Proxy rights for lenders have become the latest battleground in deal negotiations, according to sources, coming as the tussle over transaction terms seeps into once-arcane aspects of documentation and amid fierce competition among lenders.
One particularly important aspect of proxy rights, which result in the lender appointing its own board in certain circumstances, revolves around the notice period that lenders are required to give the sponsor before exercising those rights. From the lender’s perspective, the ideal is no notice period.
If advance notice is required, any upper hand lenders had may be mitigated: The company may end up in bankruptcy as a result, forestalling any remedies lenders have.
“Lenders like knowing they can take the keys, but a long proxy notice might mean you can’t simply take them,” Paul Hastings partner Jenn Daly said. “Lenders often ask themselves, does this really matter? If the sponsor has a notice period, though, the company may file.”
The sole act of lenders appointing a board basically strips the sponsor of governance and effective control of the company, even though the sponsor still owns the equity of the company.
A lender-backed board could vote to initiate a restructuring, which may, and often does, result in lenders fully controlling the company and receiving a majority of the equity.
That outcome is not a guarantee, though, as new board members are still fiduciaries. Any restructuring undertaken needs to fulfill the directors’ fiduciary duties, and the lender becoming owner might not always be the best path.
New directors whom lenders appoint to boards will generally consist of independent directors and seasoned executives from the sector the company operates in, according to David Hillman, a partner and global co-chair of the restructuring group at Proskauer.
This post-default tool is effective even if it is used as a tool of last resort. It is far more common in private credit because it is much less likely to happen in the syndicated market, Hillman said.
“Bank groups or bondholders are unlikely to exercise proxy rights,” he said. “Lenders take great care on when and how to implement the board flip because missteps can expose the uninitiated to significant pitfalls and risks.”
One lender noted that proxy rights and notice periods are not even in the credit agreement, they are in the security agreement, which might put it out of lenders’ minds.
A second lender, though, called it the “biggest hot-button credit term,” adding it’s a large-market provision that is working its way down market. One common version of the notice period that is becoming accepted in the market is a two-day notice period, except for a payment default in which no notice would be required.
While the issue hasn’t always been front of mind for buyout shops, attorneys for the sponsors are bringing it to the fore and emphasizing its importance, Daly said. That, in turn, is making it more likely that lender proxy rights will indeed be front of mind for the private-equity firms.
Raising issues over notice periods may cause a lender to miss out on a deal.
“You probably could lose a deal over it. It’s infrequent that it comes down to just one term, but it can be a factor,” the second lender said. Instances where the firm may consider accepting a notice period are for high cash-flow businesses and sponsor relationships that have a high degree of trust.
Daly agreed that the issue has been becoming more contentious in the deal negotiation process.
“If you do raise it, sponsors can sometimes credibly tell you that others are not raising the issue. Lenders could risk losing the deal if they are the only lender to continue to push that specific item,” she said. “It has become that much of a hotly discussed point; it’s a meaningful thing to give away.”
Andrew Hedlund
andrew.hedlund@levfininsights.com
+1 480 313 1334
