In Sickness And In Health – A Review of transfer provisions in European leveraged loan agreements

The borrower will want to know that its lenders are likely to be supportive and reasonable when dealing with consent and waiver requests during the life of the facilities. This is relevant both to the good times, when it may be wanting to borrow more to facilitate its growth, and to more troubled times should it find itself in a potential default scenario.

Given that the class of entity to which debt transfers can be made includes not only banks and financial institutions but also trusts, funds or other entities which are regularly engaged in or established for the purpose of making, purchasing or investing in loans, securities or other financial assets, the borrower will be alive to the need to protect itself from having to provide its private financial and other business information to any lender which is potentially not aligned with the best interests of the business or which could even be a competitor.

The need for Borrower consent

It is market standard that borrower consent to transfer is required unless one of the exceptions applies. Invariably, that consent is required not only for any assignment or transfer of a loan, but also for any voting sub-participation or other transaction of equivalent economic effect where the transferor would no longer substantively exercise the voting rights.

The borrower's right to refuse consent to transfer is usually fettered in a couple of ways.

• First, by a ‘deemed consent’ provision, so that if the borrower does not respond to a lender’s request for consent to transfer within the specified period, the transfer is deemed to have been agreed.

• Sponsors have tried to erode this provision over the last few years. Sometimes on the most sponsor friendly larger deals it is not included at all or, if it is included, the specified period is now often pushed out to 10 business days and (rarely) even longer.

• Secondly, by the requirement that the borrower does not “unreasonably withhold or delay” its consent decision. Occasionally the most sponsor friendly terms will seek to delete the reasonableness requirement in its entirety or even (to counter any implied term argument) to specify that the borrower can decide whether to consent or not in its sole discretion, in particular, where a consent request concerns a prohibited transferee.

Prohibited transfers

As it is hard to prove whether or not a particular refusal decision has breached this reasonableness requirement, it has become usual for borrowers to want to prohibit completely certain types of transfers via the inclusion of override transfer restrictions, including:

• to a ‘loan to own’/distressed investor (as a business model principally focussed on acquiring debt commitments with a view to eventually owning equity or acquiring a blocking stake is clearly in direct conflict with the aspirations of the borrower group). Note here that lenders may require this prohibition to: (1) exclude independent debt fund affiliates and related funds of loan to own/distressed investors which have been established for at least 6 months operating subject to customary information barriers (collectively, ’independent funds’), and (2) fall away whilst a material event of default is continuing as, at that stage, these buyers may well represent the best way for a lender to exit the deal;

• to a “competitor” (which is generally defined to mean an industrial competitor to the borrower’s business and (increasingly) also any other private equity sponsor or other competitors of the sponsor shareholders). Ideally, lenders should seek to ensure that this definition is limited in scope to genuine competitor entities and does not encompass other suppliers or trade creditors of the borrower. As above, lenders typically require that this restriction should be subject to an exclusion for independent funds;;

• to a “defaulting lender” (noting that sanctioned persons are now often included in this definition);

• of the RCF to any entity other than to an entity which is a regulated deposit-taking bank and satisfies investment-grade ratings criteria. (Occasionally minimum ratings criteria may also be applied in relation to the transfer by a lender of any undrawn committed term facility, such as a capex or delayed draw term loan, to any transferee.) Note that lenders may require these prohibitions to: (1) exclude transfers to affiliated entities in order to not frustrate internal transfers, and (2) fall away whilst a material event of default is continuing;

• (a more recent and more contentious development) to a ‘net short lender’ or to an entity which would become a net short lender on investing in the loan. This is broadly an entity which due to holding CDS or other derivative instruments, would stand to profit more from the failure of the borrower’s business than it would profit from its longer-term investment in the loan.

This exclusion started to be seen in response to the Windstream litigation in the States, where an economically motivated net-short lender was uncooperative in the restructuring of the business.

Whilst it is easy to understand a sponsor’s motivation behind wanting this prohibition, in practice it is exceedingly difficult for it to not potentially capture ‘innocent’ lenders who have simply put in place back-to-back hedging positions to support their investment. Accordingly, it tends to only be accepted by lenders on larger widely syndicated loans and may be negotiated so as to exclude traditional banks from its ambit. A linked point is that, if this concept is accepted in the transfer provision, then an entity which becomes a net short lender during the life of the facilities would generally become subject to the ‘yank the bank’ clause too.

These restrictions would all also usually be extended to try to prevent any ineligible entity from circumventing the prohibitions by using an affiliate or fronting institution to acquire the debt or voting rights.

Clearly it is in everyone’s interest to ensure that the definitions relating to the types of entities to which transfers are simply prohibited are clear and that they do not accidentally capture entities (such as direct lending funds of other private equity sponsors) which may fall within the definitions simply by virtue of their being an affiliate or related fund but which would not be of concern to the borrower. For this reason, affiliates and related funds which are independently managed and operate behind information barriers should be clearly excluded from the prohibitions.

We mention ‘approved lender’ lists below, and a difficult negotiation point is whether the borrower should be able to challenge a transferee as being ineligible despite them being specifically listed on the approved lender list if the borrower alleges that they are also an entity of a type to whom transfers are simply prohibited. Increasingly, the overriding transfer restrictions discussed above are expressed to apply in all cases irrespective of whether the entity in question is included on an approved lender list, although this is negotiated from deal to deal.

Another new concept seen very occasionally on European top-tier widely syndicated leveraged loans in the last few years is the ‘lender commitment cap’. This provision represents an attempt by the sponsor to restrict entities from building up commitments above the capped amount (which has been set at levels of between 10 – 20% of commitments) to prevent any one entity from having a blocking vote (or otherwise having what is seen as being excessive influence on the voting dynamics of the syndicate or lender club).

This is an extremely aggressive request and is particularly difficult for outgoing lenders who would not be likely to be able to verify what a potential transferee says that its existing commitments are at any point in time.

I’m not speaking to you…

What happens should a lender transfer debt to a person who is not a permitted transferee is complex area of English law. It is an unattractive option for a borrower to have to resort to litigation should the transfer provisions be breached. This has resulted in it now being common for sponsors to include provisions which disenfranchise the rights of a transferee who has acquired debt despite the prohibitions in the facilities agreement.

Such provisions not only provide that the transferee does not get a vote on any lender decision, but also that they do not get to receive any borrower information under the facilities agreement nor to attend any lender meetings nor to receive any minutes of those meetings. Some of the most sponsor friendly documents go on to provide that the borrower is not obliged to pay any interest or periodic fees on that portion of debt. The latter provisions require careful consideration by the lenders noting that minor breaches of the transferability provisions (e.g., a requirement to copy the sponsor into any consent request addressed to the company) may result in issues for internal transfers between funds and relationship issues in relation to any external transfers.

It should be obvious that for these provisions to be workable, particularly for facility agents, the documentation needs to contain a clear mechanism to keep records of all transfers and for the borrower to notify the facility agent of any entity which it believes should be treated as being disenfranchised.

As it is not inconceivable where transfer provisions are very complex that a lender may inadvertently transfer debt to an entity which turns out to be ineligible, many facilities agreements now contain provisions to allow for a short window of time in which the ineligible lender is able to retransfer the debt back to the transferor lender without the need for borrower consent. In doing so, the retransfer is expressed to cure the disenfranchisement of that portion of debt. Sometimes there is a proviso that retransfer cannot happen if the ineligible lender is a loan to own investor or a competitor, so as to further discourage such ineligible transfers from being made in the first place.

Exceptions to the need for Borrower consent

For lenders to be confident that they will not be unduly fettered in their ability to transfer their debt if necessary, they must be happy with the scope of the exceptions to the requirement for borrower consent.

These exceptions take a few different forms:

• Transfers by a lender to any of its ‘affiliates’ or ‘related funds’ are generally unrestricted (apart from potentially transfers to any “loan to own”/distressed investor, competitors or any “defaulting lender” above).

• Transfers to another entity which is already a lender of record are also generally not restricted (apart from potentially transfers to any “loan to own”/distressed investor, competitors, or any “defaulting lender” above).

• Whilst the LMA standard form facilities agreement provides that borrower consent to transfer is not required at any time whilst an event of default is continuing, for many years now it has been common for this exception to be narrowed to apply only when specified ‘material events of default’ are continuing. The scope of those material events of default is often limited to non-payment and insolvency/creditor process events. An addition to this definition of those events of default reflecting financial covenant breach or a failure to provide compliance certificates is negotiated on some deals.
  Transfers to named entities on an approved lender list (other than to the extent such entity is a loan to own”/distressed investor or competitor). Note that there are a few different names for this list in use in the market.

The obvious advantage of this list is that it should give complete certainty to the lenders about to whom they can trade on their debt without requiring borrower consent. In practice it can be hard for a trading desk to agree a trade on the secondary loans market when that trade would then have to be delayed for a number of business days whilst borrower consent is sought.

The following points relating to approved lender lists can cause difficulties for lenders:

• the completed approved lender list (that is, one containing a reasonable number and spread of names) should be provided as a condition precedent.
  
  
• the facilities agreement should be reasonable and clear about the borrower’s right to remove names from the list, including the number of names which can be removed unilaterally by the borrower in any one year and over the life of the facilities. Lenders are likely to require the borrower to allow the lenders to ‘top up’ the list with new additional permitted transferees if the borrower exercises its right to remove any names, with the borrower being obliged to consider those new names acting reasonably and promptly.

Sometimes instead of an approved lender list, a prohibited lender list concept is agreed. No transfer may then be made to any listed entity on that prohibited list. This concept has historically been seen more often in the US than on European deals.

Occasionally and even more controversially, a borrower may ask for a prohibited lender list in addition to an approved lender list.

Talk to me…

Advance notice requirements are a relatively new and aggressive concept in the European leveraged loans market.

This is an additional over-arching condition to any assignment, transfer or voting sub-participation (which applies apart from on a transfer by a lender to an affiliate or related fund). It requires that any lender which wishes to transfer all or part of its commitments must first notify the borrower in writing of the proposed trade, including the identity of the proposed new lender, no later than a specified period of time before it enters into that trade. In the relatively few deals where this provision has been included, that minimum advance notice period has been set at between 5 and 10 business days.

This concept seriously erodes the ability of the lenders to make quick debt transfers even to types of entities for which borrower consent is not required and so is very unattractive to lenders. If this provision is to be included, then lenders should consider excluding the requirement to make any advance notification in appropriate circumstances, for instance including where the transfer is to an affiliate or related fund or is made whilst a material event of default is continuing.

It’s a balance

Like any relationship, to navigate sensitive issues successfully requires an understanding of the other party’s point of view and some compromising. Private equity sponsors have legitimate concerns regarding who might end up holding their portfolio company’s debt, but lenders equally cannot risk finding themselves seriously financially disadvantaged by not being able to trade on their debt should they need to because the documentation has been drafted either too tightly or ambiguously.

Authored by Nick Cusack, Susan Whitehead, and Alistair Handy.