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Overview

The current US corporate lending market remains sophisticated, extremely large and highly varied, having numerous types of borrowers, loan products and lenders. In 2021, the US loan market continued its strong rebound that started in the fourth quarter of 2020 after the coronavirus (covid-19) pandemic had caused the US corporate lending market to plummet earlier in 2020. Throughout 2021, the US loan market was characterised by record or multi-year highs of supply of credit, demand for credit, low default rates and high mergers and acquisitions (M&A) activity. According to Refinitiv LPC, leveraged loans to corporate borrowers in the United States accounted for approximately US$1.3 trillion in 2021, an increase of over 84 per cent over 2020. Borrowers span every industry, and the loan markets they can access depends in large part on their capitalisation and credit profile. Loan products span from unsecured revolving credit facilities for investment-grade companies and widely syndicated covenant-lite term loan facilities for large-cap leveraged loan borrowers to more traditional 'club deal' senior secured credit facilities for middle-market borrowers (generally defined as borrowers with less than US$500 million in annual sales or less than US$50 million in earnings before interest, taxes, depreciation and amortisation (EBITDA)). Lenders include traditional banks, finance companies and institutional investors such as collateralised loan obligations (CLOs), hedge funds, loan participation funds, pension funds, mutual funds and insurance companies.

During 2021, the leveraged loan market climbed to new heights in many categories due to investors seeking higher yields, low interest rates, record amounts of supply, including dry powder at private equity firms, and other factors. The US economy had adjusted to covid-19, M&A activity was strong and supported the loan market, and interest rates encouraged borrowers to refinance existing debt or incur new debt. M&A activity ramped up from 2020 with huge activity from private equity firms, and loan issuance volume soared in 2021. According to the twice annual Financial Stability Report, issued in November 2021 of the Federal Reserve (the Fed), the primary measures of vulnerability from business debt, including debt-to-gross domestic product, gross leverage and interest coverage ratios, have for the most part returned to their pre-pandemic levels, and business debt has decreased on net. This reduction, together with earnings recoveries, low interest rates, government support during the pandemic and fiscal stimulus has restored many business' balance sheets. However, the Fed acknowledges that risks to the economic outlook remain, especially for small businesses and industries that were most affected by the pandemic. In addition, default rates on leveraged loans fell at the same time that underwriting standards lessened. After rising rapidly during 2020, the default rate declined to below pre-pandemic levels during the first half of 2021. At the same time, the average credit quality of outstanding leveraged loans continued to improve. The US loan market has continued to benefit from a recent relaxation of a number of US banking regulations – in particular, the leveraged lending guidelines issued by federal regulators in March 2013, which were further clarified in November 2014 by a FAQ issued on the guidance and had previously had a strong influence on the loan markets, have been significantly curtailed, as discussed in more detail below. Additional developments over recent years had the effect of easing certain components of the risk retention rules and the Volcker Rule, but the Biden administration and other government officials have proposed increasing the regulation of leveraged lending by banks and non-bank lenders.

Leveraged loan issuance levels for M&A increased dramatically during 2021. Refinitiv LPC noted that leveraged loan issuances for M&A more than doubled in 2021, and leveraged buyout (LBO) activity (which accounted for approximately 50 per cent of all M&A loan issuances in 2021) was up 154 per cent. Refinitiv LPC also reports a rise in the market from leveraged refinancing activity, which increased by 43 per cent in 2021 due in part to low interest rates, and an increase in the market from new money leveraged loans, which increased by 69 per cent. Borrowers experienced less financial distress in 2021, and the default rate fell to 0.6 per cent in 2021, the lowest in a decade according to FitchRatings, with the defaulted loan volume decreasing 85 per cent in 2021.

After the US leveraged loan market fell sharply in early to mid-2020, it recovered robustly in 2021 and has returned to be favourable for borrowers, in a multi-year trend (excluding 2020) that has persisted since the recovery from the financial crisis (other than the period affected by covid-19). For example, the market share of covenant-lite loans, which depends on incurrence-based covenants rather than maintenance covenants, has been increasing consistently since the hiatus during the financial crisis. Other borrower-favourable terms that remain prevalent in the US leveraged loan market include soft-call prepayment premiums, the ability to incur refinancing facilities, the ability to buy back loans in the market on a non-pro rata basis, covenant baskets that can grow over time based upon a percentage of adjusted EBITDA or consolidated total assets, the ability to reclassify basket capacity under covenant exceptions, accommodations designed to enable limited condition transactions, and loosened collateral requirements. In addition, many borrowers, especially those owned by large financial sponsors, continue to take the lead in drafting loan commitments and definitive loan documentation, and obtain committed covenant levels and baskets at the commitment stage.

Legal and regulatory developments

During most of 2021, the US government continued to provide some relief to corporate borrowers, other business borrowers and individuals affected by covid-19 through a number of relief bills including the Coronavirus Aid, Relief and Economic Security Act (CARES Act), the Paycheck Protection Program (established under the CARES Act) and the Consolidated Appropriations Act (CAA). In late 2021 and into 2022, some of the aid provided under these bills was tapered or discontinued.

The most significant regulatory focus of 2021 was the ongoing transition from LIBOR as the basis for interest rates for loans. On 5 March 2021, the ICE Benchmark Administration announced that it will cease publication of one-week and two-month US LIBOR settings on 31 December 2021 and cease publication of the remaining US LIBOR settings on 30 June 2023. US regulators advised US lenders not to issue any LIBOR-based loans after 31 December 2021 and to transition away to other reference rates, such as SOFR (secured overnight financing rate), as soon as possible. During 2021, ARRC (Alternative Reference Rates Committee, convened by the US Federal Reserve Bank and by the New York Federal Reserve Bank) issued supplemental versions of its recommended hardwire replacement language for US LIBOR syndicated and bilateral loans. Later in 2021, ARRC formally endorsed Term SOFR, a forward looking SOFR Rate, produced by the CME Group, as a major component of the hardwire language. As a result, many institutional market participants began incorporating the hardwired language, and SOFR loans appeared on the market in the last quarter of 2021 with some regularity. Some LIBOR transition issues are still negotiated including the exact timing of the transition, the spread adjustment at the transition time (since SOFR is not credit-sensitive) and whether and how much discretion should be given to lenders. Other potential replacements for LIBOR include credit-sensitive rates including the American Interbank Offered Rate (Ameribor) and Bloomberg Short-Term Bank Yield Index rate (BSBY). Many loan agreements will require amendments in 2022 to implement the transition away from LIBOR. On 24 March 2021, the New York State legislature enacted a bill that provides a framework and safe harbours for all contracts that are governed by New York law that use LIBOR as a benchmark and do not include any fallback provisions. The New York State Governor signed the bill into law on 6 April 2021. On 15 March 2022, the Adjustable Interest Rate (LIBOR) Act was signed into law by President Biden, establishing a nationwide framework for the replacement of LIBOR as the benchmark interest rate for contracts lacking effective fallback provisions that are either impossible or practically impossible to amend prior to the tenor cessation date. By operation of law, the LIBOR Act will replace remaining references to the most common LIBOR tenors in the 'legacy' contracts with SOFR. In many respects the federal statute parallels the New York legislation. The federal statute pre-empted in many respects several states' legislation ending a patchwork system of state-by-state laws.

From the aftermath of the 2007 financial crisis until recently, federal regulators had increased their focus on the US corporate lending market, and leveraged lending in particular. In March 2013, federal regulators issued new leveraged lending guidelines to address concerns that lenders' underwriting practices did not adequately address risks in leveraged lending with appropriate allowances for losses. These guidelines apply to federally supervised financial institutions that are substantively engaged in leveraged lending activities. Compliance with the guidelines was required by May 2013, but the full force of their impact only started being felt by the market in 2014, particularly in the fourth quarter. In November 2014, regulators released an FAQ on the guidance, and in their Shared National Credit Report issued the same month, they chastised lenders for non-compliance. Most of the attention concerning federal guidance is focused on their assertion that 'a leverage level in excess of 6x Total Debt/EBITDA raises concerns for most industries'. In February 2018, these guidelines were declared by the chair of the Fed and the head of the Comptroller of the Currency not to be legally binding on federally supervised financial institutions that are substantively engaged in leveraged lending activities. According to Refinitiv LPC, for LBO transactions completed in 2021, 81 per cent had average debt-to-EBITDA levels of six times or higher. The Shared National Credit Report issued in February 2022, which covers the first and third quarters of 2021, found that though credit risk improved modestly in 2021, banks' credit risk exposure to leveraged loans is still too high and many loans contain terms and structures that are too risky. The report noted that banks that originate and participate in leveraged lending transactions, and manage risks well, employ risk management processes that adhere to regulatory safety and soundness standards and adapt to changing economic conditions. In the current credit environment, effective risk management processes would ensure that repayment capacity assessments are based on realistic assumptions of economic recovery and appropriately incorporate new debt that many borrowers added to build liquidity as a result of covid-19 economic stress. The report noted that risk in 2022 will be affected by continued success in managing covid-19, inflation, supply chain issues, high debt levels, rising interest rates and labour challenges.

Appointments to federal financing agencies under the Biden administration, such as the appointment of Janet Yellen as the Secretary of the Department of the Treasury, Jerome Powell as the Chairman of the Board of Governors of the Federal Reserve System (the Federal Reserve) and Lael Brainard as the Vice Chairman of the Federal Reserve, are likely to result in increased regulation and enforcement of financial regulation. Some appointees and other politicians have discussed reviving the 2013 leveraged lending guidance. This could result in an increased ability for non-bank lenders to lend to highly levered borrowers and may limit leverage available from regulated banks as well.

In December 2013, the final Volcker Rule was issued, which limits the number of trading and investment activities of banking entities. Banking entities will also be required to comply with extensive reporting requirements in respect of permitted trading and investment activities. The Volcker Rule compliance period began in July 2017, and the reporting requirements became effective in June 2014. In December 2016, risk retention rules that were made applicable to CLOs came into effect, initially casting a large shadow over the leveraged loan market (given that CLOs are a prominent source of capital for leveraged lending transactions), but a federal court decision in February 2018 invalidated the rules insofar as they apply to open-market CLOs. In January 2020, five regulatory agencies approved a proposal recommending that senior AAA CLO debt liabilities that meet certain requirements should no longer be considered equity-like 'ownership interests' under the Volcker Rule, and that the 'loan securitisation' carve-out from the definition of 'covered funds' should allow a small holdings of non-loan assets, such as bonds, and in June 2020, those agencies published the final rules. The loan securitisation exclusion was amended to allow CLOs to hold loans, cash equivalents and up to 5 per cent in debt securities (other than ABS and convertibles), measured at the time such security is acquired. Ownership interests will not include CLO notes that allow the removal and replacement of the manager for cause even in the absence of an event of default. In addition, senior debt securities with certain characteristics will not be considered prohibited ownership interests as long as they have certain enumerated characteristics. These changes benefit the CLO and loan markets. Also in 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act was enacted and exempted smaller institutions. Regulators revised the Volcker Rule, effective 1 January 2020, to simplify compliance and remove burdens to compliance while keeping the overall purpose of the rule intact. Senator Elizabeth Warren proposed the Stop Wall Street Looting Act of 2021 which would effectively reimpose the risk-retention standards for US CLO managers. The bill would define managers of CLOs as securitisers and require them to purchase and hold at least 5 per cent of the value of their managed CLOs.

Many federal financial agencies seek more extensive regulation of the 'shadow-banking' sector. Some agencies have discussed increasing the power of the Financial Stability Oversight Council (FSOC) including by amending Dodd Frank to expand the FSOC's authority to designate a non-bank financial institution for regulation based on both entity-specific criteria and activity-based criteria. If leveraged lending were determined to pose a threat to financial stability, any entity participating in leveraged lending could become subject to regulation by the Fed. The FSOC identified climate-related financial risks in 2021.

Federal regulators have also continued to enforce sanctions and anti-corruption and anti-terrorism laws, and have recently reinvigorated their efforts. As a result, and in response to ever-increasing fines for violations, lenders have expanded the compliance terms included in credit documentation. These efforts have included broader representations and warranties with fewer materiality and knowledge qualifiers, as well as affirmative and negative covenants that require compliance with sanctions regulations and anti-bribery laws, and restrict borrower activities in restricted countries or with restricted entities to the extent that such activities would involve loan proceeds.

US banks also continue to address the Basel III requirements. Basel III requires banks to meet a number of capital requirements to strengthen a bank's liquidity and contain its leverage. Among other things, Basel III requires banks to increase their holdings of Tier 1 capital to at least 7 per cent of their risk-weighted assets to meet additional liquidity and capital requirements. In December 2014, the Fed proposed that the eight largest US banks should comply with capital requirements that are even more restrictive than those outlined by Basel III, including an additional capital cushion. According to the Fed, most of the firms either already met the new requirements or were taking steps to meet them by the end of a phase-in period that ran from 2016 to 2019. The Fed issued revised guidance on 15 January 2021 describing in detail the higher standards of capital planning expectations applicable to US bank holding companies subject to Category 1 standards under the Fed's framework versus those subject to Category 2 or 3 standards. These are the larger, more systemically important US bank holding companies. The Fed announced that it will try to finalise the last phase of Basel III capital reforms by January 2023 with new requirements for 'capital neutrality' across the US banking system.

Tax considerations

The US corporate lending market is subject to various federal tax considerations, most of which can be addressed with careful planning and drafting.

i Tax considerations applicable to US borrowers

The initial determination in any US corporate lending transaction will be whether the debt will be respected as debt for federal income tax purposes or characterised as equity. Interest on debt is generally deductible by the borrower (subject to an overall limit that interest deductions may not exceed 30 per cent of a payor's taxable income (determined without taking into account interest expense and subject to certain other adjustments)), whereas dividends are not. Debt terms that raise the question of whether it may be characterised as equity include a long term to maturity (e.g., in excess of 30 years), subordination to other instruments in the capital structure, a high debt-to-equity ratio at the borrower and, in some circumstances, the right to convert into the stock of the borrower.

Another determination to be made is whether the debt will be treated as giving rise to 'phantom interest' that must be taken into account by the borrower and lender even when no payments are made. In general, a debt instrument sold with the original issue discount will result in unstated interest equal to the difference between the issue price and the stated redemption price at maturity, and that interest will be taxed on an economic accrual basis pursuant to the original issue discount (OID) rules. The OID rules also apply to payment-in- kind and similar instruments. The OID rules will not apply if the original issue discount is less than a statutorily defined de minimis amount.

Borrowers subject to US tax laws must also be careful to address the applicable high-yield discount obligation (AHYDO) rules, which substantially restrict interest deductions for debt characterised as an AHYDO. An AHYDO is any debt instrument with a term of more than five years, having a yield that exceeds the applicable federal rate at the time of its issuance by five percentage points or more, and that has 'significant original issue discount'. Debt will have significant OID if, at the end of any accrual period ending after the fifth anniversary of its issuance, the aggregate amount of interest and discount required to be included in income by a holder exceeds the amount of interest and discount actually paid in cash by more than one year's yield on the instrument. AHYDO rules may be avoided by incorporating a savings clause in the loan documentation that requires the borrower to pay the minimum amount of principal plus accrued interest on the loan necessary to prevent the deduction of any of the accrued and unpaid interest and OID from being disallowed or deferred.

US companies are generally not required to pay US taxes on the earnings of non-US subsidiaries, including upon the actual distributions of the earnings. The provision of a guarantee or the pledge of assets by a non-US subsidiary to support the loan obligations of a US parent until recently, however, would often have resulted in an inclusion in gross income for the US parent of an amount of earnings of the non-US subsidy up to the amount of the credit support. In addition, a pledge by the US parent of two-thirds or more of the voting stock of a non-US subsidiary is considered tantamount to a pledge of that subsidiary's assets and would therefore have been subject to the same rules. For the foregoing and other reasons, such as guarantee fees in non-US jurisdictions, as well as the complexity and cost of obtaining security in other jurisdictions, loan documents in the US often provide that a non-US subsidiary of the borrower will neither guarantee the loans nor pledge its assets, and the pledge of the subsidiary's voting stock will be limited. In May 2019, the Treasury Department released final regulations under Section 956 of the US Internal Revenue Code of 1986, as amended, which have the effect of removing the US federal income tax impediment to a controlled foreign corporation providing credit support with respect to debt issued by its parent US corporate borrower. This development has resulted in lenders pushing for guarantees and security from subsidiaries in non-US jurisdictions, and the negotiation has focused on weighing the costs of providing the guarantees and security to the US borrower against the benefits to the lenders.

ii Tax considerations specific to non-US lenders

There are a number of US tax considerations specific to US borrowers and non-US lenders in corporate lending transactions. For example, if a lender is an offshore fund, it is not likely to join a syndicate in a US loan transaction until after initial funding has been made by other lenders. This is because doing so could trigger tax filing and payment obligations in the United States for the fund or its investors. In contrast, trading in outstanding securities acquired in the secondary market will not result in such obligations.

iii US withholding taxes

In general, the United States does not require withholding tax on interest payments to US lenders, but it will require withholding tax on interest payments to non-US lenders in the absence of an available exemption. This tax is generally equal to 30 per cent of the gross amount of the payments made to the non-US person and is required to be withheld by the borrower.

Lenders that are otherwise subject to the withholding tax may avail themselves of one of three exemptions to reduce or eliminate this tax: (1) the 'portfolio interest exemption'; (2) treaty eligibility; and (3) effectively connected income.

The portfolio interest exemption is available to a non-US person that is not a bank if certain conditions are met, many of which can be satisfied by including certain non-controversial provisions in the loan documentation, together with the submission of certain federal tax forms to the borrower certifying that the person is not a US person. In addition, if a non-US lender is resident in a country that has an income tax treaty with the United States, the provisions of the treaty may reduce or even eliminate withholding taxes. Finally, a non-US lender that makes a loan through a US branch that is engaged in a US trade or business will be exempt from US withholding taxes, but not US federal income taxes (imposed on a net basis), on interest payments made by the borrower. Most US loan documentation provides contractual protection against withholding by requiring the borrower to 'gross up' interest payments if withholding becomes payable, although this requirement is often limited to withholding that results from a change in law after the effective date of the credit agreement.

iv FATCA

The Foreign Account Tax Compliance Act (FATCA) requires non-US financial institutions with US customers and non-US non-financial entities with substantial US owners to disclose information regarding the US taxpayers. FATCA became effective on 1 July 2014. If an institution or entity does not comply with FATCA, a 30 per cent withholding tax is triggered, and responsibility for collecting the tax generally falls on the US borrower. The tax is applicable on all payments normally subject to US taxation, such as dividends, as well as to income that is traditionally excluded, such as bank interest and capital gains. Payments of principal were also scheduled to become subject to FATCA withholding tax beginning as early as 1 January 2019, but in December 2018, the Treasury Department issued proposed regulations that would remove the requirement to subject payments of principal to FATCA withholding and noted in the proposal that companies could rely on the proposed regulations until the final regulations are adopted. Borrowers acting as withholding agents that fail to withhold will be subject to financial penalties. As such, loan documentation in the United States now usually requires a lender to provide information to the borrower upon request to prove compliance with FATCA, and that in any event FATCA withholding obligations will not benefit from any gross-up provisions.

Credit support and subordination

i Security

Taking a security interest in assets that are located in the United States is relatively streamlined and is governed in most instances by Article 9 of the Uniform Commercial Code (UCC). In general, a security interest will attach if the collateral is in the possession of the secured party pursuant to agreement or if the borrower has signed a security agreement that describes the collateral, value has been given and the debtor has a right to the collateral. If all three of these conditions are met, the security interest 'attaches' and is enforceable. Notably, in the United States a single security agreement can effectively create a security interest in substantially all of the assets of a borrower. However, unless that security interest is 'perfected', it may not come ahead of other security interests taken in the same collateral, and perfection can differ depending on the assets comprising the collateral. Under the UCC, a lender may perfect its security interest in collateral by satisfying the requirements for perfection outlined in the UCC and once perfected, that security interest will take priority over all other security interests that are not perfected or that have been perfected subsequently. Each state has adopted variations from the standard UCC, so although they are generally very similar, the UCC adopted by the relevant state should be referred to when taking a security interest.

The most common way to perfect a security interest in assets covered by the UCC is to file a UCC-1 financing statement in the appropriate filing office. The UCC-1 financing statement generally requires the names of the debtor, and the secured party or its representative, and a description of the collateral. The description can be as general as 'all assets' but will more often track the description of the collateral found in the related security agreement. UCC filing fees are typically small, and there are few, if any, other costs related to taking security interests in the property covered by UCC filings. For borrowers that are US corporations, limited liability companies or registered partnerships, the appropriate filing offices will be their respective jurisdictions of organisation. For non-US entities that do not have a filing system for perfection in their home jurisdictions (which is most other jurisdictions besides provinces of Canada other than Quebec), the appropriate filing office would be the District of Columbia. Although a UCC-1 filing will serve to perfect most collateral, certain kinds of UCC collateral, most notably deposit accounts and cash, can only be perfected by control or possession, most often by housing the account with the agent or another lender, or by entering into a control agreement with the bank where the account is located. In addition, some assets may be perfected by more than one method under the UCC, although one method may be preferable to another. For example, perfection by possession of a stock certificate will take priority over a UCC-1 financing statement that was filed earlier and covers the same stock.

In addition to deposit accounts, cash and stock noted above, there are a number of assets that are governed by special rules relating to perfection and priority or other special considerations. These include, but are not limited to, agriculture; aeroplanes; fixtures; intellectual property; letters of credit; vehicles; oil and gas, and other mineral rights; railcars; real property; satellites; ships; and warehoused inventory. The laws governing taking security interests in real property, for example, vary from state to state, generally take longer to satisfy and can involve significant costs. There are often recording taxes and fees imposed by state and local laws, which can be excessive, so lenders sometimes take assignment of mortgages in connection with new financings rather than enter into new ones. Loans secured by mortgages may be limited to the value of the property rather than the amount of the loan to avoid onerous mortgage taxes. To secure interests in intellectual property, such as registered trademarks, copyrights and patents, federal filings will be required that specifically list each item, and these filings must be updated for any property acquired afterwards.

ii Guarantees and other forms of credit support

Guarantees are commonly provided by parents, subsidiaries and side-by-side subsidiaries of a common parent in the US corporate loan market. In large-cap transactions, parent guarantees are often limited in recourse to the stock of the subsidiary borrower, although this is less often the case in middle-market loans. Subsidiary guarantees are typically full and unconditional, but they are often limited to guarantees from domestic subsidiaries to avoid adverse tax consequences to the borrower of a non-US guarantee (discussed in Section III) and may be limited to wholly owned domestic subsidiaries. Guarantees may be supported by security interests in the guarantors' assets to the same extent that the loans are secured by the borrower's assets.

iii Priorities and subordination

There are three primary methods of achieving priority in US corporate lending transactions:

  1. possessing a prior, perfected security interest in the assets of the borrower or being the beneficiary of an intercreditor agreement establishing priority in liens;
  2. being 'structurally senior' to the other debt; and
  3. being the beneficiary of a subordination agreement.

When a lender obtains a first priority perfected security interest in the assets of the borrower in a US loan, the lender obtains the right to receive a priority distribution equal to the proceeds of sale (or value) of that asset to the exclusion of any other creditors (except for holders of certain statutory liens). This means that in the event of a foreclosure, bankruptcy or other liquidation, the secured lender will be entitled to be paid out of the proceeds of the assets securing the loans before any lender having a junior security interest or no security interest in the asset may be paid. Priority in liens is typically established by perfection, as discussed in Section IV.i, but it can also be established contractually by an intercreditor agreement. Lenders under a senior secured credit agreement may agree to allow the borrower to incur additional first lien indebtedness or second lien indebtedness, and enter into an agreement with the lenders of that indebtedness as to priority in security, as well as to how remedies will be enforced in respect of the collateral, among other things.

While achieving structural seniority in the US corporate loan market, like other markets, depends entirely on lending to a level within the borrower's capital structure that is below the level to which another lender extends credit, contractual seniority is established by a subordination agreement. Contractual subordination is achieved by an agreement in which the subordinating creditor agrees that in the event of a bankruptcy or other distribution of assets of the debtor, any amounts otherwise distributable to the subordinating creditor will instead be paid to a specified creditor or class of creditors holding 'senior debt' until they are paid in full. The class of 'senior debt' is usually defined as all indebtedness for borrowed money whether now existing or incurred hereafter, as well as capital leases. It is not necessary that the subordination agreement be between the subordinated creditor and the senior creditor, and often the senior creditor is the third-party beneficiary of an agreement between the borrower and the subordinating creditor. Subordination terms in the United States also typically provide that if there is a payment default on the senior debt, no payment may be made on the subordinated debt until the default is cured or the senior debt is paid in full. In addition, many subordinated debt provisions state that, in the event of a non-payment default on the senior debt, there will be no payments on the subordinated debt for a specified blockage period, which typically runs between 90 and 180 days. Although subordinated debt issuances were common in the US market in the 1990s, they are relatively rare in the current US corporate loan market.

Legal reservations and opinions practice

i Legal reservations

There are no financial assistance laws in the United States, but a federal bankruptcy court can void a guarantee or the pledge of assets by a subsidiary or parent of the borrower if the guarantee is deemed a 'fraudulent transfer', meaning that the guarantor was insolvent at the time of the guarantee or was rendered insolvent, and the guarantee and the guarantor received 'less than reasonably equivalent value' for the guarantee. Given that both aspects of this test must be met for a guarantee to be deemed a fraudulent transfer, as long as a guarantor is solvent at the time of the guarantee, it does not have to receive equivalent value. Most states have similar fraudulent transfer laws, which can also be applied by the bankruptcy court to void the guarantee. This is less of a concern for parent guarantees than subsidiary guarantees, as a parent is typically deemed to have benefited from the loan to its subsidiary through its equity ownership.

ii Opinions practice

It is typically the borrower's counsel that provides a legal opinion in respect of loans to the loan arrangers or agent on behalf of the initial lenders. The opinion will usually cover the following:

  1. the authority of the obligors to enter into the loan documents;
  2. the execution and delivery of the loan documents by the obligors;
  3. the enforceability of the loan documents;
  4. conflicts with laws;
  5. organisational documents and material agreements;
  6. the creation and perfection of security interests in collateral, which may be perfected by filing a UCC-1 financing statement;
  7. possessory stock pledges; and
  8. sometimes, collateral consisting of real estate, intellectual property, or deposit and securities accounts.

Depending on the jurisdictions in which the borrower and the guarantors are organised, there may be opinions as to authorisation, execution and delivery of loan documents, as well as to conflicts with organisational documents and perfection, by various local counsel.

iii Choice of law and enforcement of foreign judgments

In general, courts in the United States recognise choice of law provisions in contracts (sometimes subject to the requirement that the choice of law has a substantial relationship with the contract and the transactions contemplated by the contract) so long as the application of the chosen law would not be contrary to a fundamental policy of another jurisdiction with a materially greater interest in the determination of a particular issue and the application of the chosen law would not threaten public policy or violate any fundamental principle of justice. Similarly, US courts will enforce final judgments of foreign jurisdictions so long as, among other things, the judgments were rendered under systems that provide impartial tribunals and procedures compatible with the requirements of due process of law, the other court had personal jurisdiction and jurisdiction over the subject matter, and the cause of action was not repugnant to public policy.

Loan trading

Loan trades are made by either assignment or participation. Lenders typically trade in syndicated loans over the dealer desks of the large underwriting banks. In assignments, an investor becomes a party to the loan documents and participates as a 'lender' under the loan documents, including with respect to voting rights. As such, assignments are typically subject to a minimum threshold and will require the consent of the administrative agent and the borrower, which may not be unreasonably withheld. If an event of default, which is sometimes limited to payment and bankruptcy defaults, is continuing, a borrower will lose its consent right. Investors may also purchase participations by entering into a participation agreement with a lender to take a participating interest in that lender's commitment. The selling lender remains the holder of the loan. Consent is rarely required, and the participant has the right to vote only on items such as the rate, terms and release of all or substantially all of the collateral. Guarantees and security are granted to the administrative agent on behalf of all of the lenders, present or future, so new lenders benefit from them to the same extent as if they had been part of the original syndicate without the need for the guarantor to sign or otherwise approve the transfer documentation. Loan derivatives common in the US corporate loan markets include loan credit default swaps (LCDS), in which the seller is paid a spread in exchange for agreeing to buy a loan at par, or some other pre-negotiated price. If the loan defaults, the LCDX, an index of 100 LCDS obligations that are traded over-the-counter, and total rate of return swaps, in which case a purchaser buys the income stream from a loan with a 10 per cent down payment that serves as collateral and a loan from the seller, and is obligated to purchase the loan at par or cash, and settle the position upon a default.

Other issues

After a year characterised by ups and downs in 2020, the leveraged loan market started 2021 off strong. It did not take long for borrowers and private equity sponsors to obtain similar terms as they were prior to the pandemic. Many of the current trends in the US corporate loans market remain borrower-favourable terms that were popular at the height of the economic boom in 2006–2007. When these features largely disappeared from the market during the financial crisis, many believed it would be several years before these terms would return, yet these terms have again become widely available to borrowers, despite the temporary reversal of the economic conditions during covid-19. In the current market, borrowers negotiating credit agreements continue to test the limits of what the market will bear.

i Covenant-lite

Covenant-lite deals remain a strong part of the US leveraged loan market. Some covenant-lite deals contain no financial covenants, but otherwise resemble traditional credit agreements. Other covenant-lite loans, in addition to lacking maintenance covenants, also have high-yield style incurrence tests allowing unlimited debt, liens, investments, restricted payments and acquisitions upon pro forma compliance with applicable incurrence ratios, providing the ability to reallocate previous transactions from fixed dollar baskets to ratio baskets, and providing for the incurrence of ratio basket without taking into account a simultaneous use of a fixed dollar basket. Covenant-lite credit agreements also allow for restricted payments, investments or payment of junior debt subject to grower baskets based increasingly on a percentage of adjusted EBITDA. In a growing number of covenant-lite deals, asset-based lending (ABL) structures are becoming more common, with a stand-alone term loan lacking maintenance covenants, and a stand-alone ABL revolver having a 'springing' fixed-charge coverage ratio tested only if borrowing availability falls below a specified level. In these structures, term loans usually have cross-acceleration to the ABL, rather than cross-default, which prevents the term lenders from indirectly benefiting from the ABL's financial covenant. In addition, ABL financial covenants have trended toward higher thresholds before testing is triggered, excluding outstanding letters of credit for purposes of testing the trigger and setting covenant levels at higher cushions over the financial model for the borrower.

If there is a cash-flow revolver instead of an ABL, the covenant-lite documentation has typically contained a financial covenant that applies only to the revolver and, in many cases, only if the revolver exceeds a specified threshold of outstanding borrowings. Breach of the financial covenant will not result in a breach of the term loan or will only result in a breach of the term loan if the revolving lenders have not waived the default by the end of a 45- to 90-day standstill period. Until the expiry of the standstill, the revolving lenders will have exclusive rights to waive or amend the financial covenant or exercise remedies in respect of the breach.

ii Convergence of leveraged loans and high-yield markets

There is a continued convergence in the US leveraged loan and high-yield bond markets, resulting in term loan B facilities with high-yield style terms. Trends contributing to this convergence include the tendency for the same company to raise capital in both the leveraged loan and high-yield bond markets, a switch by loan arrangers to a fee-based business model, a shift in the emphasis from holding loans to syndication and trading, and the increased influence in the loan market of institutional investors, hedge funds and other investors familiar with the covenant structure of the bond market. High-yield style terms being adopted in the loan market include incurrence-based covenants and builder baskets as discussed above, as well as greater refinancing flexibility.

iii Refinancing facilities

In addition to incremental facilities, which have been common to US loan agreements for some time, credit agreements in many large-cap deals now include refinancing facilities. Refinancing facility provisions permit the borrower to refinance a portion of its existing credit facility with either new tranches of loans under the credit agreement or additional debt incurred outside the credit agreement. Debt incurred outside the credit agreement may be secured on a pari passu basis or by junior liens, in each case subject to an intercreditor agreement. This development allows the borrower to refinance loans with debt that is outside the credit agreement but still shares in the collateral, without requiring the consent of the lenders. Unlike incremental facilities, refinancing facility provisions rarely contain most favoured nation provisions affecting pricing.

iv Soft calls

If a prepayment premium is included for term loans in a large-cap deal, and even in some middle-market transactions, it now tends to be a 'soft call', meaning it is only payable if there is a 'repricing event'. Repricing events occur when there is a refinancing at a lower interest rate or an amendment to reduce the interest rate. The soft call is typically priced at 1 per cent of the amount refinanced or repriced in the first six months or year of the loan. Some loans contain exceptions for refinancings where the primary purpose is not repricing, such as change of control transactions, qualifying initial public offerings and transformative acquisitions, investments and dispositions.

v Stronger commitment terms

In underwritten financings, borrowers with strong market power, including portfolio companies of strong equity sponsors, have been successful in obtaining committed financial covenant levels and agreement upon detailed financial definitions in the term sheet stage. Increasingly, other significant terms once reserved for negotiation in the definitive loan documentation are being agreed up front in the commitment papers, including material debt and lien baskets, restricted payment carveouts, builder baskets and other negative covenant carveouts. In many cases, these borrowers have controlled the commitment documentation, often using the sponsor's 'form', and requiring the committing lenders to agree to a prior sponsor precedent as the guiding documentation for all items not specified in the term sheet.

vi Loosened collateral requirements

Commitment letters have started relaxing the scope of the collateral requirements that need to be satisfied at closing. They have begun to allow lien searches (sometimes excluding UCC liens) to be included in the list of items that can be delivered post-closing, and they have limited perfection of collateral at closing to those items that may be perfected by the filing of UCC-1 financing statements and to the delivery of certificated securities of US subsidiaries only, or even material US subsidiaries only. Large-cap deals now often eliminate the requirement for bank account control agreements, except in the ABL context, and an expansive list of excluded collateral has become standard, including excluding owned real estate valued below a specified threshold, all leaseholds, non-US collateral, assets securing receivables financings and any liens resulting in adverse tax consequences, among others.

vii SPACs

Special purpose acquisition companies (SPACs) provide a borrower with an alternative method to accomplish an IPO, and SPACs grew at an even higher rate in 2021 than in 2020. A SPAC will conduct an IPO and acquire the interests in a private company using the IPO proceeds, which provides borrowers and sponsors an alternative to a direct IPO of a borrower. Many leveraged lending deals in 2021 allowed borrowers to sell equity to a SPAC without the sale constituting a change of control under the loan agreement. Both traditional banks and direct lenders have provided funding in SPAC transactions.

viii Direct lending

Direct lending, where lenders that are not traditional regulated banks, raise money from investors and make leveraged loans to borrowers directly continues to make increasing strides in the leveraged lending market. Direct lending deals have grown from smaller, club deals to middle-market borrowers looking for financing on terms that regulated banks were unable or unwilling to provide to larger deals made to larger borrowers looking for alternatives to traditional bank financing. Direct lending soared in 2021 with an increasing number of large and jumbo financings in excess of US$1 billion. Unregulated, non-bank lenders have more flexibility to execute deals quickly and in some cases, provide debt in a deeper part of a borrower's capital structure, such as second lien debt, in exchange for better terms than borrowers may need to provide to traditional banks.

ix Sustainability-linked loans

Corporate borrowers are growing more interested in socially responsible investment and goals. The US loan market experienced significant growth in sustainability-linked loans (SLLs) in 2021. In 2020, the volume of SLLs was US$5 billion; in 2021, it was US$218 billion. These loans are designed to motivate companies to meet their environmental, social and governance (ESG) goals. SLLs incorporate financial incentives into their terms. SLLs have become popular because they are available for many types of companies (investment grade and increasingly to leveraged companies), they offer diverse terms and provide flexibility in their use of proceeds. Often, the interest rate is performance-based and adjusts up or down depending on the borrower's ability to meet predetermined sustainability performance targets measured by key performance indicators, including diversity of the board of directors and environmental targets.

Outlook and conclusions

At the time of writing, participants in the US leveraged loan markets are looking at 2022 with guarded optimism given the improved health conditions and low default rates. However, this optimism is offset by geopolitical risks, widespread and high inflation, supply chain issues, increasing interest rates, and potential new covid variants. Many direct lenders still have capital to put to use, but M&A activity has stalled during the first and second quarters of 2022. At this time, the trend of borrower-friendly debt terms continues.