CLE for In-House Counsel
January 7, 2014
Beverly Hills, CA

Understanding Credit
Agreements from a Borrower's
Perspective
...
What You Are Going to Learn

• Principal Objectives of the Parties
• Types of Credit Facilities
• The role of Guarantors a...
Main Concerns of the Parties

• Lender's Perspective
• Most important considerations:
• Will lender recover the principal ...
Main Concerns of the Parties

• Borrower's Perspective
• Ensure that lender's attempts to monitor business activities do n...
Types of Facilities

• Revolving Loans
• The Visa of corporate finance

• Term Loans
• Borrow now – pay over time

• Speci...
Types of Facilities

• Revolving Loans:
• Borrower may borrow, repay, and re-borrow the loans during the term of
the commi...
Types of Facilities

• Term Loans:
• By contrast to a revolving loan, a term loan, once borrowed and repaid
may not be re-...
Specific Loan Structures

• Senior, Second Lien and Unitranche Loans
• Asset Based (Borrowing Base) Loans
• Project and Fa...
Guaranties and Collateral

• Obligations of borrower may be guaranteed
• Parent company, principal shareholders or subsidi...
Pricing (How Lenders Make Their Money)

• Interest
• Floating rates – Prime, LIBOR, ABR
• Fixed rates

• Fees
•
•
•
•

Com...
Pricing - Interest Rate

• Floating Rate
• Interest is calculated as a floating rate index (Prime, LIBOR, ABR)
• Multiple ...
Pricing - Fees
• Facility Fees:
• Upfront fees paid on the entire credit commitment, both used and unused
• Most common in...
Pricing - Price Maintenance Protections

• Capital Cost and Tax Indemnities
• Allocates to the borrower additional costs i...
Standard Terms

• Representations and Warranties
• Striking a balance between knowing enough and counting the ceiling
tile...
Representations and Warranties

• Lenders goal:
• Receive material information about borrower, its subsidiaries and its
bu...
Representations and Warranties

• Legal Matters Representations
• Representations address the legal status of the borrower...
Representations and Warranties

• Financial Conditions Representations
• Representations address the financial and other b...
Representations and Warranties

• Representations and Disclosures Regarding the
Business
• Discloses particular facts abou...
Conditions Precedent

• Specifies the conditions that borrower must meet before
the credit agreement is binding or the len...
Conditions Precedent

• Effectiveness Conditions
• Matters relating to organization and authorization
• Good standing cert...
Conditions Precedent

• Ongoing Conditions
• Representations - all representations remain true and accurate as of
the date...
Covenants

• Protect the lenders' investment during the life of the
loan by monitoring borrower's business activities
• In...
Covenants

• Information covenants: requires financial statements
and other specified information to be supplied by
borrow...
Covenants

• Financial covenants: test the financial performance of the
borrower; are earnings, debt or net worth within c...
Covenants

• Affirmative covenants: tells the borrower what it must
do
• Maintain insurance in amounts and against risks c...
Covenants

• Negative covenants: tells the borrower what it may not do
• Incurring debt
• Incurring liens
• Selling assets...
Events of Default

• Specified events or circumstances that suggest a
decreased likelihood borrower will be able to pay it...
Events of Default

• Immediate event of default - allows lenders to immediately
accelerate the entire principal
• Failure ...
Events of Default

• Event of Default with grace period or time to cure
• Certain payments of interest
• Inaccuracy of rep...
Amendments and Waivers

• Lender approval percentages for different types of amendments and
waivers
• Changes in pricing, ...
Lender Assignments Provisions

• Standards to be met for assignments (e.g. minimum dollar amounts) and
requirements for el...
Governing Law and Jurisdiction for Disputes

• Which state's substantive law is applied

• New York commercial law which i...
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Corporate: Negotiating Credit Facilities

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Corporate: Negotiating Credit Facilities

  1. 1. CLE for In-House Counsel January 7, 2014 Beverly Hills, CA Understanding Credit Agreements from a Borrower's Perspective Don Weaver Partner, Los Angeles Dentons LLP USA 213 892 5017 don.weaver@dentons.com Ike Chidi Associate, Los Angeles Dentons LLP USA 213 892 5013 Ike.chidi@dentons.com
  2. 2. What You Are Going to Learn • Principal Objectives of the Parties • Types of Credit Facilities • The role of Guarantors and Collateral • Pricing • Understanding and Negotiating Standard Terms and Conditions 2
  3. 3. Main Concerns of the Parties • Lender's Perspective • Most important considerations: • Will lender recover the principal sum advanced and receive interest payments promptly? • How a lender protects itself: • • • • • The loan amount and collateral coverage ratios Conditions for borrowing Representations and warranties Covenants Events of default 3
  4. 4. Main Concerns of the Parties • Borrower's Perspective • Ensure that lender's attempts to monitor business activities do not interfere with day-to-day operations and principal objectives • Moderate representations and obligations with reasonableness and materiality thresholds • Avoid defaults with grace periods and cure rights before events of default mature and remedies are triggered • Minimize upfront and ongoing expenses • Maximize ongoing flexibility through lender approval procedures for waivers and amendments 4
  5. 5. Types of Facilities • Revolving Loans • The Visa of corporate finance • Term Loans • Borrow now – pay over time • Specific Loan Structures • One size doesn't fit all 5
  6. 6. Types of Facilities • Revolving Loans: • Borrower may borrow, repay, and re-borrow the loans during the term of the commitments; typically no set amortization • Outstanding amount may not exceed the aggregate revolving credit commitments • Generally provided to borrowers that need working capital facilities where liquidity needs fluctuate or where cash flow or other forms of capital are unavailable 6
  7. 7. Types of Facilities • Term Loans: • By contrast to a revolving loan, a term loan, once borrowed and repaid may not be re-borrowed • Typically requires amortization of principal • May be provided for working capital purposes, but often associated with long term capital needs of borrower, e.g.: • finance an acquisition • refinance other debt • provide funds for capital improvements 7
  8. 8. Specific Loan Structures • Senior, Second Lien and Unitranche Loans • Asset Based (Borrowing Base) Loans • Project and Facility Financings • Mezzanine Loans • Swing Line Loans • Letter-of-Credit Sub-Facilities • Multi-Currency Facilities 8
  9. 9. Guaranties and Collateral • Obligations of borrower may be guaranteed • Parent company, principal shareholders or subsidiaries or affiliates of borrower assume the responsibility for the obligations of borrower • Payment vs. payment and performance • Upstream guarantees / fraudulent conveyance • Obligations of borrower or guarantors may be secured • Borrower or guarantor grants a security interest in all or certain assets in favor of lender • • • • • Real property Tangible and intangible personal property Borrowing base Shares or membership interests of borrower Recourse vs. nonrecourse 9
  10. 10. Pricing (How Lenders Make Their Money) • Interest • Floating rates – Prime, LIBOR, ABR • Fixed rates • Fees • • • • Commitment Facility Non-utilization Prepayment • Pricing Protections • Capital costs and tax indemnities • LIBOR floors and breakage 10
  11. 11. Pricing - Interest Rate • Floating Rate • Interest is calculated as a floating rate index (Prime, LIBOR, ABR) • Multiple interest periods • Interest rate swaps • Fixed Rate • Interest is calculated at a constant or fixed rate for the life of the loan • Interest Rate Margin • Specified rate percentage added to base floating or fixed rate • Margin based on credit of the borrower and may be fixed or may adjust based on credit criteria 11
  12. 12. Pricing - Fees • Facility Fees: • Upfront fees paid on the entire credit commitment, both used and unused • Most common in revolving facilities • Commitment Fees: • Borrower pays on average daily unused lender commitments to compensate lenders for maintaining their commitments to make the funds available to borrower • Found in revolving and delayed draw term facilities • Utilization Fees: • Payable when amount of loans drawn exceeds a specified percentage of the revolving credit commitments • Most common in revolving facilities where commitments are not expected to be frequently drawn upon • Prepayment Fees: • Typically charged on voluntary prepayments of principal to compensate lenders for loss of expected return through maturity • Fees typically reduce annually and are eliminated after a specified period (i.e. 1 to 3 years) 12
  13. 13. Pricing - Price Maintenance Protections • Capital Cost and Tax Indemnities • Allocates to the borrower additional costs imposed on lenders for changes of law imposing additional reserve requirements or for taxes other than income tax • Borrower should review "change of law" definition and seek reasonable time periods for lenders to make claims • LIBOR Floors and Breakage • Interest rate floor to protect against unexpected dips in LIBOR • Protects lenders for breakage costs for principal prepayments made during LIBOR interest period 13
  14. 14. Standard Terms • Representations and Warranties • Striking a balance between knowing enough and counting the ceiling tiles • Conditions Precedent • Getting your ducks in a row and your collateral secured • Covenants • Information, affirmative, negative, financial – a promise is a promise • Events of Default • Paying on “time” and fixing problems – negotiating grace and cure periods • Some Things Just Can’t Be Cured - Hard Defaults • Amendments and Waivers • Lender Assignments • Governing Law and Jurisdiction 14
  15. 15. Representations and Warranties • Lenders goal: • Receive material information about borrower, its subsidiaries and its business in deciding to make loans and monitor ongoing business • Allocates risk between the lenders and borrower • Borrower should consider: • Reduce the frequency of when reps are made or restated • Introduce materiality - "avoid a foot-fault" • Make certain factual representations "to the knowledge of" 15
  16. 16. Representations and Warranties • Legal Matters Representations • Representations address the legal status of the borrower and its subsidiaries • • • • • Organization, existence, power and qualification Due authorization Enforceability No conflicts Compliance with laws 16
  17. 17. Representations and Warranties • Financial Conditions Representations • Representations address the financial and other business attributes of borrower and its subsidiaries • Financial statements • Taxes • ERISA 17
  18. 18. Representations and Warranties • Representations and Disclosures Regarding the Business • Discloses particular facts about borrower's property or business with exceptions set out on disclosure schedules • • • • • Capitalization of borrower Subsidiaries of borrower Tangible and intangible property owned, leased or licensed by borrower Existing debt and liens on assets Other existing material facts (e.g. lawsuits and judgments, environmental conditions, sale of assets) 18
  19. 19. Conditions Precedent • Specifies the conditions that borrower must meet before the credit agreement is binding or the lenders will advance funds: • A list of closing items that specifies (i) the documents borrower must deliver to the lenders, (ii) what actions borrower must take and (iii) what other circumstances must exist in order for credit to be available • Conditions must be satisfied either (i) at closing or the date of the initial loan (effectiveness conditions) or (ii) at each borrowing (ongoing conditions) • Borrowers should: • Seek specificity and avoid broadly stated or ambiguous conditions that may hold up an advance • Avoid ongoing deliveries (e.g. legal opinions) that will increase costs 19
  20. 20. Conditions Precedent • Effectiveness Conditions • Matters relating to organization and authorization • Good standing certificates • Written resolutions • Formation documents • Ensuring security interest in collateral is perfected • Filing UCC-1 financing statements and mortgages • Execution and delivery of loan agreements and backup documents • • • • • • Credit agreement Security agreement and pledges Promissory note Guaranty Officers certificates Appraisal and environmental report 20
  21. 21. Conditions Precedent • Ongoing Conditions • Representations - all representations remain true and accurate as of the date originally made or as of each lending date • Defaults - no default or event of default exists at the time of borrowing • No material adverse changes have occurred since borrower's most recent audited financial statements 21
  22. 22. Covenants • Protect the lenders' investment during the life of the loan by monitoring borrower's business activities • Information covenants • Financial covenants • Affirmative covenants • Negative covenants • Borrower should approach covenants with great degree of care • Constraints and burdens may affect ability to conduct day-to-day business • Extensive affirmative and negative covenants may impose significant ongoing costs and time commitments 22
  23. 23. Covenants • Information covenants: requires financial statements and other specified information to be supplied by borrower on a regular basis • Provide for the basis on which financial statements are to be prepared • Information relating to borrower's affairs such as occurrence of a material adverse change in business of the borrower or the occurrence of a default • Material litigation and the incurrence of third party debt or liens 23
  24. 24. Covenants • Financial covenants: test the financial performance of the borrower; are earnings, debt or net worth within certain pre-agreed minimum levels? • Date specific - test borrower's financial position at a certain date (net worth) and measured at fiscal end dates (e.g., quarterly/annually) • Performance based - test borrower's financial performance for an agreed fiscal period • Hybrid - test two indicia of borrower's business, one date-specific and one period specific (e.g., leverage ratio compares debt of borrower at a fiscal end date to borrower's EBITDA for the four quarters that end on that date) • Borrowers should make sure: • Defined terms used in financial covenants (e.g. EBITDA are crafted to reflect revenue and other items specific to its business) • Financial ratios are crafted to reflect seasonality or other common fluctuations in revenues 24
  25. 25. Covenants • Affirmative covenants: tells the borrower what it must do • Maintain insurance in amounts and against risks customarily maintained by other businesses in the same industry and location • Compliance with all laws, rules, regulations • Payment of all taxes • Permit lenders to inspect borrower's books and records • Maintenance of assets • Borrower should seek materiality and reasonable standards in affirmative covenants 25
  26. 26. Covenants • Negative covenants: tells the borrower what it may not do • Incurring debt • Incurring liens • Selling assets • Making investments and capital expenditures • Paying dividends • Affiliated transactions • Borrower should: • Carefully review covenants to make sure that anticipated material expenditures, acquisitions and divesting are permitted • Seek specific "baskets" and exceptions to avoid the need for ongoing lender waivers 26
  27. 27. Events of Default • Specified events or circumstances that suggest a decreased likelihood borrower will be able to pay its obligations under loan • Certain defaults are immediate "hard defaults" where others arise only after notice is given or time has lapsed • Allows lenders to: • Accelerate repayment of debt • Enforce remedies including rights in collateral 27
  28. 28. Events of Default • Immediate event of default - allows lenders to immediately accelerate the entire principal • Failure to pay principal when due • Breach of certain material affirmative and negative covenants (maintain corporate existence) • Breach of financial covenants • Cross defaults vs. cross acceleration • Borrower or guarantor becoming insolvent • Borrowers should request: • Limited time periods (e.g. 10 business days) to cure material affirmative and negative covenants that are "curable" • Grace periods for payment defaults (e.g. 3 business days) • Change of control and events outside borrower's control be prepayment events so as to not trigger cross defaults under other credit facilities 28
  29. 29. Events of Default • Event of Default with grace period or time to cure • Certain payments of interest • Inaccuracy of representation • Breach of most affirmative and reporting covenants • Borrowers should seek: • Objective language - to reduce the exercise of lender discretion • Grace period for payments of interest and third-party costs (i.e. 3 to 5 business days) • "30 day cure period" for breaches of representations and warranties • Longer grace period for breaches of performance covenants (i.e. 30 + 30 days) 29
  30. 30. Amendments and Waivers • Lender approval percentages for different types of amendments and waivers • Changes in pricing, payment terms and release of substantially all collateral every lender • Changes or waivers of covenants - majority or supermajority • Borrowers should seek: • Approval of only affected lenders for certain pricing and payment changes and waivers • The right to replace non-approving lenders • Limit approval rights of loan participants 30
  31. 31. Lender Assignments Provisions • Standards to be met for assignments (e.g. minimum dollar amounts) and requirements for eligible assignees • Criteria for loan participants • Borrowers should seek: • Reasonable approval rights so long as no event of default • Net worth and credit criteria for assignees, especially if there are ongoing funding commitments • Restrict assignments to competitors • Limitations on numbers of assignees to ensure manageable lender group relations 31
  32. 32. Governing Law and Jurisdiction for Disputes • Which state's substantive law is applied • New York commercial law which is "creditor-friendly" is often required by Lenders • Section 5-1401 of New York's General Obligations Law - allows parties to choose NY law regardless of whether there is otherwise a reasonable relation to New York if transaction is $250K or more (California has similar provision Cal. Civ. Code, Section 1646.5) • Where will disputes be heard? Waiver of jury trial • California's C.C.P. 638 32

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