The Roundtable has received requests for a guide to reviewing loan syndication agreements for problematic clauses. A specific or detailed guide is not possible since the legal documentation for almost every syndicated loan is extensively customized, with unpredictable definitions, clauses, extensive cross-references, and unusual constructions. Investors should therefore review each loan agreement carefully, making their own analyses and decisions.
The Roundtable offers the following checklist outline of potentially problematic clauses as a starting point for review by investors:
THE DEFINITION SECTION OF THE AGREEMENT:
- Be sure to read all defined terms carefully. Many significant implications can be “hidden” in the definitions.
THE COVENANTS SECTION OF THE AGREEMENT:
Provisions regarding sales of collateral:
- What sales of collateral are permitted?
- Are any tests utilized with regard to sales of collateral? If so, do the tests truly protect the secured lenders?
- What restrictions are placed on the borrower’s use of the proceeds from the sale of collateral? Ideally, the borrower should be required to use all of the proceeds from the sales of the secured lenders’ collateral only for repayment of the secured debt.
Provisions regarding the exchange of collateral:
- What authority is granted to the borrower to exchange collateral? Frequently, the borrower is allowed to exchange the secured lenders’ original collateral for assets of an indeterminate nature, or even for mere equity interests - including interests in the stock of the borrower itself! Allowing an exchange of hard assets for an equity interest converts the loan into a mere stock loan. Obviously, such new collateral may not have the same value to a secured lender as the original collateral.
Provisions regarding additional liens:
- What authority does the borrower have to allow additional liens on the collateral (via subsequent secured financings or other means)?
- What are the rights of the new lienors relative to those of the existing secured lenders?
- Do the new liens receive pari passu treatment (i.e., do they have an equal right to payment from the collateral)? Such valuable treatment may be granted in a variety of obscure and indirect ways, not always easily discernable to readers.
- Are there limitations or caps on new liens? Check any caps on new liens carefully, being sure to check all cross-references in order to make sure that such caps are truly what they appear to be on first glance. All too frequently they are not.
THE AMENDMENT/VOTING SECTION OF THE AGREEMENT
Many loan agreements permit amendments with the approval of less than all the lenders. (It is wise to remember that the right to amend the agreement is the right to change every single term of the agreement and the fundamental understanding of the secured loan itself.)
One area impacted by the potential ease of amendment is the authority to release collateral.
Here are some relevant questions to ask:
- Is lender permission required for releases of collateral?
- If so, what percentage of the syndicate lenders must agree to the release?
- Is the Administrative Agent (as a possible lender itself) allowed to vote?
- Does a rule of proportionality apply (i.e., a release of 80% of all secured lenders’ collateral requiring the approval of 80% of all lenders’ in interest)?
- Can a bare majority of lenders (50.1%) authorize a disproportionate release, thereby disregarding a substantial minority of dissenting secured lenders?
Actual voting requirements are also all the more important due to commonly ambiguous legal drafting.
In the case of collateral release, borrowers may be “prohibited” from releasing all or substantially all of the lenders’ collateral without the consent of all directly affected lenders.
However, the economic significance of this “prohibition” is muted since anything up to “substantially all” of the lenders’ collateral may be released upon a bare majority vote.
GENERAL WARNINGS
Be wary of loan language that appears to prohibit but actually enables. For example:
- We’ve seen the borrower-empowering ambiguity inherent in the phrase “substantially all” in the context of “prohibitions” on collateral release.
- Similarly, it not uncommon to find that sections proclaiming “Limitations on Asset Dispositions” actually offer little more than borrower board approval as a bulwark against sales of secured lenders’ collateral.