As the high-yield bond markets remain closed in Europe, mezzanine finance is likely to make a return to the capital structure in leveraged finance transactions. This will lead to inevitable negotiation of the intercreditor agreement between the senior lenders and the mezzanine lenders. Given the importance of mezzanine debt to getting deals done, it is likely that mezzanine lenders will be able to negotiate a favourable position for themselves, focusing on areas where they experienced difficulties in the wave of restructurings during 2009 and 2010 using pre-credit crunch documentation. In particular, the IMO Car Wash and the European Directories cases have brought release language and valuations to the forefront of intercreditor negotiations. Why are these issues so important to mezzanine lenders, and what steps are they taking to strengthen their position?
What Does the LMA Intercreditor Agreement Say?
Where shares in an obligor are being sold on enforcement of security, the current version of the LMA intercreditor agreement (the LMA ICA) permits the security agent to release guarantees, security and other claims granted in favour of both the senior creditors and the mezzanine creditors, if it is instructed to do so by the senior creditors (a group comprising senior lenders and hedging counterparties).
These provisions have proved to be controversial amongst the providers of mezzanine finance and other junior capital, particularly in the case of pre-packaged administration sales to senior lender-owned vehicles. Junior creditors have, in many cases, been left with no claims or recoveries.
Equally important to mezzanine creditors is the sale price obtained by the security agent when enforcing security, whether that security enforcement is by way of a share sale or a business/asset sale. Clause 13.2.3 of the LMA ICA broadly mirrors the obligations that a secured party has under English law anyway when enforcing security by providing that:
“… the Security Agent shall take reasonable care to obtain a fair market price in the prevailing market conditions (though the Security Agent shall have no obligation to postpone any such Distressed Disposal or disposal of Liabilities in order to achieve a higher price).”
The LMA ICA imposes no specific requirements on the way in which the security agent should effect a sale.
How Can Mezzanine Lenders Improve Their Position?
Given that they are vital to getting any deal over the line in the current climate, mezzanine lenders have been fighting back. Many recent deals have included additional requirements that have to be met before the security agent may release security. These include:
Public auction/public bid process/cash consideration. The sale of the relevant assets has to take place via a public auction or other competitive bid process and the consideration has to be cash in most circumstances. These protections are likely to be of particular importance where the senior lenders are looking to restructure the business by transferring the group to a bank-owned SPV. However, it is possible for the senior lenders to circumvent any cash consideration requirement by providing a new facility to the bank-owned SPV purchaser. This would be used to fund the acquisition and repay the existing senior debt.
Valuation opinions. These are becoming common in large mezzanine and high-yield financings if the assets are not sold via a public auction or other competitive bid process. Junior capital providers are requiring valuations of the businesses being sold, as well as fairness opinions from one of the Big Four accountancy firms or an investment bank confirming that the sale price of the shares or assets is fair according to market conditions. It remains to be seen how quickly these will be capable of being provided, whether conflicts issues arise, and whether any firm or investment bank will be willing to provide one in a controversial high-profile situation.
Consultation. Consultation between the senior creditors and the mezzanine creditors prior to enforcement has also been provided for in recent transactions, save in certain situations. This would make it very difficult for the senior creditors to take any action prior to the end of the consultation period. Although the consultation period would usually be short, these consultation rights do, to a large extent, prevent the junior capital providers being taken by surprise.
Each of these additional requirements will have the effect of slowing down any restructuring since valuations and opinions take time to obtain and could lead to potentially more litigation as they have yet to be tested. However, it seems clear that protection mechanisms for junior capital providers which go beyond the current LMA ICA are here to stay.
Law stated as at 17 November 2011