Split Collateral Intercreditor Agreements: Part 2 … The Current State of Play
In Part 2 of this two-part series, Robert B. Stein probes deeper into the topic of split collateral intercreditor agreements, honing in on DIP financing and adequate protection, limitations on modifications to loan documents and the purchase option.
The section of the split collateral intercreditor agreement that addresses the rights and obligations of the secured lender, which elects to provide debtor-in-possession financing or use of cash collateral, and the secured lender, which elects not to, is generally not controversial and follows a predictable format.
Because it is far more common for the pre-petition ABL lender (and not the pre-petition term lender) to provide post-petition financing, the provisions of this section of the split collateral intercreditor agreement tend to focus on: A) what types of secured extensions of post-petition credit may be provided by the ABL lender and on what terms and B) which aspects of such DIP financing or use of cash collateral will not be objected to by the pre-petition term lender.
DIP Financing and Adequate Protection
Such provisions often include the following:
• The term lender agrees not to provide DIP financing to the loan parties if the ABL lender is providing such DIP financing.
• The term lender will not object to the ABL lender’s agreement to either permit use of cash collateral or provide DIP financing, so long as: the priority of the term lender’s lien on pre-petition collateral is not altered, it receives a replacement lien on post-petition assets with the same priority as its pre-petition liens and the aggregate amount of DIP financing, together with the amount of pre-petition revolving debt, does not exceed an agreed upon cap.
• Both lenders agree not to contest the motion of the other lender for adequate protection or any objection by such lender to a debtor’s motion when the objecting lender claims lack of adequate protection.
• Each lender agrees that it will not seek relief from the automatic stay with respect to its second priority lien unless the other lender so consents, nor will it oppose the other lender’s request for such relief with respect to such other lender’s first priority lien.
• Each lender agrees that it will not object to a motion by the other lender to sell collateral subject to such other lender’s first priority lien pursuant to a §363 sale, free and clear of the second priority lien.
Limitations on Modifications to Loan Documents
The provisions contained in this section of the split collateral intercreditor agreement are also not particularly controversial. The following constitutes a list of the types of modifications common to both the working capital facility and the term loan, which typically cannot be made unless the non-modifying lender first consents to: 1) increasing the rate of interest on the obligations beyond an agreed upon margin, 2) shortening the maturity date, 3) increasing the principal amount of the underlying commitment and 4) adding events of default or making more restrictive the existing events of default. In addition, the term lender will often agree that it may not increase the principal amount of any scheduled amortization payment, or accelerate the due date of any such payment (except in connection with an acceleration of all of the term loan obligations). Finally, the ABL lender will usually agree that it may not increase rates of advance. An aggressive term lender may also take the position that, absent its prior consent, the ABL lender may not loosen its eligibility criteria or agree to add new components to the borrowing base, but the experienced ABL lender will resist such efforts for the reason that they unduly impinge on the ABL lender’s discretion.
The Purchase Option
An option in favor of the term lender to purchase the ABL lender’s commitment and all outstanding revolving loans (including letter of credit exposure) has become an accepted feature of the split collateral intercreditor agreement, and the reason is not surprising. Deterioration in a borrower’s financial condition leads to greater risk of non-payment of the cash-flow-based term loan than it does to the formula-based revolving loan. The term lender’s exit strategy requires a time horizon of significantly greater duration than the ABL lender’s, which in turn necessitates the ability of the term lender to “control the credit,” including by means of taking out the ABL lender. ABL lenders are usually not opposed to granting a purchase option to term lenders, and there are only a few sticking points to be negotiated in this area.
The first challenge is to properly define those events which, upon their occurrence, trigger the right of the term lender to exercise its purchase option. These include: notice by the ABL lender of its intention to accelerate or exercise remedies, the occurrence of an insolvency event applicable to a loan party, payment default under the term loan (with such cure period as may be negotiated as between the lenders), a sale of all or a substantial portion of the working capital assets following an event of default under the revolving credit facility and the expiration of the 150-day forbearance period discussed above. In addition, if a revolving credit facility is syndicated, the term lender will want some assurances that the revolving lender with which it has entered the split collateral intercreditor agreement will continue to control the syndicate, and therefore a triggering event may include the failure of the primary revolving lender to be the collateral agent or to hold at least a majority of the revolving credit commitments.
If the term loan lender receives notice that one of the above triggering events has occurred, it may exercise its purchase option by giving notice to the revolving lender at any time thereafter, provided payment of the revolving loans and other credit extensions purchased by the term lender is made within a short period of time following such notice, usually within five or ten days. The revolving lender must forbear from accelerating its loans and exercising any secured creditor remedies once it receives notice from the term lender that it has elected to exercise its purchase option.
The amount to be paid by the term lender to purchase the outstanding revolving obligations will depend upon the nature of the triggering event and the types of obligations outstanding under the revolving loan agreement at that time. Outstanding letters of credit and outstanding hedging obligations are usually cash collateralized by the purchasing term lender in an amount equal to 105%-110% of such contingent obligations. Payment of the full amount of outstanding revolving loans (including accrued interest and applicable fees) and the full amount of any applicable early termination fee often turns on the type of triggering event which permits the term lender to exercise its purchase option. It is not uncommon for a split collateral intercreditor agreement to provide that if the triggering event is based on notice by the revolving lender of its intent to accelerate or exercise remedies, the occurrence of an insolvency event or the occurrence of a payment default under the term loan facility, then the purchasing term loan lender has no obligation to pay the early termination fee and is obligated only to “pay in full” the revolving obligations (see Waterfall discussion in Part 1 of this series).
If the triggering event is based on any of the other enumerated events, the term loan lender is obligated to fully pay all outstanding revolving obligations (even if they exceed the applicable formula amount) and the early termination fee, as if the borrower had elected an early termination of the revolving credit facility. The logic behind the disparate treatment in the amount paid to the revolving lender is predicated on whether the option-exercising term lender is reacting defensively, based on the most serious actions taken or threatened by the revolving lender or the loan parties (e.g., payment default, exercise of remedies or bankruptcy) or is instead acting offensively (e.g., the primary lender no longer controls the votes but the underlying credit is not necessarily adversely affected).
The increasingly common use of the split collateral intercreditor agreement in middle-market financings indicates an evolution in tone that opposing secured lenders now take in dealing with one another, particularly in an era in which full collateral coverage is not a sure thing. The marketplace has reached a consensus of sorts, embodied in the split collateral intercreditor agreement, that rejects the old attitude of “what’s mine is mine and what’s yours is yours,” and instead substitutes a more measured approach, one that is more finely tailored to the business needs of each lender.
Robert B. Stein is partner and Financial Services Practice group leader at Blank Rome LLP.