Debt buy-backs of European leveraged loans
The European leveraged loan market has, as a whole, been affected by the economic consequences of recent government decisions and central bank action. As a result, the trading price of several leveraged loan names has fallen, in some cases, significantly below par. The precise reasons for this will obviously vary from name to name, particularly the degree to which the future business prospects of a company have been negatively impacted by the "social distancing" measures imposed by governments around the world. However, the current market conditions have led a number of banks, borrowers and financial sponsors to consider whether now might be an opportune time to conduct a debt buy-back programme.
This is not a new phenomenon. The fall in the traded price of certain European leveraged loan names immediately following the global financial crisis in 2008 led a number of borrowers and financial sponsors to take advantage of this by buying back or purchasing some of their debt in the secondary market. The consequential deleveraging helped avoid financial covenant defaults and maximised returns on the financial sponsor's investment. At the time, the use of a debt buy-back programme sparked a degree of controversy and there was some debate as to whether such transactions were even permissible as loan documentation neither expressly prohibited, nor expressly contemplated, what would happen if such a transaction were undertaken. It was as a result of this debate that the LMA sought to regulate the process and the inclusion of a debt purchase transaction clause is now a standard feature of European leveraged loan documents.
The LMA provides for a debt purchase transaction by a member of the banking group to be conducted, subject to satisfying certain conditions, by means of one of two processes: a "solicitation process" or an "open-order process". The solicitation process provides for each lender to be approached to enable them to offer a price at which to sell an amount of their participation in one or more facilities to the relevant borrower, whereas an open-order process provides for the borrower to make an open offer for lenders to tender their participations at a given price. Debt purchases by the banking group by other means are not permitted and there are also various restrictions on the source of funds for financing the transaction. Debt purchases by affiliates of the financial sponsor result in their disenfranchisement.
Whilst most financial sponsor deal precedents include the LMA language and permit debt purchases by a member of the banking group using the two processes referred to above, they often go further and provide even more flexibility as there is typically no restriction on a debt purchase being effected by other means, including bilateral purchases in the market. Insofar as the source of funds is concerned, there is a significant degree of variation as to what is permitted. Whichever process is used, typically the debt can be either (i) bought back by the borrower or other member of the banking group, or (ii) purchased by a related party, for example, the financial sponsor or one of its affiliates. It is worth noting that the issues relevant for the analysis of the debt purchase will differ depending on whether the transaction is led by a member of the banking group or a related party.
The development of contractual provisions in loan documentation means that the debate as to whether debt buy-backs are conceptually permissible is no longer relevant. However, there are still several significant issues to consider which may impact the process including those listed below.
Timing and pricing: has the process for making the debt purchase been agreed, as the particular process to be adopted will likely influence the time to implement it and may impact the ability to take advantage of market conditions? Has a pricing strategy been agreed between the parties in light of the existing volatile nature of the secondary trading markets?
Purchaser: will the debt be purchased (directly or indirectly) by a member of the banking group or by the financial sponsor or one of its affiliates? Relevant considerations will include: (i) will a bank be required to act as a purchasing agent? (ii) is it intended that the debt be extinguished, or will it be kept on the books with a view to it being sold back into the market at a future date? (iii) is the expectation that the purchaser of the debt should be disenfranchised so that, other than for certain material matters, they cannot exercise voting rights in respect of amendments and waivers?
Transfer provisions: do the transfer provisions or any white list referred to in the loan documentation permit the transfer of loans without borrower consent? Will the purchaser constitute a qualifying lender and are there any other banking monopoly or licensing issues that might apply in the relevant jurisdiction?
Tax: will the purchase of participations in loans (and their likely subsequent cancellation) at a value below par be considered a taxable gain in the relevant jurisdiction? Has there been any consideration of the impact on interest deductibility in respect of the repurchased debt?
Financial reporting: will there be any impact on any financial covenant(s) and the calculations of EBITDA, net debt, excess cashflow and debt service?
Ratings: has a preliminary view been sought from any ratings agencies? For example, will the quantum of debt repurchased have any consequence on the credit rating of the borrower?
Intercreditor terms: are there any prohibitions in the intercreditor agreement on the payment of principal and interest on the debt being purchased and will such debt fall within the definition of one of the classes of junior debt that is regulated after the debt purchase occurs? Can the repurchased debt benefit from the proceeds of the enforcement of the transaction security in the waterfall?
Security: is the purchaser entitled to become a beneficiary of the existing security package and, if so, is there any risk under the laws of the relevant jurisdiction that this could "taint" the security or make it more vulnerable to challenge in an insolvency scenario?
Legal, regulatory and compliance: are there any insider dealing or market abuse implications in any relevant jurisdiction that need to be considered before commencing a debt purchase programme? Has consideration been given to managing the disclosure of information in relation to investors which may wish to remain as "public" side lenders? Will the debt purchase limit access to any government support measures that might be available in the relevant jurisdiction?
Directors' duties: has due consideration being given to the rationale for the proposed debt buy-back and is this consistent with any duties (legal or reputational) of the directors in each relevant jurisdiction?
Reputational risks: depending on how the process will be conducted, might there be any reputational risk for any bank acting as a purchasing agent or participating lender? Will there be any adverse consequences on the borrower's and financial sponsor's ability to access government support measures in the relevant jurisdiction or the relationship with their existing lenders?
Whilst provisions will vary depending on the documentary terms and relevant facts, the above summary is intended to provide a high-level introduction to some of the key issues that may be relevant when considering a European leveraged loan debt buy-back programme.