Intercreditor Agreements (Pari Passu) 1:45pm - 3:15pm April 26, 2007

Transcription

1 2007 ANNUAL SPRING INVESTMENT FORUM American College of Investment Counsel Chicago, Illinois Intercreditor Agreements (Pari Passu) 1:45pm - 3:15pm April 26, 2007 Chester L. Fisher, III Bingham McCutchen LLP Sarah Coucher Bingham McCutchen LLP Armando M. Gamboa Prudential Insurance Company of America

2 SELECTED INTERCREDITOR AGREEMENT ISSUES 1 April, 2007 BINGHAM MCCUTCHEN LLP Chester L. Fisher III, Esq. 1 Copyright 2007 by Chester L. Fisher III.

3 Selected Intercreditor Agreement Issues 1. Why have an intercreditor agreement? Generally, the need for an intercreditor agreement arises in three situations: (i) (ii) (iii) There is shared collateral among two or more groups of creditors. There is a need to have payments from an obligor shared by two or more groups of creditors as of a specified time, regardless of whether the obligations are secured. One group of creditors will be subordinated to one or more other groups. (This outline will not address subordination issues.) 2. What are the significant issues in sharing collateral? (i) Collateral Agent. Ordinarily, with collateral securing obligations owing to a number of creditors, a collateral agent will be appointed to be, technically, the secured party. Frequently, that entity is the agent bank if one of the groups of creditors is a group of banks. Generally speaking, that arrangement is satisfactory to institutional investors (as opposed to having an independent entity, like a trust company, named as the collateral agent). Again, ordinarily, the intercreditor agreement will set forth the requirements for permitting the collateral agent to foreclose on the collateral or take other action with respect thereto (such as voting shares pledged to secure the debt). (ii) Conditions to Action Against Collateral vis-à-vis Obligor. The underlying collateral documents (such as a security agreement, pledge agreement or mortgage) will usually set forth the requirements that have to be met vis-à-vis the obligor in order for action to be taken with respect to the collateral. More often than not, there will have to be a payment default (whether as a result of a missed scheduled payment of principal or interest or as a result of acceleration) in order for action to be taken. 2 If the conditions to act against the collateral in the 2 Note that there are some actions that can often be taken in the absence of a payment default. For example, a pledge agreement may give the pledgee the right to vote the pledged shares

4 -2- underlying collateral documents have been satisfied, usually some vote of creditors, as provided in the intercreditor agreement, is required in order for the collateral agent to take action against the collateral. 3/ (iii) Vote of Creditors. Frequently the major voting issue is whether all creditors will vote as one class with a majority or some other percentage of the total outstanding exposure 4/ determining whether action is taken, or whether a majority (or some other percentage) of each group of creditors, voting separately, must endorse a proposal to take action. Obviously, which creditors will be in favor of which alternative will depend on the creditors relative exposures. However, even if one group of creditors is dominant and the other group or groups of creditors are willing to permit one class voting with a majority threshold, the minority creditors will want the right to act at some point, regardless of the desires of the majority, at least if there is a scheduled payment default (a failure to make a scheduled payment of principal or interest, as distinguished from an acceleration based on, for example, a covenant default). That right may be conditioned on the passage of some period of at any time when an event of default is in existence. This may be a very useful right for a lender to have since it may be possible to use it to replace a borrower s board of directors and senior officers without accelerating the debt. 3/ It is frequently provided in the intercreditor agreement or in a collateral agency agreement that the collateral agent will not act without instructions from the requisite creditors. (A collateral agency agreement is a document executed by the creditors and the entity that will act as collateral agent which appoints the entity as collateral agent.) This is probably a good provision to have, particularly if a creditor from another creditor group will act as collateral agent. Some intercreditor agreements do give a collateral agent authority to act on its own and, while most collateral agents would not act without authorization from the requisite percentage of creditors, a collateral agent that has an economic interest in the deal might view the risks of acting differently than an independent collateral agent. If the collateral agent does have the right to act on its own, that could result in effectively overriding whatever voting provisions might exist. This situation can arise in an intercreditor agreement in which institutional investors are participating with banks and one of the banks is acting as collateral agent. 4/ Exposure is referred to, instead of principal amount, because banks will want to count outstanding but undrawn availability under a revolving credit facility, undrawn letter of credit exposure and bankers acceptances, as well as the net amount of outstanding swaps, in addition to principal. For purposes of voting on amendments outside of the context where an event of default has occurred, these other types of exposure are generally taken into account in determining any creditor s exposure (as well as the aggregate exposure of all creditors). If an event of default has occurred (or some other serious event, like a setoff by a bank, has occurred), undrawn availability under a revolving credit facility would no longer be taken into account, but the other types of exposure would be.

5 -3- time (such as 30 days) and the right of the majority to take back control of the foreclosure proceedings as long as they act in good faith to realize proceeds from the sale of collateral (i.e., they can t take back control of the foreclosure proceeding in order to sabotage the minority s efforts to take action). To the extent that one group of creditors is significantly larger than the others (certainly when one group of creditors has in the vicinity of 2/3 to ¾ of the total exposure), the more it should argue for control of the collateral, subject to the exception referred to in the two preceding sentences. (iv) (v) Bankruptcy and Other Action. Consideration should be given to whether the intercreditor agreement should block action by a creditor, without the requisite vote, that could have the same effect as commencing an action against the collateral. Thus, for example, it may be appropriate to block commencement of insolvency proceedings, or an exercise of setoff rights, against the obligor without the requisite vote of creditors. On the other hand, while it may be considered, usually creditors are reluctant to give up the right to accelerate debts owing to them and then sue an obligor for unpaid debts, even if they don t have the right to access collateral. 5/ This may be acceptable to non-acting creditors since there should be a period of at least months between the time a lawsuit is started and the time a successful creditor can commence levying on the obligor s assets. That period may be sufficient to permit a consensual resolution of the underlying issues. Release of Collateral. Frequently an intercreditor agreement will provide for the automatic release of liens on encumbered assets if they are being sold in compliance with permissions in the underlying debt documents (such as a permission for the disposition each year of assets having a book value not in excess of 10% of consolidated total assets). In addition, the automatic release will probably be conditioned on the absence of an event of default. If the underlying debt documents do not have that type of permission, an intercreditor agreement may provide for a release of liens on a relatively small portion of the encumbered assets upon the vote of some percentage of the creditors (which may be a lesser percentage than would apply to a vote to take 5/ Note that default rates of interest are generally allowed to accrue and be recovered with the same priority as non-default interest.

6 -4- action against collateral). A release of liens on more than a relatively small percentage of the encumbered assets is likely to require a high percentage vote (although not necessarily 100%) unless the proceeds are to be used to pay back the secured debt, in which event there may be an automatic permission (unless an event of default exists in which event a percentage vote equal to the vote required to take action against the collateral may be required). (vi) Amendments to Collateral Documents. Frequently, no amendments of the collateral documents will be permitted without the vote of all creditors (or a very high percentage thereof). There may be an exception for clarifying changes or changes to ministerial provisions of the documents (e.g., the manner in which notices are given). 3. What are the significant issues in sharing payments? (i) True-ups. A true-up is more commonly found in a workout than in a new deal. In a workout, it is frequently important to allow an obligor to continue its operations in the ordinary course, which will include draw-downs and pay-backs of revolving credit loans and other working capital-type credit arrangements. Unless prohibited, voluntary prepayments of other debt could also be made. Finally, the period involved may include regularly scheduled amortization payments which the obligor might be in a position to make. All of these payments, of course, have the potential to allow one group of creditors to get paid down disproportionately if the workout fails and the obligor goes into bankruptcy. To guard against that possibility, creditors may agree on a true-up. This means that the various creditors agree on a date as of which their outstanding exposure would be measured in order to establish the relationship that each creditor s exposure bears to the others (or such relationships may just be set as a result of negotiation, given the arguments that may be made in favor of alternative dates). For example, Creditors A, B and C may have outstanding exposures of $50MM, $30MM and $20MM, respectively, as of the selected date and thus have 50%, 30% and 20%, respectively, of the total debt. During the course of the workout, as the result of the normal operation of a revolving credit facility, Creditor B

7 -5- may find its exposure reduced to $15MM, while the exposures of Creditors A and C remain unchanged. If a bankruptcy then ensues, Creditor B s exposure has been reduced from 30% to 17.6% of the total, while the percentages of Creditors A and C have gone up. The intercreditor agreement will provide that amounts distributable to the creditors in the waterfall (see below) will be paid to Creditors A and C (with nothing to Creditor B), in the proportion of 5 to 2 for each distribution, until the exposures of Creditors A and C have been reduced to $25MM and $10MM, respectively. At that point, the 50%/ 30%/20% relationship will have been restored and additional distributions can then be made ratably to all three creditors. One issue that can come up is whether any creditor must come out of pocket if the assets of the obligor turn out to be insufficient to satisfy the true-up. This can be a contentious issue since many creditors have a severe institutional aversion to paying back money they have received. In order to determine whether this issue is worth the aggravation, reference can be made to the size of revolving credit and other operating facilities relative to the size of non-operating credit facilities and the size of the obligor (e.g., if the revolver is small, fluctuations in the amount outstanding may not be material to the over-all debt structure), whether the obligor has true seasonal borrowing needs or whether the revolver really represents embedded capital (and thus stays relatively constant), and similar considerations assessing the likelihood of needing recourse to paid-down creditors in order to satisfy the true-up. (ii) Sharing. In a new deal, the intercreditor agreement may provide for different types of sharing depending on the transaction. If a sharing arrangement is not in effect under an intercreditor agreement, a creditor can retain any payments made in respect of the obligations owing to it (subject to bankruptcy limitations such as preference, fraudulent conveyance, equitable subordination, etc.). (a) Sharing of Guaranty Payments. An intercreditor agreement (which may be called a sharing agreement ) may provide for sharing of only those payments received from guarantors (i.e. payments from the primary obligor, whether scheduled or not, would not be subject to sharing). Since the likelihood is that no payments will be

8 -6- received from a guarantor in respect of the guaranteed obligations unless there is a serious problem with the primary credit, the intercreditor agreement may simply provide that whenever a payment is received from a guarantor in respect of the guaranteed obligations, that payment will be shared. (In other words, the intercreditor agreement will not specify that an Event of Default or other condition must be continuing at the time sharing is to commence.) The concern underlying this type of intercreditor agreement is that one group of creditors may have enforceable guarantees while another may not. See the Validity of Obligations discussion below. (b) Trigger Events. In a new deal, an intercreditor agreement may provide for sharing of all amounts received from (1) the primary obligor (including amounts paid in respect of scheduled payments of principal and interest), (2) any guarantor of the primary obligor s obligations, (3) any realization on collateral, etc. 6/ upon the occurrence of certain events (so-called trigger events ). Such events are likely to include payment defaults (whether as the result of a missed scheduled payment or an acceleration), bankruptcy, commencement of enforcement action against collateral (if any), and setoff. They may also include the refusal of a revolving credit lender to make a revolving credit loan or the occurrence of an event of default as the result of a breach of one or more significant covenants (such as an interest coverage ratio, leverage ratio or net worth covenant). 7/ 6/ One point to avoid is having the sharing obligation so broadly drafted that it could be construed to include payments made by a person to purchase the obligation held by the creditor unless that is intended (which would be unusual). 7/ Some intercreditor agreements will have acceleration as the only trigger event. This is probably not a good idea since it can put a creditor on the horns of a dilemma. That is to say, a creditor could be forced to decide between (a) accelerating in order to commence the sharing arrangement notwithstanding the adverse effect on the obligor resulting from such action (e.g., trade creditors requiring cash on delivery, customers delaying orders to see if the obligor will survive, etc.) and (b) not accelerating to avoid the adverse effect of such action on the obligor but

9 -7- If a covenant default will be a trigger event, and if revolving credit lenders are parties to the intercreditor agreement, it is likely that they will only want the trigger event to be deemed to have occurred when notice thereof has been given to all creditors. The reason for this is that many covenants are tested at the end of a fiscal quarter but it may not be clear that an event of default existed at the end of a quarter until the obligor s compliance certificate is delivered 45 or more days later. During this interim period, a revolving credit lender may get repaid and may relend several times. Unless specific provision is made to the contrary, the intercreditor agreement could literally require sharing of all payments made to the revolving credit lenders without taking into account the subsequent relendings. On the other hand, a term lender might be concerned that a revolving credit lender would get wind of a likely default and in some fashion use the interim period to get paid down. One way to address this point is to have a true-up arrangement cover the period from the time the trigger event occurred to the time all creditors have obtained notice thereof. That way, a revolving credit lender would, effectively, only be required to share any net reduction in its exposure during the interim period. (c) Sharing of Proceeds from Collateral. An intercreditor agreement may only provide for sharing of amounts received upon a realization on collateral. In such circumstances, while other payments may be very unlikely (e.g., an optional prepayment by the obligor), it is still possible that they could be made to one or more creditors, but would not be subject to any sharing obligation. (d) Miscellaneous Sharing. Some intercreditor agreements provide for sharing of proceeds received from specified events, even in the absence of a then not starting the sharing period and thus potentially allowing other creditors to receive and keep substantial paydowns.

10 -8- default. Typical examples would be sales of specified assets or proceeds received from a public issuance of securities. (iii) Waterfall. One area which is the subject of considerable negotiation is the priority to be accorded to different types of obligations that the obligor has to its creditors. That is to say, many intercreditor agreements will provide that distributions of amounts to be shared will be applied first to the costs of foreclosure or other similar action, whether taken by the collateral agent or, if permitted, by the creditors, second, to the fees and costs (other than foreclosure costs) of the collateral agent, third, to interest on all creditors obligations, fourth, to principal, fifth, to make-whole amounts and other fees (such as commitment fees, facility fees, etc.) and sixth to the obligor. 8/ The major issue is often the placement of the make-whole amount in the priority waterfall. This is because (x) intercreditor agreements usually involve banks that lend at a floating rate of interest and that therefore do not have a claim for a make-whole amount 9/ and (y) make-whole amounts can be substantial (10% to 20%, or even more, of the principal amount being prepaid). The banks argument is that the make-whole amount is really a claim in respect of unpaid interest and they are not making a claim in respect of all the interest that, in a liquidation, would not be paid to them as the result of the early termination of their lending facility. The noteholders argument is that the noteholders are in a different kind of business than the banks one with long term fixed rate obligations (such as GIC s) and that, without the make-whole, they will suffer a loss on account of those obligations, which the banks will not. It is rare to find the make-whole amount placed higher than the 8/ This is a cursory summary. There may well be other priority categories. For example, before payment of obligations owing to the creditors, there may be a priority for keeping payments current on debt secured by property not encumbered in favor of the creditors or as to which the creditors only have a junior security interest. One reason to do this could be to keep the obligor s business intact so it can be sold as a going concern. Another higher priority category may be for indemnity payments owing to creditors (e.g., to cover the costs of litigating against a governmental entity asserting that the creditors are responsible for environmental clean-up costs relating to encumbered property). 9/ They may have a claim for breakage costs if a loan has LIBOR pricing and is repaid at a time other than the end of an interest period. However, such costs, relative to a typical make-whole amount applicable to a term loan, are usually very small.

11 -9- principal amount in the priority waterfall (i.e., that is, it will be below interest), although it is sometimes placed in the same priority category as principal. Alternatively, sometimes a compromise is struck whereby a percentage of the make-whole amount, or a portion of the make-whole amount up to an absolute dollar amount, is placed in the same priority category as principal. 10/ From an institutional investor s perspective, perhaps the best result (which has been achieved a number of times) is to have no distinction made among the various types of obligations owing to the creditors so that they are all placed in the same priority (i.e., principal, interest, make-whole amount, fees, etc. all being placed in the third priority in the example above). Another area to note is additional advances made by creditors to the obligor which were not contemplated when the intercreditor agreement was signed. Frequently, the amount of debt, and the interest rate and fees related thereto, subject to the sharing provisions of an intercreditor agreement will be set at some margin above the amount or rate prevailing at the time the intercreditor agreement is signed. This is done so as to facilitate an exit from the credit by each of the participating lenders. (That is, if the credit has deteriorated, the interest rate or fees required by a replacement lender may be higher than those required by the original lender; similarly, the obligor may need an infusion of new money, rather than just a replacement of an existing lender.) A margin of 10% above the original principal amount and perhaps 2% above the initial interest rate (or the initial margin, as the case may be) would probably be in the acceptable range. A increase of 50 to 100 basis points in applicable fees might also be in the acceptable range. Increases in obligations above the margin are frequently not prohibited by the intercreditor agreement but repayment of such additional amounts is usually assigned to a priority category in the 10/ One point to note in this regard arises in connection with an interest rate increase that may be agreed to in a workout. Obviously, such an increase would increase the make-whole amount (assuming a make-whole amount is payable). Assuming that the obligor will agree to the increase in the make-whole amount, it can be difficult to have the increase in the make-whole amount treated in the same fashion as the original make-whole amount (in part because it becomes harder to make the argument about fixed rate obligations having been entered into on the basis of the income expected from long term fixed rate investments; obviously, when the investment was originally made, the increased interest rate was not anticipated).

12 -10- waterfall below payment of all amounts owing in respect of the original obligations plus the applicable margin. Finally, if letters of credit or other contingent obligations payable to any creditor are outstanding at the time of any distribution under the waterfall, intercreditor agreements usually provide that the amount that is allocable to such contingent obligations is held by the collateral (or other) agent until the contingent obligation expires or becomes a liquidated obligation. If it expires undrawn, the amount held by the agent is run through the waterfall at the time of expiration. If the obligation becomes liquidated, the amount held in respect thereof is paid to the creditor holding the obligation. (iv) (v) Amendments to Underlying Loan Agreements. Intercreditor Agreements may or may not block amendments to the underlying loan agreements. The motivation behind wanting a block is to prevent a creditor from creating a situation in which an acceleration, or at least a scheduled payment default, becomes more likely which, in turn, may cause a sharing arrangement to go into effect, permit foreclosure proceedings to be commenced, etc. The motivation behind opposing a block is for a creditor to remain free to structure the best deal it can with the obligor without having to get the approval of other creditors (recognizing that payment of any new obligations may be effectively subordinated to original obligations (as noted in the last sentence of the penultimate paragraph of the preceding subsection), access to collateral following a breach of a new provision may be limited, etc.). It is not clear that there is any generally accepted approach to amendments to underlying documents except that amendments to increase the amount or type of obligations owing to a creditor (including interest rate increases), or to increase the frequency of interest payments or to shorten the average life of principal, are either prohibited without the consent of other creditors or are subjected to some kind of subordination arrangement as referred to in the preceding subsection. Validity of Obligations. An issue that comes up frequently when upstream guaranties are being given is the treatment of obligations held by creditors that are found to be invalid. For example, a subsidiary s guaranty of its parent s debt may be subject to attack as a fraudulent conveyance if (x) the subsidiary received no discernable benefit from giving the guaranty (e.g.,

13 -11- none of the funds advanced to the parent were made available to the subsidiary and the subsidiary has no business dealings with the parent that would be preserved or enhanced by the funds advanced to the parent), and (y) the subsidiary is or is rendered insolvent or has or is left with insufficient capital to conduct its business or pay its debts as they come due. The guaranty held by a term lender might be subject to such attack since it generally makes a single loan that the parent could, for example, use to buy an asset used only by the parent - whereas the guaranty held by a revolving credit lender might not. Even if no part of the original advance made by the revolving credit lender is on-loaned to the subsidiary, a subsequent advance might be and the simple fact that the subsidiary has access to the credit may be a sufficient benefit to the subsidiary to avoid having the guaranty invalidated. The problem from an intercreditor perspective is that the only source of recovery may be from the guarantying subsidiary and the creditors can not collect from that subsidiary more than it owes. Thus, if the term lender advanced $25MM to the parent, guaranteed by the subsidiary, and the revolving credit lender did the same, if only the revolving credit lender s guaranty is upheld, only $25MM can be collected from the subsidiary. This, in turn, would likely mean that each creditor would receive only $12.5MM. 11/ That possibility causes many banks to insist that invalid obligations not be entitled to share in distributions under an intercreditor agreement. Generally, that position prevails except with respect to intercreditor agreements that provide only for sharing of payments received from guarantors. In that case, the primary purpose of the agreement is to address what happens in case a guaranty is invalidated. 11/ The same analysis applies to a claim for a make-whole amount if the make-whole amount is invalidated. While the traditional make-whole amount seems very likely to be upheld, at least under New York law, it may not be entitled to the special treatment given by Section 506(b) of the Bankruptcy Code to secured claims. That Section allows over-secured creditors to receive postpetition interest and any reasonable fees, costs or charges provided for under the agreement under which such claim arose. Bankruptcy courts have raised questions about whether a make-whole amount is a reasonable fee, cost or charge for purposes of this section. If it is not, allowing distributions from collateral proceeds to be made in respect of the make-whole claim in the intercreditor agreement would dilute the recovery of any creditor that did not have a make-whole claim.

14 -12- Frequently, in an effort to reduce to some extent the possibility that a particular claim will be invalidated, intercreditor agreements will prohibit the parties thereto from attacking the validity of any claim against the obligor held by any creditor. 12/ Sometimes there may be an effort to go farther and block any party from supporting any person who is trying to invalidate such a claim. A goal of such language may be to create an argument that the parties to the intercreditor agreement can not vote for a plan of reorganization in bankruptcy that does not give effect to all creditors claims (although it would seem unlikely that all creditors would agree to making that goal explicit). 12/ Note that intercreditor agreements frequently also contain language prohibiting creditors from attacking the validity of the liens securing other creditors debt.