By: Anthony Callobre, Esq.
March 12, 2014
A unitranche loan is a term loan that combines both senior and junior components in a single credit facility. Unitranche loans are typically made by a small syndicate of lenders and are documented in a single set of loan documents. Pursuant to these documents, the borrower agrees to pay a blended interest rate on the entire principal amount of the unitranche loan and grants a single lien in favor of the administrative or collateral agent to secure the payment and performance of the entire unitranche loan.
Unitranche loans are divided into senior (“first-out”) and junior (“last-out”) components pursuant to a separate agreement among lenders (the “AAL”) to which the agent and the lenders, but typically not the borrower, are parties. The AAL is essentially the intercreditor agreement for a unitranche. Through elaborate, and often extensive and complicated, waterfall provisions, the AAL provides for a payment priority in favor of the first-out lenders. The AAL also reallocates interest payments so that the first-out lenders receive a lower interest rate and the last-out lenders a higher rate. In addition, AALs contain provisions dealing with voting rights, enforcement rights, assignments, buyout rights, and bankruptcy.
Unitranches are popular financing devices for middle-market borrowers. Since unitranches involve a single streamlined set of loan documents, a single set of financial and other covenants, a blended interest rate, and little syndication risk, borrowers value these facilities for their efficiency, speed and ease of execution.
An asset-based lender is a logical participant in the “first-out” component of a unitranche. Before entering into a unitranche, however, an asset-based lender should be aware of certain unique issues that these loans pose for first-out lenders. Following is a brief discussion of a few of these issues.
Under the unitranche loan agreement, most amendments, consents and waivers require the consent of a simple majority of the unitranche lenders. AALs, however, frequently contain provisions that alter this requirement. For example, AALs traditionally have provided that the unitranche loan agreement’s majority lender consent requires an affirmative vote of a majority of both the first-out lenders and the last-out lenders – sometimes with a minimum number of required lenders within each tranche. Given the divergent approaches of first-out lenders, who view unitranches from the standpoint of fully secured creditors, and last-out lenders, who understand that they are likely undersecured, this kind of voting arrangement frequently leads to deadlock.
Some first-out lenders and last-out lenders have grown dissatisfied with this voting convention under the AAL and have negotiated different voting arrangements. It is increasingly common, for instance, to see a provision in the AAL that allows a vote of a majority of both the first-out and last-out lenders only when an event occurs that adversely impacts the tranche that would otherwise be in the minority. An example of this would be a provision that requires a vote of both the first-out and last–out lenders in a situation where the first-out lenders hold only a minority of the overall unitranche loan but an event occurs that has special significance for the first-out lender (such as a breach of the ratio of first-out loans to EBITDA of the borrower). It is also becoming common for one tranche to have the right to drag along the other tranche with respect to voting on particular issues.
An asset-based lender, in its role as a senior-secured creditor, normally expects to be the creditor that “drives the bus” when it comes to the enforcement of creditor remedies. In first-lien/second lien financings in which the asset-based lender is the first-lien lender and in senior/mezzanine loans in which the asset-based lender is the senior lender, this is in fact the result. Pursuant to the intercreditor or subordination agreement for these financings, upon the occurrence of an event of default under the loan and security agreement between the asset-based lender and the borrower, the asset-based lender ordinarily has the right, without delay or any required advance consent of the second-lien lender or subordinated lender, to foreclose on its senior lien on the collateral and/or commence litigation or other remedies to collect its loans. But in unitranche loans, the asset-based lender does not have these same unfettered enforcement rights.
As suggested in the discussion above regarding voting rights, under the voting provisions of the unitranche loan agreement and the AAL, first-out lenders in unitranche loans could be hindered in a variety of ways when seeking the right to demand the exercise of enforcement remedies following a default under the unitranche loan agreement. The first-lien lenders may be entirely shut of the voting on the issue of enforcement if these lenders hold only a minority portion of the unitranche loan and the AAL does not alter the majority voting requirement of the unitranche loan agreement by requiring the vote of a majority of both the first-out and last-out tranches. And even if the AAL requires voting by a majority of both the first-and last-out tranches, the first-out lenders could be blocked in their desire to enforce remedies by a contrary vote of the last-out lenders.
Fortunately, most AALs contain remedies provisions that resolve these voting issues somewhat favorably for first-lien lenders. Through the use of a remedies enforcement standstill, the AAL grants first-out lenders the right to enforce their default remedies after the passage of (typically) a 30-day standstill period, well before the typical 90-days standstill period that applies to the last-out loans. It should be noted, however, that even the relatively short 30-day standstill provision applicable to the first-out loans presents an enforcement delay for asset-based lenders that they would not face under an intercreditor agreement for a first-lien loan or a subordination agreement for a senior-mezzanine loan, neither of which normally contains a standstill period applicable to the senior-secured loans.
Complexity of Agreement Among Lenders
Intercreditor agreements used in first-lien/second-lien financings and subordination agreements used in senior-mezzanine loans are typically lengthy, complicated, and, absent mutually acceptable precedent documents between the lenders, highly negotiated. Incredibly, the AAL is even longer, more complicated, and, given the emerging nature of the unitranche product and the resulting lack of widespread precedent, frequently more heavily negotiated than intercreditor agreements and subordination agreements. Prior to the occurrence of any default under the unitranche loan agreement, the first-out and last-out lenders enjoy equal rights to receive payments on the unitranche loan. However, following the occurrence of various “waterfall events,” the first-out lenders are paid before the last-out lenders under very elaborate waterfall provisions that frequently have many levels and span several pages of the AAL. Additionally, some AALs feature different waterfall triggering events that have different payment consequences. An asset-based lender that is new to the unitranche loan market may find the AAL to be a daunting document.
Enforceability of the AAL
Unitranches are fairly new financing devices. Consequently, there are few reported cases addressing the enforceability of certain provisions of the AAL, especially those pertaining to bankruptcy matters. Even as to intercreditor and subordination agreements, which have been used for many years in first-lien/second lien and senior/mezzanine loans, it is still unclear whether all of the bankruptcy-related provisions contained in those documents are enforceable. While there is no real doubt about the enforceability of common lien and payment subordination provisions contained in intercreditor and subordination agreements, there remains continuing uncertainty about whether courts will enforce agreements, consents and waivers made by junior creditors in favor of senior creditors that arguably impact fundamental bankruptcy policy matters.
Most attorneys and legal commentators believe that courts reviewing AALs will be guided by cases involving intercreditor and subordination agreements used in first-lien/second lien or senior/mezzanine financings. Nevertheless, since borrowers are typically not parties to AALs, there is a risk that bankruptcy courts will hold that they do not have the jurisdiction to enforce these agreements. A requirement that borrowers be parties to AALs might effectively mitigate this risk. But even if a bankruptcy court exercises jurisdiction over the AAL, the court could struggle with the single lien and single set of loan documents features of unitranches and awkwardly apply intercreditor or subordination agreement precedents, designed for the separate lien, separate documentation structures of first-lien/second-lien and senior/mezzanine financings, when ruling upon AALs.
Unitranches are fairly illiquid. There is currently no significant secondary (trading) market for unitranches. And even if the asset-based lender identifies a proposed assignee, there are additional hurdles to assignment. First, under the terms of the AAL, the asset-based lender must offer to assign its loan to others in the unitranche syndicate before making an assignment outside the syndicate. Second, any assignee would have to become a party to the AAL, a document that lacks the kind of standardization that facilitates smooth loan trading. Lastly, while AAL’s commonly contain mutual buy-out rights in favor of each of the first-out and last-out lenders, these rights are at the option of the purchasing party. The first-out lenders do not have the right to “put” their loans to the last-out lenders. In short, an asset-based lender should view a unitranche as a relationship loan to be held in its portfolio, rather than a loan that may be easily traded.
As noted above, unitranches involve a single term loan, documented in a single loan agreement, secured by a single lien granted in favor of the administrative or collateral agent. As such, in a bankruptcy proceeding involving the unitranche borrower, there is a risk that the entire unitranche loan will be viewed as a single secured claim. Since it is frequently the case that the collateral for a unitranche is insufficient to secure the entire unitranche loan, if the unitranche is treated as a single secured claim in bankruptcy, it will be regarded as an undersecured claim. This result would adversely impact the asset-based lender’s right, in its role as a first-out lender, to receive post-petition interest, expenses and adequate protection payments. Additionally, a single claim characterization in bankruptcy could allow the last-out lenders, if they constitute a majority of the creditors in their class and hold more than two-thirds of the amount of the unitranche, to accept a plan or reorganization over the objection of the first-out lenders.
It may be possible to mitigate these risks through careful drafting of the loan documents. For example, an explicit provision in the AAL granting first-out lenders the right to receive post-petition interest on their claim before payments are made to the last-out lenders, even if such post-petition interest is not an allowed claim in the bankruptcy, should enable the first-out lenders to receive post-petition interest. And insistence that the borrower grant two liens under the unitranche loan documents, one to secure the first-out obligations and one to secure the last-out obligations, may prevent the treatment of the unitranche as a single secured claim.
Unitranches are popular financing devices for middle-market borrowers and asset-based lenders will be presented opportunities to participate in unitranches as first-out lenders. As a result, ABLs will need to embrace those opportunities to ensure an appropriate share of the middle-market leveraged lending business. Nevertheless, unitranches present several unique issues for asset-based lenders and require careful drafting and negotiation of the relevant loan documents to ensure that asset-based lenders are afforded rights and remedies consistent with their expectations.