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THE SECURED LENDER APRIL 2015 23 Volving Privately Negotiated Second Lien Carve-Outs Secured by Asset Classes Be Used in Order to Extract Value in an Term Loans

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THE SECURED LENDER APRIL 2015 23 Volving Privately Negotiated Second Lien Carve-Outs Secured by Asset Classes Be Used in Order to Extract Value in an Term Loans PREDICTIONS FOR INTERCREDITOR ARRANGEMENTS IN 2015 AND BEYOND The Devil Really is in the Det ils BY KATHERINE E. BELL, JENNIFER B. HILDEBRANDT AND JENNIFER S. YOUNT Intercreditor arrangements are one of the most challenging aspects of transactions, yet they have become increasingly prevalent in recent years. Changes in law, the regulatory environ- ment, the credit markets, the economy, and the way that companies do business can all trigger new developments in intercreditor arrange- ments. This article examines five areas where we anticipate developments in intercreditor arrange- ments in 2015 and beyond and describes the reasons for the developments. 22 REGISTRATION IS NOW OPEN FOR CFA’S 71ST ANNUAL CONVENTION IN AUSTIN, TX WWW.CFA.COM “The devil is in the details” is appropri- assets of businesses are becoming more ate cautionary advice for anyone tasked complex – intangible asset classes like with documenting the relationships intellectual property are more impor- among different lenders. tant in every business today and are Intercreditor arrangements exist in intertwined with other traditional asset circumstances where more than one classes. The foregoing raises unique group of lenders has a claim against and increasingly complex intercreditor the same loan parties and some or all considerations. of the lenders have a claim as secured In light of the overlapping and com- creditors against their assets. A variety peting rights of lenders and increasingly of different types of intercreditor ar- complex intercreditor arrangements, rangements are common in the market intercreditor arrangements are – not today -- first lien/second lien, split col- surprisingly — one of the most chal- lateral, unitranche, senior/mezzanine lenging aspects of transactions. This and others – and they exist in every is unlikely to change. However, past market, across industries, and in both experience has shown that changes asset-based and cash-flow transactions. in law, the regulatory environment, Intercreditor agreements are designed the credit markets, the economy, and to set forth the ground rules for lenders the way that companies do business, playing in the same sandbox with the can all trigger new developments in same toys at times when the stakes are intercreditor arrangements. This article high and incentives may not be aligned. examines five areas where we anticipate With multiple claims against the same developments or changes in intercredi- loan parties and common collateral, tor arrangements in 2015 and beyond. come overlapping and competing rights Of course, we remain in the midst of and differing incentives. As a result, change in many of these areas. each intercreditor negotiation repre- sents a series of compromises among 1) Second Lien/Junior Creditors Will competing lenders. Press for More Favorable Intercredi- Additionally, intercreditor arrange- tor Terms: ments have grown more complex in re- The U.S. loan market is in the process cent years. There are a variety of reasons of adjusting to a more restrictive for this. With supply exceeding demand, regulatory environment, with, among steep competition among lenders in the other things, increased regulatory markets has required lenders to be cre- scrutiny over banks’ leveraged loan ative in structuring deals and flexible on underwriting standards. Regulatory terms in order to win deals. Therefore, it scrutiny is expected to limit bank is common today for financing transac- lending activity compared to levels tions to involve multiple tranches of over the past several years. Nonbank debt, multiple liens and the flexibility lenders have jumped on this oppor- to fold in additional debt and liens over tunity, with a slew of new nonbank the term of the credit facility. It is also lenders raising capital and positioned more common today for asset pools and to fill the void. As a result, a greater revenue streams to be more finely sliced number of transactions will involve and diced and allocated with different nonbank lenders in one or more roles priorities among different lenders in dif- in the debt structure going forward. ferent tranches of debt. Moreover, the underlying operations of loan parties Many nonbank lenders have more have become more and more complex latitude in their underwriting approach, over the years. For example, businesses have higher cost of funds, and have are becoming increasingly global every greater risk tolerance than traditional day. This means that multiple legal banks. Consequently, the increase in the regimes may have an impact on lenders number of these players in the market is to that business. Also, the underlying likely to lead to an increase in deals in- THE SECURED LENDER APRIL 2015 23 volving privately negotiated second lien carve-outs secured by asset classes be used in order to extract value in an term loans. As this occurs, we anticipate like intellectual property and other exit scenario. We expect that practi- that many of those second lien lenders intangibles. tioners and lenders will increasingly will press for greater control over the focus on these provisions to bring credit compared to the intercreditor Increased complexity in the allocations them in line with the level of sophis- arrangements that would be in place in of collateral among competing credi- tication of how intellectual property circumstances where the second lien tors invites potential valuation battles. assets are used by businesses today. is provided through a high yield bond Some lenders have already placed issuance or other issuance involving provisions in split collateral intercredi- 4) Intercreditor Arrangements Will more passive investors. In addition, tor agreements which specify valuation Evolve to Address Cross-Border Con- tightening credit markets generally give methodology under certain circum- siderations: second lien and mezzanine lenders more stances, such as provisions setting The prevalence of cross-border financ- negotiating leverage. forth the allocation of proceeds of sales ing transactions and more complex Under circumstances in the past that involve mixed collateral (meaning capital structures continues to grow. involving a greater concentration of priority collateral of both classes of Consequently, we expect that stan- privately negotiated second lien term lenders). However, many split collat- dard intercreditor agreements will loans with nonbank lenders or tighter eral arrangements do not include such evolve to address the complexities credit markets, we saw more negotiation provisions today. We expect increased raised by the overlay of different legal around restrictions relative to amend- attention and negotiation around valu- frameworks applicable to entities and ments to senior debt, caps on senior ation methods and allocations in split assets located in other jurisdictions. debt (including accordions and post-pe- collateral intercreditor arrangements Below are a few examples of provi- tition financing), and shorter standstill going forward. In addition, with the sions that we expect will become periods. This trend has already begun increase in split collateral arrangements, more prevalent in intercreditor ar- to reemerge and we anticipate more to we expect to see more litigation in split rangements: come. collateral transactions in the context of • contractual frameworks to replicate Section 363 sales and plan confirmations a two-lien structure in jurisdictions 2) There will be an Increase in Split (and the issues involved will likely be where obtaining two liens is not Collateral Intercreditor Arrange- relative to the valuation and allocation feasible, and ments and More Focus on Valuation of the collateral pools). • preservation of expectations rela- Methods: tive to the right of a junior creditor to Over the past few years there has 3) There will be Increased Sophistica- exercise remedies after a standstill been a marked uptick in the number tion Around Access, Use and License period in jurisdictions where junior of transactions involving split-col- Rights Related to Intellectual Prop- lien creditors are not statutorily en- lateral intercreditor arrangements. erty in Split Collateral Deals: titled to such remedies while senior Fewer and more flexible covenants, The importance and value of intel- creditors are unpaid. coupled with extremely competitive lectual property in commerce today pricing, have proven attractive –- cannot be overstated. In many split 5) In Light of Recent Case Law, Senior resulting in private equity funds and collateral transactions, intellectual Lenders Will Negotiate For Broader borrowers seizing upon the benefits property is the priority collateral of and Clearer Chapter 11 Protections: of asset-based loan facilities. In ad- the term lenders. Yet, the asset-based At least two recent court decisions dition, the presence of flexible debt lenders very likely need access, use indicate a trend towards courts provisions (refinancing facilities and and/or license rights to realize upon, narrowly interpreting intercreditor side-car incremental provisions) and and preserve the value of, their prior- agreements’ restrictions on junior lenient covenant packages, which ity collateral. Given the importance lenders’ actions in bankruptcy pro- are more and more prevalent in and value of intellectual property ceedings: In re Boston Generating, market loan documentation today, today, ensuring adequate access, use, LLC, 440 BR. 302 (Bankr. S.D.N.Y. 2010) work together to make it feasible for and license rights relating to intel- (“Boston Generating”)
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