Lenders in Complex Corporate Financings: Use Care to Protect Rights

The increasing complexity of corporate financings, coupled with market uncertainty and a credit crunch, is making it more important than ever for lenders in multicreditor deals to protect their rights and interests during negotiations, according to James C. Hale, a corporate finance partner in the Roanoke office of LeClairRyan.

Financing for mergers and acquisitions, leveraged buyouts and recapitalizations often contain components of traditional secured lending as well as mezzanine debt and equity, Hale notes, making it crucial for creditor parties to use great care when it comes to negotiating the finer points of deals.

"It is these details that pose substantial risk to each member of the lender group," Hale says. "With the volatility in the financial markets, intercreditor and subordination terms among lenders have gained new significance. Restrictions on payments and distributions, rights to collateral proceeds, standstill periods, buyout options, priorities upon distribution and their impacts on each credit provider require thorough consideration."

Given the market's increased complexity, first and subordinate lien lenders involved in multicreditor financing transactions need to pay close attention to such key issues as:

Subordination
Intercreditor and subordination agreements commonly contain provisions stating that senior lenders' loans and associated interests and rights are superior to those of sub-debt lenders. A sophisticated first lien holder may demand assurances that subordinated liens are junior in priority, regardless of the failure of the first lien holder to properly perfect its lien, the successful challenge of lien validity by a third party, or any other invalidation of the lien. Many of the relative rights of the parties are, in fact, determined by the other terms of the agreement. Lenders in multicreditor deals must pay close attention to those other terms.

Loan Modifications
Prohibitions against modification of each lender's agreement with the borrower, subject to the consent of the other credit providers, are typical. Negotiated restrictions to loan modifications will often allow a lender to make non-material modifications to an agreement without prior consent. Furthermore, express prohibitions may have a major impact on subordination of collateral, the ability to raise fees or interest, adjusting payment terms and other important issues.

Payments and Distributions
Terms dealing with debt payments and distributions of stock in repayment should be explicit about what is permissible and the conditions under which they may be made and accepted. Permitted payments may be fixed, may be tied to the financial performance of the borrower or reductions in principal outstanding, and prepayments may be prohibited. Senior lenders will often seek to prohibit payments or distributions to subordinated creditors in the event that the loan facility is in default.

Standstill
Senior lenders often require that subordinated lenders agree to a standstill period in the case of a borrower's default, meaning that the lender cannot sue for the debt, exercise rights as a secured creditor, accept payment on its debt or exercise warrants. The standstill period is often 180 days, but lenders may negotiate that time period. Lenders can create exceptions to the standstill to ensure that the senior lender acts expeditiously to protect the interests of the lender group and maximize the return to junior lenders.

Distribution Upon Liquidation
Intercreditor and subordination agreements should be very explicit as to the distribution of proceeds of collateral securing the financing facilities upon the liquidation of assets of the borrower. The order and priority in which the proceeds are distributed is called the "waterfall." Lenders should insist that a waterfall provision be inserted in the agreement, and that the order, allocation, special treatment of certain collateral, and other terms of distribution upon liquidation are unambiguous.

Bankruptcy
The interests of a senior lender can be vastly different from those of junior lender in a bankruptcy or reorganization. Although often requested, sub-lenders need to be careful about transferring authority to the senior lender in an insolvency proceeding. Treatment of collateral, approval of a plan of reorganization, and permitting debtor-in-possession financing affect each lender differently. A sub-debt lender may insist on a buyout option of the senior credit facility. The terms of the buyout are negotiable, but would allow the junior lender to control its destiny in the event bankruptcy is pending or threatened.

"In today's environment, the implications of the agreement among lender parties have gained substantial significance," Hale notes. "Every deal requires a different risk calculus and allocation. As lending covenants and conditions change with the market, so too should the terms and relative interests of credit parties in a multi-tiered financing transaction."

"Each credit party must thoroughly evaluate the manner in which the credit will be administered by each of the lending parties throughout the term of the facility - when the financing is in good standing and, more particularly, in the event that the borrower becomes distressed or in default," he concludes.

A uniquely structured, business-minded law firm, LeClairRyan specializes in developing legal solutions to its clients' business challenges.

Source:
http://www.abfjournal.com/story.asp?id=21799