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During these unprecedented times, many funds seek opportunities to deploy capital, with a particular focus on the “special situations” space. A certain amount of heightened risk (or risk perception) in this economic climate can be attractive, particularly to those funds with higher return needs. Businesses evaluate a wide array of investments, ranging from purchasing heavily discounted paper for credits with short-term issues where the business is ultimately sound and debt pricing will improve, to credits with a view to taking control of the underlying asset. Below are some of the salient issues that organisations should consider as part of their strategic debt and distressed equity investments.

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DEBT INVESTMENTS

Transfers – Can You Get In?

  • How freely transferable the instrument is
  • Consent typically required for private loans; generally not for bonds
  • Whitelists, blacklists and event of defaults
  • Prohibitions on transfers to industrial competitors, loan-to-own/distressed funds, and PE houses and similar businesses
  • Treatment of sub-participations and other synthetic transfers
  • Minimum holds/transfer amounts
  • Standardised trading terms (e.g., LMA distressed or par, LSTA)

Additional Debt and Lien Capability

  • Debt capacity – ratio debt, “freebies”, hard caps and soft cap “growers”
  • Ability to secure debt and ability to prime; negative pledge restrictions
  • Ability to incur (and secure) structurally senior debt through non-guarantor restricted subsidiaries and temporally senior debt through inside maturity baskets
  • Reclassification and carry forward/carry back
  • Incremental term/revolving debt – who can provide, sidecars, MFN issues
  • Reserved indebtedness

Financial Covenants

  • “Cov lite” (springing covenant) or “cov loose” (single leverage covenant)
  • “Springing” RCF covenant, i.e., only tested if RCF drawn to a certain per cent with certain exclusions taken into account
  • Definitions – Consolidated Net Income, EBITDA, add-backs (including with regard to extraordinary items and restructuring costs, topical in current environment); material exclusions from indebtedness calculations; IFRS treatment
  • Pro forma adjustments – total caps, independent verification and realisation periods
  • Testing – timing and election for certain permissions
  • Equity cures, deemed cures and auto-cures

Credit Support

  • Guarantor coverage test and material deficiencies
  • Transaction security; material asset security/qualifying floating charge
  • Agreed security principles
  • Jurisdictional issues

Other Key Covenants/Leakage

  • Restricted payments
  • Permitted acquisitions/permitted investments
  • Unrestricted subsidiary designation and non-guarantors
  • Asset sales/disposals

Events of Default

  • Grace periods/other available cures
  • MAE/audit qualification/cessation of business

Voting

  • Consent, waiver and amendment thresholds
  • All lender matters
  • Ability to change scope/nature of security package
  • Structural adjustments
  • Sponsor/sponsor affiliate disenfranchisement
  • “Snooze/lose” and “Yank the bank”

Debt Buybacks

  • Sources of cash available
  • Disenfranchisement

Intercreditor Issues

  • Who drives enforcement
  • Ranking of claims and security
  • Option to purchase
  • Release mechanics for non-distressed disposals/value safeguards for distressed disposals
  • Standstills/payment stops for junior creditors

Path to Control

  • Control strategies
  • Fulcrum security/optimal enforcement point
  • Intercreditor issues
  • Holdout risks – under transaction documents and in practice
  • Cram down/in risk
  • Potential restructuring tools

Securitisation and Structured Product Considerations

  • Public and private securitisations and the ability to access cheaper, scalable institutional funding at an earlier point of portfolio or business growth
  • Diversity in capital structure
  • Refinancing ability without sufficient cashflow amortisation
  • Methods of complementing existing credit routes to maximise efficiency and returns

EQUITY INVESTMENTS

Initial Key Considerations

  • Timing concerns, including “anti-phoenix” considerations
  • Valuation and value-breakage, including prospects for recovery
  • Ability to conduct diligence and obtain protections (such as W&I insurance on a synthetic basis), including geographical restrictions arising out of COVID-19
  • Protections for corporate carve-outs and seller insolvency or other future unwind
  • Antitrust, regulatory, creditor jurisdictional or other frustrating factors
  • Share versus business sale or other creative structures (e.g., acqui-hire, licensing), including tax structuring and investment structuring vehicles (pref, government schemes, convertible equity)

Common Transaction Issues

  • Existing shareholder dynamics
  • Key contracts and leases, change of control provisions and third-party consents
  • Related party arrangements
  • Potential litigation
  • Tax and pension liabilities

Employees

  • Identification of key employees, including those outside the executive and management teams, and termination of under-performing executives and associated cost
  • Impact of TUPE
  • Works councils or similar institutions
  • Management rollover and incentive arrangements

Ongoing Governance – Control or JV

  • Rollover
  • Key shareholder agreement provisions:

Future funding obligations
Board representation and reserved matters
Deadlock and exit
Management incentives and waterfall