The risks to distressed debt investors who purchase the debt of a borrower without being eligible to do so under applicable credit documents are not illusory. Recent cases likeMeridian Sunrise Village, which we wrote about here, illustrate why it is important for investors to review underlying credit documents before pulling the trigger on an investment.
The Loan Syndications and Trading Association (LSTA) makes that job somewhat easier. One of the LSTA’s core functions is standardizing loan documentation. When parties to a loan have documented their transaction using the LSTA’s Model Credit Agreement Provisions (MCAPs), the outcome can be more predictable than for transactions documented on bespoke forms. Moreover, such transactions are easier for potential lenders to review if they are familiar with MCAP provisions.
The LSTA Recently Released Revised Model Credit Agreement Provisions (MCAPs)
The LSTA released revised and expanded MCAPs last summer, which include the LSTA recommended approach to the treatment of entities blacklisted from taking a position in a borrower’s loan, referred to as the DQ Structure. More recently, the LSTA issued a follow-up Market Advisory addressing modifications by market participants of the LSTA’s DQ Structure in recent credit transactions. In short, the LSTA takes the position that the benefits of market certainty and predictability in using the established DQ Structure are undermined when this finely tuned structure is altered, potentially impacting secondary loan market participants and undermining overall loan market liquidity. Examples of the types of modifications to the DQ Structure that affect the overall balance achieved in the MCAPs are provisions that allow a borrower to unilaterally void trades to parties on their DQ schedule (the MCAPs contemplate this, as described below, but do not void the trades), and provisions which prohibit loan obligations being used as reference obligations under credit default swaps or other derivative instruments entered into with parties on the DQ schedule.
The MCAPs Include Expanded Provisions for Blacklisting Potential Lenders
The DQ Structure is an important mechanism that allows borrowers to protect themselves from potentially predatory lenders, and from potential competitors, who could gain access to proprietary information belonging to a borrower by joining the borrower’s lending syndicate. The DQ Structure applies to both assignments and participations in a loan, thereby preventing lenders from structuring around it. Borrowers can designate any party they want to appear on the DQ schedule up until closing of the loan, and the MCAPs also specifically contemplate borrowers including competitors on this list of disqualified institutions after the loan has closed. The MCAPs do not define what a competitor is for any particular borrower, but leave this to be assessed by the parties on a case by case basis.
Borrowers Blacklist Potential Competitors on a DQ Schedule to the Loan Agreement
Under the LSTA’s DQ Structure, borrowers blacklist lenders by identifying them on the DQ schedule to the loan agreement. Lenders are prohibited from assigning loans or enabling participations in the loans to entities on the DQ schedule prior to the date the credit agreement is entered into.
The DQ Schedule Can Be Updated
The DQ schedule is not a static one: borrowers can update the list of disqualified institutions as and when needed to add competitors once the loan has closed, though not other lenders. The MCAPs provide for a notice mechanism that ensures that the agent to the loan facility, lenders and prospective lenders in the loan facility receive notice of changes to the list of entities blacklisted from participating in a borrower’s loan through platforms like Debt Domain, Intralinks, or Syndtrak. Agents are specifically authorized in the MCAPs to post the DQ schedule to the public side of the platform being used for the borrower’s loan.
The ability for a borrower to update a DQ schedule is balanced by protections for potential lenders: in the event a competitor is added to a DQ schedule after a loan agreement has been executed, a short waiting period is triggered before such a party becomes a disqualified lender, thereby allowing the change to the DQ schedule to be disseminated and assimilated by existing lenders and potential debt purchasers.
Agent Bears No Responsibility For Loan Assignments to Ineligible Lenders
The agent to a borrower’s loan facility bears no responsibility under the LSTA’s MCAPs for monitoring the DQ schedule, nor is an agent required to investigate whether any particular lender or potential participant in the facility is in fact eligible to hold the borrower’s debt. As a result of the agent not being liable in such a scenario, lenders are authorized under the applicable provisions to provide the DQ schedule to potential debt purchasers, to support representations and warranties from these buyers that they are eligible to purchase the loan.
Violation of the DQ Schedule
If a borrower’s debt is purchased by an entity that has been disqualified, the LSTA’s approach in the MCAPs is to avoid market uncertainty, and the litigation that results from the transfer. A trade to an ineligible lender is not invalidated under the LSTA’s DQ Structure. Instead, borrowers have a number of options:
- Prohibit the disqualified institution from accessing sensitive information: a borrower can prohibit a blacklisted lender from attending or participating in lender meetings, can prevent disqualified lenders from receiving information provided to other lenders, or having access to the platform on which the loan is administered by the agent.
- Controlling a disqualified institution’s ability to vote: for the purposes of consent to any amendment, waiver, modification or action under the loan documents, the MCAPs provide that each disqualified institution is deemed to have consented to such actions in the same proportion as the loan parties that are eligible lenders.
- Specific restructuring provisions: in the context of a vote on a plan of reorganization, disqualified institutions are deemed to agree in the MCAPs not to vote on any plans of reorganization. In the event that a disqualified institution violates this provision and votes on a plan of reorganization, the MCAPs provide that their vote is not deemed to be in good faith, is designated pursuant to section 1126(e) of the Bankruptcy Code, and is not counted in determining whether a class has accepted or rejected the plan of reorganization in accordance with section 1126(c) of the Bankruptcy Code. A disqualified institution further agrees not to contest any request by a party for relief from the Bankruptcy Court effectuating these provisions.
- Terminate revolving loan commitments: a borrower can terminate the revolving commitment of a disqualified institution, and repay all obligations of the borrower owing to that disqualified institution.
- Purchase or prepay term loan commitments: a borrower can purchase or prepay the term loans held by the blacklisted lender, by paying the lesser of the principal amount of the term loan held by that lender, the amount that the disqualified institution paid to acquire the term loan, and (at the parties’ option when entering into the loan agreement) the market price of the term loan.
- Require assignment to eligible assignee: a borrower can require a blacklisted entity to assign its piece to an eligible lender, at the lesser of the principal amount of the term loan held by that lender, the amount that the disqualified institution paid to acquire the term loan, and (at the parties’ option when entering into the loan agreement) the market price of the term loan.
Don’t Mess With My Chi!
The LSTA DQ Structure has been designed with balance in mind. Balancing the yin of borrowers, with the yang of lenders, the LSTA’s recent Market Advisory makes it clear that messing with the chi of the MCAPs by modifying the finely tuned balance that has been reached in the DQ approach affects market liquidity. If there’s one thing to take away from the LSTA’s Market Advisory, it’s that parties should avoid deviating from the MCAPs if possible, or risk impacting secondary loan market participants and undermining overall loan market liquidity.