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Structuring Intercreditor Agreements in Split Collateral Lien Structures Between ABL and Term Lenders Navigating Collateral Pool, Priority of Rights, Access to Collateral, Standstill Period, and Waterfall Provisions

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THURSDAY, OCTOBER 2, 2014

Presenting a live 90-minute webinar with interactive Q&A

Eric W. Kimball, Partner, Holland & Knight, Dallas

Brent R. McIlwain, Partner, Holland & Knight, Dallas

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Copyright © 2014 Holland & Knight LLP All Rights Reserved

HOLLAND & KNIGHT CONTINUING PROFESSIONAL DEVELOPMENT WORKSHOPS:

SPLIT COLLATERAL INTERCREDITOR ARRANGEMENTS

Presented by

Eric W. Kimball [email protected]

Brent R. McIlwain

[email protected]

mailto:[email protected]

mailto:[email protected]

• Survey of typical financing structures that you may encounter in middle-market transactions and a comparison of their lien and debt subordination characteristics

• Discussion of key intercreditor agreement points, including ‒ Defining what constitutes “ABL Priority Collateral” and “Term Loan

Priority Collateral” ‒ Defining what constitutes “ABL Debt” and “Term Loan Debt” ‒ Payment blockage ‒ Turnover ‒ Remedies standstill ‒ Application of proceeds, including mixed collateral proceeds

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Overview HOLLAND & KNIGHT

CONTINUING PROFESSIONAL DEVELOPMENT WORKSHOPS

• Discussion of key intercreditor agreement points (continued) ‒ Collateral access rights ‒ Amendment restrictions ‒ Release of liens ‒ Bankruptcy related rights ‒ Purchase option

• Assumption: separate loan documentation for ABL lender group

and separate documentation for term loan lender group

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Overview (continued) HOLLAND & KNIGHT



TYPES OF FINANCING STRUCTURES AND DISTINGUISHING FEATURES

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HOLLAND & KNIGHT CONTINUING PROFESSIONAL DEVELOPMENT WORKSHOPS

• Subordinated Debt ‒ Seller/Insider Debt ‒ Unsecured Subordinated Debt ‒ Secured Subordinated Debt

• Second Lien Term Debt

• Unitranche Financing

• Split Collateral Financing

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Types of Financing HOLLAND & KNIGHT


• Debt Subordination – One creditor ranks behind the debtor’s

payment obligations to another creditor – Senior Creditor: Lender with prior right to payment – Junior Creditor: Lender with subordinate right to payment

• Lien Subordination – Two creditors have a security interest in the

same assets and agree that one creditor has a prior ranking – First Lien Creditor: Lender with senior lien – Second Lien Creditor: Lender with subordinate lien

• Split Collateral Financing – Lien subordination; no debt subordination

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Debt Subordination vs. Lien Subordination



KEY INTERCREDITOR AGREEMENT POINTS

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Defining Priority Collateral Buckets

• ABL Priority Collateral – All receivables (with a carve-out for receivables related to term loan

priority collateral), or alternatively, receivables arising from sale of inventory or provision of services

– Inventory – Chattel paper, instruments and general intangibles to the extent governing

or evidencing receivables – Cash and deposit accounts (carve-out for cash proceeds of term loan

priority collateral and term loan deposit accounts) – Other proceeds of the foregoing

• Term Loan Priority Collateral: everything else, with two common

exceptions – Business interruption insurance – Treatment of collateral purchased with cash proceeds of receivables

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Defining Maximum ABL Debt

• Purpose • Maximum ABL Debt

– Maximum closing date commitment amount plus a cushion • Alternative, lesser of (x) maximum closing date commitment amount

plus a cushion, or (y) borrowing base plus unintentional overadvances plus protective advances plus a cushion

– Incremental commitments plus a cushion – DIP financing – Cash management and hedging obligations – Interest and fees related to principal and other obligations within cap

• Post-petition interest and fees, even if disallowed in a bankruptcy, should be expressly included

– Indemnity obligations – Less permanent commitment reductions (with a corresponding reduction

in principal balance)

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Defining Maximum Term Loan Debt

• Maximum Term Loan Debt – Closing date term loan balance plus a cushion – Incremental term loan commitments plus a cushion – DIP financing – Interest and fees related to principal and other obligations within cap

• Post-petition interest and fees, even if disallowed in a bankruptcy, should be expressly included

– Indemnity obligation – Less permanent term loan principal payments

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Lien Subordination

• Override of statutory lien priority

– Blanket lien subordination as to non-priority collateral – Alternatively, lien subordination to the extent of priority lender’s maximum

debt cap

• Effect of non-perfection or avoidance of liens – Absolute subordination even if unintended payment subordination results

• Effect of subordination of priority lien

• Special issues with respect to prior UCC filings by a lender

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Payment Blockage

• General rule: with debt subordination, junior creditor should not be paid until the senior creditor is paid in full

• With split collateral financings, there is no debt subordination, but the ABL lender may require restrictions on certain payments ‒ Optional term loan prepayments ‒ Excess cash flow sweeps ‒ Mandatory principal and scheduled amortization and interest payments

should not be restricted • Placement of restrictions and the consequences

‒ Turnover ‒ Default ‒ Making documents work together

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Remedies Standstill

• General rule: No enforcement action may be taken by a second lien creditor until a standstill period has run

– Priority collateral • Typically no standstill • Advance notice

– Non-priority collateral • Permanent standstill or stated time period plus extension • Subject to customary exceptions (such as filing proof claim,

taking actions to perfect lien, voting on a plan, making a credit bid and exercising unsecured creditor remedies)

• Real property specific issues • Deposit account specific issues • Access agreement specific issues

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• Subordinated creditor (that is, with debt subordination) is

required to hold in trust and deliver to any payments received in contravention of intercreditor agreement

• Second lien creditor (that is, lien subordination only) is required to deliver to first lien creditor collateral proceeds received pursuant to an enforcement action

• Split collateral (lien subordination) on respective collateral – Priority collateral proceeds – Non-priority collateral proceeds – Ordinary course payments should not be subject to turnover,

with potential exceptions depending on payment blockage treatment

– Voluntary prepayments – Excess cash flow payments – Safe harbor provisions

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Turnover of Payments HOLLAND & KNIGHT


Application of Proceeds Waterfall

• Triggers

– Existence of an insolvency proceeding or exercise of remedies, or both – Alternatively, all priority collateral proceeds

• Dangers of alternative formulation for ABL lenders and term loan lenders

• Application

– ABL priority collateral applied to ABL obligations up to maximum debt cap – Term loan priority collateral applied to term loan obligations up to

maximum debt cap

• Permanent commitment reductions

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Collateral Access and Use Rights

• Types of property subject to access and use – Real property – Equipment – Books and records – Intellectual property

• Obligations and limitations related to access and use

– Length of access or use period – Rent and royalty-free, except for payment of out-of-pocket costs – Indemnification for third-party liability – Insurance – Unfinished inventory – Quality standards – Interaction with security agreement license

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• Increasing amount of debt above stipulated cap

‒ if exceeded, breach or automatic subordination of lien, or both • Increasing interest rate by more than 200 to 300 bps per annum

‒ this should not limit imposition of the default rate or be violated by changes or elections in floating reference rates (e.g., Prime, LIBOR)

• Changing payment dates or amortization amounts • Extending the maturity date • Restricting the payment of the other debt to a greater degree • Changing advance rates, availability blocks or borrowing base that

have the effect of increasing availability • Subordination of liens as to priority collateral

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Typical Amendment Restrictions


• Scope of release: affects non-priority lender • Triggers

– Exercise of remedies as to priority collateral • Commercial reasonableness of exercise • Credit bidding

– Sale of priority collateral pursuant to both loan documents

• Self-executing release – Power of attorney

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Release of Liens HOLLAND & KNIGHT


Bankruptcy Related Provisions

• Negotiation regarding bankruptcy related intercreditor provisions is ordinarily less controversial in split collateral financings, but important nonetheless

1. What is not typically addressed

– Filing proofs of claim – Plan related provisions/Claim voting

2. What is typically addressed – DIP financing – Cash collateral use – Adequate protection rights – Rights to seek relief from the automatic stay – Rights to approve of, or object to, sales of assets under Section 363 of the

Bankruptcy Code

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• DIP Financing – Which lender typically provides? – Consents

• Usually cuts across collateral lines • Protections for priority collateral • Subject to debt caps

– Adequate protection • Replacement liens on post-petition collateral • Other adequate protection

– Priming issues

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Bankruptcy Related Provisions (continued) HOLLAND & KNIGHT


Bankruptcy Related Provisions (continued)

• Cash Collateral Use – ABL collateral more likely to generate cash collateral – Consents

• Term Lender typically pre-consents to ABL cash collateral use • Protections for priority collateral

– Adequate protection • Replacement liens on post-petition collateral

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• Adequate Protection Rights – Typically each Lender has right to request adequate protection

• Reciprocal agreement not to contest • Adequate protection should honor priority collateral

• Automatic Stay

– Rights to seek relief from automatic stay related to priority collateral – A corollary to right to seek adequate protection – Practical issues

• How does company operate without fixed assets? • Can collateral be effectively split absent liquidation?

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Bankruptcy Related Provisions (continued) HOLLAND & KNIGHT


Bankruptcy Related Provisions (continued)

• Sales under Section 363 – Lenders typically have reciprocal pre-consent to sales of priority collateral – Practical issues

• Sales typically involve substantially all assets or mix of priority and non-priority collateral

• Allocations of value

• Other Issues

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Buy-Out Right

• Triggering Events

‒ ABL payment default (including acceleration and maturity) ‒ ABL termination of commitments ‒ Commencement of a bankruptcy proceeding ‒ ABL exercise of secured creditor remedies ‒ ABL failure to fund revolving advances for X consecutive days

• Window vs. open-ended option • Who can exercise • Borrower pre-consent

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Buy-Out Right (continued)

• Obligations include ‒ All pre-petition obligations within maximum debt cap ‒ DIP financing (sometimes) ‒ Cash collaterization of letters of credit ‒ Cash collaterization of bank product obligations ‒ Post-petition interest ‒ Default interest ‒ Prepayment premium

• Irrevocable • Standstill before sale • Agency transfer • Other issues

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Loan Agreement Provisions

• Cushion on covenant baskets and thresholds • Cross-default or cross-acceleration • Prepayments

– Optional prepayments – Excess cash flow prepayments – Asset sale generating priority collateral proceeds – Asset sale generating non-priority collateral proceeds

• Delivery of possessory collateral • Assignment • Confidentiality

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SUMMARY CHART

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Provision/ Issue

Seller/Insider Debt

Unsecured Subordinated

Debt

Secured Subordinated

Debt

Second Lien Term Debt

Split Collateral Financings

Unitranche

Secured Typically not No Yes Yes Yes Yes

Lien Subordination

Yes, in rare case where secured

Not applicable Yes Yes Yes, for priority collateral

No

Cushion on covenants and defaults vis-a-vis Senior/First Lien Debt

No Yes, typically 10-15%

Yes, typically 10-15%

Yes, typically 10-15%

Sometimes, and if yes, typically 10-15%

No

Payment Subordination

Yes Yes Yes No No Yes

Payment Blockage

Yes, indefinite Yes, typically 180 days for senior covenant defaults and perpetual for senior payment defaults

Yes, typically 180 days for senior covenant defaults and perpetual for senior payment defaults

No, as to regularly scheduled payments; restrictions may be imposed on optional and mandatory prepayments

No, as to regularly scheduled payments; restrictions may be imposed on optional and mandatory prepayments

Yes, during continuance of triggering event


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Provision/ Issue

Seller/Insider Debt


Debt


Debt



Unitranche

Remedy Standstill

Yes, indefinite Yes, typically maximum of 180 days; may terminate upon acceleration or bankruptcy

Yes, typically maximum of 180 days for general creditor remedies; may terminate upon acceleration or bankruptcy; may be longer for exercise of rights against collateral and extended if Senior Lender is exercising remedies against collateral

Yes, typically 90-180 days; only applies to exercise of rights against collateral; may be extended if Senior Lender is exercising remedies against collateral

Yes, permanent standstill or 90-180 days; only applies to exercise of rights against non-priority collateral; may be extended if Senior Lender is exercising remedies against non-priority collateral

Sometimes, if so, limited to less than 60 days once a triggering event has occurred.

Turnover Yes, applies to all distributions received other than reorganization debt/equity securities

Yes, applies to all distributions received other than reorganization debt/equity securities

Yes, applies to all distributions received other than reorganization debt/equity securities

Yes, but applies only to proceeds of collateral

Yes, but applies only to proceeds of non-priority collateral

Yes, may turn on whether agent received or lender received directly

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Provision/ Issue

Seller/Insider Debt


Debt


Debt



Unitranche

Bankruptcy Voting Rights

Retained (but subject to restrictions); not waived

Retained (may be subject to restriction against voting for cram-down plan); not waived


Retained; not waived

Retained; not waived


Limitation on amendments to Senior/First Lien Loan Documents

No Yes Yes Yes Yes Yes

Release of Second Liens outside of Bankruptcy

Yes, if rare case where it is secured

Not applicable Generally, automatic release of liens on assets sold by or with consent of Senior/First Lien Lender; permanent reduction of Senior/First Lien Debt may be required

Generally, automatic release of liens on assets sold in accordance with Second Lien documents or if sold by First Lien Lender; permanent reduction of First Lien Debt generally required

Generally, automatic release of liens on non-priority collateral sold in accordance with Second Lien documents or if sold by First Lien Lender; permanent reduction of First Lien Debt generally required

Not applicable

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Provision/ Issue

Seller/Insider Debt


Debt


Debt



Unitranche

Release of Second Liens during Bankruptcy

N/A Not applicable, but no waiver of right to object to court-ordered sale

Generally, agreement not to object in capacity as a secured creditor to court-ordered sale if second liens attach to sales proceeds

Generally, agreement not to object in capacity as a secured creditor to court-ordered sale if second liens attach to sales proceeds

Generally, agreement not to object in capacity as a secured creditor to court-ordered sale of non-priority collateral if second liens attach to sales proceeds

Generally, agreement not to object in capacity as a secured creditor to court-ordered sale if liens attach to sales proceeds

Option to buy out Senior/First Lien Debt at Par

No Not common Not common Yes Yes Yes

Advance Consent to DIP financing and use of cash collateral supported by Senior/First Lien Lender

Not applicable (no debt cap)

Usually not given

Usually given with attached conditions




Waiver of right to seek “adequate protection” for Junior/Second Lien Debt

Yes, if rare case where it is secured

Not applicable Generally not waived

Generally not waived



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