Crash Course in Covenants and Collateral

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Crash Course in Covenants and Collateral Robert

Clubb May 19, 2016 Structuring Considerations

Dodd-Frank and guaranties/grants of collateral

1 Crash Course in Covenants and Collateral Robert J. Heinrich Emily L.M. Clubb May 19, 2016 Structuring Considerations Borrowers and guarantors Consider who ultimately gets the funds Cross-defaulting/guarantying/collateralization Dodd-Frank and guaranties/grants of collateral Fraudulent transfer issues/preferences Consideration is key Common enterprise clause 1 Guarantee Scenario 1

2 Structuring Considerations (cont.) Deemed dividends U.S. borrowers: Beware of deemed dividends where pledge or guaranty involves a foreign controlled corporation Limit U.S. pledges of stock of first-tier foreign subsidiaries to 65% of total voting stock No upstream guaranties by foreign subsidiaries No collateral grants by foreign subsidiaries 3 Deemed Dividend Example "Excluded Property" means any voting stock, membership interest or other equity interest of any foreign Subsidiary in excess of 65% of the aggregate voting stock, membership interest or other equity interest of such foreign Subsidiary 4 Commonly Negotiated Items Cross-defaulting/guarantying/collateralization Covenants and representations Affirmative/negative Financial Defaults Payoffs 5 2

3 Covenants and Representations Base definitions Indebtedness Investments Liens Qualifiers Materiality (e.g., "in all material respects," "material adverse effect") Knowledge (When? Whose knowledge?) 6 Covenants and Representations (cont.) Baskets and thresholds Examples Baskets for types of permitted indebtedness Minimum thresholds for providing notice of damages or judgments of a certain value Applicability Borrower and subsidiaries Material subsidiaries Guarantors 7 Financial Covenants Debt to EBITDA ratio Total leverage ratio Senior leverage ratio Fixed charge coverage ratio Indicates a borrower's ability to satisfy fixed financing expenses (interests and leases) Debt service coverage ratio Measures ability of cash flow to pay current debt obligations 8 3

4 FCCR Example "Fixed Charge Coverage Ratio" means, for any period for which such ratio is being computed, the ratio of (a) (i) EBITDA, minus (ii) all dividends and distributions paid in cash, minus (iii) all federal and state income taxes paid in cash, minus (iv) Capital Expenditures not funded by borrowed money, to (b) the sum of (i) cash interest paid on Indebtedness, plus (ii) cash interest paid on Capitalized Lease Obligations, plus (iii) scheduled principal payments of Indebtedness, plus (iv) scheduled principal payments on Capitalized Lease Obligations; all as determined, without duplication, for such Person and its Consolidated Subsidiaries for such period Borrower shall not permit the Fixed Charge Coverage Ratio to be less than :1.00 as determined for any period of four consecutive fiscal quarters ending on the last day of each fiscal quarter commencing with December 31, DSCR Example "Debt Service Coverage Ratio" means the ratio of (a) the sum of (i) EBITDA, minus (ii) Restricted Payments paid in cash, minus (iii) Capital Expenditures not financed with long term Indebtedness; and (b)the sum of (i) Interest Expense, (ii) regularly scheduled principal payments with respect to Indebtedness, and (iii) payments made with respect to Capitalized Leases; all determined for such Person for the 12 month period preceding the date of determination Borrower shall not permit its Debt Service Coverage Ratio to be less than :1.00 as of December 31, 2016 or as of the last day of any fiscal quarter thereafter 10 Financial Covenants (cont.) Minimum tangible net worth Shows physical net worth of a company Cap on operating leases Cap on capital expenditures Usually an annual limitation 11 4

5 Defaults General insecurity clause When is it needed? Are financial covenants set to alert lender of potential default? Is it a new company or new relationship that has not yet been tested? 12 Insecurity Clause Examples DEFAULT. Each of the following shall constitute an Event of Default under this Agreement: Insecurity. Lender in good faith believes itself insecure. Adverse Change. A material adverse change occurs in Borrower's financial condition, or Lender believes the prospect of payment or performance of the Loan is impaired. 13 Defaults (cont.) Cross defaults Bankruptcy defaults Automatic acceleration Grace/cure periods 14 5

6 Cross Default Example DEFAULT. Each of the following shall constitute an Event of Default under this Agreement: Any Borrower [a] fails to pay when due any other Indebtedness issued or assumed by such Borrower or [b] fails to comply with the terms of any agreement executed in connection with such Indebtedness and such default continues beyond any applicable cure period 15 Bankruptcy Default Example DEFAULT. Each of the following shall constitute an Event of Default under this Agreement: Borrower (i) commences any case, proceeding or other action under any existing or future Debtor Relief Law, seeking (A) to have an order for relief entered with respect to it, or (B) to adjudicate it as bankrupt or insolvent, or (C) reorganization, arrangement, adjustment, winding-up, liquidation, dissolution, composition or other relief with respect to it or its debts, or (D) appointment of a receiver, trustee, custodian, conservator or other similar official for it or for all or any substantial part of its assets, or (ii) makes a general assignment for the benefit of its creditors; 16 Bankruptcy Default Example DEFAULT. Each of the following shall constitute an Event of Default under this Agreement: there is commenced against Borrower in a court of competent jurisdiction any case, proceeding or other action of a nature referred to in clause (a) above which (i) results in the entry of an order for relief or any such adjudication or appointment or (ii) remains undismissed, undischarged, unstayed or unbonded for 60 days; there is commenced against Borrower any case, proceeding or other action seeking issuance of a warrant of attachment, execution or similar process against all or any substantial part of its assets which results in the entry of an order for any such relief which has not been vacated, discharged, stayed or bonded pending appeal within 60 days from the entry thereof; 17 6

7 Grace/Cure Period Example DEFAULT. Each of the following shall constitute an Event of Default under this Agreement: Borrower fails to pay any principal or interest of any Loan, whether due at stated maturity, by acceleration or otherwise, and such failure remains unremedied for a period of five days Borrower fails to perform any covenant, term, condition or agreement contained in sections 5 and 6 hereof [certain affirmative covenants and all negative covenants], or Borrower fails to perform any other covenant, term, condition or agreement contained herein and such failure continues unremedied for 30 days 18 Payoff Letters What should you ask for? Define "all obligations" Immediately release liens Possessory collateral Global release of claims Clarify who files termination statements 19 Lien Release Example Effective upon its receipt of the Payoff Amount, the Bank absolutely and irrevocably discharges and releases all liens, security interests, collateral, pledges, mortgages, guarantees, sureties, assignments and other rights that have been granted to the Bank as security for, in support of or otherwise in connection with the Obligations 20 7

8 Collateral Perfection by Filing Filing a UCC financing statement Perfect most types of collateral General intangibles Inventory and equipment Commercial tort claims Accounts receivable Exceptions if control or possession is mandatory or permissive Investment property Deposit accounts 21 UCC Financing Statement Reminders Debtor name Certified articles Individuals Collateral description "All assets" Specific listings Location, forms, fees Fixture filings E.g., Florida, Louisiana, Tennessee, St. Louis 22 Perfecting Investment Property Uncertificated securities File financing statement Certificated securities Deliver certificated security to lender Deliver signed blank stock power (allows transfer of ownership of certificated securities) Usually file financing statement as well Securities account Control agreement 23 8

9 Issues in Perfecting LLC Interest Review organizational documents for: Reference to Article 8 as governing Restrictions on transfer UCC Anti-Assignment Rules can override those provisions Some states do not have standard antiassignment rules (Delaware) Consent from other members 24 Perfecting Security Interests in Deposit Accounts Lender is the bank that maintains deposit account Control agreement if lender is not the bank that maintains deposit account Deposit account is in the name of the lender 25 Intellectual Property Copyrights U.S. Copyright Act preempts UCC for perfection and priority For copyright registrations and applications, but not unregistered copyrights File Notice of Security Interest in Copyrights with U.S. Copyright Office List out the specific copyrights covered Trade secrets No federal preemption 26 9

10 27 Intellectual Property (cont.) Trademarks and patents Filings under UCC are sufficient for perfection Recording in U.S. Patent and Trademark Office provides protection against subsequent bona fide purchasers Common practice for all intellectual property File UCC financing statement Record Notice of Security Interest in appropriate office Vehicles (Certificates of Title) Electronic filing with DOT Listing lender as lien holder Can search electronic filings online Filing alone not enough Need underlying security agreement 28 Collateral Not Covered by UCC Real estate Life insurance 29 10

11 Life Insurance Not governed by UCC Filing is not effective for perfection Collateral assignment Generally on insurer's form Needs insurer's acknowledgement Must be assigned by policy owner In-force ledger From insurance company prior to closing Shows other liens, current status of policy 30 Special Lien Issues for Agricultural, and Food and Beverage Lenders Food Security Act of 1985 Perishable Agricultural Commodities Act Packers and Stockyards Act State law issues 31 Contact Information Robert J. Heinrich Emily L.M. Clubb North Water Street, Suite 1700 Milwaukee, WI

Crash Course in Covenants and Collateral

Crash Course in Covenants and Collateral Robert J. Heinrich Emily L.M. Clubb May 19, 2016 Structuring Considerations Borrowers and guarantors Consider who ultimately gets the funds Cross-defaulting/guarantying/collateralization