In February 2017, Judge Katherine Polk Faila of the Southern District of New York issued a bench ruling1 in Cumulus Media Holdings Inc. v. JPMorgan Chase Bank, N.A. (S.D.N.Y. Feb. 24, 2017), in which she found that a proposed exchange of senior notes for revolver commitments would violate certain covenants of the issuer’s credit agreement protecting the term loan lenders. See Debt Dialogue, March 2017, “Cumulus Media: Term Loan Lenders Block Amendments to the Revolver.” An aspect of that ruling, in which the court held that the proposed exchange would violate a credit agreement prohibition on amendment of the issuer’s debt documents that materially adversely affects the lenders, warrants further attention. Beyond the immediate holding, the ruling suggests that modifications to the credit documentation of a financially distressed debtor could give rise to a material adverse event default under the standard terms of a credit facility.
In December 2016, Cumulus Media Holdings Incorporated proposed an exchange of $610 million of its unsecured notes for $305 million of new first-lien debt under its revolving credit facility and class A common stock of Cumulus. The proposed transaction contemplated assigning revolving credit commitments to the senior note holders and adding an incremental revolving facility of $105 million, structuring the debt as a revolving credit facility rather than a term loan to avoid repricing the outstanding term loans under the “most favored nations” pricing protections under the incremental provisions of the credit agreement. At the time of the proposed exchange, Cumulus had approximately $1.45 billion in collateral and $1.81 billion in outstanding term loans that are secured by the collateral. As the exchange offer was structured, no consent of the term lenders was required under the credit agreement.
That same month, Cumulus brought an action in the U.S. District Court for the Southern District of New York against the agent under the credit agreement, seeking a declaratory judgment from the court that the credit agreement permitted the proposed transaction. A group of lenders holding secured term loans under the credit agreement intervened in the case, seeking their own declaratory judgment that the proposed transaction violated certain negative covenants under the credit agreement, which constituted an event of default. Among other claims,2 the term lenders asserted that the proposed incremental amendment would adversely affect their interests and would violate the “Amendment of Material Documents” covenant of the credit agreement. That covenant provided in pertinent part that no material amendment could be made to “any … credit agreement … except for any such amendment … that … would not, in any material respects, adversely affect the interests of the Lenders.” The additional $105 million of first-lien revolving loans, the term lenders argued, was such an amendment because it would further dilute their interests in the collateral.
The Court’s Ruling
The court agreed with the term lenders and the agent, holding that the exchange of senior notes for revolving loans would be materially adverse to the interests of the term lenders, and thus was prohibited under the credit agreement.
Cumulus argued that a ruling along these lines would abrogate the issuer’s rights under the credit facility to modify its debt structure that had been part of the bargain that Cumulus had initially cut with its lenders under the credit agreement. The court responded that the amendments would have been permitted had Cumulus’ financial situation not been so dire. “[It] is only because the value of Cumulus’ collateral is less than the sum of its debts,” the court said, “that the creation of the additional secured interests would affect adversely the interest of the term lenders in a material respect.”
The covenant in the Cumulus credit agreement against amendment of material documents is unusual, so the court’s interpretation of this provision per se is not likely to have broad repercussions. Perhaps inadvertently, however, the court’s ruling raises an issue of potentially wide-ranging consequence for distressed issuers and their creditors.
While a covenant against amendment of material documents is not a standard feature of credit agreements, an event of default for materially and adversely affecting the borrower’s ability to repay its borrowings under a credit facility is relatively common. The Cumulus ruling appears to suggest that a debt restructuring that increases the amount of the secured debt of a distressed issuer, at least where the face amount of an issuer’s secured debt is or would exceed the value of the supporting collateral, is such a material adverse event. This may be so even if the negative covenants and other terms of the credit agreement expressly permit the issuer to incur the additional debt.
Judge Faila’s ruling has not been officially reported, and was not even directed at the material adverse event default under the credit agreement she was asked to interpret. Nevertheless, it is a tool that might be used by existing secured lenders to thwart a non-consensual debt restructuring facially permitted by their documents but which they oppose. Creditors are therefore advised to be alert to this potential consequence of the Cumulus ruling, as they jockey for influence and leverage against other competing constituencies of distressed borrowers seeking to restructure.