In a very recent decision, the U.S. District Court for the Southern District of New York determined that a negative inference to an exception to a negative covenant prevented a company from undertaking a proposed restructuring transaction. We find the case unique not because of the result necessarily, but rather because the court used the negative inference to override another express provision in the Credit Agreement. Moreover, the court did not base its decision on the portion of the Credit Agreement that the parties believed principally addressed the issue (though they of course argued for diametrically opposite results).

Synopsis

In its Cumulus decision, the U.S. District Court for the Southern District of New York had to determine whether a proposed restructuring transaction designed to retire Cumulus’s unsecured Senior Notes violated the negative covenants in the company’s senior secured Credit Agreement. The Credit Agreement included a Term Loan with an outstanding balance of approximately $1.81 billion, an undrawn Revolver, and certain incremental availability that could be drawn with the agreement of the participating lenders. In the proposed transaction, the existing Revolver lenders would assign their Revolver commitments to the holders of the Senior Notes, who would then agree to amend the leverage ratio covenant as well as fund an incremental Revolver facility. Cumulus would then draw on its Revolver (including the incremental facility) and use the funds to retire its unsecured Senior Notes.

Cumulus, on the one hand, and the agent and holders of the Term Loan, on the other, disagreed about whether the negative covenant related to prepayment of the Senior Notes permitted the transaction. While the covenant generally prohibited any prepayments, it contained an exception “for any refinancing of the Senior Notes permitted pursuant to the [Credit Agreement].” Cumulus contended that the proposed draws on the Revolver fell within the term “any refinancing” and were otherwise permissible under the Credit Agreement. The agent and holders, by contrast, contended that the only permitted refinancing of the Senior Notes would be one that met the defined term “Permitted Refinancing,” which definition did not encompass the proposed transaction.

The court took a different tack altogether (and did not resolve the parties’ dispute over the negative covenant concerning prepayment of the Senior Notes). The court focused on a different negative covenant: one that prohibited Cumulus from incurring any debt, with some particularly relevant exceptions. One of the exceptions permitted Cumulus to incur debt “in respect of the Senior Notes . . . and any Permitted Refinancing thereof.” The court held that since this exception to the negative covenant against incurring debt allowed only for a “Permitted Refinancing” of the Senior Notes, by negative inference any debt used to refinance the Senior Notes that was not within the definition of “Permitted Refinancing”—such as the draws on the Revolver in the proposed transaction—was prohibited.

Cumulus argued that draws on the Revolver fell within a separate and distinct exception to the prohibition against incurring debt—indeed, the very first exception—that allowed Revolver draws. The court rejected this argument, finding that the negative inference to the exception related to the Senior Notes carried the day. It thus determined that this negative inference trumped Cumulus’s ability to make draws on the Revolver that were otherwise expressly permitted.

The court also had to resolve a dispute concerning whether the agent and holders of the Term Loan could invoke a negative covenant that prohibited amendments to essentially any Cumulus agreement that would be materially adverse to the lenders. Cumulus contended that it had obtained the requisite consent of Revolver lenders as provided under the Credit Agreement—the amendments did not require consent from the Term Loan holders—and thus the Term Loan holders could not complain about being adversely affected. The court disagreed, holding that even though consent of the Term Loan holders was not required for the amendments, they could still successfully claim that the draws on the Revolver would be materially adverse to their positions (which were undercollateralized) because they would be forced to share collateral with the Revolver lenders.

Existing Capital Structure

The company, Cumulus Media Holdings, Inc. and Cumulus Media Inc. (collectively, “Cumulus”), is the borrower of approximately $1.81 billion under a Term Loan in a Credit Agreement secured by collateral with a value today of approximately $1.449 billion.1 The Credit Agreement also provides for a Revolver, which is presently undrawn.2 Cumulus additionally has issued $610 million in unsecured Senior Notes.3

Cumulus cannot draw at present on the Revolver unless its consolidated first lien net indebtedness is less than five times EBITDA4—this financial measurement is known as a “leverage ratio.” Cumulus’s debt is out of compliance with this leverage ratio test and thus it cannot now make Revolver draws.5 Cumulus can, however, borrow under an Incremental Facility with the agreement of the lenders that elect to extend any such additional funds.6

Cumulus also faces a financial crunch. While the Term Loan is scheduled to mature in 2020, the Credit Agreement contains a “springing maturity” that causes the Term Loan to come due in January 2019 if more than $200 million of the Senior Notes are outstanding at that time.7 Cumulus claims that a January 2019 maturity for its Term Loan would inflict serious financial and operational stress.8

The Proposed Restructuring Transaction

Cumulus recently proposed a transaction to avoid the springing maturity by paying off the Senior Notes through a financial restructuring that would utilize draws on the Revolver as well as the Incremental Facility.9 The steps would be as follows:

First, the current lenders under the Revolver—that is, entities that have committed to make loans under the Revolver but who have not, as of yet, been required to fund any such loans—would assign their commitments on the Revolver to the holders of the Senior Notes (in such a capacity, the “New Revolving Lenders”).10

Second, the New Revolving Lenders would amend certain provisions of the Revolver, including the leverage ratio test, so that Cumulus would be permitted to draw $200 million on the Revolver.11

Third, Cumulus and the New Revolving Lenders would agree upon and fund a $105 million Incremental Revolver Facility.12

Fourth, Cumulus would use the $305 million of availability from the previous two steps (plus some equity) to retire the Senior Notes.13

The Lawsuit Over Negative Covenants

Cumulus initiated litigation against JP Morgan Chase Bank, N.A. (“JPM”), the agent for the Credit Agreement, and requested that the court order that the proposed restructuring transaction does not violate the Credit Agreement.14 JPM responded to the complaint,15 and an ad hoc group of holders of the Term Loan (the “Term Loan Holders”) intervened on JPM’s side.16 Each party moved for summary judgment.17

The parties disagreed over whether the proposed restructuring transaction violated either of two negative covenants in the Credit Agreement. Section 8.8, entitled Limitation on Restricted Payments, prohibits (with some exceptions) Cumulus from making payments on the Senior Notes.18 Section 8.16, entitled Amendment of Material Documents, prohibits amendments to certain documents that would adversely affect the interests of the lenders under the Credit Agreement in any material way.

The Parties’ Arguments Over Section 8.8 – Limitation on Restricted Payments

Section 8.8 of the Credit Agreement provides, in relevant part, as follows:

[Cumulus] agrees that it shall not . . . make any optional payment or prepayment on the principal of the Senior Notes . . . or redeem or otherwise acquire, purchase or defease any Senior Notes . . . ; except that:

(j) [Cumulus] may make payments in respect of the Senior Notes . . .

(i) in connection with any refinancing of the Senior Notes . . . permitted pursuant to the terms hereof . . . .

Cumulus’s motion for summary judgment focused on the language in Subsection (j)(i) of the Credit Agreement that permitted it to make “any refinancing” of the Senior Notes.19Cumulus asserted that it could refinance the Senior Notes with any debt permitted by the Credit Agreement, which would include the proposed Revolver draws.20 So long as these draws were otherwise permitted under the Credit Agreement (as amended), Cumulus contended that it did not matter that the new debt did not meet the requirements of a specific defined term: “Permitted Refinancing.”21

By contrast, JPM and the Term Loan Holders argued that “any refinancing of the Senior Notes” was qualified by the requirement that the refinancing be “permitted pursuant to the terms [of the Credit Agreement].”22 In their view, the only refinancing that could possibly meet this requirement would be one that met the formal definition of “Permitted Refinancing” under the Credit Agreement.23 Since the proposed restructuring transaction did not meet that definition, it did not meet the exception in Subsection 8.8(j) and thus was not permitted under the general prohibition of Section 8.8.24

The Court’s Ruling

In an oral ruling read into the record, the court ruled in favor of JPM and the Term Loan Holders, but it did not base its ruling on Section 8.8 or adopt any of the parties’ arguments thereunder.25 Indeed, it did not decide whether or not Section 8.8’s limitation on payments on the Senior Notes prohibited the proposed restructuring transaction.26 Rather, it concluded that a different section of the Credit Agreement that concerns permitted indebtedness prohibited the transaction.27 Let’s unpack that analysis—what we call the negative inference on the exception to the negative covenant.

Section 8.2 of the Credit Agreement starts with the general prohibition that Cumulus shall not “create, incur, assume or suffer to exist any Indebtedness.”28 In simple terms, Indebtedness includes essentially any debt for borrowed money.29 If it weren’t for the exceptions, Cumulus would violate this provision if it were to borrow money under the Credit Agreement, the Senior Notes, or any other funded debt.

The very first exception to the general prohibition, of course, is for Cumulus’s borrowings under the Credit Agreement.30 Without question, any and all borrowings that are permitted under the Credit Agreement are expressly excepted from the general prohibition on Cumulus incurring debt. There are no limitations on the breadth of this exception.

The Credit Agreement also contains an exception for the Senior Notes in Subsection 8.2(h) to the general prohibition against incurring debt. Cumulus is entitled to incur Indebtedness “in respect of the Senior Notes . . . and any Permitted Refinancing thereof.”31 (Note the use of the defined term “Permitted Refinancing.”) Thus, because of this exception, Cumulus did not violate the general prohibition against indebtedness by issuing and having outstanding the Senior Notes. In addition, this exception permits any “Permitted Refinancing” of the Senior Notes—that is, a refinancing that would meet the requirements of the defined term “Permitted Refinancing.”

Here’s where the ruling gets interesting. The court focused on the fact that the exception in Subsection 8.2(h)—again, one of many exceptions to the general prohibition against incurring debt—applies only to a refinancing of the Senior Notes that fits within the definition of “Permitted Refinancing.”32 This exception does not use the arguably broader language that exists in Section 8.8 (and that Cumulus relied upon in its motion for summary judgment), which permits Cumulus to make payments in respect of the Senior Notes for “any refinancing of the Senior Notes permitted pursuant to the terms of the Credit Agreement.”

Of critical importance, the court found that Subsection 8.2(h)—which is an exception that permits Cumulus to incur the Senior Notes and any Permitted Refinancing thereof—generates a negative inference that prohibits any refinancing of the Senior Notes that is not a Permitted Refinancing.33 If this were not the case, the court stated, Cumulus would be incurring refinancing debt under the proposed transaction that was not a “Permitted Refinancing,” and thus outside the scope of Subsection 8.2(h).34 In this regard, we have dubbed it the negative inference to the exception: anything that sounds closely related but does not fit within the exception must by negative inference be prohibited.

Cumulus argued that the new debt used to refinance the Senior Notes in the proposed transaction would consist of draws on the Revolver, which are expressly permitted under the exception set forth in Subsection 8.2(a).35 Following this argument, it should make no difference that the Revolver draws were not “Permitted Refinancings” recited in Subsection 8.2(h), given that satisfying one exception (i.e. Subsection 8.2(a)) is sufficient to override the general prohibition on indebtedness. Moreover, Cumulus noted that the permitted uses provision of the Credit Agreement allows draws to be used for general corporate purposes—i.e. anything—which certainly should include repaying existing debt.36

The court rejected this argument.37 It found that Subsection 8.2(h)—beyond simply being an exception to the general prohibition against incurring debt—created an “express limitation” against incurring debt to refinance the Senior Notes unless that debt met the definition of “Permitted Refinancing.”38 The court also stated that it had to read the Credit Agreement to maximize Cumulus’s ability to borrow money without compromising the likelihood of repaying the Term Loan.39 In this regard, the court concluded: “What Cumulus wants me to do is to extract, to pluck assorted provisions out of context, string them together in a way that may permit this refinancing but actually undermine and indeed violate the remainder of the agreement and I am not going to do that.”40

This analysis is unique. We are not aware of any other decision that uses a negative inference from a subsection that permits certain debt to disallow the incurrence of other debt that is otherwise expressly permitted.41 Another way to look at the result is that the court constructed a “Use of Proceeds” test even though the Credit Agreement had no such limitation—i.e. Cumulus shall not use the proceeds of draws on the Revolver to pay down the Senior Notes.

The Court’s Analysis of Section 8.16 – Amendment of Material Documents

The parties also disputed whether the proposed restructuring transaction was prohibited by Section 8.16 of the Credit Agreement, which provides, in relevant part, that Cumulus agrees to not amend any indenture, credit agreement or other document—which the court found included the Credit Agreement at issue42—unless the amendment would not, in any material respect, adversely affect the interests of the lenders . . . .43 The proposed transaction, which included amendments to the Revolver in the Credit Agreement, would add $305 million of secured Revolver debt to the existing $1.81 billion of secured Term Loan debt, for which the collateral is only $1.449 billion.44 In other words, the Term Loan is already underwater, and incurring further secured debt without increasing the amount of collateral would push it even further underwater. According to the court, the holders of the Term Loan would have to share the collateral and would thus lose their primary rights to $209 million in collateral value.45 This loss in collateral value would be materially adverse to the lenders and prohibited by Section 8.16.46

Cumulus argued that, since they had followed the amendment provisions of the Credit Agreement—which provides that only the lenders under the Revolver (and not the Term Loan) need to approve the proposed amendments—Section 8.16 could not be read to prohibit the amendments.47 The court rejected that argument, holding that the amendment sections of the Credit Agreement define “the scope of permissible amendments” and “identify the parties that must consent.”48 Section 8.16, however, further “cabins” Cumulus’s ability to exercise those amendment rights.49 In the court’s view, the negative covenant against amendments is thus an additional hurdle that the company must surmount even though it has otherwise satisfied the requisite consent thresholds for the proposed amendments.50

No word, as of yet, on whether or not Cumulus will appeal.