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Bulletin, Tuesday 14 August 2012
Intercreditor issues in mezzanine financings
Banking & finance
In financing transactions involving mezzanine debt, intercreditor
arrangements are essential in order to regulate rights as between
the various classes of lenders. These arrangements are also usually
the subject of detailed and complex negotiations, particularly
given the importance of the relevant provisions in any potential
restructuring or enforcement.
Although every deal is different, in the current challenging economic
climate, senior lenders are increasingly uncomfortable with the
inclusion of secured mezzanine debt in the relevant capital structure.
To the extent that senior lenders are allowing for mezzanine debt
secured over the same assets as the senior debt, we are seeing
sustained tensions between senior lenders and mezzanine lenders
when negotiating their intercreditor arrangements. In this bulletin,
we examine some of the key issues for mezzanine lenders when
negotiating intercreditor arrangements.
Subordination of debt and security
Mezzanine debt, by definition, ranks behind senior debt in terms of
the right of repayment and enforcement of security. Senior lenders
often seek a full subordination of the rights of mezzanine lenders,
so that until the senior debt is fully repaid the mezzanine debt
cannot be repaid. The right to declare the mezzanine loan amount
due and payable (often also triggering senior cross-default)
should however be preserved.
Mezzanine lenders should seek to limit the extent of their
subordination by agreeing that certain payments (eg. interest,
fees and amortisation payments) may be made to them provided
that there is no senior event of default or a ’material’ default
subsisting or caused by that payment.
Permitted payments
Mezzanine lenders will generally be entitled to be paid upfront
fees and to allow their interest to capitalise during the period in
which senior debt remains outstanding. Senior lenders may seek
to block recurring fees and ‘cash pay’ interest during this period,
or more commonly to ensure that such payments are not permitted
to be made in the following circumstances:
–– immediately when there is a senior payment default;
–– immediately (or following the expiry of a limited remedy period)
when a breach of a financial covenant has occurred; and/or
–– after the issue of a ‘stop notice’ following the occurrence of
a senior event of default.
From a mezzanine lender’s perspective, these restrictions may be
too broad, particularly where the covenant and default regime
under the senior facility agreement is highly restrictive.
Mezzanine lenders could therefore seek to:
–– limit the ability of senior lenders to block payments to an
agreed list of material senior events of default that have
occurred and are subsisting, including breaches of financial
covenants, insolvency events, cross-defaults and/or a breach
of the intercreditor deed itself; and
–– limit the period of time for which payments may be blocked
(a common time frame is 180 days), after which time the
senior lenders must either trigger acceleration/enforcement,
waive the default or allow payments to mezzanine lenders.
In addition, senior lenders will not usually permit the repayment
of principal amounts owed to the mezzanine lenders while the
senior debt is outstanding. However, mezzanine lenders should
seek to negotiate an exception whereby their debt is permitted
to be repaid or refinanced on maturity.
Acceleration and enforcement
Mezzanine lenders should generally have the right to declare a
default (but not request or receive repayment), so that interest
then accrues at the default rate. Senior lenders however, usually
seek to restrict the right of mezzanine lenders to accelerate their
debt and enforce their security. Depending on the circumstances,
we have seen mezzanine lenders retain the right to accelerate
and enforce in the following circumstances:
–– after the occurrence of an insolvency event where the senior
lenders have failed to enforce within an agreed period of time;
–– when the mezzanine debt is not repaid on its maturity date;
and/or
–– more broadly, when a mezzanine event of default is subsisting,
subject to the expiry of a standstill period (we have recently
seen periods range from 180 days to 360 days).
Exercising insolvency rights
It is important that mezzanine lenders do not lose the ability to
prove for their debt on the insolvency of the borrower or another
security provider. A common position under intercreditor agreements
is that mezzanine lenders grant senior lenders the right to prove
for the mezzanine debt and exercise the mezzanine lenders’ rights
in an insolvency. However, mezzanine lenders should seek to retain
the ability to prove for their debt and exercise their other rights
in an insolvency in the event that the senior lenders fail to act
within the appropriate time period.
To assist senior lenders in restructuring defaulting loans, we have
at times seen the inclusion in intercreditor agreements of the right
for the security trustee (acting on senior lender instruction), to
control and exercise mezzanine lenders’ voting rights at meetings
of creditors or following the appointment of a liquidator or receiver
or in the context of a scheme of arrangement being entered into
in respect of an obligor.
Whether mezzanine lenders will be able to challenge the exercise
of such rights by senior lenders will depend on a variety of matters,
including the construction of creditor classes and where value breaks
in the capital structure. Mezzanine lenders should exercise caution
before granting any such voting permissions to senior lenders.
Mezzanine lenders should also be alert to provisions in intercreditor
agreements that entitle senior lenders in an enforcement scenario
– when the shares in an obligor are to be sold – to unconditionally
release such obligor (and possibly their subsidiaries) from any
subordinated mezzanine debt, guarantees and security without
any further action by such subordinated lenders. We have seen
senior lenders invoke this right on a number of recent deals to
assist in facilitating debt restructures.
Buyout of senior debt and right to cure
Mezzanine lenders may seek the right to purchase (or procure that
another entity purchases) the senior debt at par value where a senior
event of default is subsisting. This gives the mezzanine lenders
the right to take such action or prevent senior lenders from taking
enforcement action before the expiry of any senior standstill period.
Particularly important in a restructuring context, mezzanine lenders
should have the right to cure senior events of default that are
remediable (eg. financial covenant breaches or a failure to pay) by:
–– injecting additional debt or equity capital into the structure;
–– having the ability to prepay amounts owing under the senior
facility; and
–– taking other actions considered desirable by the mezzanine
lenders and approved by the senior lenders.
Ultimately, the willingness of a mezzanine lender to exercise such
rights will depend on various factors, including the quantum of
senior and mezzanine debt and, in a distressed-debt scenario,
where ‘value breaks’ in the capital structure.
Amendments and waivers
Senior lenders are seeking increased flexibility to amend the terms of
senior finance documents without the consent of mezzanine lenders.
This includes amending majority or unanimous consent matters,
which may include granting waivers and converting ‘cash pay’
interest to ‘payable in kind’ interest.
Such provisions may allow senior lenders to devise restructure
strategies that they can implement with minimal regard for the
mezzanine lenders, particularly if they are ’underwater’. Mezzanine
lenders should seek to agree a list of areas so that ’material’
amendments – including pricing, payment dates, fees, financial
covenants, maturity dates and any related consents or waivers –
would also require their consent.
Drag-along rights
Senior lenders may seek to ensure that any waiver they grant in
respect of an event of default or breach is also deemed to bind, or
‘drag-along’, the equivalent rights of mezzanine lenders under the
mezzanine debt. From a senior lender’s perspective, this allows
simpler administration of consents and limits the mezzanine
lenders’ ability to frustrate that process.
Mezzanine lenders may seek carve-outs from this in order to retain
consent rights in respect of various material issues, including:
–– disposals of assets;
–– changes to the payment regime or cashflow waterfall; and
–– material undertakings, including negative pledges, permitted
debt, permitted payments and change of control restrictions.
Refinancing and raising additional senior debt
Some intercreditor agreements (particularly in the leveraged market)
provide that new senior debt is permitted without the consent of
mezzanine lenders if it refinances existing senior debt or it falls
within an acceptable level of additional debt (a ’headroom level’),
which is usually up to 10 per cent of the original senior debt.
It is commonplace for senior lenders to request the ability to reset
financial covenants and lock-up levels within certain parameters
as part of this process.
Mezzanine lenders should consider the viability of the requested
headroom level. Obviously it is in the mezzanine lender’s interest
to restrict the amount of debt that ranks ahead of it and to ensure
that any new senior debt is not provided on any more favourable
senior terms.
Conclusion
With increasingly conservative limits on the quantum and conditions
upon which senior debt is available in the market, there remains
an important need for mezzanine debt in many capital structures.
Intercreditor terms in Australian financings have evolved and will
continue to do so, responding to changing market conditions. There
are efforts underway to produce a set of standardised intercreditor
principles for the Australian leveraged finance market using insights
from the London Loan Market Association precedent document.
With senior lenders reluctant to permit mezzanine debt, we have
more recently seen ‘equity lends’ with security taken over shares in
the principal asset-owning entities but not directly over the assets
themselves. However, the traditional mezzanine market remains
important and the issues highlighted above (amongst others) will
continue to be key negotiation points for mezzanine lenders seeking
to preserve and enhance their subordinated rights.
Contacts
If you would like further details about the information contained
in this bulletin or assistance with any finance-related issues,
please contact:
Sydney
Paul Rubenstein, Partner
Telephone 61 2 9226 7222
[email protected]
Melbourne
Stephen Sharp, Partner
Telephone 61 3 9229 9707
[email protected]
Nathan Briner, Partner
Telephone 61 2 9226 7227
[email protected]
Ben Mahoney, Partner
Telephone 61 3 9229 9711
[email protected]
This publication is intended to provide a general outline and is not intended to
be a complete or definitive statement of the law on the subject matter covered.
Further professional advice should be sought before any action is taken in relation
to the matters described in this publication.
Arnold Bloch Leibler Lawyers & Advisers
Level 21 333 Collins Street Melbourne VIC 3000 Australia Telephone 61 3 9229 9999 Facsimile 61 3 9229 9900
Level 24 Chifley Tower 2 Chifley Square Sydney NSW 2000 Australia Telephone 61 2 9226 7100 Facsimile 61 2 9226 7120
www.abl.com.au