Limited conditionality commitment letters, a relatively new phenomenon in Canada, were developed in the United States, where sellers have typically resisted the inclusion of financing conditions in acquisition agreements. As a workaround, U.S. buyers convinced their lenders to grant financing commitments with limited conditions to funding the required amount on closing. Recently, in the context of acquisitions of private targets involving debt commitments of $1 billion or more, a number of commitment letters from Canadian lenders have contained similar limited conditions. This article will focus on some of the traditional conditions that are generally not present in limited conditionality financing commitment letters and on the impact of such omissions on lenders and buyers.
Traditional acquisition financing commitments included two conditions to funding: (i) all the representations and warranties made by buyer in the financing documentation with respect to itself and target must be brought down at closing, and (ii) all security interests granted to the lenders must be perfected at or prior to closing. An alternative to this traditional approach emerged in the 2005 acquisition of SunGard Data Systems Inc. by a private equity consortium. In that going private transaction, the two traditional conditions were replaced by a two-part clause that greatly limited (i) the representations and warranties that had to be brought down at closing, and (ii) the collateral that needed to be provided or perfected as a condition to the funding of the debt financing. This type of clause, consisting of these two parts, has fittingly come to be called a “SunGard clause”.
SunGard Part One: Limitations on the Bring-Down of Representations and Warranties
How, then, does a SunGard clause typically limit the representations and warranties that must be brought down at closing? Generally speaking, the first part of a SunGard clause limits the bring-down to the following:
- Representations and warranties in the purchase agreement that concern target and are material to the interests of lender, but only to the extent that a breach of such representations and warranties would give buyer the right to terminate its obligations under the agreement; and
- Certain specified representations regarding buyer.
The first part of the SunGard clause essentially requires lenders to rely, in large part, on the representations and warranties contained in the purchase agreement to protect their interests through the pre-closing period. Lenders will therefore carefully review the representations and warranties regarding target contained in the purchase agreement, the exceptions thereto set forth in the disclosure schedules and the termination provisions in the purchase agreement relating to breaches of representations and warranties. Second, lenders may require that the commitment letter include a limitation on buyer’s ability to agree to amendments to the purchase agreement, which may either take a lender-biased formulation (buyer may not agree to any amendments to the purchase agreement without lender’s consent) or a purchaser-biased formulation (buyer may not agree to any amendments that are material and adverse to the interests of lender).
With respect to the specified representations regarding buyer that must be brought down at closing, in the U.S. these were limited prior to the 2007 economic downturn to representations and warranties that were within a buyer’s control, such as (i) corporate power and authority, (ii) enforceability of the credit documents, and (iii) no conflict with certain laws and regulations. Though buyers are generally reluctant to go beyond these, lenders – particularly since the financial crisis – have not infrequently pressed for and obtained additional representations and warranties, including (i) absence of litigation that would be adverse to the interests of lender, (ii) no conflict with applicable laws and material agreements, (iii) receipt of third-party approvals, (iv) compliance with financial covenants, and (v) post-acquisition solvency of buyer and its subsidiaries.
While these additional specific representations can offer broader protection to lenders and thereby help buyers obtain financing, buyers do need to weigh the potential consequences of agreeing to bring down a representation over which they do not have control. Essentially, each such representation increases the risk to buyer that it will be under an obligation to close pursuant to the terms of the purchase agreement without the funding to do so.
SunGard Part Two: Limitations on Collateral
The second part of a SunGard provision typically:
- Limits the security that must be provided or perfected as a condition to the availability and the funding of the debt facilities on closing to that which may be perfected solely by means of:
- the filing of a financing statement under the Uniform Commercial Code or the Personal Property Security Act or equivalent legislation of the relevant Canadian jurisdiction, or
- a pledge of the securities of target; and
- Requires the remainder of the security to be delivered within a certain number of days after closing.
Syndication expressly excluded as a condition precedent
In a traditional syndicated financing, funding is typically conditional on the successful completion of the syndication of the facility. However, some limited conditionality commitment letters include an express provision that the commitments are not conditioned on syndication. In such a case, lead lenders or arrangers may be compelled to fund the full amount of the facilities even if the syndication does not occur by closing. Lenders have addressed this risk by including “flex rights” that allow them to (i) increase pricing and other fees related to the financing, and (ii) change some of the other material terms and conditions of the financing. Because these flex rights may result in costly financing for buyers, they should be carefully reviewed by buyers and, wherever possible, limited in scope.
Absence of conditions precedent relating to financing markets
Traditional acquisition financing commitments included the absence of a material adverse change (MAC) in debt financing markets as a condition to funding. Lenders have regularly insisted on such a condition as it allows them to terminate their commitment if market disruptions impair their ability to syndicate the loan. Though the SunGard commitment letter contained a very limited market MAC condition, subsequent limited conditionality commitment letters in the United States, and more recently in Canada, omitted this type of condition altogether. Lenders may be more comfortable without a market MAC condition where they believe that there is little risk of market disruptions or, similar to cases where syndication is expressly excluded as a condition precedent, the commitment includes flex rights.
Absence of condition precedent relating to due diligence
Traditional acquisition financing commitments included the lenders’ completion of their due diligence investigation of buyer and target, satisfactory to the lenders, as a condition to funding. This type of condition is typically not included in limited conditionality commitment letters. From a lender’s perspective, this means that due diligence needs to be completed before the signing of the commitment letter.
Inclusion of the “Mirror MAC” condition regarding Target
Traditional acquisition financing commitments did not include a MAC relating to the business of target or buyer as a condition to funding. While limited conditionality commitment letters do typically include a business MAC condition, this does not practically speaking add to the conditionality of the debt financing as it is usually limited to target’s business and mirrors the language used in the purchase agreement, including the exceptions to MAC contained therein.
The increasing willingness of Canadian lenders to issue limited conditionality commitment letters is a positive development, but it does mean that buyers and lenders need to focus on the provisions described above and the issues they raise.
Specifically, lenders will need to:
- Carefully review the purchase agreement and buyer’s ability to amend it;
- Consider which representations and warranties should be brought down and which security interests should be perfected as conditions to funding;
- Consider the scope of the flex rights they need to safeguard their interests; and
- Complete their due diligence at an early stage.
Buyers, on the other hand, should be concerned with
- Any condition to funding in the commitment letter that is not also a condition to closing in the purchase agreement; and
- Additional provisions that can increase the cost of the financing, such as flex rights.
Buyers and lenders should bear in mind that the precise combination of provisions used in a limited conditionality commitment letter will vary from transaction to transaction and will depend on a number of factors, including the respective needs and bargaining power of the parties, the risk profile of buyer and target, lender’s ability to syndicate, and the state of financing markets. Experienced counsel can help buyers and lenders assess their needs and negotiate a commitment letter that is suitable for the specific transaction under consideration.