The level of interest in high yield US loan products has become pronounced in the ultra-low interest rate environment in Europe. What issues need to be considered to import these US trends and technology for European syndicated transactions given the legal and regulatory differences in Europe?
In the US, sponsors will insist on precedents from previous transactions while market practice in Europe expects to use the Loan Market Association’s (LMA) forms. In-house compliance lawyers of US arrangers may be lawyers in the US offices and will expect reassurance that the LMA provisions offer equivalent protection to the bank’s forms (increased costs, illegality, mitigation, tax, defaulting lenders and sanctions, to name a few). Operational provisions may also differ. In the likely event that administrative functions are shared across the Atlantic (letter of credit facilities may be administered in the US, while the term loan facilities may be administered in Europe), the loan agreement will need to work for both sets of operational teams. European syndication of term loans B has followed US tradition to permit potential lenders to comment on the loan agreement as syndication takes place before the credit agreement is executed. During the posting period, a significant amount of jostling can be expected on covenants which mirrors the power of investors influencing covenants during the private marketing period of a high yield bond.
Voting thresholds and assignment practices differ across the Atlantic. In the US, a majority threshold is required for amendments and waivers as opposed to 66 2/3% in LMA agreements. Unlike high yield bonds with no transfer restrictions, the term loan B market has typically adopted the compromised concept of the “black” list of disqualified institutions, competitors and affiliates (customary in the US) or the “white” list of acceptable institutions to whom loans can be transferred without consent (customary in Europe). In marrying US and European voting and assignment concepts, a balanced package needs to be considered that works for the borrower and the European syndicate.
Where a term loan B is funded in the acquisition context, conditions to funding differ across the Atlantic. European sellers require bidders to have “certainty of funds” whereas in the US, the concept is codified by the SunGard provisions. The differences between the two are more optical than substantive, except that US lenders typically benefit from a condition that certain key “acquisition agreement representations” and “specified representations” made with respect to the target, must be true and correct. In Europe, only core representations with respect to the Borrower provide a draw stop to initial funding and not representations with respect to the target group. As US arrangers will expect the spectrum of “specified representations” to be commensurate with their form commitment letters, internal legal approval is required to use the European “certain funds” concept or to loosen the required “specified representations”, including carve-outs for creation (rather than perfection) of security interests, non-UCC lien searches and sanctions.
Borrowers increasingly demand flexible capital structures to incur incremental debt in tandem with acquisition flexbility. US debt covenants impose minimal conditions on the type of debt and the structural level at which it can be incurred, typically subject to the satisfaction of secured and total leverage ratios, due to the fact that all US companies in the group tend to be guarantors and grant security over all assets. When this flexibility is applied in Europe, credit leakage must be considered given the approach of using a guarantor coverage ratio (based on total assets and total EBITDA) in determining the guarantor/security package. Provisions of guarantees may be further limited by financial assistance, maintenance of adequate capitalisation and corporate benefit rules. Therefore, despite being given 100% weight in the guarantor coverage ratio, a guarantee could in fact be severely limited in value. Additionally, in many jurisdictions the existing collateral documents will need to be amended or security retaken to secure additional debt, while in the US future debt can be secured by a security agreement (other than real estate) entered into at the time of the initial signing of the loan agreement. The amendment and retaking of security may trigger a new hardening period exposing existing lenders to claw back risk in insolvency.
Intercreditor documentation also needs to be considered. A US-style intercreditor agreement typical does not include European intercreditor concepts of standstill, release of junior debt claims and debt purchase options as Chapter 11 of the US Bankruptcy Code mandates restructuring tools, including the automatic stay, valuation principles, ability to sell the business free and clear of claims and debtor-in-possession financing. With differing statutory provisions across Europe, a US term loan B will need a European intercreditor agreement to provide for these concepts contractually and uniformly.
This article was first published in Butterworths Journal of International Banking and Financial Law, May 2016