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An Overview of “Silent Second Lien” Loans in the US and Europe

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An Overview of “Silent Second Lien” Loans in the US and Europe Legal Update May 16, 2017 What Does “Silent” Really Mean? An Overview of “Silent Second Lien” Loans in the US and Europe Many capital structures include one or more junior lien on the first lien lender’s collateral for debt facilities that are junior to senior debt the purpose of capturing on a priority basis secured by the same assets or property. One (including ahead of trade debt) any residual such type of junior debt that doesn’t fit neatly in value of the collateral remaining after traditional structures, but is commonly satisfaction of the first lien debt. In these discussed, is debt with a “silent second lien.” situations, the junior lien lender’s rights in and This Legal Update briefly describes the silent to the collateral are to be passive or “silent,” and second lien debt product (including how this the first lien lender’s rights in and to the terminology is often vaguely used or overused in collateral generally are to be unimpaired and the market), highlights some differences unimpeded. In the underlying intercreditor between the US and European markets and documents, this generally is reflected by the discusses considerations in connection with the junior lender subordinating its lien and severely use of the product in each market and in cross- limiting its enforcement and other rights in favor border transactions. of the senior lender in exchange for receiving a co-extensive lien on all of the collateral held by Overview the senior lender. Such an arrangement would likely take on many characteristics of mezzanine Lenders choose to extend credit on a secured or financing, including an expectation of an unsecured basis based on market conditions, the extended or complete standstill in the event of a borrower’s historical and projected performance borrower default. and perceived ability to repay the debt, and an evaluation of other relevant factors. One type of In the US debt markets, the components of the secured debt is silent second lien debt, which is silent second lien position can include usually provided in the form of loans (as agreement by the silent second lien lender to: opposed to notes). • subordinate its lien priority in all respects to There can be a debate in the lending markets as the lien securing the obligations of the first to all of the elements of a “silent second lien,” lien lender, irrespective of the manner or and the term “silent second,” although used order of grant or perfection or of validity, often in deal negotiations, has different perfection or priority, including in meanings to different institutions and different bankruptcy, of such lien; meanings in the United States and Europe. • cooperate so that the lien of the first lien Conceptually, at least in the United States, the lender extends to the same collateral as structure generally is used where junior debt securing its second lien; would otherwise be unsecured but is accorded a • not object to the validity or enforceability of • permit the refinancing of the first lien lender’s the first lien lender’s security interest; debt, with the replacement facility to succeed • not take certain enforcement actions with to the benefits of such “silent second” respect to the shared collateral (but instead be arrangement. subject to a standstill), in the event of a In European-only transactions, the term “silent” payment and/or other default by the is rarely used although the main principles of borrower, in favor of the first lien lender “silent” second liens are present and accepted taking such actions and not challenge such when structuring European transactions. actions by the first lien lender; A table summarizing and comparing certain • generally cooperate in connection with the aspects of the silent second lien product in the first lien lender’s exercise of remedies, US and European practices is provided below. including being required to release its liens in One of the more interesting takeaways from certain circumstances; this analysis is that even if the underlying result • not receive or retain (but instead be is similar, the rationale and approach is affirmatively obligated to turn over to the first different. For instance: (i) in Europe, junior lien lender) any proceeds of dispositions of secured debt may oftentimes appear “silent” in the collateral until payment in full of the first the US sense in order to account for legal or lien lender’s claims, even if the first lien is corporate benefit restrictions in certain avoided in bankruptcy or otherwise nullified jurisdictions that restrict financial assistance or or if the first lien lender’s claims are prohibit subsidiary guarantors of the disallowed (e.g., post-bankruptcy interest borrower’s debt from providing full cross- owing to an undersecured creditor); collateralized and cross-guaranteed support • waive certain rights usually associated with (rather than for the financial and business status as a lender with secured and/or motives in the United States); (ii) in US unsecured claims; practice, it is assumed that in the event of the borrower’s bankruptcy, the borrower will be • limit its rights to vote on the borrower’s plan of reorganized or its assets liquidated under the reorganization in bankruptcy (e.g., that the US Bankruptcy Code, whereas in European second lien lender will vote in alignment with practice, no such assumption is made as no the first lien lender or at least not vote for a plan consistent equivalent court-approved process that is inconsistent with the other provisions of readily exists across European insolvency the operative subordination agreement); regimes, and therefore, the focus on • not oppose the first lien lender’s other intercreditor arrangements is to facilitate a decisions in bankruptcy, e.g., to permit the swift enforcement sale outside of court and use of cash collateral and to provide (or bankruptcy proceedings and the effective permit) post-petition financing on a “super- distribution, among creditors, of sale proceeds priority” basis regarding adequate protection or recoveries. or regarding dispositions in respect of shared collateral; and 2 Mayer Brown | What Does “Silent” Really Mean? An Overview of “Silent Second Lien” Loans in the US and Europe Feature US Practice European Practice Documentation First lien and second lien debt often First lien and second lien debt generally documented in separate and documented in separate and independent independent debt instruments, debt instruments. including security documents, and There will generally be only one set of subject to an intercreditor agreement. security documents, which are held by a common security agent on behalf of the first and second lien creditors with the first lien/second lien structure being contractually agreed to in an intercreditor agreement signed by all creditors. Subordination Generally, complete lien subordination, Usually contractually subordinated to first but level of debt subordination varies, lien debt in relation to both secured and from no debt (only lien) subordination unsecured recoveries. up to and including complete payment subordination until the first lien debt is paid in full. Scope of Security Same as first lien/senior debt. Same as United States. Ranking of Security Ranking second to first lien/ Same as United States. Because there is senior debt. generally a shared security package documented in one set of security documents, the second lien lenders will contractually agree in the intercreditor agreement that the first lien debt ranks ahead of the second lien debt in relation to such security. Payment Block in the Usually (a) permanent until first lien Same as United States but more likely to Event of a Payment debt is paid in full, (b) for a time have a set period of time. Default on First Lien Debt period such as 90-180 days or (c) by Borrower none, with (b) being the most common for institutional non- affiliated parties. This has the potential to be highly negotiated. Payment Block for Other Usually (a) for a time period such as 90- Same as United States, but more likely to Defaults by Borrower 180 days or (b) none, with (a) being the have a set period of time. most common for institutional non- affiliated parties. This has the potential to be highly negotiated. Unsecured Creditor Rights Usually extremely limited, subject to Same as United States, but of Second Lien Lender material failure by the first lien lender standstill periods are often shorter to take enforcement action and/or (e.g., 75–90 days). standstill time period (e.g., 90–180 days). 3 Mayer Brown | What Does “Silent” Really Mean? An Overview of “Silent Second Lien” Loans in the US and Europe Feature US Practice European Practice Secured Creditor Same as above. In short, the first lien Same as above, but the first lien lenders Enforcement Rights of lender is expected to be able to “drive retain control of the enforcement process Second Lien Lender the bus” when it comes to the unless they instruct the security agent not enforcement of remedies. to enforce or do not provide instructions to the security agent within a certain period of time. Enforcement includes making payment claims under any guarantees. Bankruptcy Fundamental elements of arrangement, For the reasons discussed in the text e.g., subordination and accompanying above, usually not as detailed or specific turnover obligations expressly continue as in the United States. into and apply in bankruptcy. Also, there will be bankruptcy-specific provisions—including as to plan voting, use of cash collateral, post-petition financing on a “super-priority” basis, and bankruptcy sales—expressly setting forth the dominant rights of the first lien lender. The range with respect to the negotiation of these bankruptcy- specific provisions varies depending on the provision at issue and the other particular circumstances of the transaction.
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