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Podcast: 2020 in the Rear View Mirror (almost): Current Topics and Trends in Debt Documentation


Time to Listen: 35:30 Practices: Credit Funds, Special Situations, Asset Management, Finance, Lending

In this Ropes & Gray podcast, capital solutions and finance partners Joanne De Silva, Alyson Gal and Leonard Klingbaum, counsel Milap Patel and associate Rob Bennett, discuss topics and trends in debt documentation over the course of 2020. The discussion includes a reflection on the challenges faced and strategies implemented as documentation provisions performed under enormous stresses as a result of the global pandemic. Topics discussed include MAE conditionality, financial covenant definitions, value and priority shifting financings in the context of restructurings and general liquidity transactions and key terms under negotiation.

credit-funds


Transcript:

Leonard KlingbaumLeonard Klingbaum: Hello, and thank you for joining us today on this Ropes & Gray podcast. I'm Leonard Klingbaum, a partner in the finance and capital solutions group. I'm joined today by my partners Alyson Gal and Joanne De Silva, as well as Milap Patel, a counsel in the finance and capital solutions group, and Rob Bennett, an associate in the finance and capital solutions group. Today's podcast is a discussion on the topics and trends that we have seen over the course of 2020 in debt documentation, and we will talk about things such as MAE conditions, financial covenants, financings and restructurings, and priming transactions. To get us started, I welcome my partner, Alyson Gal. Alyson?

Alyson GalAlyson Gal: Thanks, Leonard. No one could deny that this has been an eventful year. We will be having a conversation on this podcast about how documentation provisions performed under the enormous stresses that we have experienced this year and how we have seen different scenarios play out.

One thing we should say at the outset is that we are not taking sides on any of these topics. We are frequently on all sides of these issues, both as a firm and individually, and we know that many in the audience are too.

First, it seems like eons ago, but recall that in the spring when the pandemic first hit the economy with widespread shutdowns and the near elimination of revenues from many companies, borrowers’ ability to access revolvers and their likely financial covenant breaches were the immediate focus for many companies. Rob, can you remind us of the debate that was going on in the spring around how the pandemic-related shutdowns impacted borrowers' ability to draw on revolvers and how that all played out?

Rob BennettRob Bennett: Thanks, Alyson. As you all know, there was tremendous turmoil in global markets during the last year from COVID-19-related issues. At the beginning of the pandemic, many companies focused on ensuring they had sufficient liquidity to support operations during a potentially prolonged downturn. During that time, there were several things that borrowers, because they were worried about liquidity, and lenders, because they were in turn worried about their own balance sheets, focused on. Borrowers generally are required to bring down representations and warranties in connection with each revolving draw. Borrowers and lenders were focused in particular on the language of their “no material adverse change” clauses, including whether the MAC representation covers a material adverse change in the borrowers' business “prospects.” Separately, borrowers were also focused on their solvency representations, particularly whether the solvency representation was limited to historical solvency. If so, the borrowers would only have to represent that they were solvent at the time of the original closing of the credit facility. If the solvency representation was not limited to the original closing, it would create a higher standard for the borrowers to meet because they would have to be pro forma solvent, taking into account the downturn.

There was also serious concern in the marketplace that certain lenders may not have had sufficient liquidity to fund revolver draws. At the same time as borrowers were looking at drawing on revolvers to shore up liquidity, certain lenders were looking at ways to avoid funding due to their own capital constraints. Some non-bank lenders, particularly those that were levered, were concerned about their own ability to fund revolvers. Most had not modeled the scenario where all of their clients drew down on their revolvers at the same time. Certain lenders tried to shore up their positions, whether by clubbing out pieces of revolvers to other lenders or drawing on their own revolvers at the fund level.

One of the other provisions that was important to consider in connection with revolving draws was financial covenant compliance. These revolvers often have financial maintenance covenants that are “springing” in nature – this means they will only apply to the revolving credit facility if certain thresholds are met. For example, a covenant may only be tested if the revolving credit loan is outstanding or above a certain dollar amount on the date of testing. Therefore, a borrower can avoid being required to meet any financial maintenance covenant if it reduces its revolving credit usage below the threshold trigger at the time of testing. However, in more lender-favorable credit agreements, lenders require the financial covenant to be satisfied on a pro forma basis as a condition to making a new revolving loan.

Alyson Gal: That would provide greater lender protection. It seems like this experience must have really focused lenders on the limitations of MAC-based conditionality. What are some ways that lenders could address those limitations?

Rob Bennett: Lenders and borrowers alike reviewed material adverse change and material adverse effect clauses in their loan documents in the earlier part of this year. However, a decision to withhold funding on the basis solely of a MAC clause having been tripped is a decision that lenders do not take lightly. The risk of taking an aggressive stance may have a disastrous impact on a borrower's liquidity and survival, and therefore, subject a lender to significant liability and reputational risk. Generally, MAC clauses include several prongs, including the potential or actual impact on a borrower's business and the impact on a borrower's ability to perform under its loan documents. In the future, lenders may push for certain MAC clause definitions that include events that have a material adverse effect on the borrower's prospects. But I think it is key here to consider in the overall context that even in the worst of the worst, when things were very bad back in March and April, which lenders were still very hesitant to invoke these clauses due to their own liability.

Alyson Gal: Rob, you make a good point. It is very hard to be confident that you will be successful in asserting a MAC clause and the risk that after litigation a lender will be found to have unjustifiably refused to fund is very chilling on a lender's attempt to or consideration of invoking a MAC clause. That is why I always suggest to clients which are considering conditions to funding and what conditions they are going to require, that if there are certain things that are critical to their business comfort level with funding a particular loan, they put those specific conditions in the loan document as conditions rather than merely relying on a general MAC clause.

During this period, though liquidity was the first order of business, borrowers and lenders were also highly-focused on financial covenant compliance and how the extraordinarily complex financial definitions that have evolved in loan documents might be interpreted by borrowers. Milap, can you talk about some of the points that were front of mind this year?

Milap Patel

Milap Patel: Well, Alyson, it has been quite a year. The economic turmoil as a result of the COVID-19 pandemic certainly put pressure on financial covenant compliance. It caused sponsors and borrowers to take a closer look at their EBITDA definitions, in particular, whether the add-backs and adjustments set forth in the EBITDA definitions of their credit agreements could be broadly interpreted in a manner to address the COVID-19 pandemic. Essentially, both borrowers and lenders found themselves in a position of interpreting language for circumstances that were not previously contemplated, and this resulted in some borrowers pushing the boundaries of historical practice and custom in the face of unchartered waters. 

For example, many credit agreements contain an add-back for extraordinary, unusual or non-recurring charges. “Extraordinary” is a term that was historically used under GAAP, but it is no longer a term recognized under GAAP, although it still appears in credit agreements as a holdover from the past. “Non-recurring” is not a GAAP term either, but it is customarily understood to include charges or expenses that are unusual, infrequent or one-time in nature.

I view the justification of COVID-related add-backs on a sliding scale with one side of the spectrum being more easily defensible add-backs for non-recurring expenses relating to COVID testing, extra training costs and additional cleaning expenses. The next category of add-backs that are more controversial would be whether regular, ordinary operating expenses could be added back in calculating EBITDA. For example, for a restaurant or retail store location that is shut down, could the borrower add-back the cost of paying rent and the payroll costs associated with such location? That was a debated point earlier this year, and there are many other variables and nuances to consider in trying to make such a determination. For instance, one may draw different conclusions depending on whether the reason for the closure of such restaurant or retail location was as a result of a government mandated shutdown or was the result of the borrower's business decision? Ultimately, there is no right answer for the industry as a whole, and the analysis is very fact specific and it also hinges on what the words in the credit agreement say.

Alyson Gal: Milap, one thing I had heard was under consideration was borrowers’ attempt to add-back lost revenues, that is to increase their EBITDA by revenues that they believe they would have earned if not for the shutdowns. Is there reason to believe that adding back lost revenues is something that would or could be permissible? That just seems like a tough argument.

Milap Patel: You are right. At first glance, Alyson, it certainly seems like a stretch. It is very uncommon to see an EBITDA definition that explicitly permits the add-back of lost revenue, and thus, it may not be supportable under most current definitions. However, there are parallels to adding back revenue in other contexts. For example, some credit agreements give pro forma credit for new store locations or new customer contracts, which would enable the borrower to recognize the full year's anticipated growth and revenue from such new locations and contracts at the time of opening such new store or entering into a customer contract. Another parallel is the ability to pro forma the revenue of a target company upon consummation of a strategic acquisition. So really, at the end of the day, desperate times can lead the borrower to take aggressive positions, and the actual words on the page are open to interpretation.

Alyson Gal: Thanks, Milap. What, if anything, have borrowers and lenders been proposing as changes to financial covenant formulations in order to improve on these definitions or to add more certainty?

Milap Patel: The solution to ambiguity in the documentation is to have the lawyers draft language. As it turns out, the liquidity crisis led to borrowers having difficulty making interest and amortization payments, and thus, it brought borrowers and lenders to the table to craft responsive language to address the definitional uncertainties and potential financial covenant breaches. Borrowers negotiated financial covenant holidays that suspended financial covenant testing through either Q4 2020, or for those borrowers with more foresight or negotiating leverage, through Q2 2021. That covenant relief was coupled with the addition of a minimum liquidity covenant and increased financial reporting, including a 13-week cash flow forecasts. 

We saw three different approaches for testing financial covenants once the financial covenant holiday period ended. The first approach is the annualization approach. For example, for a company whose next financial covenant test date is Q1 2021, the company would multiply actual EBITDA for such Q1 2021 quarter by four. The second approach is the historical approach using 2019 results. So in this example, the company would use historical financial results from Q2 2019, Q3 2019, Q4 2019 and then the actual Q1 2021 results. And the third approach is the deemed EBITDA approach, whereby lenders and the company would agree upon EBITDA numbers for 2020, and those numbers be based upon 2019 historical periods multiplied by a growth factor.

We also saw a host of credit agreement amendments relating to PPP loans. For instance, amendments clarified that there would be no adjustment or add-back to EBITDA for either the incurrence of the PPP loan or the forgiveness of the PPP loan, as the forgiveness of such a loan would ordinarily give rise to cancellation of debt income, a non-cash item. Also, some borrowers were able to get an explicit carve-out of PPP loans for purposes of calculating leverage ratios. And finally, some amendments provided for additional time to deliver audited financials and also granted “going concern qualification” waivers.

Alyson Gal: Wow – a lot of changes there. Turning to restructurings, the pandemic shutdowns and general impact of COVID-19 on the economy created liquidity issues for a wide array of businesses, leading to creative and, some would say, aggressive approaches to raising liquidity. In a number of these situations, certain lenders, who for reasons that have to do with access to liquidity or simply being able to negotiate competitively, were able to negotiate favorable terms for themselves while other lenders were left with worse treatment in terms of economics or priority or both. One area in which we saw lender groups jockeying for positions was bankruptcy restructuring. Leonard, can you talk a bit about how restructuring discussions evolve and some of the ways in which groups of lenders can end up with differing opportunities as part of that process?

Leonard Klingbaum: Thanks, Alyson – happy to do so. The jockeying for positions has become even more prevalent in this current economic climate than ever before. To some extent, that relates to the fact that lenders and borrowers have been taking more aggressive positions than in the past. We have seen that with such things as priming and dropdown transactions being made available to a subset of lenders, but not the whole lender group. My colleagues will discuss those sorts of situations in a little bit more detail later on. But suffice it to say the coalescence around transactions available to some, but not all, lenders drives the need to be out in front of the borrower and other lenders sooner rather than later. One of the ways we've seen lenders get out ahead of other lenders is through the use of cooperation agreements. These are essentially agreements among the borrower and at least the required lenders laying out a plan amongst that group to restructure the debt of a borrower and protect the majority of lenders. Such agreements may include plans to effectuate priming transactions as a means of injecting additional capital and improving the majority lender position in a capital structure, and ensuring that no other parties will have the opportunity to redirect the borrower's approach. Notably, such agreements and their related underlying anticipated transactions may afford some lenders the opportunity for additional fee income in the form of things like structuring, backstop and underwriting fees. With a growing view that the cost of Chapter 11 often outweighs the benefits or that a formal process injects uncertainty and risk, pre-negotiated plans also are a growing theme we are seeing. Like cooperation agreements, such plans give majority lenders heightened controls and often times additional fee income to those driving the process. Moreover, they often put minority lenders in a disadvantageous position through the process and importantly, in the capital structure of a reorganized borrower. In addition to priming transactions, exclusive cooperation agreements or pre-negotiated plans, we also anticipate a growing use of non-pro rata priming DIP financings.

Alyson Gal: Leo, how can priming transactions like ones we have seen lately be translated into DIP financings?

Leonard Klingbaum: Traditional DIP financings are where typically existing secured lenders provide financing during a company's Chapter 11. That kind of financing is typically done on a priming basis – that is, pursuant to Section 364(d) of the Bankruptcy Code, lenders are granted a lien that jumps ahead of all other pre-petition liens. As you may well know, the additional feature of many DIP financings includes a roll-up. That concept can take different forms. One such form is the traditional “creeping roll,” where receivables collected post-petition are used to pay down pre-petition debt and gives the debtor a corresponding amount of availability under its DIP financing. Over time, the idea is to move a debtor's pre-petition facility into entirely post-petition debt.

The other approach has been what I affectionately call the “plunk over” – that is, at a given point in time, usually entry of a court's final DIP order, a sum certain of pre-petition debt is deemed refinanced by an equal amount of post-petition DIP financing. The ratio of converted debt to new money being loaned can range anywhere from one-to-one to as much as one-to-three or even one-to-five. The roll-up, however, may not need to be pro rata. At its heart, it is an up-tiering exchange of debt – that is, taking first lien pre-petition debt and making it superpriority, or priming, post-petition debt. Not unlike some of the transactions that will be discussed later, these transactions may not need to be pro rata, although they have tended to be. But as we've said several times in various settings, the current state of loan documentation may not afford lenders equal protections. For example, amending the pro rata payment provisions could be done by a majority vote. In that situation, you could see roll-ups preceded by amending loan documents to change the pro rata payment provisions such that the deemed refinancing by a roll-up is not on a pro rata basis. Also, the growth of open market purchases of debt perhaps could be translated into a non-pro rata priming transaction, but in the context of a DIP financing.

Once again, we can see opportunities for groups of lenders to control an outcome whereby they prime other lenders, receive enhanced economics and potentially collect on ancillary fees, such as structuring and commitment fees. An important note, though, is while the flexibility within loan documents permits some lender-on-lender violence, it also permits issuers and sponsors to have a path forward without the need to attain 100% consensus, which is a standard often hard to achieve.

Alyson Gal: Thanks, Leonard. One thing that is important to note about priming transactions in the context of a DIP financing is that converting debt from pre-petition debt to post-petition debt means that they are taking debt that can be restructured without the consent of a lender in a bankruptcy and turning it into debt that has to be paid in full, in cash, as part of a bankruptcy restructuring – that is a really important elevation of rights. Are there things that credit funds and other lenders can do to position themselves to be in the best position in these situations?

Leonard Klingbaum: Frankly, it remains my view that the best thing to do is to get involved early – ensure some visibility, or better, drive a process. While there is no guarantee that this will result in being part of the majority that leads a transaction or collects on fees, it is more likely to succeed than being too passive. Of course, being proactive may not jive with your overall strategy or your firm's institutional preferences, so clearly, those factors need to be considered as well.

Alyson Gal: Turning to the non-bankruptcy context, an area that has been of intense focus in 2020 are aspects of credit documents that facilitate the ability of companies to raise additional liquidity on a priority basis. Some of the most controversial liquidity raising transactions have involved non-pro rata exchanges, where lenders provide the borrower with additional liquidity or a discount on their existing debt in exchange for the right to exchange their existing loans for debt that has priority over the un-exchanged debt of the same tranche. Because these transactions have the effect of elevating some lenders' claims over others of the same or even previously senior priority, these deals have been labeled “lender-on-lender violence,” and have also been given the neutral seeming label of “liability risk management transactions.” Joanne, can you talk about how these recent transactions differ from what has been done in the past and what form these deals typically take?

Joanne De SilvaJoanne De Silva: Sure – thanks, Alyson. There is nothing new about borrowers taking a close look at their existing loan documents to find ways to raise liquidity, and finding avenues to do this that their current lender group may not be thrilled about. Using investment baskets to contribute valuable IP or other assets to unrestricted or non-guarantor entities, where those very assets can then serve as collateral for a new loan is one type of transaction that has become somewhat notorious. The now famous J. Crew blockers are one way that lenders have protected against this, by restricting the designation of subsidiaries that hold material IP as unrestricted subsidiaries, and limiting transfers of material IP to unrestricted subsidiaries.

Another way that companies have sought to raise liquidity is by using incremental debt capacity to incur expensive pari passu debt, while looking for exceptions to the MFN to avoid providing a rate increase to existing lenders. This is often employed by companies whose credit quality has worsened since its existing credit agreement was put in place. This makes considering the size and scope of the aggregate investment capacity viewed as the totality of the various carve-outs, and incremental debt capacity, all the more significant when negotiating loan documents.

Some aspects of these recent transactions that have drawn so much attention are:

  • first, that majority lenders are provided the opportunity to exchange into priority debt while others are not; and
  • second, that majority lenders are using their voting control to amend the existing loan agreement to create the very priming debt baskets that permit these non-pro rata transactions, and sometimes strip the agreement of other protective covenants.

Ropes has been involved in many of these transactions from a variety of perspectives, so I should say that what I am covering is from publicly available sources. Many of these situations are in litigation and our clients are involved in some of them, so we are not able to provide a view on whether certain transactions are permitted under the documents.

I also note that given the competition for new financings, there is somewhat limited appetite for significant changes to precedent credit agreements. Having said that, we are seeing some pushback on certain looser provisions in loan documents, which have been relied on by companies to obtain new debt that primes its non-participating existing lenders.

One example of this is the “pro rata sharing” provision. Transactions where some lenders receive payments that others do not implicate these “pro rata sharing” provisions as well as payment waterfalls. These are the provisions that require that all payments, or a certain specified payments, be made to lenders on a pro rata basis that corresponds to their percentage share of the facility.

In past priming transactions, the focus has been on whether these provisions were broadly written to cover optional payments as well as required payments, and on whether the provisions were able to be amended by a majority vote or required the consent of all affected lenders. Companies have argued that even where the amendment provisions require a higher voting threshold for specified pro rata sections of the credit agreement, that the majority lender standard should apply to transactions that “are otherwise permitted by the credit agreement” and for amendments of other sections that might impact pro rata sharing.

In a tightly drafted pro rata sharing provision that could not be modified by a majority lender vote, non-pro rata payments could only be made through Dutch option processes, which were offered to all lenders.

Recent transactions, such as Serta and Boardriders, use a new approach by focusing on an exception to the pro rata sharing provisions that permit borrowers to make “open market purchases” of their loans on a non-pro rata basis. Generally speaking, borrowers borrowed new money on a superpriority basis, priming all the existing debt, and also exchanged some of their lenders' existing loans into priority debt that primed all of the old debt and was junior to the new money loan. The transactions did require some amendments, since the superpriority debt and tranching would not have been allowed without them, but those amendments were permitted by a simple majority vote. The most difficult part of the transaction, the non-pro rata exchange, the aspect that otherwise would have required an all-affected lender vote, was simply sidestepped through reliance on the “open market purchase” exception.

Claims have been asserted that this is not a proper use of the “open market purchases” exception and that question has not been fully resolved. Some have suggested that the drafting of “open market purchase” exceptions could be tightened to require cash consideration and to exclude privately negotiated debt exchanges.

There are other legal arguments being made in these deals. For one, minority lenders are asserting that subordination of liens on the collateral should require an all lender vote. They argue that subordination under circumstances where the junior debt trades so far below par is tantamount to a release of all or substantially all of the collateral which in itself, is typically included in the list of “sacred rights.”

Another aspect of Serta was that the majority voted to permit the exchanged and new money debt to be senior in right of payment and not just senior with respect to the liens that secured the debt. If the amendment provisions don't say that subordination is an all lender vote, the argument is it can be done. This has led to some recent deals expanding the scope of amendments requiring affected lender consent to include payment subordination.

Alyson Gal: Thanks, Joanne. We have been getting a lot of questions about what changes lenders could ask for in addition, to prevent being on a losing end of one of these priming transactions. What types of provisions are investors pushing for in response to these deals?

Joanne De Silva: Lenders have been seeking a number of provisions, with some at the top of the list gaining more traction and others being yet to catch on. So I would say at the top are the pro rata sharing and waterfall provisions, where lenders are increasingly focused on ensuring that these are included in sacred rights, although this would not prevent priming deals done in separate agreements, as with Serta. Lenders are also focused on getting rid of the vague “except as otherwise permitted” exceptions to sacred rights requirements for modifications to pro rata sharing, so that the pro rata sharing provisions are effectively tightened up.

Another provision which has been getting a lot of attention is adding lien and payment subordination to sacred rights, which would prevent tranching by separate agreement.

And then, less common is tightening the “open market purchase” exception to pro rata sharing, although coming up with the correct formulation here is tricky since prohibiting these in connection with a consent to a priming transaction would get at the exact situation, but prohibiting these from being done other than through cash-discounted payments could be another way to approach it. And then, newer arguments that are floating around that have yet to gain universal traction are tightening up the ability to assign loans to credit parties, by adding a restriction and including this in sacred rights, and requiring that all consent consideration be offered pro rata to all lenders, including new financing opportunities and/or exchange opportunities – and that one could be tough since sponsors and lenders may well wish to preserve flexibility.

Alyson Gal: Thanks. Borrowers and lead lenders are definitely thinking about how to make provisions clearer to avoid litigation risk where they have the opportunity to do so. In J. Jill's recent amendment, according to public reports, one of the amendments made explicit that “open market purchases” could be made at, below, or even above par and could be made for either cash or noncash consideration, thus trying to make it clear that what has been done in recent transactions under the “open market purchase” exception are permitted.

Turning to the market response to some of these events, how have we been seeing borrowers and lenders trying to address some of the contested issues we have seen in 2020 in documentation?

Rob Bennett: Another area where we are seeing “sacred rights” get a lot of attention is in a different context than what Leonard and Joanne described, though also tied to liquidity. This is to the extent to which majority lenders can provide borrowers with liquidity through payment deferrals or PIKing of interest. Extension of amortization payments, pushing out maturity and delaying interest payments are all clearly and uniformly sacred rights, but where a majority of lenders are willing to forbear on principal payments or to PIK interest, it gets a bit trickier. Many loan agreements have strong collective action provisions that require lenders to act through the agent – this effectively can allow majority lenders to PIK interest without a sacred rights vote.

Alyson Gal: What about the ability to pay interest “in kind” by majority vote? Isn't it clear, Leo, that permitting interest to be paid through adding it to principal is a delay in payment and therefore requires a 100% vote?

Leonard Klingbaum: That's an interesting question, Alyson, and it's not necessarily obvious. Flexible loan documents often provide that a “payment” has to be made on a date certain. Paying in kind may be considered payment. If that's the case, then payment isn't technically deferred. Rather, it's been paid on schedule just in a different form. I will say, that is an aggressive read of a credit document, but not outside of the realm of possible arguments that somebody could make.

Alyson Gal: And if there is one lesson that lenders keep learning, it is that if something is not expressly and explicitly prohibited in a loan document, someone will eventually make an argument that it is permitted.

Turning more generally to market dynamics, what are we seeing, Milap, in terms of borrower leverage to get flexible terms versus lenders tightening agreements in areas of sensitivity? What are the key provisions under negotiation as we near the end of 2020?

Milap Patel: In committed bank financings, the lead arrangers agree with the borrower on a specific list of amendments and changes that can be made to the terms of the committed financing in order to complete a successful syndication to the market. Such list of potential amendments is referred to as the “flex items” or the “flex terms,” and it is found in the confidential fee letter between the lead arrangers and the borrower. The list of flex items, and the frequency of how often such flex items are actually exercised by the lead arrangers, provide valuable insight into the types of issues that are subject to market push and pull.

The most common flex item is, of course, increasing the pricing of loans through either margin, OID or adding a LIBOR floor. In recent fee letters, we have seen flex include expansion of the scope of sacred rights. For example, changing the voting threshold for pro rata sharing amendments to 100% lender votes as opposed to a required lender threshold of 50%. As Joanne discussed earlier, there is also a trend of including amendments to lien and payment subordination as sacred rights. Other flex items include J. Crew and Chewy blockers. J. Crew blockers are an attempt to address the risk that the borrower would transfer intellectual property to an unrestricted subsidiary, and the flex here takes the form of a prohibition on transfers of material intellectual property to unrestricted subsidiaries. Chewy blockers are an attempt to address the fact that the guarantee provisions of certain credit agreements require only wholly-owned subsidiaries to provide guarantees. Under such credit agreements, the borrower would have the ability to transfer a portion of the equity of a guarantor subsidiary to a third party or to an affiliate, and thus, the guarantee would be automatically released. The Chewy blocker would require that any such transfers of equity be for a bona fide business purpose in order to release the guarantee.

Mandatory prepayments are another common area for flex provisions. For example, asset sale leverage step-downs and excess cash flow leverage step-downs are an item that we commonly see in flex. It is typical to see deals go to market with ECF sweeps starting at 50%, with flex to 75% upon market pushback. Incremental facilities are another key focus item for lenders, as the flex terms typically includes elimination of the MFN sunset and also elimination of certain exceptions to the MFN protection: for example, incrementals used to fund permitted acquisitions or incrementals made from the free and clear basket.

Another common flex item is pro forma cost savings add-back cap. It is common to see sponsors and borrowers go to market with no cap on the amount of cost savings that could be added back to EBITDA, and the flex item would include a percentage cap that would be applied if successful syndication is not achieved.

And finally, with respect to junior debt prepayments, it is common to see deals go out with a junior debt prepayment covenant that only applies to subordinated debt, such that only payments of subordinated debt will be prohibited by the credit agreement. In a first lien second lien deal, the first lien lenders may seek to expand the scope of the definition of junior debt to include “contractually junior lien debt,” and thus, second lien debt payments would be included and restricted by the covenant.

Leonard Klingbaum: Thanks to the four of you for joining me today. And thank you to our listeners. For more information on the topics that we discussed or other topics of interest to the investment and credit fund communities, please visit our website at ropesgray.com. And, of course, if we can help you navigate any of the topics we discussed, please don't hesitate to get in touch. You can also subscribe to this series wherever you regularly listen to podcasts, including on Apple, Google and Spotify. Thanks again for listening.

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