With each downturn in a sector of the economy, the documentation of widely-syndicated loans gets tested anew, and invariably, novel issues surface. One such issue that is just now being grappled with concerns the ability of less than 100 percent of the lenders under a secured syndicated credit agreement to agree to subordinate the liens securing the credit agreement to liens securing new financing.
The issue is most likely to come up where a subset of the existing lenders is prepared to extend new financing to a troubled borrower, but only if the lenders receive priming liens on some or all of the collateral. The issue is, of course, treated differently in a bankruptcy proceeding of a borrower, where in order for a debtor-in- possession lender to receive a priming lien on collateral, the borrower must provide the existing lenders with "adequate protection" that the amount of collateral available to satisfy their secured obligations will be maintained.
As discussed below, this important issue does not appear to have been directly addressed in most syndicated credit agreements, and lenders under a syndicated credit agreement may be surprised to discover that their liens may be able to be primed by new financings with the approval of less than all lenders. Although this article treats only lien subordination issues, the same concerns would be posed if the new money were seeking payment priority subordination from the existing lenders as well as lien subordination.
Changes to Credit Agreements
On the face of most senior syndicated credit agreements, it appears that a priming lien on collateral that secures an existing credit agreement can be approved by the percentage of senior lenders sufficient to approve garden-variety amendments and waivers. A typical credit agreement for a widely syndicated secured financing contains an amendments and waivers section which establishes a requisite majority of lenders -- usually either a simple majority or two-thirds, based upon outstanding loans and commitments -- which is authorized to approve any changes to the credit agreement and the related documents, subject to certain enumerated exceptions.
These exceptions are a narrowly defined category of modifications to the credit documentation that are considered so fundamental that each lender is given the right to approve or disapprove the changes. The typical credit agreement would include in such litany of fundamental modifications such changes as: increases in the commitment of a lender, extensions of the maturity date or reductions of the amount of any scheduled principal payment, reductions in the rate of interest, and releases of all or substantially all collateral or guarantees. Changes to financial and operational covenants would typically not require unanimous lender vote.
The lenders under a typical senior credit agreement rely upon negative covenants in the credit agreement to restrict the borrower's incurrence of new indebtedness and the creation of new security interests. These covenants generally take the form of flat prohibitions of all debt and liens, followed by carefully negotiated exceptions itemizing the categories and amounts of debt and liens which are permissible.
In addition, there may be financial formula covenants -- such as leverage ratios or minimum net worth tests -- that would also restrict debt. These would be the provisions that would require waiver or modification to permit the new workout credit contemplated by the scenario above, and it is clear that only the requisite majority of lenders -- not 100 percent of the lenders -- would be needed to approve such modifications to permit the incurrence of debt and liens in such amounts.
Unintended Unanimous Lender Approval Required
But what about priority -- does the authority of the requisite majority to amend provisions restricting liens and indebtedness also inherently include the authority to subordinate the liens securing the existing senior loans? In a typical senior syndicated credit agreement, there is no explicit provision requiring 100 percent approval to subordinate the liens securing senior loans. There are, however, at least two possible bases on which it may be argued that unanimous lender approval would be required: a release of collateral and unexpected changes to the agreement.
Release of Collateral
First, the subordination of the liens securing the existing senior loans could be viewed as being tantamount to a release of collateral. As noted above, under secured senior credit agreements significant collateral releases often need the approval of all lenders.
An agreement to subordinate the existing lenders' liens on collateral will generally include a contractual agreement that the security interests of the existing lenders are junior in priority to new security interests securing the priming loan, and an agreement to turn over to the holders of the new priming loans any collateral proceeds that may be received from the borrower in respect of existing liens. There is usually no assurance that there will be any proceeds of the collateral remaining after the priming loans have been satisfied to apply to the existing credit agreement obligations, and for this reason, the argument goes, such a subordination arrangement should be treated as if it were functionally a release of collateral.
But there is a difficulty with this argument; namely, a subordination arrangement will rarely if ever mandate that the subordinated creditors actually release existing security interests. It would be against the interests of a priming loan to do so because the priming loan receives the benefit of the existing security interests through the subordinated creditors' requirement to turn over proceeds. Further, by their nature the existing security interests will be prior in time to any new security interests added by the priming lenders, and therefore will provide priority to other creditors which are outside of the senior-subordinated intercreditor arrangements. Thus, the priming lenders will not generally require collateral releases from the existing lenders, and the proponents of the priming loan can argue that no release of collateral means literally no release of collateral -- and therefore no requirement of unanimous lender approval.
Changes Too Far Outside of Anticipated Changes
Taking a different approach to this controversy, one might suggest that this issue is not even governed by the amendments and waivers provision of the credit agreement. Under this argument, the literal reading of the amendments and waivers section -- that the requisite majority of the lenders can bind nonconsenting lenders to any change in the credit documents other than the enumerated exceptions -- proves too much, and some changes are so far outside the contemplation of anticipated changes to an ordinary credit arrangement that they cannot be approved without the consent of all lenders, notwithstanding the terms of the amendment section.
For example, a standard credit agreement arguably would not mandate the approval of all lenders to transform a term loan into a revolving credit facility with comparable economic characteristics (permitting repayment and reborrowing, but not in amounts greater than, or for periods beyond, those reflected in the term loan), but a change would likely be at odds with the expectations of the parties. Perhaps subordination of liens falls into a similar gray area of extra-contractual limitation.
Reasonable people can perhaps differ on whether subordinating existing liens to new money financing should require the consent of 100% of the existing lenders under a syndicated secured credit agreement. To the extent that the market comes to the view that 100 percent approval is appropriate -- or that such approval should be clearly not required -- the amendments and waivers provisions in standard syndicated credit agreements will need to change to catch up.