would benefit from disclosing the possibility of default to the lenders Lenders would rather know about potential default than be misled 8

9 4. Cash hoarding restrictions Danger: if lender does not have full cash dominion and fears that borrower may do an "all-in-draw" because (i) borrower anticipates that lenders may not fund, or (ii) borrower anticipates that it will have an Event of Default and not be able to draw on the revolving loan Address with condition precedent to subsequent draws The limit of cash should equal a normalized amount of cash carried by the borrower on the balance sheet for working capital purposes Alternative: address risk of cash hoarding by excluding netting of cash in the calculation of total debt, or permit netting only if the revolver is undrawn 9

10 4. Cash hoarding restrictions In deals on the brink of bankruptcy the anti-hoarding provisions may create an incentive for borrower to prepay vendors in order to avoid this constraint, which increases borrowings 10

11 5. Equity cures Equity cure = provision in loan agreement for sponsor finance deal whereby the parent sponsor entity has a right to put in additional cash (by way of equity or subordinated debt) to cure EBITDA shortfalls for purposes of determining compliance with the financial covenants, or to pay down the amounts outstanding under the loan (but for no other purpose) Need to ensure the equity cure provision hangs together in the agreement properly with other terms such as restrictions on distributions, application of proceeds etc. 11

12 5. Equity cures specify that any debt reduced by the equity cure cannot be deducted from the calculation of the leverage ratio (at least in the quarter that the equity cure was made) to avoid double-dipping If permitted, common negotiating items include: whether cure can be inserted as debt or equity contribution limits on number of times an equity cure can be made in a given period or overall 12

13 6. Defaulting lenders Problem for borrowers, agent and other syndicate members May occur on revolving, L/C, swing-line or multi-draw term loans Definition: a lender which fails to fund, fails to confirm its commitment to fund or fails to make payments under other loan agreements or whose parent or affiliate goes bankrupt 13

14 6. Defaulting lenders Consequences: defaulting lender may not vote on amendments or waivers credit agreement may give borrower right to replace ( yank-a-bank ) reduce commitment of defaulting lender without pro rata reduction of other lenders borrower does not have to pay fees for unfunded portion 14

15 6. Defaulting lenders Consequences: obligation to borrower to post cash collateral to keep L/C and swing line facilities open non-defaulting lenders have "call" on defaulting lender s commitment to fund future advances payments of principal, interest and fees due to defaulting lender are held and applied to defaulting lender s obligation to fund right to replace agent (if it is the defaulting lender) 15

16 7. Approved lender clauses A borrower may not wish certain types of hedge funds to join the lending syndicate; the agent and other syndicate members may share the concern The borrower s private equity sponsor may have a lending affiliate. The agent and other syndicate members may be at risk if that affiliate becomes part of the syndicate Typically prior to default lenders may only assign their loan, in whole or in part to "Eligible Assignees" which are either "Approved Funds" by agreed definition, or approved specifically by the borrower and the agent 16

17 8. Accordion or incremental features Allows borrower to add a new term loan or increase a revolver, or both, under an existing loan facility up to a specified amount Accordion or incremental facilities are popular as borrowers try to reduce the fees they are charged but bargain for a commitment to fund May include: a most-favoured nations provision, such that interest charged on the existing loan is increased to be within bps of the new loan; a leverage ratio test (requirement that there be no increase in the closing date leverage ratio after giving effect to the incremental loan) 17

18 9. The Indalex decision Recent Ontario Court of Appeal decision Material shift in thinking about the priority of pension deficits relative to secured creditor liens Implications for DIP loans and pre-filing loans (particularly ABLs margined against inventory and A/R) Mitigating the Indalex risk 18

19 McMillan An integrated team of lending and workout legal professionals providing structuring advice, pragmatic solutions and transactional service Offices in Montreal, Ottawa, Toronto, Calgary, Vancouver and Hong Kong Our expertise includes syndicated lending, club & bilateral loans, asset-based lending, second lien & mezzanine financing, high yield debt and commercial paper offerings, dip financing and restructuring/ workout loans, infrastructure financing, LBO and acquisition financing, leasing and other structured products Large Canadian and U.S.-based institutional lending client practice including major Canadian banks, government and foreign financial institutions 19

20 McMillan Adam Maerov Partner, Restructuring Group Stephanie Robinson Partner, Financial Services Group

21 QUESTIONS? 21