Recent Trends in US Term Loan B

Lending & Secured Finance 2014

The International Comparative Legal Guide to:

Published by Global Legal Group, with contributions from:

A practical cross-border insight into lending and secured finance

2nd Edition

Adjuris

Ali Budiardjo, Nugroho, Reksodiputro

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Asia Pacific Loan Market Association

Bhikha & Popat Advogados

Bingham McCutchen LLP

Bonn & Schmitt

Brian Kahn Inc. Attorneys

Bruun & Hjejle

Chiomenti Studio Legale

Clayton Utz

Cleary Gottlieb Steen & Hamilton LLP

Cordero & Cordero Abogados

Cornejo Méndez Gonzalez y Duarte S.C.

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Dave & Girish & Co.

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Maples and Calder

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Simpson Thacher & Bartlett LLP

Skadden, Arps, Slate, Meagher & Flom LLP

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The Loan Syndications and Trading Association

TozziniFreire Advogados

White & Case LLP

Editorial Chapters:

1 Loan Syndications and Trading: An Overview of the Syndicated Loan Market – Bridget Marsh &

Ted Basta, The Loan Syndications and Trading Association 1

2 Loan Market Association – An Overview – Nigel Houghton, Loan Market Association 7

3 Asia Pacific Loan Market Association – An Overview – Janet Field, Asia Pacific Loan Market Association 11

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The International Comparative Legal Guide to: Lending & Secured Finance 2014

Country Question and Answer Chapters:

18 Albania KALO & ASSOCIATES: Nives Shtylla 87

19 Angola SRS Advogados in cooperation with Adjuris: Carla Vieira Mesquita &

Gustavo Ordonhas Oliveira 94

20 Argentina Marval, O’Farrell & Mairal: Juan M. Diehl Moreno & Diego A. Chighizola 101

21 Australia Clayton Utz: David Fagan 109

22 Bermuda MJM Limited: Jeremy Leese & Timothy Frith 117

23 Bolivia Criales, Urcullo & Antezana - Abogados: Carlos Raúl Molina Antezana &

Andrea Mariah Urcullo Pereira 127

24 Botswana Khan Corporate Law: Shakila Khan 134

25 Brazil TozziniFreire Advogados: Antonio Felix de Araujo Cintra 141

26 British Virgin Islands Maples and Calder: Michael Gagie & Matthew Gilbert 147

27 Canada McMillan LLP: Jeff Rogers & Don Waters 154

28 Cayman Islands Maples and Calder: Alasdair Robertson & Tina Meigh 162

29 China DLA Piper: Robert Caldwell & Peter Li 169

30 Costa Rica Cordero & Cordero Abogados: Hernán Cordero Maduro & Ricardo Cordero Baltodano 177

31 Cyprus Andreas Neocleous & Co LLC: Elias Neocleous & George Chrysaphinis 184

Continued Overleaf

General Chapters:

4 An Introduction to Legal Risk and Structuring Cross-Border Lending Transactions – Thomas Mellor &

Marc Rogers Jr., Bingham McCutchen LLP 15

5 Global Trends in Leveraged Lending – Joshua W. Thompson & Caroline Leeds Ruby, Shearman &

Sterling LLP 20

6 Recent Trends in U.S. Term Loan B – Meyer C. Dworkin & Monica Holland, Davis Polk & Wardwell LLP 26

7 Yankee Loans – Structural Considerations and Familiar Differences from Across the Pond to Consider –

R. Jake Mincemoyer, White & Case LLP 31

8 Issues and Challenges in Structuring Asian Cross-Border Transactions – An Introduction – Roger Lui &

Elizabeth Leckie, Allen & Overy LLP 36

9 Acquisition Financing in the United States: Outlook and Overview – Geoffrey Peck & Mark Wojciechowski,

Morrison & Foerster LLP 41

10 A Comparative Overview of Transatlantic Intercreditor Agreements – Lauren Hanrahan & Suhrud Mehta,

Milbank, Tweed, Hadley & McCloy LLP 46

11 Oil and Gas Reserve-Based Lending – Robert Rabalais & Matthew Einbinder, Simpson Thacher &

Bartlett LLP 52

12 Lending to Health Care Providers in the United States: Key Collateral and Legal Issues – Art Gambill

& Kent Walker, McGuireWoods LLP 56

13 A Comparison of Key Provisions in U.S. and European Leveraged Loan Agreements – Sarah M. Ward &

Mark L. Darley, Skadden, Arps, Slate, Meagher & Flom LLP 61

14 Financing in Africa: A New Era – Nicholas George & Pascal Agboyibor, Orrick, Herrington & Sutcliffe LLP 67

15 LSTA v. LMA: Comparing and Contrasting Loan Secondary Trading Documentation Used Across the

Pond – Kenneth L. Rothenberg & Angelina M. Yearick, Andrews Kurth LLP 72

16 The Global Subscription Credit Facility Market – Key Trends and Emerging Developments –

Michael C. Mascia & Kiel Bowen, Mayer Brown LLP 79

17 Majority Rules: Credit Bidding Under a Syndicated Facility – Douglas H. Mannal & Thomas T. Janover,

Kramer Levin Naftalis & Frankel LLP 83

The International Comparative Legal Guide to: Lending & Secured Finance 2014

Country Question and Answer Chapters:

32 Czech Republic JŠK, advokátní kancelář, s.r.o.: Roman Šťastný & Patrik Müller 192

33 Denmark Bruun & Hjejle: Jakob Echwald Sevel & Peter-Andreas Bodilsen 198

34 England Skadden, Arps, Slate, Meagher & Flom LLP: Clive Wells & Paul Donnelly 205

35 France Freshfields Bruckhaus Deringer LLP: Emmanuel Ringeval & Cristina Radu 215

36 Germany Cleary Gottlieb Steen & Hamilton LLP: Dr. Werner Meier & Daniel Ludwig 224

37 Greece KPP Law Offices: George N. Kerameus & Panagiotis Moschonas 235

38 Hong Kong Bingham McCutchen LLP in association with Roome Puhar: Vincent Sum &

Naomi Moore 242

39 India Dave & Girish & Co.: Mona Bhide 253

40 Indonesia Ali Budiardjo, Nugroho, Reksodiputro: Theodoor Bakker & Ayik Candrawulan Gunadi 259

41 Italy Chiomenti Studio Legale: Francesco Ago & Gregorio Consoli 266

42 Japan Bingham Sakai Mimura Aizawa: Taro Awataguchi & Toshikazu Sakai 274

43 Korea Lee & Ko: Woo Young Jung & Yong Jae Chang 282

44 Kosovo KALO & ASSOCIATES: Vegim Kraja 289

45 Luxembourg Bonn & Schmitt: Alex Schmitt & Philipp Mössner 297

46 Mexico Cornejo Méndez Gonzalez y Duarte S.C.: José Luis Duarte Cabeza & Ana Laura

Méndez Burkart 303

47 Morocco Hajji & Associés: Amin Hajji 310

48 Mozambique SRS Advogados in association with Bhikha & Popat Advogados: Momede Popat &

Gonçalo dos Reis Martins 317

49 Netherlands Loyens & Loeff N.V.: Gianluca Kreuze & Sietske van ‘t Hooft 322

50 Nigeria Ikeyi & Arifayan: Nduka Ikeyi & Kenechi Ezezika 330

51 Peru Miranda & Amado Abogados: Juan Luis Avendaño C. & Jose Miguel Puiggros O. 337

52 Portugal SRS Advogados: William Smithson & Gonçalo dos Reis Martins 346

53 Russia White & Case LLP: Maxim Kobzev & Natalia Nikitina 352

54 Singapore Drew & Napier LLC: Valerie Kwok & Blossom Hing 359

55 South Africa Brian Kahn Inc. Attorneys: Brian Kahn & Michelle Steffenini 367

56 Spain Cuatrecasas, Gonçalves Pereira: Manuel Follía & Héctor Bros 373

57 Switzerland Pestalozzi Attorneys at Law Ltd: Oliver Widmer & Urs Klöti 381

58 Taiwan Lee and Li, Attorneys-at-Law: Abe Sung & Hsin-Lan Hsu 390

59 Thailand LawPlus Ltd.: Kowit Somwaiya & Naddaporn Suwanvajukkasikij 398

60 Trinidad & Tobago J.D. Sellier + Co.: William David Clarke & Donna-Marie Johnson 405

61 USA Bingham McCutchen LLP: Thomas Mellor & Rick Eisenbiegler 414

62 Venezuela Rodner, Martínez & Asociados: Jaime Martínez Estévez 425

63 Zambia Nchito & Nchito: Nchima Nchito SC & Ngosa Mulenga Simachela 430

Chapter 6

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Davis Polk & Wardwell LLP

Recent Trends in

U.S. Term Loan B

There has been much discussion recently in the United States

financial markets about the convergence of terms and features in term

loan B (“TLB”) with those typically found in high yield bonds (“HY

Bond”). Though typically described as a “convergence”, the changes

are relatively one-sided, with the TLB gravitating toward features

long familiar to issuers and buyers of HY Bonds. This phenomenon

has been with us for years, but has accelerated recently. In 2013, a

year dominated by strong investor demand and “best efforts”

refinancings and dividend recapitalisations, borrowers and sponsors

predictably tested the market’s appetite for greater flexibility, which

frequently meant borrowing even more technology from HY Bond

documents. In this article, we consider some of the ways in which

U.S. TLB terms have continued to move toward – and in some cases

exceed the flexibility found in – HY Bond terms, and examine the

market and other forces driving that trend.

Changes in the U.S. TLB Market

The U.S. TLB market has its origins in the commercial bank term

loan market. In the traditional bank loan model:

loans are made on a lend-and-hold basis with the expectation

that lenders would have ongoing exposure to, and a close

working relationship with, the borrower;

a highly leveraged borrower is typically expected to deliver

over time;

financial maintenance covenants provide lenders with an

important monitoring tool and an early warning that a

borrower is experiencing financial difficulty; and

the lender syndicate is a relatively discrete group of banks,

most of which have broader relationships with the borrower

and can accommodate unexpected transactions or covenant

breaches through amendments, often with a minimal fee.

Accordingly, in this model, upfront covenant flexibility is limited,

accommodating appropriate operational flexibility, but not major

adjustments in capital structure or significant corporate events not

anticipated at closing. Moreover, lenders in that market have

traditionally expected to share pro rata among themselves in the

cash flow of the business and other prepayment events. This was

the model many participants and practitioners in the term loan

market grew up with, and is the model that continues today in many

parts of the U.S. market and in other jurisdictions.

Practitioners active in today’s U.S. TLB market will scarcely

recognise this paradigm. The U.S. TLB market is now dominated

by non-traditional lenders: CLOs, hedge funds and institutional

investors. These investors tend to view a term loan to a leveraged

borrower as a transaction – a prepayable, senior secured floating

rate investment – rather than one part of a broader institutional

relationship. They are often equally comfortable investing in HY

Bonds, where many of the protections traditionally found in the

commercial loan market are absent. Accordingly, these lenders

focus on key economic terms, and are not as concerned about, and

often are not set up to monitor, financial maintenance covenants.

The makeup of this lender base and the absence of the close

working relationship that characterises the commercial loan market

means that amendments are not as readily available and cannot be

credibly promised or relied upon in negotiating loan

documentation. These investors are less focused on deleveraging

over time and more willing to rely on less protective incurrence

tests to guard against overleverage by the borrower and their

position in the capital structure. At the same time, financial buyers

and other sophisticated borrowers have recognised this change, and

have pushed incrementally for greater flexibility in initial terms.

TLB covenants and other terms have evolved in response, giving

lenders the economics they demand while increasingly providing

borrowers greater flexibility. Over time, this dynamic between

lender interests and borrower demands has had a profound impact

on U.S. TLB terms.

Economic Terms

Yield

TLB are generally floating rate, and the built-in interest rate hedge

that this provides is an important distinguishing feature of the asset

class compared to (generally) fixed-rate HY Bonds. But it is

interesting to note that the advent of LIBOR and base rate “floors”

has – during the extremely low interest rate environment of the past

several years – caused TLB to be fixed-rate instruments accruing

interest at a rate equal to the floor plus the interest rate margin,

albeit with significant protection if LIBOR rises in the future. More

significantly, during this period, original issue discount (“OID”),

which has long been a feature of HY Bonds, has become a standard

component of TLB pricing. In fact, in both initial syndications and

secondary trading (including for purposes of “most-favored-nation”

and “repricing” protections for incremental and refinancing

provisions), TLB pricing is now thought of in terms of overall

“yield” (a terminology previously reserved for bonds), rather than

simply a rate consisting of LIBOR plus an interest rate margin.

Call Protection and Prepayments

A second element of economic convergence is the widespread

inclusion of “call protection” in TLB. In HY Bonds, call protection

Monica Holland

Meyer C. Dworkin

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Davis Polk & Wardwell LLP Recent Trends in U.S. Term Loan B

is designed to preserve an investor’s income stream, by including a

no-call period for the first years following issuance (often half the

life of the bond), followed by a “call period” subject to prepayment

premiums that decline over time. In contrast, TLB call protection

usually takes the form of a “soft call” – a prepayment premium of

typically 1% payable in connection with repricings of TLB

occurring 6 to 12 months following the closing of the TLB.

However, there are examples, particularly in the second lien TLB

market, of “hard calls” – a prepayment premium of typically 1% to

3% payable in connection with any voluntary and certain

mandatory prepayment of TLB within 1 to 3 years following the

closing date, and in some cases these financings have incorporated

no-call periods (often with “make-whole” calls permitted). A few

TLBs have even provided for special terms permitting prepayments

with proceeds of an equity issuance – a so-called “equity claw” –

typically the sole province of HY Bonds.

As the market’s focus has shifted from deleveraging over time, it

has similarly reduced its focus on mandatory prepayment events,

including through the elimination of the “equity sweep” and the

dilution of the asset sale and excess cash flow (“ECF”) prepayment

requirements. Specifically, asset sale prepayment provisions often

exclude a range of dispositions, include per-transaction and/or

aggregate materiality thresholds (below which the prepayment

requirement does not apply) and are subject to permissive

reinvestment rights during 12 to 18 month reinvestment periods.

Significantly, as greater flexibility to incur secured indebtedness

has been built into loan documentation, asset sale prepayment

covenants now often permit the borrower to share asset sale

proceeds on a ratable basis with other pari passu secured debt.

Similarly, the calculation of the excess cash flow that is required to

be swept is subject to broad deductions, including for anticipated

expenditures and investments, certain restricted payments and

prepayment of other indebtedness. Importantly, the ECF sweep will

frequently be reduced dollar-for-dollar by voluntary prepayments or

repurchases, even if made non-pro-rata among the TLB lenders.

This is in stark contrast to that traditional pillar of the commercial

bank market requiring pro-rata treatment across all lenders of a

particular class, as it effectively reallocates a borrower’s cash flow

to particular lenders at the expense of others. Finally, TLB often

afford lenders the right to reject mandatory payments, thereby

making the prepayment requirement resemble more closely the

traditional “offer to repurchase” in a HY Bond.

Covenants

Occasionally a negative covenant package for a TLB will be

indistinguishable from a related HY Bond, having been copied

directly from a concurrent or recent bond offering. More often,

provisions that are the functional equivalent of the HY Bond terms

are included in a more traditional-looking TLB package. Even the

entities covered by the typical TLB package bear a striking

resemblance to the typical HY Bond transaction. For example, a

TLB document typically no longer limits a borrower’s ability to

designate subsidiaries as “unrestricted subsidiaries” (thereby

excluding such subsidiaries from the covenants, collateral package

and EBITDA calculations under the TLB) to an overall dollar cap.

Rather many TLB, akin to the HY Bond structure, limit the ability

to so designate subsidiaries solely by reference to the borrower’s

investment capacity and, in certain instances, pro forma compliance

with an incurrence ratio, which is actually more borrower friendly

than HY Bonds, in which a fixed charge coverage ratio (“FCCR”)

condition typically applies to all such designations. The following

are certain other select areas of covenant convergence.

Financial Covenants

Perhaps the most conspicuous example of the “convergence” of

TLB toward HY Bonds is the continued presence and even

predominance in the U.S. TLB market of “covenant lite” structures.

Traditional term loans contained “maintenance” covenants –

covenants, such as maximum leverage ratios and minimum

coverage ratios – that are tested either at all times or on a specified

periodic (typically quarterly) basis. In contrast, HY Bonds were

said to have an “incurrence-based” covenant package, because

financial covenants were tested only upon, and as a condition to the

permissibility of, specified actions (e.g. debt incurrence or making

restricted payments). In a covenant-lite TLB, maintenance

covenants are replaced with incurrence covenants, which permit

borrowers to incur debt, make an investment or restricted payment

or take any other applicable action subject to complying with the

applicable financial covenant test (and other applicable

requirements). The deleveraging over time that financial covenants

traditionally mandated has therefore been replaced with a model

that permits major corporate transactions to proceed so long as the

transaction does not cause the overall leverage to exceed an agreed

maximum.

In determining compliance with such “incurrence” covenants, TLB

facilities have also adopted a number of other borrower-friendly

features from HY Bonds. These include defining “EBITDA” –

which is the denominator of any leverage ratio and numerator of

any coverage ratio – to include broad and often uncapped “add-

backs” for items such as restructurings costs and projected cost

savings and synergies (including costs savings and synergies

relating to initiatives with respect to which actions are only

expected to be taken within 12 to 24 months) and determining

compliance with such covenants on a “pro forma” basis by, for

example, calculating EBITDA in connection with an acquisition to

include the acquired entity (and its EBITDA) in the borrower’s

results throughout the relevant test period. In addition, many

leverage covenants are now calculated on a “net” basis – reducing

the debt in the numerator by the amount of unrestricted cash of the

borrower (often without any cap).

Asset Sales

TLB have largely eliminated fixed dollar limitations on a

borrower’s ability to divest its assets. Instead, assets sales are

generally permitted so long as the sale is made at fair market value,

75% of the sale consideration in “cash” (subject to a basket for

designated non-cash consideration) and the net proceeds of such

sale are applied to prepay outstanding loans (subject to the

materiality thresholds, broad reinvestment rights and rejection

rights referred to above). In effect, the TLB asset sale covenant has

been converted from a negative covenant as it was in traditional

credit facilities to the functional equivalent of a requirement to

make an offer to prepay the loans if not applied first to other

permitted purposes, similar to what one would find in a HY Bond.

Debt Incurrence

The typical 2013 TLB credit facility is crowded with flexibility

allowing the borrower to adjust its capital structure and incur

incremental indebtedness. This flexibility comes in numerous

forms: refinancing facilities, incremental facilities, amend-and-

extend provisions, acquisition related debt, permitted ratio debt,

basket debt and others, with additional variability among these

forms for incurring them on a first-lien, second-lien or unsecured

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Davis Polk & Wardwell LLP Recent Trends in U.S. Term Loan B

basis, and inside or outside the credit facility itself. These various

types of flexibility have developed independently and in different

forms, and the combination of them has resulted, in many cases, in

overlapping or inconsistent standards within TLB agreements, and

little uniformity across the industry. However, they speak to the

ongoing trend of viewing credit facilities as flexible documents

designed to survive significant corporate transactions, in this case

debt incurrence, subject to maintaining a certain leverage profile.

There are three primary instances of flexibility that borrowers have

been able to achieve in some transactions that owe their origins to

HY Bonds.

First, a limited number of TLB now permit debt incurrence subject

to satisfaction of a FCCR or interest coverage ratio (usually of

2.00x or greater). While in a low interest rate environment this

creates significant flexibility, there are several mitigants that have

survived in the TLB market. First, even where a FCCR test for debt

incurrence applies, secured debt is only permitted subject to

satisfaction of a leverage ratio. This can be contrasted with secured

HY Bonds which frequently contain no ratio test for junior lien debt

(although they do for pari passu or senior secured debt). Second,

TLB typically still include more stringent parameters around the

terms of pari passu/junior lien debt (including limitations on final

maturity, weighted average life, prepayments and, sometimes, more

restrictive terms), although it must be noted that many of these

requirements are currently under pressure from borrowers.

Second, the ability to “reclassify” debt incurred under fixed dollar

baskets to ratio debt baskets is now included in a limited number of

TLB. The rationales for resisting this are that a borrower that could

not meet the ratio debt test at the time of incurrence should not be

“rewarded” for later improving performance. And, that lenders

should not be subject to what might be an unrepresentative “high-

water mark” of EBITDA performance over the life of the loan as the

point for recharacterising basket debt as ratio debt, and resetting the

starting point for using such fixed dollar baskets. But to a borrower,

these arguments contain echoes of a maintenance-covenant

construct: the debt is “stuck” in the basket under which it was

incurred. Borrowers argue (with varying degrees of success) that,

with the market’s new, relatively relaxed attitude toward

deleveraging, if borrowers can satisfy the debt incurrence ratio at

the time of reclassification, lenders are not harmed by such

reclassification.

Third, another concept appearing occasionally in TLB is

“contribution indebtedness”, which allows the borrower to incur

debt equal to 100% (or occasionally up to 200%) of equity proceeds

it receives from investors. This originated as a HY Bond concept

and is permitted on the theory that if investors are willing to further

capitalise an issuer on a 50% or 33% equity basis, bond lenders

should be satisfied.

Restricted Payments

TLB covenants still tend to differentiate between investments,

equity payments (usually called restricted payments in that market)

and prepayments of junior debt, while HY Bonds treat these items

as part of a single “restricted payments” covenant. However, as

available amount builder baskets and maximum ratio conditions in

TLB are increasingly applied across all three classes of payments or

transactions, this distinction has become more form than substance,

and has been eliminated in a minority of TLB deals.

In HY Bonds, restricted payments may be made in the amount of a

builder basket equal to 50% of consolidated net income (“CNI”),

100% of equity proceeds and certain other builder components,

subject to compliance with FCCR greater than 2.00x. TLB more

often include an “available amount” or “cumulative credit” basket

that builds based on excess cash flow and other components and

may only be used subject to satisfying certain leverage levels. More

recently, however, the TLB cumulative credit concept has trended

closer to the HY Bond standard by building based on 50% of CNI

(or in a small number of deals, the greater of retained ECF and 50%

of CNI) and replacing the leverage ratio condition with a coverage

ratio.

Another common feature of TLB deals is that the leverage ratio

and/or absence of default conditions to the use of the builder basket

is often limited to the making of equity payments (as opposed to

investments), with the effect of establishing a more lenient set of

conditions than HY Bonds, where the FCCR condition applies to all

uses of the builder basket. Relatedly, some recent deals have also

seen the advent of an unlimited ability to make restricted payments

and investments and prepay junior secured debt, subject to the

satisfaction of a leverage ratio. This may be driven, in part, by the

desire to hard-wire dividend recapitalisation capacity into TLB as

an alternative to a sale given the recent relatively anemic M&A

activity.

Finally, in most HY Bond issuances, the issuer is not limited in the

amount of investments it can make in restricted subsidiaries

(whether or not guarantors), whereas TLB typically limit

investments by the borrower and guarantors in non-guarantor

subsidiaries. However, in recent months, a few TLB deals have

eliminated even this distinction, particularly where a U.S. borrower

has significant non-U.S. operations or a non-U.S. growth strategy.

This change has a number of important implications, including

greatly facilitating acquisitions of entities that cannot or do not

intend to become guarantors of the credit. From the borrower’s

perspective, these features may seem essential to the realization of

international strategies and increasingly complex global corporate

structures that may evolve during the life of the loan. Limitations

on cross-border transfers that are second-nature to a creditor may

seem unduly constricting to a borrower.

Flexibility to Make Acquisitions

One useful case study in the continuing march towards maximum

flexibility in loan documentations is the trends in 2013 relating to

borrowers’ ability to make acquisitions. This is particularly driven

by sponsors who frequently view their portfolio companies if not as

an acquisition platform, at least as a business that should be

positioned to grow opportunistically over time. This manifests

itself in several ways. First, it is now common to allow incremental

facilities to be utilised on a “funds certain” basis. Though it takes

a number of forms, some more aggressive than others, the theme is

consistent: if an incremental facility will be utilised to finance an

acquisition, then the conditions precedent to incurring such

incremental indebtedness should match as closely as possible the

conditions precedent to a limited “SunGard” conditionality.

Second, negative covenants frequently permit indebtedness to be

incurred to finance an acquisition subject to either satisfaction of an

agreed ratio or – borrowing from HY Bonds again – if the leverage

ratio giving pro forma effect to the acquisition is not worse than it

was immediately before. Third, call protection in TLB now often

have an exception for material acquisitions, with the result that if

the borrower is forced to refinance its existing debt in order to

consummate an acquisition, it will not be penalised by having to

pay a prepayment premium to the existing lenders. HY Bonds are

not so generous. Finally, permitted acquisition baskets are typically

not only uncapped (except with respect to acquisitions of non-

guarantor entities) but also not subject to pro forma compliance

with a leverage ratio. Taken together with negative covenant

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Davis Polk & Wardwell LLP Recent Trends in U.S. Term Loan B

baskets that grow as total assets or EBITDA grow and expansive

pro forma adjustments, these provisions ensure that borrowers can

enter into strategic transactions without seeking the consent of their

bank group, or refinancing their existing debt, and without incurring

the associated costs of doing so.

Relationships among Lenders

In many respects, the changing makeup of the investors in TLB has

been reflected in provisions that alter, in sometimes dramatic ways,

the relationships between lenders and the “exit rights” that such

lenders view as important to their investment decision.

Assignments and “Secondary” Market

One of the clearest remaining distinctions between the TLB and HY

Bond markets is that a borrower’s consent to assignments is still

required in TLB. In contrast, free transferability is a hallmark of

HY Bonds, subject to applicable securities law restrictions. It

should be noted, however, that a borrower’s consent in TLB is

usually subject to a “deemed consent” if the borrower fails to

respond within a specified period, which highlights the focus on

liquidity of TLB.

Bilateral Changes

The rights of lenders to deal individually with borrowers has

continued to expand, akin to the “affected holder” standard in HY

Bonds. In today’s TLB, individual lenders frequently may modify

their economic rights (e.g., pricing and maturity) without majority

lender approval. Borrowers may also incur additional tranches of

debt or fungible incremental debt under TLB. In addition, borrower

buybacks are often permitted on an “open market” basis – non-pro-

rata and without offering to all lenders – as has always been true of

HY Bonds.

Affiliated Lenders

In another change conforming to HY Bonds, affiliates of borrowers

outside the consolidated group may buy TLB on the open market.

This development arose following the financial crisis, as many

borrowers realised that, unlike HY Bonds, their TLB did not

contemplate, and in many cases did not easily permit, them to take

advantage of depressed secondary trading prices to restructure their

balance sheet. Borrower and affiliates buyback provisions have

now become standard in TLB transactions, though they have

evolved in a way that is not identical to HY Bonds. There is usually

a cap on the aggregate holdings of such affiliates of 20-30% of the

TLB and voting rights are limited to core economic issues directly

affecting their interests as lenders, with restrictions on receiving

lender-only information and attending lender-only meetings. “Debt

fund affiliates” of borrowers are typically not subject to the

foregoing limits and may purchase loans in excess of the cap (but

are limited to constituting not more than 49.9% of lenders for

purposes of voting). In HY Bonds, affiliates of an issuer may

purchase notes without cap, but the Trust Indenture Act (“TIA”) and

the terms of most HY Bonds even if not TIA-governed, provide that

such affiliates have no voting rights. Thus, this is another area

where the evolution of the TLB market has gone past the traditional

flexibility of HY Bonds, as affiliated lenders now have a greater

voice than affiliated noteholders.

Conclusion

As noted above, a principal driver of the evolution of the TLB

market toward that of HY Bonds has been the changes in the

relevant lender base. While commercial banks and other private-

side institutional investors were historically the principal holders of

bank loans, the TLB market is today largely driven by debt funds

and other public-side investors. As a result, there has been a shift

in the TLB origination process from a “lend-and-hold” model, in

which the arranging commercial banks made and held the bank

loans to maturity, to an “originate to sell” model, in which arranging

banks syndicate the TLB to public-side investors and do not expect

to hold those loans. Arranging banks have been under pressure,

particularly in the context of best efforts transactions which

dominated the market in the last 12-to-18 months, to arrange loans

that provide maximum flexibility to the borrower while being

attractive to public-side investors. Given that these institutions

have long been comfortable with the covenant package and other

issuer-friendly features included in HY Bonds, it is no surprise that

these terms have increasingly found acceptance in the TLB they are

willing to buy.

ICLG TO: LENDING & SECURED FINANCE 2014WWW.ICLG.CO.UK

Davis Polk & Wardwell LLP Recent Trends in U.S. Term Loan B

Meyer C. Dworkin

Davis Polk & Wardwell LLP

450 Lexington Ave

New York, New York 10017

USA

Tel: +1 212 450 4382

Fax: +1 212 701 5382

Email: [email protected]

URL: www.davispolk.com

Mr. Dworkin is a partner in Davis Polk’s Corporate Department,

practising in the Credit Group. He advises financial institutions

and borrowers on a variety of credit transactions, including

acquisition financings, asset-based financings, debtor-in-

possession financings and bankruptcy exit financings. In addition,

Mr. Dworkin regularly represents hedge funds, investment banks

and corporations in negotiating prime brokerage agreements,

ISDA and BMA standard agreements and other trading and

financing documentation and other complex structured financial

products.

Monica Holland

Davis Polk & Wardwell LLP

450 Lexington Ave

New York, New York 10017

USA

Tel: +1 212 450 4307

Fax: +1 212 701 5307

Email: [email protected]

URL: www.davispolk.com

Ms. Holland is a partner in Davis Polk’s Corporate Department,

practicing in the Credit Group. She has extensive experience in

the representation of senior lenders and borrowers in connection

with domestic and cross-border acquisition and leveraged buyout

financings, first- and second-lien financings, workouts, debt

restructurings and intercreditor issues.

The Firm

Davis Polk & Wardwell LLP is a global law firm with more than 900 lawyers in 10 offices worldwide. For more than 160 years, we

have advised industry-leading companies and global financial institutions on their most challenging legal and business matters.

We offer high levels of excellence and breadth across all our practices, including capital markets, mergers and acquisitions,

insolvency and restructuring, credit, litigation, private equity, tax, financial regulation, investment management, executive

compensation, intellectual property, real estate and trusts and estates.

The Credit Practice

We are among the world’s most experienced law firms in advising banks and other financial institutions and borrowers on LBOs

and other leveraged and investment-grade acquisition financings, structured financings, project financings, debt restructurings,

bridge loans, recapitalizations and many other types of transactions involving the use of credit. We are also the leading advisor

to banks providing debtor-in-possession, bankruptcy exit financings, rescue financings and other distressed or bankruptcy-related

financings in their various forms.

www.iclg.co.uk

59 Tanner Street, London SE1 3PL, United Kingdom

Tel: +44 20 7367 0720 / Fax: +44 20 7407 5255

Email: [email protected]

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