The influential London-based Loan Market Association has amended its suggested loan agreement contracts to address the increasingly common occurrence of debt buybacks.
Previously, the LMA's widely used standard loan agreement forms were silent on whether a borrower could buy back its own debt, as the practice had rarely been seen. But after credit market conditions deteriorated last year, several private equity portfolio companies (or their sponsors) in the UK repurchased a portion of their syndicated bank debt at a discount on the secondary market in order to lower their effective interest costs.
There was considerable debate in the legal community as to whether such buybacks are or should be permitted under existing documentation. Under English law, these buybacks could be characterised as an effective prepayment, which could be in breach of the loan documentation.
New language in the LMA's agreement forms present two options: the first simply prohibits any debt buyback by a borrower, while the second permits buybacks, but specifies that if a borrower offers to buy back debt from one lender, it must extend the opportunity to all of the syndicate members. The forms also now stipulate that debt buybacks must be financed with the borrower's excess cash flow.
“The borrowers who before could have privately bought back some of the debt that was trading well below its par value will have more difficulty doing so if they have a new form with the new language in it, because they could be forced to offer pro rata to buy back from their entire lender community,” says Katherine Ashton, a corporate partner at Debevoise & Plimpton.
The LMA has also written into its new forms that a borrower's parent company or affiliate (such as a private equity sponsor) may buy the borrower's debt, but it then cannot vote that debt. The rationale behind the provision is that if a sponsor held enough of the borrower's debt, it could potentially prevent the other lenders from negotiating a debt-for-equity swap.
“Obviously these transactions are highly negotiated so you wouldn't have to go with either of the LMA options,” Ashton says. “Nevertheless, it pretty much ensures that anyone who's using the LMA form will at least discuss this issue in the future, which wasn't always the case in past loan agreements.”
The US has its own standard loan agreement forms issued by the Loan Syndications and Trading Association, but these aren't used as widely as the LMA forms are in the UK – loan agreements tend to be negotiated more on a case-by-case basis. Many of the same issues have arisen, however, as most existing US loan agreements do not consider the possibility of debt buybacks. US lenders can now look across the pond for guidance.