Liability Management Transactions: Quarterly Update Through Q3 2023

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Overview

As has been widely discussed by various market practitioners and commentators, the frequency of loan and bond issuers engaging in so-called Liability Management Transactions (“LMTs”) has increased dramatically over the past several years. This report is a compendium of all Liability Management Transactions tracked by Covenant Review and sister company LevFin Insights since 2014, including both public and private transactions. We intend to update this report on a quarterly basis.

Types of LMTs

There are roughly four broad categories of LMTs: Double-Dips, Drop-Downs, Uptiers, and Chewy Releases. We provide a brief description of the features of each of these transactions, though we note that each transaction is driven by the specific capital structure and covenant requirements. Accordingly, there are variations within each of the foregoing prototype LMTs. That said, there are common themes and document flexibilities that are utilized in these LMTs. Generally speaking, LMTs involve a balance sheet restructuring. This can be achieved in many ways, including through priming debt incurrences, equal priority claims on collateral assets, collateral stripping through investments or asset sales, and coercive covenant-stripping amendments, among other techniques.

Double-Dip LMTs

Double-Dips, the newest flavor of LMTs, involve the potential enhancement of claims against existing collateral assets. This usually occurs via the following structure: (1) incurrence of a new debt facility at a non-guarantor subsidiary of the existing borrower / issuer, either within or outside of the restricted group; and (2) on-lending the proceeds of the new debt facility to the existing borrower / issuer via an intercompany loan facility, with the new non-guarantor subsidiary borrower as the lender. The facility incurred under step one is usually guaranteed and secured by the existing guarantors and collateral assets that provide credit support for the existing debt obligations. On top of that, the intercompany loan facility is also guaranteed and secured by the same guarantors and collateral. In this way, the secured claims include both of the facilities incurred under clauses (1) and (2), as the intercompany loan facility provides the third-party lenders with an indirect claim against the guarantors / collateral assets. This is because the intercompany loan itself is an asset of the new non-guarantor subsidiary borrower, which is often also pledged for the benefit of the third-party lenders. In other words, for each $100 of new money, the new lenders now have $200 of claims – hence a “double dip.”

Double-Dip transactions are usually facilitated by the following covenant provisions:

• Debt and Liens Covenant capacity:
  • The related credit agreements and/or indentures must have sufficient debt and liens capacity to allow both the debt incurrence by the applicable non-guarantor subsidiary (i.e., the “New Money Loan”), and the subsequent intercompany loan facility incurrence of the on-lent proceeds of the New Money Loan.
    o The debt agreements also must provide sufficient capacity for the guarantees (and collateral support, if any) provided by the existing credit parties in respect of the New Money Loan obligations incurred by the non-guarantor subsidiary.
• Investments Covenant capacity:
  • As the provision of a guarantee is also normally an “Investment,” capacity under the Investments Covenant is usually required as well. Often, however, the Investments Covenant includes a generic cross reference permitting any debt that is permitted to be incurred by the Debt covenant under the Investments Covenant as well. As such, if the Debt covenant provides sufficient capacity, often this will be sufficient to justify the Investment portion of the Double-Dip.
• Other potential relevant provisions:
  • There also must not be any requirement that intercompany loans and guarantees be subordinated to other obligations; this is a common limitation but often only applies to intercompany loans using the dedicated intercompany debt basket.
  • To the extent an unrestricted subsidiary is the borrower under the new facility, there must also be no limitation on credit support provided by the restricted group in respect of unrestricted subsidiary debt obligations.

Although the ultimate enforceability in bankruptcy of the two claims for the full amount for Double Dip transactions is still an open question, it is certainly clear that borrowers and issuers have been utilizing this structure with increasing frequency throughout 2023.

Drop-Down LMTs

Drop-Down LMTs generally take one of two flavors: those utilizing unrestricted subsidiaries, and those utilizing non-guarantor restricted subsidiaries.

• Drop-Downs utilizing unrestricted subsidiaries: These transactions typically involve the transfer of one or more assets of the relevant borrower to an Unrestricted Subsidiary, which is itself not subject to the covenants. That Unrestricted Subsidiary, in turn, can either incur debt that is structurally senior in respect of the transferred asset(s), or alternatively sell the asset(s), which then results in the net cash proceeds of any such asset sale not being subject to the credit agreement asset sale sweep.
• Drop-Downs utilizing restricted non-guarantor subsidiaries: These transactions, which are somewhat less common, typically involve the transfer of one or more assets within the restricted group from a guarantor to a non-guarantor Restricted Subsidiary, as permitted by the Investments covenant. That entity, in turn, can incur debt to the extent permitted by the Debt covenant, and that new debt (even if unsecured) will also be structurally senior to the claims of the existing credit agreement lenders.

Uptier LMTs

Uptier LMTs typically involve amending an existing credit agreement with the consent of a majority lender group to permit the incurrence of a senior priority debt tranche and the non-pro rata exchange of some or all of the existing consenting lender credit agreement debt into the new priority tranche. This may or may not be accompanied by a “new money” debt commitment, or simply involve the exchange of pre-existing debt. Although some uncertainty was created due to court rulings in the Serta and Boardriders litigations, it appears that borrowers will continue to utilize these transactions after Judge Jones’s ruling in the Serta Simmons Chapter 11 litigation.

Chewy LMTs

The Chewy transaction involved (in part) the release of a restricted subsidiary guarantor from its obligations under the existing PetSmart credit agreement due to the transfer of a portion of equity of Chewy to an unrestricted subsidiary, as well as the spin-off of another portion of Chewy equity to the equity sponsor. Because non-wholly owned subsidiaries are typically excluded from the guarantee requirements under broadly syndicated credit agreements, this could result in valuable subsidiaries being released from their guarantee and collateral support of existing obligations through the transfer of a small portion of equity outside of the restricted group. In response, the market has witnessed an uptick in “Chewy blocker” provisions, which seek to address this flaw in a myriad of ways.

Envision LMTs (and other miscellaneous LMTs)

In the Envision transaction, the sponsor (KKR) combined elements of both Drop-Down and Uptier LMTs. This included both the designation of valuable assets (of a specified subsidiary) as an unrestricted subsidiary, followed by an uptier exchange offer transaction. We explain the details in our Envision Blocker report, but this transaction illustrates the “creativity” of sponsors in the LMT space.

There also are a smattering of additional LMT transactions, which include asset based revolver-related amendments, payment default grace period-related amendments, and other kinds of coercive exchanges.

In the following charts, we outline each of the LMTs that have been covered since we began tracking these types of transactions in 2014, together with the sponsor (if any) that drove the transaction, a brief description of what happened in the transaction, and the ultimate outcome (if known). As we can see from the details below, often a LMT still leads to a
bankruptcy filing.

LMTs with Double-Dip Elements

Drop-Down LMTs