“Unitranche loans” are the latest innovation in middle market lending. This memorandum describes the evolution of the unitranche structure and some of the key economic and legal features of these facilities.


A “middle market” loan facility ranges from $50 million to $500 million and is made to borrowers with pre-tax earnings of $15 million to $100 million. Most middle market facilities are “club” deals originated by three to five lenders. Once a smaller market dominated by asset based revolving lenders, middle market origination has evolved to include a wide array of financial institutions, including hedge funds specifically formed to make loans in this market. In addition, private equity sponsors have taken advantage of this market to finance acquisitions of smaller companies or to fund a dividend from an existing portfolio company. While a portion of a middle market facility may still contain an asset based tranche, the larger middle market facilities will likely include either one or two tranches of term loans.


Once middle market facilities began to include term loan tranches, the facilities took on some characteristics of larger syndicated facilities. First lien and second lien tranches were included in the facilities and were documented with separate sets of credit agreements and security documents, as well as an intercreditor agreement that delineates the rights between the first lien and second lien lenders. First lien lenders and second lien lenders typically have separate liens on the collateral with separate collateral filings setting forth this arrangement, and the intercreditor agreement provides the first lien lenders with priority over the second lien lenders’ liens on the collateral. An intercreditor agreement is usually entered into among the first lien lenders, the second lien lenders and the borrower. The other lenders to the facilities are typically not parties to the intercreditor agreement, instead the first lien and second lien agents enter into the intercreditor agreement on their behalf.  

A traditional first lien/second lien intercreditor agreement provides that upon default or upon the first lien agent’s commencement of the exercise of remedies, the second lien lenders may agree to purchase all of the first lien obligations. In addition, a defining characteristic of a first lien/second lien intercreditor agreement is the standstill period against the second lien agent’s exercise of remedies. A first lien/ second lien intercreditor agreement will require that prior to the second lien agent’s exercise of remedies against the collateral, the second lien agent must wait a period of time (usually 180 days, but it can vary from 90 to 270 days) before it exercises rights and remedies against the collateral. The standstill period will continue if the first lien lenders are diligently exercising their rights and remedies against all or a material portion of the collateral.  


Participants in the commercial bank loan middle market have recently developed and are actively using “unitranche facility” credit documentation. Unlike a first lien and second lien facility, the unitranche facility is provided under a single credit agreement, with a single set of security documents. Instead of an intercreditor agreement entered into among the first lien agent, the second lien agent and the borrower, the intercreditor arrangements for a unitranche facility are set forth in an “Agreement Among Lenders” or an “AAL” entered into among the various lenders to the facility. These intercreditor arrangements provide lenders with a “firstout” and “last-out” payment stream, with a single lien on the borrower’s collateral. The use of the unitranche facility is better suited for a middle market club deal, since it would be too burdensome to have all of the lenders in a broadly syndicated facility enter into an AAL.

Unitranche facilities can be put in place quickly – faster than a traditional first lien/second lien facility. Using a unitranche facility spares the borrower and the lenders from negotiating and drafting two separate sets of loan documents, which in theory reduces the time to document and finalize a transaction. In addition, since a unitranche facility will provide for a single lien on the borrower’s collateral, the unitranche facility requires only one set of collateral filings, which will reduce closing costs.  

There are no “market-standard” resolutions of the issues arising between the first-out and last-out lenders in a unitranche facility. While the scope of the issues involved largely depends on the negotiating power of the first-out and last-out lenders, the AAL will typically set forth the economic and voting arrangements between the first-out lenders and the last-out lenders, with the first-out lenders receiving payment priority over the last-out lenders in certain circumstances.


A unitranche facility splits the loan into “first-out” and “last-out” tranches, effectively creating senior and junior tranches of loans. The interest rate for the facility is allocated among the lenders disproportionately to provide the first-out tranche with a lower effective interest rate than the last-out tranche. Under the firstout and last-out arrangements, interest payments are made to an administrative agent who is responsible for distributing to the first-out and last-out lenders their portion of the interest payment based on the agreed upon allocation.  

Mandatory and optional principal payments are usually paid ratably to the first-out and last-out lenders until the occurrence of certain “waterfall trigger events.” Upon the occurrence of these waterfall trigger events, the firstout lenders will receive priority payment on both their interest and principal until any payment is distributed to the last-out lenders. Waterfall trigger events usually include: (1) a payment default under the Credit Agreement; (2) failure of the borrower to comply with all or certain financial covenants, usually within a percentage range; (3) bankruptcy and insolvency events; and (4) failure of the borrower to conduct all or a material portion of its business, usually following a certain cure period. The payment waterfall typically only applies with respect to payments and proceeds received by the agent from the collateral, meaning that any other proceeds received by the agent would be distributed ratably to the lenders.  


Intercreditor agreements for first lien and second lien facilities usually do not include any arrangements with respect to voting. On the other hand, most AALs will set out certain voting arrangements. Under these arrangements the first-out and last-out lenders will agree that amendments requiring the consent of “Required Lenders” under the credit agreement will, notwithstanding any other provision in the credit agreement, require both “Required First-Out Lenders” and “Required Last-Out Lenders.” In addition, the AAL may provide for cross-over voting restrictions, meaning, for example, if a last-out lender acquires a portion of the first-out loans, the AAL may provide that the last-out lender has no ability to vote with respect to its ownership of the first-out tranche.

An AAL usually contains similar provisions to a first lien/ second lien intercreditor agreement with respect to the buy-out option, however the AAL includes additional triggers and the buy-out option is typically reciprocal (meaning that both the first-out and the last-out are afforded the opportunity to buy the other tranche’s obligations). The buy-out right is usually triggered upon the occurrence of a particular set of circumstances which may include: (1) the failure of the lenders in a tranche to approve an amendment that the requisite lenders of the other tranche have agreed to approve; (2) a payment default under the credit agreement; (3) an acceleration of the obligations under the credit agreement or the agent has otherwise commenced exercising its secured creditor remedies; (4) commencement of bankruptcy and/or insolvency proceedings; and (5) the first-out lenders have notified the agent that a waterfall trigger event has occurred. In most circumstances, the buy-out price is essentially the same as those contained in a first lien/second lien intercreditor agreement – all of the outstanding obligations for the particular tranche. In the scenario where the buy-out right is triggered in connection with a particular lender’s failure to approve an amendment, the buy-out price is typically limited to the amount necessary to purchase the loans of that nonconsenting lender. The buy-out provisions will provide that the purchasing lenders turn over prepayment premiums to the selling lenders in the event that a prepayment premium is paid to the purchasing lenders during a set period of time following the exercise of the buy-out.


Some AALs may include the concept of a right of first offer. The concept provides that if a lender of a particular tranche desires to assign its loans to a third party, then the lender must offer the assignment to the other lenders prior to making the assignment to the third party. Depending on the AAL, these types of provisions may vary in scope and size. A right of first offer may require that the assigning lender only make the offer to the other lenders of the assigning lender’s particular tranche prior to assigning its loan to a third party. Other rights of first offers may require that the assigning lender offer the assignment to the lenders of its particular tranche and then, to the extent that the lenders of that tranche decline the offer, to the lenders of the other tranche prior to assigning its loan to a third party. In any event, lenders should be aware of these provisions as they may impact the liquidity of their loans and how quickly their loans can be assigned.  


Like the first lien/second lien intercreditor agreement, the concept of the standstill period has worked its way into AALs, but with a few nuances. The first nuance is that there are usually two periods involved depending on which class of lenders makes the demand on the agent to commence the exercise of secured creditor remedies. In the case where the Required First-Out Lenders demand that the agent commence the exercise of secured creditor remedies, there is typically a waiting period, usually around 30 days, before the agent may exercise secured creditor remedies. This period of time will give the last-out lenders the ability to discuss the demand with the first-out lenders and to determine whether or not the last-out lenders desire to exercise the buy-out right.

When the Required Last-Out Lenders make a demand on the administrative agent to commence the exercise of secured creditor remedies, the more traditional standstill period goes into effect. In this scenario, the agent will wait a period of time, typically in the 90-180 day range, before following the last-out lenders’ request to exercise secured creditor remedies. If after the expiration of this period the first-out lenders are not exercising their rights against all or a material portion of the collateral, the agent will follow the last-out lenders’ instructions.


A traditional first lien/second lien intercreditor arrangement will set out the rights of both the first lien lenders and the second lien lenders in the event of a borrower’s bankruptcy. These rights usually include restrictions on the second lien lenders’ ability to object to a sale under Section 363 of the Bankruptcy Code, restrictions on the second lien lender’s ability to object to a debtor-in-possession facility provided by the first lien lenders and other arrangements relating to adequate protection and post-petition interest. These types of provisions have also made their way into AALs. Just as some question the enforceability of these provisions in intercreditor agreements, we would expect similar questions to arise regarding their enforceability in AALs. Similarly, we would expect case law regarding the interpretation of intercreditor agreements to provide guidance with respect to the interpretation of AALs. Additionally, while it is clear in the first lien/second lien context that the first lien lenders and the second lien lenders are two distinct and separate classes of creditors, it remains to be seen whether or not a bankruptcy court would recognize first-out and last-out lenders as separate classes of creditors. This is because in a traditional first lien/second lien facility the borrower enters into separate and distinct lending arrangements with each lender group whereas in a unitranche facility the borrower has just one single lending arrangement. This distinction, notwithstanding the rights set forth in the AAL, could lead a court to conclude that the first-out and last-out lenders are a single class of creditors. Such a finding could impact the ability to obtain post-petition interest or adequate protection and/or vote and confirm a chapter 11 plan irrespective of the terms of the AAL.


Unitranche structures have evolved within the past year, and are continuing to change. They differ markedly from first and second lien structures, and while unitranche facilities offer timing and simplicity advantages to borrowers, the negotiation of the AAL requires focused effort among counsel to the first-out and second-out lenders.