In recent years, traditional multi-level debt structures have yielded considerable space to the unitranche transaction, which combines elements of senior and junior financings into a single loan agreement. The document spelling out the relationship among the lenders, an Agreement Among Lenders (AAL), is not signed by the borrower but is intended to operate similarly to an intercreditor agreement. From the borrower’s point of view, a unitranche financing provides simplified documentation and streamlined reporting. Lenders eager for yield and market share have accommodated borrower demand for simplicity by offering the unitranche option. Billions of dollars of unitranche financings are currently outstanding.
A Lack of Court Testing
For all their popularity, the unitranche model has not yet been examined in court to any significant degree. When a unitranche borrower begins to experience distress and the possibility of a bankruptcy becomes real, the lenders party to the AAL will want to have already thought through their rights and obligations in response to the borrower’s situation and developed a relationship of trust and mutuality. Because the borrower is not a party to the AAL, there is some legitimate risk that a bankruptcy court will conclude that it is not entitled to determine any controversies that may exist with respect to the AAL. Instead, the bankruptcy court may look solely to the language of the AAL and refrain from exercising any of its broad discretion to decide intercreditor issues.
Worse yet, the bankruptcy court could send the lenders to a non-bankruptcy forum, concluding that it does not have jurisdiction over any dispute exclusively between non-debtor parties. In this case, by the time a non-bankruptcy court resolves any issues of fundamental importance, the typically fast-moving bankruptcy process may have concluded its restructuring, sale or liquidation process, leaving lenders in a different forum to sort things out amongst themselves.
When a unitranche borrower ends up in distress — either in or out of court — the lenders will benefit from the time and thought invested in their relationship through a well-written agreement spelling out their respective rights.
Outside the unitranche context, bankruptcy courts routinely issue decisions emphasizing the need for clear drafting. Indeed, bond investors have been rattled by recent bankruptcy court decisions limiting their ability to obtain make-whole payments in the absence of precise contractual language. The decisions serve as a reminder of the crucial role of courts in interpreting contractual language and the uncertainty inherent when courts are tasked with ruling on imprecise language.
Bondholders depend on the certainty of a return for a fixed period of time. As a result, an indenture agreement governing the bonds generally mandates that any early payment must be accompanied by an additional payment of future interest to make up for any income lost by the investors as a result of a prepayment. Yet, in recent bankruptcy cases, e.g., the Chapter 11 of American Airlines1 and Momentive Performance Materials,2 bankruptcy courts have allowed the bankrupt companies to satisfy outstanding indebtedness without including a make-whole payment to senior creditors. In the Momentive case, the court’s ruling was widely reported to cost the bondholders more than $200 million.3
These courts, reviewing the indentures, have determined that the operative language failed to support bondholder claims for make-whole payments. In the American Airlines case, the agreement required payment of the make-whole amount if the company voluntarily accelerated the payment of its debt.4 In a September 2013 decision, the Second Circuit determined that automatic acceleration of indebtedness occasioned under federal bankruptcy law by the company’s Chapter 11 filing was not a voluntary acceleration by the company.5 Similarly, in the recent Momentive decision, the Bankruptcy Court for the Southern District of New York concluded that the debtor company was not prepaying debt that became automatically due by virtue of the company’s bankruptcy filing.6 The Momentive plan just became effective in late October 2014 and remains under appeal. Now that the company’s confirmed plan is in the process of being implemented, reversal is considered unlikely. Meanwhile, the impact of the decision on other similar make-whole situations was immediate, such as the long-running Energy Future Holdings Chapter 11 case.7
Decisions concerning the make-whole issues affirm a core principal: Understanding how language drafted by contracting parties will be interpreted and enforced by the judiciary — especially in an insolvency — is of utmost importance. In the case of the make-whole controversies, the courts have not been afraid to “let the chips fall where they may” based on the particular language being interpreted in the agreements at issue. There is no law requiring make- whole payments to senior creditors to be automatically enforceable in a bankruptcy context. Rather, to obtain that result, the parties must have first drafted clear and unambiguous language for a court to review and enforce. The recent rulings will send lawyers and bondholders back to tighten up existing agreements at the first opportunity and create stronger language in their agreements going forward.
American Roads Decision
As public markets grapple with fallout from make-whole controversies, lenders structuring and participating in unitranche financings should note the importance of carefully crafting language that will hold up when tested. For many years, bankruptcy courts have analyzed the rights of borrowers and lenders under traditional multi-level debt structured financings consisting of a first-lien and a second-lien lender, each with their own set of loan documents and an intercreditor agreement to which the debtor is a party. Market participants in these transactions have developed well-honed legal agreements to address their rights and obligations including the impact of a borrower’s insolvency. Well-established precedent guides the courts and parties in documenting and enforcing such traditional arrangements on many issues.
While AALs used in the unitranche context have not been tested to any significant degree, one noteworthy decision was issued by the United States Bankruptcy Court for the Southern District of New York in 2013 in the American Roads Chapter 11 proceeding.8 That decision upheld a no-action clause in an indenture in a so-called “insured unitranche” financing and thus barred a group of bondholders from objecting to a proposed plan supported by a bond insurer. It may be that the court upheld the no-action clause because the creditors still had a remedy to pursue against the insurer, but the case provides insight into how a court may view an AAL in a more typical unitranche transaction. Specifically, a bankruptcy court may determine that lenders holding junior positions in a unitranche financing under an AAL to which the debtor is not a party lack standing to be heard in the bankruptcy case.
To position unitranche lenders in a manner that will build trusting relationships, a well-drafted AAL needs to cover a number of key points. These include provisions relating to: respective standstill and voting rights, payment waterfalls from collateral proceed; and respective rights regarding DIP/post-petition financing, planned §363 sale proposals/transactions, automatic stay relief, and voting on proposed reorganization plans and claim classification issues. Thus, parties to the AAL must think through not only the logistics of advancing and monitoring the loan but also the creditor parties’ respective rights during a time of distress.
Careful drafting is essential in helping parties consider business issues in advance and reach agreement. If parties need to turn to the AAL during the time of a borrower’s distress, the document should serve as an invaluable tool in navigating the situation, not as fodder for litigation between lenders. Thus, when times get tough, lender parties will need the benefit of a well-crafted agreement that helps them reach a solution and does not inadvertently accelerate a troubled situation. Unitranche transactions remain relatively illiquid, especially in times of distress. Therefore, it is even more important to structure the AAL carefully at the outset with a trustworthy partner to ensure a constructive solution during a period of borrower distress.
The middle market financing segment has benefitted from the growth of the unitranche product over recent years. Borrowers have been well-served by reduced documentation and simplified compliance processes. Lenders participating in such transactions need to ensure that, in the effort to simplify the process for the borrower, important rights are sorted out among lenders with good relationships in the event of a default. As with the make-whole controversy in the public debt markets and the no-action provision in the insured unitranche context, ultimately the language of the agreements will be critical. While in a perfect world of performing borrowers, language drafted about lender remedies would never need to be consulted, prudence teaches that taking the time to build trust and agree on language that spells out rights, remedies and obligations during challenging times, will be well worth the effort, especially in the untested world of unitranche financing.
Philip R. Rosenblatt is chair of the business department at the law firm of Nutter McClennen & Fish LLP, and co-chair of the firm’s commercial finance group. He has extensive experience in complex finance, asset-based loan and securitization transactions.
John G. Loughnane is a partner in the business department of Nutter McClennen & Fish LLP. He has more than 20 years of experience focused on growing and restructuring companies. He works to protect the rights of well-established clients dealing with the financial distress of other parties including licensors and licensees, secured and unsecured creditors, customers, vendors and employees.
1. U.S. Bank Trust National Association v. American Airlines Inc. (In re AMR Corp.), 730 F.3d 88 (2d Cir. 2013)↩
2. Corrected and Modified Bench Ruling on Confirmation of Debtors’ Joint Chapter Plan of Reorganization for Momentive Performance Materials Inc. and its Affiliated Debtors. In re MPM Silicones, LLC, Case No. 14-22503, (Bankr. S.D.N.Y. Sept. 9, 2014) (D.I. 979)↩
3. Dawn McCarty, “Apollo’s Momentive Plan Nears Acceptance on Changed Votes” Bloomberg News (August 25, 2014).↩
4. 730 F.3d at 94.↩
5. 730 F.3d at 99.↩
6. See note 2 supra.↩
7. Nick Brown, Tom Hals and Billy Cheung, “Energy Future’s Turnaround May Get Surprise Boost from New York Judge” Reuters (September 5, 2014).↩
8. In re American Roads LLC, 2013 WL 4601006 (Bankr. S.D.N.Y. Aug. 28, 2013).↩