Loans and Secured Finance 2016

Transcription

1 Loans and Secured Finance 2016 United Kingdom ARTICLE SEPTEMBER 2015 Reproduced with permission from Law Business Research Ltd. This article was first published in Getting the Deal Through: Loans & Secured Financing 2016, (published in August 2015; contributing editor: George E Zobitz, Cravath, Swaine & Moore LLP). For further information please visit LOANS AND SECURED FINANCINGS 1. What are the primary advantages and disadvantages in your jurisdiction of incurring indebtedness in the form of bank loans versus debt securities? The term debt securities includes instruments such as standalone bonds, notes issued under debt-issuance programmes, commercial paper, high-yield bonds and both listed and unlisted private placements. The choice as to whether to opt for a loan or debt securities will ultimately depend on a number of factors including the quality of the credit, size and location of the borrower s business, market conditions, deal size and borrowing purpose. These factors also determine the extent to which the perceived advantages of a certain product will apply to any given borrower. In general, the advantages of a bank loan over debt securities include: its private nature (see question 10 for exceptions); no disclosure requirements (disclosure requirements for listed bonds can be cumbersome, particularly for a debut issue); no credit rating requirement; greater flexibility in terms of utilisation of funds (e.g. commitments and revolving credit); ability to finance sums considered too small for capital markets; the relative ease of effecting waivers (the dispersed nature of bondholders means obtaining consent can be challenging); can be repaid at relatively low cost (ability to voluntarily prepay bonds is often limited by makewhole provisions); and a shorter transaction timetable (although programme and certain other issuances can be effected in short time-frames). The comparative advantages of bonds are as follows: companies with access to capital markets can generally access cheaper and longer-term funding through bonds than through loans; investment grade bonds have no financial covenants and otherwise very limited covenants and are unsecured; and high yield bonds have incurrence rather than maintenance covenants (see questions 4 and 39 for trends in the loan market towards looser covenants). 2. What are the most common forms of bank loan facilities? Discuss any other types of facilities commonly made available to the debtor in addition to, or as part of, the bank loan facilities. The most common forms of loan facilities are term loan and revolving credit facilities. It is not uncommon to incorporate a sublimit within the revolving facility, allowing a certain amount of the revolving commitments to be drawn in the form of a swingline loan or a letter of credit, performance bond or other form of guarantee. Standalone facilities can also be put in place catering for these types of advance.

2 Swingline facilities provide for very short-term advances (typically up to five business days) and usually support a commercial paper programme they can be drawn on very short notice (often same day) and provide a backstop if, for example, liquidity issues in the commercial paper market mean that maturing papers cannot be rolled over. Before the financial crisis, syndicated letters of credit and performance bonds tended to be issued by one of the syndicate lenders, as issuing bank, which would then be indemnified by other lenders if the borrower failed to reimburse it. The availability of this type of issuance has decreased significantly since then as banks are less willing to take the credit risks associated with a fronting role. It is now common to require cash collateralisation or alternatively to provide for the issuance of a syndicated letter of credit by the relevant banks in their commitment proportions. Other types of facilities made available include uncommitted facilities such as incremental/accordion facilities. These allow the borrower to incur additional debt up to a certain amount and within agreed parameters which may benefit from the security package if the borrower is able to find lenders willing to lend. Unitranche facilities, combining senior and junior debt into a single agreement, are a growing trend and particularly popular with mid-market borrowers. 3. Describe the types of investors that participate in bank loan financings and the overlap with the investors that participate in debt securities financings. Traditional banks still play an important and active role in the loan market and remain dominant in the investment grade market. In other sectors, particularly in the leveraged market, real estate and infrastructure sectors, institutional investors (CLOs, finance and insurance companies, hedge, high yield and distressed funds and loan mutual funds), many of whom also participate in the debt capital markets, continue to be more prominent in syndicates. The last few years have also seen the rise of alternative credit providers such as direct lending funds, particularly in the mid-market. This has been fuelled by a variety of factors, including pursuit of yield in a low interest rate environment and the funding gap left by constrained bank liquidity and the increasingly strict regulatory capital environment applicable to banks. Alternative credit providers are generally unable to provide working capital and ancillary services (unless they have a joint venture type arrangement with a bank). 4. How are the terms of a bank loan facility affected by the type of investors participating in such facility? Alternative credit providers such as direct lending funds tend to be able to offer more flexible and bespoke structures, fewer covenants with looser headroom and no/minimal amortisation. The competition from these providers and the high yield market, the willingness of US investors to invest in European assets and convergence of the European and US markets more generally, especially in the leveraged space, has resulted in cross over of US terms and structures (particularly from the high yield and term loan (TLB) markets) into European loan market. It is not uncommon, for example, to see call protection included for term loans in a leveraged facility agreement. See question 39 for further examples of this trend. On deals where syndicate composition is likely to be diverse, there is greater focus on mechanisms for dealing with non-consenting lenders e.g. snooze and lose provisions under which lenders who fail to respond to requests for consent are not counted in the voting calculation. 02

3 5. Are bank loan facilities used as bridges to permanent debt security financings? How do the structure and terms of bridge facilities deviate from those of a typical bank loan facility? Short term loan facilities can be used as a bridge to longer term (re)financing from the capital markets or other takeout and have been a noteworthy feature of the M&A market recently. This trend has been driven by the favourable terms achievable in the high yield market as well as a number of factors making it difficult to rely solely on this market in a bid context e.g. confidentiality concerns, transaction timetables and certain funds type requirements, bid uncertainty and volatility of the market. Tenor is typically around 12 months with the option to extend by 6 or 12 months. Interest rates tend to be higher than rates applicable to other forms of financing and a margin ratchet is typically included to encourage early take out. 6. What role do agents or trustees play in administering bank loan facilities with multiple investors? A facility agent invariably acts on behalf of other syndicate lenders in the day to day administration of the loan. Its rights and duties are set out in the loan agreement. The role is largely administrative in nature e.g. processing payments, notices and waivers. It has limited discretions and in most matters will act on majority lender instruction. If there is security, usually a syndicate member or one of its affiliates will be appointed to act as security trustee to hold the security on trust for the benefit of all the lenders from time to time. The security trust structure enables a new lender (on transfer by novation or assignment) to benefit from the existing security package without the need for the security to be re-registered/re-confirmed or for new security to be granted. The rights and duties of the security trustee will usually be set out in the facility agreement or intercreditor agreement. These documents will also include provisions dealing with how enforcement proceeds are to be applied. The fiduciary duties of a security trustee are more extensive than those of a facility agent under common law. Both will, however, generally benefit from a number of contractual exculpatory and reimbursement provisions, including wide indemnities against any cost, loss or liability incurred, absent any gross negligence or wilful default. 7. Describe the primary roles and typical fees of the financial institutions that arrange and syndicate bank loan facilities. Banks mandated by the borrower to arrange, underwrite and syndicate the loan are generally referred to as mandated lead arrangers/underwriters. Responsibilities include taking on underwriting commitments, negotiating the loan documentation, preparation of any information memorandum as well as wider syndication. The arrangers who put together the syndicate are often also given the title of bookrunner. Fee structures for these roles vary and are generally documented in a separate and private fee letter between the relevant parties. 8. In cross-border transactions or secured transactions involving guarantees or collateral from entities organised in multiple jurisdictions, which jurisdiction s laws govern the bank loan documentation? Loan agreements and intercreditor agreements are typically governed by English law, with the security documents generally governed by the law of the jurisdiction where the assets are located. 03

4 REGULATION 9. Describe how capital and liquidity requirements impact the structure of bank loan facilities, including the availability of related facilities. Increased capital requirements and new industry regulations have had an impact on the leverage multiples that banks are able to offer and have meant that banks are now generally less willing than in the past to provide long-term loans or to lend to speculative grade credits. When implemented, the liquidity coverage ratio introduced by Basel III is likely to make it more expensive for banks to provide liquidity facilities (e.g. swinglines or other backstop facilities) to certain types of customer and so sources of finance which need to be backstopped (e.g. commercial paper programmes) may become less attractive. The availability of fronted letters of credit since the financial crisis is discussed in question 2 above. 10. For public company debtors, are there disclosure requirements applicable to bank loan facilities? Generally no. However, in the context of an acquisition of a UK public company, the Takeover Code requires that the offer document includes details of any debt facilities used to finance the bid and refinance the existing debt of the target. Copies of these finance documents must also be made available for public inspection within a specified period following the firm offer announcement. There are also disclosure requirements under the UK listing rules if the financing is for a transaction which constitutes a Class 1 transaction. 11. How is the use of bank loan proceeds by the debtor regulated? What liability could investors be exposed to if the debtor uses the proceeds contrary to regulations? Can investors mitigate their liability? Banks and other regulated lenders are subject to regulatory obligations to identify money laundering and to implement certain controls in respect thereof including customer due diligence/monitoring. Sanctions and anti-corruption laws also have a direct impact on loan transactions and regimes imposed by a number of jurisdictions are often relevant depending on the nationality and location of operations of the lenders and the borrower group. EU sanctions, for example, typically prohibit EU nationals, EU companies and non-eu companies who do business in the EU from (i) dealing with funds or economic resources belonging to, owned, held or controlled by a sanctioned person, and (ii) directly or indirectly making funds or economic resources available to, or for the benefit of, a sanctioned person, in each case with knowledge of or reasonable cause to suspect that result or without appropriate authorisation or a licence from the relevant authorities. US sanctions are framed in a more pervasive way, generally imposing strict liability with regard to civil penalties, and most internationally active banks and other organisations are either subject to, or regard themselves at risk of being pursued in relation to, US sanctions. Historically, these matters were addressed as part of a lender s pre-contract due diligence and, in terms of contractual protection, lenders simply relied on the general compliance with applicable laws representations and undertakings. Increasingly aggressive enforcement action and the severity of the penalties imposed by sanctions authorities, as well as reputational concerns, has led many lenders to seek additional contractual assurances from borrowers regarding the borrower group s compliance with all sanctions and anti-corruption 04

5 laws. Representations and undertakings on these topics are still resisted by stronger borrowers but, in general, have become common in the English law loan market. The restrictions on providing financial assistance are discussed in question Are there regulations that limit an investor s ability to extend credit to debtors organised or operating in particular jurisdictions? What liability are investors exposed to if they lend to such debtors? Can the investors mitigate their liability? See question 11 above. 13. Are there limitations on an investor s ability to extend credit to a debtor based on the debtor s leverage profile? Currently not. 14. Do regulations limit the rate of interest that can be charged on bank loans? Generally no. However, in insolvency proceedings, extortionate credit transactions can be set aside. Penalty clauses are also unenforceable. Whether a particular default interest clause is penal will depend on the facts of the case. 15. What limitations are there on investors funding bank loans in a currency other than the local currency? None. 16. Describe any other regulatory requirements that have an impact on the structuring or the availability of bank loan facilities. The key regulatory requirements and their impact are covered above. SECURITY INTERESTS AND GUARANTEES 17. Which entities in the organisational structure typically provide collateral and guarantee support for bank loan financings? Are there limitations on which entities in the organisational structure are permitted to provide such support? In secured leveraged transactions, subject to agreed security principles, security is typically taken over all of the material assets of the borrowers and guarantors, shares held by the holding company in the parent of the banking group (where a double holdco structure is used) and shares in intermediate holding companies between borrowers and guarantors. In an acquisition, implementation of the security package with respect to the target group is usually phased. See question 28 for English law restrictions. 18. What types of obligations typically share with the bank loan obligations in the collateral and guarantee support? If so, are all such obligations equally and ratably covered by the collateral and guarantee support? In leveraged structures, certain hedge counterparties typically share in the collateral and guarantee package, pari passu alongside the senior secured lenders. The last few years have seen a rise in pari loan/bond structures (where senior secured loans and senior secured bonds rank pari passu) and all bond/super senior RCF structures (where there is a super priority class comprised of revolving lenders and certain other liabilities, typically hedging for the super senior debt). 05

6 Where there are defined benefit pension liabilities, the scheme trustee may in certain circumstances (particularly if the transaction affects the credit quality of the group) be granted rights to share in the security package or extract some other form of credit support from the employer group. 19. Which categories of assets are commonly pledged to secure bank loan financings? Describe any limitations on the pledge of assets. There are no specific categories of asset over which security cannot be granted or over which it is too difficult to create security under English law. Security is often taken over real estate, shares, bank accounts and other claims and receivables (such as insurances policies) as well as intellectual property rights. There are, however, some practical limitations: Third party consents may be required to create some types of security over certain assets, which may be challenging to obtain. The limits of the distinction between fixed and floating charges (as to which see question 20) can be uncertain, in particular in its application to cash and receivables. A pledge or lien can only be granted in respect of an asset over which possession may be taken. It is not possible to create a legal mortgage of future assets. Grant of security is also subject to the legal limitations outlined in question Describe the method of creating or attaching a security interest on the main categories of assets. Under English law, there are four types of consensual security interest: pledge through transfer of possession, where the pledgee has the power to sell the secured assets and to use the proceeds of sale to discharge the secured obligation; contractual lien where the lienee merely has a passive right of retention until the secured obligation has been performed; mortgage through transfer of title (which can be legal or equitable and including assignment by way of security); and charge (fixed or floating). A charge involves an agreement by the chargor that certain of its property be charged as security for an obligation and is a security interest which entails no transfer of title or possession to the chargee; whether a charge is fixed or floating depends on the degree of control exercised by the secured creditor. The exact choice of security interest depends on the nature of the asset and its importance in the context of the security package. Typically, there are mortgages over real estate, equitable mortgages or fixed charges over registered shares, fixed charges over assets which are identifiable and can be controlled (e.g. blocked bank accounts) and certain intellectual property rights, assignments by way of security of key contractual rights and receivables and a floating charge sweeper over all assets of the company. 21. What steps are necessary to perfect a security interest on the main categories of assets? What are the consequences of failing to perfect a security interest? Subject to limited exceptions, security interests created by English companies must be registered at Companies House within 21 days of creation, whether over assets in the UK or abroad. If this is not done, the security will be void as against a liquidator, administrator or creditor of the company and the secured liabilities will become immediately repayable. 06

7 Certain types of assets (for example real property, ships, aircraft and certain intellectual property rights) may also be registered, generally for priority purposes, on specialist registers. Other perfection steps also relate to priority and depend on the nature of the asset. For example, an assignment of a receivable is perfected by giving notice of the assignment to the account debtor until this takes place, certain set-off rights continue to accrue and there is a risk that a subsequent assignee who takes without notice of such earlier assignment will obtain priority by being the first to give notice. 22. Can security interests extend to future-acquired assets? Can security interests secure future-incurred obligations? It is possible to create an equitable mortgage or charge over future assets, but not a legal mortgage. For a revolving facility the secured obligations must be defined so as to include the balance of the revolving loan from time to time. There are complicated rules relating to priority of subsequent advances forming part of the secured obligations. 23. Describe any maintenance requirements to avoid the automatic termination or expiration of security interests. Generally none. 24. Are security interests on an asset automatically released following its sale by the debtor? If so, are the releases mandated by law or contract. Assets secured by way of a floating charge can be sold without a release as the chargor is permitted to deal with the assets in the ordinary course of its business pending an event which causes the charge to crystallise. A purchaser is, however, likely to require a certificate of non-crystallisation. Other security is usually released by deed, unless the assets are being sold on enforcement or by an administrator or liquidator. 25. What defences does a guarantor have against claims for non-fulfilment of guarantee obligations? Can such defences be waived? The accessory nature of a guarantee makes it vulnerable to the extent that the guaranteed obligations are challenged as the guarantor may rely on any defence available to the person whose obligations are guaranteed. It is therefore customary for a guarantee given to lenders in financing transactions to include an indemnity which creates a primary obligation of the guarantor. Certain acts by a lender will automatically release a guarantor from liability e.g. if a lender agrees to give the debtor extra time to pay or materially alter the underlying agreement without the guarantor s consent. Guarantees typically include contractual waiver of such defences. It is uncertain whether such a provision would be effective to save the guarantee in all circumstances and in practice confirmations should be obtained from the guarantors if there is to be an amendment to the underlying secured obligations, especially if the changes relate to the maturity date, amount of debt or pricing. 26. Describe any parallel debt or similar requirements applicable in a secured bank loan financing where an agent acts for multiple investors. A parallel debt structure is often used as a supplement to the security trustee structure if there are foreign jurisdictions where security is granted but which do not recognise trusts. Under such a structure, a security agent will hold and administer the security on behalf of the syndicate from time to time and will be granted an independent right to demand repayment of the secured obligations under a separate undertaking held by the 07

8 security agent in its own right. The arrangement does not have the effect of increasing the total amount owed by the obligors. 27. What are the most common methods of enforcing security interests? What are the limitations on enforcement? Although certain rights and powers to enforce security come from the general law, security documents generally extend these. The most common methods of enforcements are: appointment of a receiver, foreclosure, possession and sale, administration and (for charges created after 15 September 2003, in certain relatively limited but important circumstances) administrative receivership. Other remedies depend on the nature of the security asset, for example security over bank accounts may be enforced using a contractual right of set-off or appropriation. Generally, the insolvency of the debtor does not affect the enforceability of security, subject to certain exceptions. First, there are claw-back risks see question 28. Secondly, subject to certain carve-outs for financial collateral, during certain types of insolvency proceeding, in particular administration, a moratorium applies preventing secured creditors from enforcing their security without permission. 28. Describe the impact of fraudulent conveyance, financial assistance, thin capitalisation, corporate benefit and similar doctrines on the structure of bank loan financings. The key issues when considering the validity and enforceability of guarantees and security as a matter of English law are capacity and corporate benefit, financial assistance rules and claw back risks in an insolvency. Capacity and corporate benefit In order to grant valid guarantee and security, the grantor must have the requisite capacity and there must be adequate corporate benefit. The corporate benefit analysis must be considered on an entity by entity basis. Upstream and cross-stream guarantees and security may be problematic and a unanimous shareholder resolution is usually required by secured creditors as a condition precedent to funding if there are upstream or cross-stream guarantees and security. Financial assistance Financial assistance rules prohibit a UK public company from giving financial assistance for the purpose of the acquisition of its shares or those of a parent company, and a UK private company from giving financial assistance for the purpose of the acquisition of shares of a public parent company. Financial assistance includes giving guarantees or security. The prohibition applies whether the financial assistance is given before, at the same time, or after the acquisition takes place. Certain exceptions apply but they are often not relevant in the context of secured lending. In practice, if security and guarantees are required from the target group then, post acquisition, the relevant public companies in the target group can be re-registered as private companies before the financial assistance is given. Vulnerable transactions Certain transactions entered into by a company within a certain period prior to its insolvency may be vulnerable to challenge under English insolvency law e.g. rules relating to preferences, voidable floating charges and transactions at an undervalue. 08

9 Vulnerability periods differ depending on the ground for challenge and are: six months for preferences (two years if the counterparty is a connected person), two years for transactions at an undervalue and one year for a voidable floating charge claim (two years if the counterparty is a connected person). There are a number of defences that may be available. INTERCREDITOR MATTERS 29. What types of payment or lien subordination arrangements, or both, are common where the debtor has obligations owing to more than one class of creditors? Subordination in banking transactions is typically effected by the use of structural subordination (where ranking is determined by which company in the group is a debtor (either as a borrower or guarantor) to the junior and senior creditors) and contractual subordination (where creditors contractually agree to the ranking as amongst themselves). Contractual subordination is generally achieved through the use of an intercreditor or subordination agreement. Contractual subordination is often coupled with a turnover trust as a fall-back to maximise the recoveries of the senior creditors in an insolvency of the debtor. Under a basic trust subordination arrangement, the junior creditor agrees that any money it receives from the debtor in insolvency (e.g. in the event of mandatory insolvency set-off or other mandatory distribution contrary to the intercreditor agreement) will be held on trust for the senior creditors to the extent of the senior debt. Where effective, this has the advantage of giving the senior creditors a proprietary claim against the junior creditor and means the senior creditors will not be exposed to credit risk on the junior creditor. It is generally agreed that, as a matter of English law, contractual subordination should be enforceable as between the contracting parties. In jurisdictions where trusts are not recognised, there is a risk that a junior creditor trustee will be treated as sole owner of the turnover property. There is also a limited risk that, in the event of an insolvency, the turnover trust provisions may be re-characterised as a security interest, which would be void for lack of registration. There is case law support for the proposition that a turnover trust provision will not be re-characterised as a charge if it is limited to the amounts required to pay the senior creditor in full and it is therefore generally thought that this risk can be mitigated with careful drafting. 30. What creditor groups are typically included as parties to the intercreditor agreement? Are all creditor groups treated the same under the intercreditor agreement? All creditors whose debt is to be ranked and otherwise regulated will be party to the intercreditor agreement e.g. senior lenders, mezzanine lenders, hedging counterparties, security trustee/agent, bondholder trustee/other representative and intra-group creditors. Different creditor groups will have different voting rights and this will be a function of what is considered to be market standard for particular debt structures and the negotiation dynamics. For example, in pari loan/bond structures, pre-2012, majority senior lenders generally controlled enforcement decisions but full proportional voting rights for senior secured noteholders, on a one euro one vote basis, has now become market standard in these deals. 09

10 The intercreditor will also regulate different creditor group s payment rights as well as enforcement rights and ability to take enforcement action. 31. Are junior creditors typically stayed from enforcing remedies until senior creditors have been repaid? What enforcement rights do junior creditors have prior to the repayment of senior debt? There is typically a standstill period during which junior creditors undertake not to accelerate or take action to enforce the junior debt to give the senior creditors time to formulate a strategy. Standstill periods vary, often by reference to the type of default that has occurred or type of debt. Enforcement restrictions are usually drafted widely to include demands for payment, the exercise of any set-off rights or steps towards insolvency proceedings. Generally, acceleration or enforcement of the junior debt prior to expiry of the standstill period will be permitted only with consent of the senior creditors or on insolvency of the debtor; if the senior creditors have taken some enforcement action, the junior creditors are also normally allowed to take equivalent action. 32. What rights do junior creditors have during a bankruptcy or insolvency proceeding involving the debtor? See above the restrictions typically fall away, subject to senior creditors rights to control the process and turnover provisions. 33. How do the terms of the intercreditor arrangement change if creditor groups will be secured on a pari passu basis? As mentioned above, proportional voting as between senior secured lenders and bondholders has become market standard in pari deals since No payment blockages or enforcement standstills apply to the senior secured bank/bond debt. The definition of instructing group in these deals is key and will be subject to negotiation. There has been a shift upwards in the required voting thresholds to enforce, from a bare majority of all senior secured creditors to 66 2/3rds per cent, typically driven by a desire to avoid giving bondholders full control of enforcement decisions. Where hedging creditors rank pari passu with senior creditors, in order to avoid senior voting being skewed by hedge movements, hedging creditors votes are generally based on actual settlement amounts due to the hedge counterparties and remaining unpaid following a permitted termination or close out. Hedge counterparties are normally only allowed to vote on open positions based on an assumed settlement amounts after the senior secured debt is discharged. LOAN DOCUMENT TERMS 34. What forms or standardised terms are commonly used to prepare the bank loan documentation? Most syndicated loans are documented using the Loan Market Association (LMA) recommended forms as a starting point for negotiations. 35. What are the customary pricing or interest rate structures for bank loans? Do the pricing or interest rate structures change if the bank loan is denominated in a currency other than the domestic currency? Syndicated bank loans are typically floating rate and interest is usually made up of the appropriate benchmark rate plus a margin. LIBOR and, for loans in euro, Euribor are the standard benchmarks used, however it is possible to easily adapt documentation to the use of other benchmarks. 10

11 36. What other bank loan yield determinants are commonly used? Original issue discounts (OIDs) and pricing floors are both used in leveraged deals. 37. Describe any yield protection provisions typically included in the bank loan documentation. An increased costs clause is a feature of virtually all loan agreements. Under the LMA increased costs indemnity, a borrower must (subject to certain exceptions) reimburse the lenders for any increased costs they incur in relation to their participation in the facilities as a result of a change in law or regulation after the date of the agreement. Since 2014, it has become common for lenders to seek to adjust the terms of the increased costs indemnity to provide expressly that, subject to certain limits, costs relating to Basel III and CRD IV fall within its scope (although lenders are sometimes willing to relax their position for stronger credits). The treatment of UK withholding tax risk in loan documentation is well settled and reflected in the LMA s English law templates. In summary, the borrower is obliged to gross-up the amount payable to the lenders should the borrower be required to deduct tax from such payments, provided the recipient lender was a Qualifying Lender on the date of the agreement. The effect is to limit the circumstances in which the borrower might become obliged to deduct tax and gross-up any payment to a lender to a change in law which results in a day-1 Qualifying Lender ceasing to be exempt from UK withholding tax. Prepayment premiums have traditionally not been a feature of the English loan market although it is now not uncommon to see call protection included for term loans in certain leveraged facility agreements see question 4. If the borrower repays mid-interest period, this will be subject to break costs. Market disruption provisions are also usually included in facility agreements where interest is calculated by reference to a benchmark. 38. Do bank loan agreements typically allow additional debt that is secured on a pari passu basis with the senior secured bank loans? See question 2. If there is an intercreditor agreement, it is important to ensure that a mechanism is included for the incurrence of additional senior secured debt. 39. What types of financial maintenance covenants are commonly included in bank loan documentation, and how are such covenants calculated? Leveraged loans in the European market have traditionally included a combination of the following financial covenants: leverage ratio, interest cover, debt service cover, cashflow cover and limits on capital expenditure, typically set to permit the business to underperform an agreed base case model by a specified percentage (e.g %). However, since 2013, covenant-lite and covenant-loose loans have re-emerged to become a reasonably significant feature of the European loan market as European investors have come under pressure to compete with the US loan and high yield markets. In covenant-lite deals, a single financial maintenance covenant, almost invariably a leverage covenant, is usually included for the benefit of the revolving credit facility lenders only. There is usually significant headroom and the covenant is a springing covenant which is tested when the revolving facility is drawn (or the drawn amounts exceed a certain threshold). Covenant-loose facilities by contrast include limited maintenance covenants, usually a leverage covenant and sometimes also an interest cover ratio, for both term and revolving facility lenders. Almost half of European leveraged loans completed during 2014 were covenant-loose. 11

12 Equity cure rights, i.e. the right to pay additional equity or subordinated debt into the business for the purposes of curing a financial covenant breach, are a feature of most leveraged loan agreements. Negotiations focus on how any equity cure amounts should be applied (to increase EBITDA or to reduce borrowings and in the case of the latter whether actual prepayment is required), the number of times the right can be exercised, whether overcures are to be permitted and the effect of the cure for the period in which it is made and any subsequent periods. 40. Describe any other covenants restricting the operation of the debtor s business commonly included in the bank loan documentation. It has traditionally been customary, especially in the leveraged loan market, to see restrictions on payment of dividends, major disposals, acquisitions, mergers, change of business and incurrence of debt as well as a negative pledge restricting the creation of further security and quasi-security, all subject to specific carve-outs and baskets. As part of the recent trend towards looser financial covenants, we are seeing certain maintenance covenants develop US-style characteristics. For example, rather than a traditional permitted basket with a set amount, it is not uncommon to see permitted debt based on a leverage test with a separate general debt basket. 41. What types of events typically trigger mandatory prepayment requirements? May the debtor reinvest asset sale or casualty event proceeds in its business in lieu of prepaying the bank loans? Describe other common exceptions to the mandatory prepayment requirements. The circumstances in which mandatory prepayment is required vary but common triggers are illegality (i.e. it becoming unlawful for a lender to continue to lend) and a change of control occurring in relation to the borrower group. A loan agreement may additionally include a combination of the following triggers: an equity or debt capital markets issue, an IPO, disposal of assets, receipt of insurance proceeds, receipt of payments under warranties in a sale and purchase agreement and excess cash flow. Requirements to make mandatory prepayments are generally subject to exceptions. For example, the requirement to prepay disposal proceeds is usually subject to a de minimis threshold, a basket and an ability to deduct reasonable costs associated with the disposal. The borrower usually has a period in which to reinvest or commit to reinvest the proceeds for certain specified purposes and specific carve-outs are included e.g. for disposals in the ordinary course of business/trading and intra-group disposals. It is also possible to exclude disposals of specific assets, or to impose some other criteria, perhaps by reference to leverage targets. Provisions are included to deal with trapped cash (i.e. where disposal proceeds are received at a subsidiary level and it is either not possible or cost efficient to upstream the cash). 42. Describe generally the debtor s indemnification and expense reimbursement obligations, referencing any common exceptions to these obligations. A borrower will typically provide extensive indemnities and cost reimbursement to the lenders, facility agent and security trustee (the finance parties ), including: increased costs (see question 37), tax indemnity, currency indemnity, acquisition indemnity in the case of acquisition financings, agents indemnities (see question 6), costs indemnities covering the finance parties transaction costs and expenses (including legal fees), and costs incurred by the finance parties in connection with the enforcement or preservation of their rights under any finance document. 12

13 september 2015 Loans and Secured Finance 2016 UPDATE & TRENDS The growth of direct lending funds, private placements and other alternatives to traditional loan finance seems set to continue and, in recent months, the nascent UK private placement market has received a boost from the introduction of LMA documentation, market guidelines and a new withholding tax exemption. It will be interesting to see whether competition from these alternative sources and the high yield/tlb markets as well as the willingness of US investors to invest in European assets will result in further cross over of US terms and covenant-lite structures into the European leveraged loan market, including the mid-market. AUTHOR(S): AZADEH NASSIRI, PARTNER T +44 (0) E azadeh.nassiri@slaughterandmay.com Azadeh is a partner in the London office of Slaughter and May. She has a broad financing practice covering, among other things, investment grade lending as well as acquisition and leveraged finance transactions and has advised on a number of complex, cross-border deals. SOPHY LEWIN, PROFESSIONAL SUPPORT LAWYER T +44 (0) E sophy.lewin@slaughterandmay.com Sophy Lewin is a professional support lawyer in the London office of Slaughter and May, where she specialises in acquisition, leveraged and investment grade loans, and non-bank lending products. Slaughter and May 2015 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. OSM _v02