Sponsors and borrowers, for their part, will wish to limit a lender's ability to transfer, on the basis that they want to manage their commercial relationships. In the case of unutilised commitments, they will also want to ensure the lender's ability to fund. In a downside context, they will also have a strong incentive to prevent loan participations ending up in the hands of investors with an agenda that differs from their own, or at least those of the originating financial institutions.
The subject of transferability therefore always receives a fair degree of attention in corporate and leveraged lending transactions as the parties seek to navigate this tension. Moreover, during the coming months, against the spectre of further Covid-induced underperformance, the parties' rights will form an important aspect of contingency planning for borrowers and lenders alike.
In this Insight we consider some of the issues to be alert to.
Almost all loan agreements will expressly deal with transferability. This reflects its importance, although it is worth noting that, absent any such restrictions, loan participations would in most cases be freely assignable. The Loan Market Association (LMA) form of leveraged loan agreement provides for two alternatives for addressing transferability. Under the first option, the borrower must be consulted but is not required to give their consent for a transfer. The second option requires the consent of the borrower for a transfer, subject to certain carve-outs.
Typically borrower consent is required on leveraged finance deals, subject to certain carve-outs, but greater flexibility is often agreed on corporate lending deals. The carve-outs in the LMA leveraged finance document permit transfers:
- to an institution on a specified, pre-approved list of acceptable transferees (known as a 'whitelist' – see below);
- to another lender or one of its affiliates or related funds;
- with the borrower's consent, which cannot be unreasonably withheld and is deemed to be given after a specified period of time; and
- to any institution permitted at any time whilst an event of default is continuing.
These carve-outs will typically be modified in at least one of the following ways.
It is common to have an agreed list of entities to which a lender can transfer its interests without the borrower's consent. This typically comprises traditional, regulated financial institutions. Some loan agreements allow lenders and borrowers the ability to replace entities on such a list during the life of the loan, although this is less commonly encountered in the mid-market.
Lenders will wish to pay close attention to any carve-outs to the approved list - whether contained in the list itself or the operative provisions of the loan agreement (in particular, to competitors and distressed investors – see below). Attention should also be given to any requirements for transferring lenders to notify a borrower or sponsor prior to any transfer being effective, even if the transferee is on an approved list. Both of these exculpations have long been a feature of larger deals and now feature in most mid-market deals and (especially in the former case) a reasonable proportion of corporate lending transactions.
Reasonableness and deemed consent
Where consent to transfer is required, the borrower will usually be required to act reasonably in relation to any such request. Consent will also often be deemed to be given by the borrower if it is not rejected (although precise language varies) within a specified period. This is typically between 5 days and 10 business days. Occasionally, bespoke provision will also be made for circumstances in which it will (or will not) be deemed reasonable for a borrower to refuse consent.
Events of default
Transferability without borrower consent on an event of default increases a lender’s options by allowing the transfer of its participation to a range of potential entities which may not be named on the approved list – without the need for express or deemed consent. It may also override restrictions that would otherwise apply on transfers to competitors or distressed investors.
Historically, transfer restrictions fell away upon an event of default. Although often negotiated, in the leveraged world, it is more commonly the case that restrictions on transfers will only fall away once and for so long as a significant event of default is continuing (or acceleration notice has been served). This will include restrictions on transfers to distressed debt funds or competitors. We could well see greater focus on the relevant event of default triggers in coming months.
The 'wrong hands'
It is commonplace for leveraged loan agreements to include restrictions which from the sponsor's and borrower's perspective seek to prevent debt falling into what they might perceive to be the 'wrong hands', notably those of competitors and distressed debt funds. As the LMA form of document does not restrict such transfers, we see a range of drafting formulations around the extent of the restrictions – and the carve-outs from them.
On competitors, sponsors will be concerned to ensure affiliates (including portfolio competitors) are captured. Lenders will wish to ensure that 'affiliates' is not too broadly defined so as to pick up businesses over which they / controlling shareholders do not have control; and that the type of business which would cause the restriction to be engaged is not too wide.
On distressed debt funds, sponsors will want to cover all institutions that undertake such an activity, and to ensure activities of concern are all captured. This will include those embarking on a loan-to-own strategy, but we do see more broadly drafted restrictions, for instance covering those seeking to obtain a voting blocking stake.
Lenders, for their part, will look to limit the scope to only the relevant part of the business undertaking such an activity (and for whom it is a material part of its investment strategy). In particular, from their perspective, a financial institution should not be prohibited from acquiring debt just because it has a debt trading arm or affiliate, provided that arm or affiliate operates independently of the acquiring entity and is subject to appropriate information barriers. A similar case is occasionally raised in relation to competitors and their affiliates too.
The relationship between such restrictions and the whitelist is frequently negotiated in the context of when any such restriction should fall away following one or more events of default. However, there is sometimes (especially in smaller transactions) less focus on whether transfers to affiliates and related funds should also be subject to such restrictions. This may be of concern to sponsors to the extent it allows, for example, a debt fund to transfer commitments to a related special situations or distressed debt fund.
A lender will need to pay attention to any bespoke pre-emption rights included, whether in favour of another lender or the sponsor. Although not frequently encountered, we have seen both.
Historically, and still today on LMA terms, restrictions on transfers only applied to absolute transfers and not sub-participations (on which the document would be silent). Accordingly, in this way lenders could avoid the transfer restrictions imposed on them by a borrower. However, sponsors and borrowers (primarily in the leveraged arena) have now long been sensitive to this and so seek to impose restrictions on such transfers – in particular, those sub-participations which transfer voting rights, although broader restrictions are occasionally encountered. Again, sub-participation restrictions are less frequently encountered in lower mid-market leveraged and corporate lending transactions.
During challenging economic times, lenders may look to revisit and restructure their balance sheets by reducing exposure to certain sectors, countries or currencies under various existing transactions, whether before or after the occurrence of a default. The transfer provisions in a loan agreement provide a simple mechanism by which lenders can divest of interests in a loan without themselves being required to lead or participate in what could become a lengthy, resource-consuming restructuring, as well as mitigating some of the reputational impact and risks associated with other forms of recovery.
As such, whilst the transfer provision tension exists in most lending relationships throughout the term of the loan, it is likely to feature more prominently over the coming months as lenders navigate the distressed cycle. We have already seen lenders successfully seeking to dial back on the sponsor-friendly positions achieved pre-pandemic, especially at the lower end of the mid-market.
Documentary restrictions on the ability to exit will be most acutely felt by investors in liquid syndicated markets. However, lenders may also seek to avail themselves of what can (perhaps counter-intuitively) be more flexible documentary rights in this respect under debt fund and bilateral clearing bank documents – including potentially by way of transfers into special situations or distressed debt funds. That being said, lenders will doubtless remain mindful of preserving relationships and reputation for the longer term when it comes to the exercise of transfer rights, irrespective of the pure documentary position.